The Potential For Return (w/ Dan Rasmussen & Greg Obenshain)
DAN RASMUSSEN: Right. And so, when we're looking at a market, I think it's really interesting-- I think there's a lot of contrarian ideas packed in here. I think one is a relative optimism about BBB and BB credit right now. I think what I'm hearing from you is that historically, buying that type of credit, owning it through the cycle, you've gotten paid-- in fact, it seems like what you're saying is you've actually, in some cases, earned more than their yield, and right now, when the spreads are this wide, walk me through the math of if this recession normalizes, if spreads go back to normal and you buy, say, a 6% or 7% yielding BB bond, what are you looking at from a total return perspective? GREG OBENSHAIN: If you're looking at, say, a 6% bond that you buy, and let's say the treasury component of that is we'll call it 1%, and so your spread is 500-- 500 over treasuries-- well, historically, BBs have really traded in the 250 range, call it. So, you have 150 basis points of tightening potential over two years. Let's call it 75 basis points a year-- just from spread tightening. DAN RASMUSSEN: 250, you mean, sorry-- 500. GREG OBENSHAIN: Yes, so there's 250-- sorry, 125 of spread tightening. DAN RASMUSSEN: In share? GREG OBENSHAIN: In share, yeah. And let's say the average duration in the high yield market is four or five. That's just a measure of sensitivity to change-- we'll call it sensitivity to change in yield. So, in addition to your 6% every year, you're earning an extra 4%. So, you're getting on average 10% returns without anything else happening, potentially. And you can get much higher than that, right? So, when we do the calculations, we'd estimate-- and this is obviously just an estimate-- that you have potential to make teens returns, annualized, on relatively safe credit. And that seems to us to be a very, very good opportunity, whereas if you think about equities, we do the math right now, I think equities do have a lot of upside from recessions. And you can talk about this. But that opportunity doesn't usually present itself for another few months once you've had the initial sell-off. DAN RASMUSSEN: That's right. And I think the other thing that I would note is about valuation levels-- coming into this crisis, we've had a very unusual market-- a market that looks a lot like '99-2000 in some ways, where you had a few corners of the market that were really, really overpriced-- or from my perspective overpriced. You had large growth stocks trading at multiples near all-time highs. The only times we've reached multiples like that in large US growth names were '99 and '73 or so. And yet in contrast, small value and even large value names we're trading at pretty historically average valuations, right-- so very normal while the large growth component was just trading at crazy prices. And then you had international equities trading at a discount of the long term averages-- so just these pockets of the market that were really overvalued-- and of course, private equity, valued like large growth, which is a pretty scary thing, given those are much are smaller companies with a lot more debt. But historically, I think if you look at a 2000 or 2001 scenario, I think a lot of the wisdom of the past decade has been just buy an S&P 500 index fund and you'll be fine. Coming out of that 2000-2001 period, Greg, if you'd started in September of '01, should you've bought the S&P 500? Or should you've bought corporate credit? Where would you have done better and what played out from there? GREG OBENSHAIN: It really depends on the crisis. But the themes that have come out across all the crises are that the S&P 500 versus the Russell, it's actually the Russell that comes back first. It's actually the smaller stocks that come back first, not the S&P. And especially in the 2000 frame when those valuations were so high, that was the S&P 500 that really took the brunt of it. In all cases, though, it's really the contractual obligations-- the corporate credit obligations-- where it's much easier for investors-- and it makes sense-- it's much easier for investors to wrap their hands around what's going on. You've got a bond in a company, you figure out what it's going to pay. Most of these investors are probably buying it for the yield, right? They're not actually playing for the upside. But because it's an obvious and easier play, it corrects much more quickly. So, it's a much more understandable problem for most investors. And it's also a lower risk way to play the recovery. So, I think it attracts a lot more attention faster. DAN RASMUSSEN: Early on. Yeah.