00:00I mentioned that BlackRock deal, a $12.5 billion bond at 7.53% yield, demand relatively tepid,
00:07about 1.6 times the deal size. Brian, is this the start of an era of weak demand and much
00:13higher
00:13costs for corporate debt? I think so. The short answer is yes, but I think let's focus on what's
00:22been causing this softness in the corporate bond market, which is this tech supply, a lot of it
00:28being these large structured deals, $10 to $30 billion or more, other being just traditional
00:33corporate bonds, but again, coming from a lot of these hyperscalers. I think the point I would want
00:38to make here is that historically, when an issuer or a sector would come with a lot of debt, there
00:45would be kind of a natural circuit breaker, almost a feedback loop from the bond market to those
00:49issuers saying, all right, we've had enough. And because of that, we're going to raise your cost
00:53of borrowing, and that's going to effectively disincentivize you from borrowing. And then
00:57you kind of get a more of a natural supply demand dynamic as things come into balance. This time
01:02around, you're talking about companies who are such believers in this AI trade and the data center
01:09need and the compute need. They're thinking about tripling or quadrupling their equity value
01:15based upon this spend. And so whether they borrow at 6.5% or 7% or 8% in
01:21the corporate bond market,
01:22honestly, the math doesn't matter because it's not the cost of the capital. It's only just getting
01:28the capital. And so, yeah, you know what? We'll pay an extra 100 basis points. We need that $50
01:33billion because we're going to spend it on this data center, and that's going to contribute to
01:37enormous growth and value for our shareholders. And so there's this new insensitive borrower to price
01:44in the marketplace. And in the beginning, the market was able to absorb it because we're in higher
01:49yields and there's a lot of insurance money, et cetera, buying it. But at this point, it starts
01:53to feel like a point of saturation, but it also doesn't feel like this spend and this borrowing
01:57is going to slow down anytime soon. So we have this interesting scenario here, an insensitive
02:02borrower, that is, and plenty of supply coming out. Winnie, is there anything that you see that
02:09would disincentivize the tech companies from borrowing? Yeah, I think that some of the points
02:15made there are just so top notch, especially because these companies have been very highly
02:22rated, very cash flow generative, and also generally under leveraged in their balance sheets. So there
02:27is a lot of room there. Now, there are some exceptions to that with a handful of these issuers
02:32having a little bit lower rating, having a little bit of a track record of investors pushing back
02:38on some of the leveraging type activities that they've done in the past. And so I think that
02:44in order for there to be an incentive to perhaps balance capital structures a little bit more in
02:50the equity market, we might need to see the bond market get a little bit more punitive in terms of
02:56cost of borrowing. It's also hard to say, you know, July is not typically the most liquid month
03:00across financial markets in general, and we've had some overhang from the macro.
03:04So it is a little bit difficult to discern, you know, how much of the recent repricing is entirely
03:10due to the hyperscaler AI trend, and how much of it is due to some of the other seasonal technical
03:15macro factors. You know, we just showed a chart on the credit default swap starting to widen out,
03:21showing the cost of insuring against corporate default is rising. And of course, this is a popular
03:26way for investors to hedge their exposure to this AI narrative. Brian, what are the ripple effects
03:31of increases in these credit default swaps? Does it lead to higher borrowing costs for the
03:35companies? And then you kind of get this, you know, self-fulfilling prophecy?
03:41Yeah, I mean, I'm looking at your chart there, I would say, first of all, most of maybe the
03:46exception of one on here in these hyperscalers have balance sheets that are some of the best in the
03:51world. You know, they're kind of fortress-like balance sheets, they're rated AA, even though they've
03:56taken their combined kind of free cash flow from $250 billion a couple of years ago to zero or
04:01negative now as they're borrowing to invest this, they're still incredibly strong. So for most of
04:05those companies, even if this AI trade and spend gets disrupted, or even kind of pauses, and we're
04:12not saying that, but even if it did happen, even though they borrowed this money, they're just going
04:16to go back to making gobbles of money and doing the other stuff they always do. And they're going to
04:20be just fine. So this is a dislocation. I think where, you know, what Wayne was probably alluding to,
04:24there are other companies, and there's a lot of them in this AI ecosystem. And we're not just
04:30talking about Microsoft, or NVIDIA, or Google, we're talking about companies that don't have that
04:36type of balance sheet profile, they're weaker, some of them are high yield companies, they're levered
04:42balance sheets. And while they may be doing fine now, while they have a tailwind with regards to
04:49their business, not if it turns to a headwind, but that wind just kind of shuts down. There's a lot
04:54of connectedness in this ecosystem. And while the NVIDIAs and the Microsofts of the world are going
04:58to be just fine based upon their core businesses, these other companies might have a really hard
05:02time servicing their debt. And at that point in time, this kind of broad ecosystem, there might be
05:07much more interesting investment opportunities. We're going to be talking about things other than
05:11spreads and more about discounts and dollar price.
05:13What kinds of companies are you hinting at, Brian? Can you give us some names or at least,
05:17you know, get a little bit more granular?
05:20Yeah, you know, we'll keep the individual exposure to names, you know, we'll keep that for a one-on-one
05:26with you and I, Scarlett. I would just say, you know, there's a lot of kind of smaller companies
05:29without the balance sheets, maybe kind of suppliers, maybe kind of smaller companies within the kind of
05:34the chip space that are reliant for their own funding, not just like on the debt markets that we're
05:39talking about today, but even just getting most of their financing and money from companies like
05:45NVIDIA or others. And if that tends to slow down or get shut off, they're going to have a real
05:50problem with their liability structure.
05:52Winnie, a lot of what we're talking about when it comes to supply and demand or technical factors,
05:57supply overhang, wider spreads. What about the fundamentals? What kind of developments or even
06:02suggestive headlines at this point would cause a meaningful repricing or reallocation in the credit
06:08and end equity market? Yeah, I think what it ultimately comes down to is how much are we going
06:14to continue to see spend forecasts increase and kind of by default issuance forecasts increase. And then
06:23when do we start to see some of the monetization of this and return on investment? And that's especially
06:30important for some of these smaller companies that are a little bit more interconnected and dependent
06:35on the broader ecosystem succeeding. And so far, it's been, I would say, a little bit of a mixed bag
06:42this earnings season. And there has been a little bit of disappointment, even around earnings that
06:47have been generally pretty strong. And so it does seem like expectations and reality are a little bit
06:53mismatched right now. Brian, in Europe and the U.S., investors are flocking to short-term credit to lock
06:59in elevated yields while longer durations have kind of struggled. Is this an effective way to get income
07:05while reducing some interest rate sensitivity? Absolutely, especially today. I mean, you know,
07:13yesterday we had a steepening in the yield curve and all the news today and publications were kind
07:18of highlighting that. Although, you know, that feels like, to be honest with you, like a lot of drama.
07:23It felt like yesterday's steepening of the curve was more about kind of positioning. And as
07:27when he was saying kind of a slow summer, low volumes, kind of pushing things around, I think
07:31we all got to step back and we're looking at the front end of the yield curve, 40 basis points
07:36higher
07:37in yield relative to the long end of the yield curve. So year to date, despite yesterday's move,
07:43the front end of the yield curve looks more attractive today than the long end while still
07:47producing, you know, similar type of income level. So the short answer to your question for your
07:51listeners and for investors out there is, yeah, I think the short end of the yield curve,
07:55whether you're expressing it through treasuries or high quality corporate bonds looks like an
08:00attractive place to be. Winnie, final question to you. Within this shorter duration, if that's what
08:04people are doing, is it worth moving down in quality and investment grade going from triple A to double
08:08A or single A? I think in some cases, yes, you still have to have credit selection at the forefront,
08:15especially given where we are kind of in the cycle and the AI cycle. There are definitely
08:19opportunities to add some alpha to portfolios by moving down the credit rating spectrum. We still
08:25like a lot of the high yield double B universe, but you are not necessarily getting compensated,
08:30you know, like you once were from a spread perspective. It's become much more of that
08:34all-and-yield dynamic.
08:35All-and-yield dynamic.
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