In theory, the Federal Reserve operates by tightening the supply of credit. Or at least making it more close. Yet so far, despite the rate hikes over the last year, the economy has remained resilient. And credit spreads have remained surprisingly tight. So what's going on? Where are the risks? Why are some pockets of the credit markets showing weakness, while others are rock solid? On this episode of the podcast, which was recorded live at the Future Proof conference in Huntington Beach, California, we speak with Wayne Dahl, a managing director and investment risk officer at Oaktree Capital Management, to get a broader lay of the land. This transcript has been lightly edited for clarity.
Key insights from the pod:
How Oaktree thinks of risk — 3:03
Why are spreads still low? — 4:00
Why haven’t we seen more defaults? — 5:30
The looming maturity wall — 7:53
Areas with refi risks — 9:54
Froth in the leveraged loan market — 11:56
The balance of power between borrowers and lenders — 13:17
Private credit and mark-to-market — 14:34
The impact of the Fed’s corporate bond buying program — 19:16
Interest rate sensitivity of the economy — 24:01
The refi boom in housing — 24:47
ETFs and credit trading — 29:56
Commercial real estate — 31:40
What Wayne worries about now — 33:10
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Joe: (00:10)
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy: (00:15)
And I'm Tracy Alloway.
Joe: (00:16)
Tracy, we just got back from California. We were at the Future Proof conference. I love going to Southern California.
Tracy: (00:23)
I mean, you can't beat Huntington Beach. It was pretty sweet.
Joe: (00:27)
It was so beautiful. It was really cool. We were out on the beach.
Tracy: (00:30)
We walked up to the pier, saw the surfers.
Joe: (00:33)
Perfect weather, watched the surfers, ate some really good food, and had some pretty good conversations about the state of financial markets.
Tracy: (00:41)
Yep. And we finally got to record an episode that we've been meaning to do for a while. We dived into, not the ocean, but the credit market.
Joe: (00:51)
I guess like the credit market, it comes up here or there in various aspects of our conversations. I guess typically when we talk about real estate, maybe a little bit about the Fed, but the credit market is obviously so diverse and it's such a its own world that we really, it had been too long since we talked about okay, what is happening in credit?
Tracy: (01:10)
Well also, I think there was this expectation that as interest rates went up, you were going to see lots of drama in the credit market. And even though we've seen bankruptcies rise a little bit, we haven't really seen the big fallout that a lot of people had been expecting.
Joe: (01:26)
Right. And, you know, look, the way people think about the Fed is that it works by tightening credit conditions, right? In theory, that's how it's all's supposed to work, as you said, when interest rates go up. And yet we have got this rise in interest rates for sure. We definitely see it on the mortgage side, like less housing activity. But the sort of broader tightening of business credit, we certainly haven't seen much of a widening and spreads at all. So it's a confusing time.
Tracy: (01:52)
Absolutely. So we really do have the perfect guest to talk about this.
Joe: (01:55)
That's right. Our guest, we spoke with Wayne Dahl, he's a managing director, portfolio manager and investment risk officer at Oaktree. We talk about all things credit. What do you see? Why did rates move so hard? Why are they still like pressed up against the ceiling?
Wayne Dahl: (02:10)
We went through a period [for] so long where interest rates were very low and money was very easy. And unfortunately during the period of Covid with some of the supply chain issues with, you know, a lot of the stimulus that was put into the economy, both through the monetary channel and the fiscal channel, that really set up kind of the perfect storm for demand to go through the roof and supply to be diminished.
And ultimately we ended up with this big inflation push, which if you go back to the formula from the seventies and eighties, how do you cure inflation? You raise interest rates quickly. And I think that's the playbook that the central banks, not only in the US but really globally, had no choice but to follow.
Tracy: (02:53)
What does risk actually mean to you and Oaktree and does it differ from maybe other financial firms’ definition of risk?
Wayne: (03:03)
Yeah. That is a great question. And anyone who's read our chairman Howard Mark's memos knows that he's very clear that risk is more than just a major of volatility. I mean, typically at Oaktree, when we talk about risk, it is our number one investment philosophy and investment tenant to keep risk under control.
Really, it's to avoid loss. And the tagline there for Oaktree is, if you avoid the losers, the winners take care of themselves. So as credit investors, especially in a market like this where yields are high, you want to earn that yield and keep that yield and not give it back in the form of default. So to us, minimizing risk is largely related to kind of minimizing loss for investors.
Joe: (03:44)
All right, let's dive deeper into credit. I mean, let's start, spreads are still pretty narrow. And you know, credit is such a huge world, so I know we have to like go from like slice to slice to slice, but big picture people don't seem particularly concerned about like defaults.
Wayne: (04:00)
Yeah. I mean, look, I think one of the things with credit that has changed is largely related to the backdrop of interest rates. And to quote Howard again, our chairman, you know, he wrote a memo in December called a sea change. And in that memo he talked about this change in what was a low return world to a high return world. And that has really, I think, shifted the dynamic and the expectations around credit.
And you're right, have credit spreads moved maybe as wide as people thought? No, but the yields have become very attractive. And ultimately, I think if you look at credit, this is something we did a lot last year.
There's kind of three ways I would look at value in fixed income. Number one is what is the yield? Well, that was very attractive. Number two, what is the price? If I can buy fixed income at a discount, then I can, you know, earn more than just the coupon. And number three, what is the spread? The first two were at very attractive levels. And spreads may be kind of at median levels, but you know, two out of three makes a pretty good investment.
Tracy: (05:06)
Well, how are you thinking about default risk now? Because certainly there were a lot of people, I mean, just last year in 2022, who were warning about we're going to get this big recession. There's going to be a big spike in defaults. We certainly haven't seen -- you know, the bankruptcy rate has picked up a little bit -- but we haven't seen this wave of failures that a lot of people were predicting.
Wayne: (05:30)
Yeah, that is definitely true. And I think for part of that, you have to think about what happened during Covid. And in a way you could almost say Covid was maybe recession part one, and we're on our way to recession part two.
And the reason why I say that is because if you think back to the end of 2019, before Covid, the Fed had stopped hiking rates in December, 2018, and at that time actually had planned to continue to hike. Chairman Powell pivoted in early January, 2019 and ultimately ended the year by cutting rates three times. There were a lot of the similar signs of slowdown in ISM data, in industrial production data. A lot of your typical signs of a recession. So in a way, Covid potentially just accelerated us into a recession that was maybe on its way already.
But what it also did is brought forth a number of defaults. You had, you know, default rates in the high yield bond market, that broadly syndicated loan market anywhere from kind of 4% to 6%. And in a way that was kind of a cleansing event that prepared us for this time here in the high yield bond market.
Because of that default rate, you cleared out a lot of the lowest rated companies that were under the most stress. Simultaneously, you had a number of downgrades, so triple B-rated securities into double B or single B-rated into high yield.
So you up the quality of the high yield bond market maximum Triple B's, minimum triple C's. And kind of created this environment where everybody just refinanced at the lowest rates in history. And they don't really have a cashflow problem or a maturity problem.
Joe: (07:13)
So you anticipated my next question and I appreciate that you brought the 2019 experience, because we don't really talk about 2019 that much anymore. But of course that was an interesting year. And then, so, okay, so we have these defaults, then the pool of credit gets better and then the big terming out of debt. And so everyone refinances, fixed rate, ultra low. Talk to us about like today in September, 2023, how that terming out is playing into things now. And like, you know, people talk about the maturity wall and what…
Tracy: (07:44)
No, Joe, you have to say ‘looming maturity’ wall. That’s the rule.
Joe: (07:48)
The looming maturity wall. Talk to us about like the effects we're seeing today from that term out?
Wayne: (07:53)
You're absolutely right. I mean, just to kind of put some numbers to that, in 2020 and 2021, the high yield bond market in the US had gross issuance of about $800 billion in a $1.3 trillion market. So you had two thirds of the market refinance.
Now, today, you're right, we've obviously, the duration has shrunk in that market because refinancings have declined. But it does kind of become a 2026 maturity, you know, kind of problem. Companies don't wait for the last minute to refinance their debt. That wouldn't be wise because what if the capital markets freeze up?
So you kind of bring that forward maybe one to one and a half years. So I think as we get into 2024, you will start to see a situation where companies are going to have to come to the capital markets. But it's not there yet.
Tracy: (08:46)
Well, I was about to ask though, because this month we have seen a pickup in new issuance. So what's going on there? Why are companies deciding this is the moment to start selling new bonds?
Wayne: (08:57)
I mean, there are certainly companies, I mean, I can't remember the exact number -- maybe less than 20% of the market that comes due over the next 18 months. So there is some amount to refinancing. There is some capital activity going on.
And some of it I think is moving exposure from one market to another market. If you look at the broadly syndicated loan market, that market is made up of floating rate debt. I mean, there is a market where people's interest cost has gone well, it's more than doubled in the last 18 months.
And the high yield market has seen some refinancing out of the loan market into secured bonds in the high yield market. So there has been some kind of new entrant in there as opposed to simply, you know, refinancing.
Joe: (09:42)
Are there sectors or types of borrowers who, in your view, are going to have a trickier time over the next 18, 24 months as some of these refinancings pick up?
Wayne: (09:54)
Well, like I said, I mean, if you want to talk about the places in, I'll say that non-investment grade or speculative grade market, that's going to have trouble. It will, I think, potentially be some of these issuers in the loan market. And again, the reason for that is they have seen their cost of financing really go up as their indexed to short rates, which are now 5.5%
Joe: (10:16)
What type of borrower is in the loan market?
Wayne: (10:19)
So you certainly get, you know, exposure to, to many industries. But the loan market today has really shifted into the financing source of leverage buyouts. That is the majority of the issuance in that market.
When you talk about a pickup in issuance in the loan market, you're typically expecting, you know, a pickup in M&A activity using loans to refinance. And one of the biggest areas that's seen a lot of M&A activity from private equity sponsors over the last few years is in some software and technology related business. So that is the largest single sector in the loan market today.
Tracy: (11:11)
Do you see froth in the leveraged loan market? Because this was an area of concern for, I mean, years. Even before Covid, you saw a lot of financial regulators start to crack down on capital requirements for leveraged loans. I should tell a story -- I was in a bank one time and I won't name the bank, but I was going to see their leveraged loan bankers, and they had a framed t-shirt in their office that said: ‘I stole this shirt off my client's back.’ So that kind of encapsulates [the mindset]…
Joe: (11:44)
What year was this? What year was this?
Tracy: (11:46)
I think it would've been like maybe 2015, 2016. It was definitely the height of the leverage loan boom. But is there froth? [Editor’s Note: from Tracy, I think it was more like 2013/2014]
Wayne: (11:56)
Look, I mean, there's definitely been froth in that market. And maybe to define that a little more clear to say, there are certainly borrowers that probably, you know, are at risk of having extended their balance sheet too much. And in the face of borrowing costs or interest rates going so high, they've kind of put themselves in a tough situation.
I think one of the things to remember in the loan market that has maybe masked some of the potential volatility over the years is the majority of buyers in that market, almost 70% are coming from the CLO market or collateralized loan obligations. And those buyers are not active traders. So you don't see loans traded like you do some of the other investment grade bonds, high yield bonds, and in a way that can kind of mask some of that building volatility.
Tracy: (12:52)
Again, one of the stories pre-pandemic was this idea that a lot of the power in the market had shifted from lenders to borrowers. So the companies who were issuing debt or taking out a loan could dictate the terms of that deal. And so we saw a lot of cov-lite deals, maybe some sketchy leveraged loans. Is that still the case, or does it feel like the pendulum has swung a little bit as interest rates have risen?
Wayne: (13:17)
I think in the broadly syndicated loan market, that's probably still largely the case. There is a lot of demand, and obviously over the last, call it, 18 months supply has been diminished. So you have people who want to buy loans as institutions, you're competing against CLOs buying loans. So that demand has kept up.
I think one of the places where maybe you have seen a little bit more of a shift there is in the private credit market that's issuing loans where you've seen kind of a pullback from some of the buyers that were very, very active in 2021. And either the new buyers or continuing buyers have been able to be a little bit more, you know, strict with their demands for terms, covenants, things like that on those deals.
Joe: (14:02)
Private credit comes up all the time, and we probably should even do more on this, but it always seems like for whatever reason, and I don't really understand it, I don't know much about the market, for whatever reason, it seems like it doesn't matter where the cycle is, it doesn't matter, it just seems like it just grows and grows.
Tracy: (14:18)
Private credit. Buy BDCs!
Joe: (14:20)
How does that happen?
Wayne: (14:21)
Well, I mean, who wouldn't want to put an asset in their portfolio that has no volatility and the price doesn't move?
Joe: (14:27)
Is it really that simple? Because people say that, I'm like, ‘Oh, it can't really be like that. That can't really be the story.’ But is that the story?
Wayne: (14:34)
I mean, Joe, to date, I think that largely has been the story. I mean, you're right. There has been a story [of] ‘Well, the time will come for the day of reckoning of, you know, all this borrowing in this private credit market, all these marks that are staying at par are going to come down.’ And, you know, perhaps we are getting closer to that date, but you're right, that really still has not been tested. Although I think people are preparing a little more, you know, for that day to come.
Joe: (15:01)
Every time I hear about like PE or VC or private credit and people are like, ‘well, the big nice thing is it doesn't move.’ And so I'm like, ‘that can't be it. It can't be that.’ And yet maybe that is a big thing.
Wayne: (15:13)
I mean, it has kind of been that easy to date. But like I said, I think people are getting a little more concerned where you see, you know, I think some private credit managers deciding, ‘do I want to deploy this incremental capital that I can draw down? Or do I need to preserve this to potentially, you know, rescue some of the deals that are already in my portfolio?’
I think investors are getting a little more picky as well when looking at some of these legacy portfolios going ‘Hey, I like private credit and I like where it's priced today, but do I want to buy the portfolio that was built in 2021 when money was free?’
Tracy: (15:47)
Does the rise of private credit affect Oaktree at all? And what I mean by that is maybe there are certain opportunities that end up getting taken by private lenders versus publicly traded. You know, a company will decide ‘I'm going to do a private deal. There's a lot of appetite, a lot of demand,’ rather than go down the publicly traded route?
Wayne: (16:08)
Maybe the caveat is it depends which group you talk to. But I think the growth in private credit, especially over the last few months has, has been positive for Oaktree and has potential to be positive for more areas.
I mean, we are certainly active in these private credit markets seeking to, you know, find value and really fill a gap that I think has grown over the last 18 months where some of the larger players have, you know, maybe stepped back, including some of the banks.
I think on the other hand, you know, Oaktree obviously we're known for our distressed debt business, which now is our global opportunities business. You know, here's an opportunity for, you know, a group like that to maybe, you know, step in and support some of these deals if things go south. So I think there's multiple ways where we can see a benefit from this growth.
Joe: (17:00)
You mentioned, you know, maybe some of these private credit managers and maybe they don't want to like deploy that additional marginal capital for that risk. It made me wonder, just going back to sort of the beginning of the conversation, you can get a real return risk free these days, which you haven't been able to get in a long time, and you don't even have to take any like duration risk. There's positive rates at the short end. Does that change risk appetite or [do] you see people it’s like, ‘yeah, look, I can make money and I don't have to take any risk.’ Does that change like how money gets deployed in your view?
Wayne: (17:31)
Yes, I definitely think it does. And really from our standpoint, it kind of shifts even where we take risk on the you know, on maybe the risk spectrum or the duration spectrum. I mean, it's rare that you have short rates being the highest part of the curve.
So what's kind of resulted in that is securities that pay interest indexed to those short rates have become even more and more attractive. So just to again, kind of put some numbers to that. If you look at the high yield market, a fixed rate market, sure their yields have gone up, but their income they generate has stayed, you know, right around low sixes despite the call it 9% yields.
Joe: (18:11)
Can you just explain that a little further?
Wayne: (18:12)
What I mean is the coupon on a high yield bond is under 6%, their price is currently below par. So you take that coupon divide it by the price, that's your current yield, that's going to be in the low sixes.
Whereas if I can buy a high-quality floating rate security, that might be a structured asset, that might be a broadly syndicated loan, I'm earning that near 5.5% SOFR rate plus a spread of, call it, 400 basis points. Now I'm earning 9.5%. So yes, risk-free is, you know, certainly a viable investment. But you know, so are a lot of other investments that are, you know, reasonably safe that have, you know, an appropriate kind of spread for their risk.
Tracy: (18:54)
So we're talking about yields sort of enticing buyers at this moment in time, but there's something else that has happened since the pandemic, which is the Federal Reserve announced this massive corporate bond buying program that in theory is now a permanent backstop for the market. Do you think that's affected investing behavior?
Wayne: (19:16)
There's no doubt that had a significant impact on investing behavior in 2020, just knowing that that backstop was there. I'm not sure how much today, I mean, I think in the case of say the high yield bond market, you have seen that market kind of shrink over the last 18 months -- shrink because deals have come due that haven't been refinanced. You've had actually more upgrades than downgrades in that market, which may be surprising given, you know, all the talk of recession and the need for spreads to be wider.
So, you know, you do kind of have this almost supply-demand mismatch on the side of you know, maybe demand kind of pushing those spreads tighter. But I think it's in the back of people's minds somewhere.
Joe: (20:03)
How do you think about the Fed here? I mean Tracy mentioned the backstop, but in terms of like the sort of good old fashioned where they on the rate side, obviously there's hope that maybe they could cut rates even in the absence of a recession, but are we clear? Is the Fed going to, like, have we got the inflation thing licked?
Wayne: (20:24)
I think that's a mistake that the market has made for the last year, that inflation would come down, regardless of what the economic backdrop is, regardless of what happens to asset prices, the Fed would turn around and cut rates. That was a big story in January of this year when you had kind of everything rallied, spreads compressed, rates rallied, high yield rallied, investment grade credit rallied, kind of everything rallied on this expectation that rates would come down before the end of the year, despite the fact that people called for a recession. And that, I think the market's kind of coming around to the fact that it's probably maybe a little bit too much wishful thinking
Joe: (21:03)
But, my memory's kind of hazy, at some point people were thinking that they would already be cutting by this point.
Wayne: (21:08)
Oh yeah. In January. Well, the other, the other triggering event for the Fed was in March. In March this year when you had the Silicon Valley Bank, Signature Bank, kind of regional bank flare up, the market really pivoted to expecting rates to be cut by about 150 basis points by the end of this year. That's completely reversed.
Joe: (21:28)
And everyone said like, ‘Oh, historically the Fed hikes until something breaks.’ And then like a few weeks later, it’s still red hot.
Wayne: (21:35)
I think the Fed's kind of in an interesting spot right now and you know, obviously you guys were at Jackson Hole and, you know, had a number of guests out at Jackson Hole. And I think looking at Chairman Powell's speech this year, maybe compared to the last two, I think he's got to be feeling pretty good about himself right now, because clearly last year he kind of had to give the market a bit of a scolding and say ‘Hey, all you dreamers out there that think inflation's going to come down and we're going to immediately kind of ease financial conditions, you're wrong. We're in this for the long haul.’ And this year he was kind of able to stand up and say, ‘thank you for listening to us. We're still in it for the long haul, as long as the data dictates.’
Tracy: (22:31)
Given your credit perspective, what do you think about the r* debate? So the idea that the neutral rate of interest might be higher than we once thought, or to put it another way, the idea that maybe the economy is more interest rate resilient than it was previously.
Wayne: (22:46)
I will say personally, I don't really have an opinion on what r* could be and should be, and I feel like I get a little cover from that because I believe Chairman Powell…
Tracy: (22:53)
He said the same thing.
Wayne: (22:55)
In his speech he also said that, so, but I do think if you look at kind of where the market, you know, moved from a rate perspective, maybe leading into Jackson Hole, if you look at that kind of shift, maybe, you know, call it like a shift in term premium across the curve, I think there's no doubt that investors were probably thinking that there's a possibility that we may kind of have some form of higher rates for longer. And in order to compensate that, let's lift the yield curve.
Joe: (23:25)
Well, how much does the terming out of debt that we talked about a few minutes ago, explain the lack of impact, you know, we haven't had a recession, we haven't a slow down. Rates have gone a lot higher than many people would've guessed, certainly in January, certainly in March, etc. How much is it just the fact, you know, there are all these charts that people look at where it's like, ‘yeah, rates are here, but actual net interest payments and share of GDP or whatever, are still pretty low.’ How much is that just a function of, you know, when [there’s] all so much fixed rate debt, these rate hikes just don't bite that quickly?
Wayne: (24:01)
I think that's definitely true in the corporate space. And don't forget, I mean, a lot of corporates built up a lot of cash during the Covid period. So much was poured into the economy that yes, they termed out debt, yes, the rates were lower, but they also built cash and, you know, saw leverage come down.
But I think from an economy perspective, one of the keys to kind of why we haven't felt that interest rate push is in the residential housing market. I mean that to me is one of the real keys to why 2023 from a consumer standpoint, from a spending standpoint, from a confidence standpoint, from a growth standpoint, has been a lot more robust than people would've expected.
Tracy: (24:42)
You mean the refinancing boom basically putting money in a lot of people's pockets?
Wayne: (24:47)
Well, what I mean is if you look at the house prices since Covid -- so from December, 2019 through, you know, 2021, house prices were up 30%, mortgage rates were 3%. If I told everyone in the room at that time ‘Hey, by the way, in the next 18 months, the mortgage rate on a 30-year mortgage is going to go from three to seven and a half, how many would've said, “oh, great, I think house prices will go up another 15%?”’
I don't think anyone would've done that, but that's exactly what happened, because in this country, with our ability to lock in that financing, like the companies, for a long time, everyone just immediately said, well, great honey, I'm sorry, that means we're not moving for the next 10 years and nobody has,
Joe: (25:33)
We did an episode about 13 or 14 months ago and our guest was like, ‘Yeah, house prices aren't going to fall. And for this reason,’ and in the back of my head, I was like, ‘Man, this guy's really going out on a limb,’ but I'm glad and it’s like he gets it, he was right.
Wayne: (25:47)
Yeah. But I mean, think about, think about what makes people happy. They see the equity in their home. I mean, that is a big part of, I think, consumers’ kind of propensity to spend, maybe spend down some more of that excess savings. It's a real driver, I think, of just kind of overall kind of balance sheet stability and from a consumer standpoint for sure.
Tracy: (26:11)
The last time interest rates were really high would've been the 1970s. And I think…
Wayne: (26:17)
A time we all remember fondly.
Tracy: (26:19)
Obviously. Well, so I think a lot of people remember the 1970s for inflation, you know, the oil crisis, things like that. Not many people -- except maybe me -- remember it as the birth of the junk bond market. And there are a lot of people who made their names in that environment, Mike Milken being one. Howard Marks, I think got his start then as well. Do you see the opportunity in the current environment of higher rates, maybe more volatility around bonds, things like that, for a similar dynamic? Could you see something brand new enter the market?
Joe: (26:54)
Oh, good question.
Wayne: (26:54)
Yeah. That is a great question. I mean, look, you're right. The junk bond market, the high yield market did really kind of benefit from that kind of peak in rates. And you're right, Howard Marks did start one of the first kind of public high yield bond funds back in the late seventies.
You know, I think the one difference maybe then versus today is rates were, you know, 15% to 20% and, you know, fixed income just rode that wave for 40 years. And Howard mentioned this in his memo, you know more, most recently that one thing he's certain is rates probably won't fall 2,000 basis points again over a 20-year period. So I don't know if you get that same dynamic in fixed income, but the market seems to always find a way to, you know, find a new way to solve an old problem.
Joe: (27:44)
I'm buying a house right now, and one of the things that people tell me, it’s like ‘Oh, well…’
Tracy: (27:48)
It’s a good time to buy a house, Joe.
Wayne: (27:51)
He's paying cash .
Joe: (27:52)
That's a long story. Funny you should say that. No, I'm not. But one of the things people say is like, ‘Oh, it's all right. You just refi in a few years.’ And what that tells me is everyone, a bunch of people at least, are like of this generation locked into a sort of Zirp mentality where it's like a 7% mortgage is super high, right? And so it's this is abnormal and the Fed's going to, and they're going to cut.
And it's kind of what we were talking about before, but could it go in the other direction? Could we have like, I mean, it just seems so unfathomable that like Fed funds rates wherever, like above 10, but it's like, is there some natural limit? Could we go much higher on rates like that none of us are thinking about.
Wayne: (28:31)
Look, that debate has certainly come up more often in the last 12 months than it certainly did in the previous 10 years. You mentioned kind of that belief about mortgages, and I think that's true. I can tell you as somebody who refinanced a mortgage in 2021 that wasn't a 30-year and thought, ‘Okay, I have seven to 10 years. Rates will probably come down again or, or won't stay high.’
But I think the big wild card in that is really just the cost of public debt. And I know you guys have spoken about this with other guests, but I mean that burden on the, you know, our budget annually to see rates at that level to refinance what's now, you know, $32 trillion of debt, you know, that's not a good story in the long run. I don't know how you have a kind of viable economy with persistent rates that high.
Tracy: (29:21)
So we've been talking about inflation and rates and yields and default risk, but I'm curious, even before Covid, there was a massive discussion around how bonds and credit are actually traded. And a lot of people talked about liquidity issues. They talked about the rise of exchange-traded funds as a mechanism for maybe trading more illiquid assets. And I'm curious in 2023 in the current environment, has the way we trade bonds changed even further?
Wayne: (29:56)
Not being a definite expert to answer the question, but I think one thing that's happened for sure is that these exchange-traded funds have increased liquidity in certain pockets of the markets. I speak a lot about the high yield market, and not surprising, that's where, you know, non-investment grade credit is kind of where Oaktree makes its name and we focus a lot.
But you know, that is a market to where today, if you wanted to trade a lot of double B-rated bonds, there's probably more liquidity because that's where the ETFs are going to be buyers. But if you still want to trade that maybe, you know, smaller, maybe slightly sketchier issue, single B minus or triple C, you know, you're still going to have some challenges from a liquidity standpoint. So I guess it kind of depends exactly what you're buying. It certainly hasn't been, you know, equally distributed across all of these different segments of the market.
Joe: (30:51)
I want to go back to real estate for a second. You know, we talked about the residential component. One area where there's like obvious weakness, is certainly large swaths of the commercial real estate market. And I understand that it's not the entire market and that commercial real estate is diverse, but offices in a lot of cities aren't doing great. Has that been felt? People wonder are there like further shoes to drop in commercial real estate? What's your view on that?
Wayne: (31:17)
You mean beyond the challenges in the office?
Joe: (31:19)
So we've seen like these big drops in office and, but then there's questions, will it get worse or have the holders of these assets really taken their marks yet or are they still living in some sort of fantasy where next year everyone comes back to the office and vacancy rates drop and everything, there's still like chapters to the CRE story?
Wayne: (31:40)
Yeah, I mean, look, there's no doubt that office has its challenges. And I'm sure we have certainly not heard the end of it. One of the things in commercial real estate, maybe unlike some of the corporate markets, when you have a maturity and a bond, you've either paid the bond or you've defaulted because the maturity's dictated that.
In commercial real estate, you don't quite have that same dynamic. There's extensions, you don't have to, you know, in the case of securitizations, you can go into real estate owned, so you're effectively defaulted, but the asset maybe didn't change hands, a mezzanine buyer can step in. So there's a lot of ways to kind of, you know, honestly like kick the can down the road to some degree.
So I don't think we've seen the end, but to your other point, there is a lot of dispersion and what is perceived today is the quality parts of the commercial real estate market certainly don't trade like stress is around the corner. And I'm not sure it is. We've had this debate at work a few times of ‘Hey, are we going to get a chance to buy this high quality industrial asset at a 15% yield?’ And so far that answer has been no.
Tracy: (32:52)
Real estate owned is a blast from the sort of like 2008/2009 past. Well, your job is to think about risk on a day-to-day basis. So I'm going to ask the very obvious, lazy journalistic question, which is what do you worry about the most?
Wayne: (33:10)
Wow. In today's environment? I think one of the things that's really challenging right now is it's very hard to define, I think, what is normal. And a lot of people look at, you know, different kind of measures of what they perceive to be normal. ‘Oh, look at the jobs market. We're seeing an uptick in part-time jobs. We're seeing an uptick in or a downdraft in full-time jobs. Oh no, that's a sign that the labor market's weakening. We're going to fall into recession.’
But really in reality, we're kind of getting back to what the labor market looked like pre-2020, you know. With inflation, is inflation going to remain sticky? A lot of that has to do with shelter prices. How quickly will those feed through? I think to me, there's just a big kind of unknown in how to interpret some of these kind of traditional economic measures that, you know, historically were our kind of benchmark or indicator for how much risk and in this case, maybe risk of recession was building.
And I think this year is an example for how hard that's been because, and I think you mentioned this earlier, Joe, the market went from thinking we were near an imminent recession 12 months ago to now thinking we might not have a recession at all.
Joe: (34:28)
Wayne Dahl, thank you so much for doing the live podcast here. It is a real treat, great perspective and appreciate you coming up.
Wayne: (34:36)
Thank you very much for having me. It's my pleasure.
Joe: (34:50)
That was our conversation with Wayne Dahl, managing director, assistant portfolio manager and investment risk officer at Oaktree recorded live at the Future Proof Conference in Huntington Beach, California.
You can follow Oaktree at
@Oaktree
.