Will credit markets be tight or illiquid in 2023? – Zed Francis
Summary
Market Outlook: The guest argues 2023 shifts from a rates story to a credit story, with 10-year yields likely range bound as Fed credibility keeps policy tight despite slowing growth.
Corporate Credit: Spreads are too tight given fundamentals, driven by demand from union and corporate pensions and reduced issuance; risks are skewed to widening as growth slows and margins compress.
High Yield: No immediate maturity wall (mainly 2024–2026), but weakening operations and diminished pricing power could drive defaults even without refinancing stress.
Investment Grade: Long IG is exceptionally tight (near bull-market percentiles) due to pension de-risking and liability-hedging demand, creating vulnerability if technical support fades.
RMD Selling: December RMD-driven forced selling and tax-loss harvesting pressured markets, followed by January reinvestment flows that can mechanically boost risk assets.
Volatility & Options: December option markets overpriced CPI/FOMC days while underpricing other days; 0DTE options enrich exchanges but are largely immaterial to broader market dynamics.
Global Central Banks: BoE’s LDI episode was a bridge-loan liquidity fix, while BoJ’s YCC strain underscores why the Fed prioritizes credibility over rapid policy pivots.
Notable Mentions: Apple (AAPL) as a tax-loss target, and Blackstone (BX)/BREIT as examples of private market liquidity dynamics, though not specific investment pitches.
Transcript
[Music] hello and welcome this is the Mutiny investing podcast this podcast features long-form conversations on topics relating to investing markets risk volatility and complex systems [Music] said Francis welcome back to Mutiny investing podcast right away right at the top plug away where could people find a website where can they find you on LinkedIn you know anything else yeah just www.convexitask.com uh and then my name is zed zed so that's probably one of five of them on LinkedIn so that's easy to find but you guys you guys post great uh essays to your site but you also I guess you repost them to LinkedIn and you put more content on LinkedIn than just your essays or how do you set that up yeah no we you know between podcasts TV appearances uh posts you know definitely do the LinkedIn thing Devin is uh my business partner is getting on me to actually utilize LinkedIn as a tool we'll figure out if I can learn something new and if it's useful but uh yeah you'll you'll see an annoying amount of us I think probably over the next year as we learn to utilize it good I look forward to it and you by the way you walked right in my trap of saying that you're you guys are philosophically boomers because you right away I said get what's your website and you said www dot like did you want to start with HTTP like who when do people gonna stop saying www dot for their website well I mean as soon as I get off my Netscape browser Maybe uh well I wanted to bring you back on was I you know uh a year in review wow how unique you know everybody does their year in their views but um I actually liked a lot of the comments you had about Q4 and what you were thinking about in 2023 so I wanted to bring you on to discuss some of those and let's just start I think with uh more of the simple ones though Q4 um you saw a lot of the action in Q4 especially in December was from tax loss harvesting and then also um rmds so let's just start I mean tax office harvesting is a little more obvious than the rmds but let's just talk a little bit about both yeah I mean I guess we'll kicking off tax loss harvesting so obviously it was a year that anybody that accumulated additional Assets in 2020 2021 likely had the opportunity to do some tax loss harvesting um especially because there's enough names that move like dramatically right you know there's probably stuff in your portfolio that was down 90 hopefully only you know 20 basis point holding but you know some serious moves and so yeah I think that definitely put some pressure on the broader Market at the end of the year and you you can kind of see it on funny days uh to me my best example of of the taxless harvesting must be happening today everybody has tools the tools are getting better for tasks harvesting but I still think most people basically open up their brokerage account and then go to the column that says you know gains losses and then filters it to the highest to the lowest and they start at the biggest loss and there was a couple of random days kind of like the week before Christmas where Apple was down three percent with the NASDAQ down 50 basis points and you're like okay this is the start of tax that's harvesting because apple is probably your largest holding with it being the largest company and it was down 20 odd percent last year or so surprise surprise is probably the biggest dollar loss you know not percent the dollar loss in your account and that's where people started and so that was a you know you can you can still kind of physically see it going on so I think that's that's one side of the pressure that you know I think is reasonably talked about and is a real thing when there's not a lot of trading volumes it can actually you know dominate to some extent um but I think the more interesting side is required minimum distribution from uh DC Divine contribution retirement plans um and the reason why I think it's less talked about and more interesting is is just important now and hasn't really been that important before so you know 6 60s 70s 80s slowly but surely most folks transition from DB defined benefit to DC to find contribution retirement plans and so there's not a lot of you know we'll call it Legacy you know money until more recently and more recently those folks with the you know the transition into how they're saving for retirement are now becoming of retirement age so it's just you know 20 years ago this wouldn't be a big number because there wouldn't be a lot of people retiring and there wasn't the pot wasn't as big but now it's like a pretty big number so it's something you should start paying attention to um as we go through the next kind of 20 years of folks actually having to you know sell things um you know and on the schedule that's mandated uh by uh uh the IRS essentially so the other piece that's interesting Beyond it not really being a dominant player until more recently is it's the required minimum distributions are set at the account value at the start of the year so say here 82 I believe is your actuary table says you're going to live 10 more years so you got to sell a tenth of your assets every year and so say at a 100 bucks so at the start of the year so it says okay you've got to sell ten dollars worth of stuff you know 10 of the hundred dollars at the start of the year but in 2022 it was obviously a year we're pretty much all assets fell so you know your your ads down 20 your speed is down 20 so and so forth 100 bucks now eighty dollars and you don't have to sell ten percent of eighty dollars you got to sell ten dollars you know it's set at that uh you know price of the account value at the start of the year so it becomes like a pretty material amount of liquidations that have to take place and again like if you don't do it it's a it's a 50 haircut basically that's you know a force tax upon you for not doing it so you're doing it you're doing it no matter what there's no way to avoid it um but it becomes pretty darn material and um everybody kind of does it in a waterfall fashion so depending on which custodian your assets are at they basically pick an arbitrary day in December when they're actually going to process all these required minimum distributions and it's essentially kind of between December 10th and like December like 23rd because nobody wants to work you know during the holidays we might have done before then we also want to get it as close to your end as possible so that's kind of your waterfall so you know those two weeks um in the middle of December I think they have a a pretty you know over waiting impact on the pressure in the market from these you know thoughtless selling programs um the the back side of it uh which is you know I think kind of possibly what we're experiencing you know the last two weeks uh of right now is you know people sell you know forced to sell those assets they have to pay taxes on them and now they have cash and they might just go put it back into the market like you know you didn't you have this windfall of cash you don't need it for life expenditures right now you might need it over the next year or whatever um but you probably have an over allocation to cash just naturally because you're forced to sell assets um and now it's in your taxable account and you probably go redeploy it into the market so it has you know I think it affect both ways uh you know a decent amount of pressure in December you know Force liquidations and then hey we got some cash like let's go put it to work and you go buy back all the same stuff that you probably just sold there's so many things that would highlight there because I actually love this subject and like you said it's not talked about enough uh one thing's I want to highlight like you said it's not on a percentage basis it's like an actual dollar amount like on that ten dollars on the hundred dollars an example like everybody thinks it's just a percentage and what does my net assets at the end of the year and it's a percentage of that like you said No it's it's much worse than that um and I think uh you and I talked about like I think you think that that that constant selling pressure that you get from um from these distributions is similar to what we saw in December of 2018 where you just saw like just this constant like tick down on the markets that's why we didn't see really a ball spike in December of 2018 and maybe not as much as December of 2022 because you just have like it's just constant every day that selling pressure over over a two-week period yeah and the parallel between 18 and 22 is you know your fixed income and your equities were down right so it's you didn't have that situation where your hundred dollars is still a hundred dollars just because you had some you know uh actual diversification benefits of holding different things you know everything's down so that you know of course is a hundred dollars to in you know 2018 to 90 bucks and in 2022 they 80 bucks um so you know definitely a parallel between those two Decembers but then part of it too is like I I think about often is and you may disagree with me on this but like to me we have just an end of one experiment when we're talking about uh these defined contribution plans you know and and thinking about you know 401k's subject IRAs or whatever it is and especially start when we're moving into Target date funds now like every Millennial or gen Z is only going to have a Target date fund really is their only optionality they maybe have a two to six options at best and so to me we haven't actually seen what this experiment looks like and like you're saying right now is once people are starting to reach retirement age they have to have these required distributions and we haven't really seen what happens on mass at really scale and I really wonder about especially you know it almost exacerbates it with the target date funds and you could speak to that as far as like you know you don't you don't get to pick and choose as much what what you can or can't sell and then you know what happens if you know we're underwater for like a decade and people are just just getting pinged with these required distributions yeah no I I I think the you know broader wealth transfer that you know everybody acknowledges is going to take place over the next 20 to 30 years is going to obviously move things substantially and the more mechanical those movements are the more you know disconnects they're they have the ability to create so you know I I I I would agree that having more and more rules-based investment guidelines both in terms of a higher meant to do distribution and invest will create bigger gaps in terms of you know we'll call it Market Fair Value pricing from one day to the next there will be some you know Harrier things that show up that hopefully great opportunities for others but it's not you know fantastic for those individuals that have to walk down that path do you think it makes any difference though like uh historically in any sort of retirement account do you have a lot of options or things that different things you're invested in but now if you're in a Target date do you think that has a dramatic effect when you're going to sell off those pieces in December I you know I don't think anybody owns anything that different ultimately uh especially in in those types of accounts are kind of more broad-based you know it's like what's the difference between a mutual couple of mutual funds and a Target date Fund in terms of the underlying assets that they hold right not not dramatic and then what do you how do you think about I was thinking about like you're saying this this constant selling pressure especially in December then like I said a lot of times they're just buying it all back in January but then the countervailing force to that is you know the Boomers have these required distributions but then Millennials have these Target day funds where they're just every quarter they're just dumping money into their target day funds and so you have pressures on both sides how do you think about like the the forces on both sides of that equation yeah I mean uh us Millennials don't make enough money to swamp offset it what would the Boomers have the I I don't I don't think there's a balance necessarily I think the the Boomers uh you know holding 70 80 percent of global assets matter a lot more than the rest of us speaking of which how do you think about that like well transfer there was a I like there was like a benign argument that essentially Bitcoin could be a a wealth transfer mechanism between the generations in the sense that like as Bitcoin increased and eventually as institutions came into Bitcoin that maybe the the Boomers were buying into Bitcoin at the top right when like the Millennials were making you know hopefully exiting their gains I mean obviously it didn't happen not likely to happen um and who knows what's going to happen in the future but like how do we have that wealth transfer and how much of a haircut does that well transfer have to take like you're saying like basically Target date funds real estate like for it to actually transfer you know how do you how do you how do you What's the timing mechanism what's the actual asset value like how much of a haircut to nav you're going to take to like really transfer that wealth and you know we'll see how real that wealth is I guess yeah I mean uh it's like everything in life those with a ton of money probably don't take any haircut they've created the correct vehicle to avoid uh both the tax man and friction um from transitioning those those assets from from one generation to the next um but you know the rest of us folks uh definitely have a leakage to both the tax man and probably have some sort of friction you know it's if most people their their main assets their house right you know for an average person okay like that's gonna be the the mechanism that's going to transfer wealth to the Next Generation most likely the two three four kids don't want the house so okay we've got to sell the house well there's you know not only a tax fund but a friction in the marketplace um to eventually get cash on the other end for those folks so yeah I mean I think there's going to be there's gonna be a lot of you know choppy interesting things that take place over the next 20 years is that event uh kind of unfolds yeah like I always like to say you have to throw out like the 100 Year back test data on housing especially if uh boomers are the first generation to own two to three houses so not only they're trying to transfer the house we're trying to transfer multiple vacation homes and the kids don't want it everybody's for selling like it's going to be really interesting to see what happens the kids might keep the you know ski house and sandals resort uh condo but I I think the house and the burbs get sold the other thing you talked about December that I thought was interesting uh at least involved markets is the idea around you know in December things were fairly benign on the month besides like fomc meetings so you had like extreme movements over like one to two days and then completely benign markets so tell me about like this bipolar Market that we saw in December yeah now the most interesting thing in the involved markets for December is effectively options were saying only two days mattered you know and they were back to back it was the CPI release and the December fomc meeting and I start start of the month basically if you were to just buying out the money but buying at the money call it was saying ah we think the Market's gonna move about four percent over the month but if you were only targeting essentially those two days you know trading that same same uh you know option strategy uh targeting those do two days it basically said like 3.6 so as the old the market was amazing those are the only two days that matter uh and then we're all gonna just go run off to Vacation uh into the holidays and be fine and so to me that was the the interesting thing is to just take the other side say you know those two days might matter but I actually want to own you know some convexity for all the other days so it just seems too too cheap um and by happenstance you know you never know if it's gonna work not that doesn't really matter the pricing seemed wrong and the options and obviously those two days happen we're actually very benign ultimately the the two days everybody was focused on and then the the fireworks were the kind of following six to seven trading days and like you said you had to play just in that month they had to pay close attention to fomc and CPI but we'll get into that in a few minutes of like what does that look like next year how close they should or do you think we should pay attention but another one of the kind of curveballs I'll throw at you is like uh there's been a lot of Sound and Fury lately about the zero uh data exploration options and being over 50 of the market and everything do you think this is uh is there anything to this what's your take uh I think the exchanges are incredibly happy [Laughter] that's much better main reason was just if an option you know has only a couple hours left it just it's no real risk like so it's not really moving Marketplace it's either a 100 or a zero Delta and guess what like people that are selling those options aren't really Delta hedging them to go ahead and hedge that risk because it's basically unhedgeable risk or like the or you know doing it with a linear instrument would be the incorrect way to hedge that risk so yeah somebody that sells a bunch of those one day options they're either just riding it out because they have enough other things in their book to keep it balanced or you know they turn around and go buy some of the same they spread it right you know like that's the only kind of reasonable way to go ahead and hedge that risk so you know ultimately um I think it's immaterial for option pricing Market movements things along those lines um but the exchanges uh are very very happy though they're going to lean into this not only going to have like a and PM every single day expiries they'll they'll start doing like 15 minute increments there makes me think of two things one um you know I'm trying to think I think it was Horizon kinetics that came up with the idea that one of the ways to like hedge inflation was to invest in the exchanges um and you know maybe that works on well the lme like the London medals exchange or maybe some of the Japanese exchanges but as you know like you're saying basically a lot of the US exchange of Chicago and everything are really just based on you know s p e-mini options you know so that doesn't really have anything to do with commodity inflation so that's that's when we look at it's like that's where the bulk of the it's all really around e-mini SPX and and the options around those positions but also what do you think about like the uh the conspiracy theory that this is just the market makers trying to like pin the numbers on SPX I mean they they market makers don't like anything that's directional right so it doesn't make sense for their bread and butter about how they like to make money exactly so the other thing that you so we'll start thinking about now like 2023 and um in your letter you talked about this story of 2022's rates but you think maybe the story of 2023 is going to be credit and so this ties back into you know how important do you think these fomc and CPI numbers are going to be and and you've said that you believe that rates are going to be more range bound next year and why what gives you that uh belief so first off I believe uh fixed income is the most important kind of metric to pay attention to for all markets at pretty much all points in time so it's not just 2022 Jason for like my entire career I've been yelling at people like it's rates stupid I that's the most important thing so it's a it's a big shift for me to say okay great uh rates put them in your back pocket know what's going on there but let's turn our Focus to credit um my main reason for that is I do think that 2023 ultimately uh rates are going to be pretty darn range bound because you have kind of two opposing forces that are gonna kind of keep things in in a and it's like a pretty wide way you know tens I think will be three percent to four and a half percent like it's not like you know 20 basis points wide But like after moving 400 basis points last year it kind of you know feels like a reasonably tight range um and the two opposing forces are I think you know whether or not we go into recession and who knows but you know the economy's slowing so you're like okay a slower growth world is going to kind of put a a cap in in yields and so I think it's pretty tough for you know tens to go above kind of four and a half percent if you know Global growth is slowing like who that knows where to but slowing um the other side of that which I think is is at least more interesting and I'm on my view is I I think the FED is not going to adjust their stance um so that's kind of putting the the you know floor if you will on the Range and yields um because you know even even if GDP growth is negative if the front end of the curve is has a four handle on it like you're just you're not going to be too far away uh from from you know three percent intense uh the reason why I have a pretty strong belief that the the FED is is gonna kind of hold the line is credibility what they care about more than anything else is being very important they must maintain that importance and credibility or else things don't really work to their liking um because what I mean that is like tangibly they really only have two tools they can move the FED funds rate and they can buy and sell assets and both of these things have you know probably some effect on the real economy in the future probably not a lot of effect on the real economy you know immediately and you know some effect on asset prices maybe somewhat immediately over the long term but like those tools and they're they're not dramatically effective for you know enforcing change tomorrow what is very effective at forcing change tomorrow is you know we'll just throw it under the umbrella of for guidance like the the feds speak they we will do anything to save the market like that as you carries a lot of weight and that's an intangible tool um and to be able to utilize an intangible tool you just have to have full credibility you can't have anybody saying oh I'm willing to fight the FED now because I don't think they can do it then if it all falls apart they must maintain that credibility um and I think the only way for them to truly maintain that credibility is to just stay on the path say don't fight us we ain't you know changing Market you're wrong we're right and I think they're gonna be much more steadfast and be willing to make you know a policy error to maintain that importance and that credibility um why do I think that they're focused on this why do I think that they're actually nervous about um you know their credibility in the marketplace is develop uh Central you know development Market central banks had a rough 22. um you know kind of kicked off with the UK obviously it started the fiscal side of the house making a uh well just say a policy error uh adding stimulus in the face of inflation that you know created some problems uh but the the central bank over there had you know nobody listened to uh their message if you will the the Market Force is overwhelmed the central bank and that's not you know a a small economy or you know a meaningless economy like this is a developed one that people take note on and say like maybe the central banks are losing a little bit of control here um and then the other one that's you know still kind of unfolding is Japan uh I think everybody was already kind of uh run off uh to the holidays when they made their shift at the end of December but then kind of getting broken on their yield curve control moving things from 25 basis points to 50 basis points of their target the market instantly taking that 25 basis points and actually pushing it through and frankly they're they're you know tens in Japan and jgbs have been trading above that 50 basis point target for pretty much all of this year is again something that's making the FED nervous that another major Central Bank people aren't listening to them right now and are you know fighting their message is actually working and winning so um I I think they'll do anything that they can to maintain credibility even if it seems like a policy error because that ultimately is more important to them for the Long Haul there's so many things I want to touch on in there one is and hopefully we'll get to a little bit more in the UK and Japan later um but credibility this is the one I've never been able to wrap my head around in the sense that like uh you know I never personally think about what is is the Fed credible or not and also but uh but then again I'm not a fed Watcher I also happen to have a general philosophy that they're more Trend followers than than being able to do anything in markets uh you may disagree with that that's fine but then also did so do you think it's more like a Keynesian beauty contest of like if the market participants in aggregate worry about fed credibility and positioning then that's what you need to worry about not is actually at the FED credible it's like do people perceive them as credible is that what you're saying no it's right no it's you you need the people that move money to listen to them and as soon as they stop listening to them then the ability to use the intangible tool of fed speed forward guidance anything along those lines you know loses its effect meaning like if we actually get to a really bad situation that the ability for the FED to kind of put up the wall and be like we'll save everybody stop selling that doesn't work anymore and and they will do anything to make sure that they still have that ability uh to influence uh basically Market participants at a whim one of the things we heard in 2022 is like everybody's talking about oh it's one of the most telegraphed recessions in history and people are positioned for it and everything but then you hear people kind of banging on like yeah but why are high yield credit spreads so tight and so do you think that like lulled people into a false sense of security we might see that start to break out a little bit in Twin Twin three year yeah I mean so you know the first halfway said why I've gone from 15 years of saying rates rates rates and I'm like yeah you know I think rates are actually gonna be kind of boring um this year especially comparative to everybody's focus and credit is where I want to focus my attention in terms of what it's saying about the market and credit as you mentioned is is incredibly tight considering you know what we've gone through in you know 2022 and most people thinking that you know slowing economy potentially recession these should be all things that says credit it should be widening and that obviously hasn't taken place um so you're like you have you have like high yield kind of like 50th percentile historical spreads you have Market IG about the same like 40th 50th percentile and then you got long and IG like 20ish percentile so like bull market like incredibly tight um so one of the main things that has happened here and my view is just very simple flows driven um you know pricing if you will that's influenced credit dramatically over the last year and and forcing it to be much tighter than you know fundamentals could possibly argue um so the main one the main one there's two main ones on the demand side demand side all right so I think a sneaky one is is there's a decent amount of money that's been funneled from uh the government to Union pensions uh as part of many of our our you know trillion dollar uh acts that have been put in place over the last two and a half years just to highlight that sorry I don't want to interrupt you but to highlight that really quick because you were the first person I really heard talking about this is uh the March 2021 covid-19 relief bill had a section 89b that really affected union pension so I just want to highlight for people to know like this 89b rule is what uh brought all a lot of this money into pensions like you're saying that's on the demand side yeah so you know government topping up their friends pensions um but of course the government want to give money there's always rules attached to it and the rules attached to it are essentially you know they couldn't take this money and go buy Bitcoin uh they needed to go ahead and invest in something that the government deems to be safe life and what does that mean it means treasuries investment grade credit MBS so it was Auto demand of new money you know being forced into those marketplaces um another dramatic you know increase in demand over the last year is Corporate I mean public Financial stupid corporate pensions are incredibly well funded it was a fantastic year for corporate pensions and everybody's like what the heck every single asset went down like what the heck are you talking about well a pension there's two sides a coin you have assets and you have liabilities those liabilities are discounted at an A or better uh curve meaning that if interest rates or credit spreads widen but interest rates go up a lot discount rates go up a lot meaning the current present value of your liabilities Falls dramatically so um you know what happened last year sure your asset portfolio is down 20 but your liabilities were down like 35 percent for for an open Pension Plan meaning you went from being underfunded to the average corporate pension plan is about you know 100 510 funded they're fully funded um for the first time since uh 2007. so what happens if you're a corporate pension and you're fully funded and well you sell risk assets you sell equities you sell vcep or or you know pull your commitments to those privates and then you you buy whatever the assets that are the discounting mechanism of your liabilities i.ea or Better Credit um so it was a huge rotation from those you know pensions acting honestly responsibly um like hey we don't need to we don't need to outperform reliabilities anymore we're fully funded we just need to perform in line with reliability so they start buying the assets that are you know the same mechanics of the discount rate of their liabilities but they're also priced in discriminated buyers like they don't really care they just want the asset and the liability to move in lockstep in perpetuity so they never have to think about the darn pension plan that's been a weight around their neck for the last 15. um so the two huge you know demand influences on credit that help get it to the place where it is right now and again you know I kind of said Market credit both IG and high yields 50-ish percentile and long and IG is like 20th percentile that's why right you know it's like specifically pensions trying to buy long duration credit that's where the real force is coming from on the demand side so surprisingly we kind of have a funky curve that is like extraordinarily flat uh between kind of front end and long run credit uh Power Force I mean that's right not counter for us on the other side Supply is also helping credit Titan um new issuance of corporate credit just goes up every single year since it became a real Market in you know kind of late 60s early 70s um grows at kind of like a GDP plus nature and 2022 was the first year and I can't even think if there might not actually been another year but in 2022 was actually net outstanding corporate credit Sans financials fell um and I think it's actually pretty simple to think why they're not issuing a lot of additional debt if you were a CFO of a corporate you know you obviously issued debt for operations hey we're building a factory like let's go ahead and raise some money to go ahead and put you know put those bricks on in the ground but they also last you know 20 years of really low interest rates were probably borrowing money to buy back stock to increase dividends doing you know some fun Financial engineering and and that's an easier decision to make when you're borrowing 10-year paper at you know two and a half percent like you were in 2020 2021 now that you have to pay six percent it probably doesn't you know it's not as easy to say let's go borrow a bunch of money at six percent to go buy back or stock um so they've kind of stopped doing that piece of it and if you only need to issue money for operations you probably have about the same amount of maturing uh as you do that you need to raise and so it was quiet so you just you had these you know dramatic influence of increased demand of pretty price indiscriminate buyers coupled with Supply way undershooting expectations simply because it probably didn't make a ton of sense to pay six percent to buy your stock back early some easier I mean a bit more difficult excuse me sell to a board to go along that path and so it just forced creditor um lots of demand not a lot of Supply well what happens prices go up so you you segmented me perfectly to talk about the the latter of corporate paper but like I want to tie that back into it like in a weird way is like you were talking about the pensions and and the reduction on the liability side I just think it's always interesting to me is like for the last I don't know decade plus people have been banging the drum that the the pensions are underfunded they're underfunded they're underfunded you know this is going to be a disaster it's a slow moving train waiting to happen and what always surprises me or makes me kind of giggle is that the the hidden forces of underlying markets tend to correct things more than people can and so like you know everybody always talks about uh wealth inequality et cetera you know the wealth inequality previously was that it's high in the 1920s well the 29 crash rectified that wealth inequality right markets tend to mean revert and and tend to take care of those things rather than politicians with a stroke of a pen and so it's always interesting to me that everybody was you know really upset about unfunded pensions and like you're saying now they're over funded and it all they took was you know rates coming back up and a little bit of a a protracted recession in 2022 to make that happen and it kind of throws everybody out the window so part of the one that where I'm tying it back in is um understandably you know a lot of people were really banging the drum previously like they can't raise rates they can't raise rates because if you raise rates to up to two to three percent you're gonna absolutely break the economy because people can't service that debt right we start getting fours and fives and all sudden everybody had to kind of recant their statements or they say they keep adjusting their numbers higher right like it's always interesting how the prognostication changes in real time uh but part of that was uh you know as some of our friends like uh Chris Cole Mike Green have said too is like if um you know the rates get too high these corporate uh entities are gonna start defaulting on mass and it's just going to be an absolute disaster but the problem is you may be able to call that but then the timing is difficult right you can have a thesis but then getting your timing right is an entirely different scenario so one of the things you brought up that I think is interesting is like when are you you know know issuing that paper and you create ladders over time and so it really depends on when those ladders are coming due and then more importantly can you refinance or repaper those positions it's not necessarily can you afford it it's just a in a Minsky sense it's like can you roll it over refinance it but more importantly when are those ladders coming due and does that give you a better sense of when that timing gets pushed back or when you see inflection points where that timing could be risky yeah so you know uh corporates acted responsibly unlike you know our our uh government of utilizing the really low interest rates to extend maturities and so you know IG space is it really extended maturities because I think they can borrow you know 50 years if they really want to right so investment grade doesn't have anything in our face um in terms of a maturity ladder high yield because they obviously can't issue well the market doesn't like to digest really long-term paper for high yield and so their maturity ladders you know kind of start waking up in 2024 and then the meat of it's you know 25 26 so it's like it's not in front of her face um so if we're going to start seeing defaults it's not going to necessarily come from inability to refinance um that paper it's going gonna come from actually you know not making money from operations becoming cash flow negative uh from actually operating your your business and you know but why that wasn't a big deal in 2022 is inflation is is good for all those folks if you borrowed a bunch of money and then you know your revenues are going up just based on inflation maybe you're you know real value-add uh in terms of of profits hasn't gone anywhere but your nominal has probably gone up um just because of inflation so 2022 was a fine environment for even you know let's call it not fantastic operators in in the high yield space 2023 that might actually change right you know we'll we'll see what Top Line looks like but I think the surprise might be a massive decrease in growth and actually inflation or at least the ability to pass through costs on the you know you know whoever you're selling your your services to uh get their services to that is potentially the problem right is actually a massively slowing in the ability to actually continue to raise prices and maintain any sort of margins um and you know wandering into a slowing growth potential recession whatever the heck it is you know could actually cause defaults in the high yield space even though there's not a maturity wall right in front of us so that's why I'm hyper focused on credit for 2023 not only is it you know I would call it too tight from you know kind of technical matters um that are abating uh at this point in time but also we're gonna have to start actually focusing on fundamentals maybe for the first time in a while and and those fundamentals might not be saying great things for for credit uh especially as we enter the back half there Earth um just from pragmatic sense what do you what do you use to track the maturity letters using like Fred data or and what are you looking at like how do you keep track of that yeah no they're you know make sure Bloomberg you can use Fred like it's actually not too hard to digest um kind of total outstanding debt um so culmination of all those sources is is kind of what you utilize to pay attention but yeah IG everybody kind of refinanced and you know latter half of 2020 2021 the 10 plus year maturities for for like kind of like weight of of the average issuance and so again investment rate is is not going to have problems anytime soon from a refinancing standpoint high yield you know kind of centers around five-ish year issuance right so that's why you know the meat of the the latter is kind of 24 five six um because they did most refinancing and you know 20 20 21. and then like I said that gives you the Aggregate and then if you want you could be a fundamental credit person and start picking and choosing your battles and right in that credit the other the thing you mentioned that it just shocks me that I have to keep reiterating this because you would think it's patent obvious but we're talking about rates inflation uh you know recession growth all these things right they come in waves and like you know if CPI numbers come down they can come back up like if anybody studied like the 1970s the waves of inflation were crazy all the intervening years of the 70s went up it went down and came back up again and it just seems like shocking to me that I can't keep having to bring this up it's like you know if we see inflation numbers come back down everybody thinks good if everything's great maybe rates come back down a little bit everybody's going to think like real estate and all these things are great again but we could easily see like I can't call the timing but let's just say the second half of this year you know inflation numbers come back up and everybody's gonna act like they're shocked and they got caught with their pants down it's like it's the most obvious thing historically it's nothing just everything works in waves and like I don't know like is that shocking that you have to say that like it just doesn't make sense to me yeah and I think part of it too is you know after prices move up 10 and then all of a sudden your comps are effectively you know that new price like yeah you know if it was a hundred bucks and that's 110 bucks you know it would have to be 121 dollars to be the same rate so it's like you know it's it just your your comps get easier and easier that are going to naturally kind of quiet the inflation numbers for a period of time and then then we'll you know see what happens if there is another wave or not um yeah I would I would agree that the focus on a month-to-month number um is probably misplaced let's uh let's talk about this Holy Trinity I would say of correlation liquidity and volatility right like they all kind of affect each other and you know what was the more interesting thing I guess in 2022 we started seeing correlations rise obviously with stock bonds um but even on my walk this morning I was listening to another podcast but uh Dylan Grice was on Alpha exchange and he was once again talking about correlation and volatility like we usually don't see spikes involved until we see spikes in correlation but it's interesting that you know uh other people like you and Chris Cole it's ever like I think you know illiquidity's tied more to volatility than necessarily correlation but like how do you how do you square that essentially like things were more correlated in 2022 and we saw you know medium-sized ball we didn't really see too many spikes involved so if correlations uh increase in in 2023 do we need to see illiquidity before we see a spike involved or how do you think about the the combination of those three factors I think most folks would say that high correlations cause the liquidity which then likely causes a significant change in volatility is like you know you're wandering path if you will um and yeah in 2022 High correlations didn't really cause significant bouts of illiquidity and basically any asset class um you know why do I think that's the case I think probably part of it is active managers were reasonably light on risk um and comparative to their historical standards so people that can quickly adjust their portfolio um you know we're kind of well positioned uh was was probably part of it and had ample liquidity um so that that probably muted uh the impact of high correlations into illiquidity you know kind of the next piece is the amount of passive investing um as a total you know percentage of all assets is is obviously incredibly High and a passive investor or you know investment product you know it's just fully invested there's no kind of like mechanics to force it to go ahead and and you know puke assets at any point in time so that's kind of quieter on that side and I think there's been a massive increase in private Investments and private Investments you know obviously not needing to necessarily Mark themselves day to day um also kind of provides a little bit of a buffer uh from high correlations driving massive increases in illiquidity and then potentially you know eventually volatility um and and the culmination of you know people being forced to sell things to live their lives uh you know they they had a buffer in in 2022 people had a decent amount of cash and or ability to you know extend credit on credit cards and whatnot um so they really weren't you know consumers didn't become necessarily forced to liquidate you know assets which can you know cause the waterfall so I I think it was the mixture of all those kind of things why a incredibly High correlation across all assets in in 2022 didn't really Drive bouts of illiquidity that most people might probably would have assumed would have taken place do you think part of that is like you you really need to get credit markets you need to see liquid credit markets or some volatility and credit markets or some sort of defaults or scares to see those true spikes in volatility yeah no I mean I I think you know credit markets are always going to be the the core of you know experience of massive illiquidity I mean that that's what you know March 2020 was actually scaring the the Fed was credit markets and treasury markets frankly like froze that's that's what matters like you know they didn't really care about the s p moving 10 every single day they weren't happy about it but that wasn't the focus do you think that um how do you think about like the B re and stuff like do you think that's foreshadowing and especially if we have all of these financialization and markets where we're trying to turn you know illiquid non-granular you know products into liquid products like and especially on the credit side does that do you think that's foreshadowing or this is just kind of an anomaly with the with the be read situation you know I wouldn't necessarily say it's foreshadowing but it definitely you know provides a little bit of extra kindling if we ever actually get to a massive illiquidity event right so it's like you know those types of vehicles likely help um you know starve off illiquity events until you get to a place where you can't fight it anymore and then cause a much bigger explosion than you would otherwise have that's right you mentioned uh Japan earlier and so I have a couple of questions about it I don't really have too much of an opinion here in the sense that like you know moving the the yield curve control band from 25 to 50 is that just a function of basically having a new head of the boj and you just wants a little bit more wiggle room or and or is this a sign that finally the the Widowmaker short ggb trade is back on and people should be taking advantage yeah I think it's a little bit more of the latter um the the amount of asset purchases that they were doing before they you know off meeting made that change was like 5x their normal daily asset purchases um so you know I think they were they were fighting it and they could sense that they were going to lose and possibly lose in a big way so again from a credibility standpoint you can't lose like you just change to make it seem like I always wanted to do this like you didn't force me to do what I wanted to do it um so yeah I think I think they're starting to lose a little bit of control but at the same time like as you said people have been fighting them and wrong for 20 years so you know it's it's kind of easy for them to bat people back um at this stage um so they'll they'll they they have you know they have some more life within them like before and some tools that they can do to you know act like the market that influence and make decisions they they did it on their own whim um but but yeah and I think they're getting to a little bit of a inflection point and their ability to control the markets as well as they have over this whole period um and anything the main reason is you you probably you know not only are things wound to a point that it's problematic but you you don't have the monetary and fiscal side of the houses probably operating in in line with each other um because you know inflation in Japan is a is a problem like you know their citizens are getting to a point where they're probably not very happy and thus you know the people that are elected officials are not very happy and they're gonna you know not want to move in the same way potentially as the monetary side of the house um and it's and then there and there are you know you know they're an island and they import a lot of things and so it's like it becomes hairy quickly for somebody like that yeah it's outside your uh purview or mandate for what you do at convex's house but I'm just wondering is that does that short Shady GB trade start to look tantalizing to you or is it still like this is just too hard and you can't predict the forces or pressures from the people running the boj yeah I mean I'd rather participate in in markets that are are not 100 manipulated because I I I'd like to think I have some Edge I don't have any Edge there like I I know what the fair value is and it doesn't matter and then just to bring it back out because you were you were my go-to when uh you know we started seeing the wonkiness in the guilt markets and it started to affect ldi and all sudden everybody you know learned what ldi meant um but one of the things that you described it on uh as a bridge loan and I thought that was a great way of describing it it gave me um a way to frame it and to think about what actually happened what transpired and why it was resolved so quickly so I guess because you have a little bit of a background in ldi especially even on the British side so can you kind of uh give kind of quick rundown on what happened there yeah so I mean the the quick rundown we were ready to talk about U.S pensions and it was like right a great year for U.S Mansions right um it's not dissimilar over in the UK um again what they care about is do they have enough assets to service liabilities if rates are going up liabilities are falling and you know probably their assets too but all in lockstep and and they you know fine way so why became an issue you know say they were 100 funded at the start of the year and you know on paper they were still 100 funded at the end of August and at the end of September too but their assets were not necessarily in liquid things um everybody when you have a very stable stable low interest rate environment probably get a little greedy and over in the UK their pension liabilities are discounted on a guilt plus linkers curve so that's treasuries plus tips basically um type of Curves there's no credit involved in their discount rate where the US again is kind of an air better curve so it is Credit in their discount rate So in theory you shouldn't own any credit if you're 100 funny you should have some guilts and linkers everything's in lockstep but over in the UK unlike you know the US most of these pension plans are still open I.E new employee is getting added to that Pension Plan they're not going into a you know 401K type of situation it's it's still a defined benefit Society um so because the pension plans open you may be fully funded with all the people you currently have working but a new liability just showed up because you hired a new person so the reason for B being a little bit of greedy in those plans is to hope that your assets can outperform your liabilities just enough you don't actually have to contribute any additional money for that new person that's being added to the pension plan and they're not going to take massive risk but they're gonna you know over time maybe start taking a little bit of risk and so you know the risk was okay we're gonna buy you know some UK corporate credit even though it's not at our discount rate like I want that extra you know 50 basis point spread I'll buy some high grade UK credit then the UK credit Market you know isn't as attractive as the U.S credit market so like oh let's buy some U.S credits you're adding a little you know going from you know guilt to credit okay that's adding a little bit of liquidity going from you know locally domicile credit to International credit that's a little bit more the liquidity um and then they started going into privates and infrastructure and things that have you know truly no instantaneous liquidity um you know they're off-market instruments um so that became their problem um in in August and September of last year that their their assets and liabilities were still you know call one one to one approximately there so the the actual pension was fine and not being damaged but when they needed some liquidity to support um a lot of the instruments in the derivative space that they they had on in their portfolio they didn't have the natural source of it because they had moved out the illiquidity ladder all the way into you know some privates and you can't post privates to The Exchange um for for supporting the collateral for your derivatives so when things were getting hairy you know the uh Bank of England reached out and said well you know what's the problem guys and they said well listen like we're totally fine trust me we're totally fine but I I mean two weeks I need two weeks to figure out this story because you know they're like we call Blackstone they're really happy to buy all of our privates but it's going to take them a little bit of time to do their needed due diligence and be a great agree to whatever haircut that it is to get her cash out um but that's it we just need a two-week Bridge Loan and they're like all right all right for two weeks guys rather than selling things we're gonna buy everything on the planet give you the you know Headroom to go ahead and figure things out and then everything's gonna be okay um and you know they were able to find us a buyer for their liquids in that two-week period and then hey you know the problem for the moment was was solved but yeah I think that you know most people are very focused on like oh the derivatives you know mass destruction and who the heck that one percent interest rates is you know having 100 Year duration in their portfolio all that kind of stuff like that's just folks that don't understand you know Alm I have you know asset liability management like they're they're not trying to make money in absolute terms they just want their assets and their liabilities to move in locksteps so they're going to own what their you know liabilities are discounted at which in that case is a decent amount of guilt and Linker risk and that's where derivatives came to play their error was not having a liquid portfolio not not the investment strategy in terms of the ability to hedge out those liabilities it was getting greedy and turning your portfolio from fully liquid to something that's you know less liquid well that's why like you said the the honey pennies of the world it didn't lead to a Cascade of consequences because like you said it's a bridge loan for illiquid you know you know Mark to Market have assets and whether they could Bridge it over that two-week period to get better pricing but there's you brought back a lot of memories for me actually because I realized we were having I vividly remember having this conversation with you while I was in a long layover in Paris at Charles de Gaulle Airport so like it's bringing back some weird memories for me but the further Nuance of the bridge loan though that think that you highlighted that was really interesting to me is it was a it's a sizing issue as well like if you're a very large pension right you have either an internal or an external team that are really managing a lot of those liabilities those linkers and even some of the derivatives for you but if you're a smaller pension you don't get great Management on that so there are a lot of they're getting pulled into commingled funds and those commingled funds weren't having like the capital calls like say at the beginning of 2022 or or in intervening periods of saying hey with a little more cash on the books we need to adjust the book around it was more like all sudden it was like there's not a problem there's not a problem now there's a huge problem and we're all in a co-mingled fund together so we're all going down together isn't that part of the Nuance as well yeah no the the the pensioners that actually were damaged in that event were the smaller plans that invested via a commingle product right because you're again like if you're doing everything and somebody managed accounts their issue was not having enough liquid Capital to continue to support holding on to those positions because you know the whole goal here is yeah you want your assets and your liabilities to match each other you just got to be able to hold that right and right that's much easier to achieve that if you're in simply managed accounts versus in a commingled product because a commingo product says hey we need more you know collateral there's not a natural source to go ahead and Achieve that in a co-mingle product so those coming out products actually did deliver um during that event and you know probably you know sold things at potentially in opportune times and actually were damaged um so there's always you know all all good ideas also need the uh right operational structure to to achieve those good ideas in the best format and um and a lot of a lot of uh you know investment Industries and and products a comingo product is often not the the right rapper to achieve your goals exactly well unfortunately we're running up on time here and I feel like where you and I are gonna have an ongoing theme of like we just keep pushing back the food talk to next time one of these days we'll do it we'll do a food pack because or maybe we need to start a whole new podcast uh as you know I've been texting you it's been interesting uh trying all these different hummuses from uh Lebanese Israeli and like it's actually made me think about markets in the same time too is like the uh comparison is the thief of joy and as you know like in that region like there's so many different varieties coming you know intermingling of countries you know from mercantilist economies it's like it's almost impossible to compare two hummuses and I just think of like all the things you and I were just talking about I'm trying to pull on here it's like there's just so many nuances in markets and otherwise you know I could spend 10 hours talking about these things so trying to cover five topics six topics in an hour is probably a terrible idea but I want to thank you for coming on again but uh plug away again uh website LinkedIn Etc oh uh I'll be why you want the www again that was good I was just gonna set you up see if you did it yeah just uh you know find us at quebecsoft.com as I said my business partner is forcing me to use LinkedIn this year so there'll be a decent amount of rando uh posts um of you know where we're attending things things where we write things like this the you know chats um but yeah please reach out and find us in those two places yeah and I don't I'm not sure if this will be out before you know we're going to be down in Miami together in probably less than 10 days for the week uh January 30th for all the hedge fund week uh if you happen to be down there say hi give a shout out we're happy to say hello grab a coffee whatever uh said thanks for coming on thanks as always Jason bye thanks for listening if you enjoyed Today's Show we'd appreciate if you would share this show with friends and leave us a review on iTunes as it helps more listeners find the show and join our amazing Community to those of you who already shared or left to review thank you very sincerely it does mean a lot to us if you'd like more information about Mutiny fund you can go to mutinyfund.com for any thoughts on how we can improve the show or questions about anything we've talked about here on the podcast today drop us a message via email I'm Taylor at mutinyfund.com and Jason is jason.com or you can reach us on Twitter I'm at Taylor Pearson in E and Jason is at Jason Mutiny to hear about new episodes or get our monthly newsletter with reading recommendations sign up at mutinyfund.com newsletter foreign [Music] this podcast is provided for informational purposes only and should not be relied upon as legal business investment or tax advice all opinions expressed by podcast participants or certainly their own opinions and do not necessarily reflect the opinions of music fan their Affiliates or companies featured due to Industry regulations participants of this podcast are instructed to not make specific trade recommendations nor reference best or potential profits listeners are reminded that managed features commodity trading Forex Trading and other alternative Investments are 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Will credit markets be tight or illiquid in 2023? – Zed Francis
Summary
Transcript
[Music] hello and welcome this is the Mutiny investing podcast this podcast features long-form conversations on topics relating to investing markets risk volatility and complex systems [Music] said Francis welcome back to Mutiny investing podcast right away right at the top plug away where could people find a website where can they find you on LinkedIn you know anything else yeah just www.convexitask.com uh and then my name is zed zed so that's probably one of five of them on LinkedIn so that's easy to find but you guys you guys post great uh essays to your site but you also I guess you repost them to LinkedIn and you put more content on LinkedIn than just your essays or how do you set that up yeah no we you know between podcasts TV appearances uh posts you know definitely do the LinkedIn thing Devin is uh my business partner is getting on me to actually utilize LinkedIn as a tool we'll figure out if I can learn something new and if it's useful but uh yeah you'll you'll see an annoying amount of us I think probably over the next year as we learn to utilize it good I look forward to it and you by the way you walked right in my trap of saying that you're you guys are philosophically boomers because you right away I said get what's your website and you said www dot like did you want to start with HTTP like who when do people gonna stop saying www dot for their website well I mean as soon as I get off my Netscape browser Maybe uh well I wanted to bring you back on was I you know uh a year in review wow how unique you know everybody does their year in their views but um I actually liked a lot of the comments you had about Q4 and what you were thinking about in 2023 so I wanted to bring you on to discuss some of those and let's just start I think with uh more of the simple ones though Q4 um you saw a lot of the action in Q4 especially in December was from tax loss harvesting and then also um rmds so let's just start I mean tax office harvesting is a little more obvious than the rmds but let's just talk a little bit about both yeah I mean I guess we'll kicking off tax loss harvesting so obviously it was a year that anybody that accumulated additional Assets in 2020 2021 likely had the opportunity to do some tax loss harvesting um especially because there's enough names that move like dramatically right you know there's probably stuff in your portfolio that was down 90 hopefully only you know 20 basis point holding but you know some serious moves and so yeah I think that definitely put some pressure on the broader Market at the end of the year and you you can kind of see it on funny days uh to me my best example of of the taxless harvesting must be happening today everybody has tools the tools are getting better for tasks harvesting but I still think most people basically open up their brokerage account and then go to the column that says you know gains losses and then filters it to the highest to the lowest and they start at the biggest loss and there was a couple of random days kind of like the week before Christmas where Apple was down three percent with the NASDAQ down 50 basis points and you're like okay this is the start of tax that's harvesting because apple is probably your largest holding with it being the largest company and it was down 20 odd percent last year or so surprise surprise is probably the biggest dollar loss you know not percent the dollar loss in your account and that's where people started and so that was a you know you can you can still kind of physically see it going on so I think that's that's one side of the pressure that you know I think is reasonably talked about and is a real thing when there's not a lot of trading volumes it can actually you know dominate to some extent um but I think the more interesting side is required minimum distribution from uh DC Divine contribution retirement plans um and the reason why I think it's less talked about and more interesting is is just important now and hasn't really been that important before so you know 6 60s 70s 80s slowly but surely most folks transition from DB defined benefit to DC to find contribution retirement plans and so there's not a lot of you know we'll call it Legacy you know money until more recently and more recently those folks with the you know the transition into how they're saving for retirement are now becoming of retirement age so it's just you know 20 years ago this wouldn't be a big number because there wouldn't be a lot of people retiring and there wasn't the pot wasn't as big but now it's like a pretty big number so it's something you should start paying attention to um as we go through the next kind of 20 years of folks actually having to you know sell things um you know and on the schedule that's mandated uh by uh uh the IRS essentially so the other piece that's interesting Beyond it not really being a dominant player until more recently is it's the required minimum distributions are set at the account value at the start of the year so say here 82 I believe is your actuary table says you're going to live 10 more years so you got to sell a tenth of your assets every year and so say at a 100 bucks so at the start of the year so it says okay you've got to sell ten dollars worth of stuff you know 10 of the hundred dollars at the start of the year but in 2022 it was obviously a year we're pretty much all assets fell so you know your your ads down 20 your speed is down 20 so and so forth 100 bucks now eighty dollars and you don't have to sell ten percent of eighty dollars you got to sell ten dollars you know it's set at that uh you know price of the account value at the start of the year so it becomes like a pretty material amount of liquidations that have to take place and again like if you don't do it it's a it's a 50 haircut basically that's you know a force tax upon you for not doing it so you're doing it you're doing it no matter what there's no way to avoid it um but it becomes pretty darn material and um everybody kind of does it in a waterfall fashion so depending on which custodian your assets are at they basically pick an arbitrary day in December when they're actually going to process all these required minimum distributions and it's essentially kind of between December 10th and like December like 23rd because nobody wants to work you know during the holidays we might have done before then we also want to get it as close to your end as possible so that's kind of your waterfall so you know those two weeks um in the middle of December I think they have a a pretty you know over waiting impact on the pressure in the market from these you know thoughtless selling programs um the the back side of it uh which is you know I think kind of possibly what we're experiencing you know the last two weeks uh of right now is you know people sell you know forced to sell those assets they have to pay taxes on them and now they have cash and they might just go put it back into the market like you know you didn't you have this windfall of cash you don't need it for life expenditures right now you might need it over the next year or whatever um but you probably have an over allocation to cash just naturally because you're forced to sell assets um and now it's in your taxable account and you probably go redeploy it into the market so it has you know I think it affect both ways uh you know a decent amount of pressure in December you know Force liquidations and then hey we got some cash like let's go put it to work and you go buy back all the same stuff that you probably just sold there's so many things that would highlight there because I actually love this subject and like you said it's not talked about enough uh one thing's I want to highlight like you said it's not on a percentage basis it's like an actual dollar amount like on that ten dollars on the hundred dollars an example like everybody thinks it's just a percentage and what does my net assets at the end of the year and it's a percentage of that like you said No it's it's much worse than that um and I think uh you and I talked about like I think you think that that that constant selling pressure that you get from um from these distributions is similar to what we saw in December of 2018 where you just saw like just this constant like tick down on the markets that's why we didn't see really a ball spike in December of 2018 and maybe not as much as December of 2022 because you just have like it's just constant every day that selling pressure over over a two-week period yeah and the parallel between 18 and 22 is you know your fixed income and your equities were down right so it's you didn't have that situation where your hundred dollars is still a hundred dollars just because you had some you know uh actual diversification benefits of holding different things you know everything's down so that you know of course is a hundred dollars to in you know 2018 to 90 bucks and in 2022 they 80 bucks um so you know definitely a parallel between those two Decembers but then part of it too is like I I think about often is and you may disagree with me on this but like to me we have just an end of one experiment when we're talking about uh these defined contribution plans you know and and thinking about you know 401k's subject IRAs or whatever it is and especially start when we're moving into Target date funds now like every Millennial or gen Z is only going to have a Target date fund really is their only optionality they maybe have a two to six options at best and so to me we haven't actually seen what this experiment looks like and like you're saying right now is once people are starting to reach retirement age they have to have these required distributions and we haven't really seen what happens on mass at really scale and I really wonder about especially you know it almost exacerbates it with the target date funds and you could speak to that as far as like you know you don't you don't get to pick and choose as much what what you can or can't sell and then you know what happens if you know we're underwater for like a decade and people are just just getting pinged with these required distributions yeah no I I I think the you know broader wealth transfer that you know everybody acknowledges is going to take place over the next 20 to 30 years is going to obviously move things substantially and the more mechanical those movements are the more you know disconnects they're they have the ability to create so you know I I I I would agree that having more and more rules-based investment guidelines both in terms of a higher meant to do distribution and invest will create bigger gaps in terms of you know we'll call it Market Fair Value pricing from one day to the next there will be some you know Harrier things that show up that hopefully great opportunities for others but it's not you know fantastic for those individuals that have to walk down that path do you think it makes any difference though like uh historically in any sort of retirement account do you have a lot of options or things that different things you're invested in but now if you're in a Target date do you think that has a dramatic effect when you're going to sell off those pieces in December I you know I don't think anybody owns anything that different ultimately uh especially in in those types of accounts are kind of more broad-based you know it's like what's the difference between a mutual couple of mutual funds and a Target date Fund in terms of the underlying assets that they hold right not not dramatic and then what do you how do you think about I was thinking about like you're saying this this constant selling pressure especially in December then like I said a lot of times they're just buying it all back in January but then the countervailing force to that is you know the Boomers have these required distributions but then Millennials have these Target day funds where they're just every quarter they're just dumping money into their target day funds and so you have pressures on both sides how do you think about like the the forces on both sides of that equation yeah I mean uh us Millennials don't make enough money to swamp offset it what would the Boomers have the I I don't I don't think there's a balance necessarily I think the the Boomers uh you know holding 70 80 percent of global assets matter a lot more than the rest of us speaking of which how do you think about that like well transfer there was a I like there was like a benign argument that essentially Bitcoin could be a a wealth transfer mechanism between the generations in the sense that like as Bitcoin increased and eventually as institutions came into Bitcoin that maybe the the Boomers were buying into Bitcoin at the top right when like the Millennials were making you know hopefully exiting their gains I mean obviously it didn't happen not likely to happen um and who knows what's going to happen in the future but like how do we have that wealth transfer and how much of a haircut does that well transfer have to take like you're saying like basically Target date funds real estate like for it to actually transfer you know how do you how do you how do you What's the timing mechanism what's the actual asset value like how much of a haircut to nav you're going to take to like really transfer that wealth and you know we'll see how real that wealth is I guess yeah I mean uh it's like everything in life those with a ton of money probably don't take any haircut they've created the correct vehicle to avoid uh both the tax man and friction um from transitioning those those assets from from one generation to the next um but you know the rest of us folks uh definitely have a leakage to both the tax man and probably have some sort of friction you know it's if most people their their main assets their house right you know for an average person okay like that's gonna be the the mechanism that's going to transfer wealth to the Next Generation most likely the two three four kids don't want the house so okay we've got to sell the house well there's you know not only a tax fund but a friction in the marketplace um to eventually get cash on the other end for those folks so yeah I mean I think there's going to be there's gonna be a lot of you know choppy interesting things that take place over the next 20 years is that event uh kind of unfolds yeah like I always like to say you have to throw out like the 100 Year back test data on housing especially if uh boomers are the first generation to own two to three houses so not only they're trying to transfer the house we're trying to transfer multiple vacation homes and the kids don't want it everybody's for selling like it's going to be really interesting to see what happens the kids might keep the you know ski house and sandals resort uh condo but I I think the house and the burbs get sold the other thing you talked about December that I thought was interesting uh at least involved markets is the idea around you know in December things were fairly benign on the month besides like fomc meetings so you had like extreme movements over like one to two days and then completely benign markets so tell me about like this bipolar Market that we saw in December yeah now the most interesting thing in the involved markets for December is effectively options were saying only two days mattered you know and they were back to back it was the CPI release and the December fomc meeting and I start start of the month basically if you were to just buying out the money but buying at the money call it was saying ah we think the Market's gonna move about four percent over the month but if you were only targeting essentially those two days you know trading that same same uh you know option strategy uh targeting those do two days it basically said like 3.6 so as the old the market was amazing those are the only two days that matter uh and then we're all gonna just go run off to Vacation uh into the holidays and be fine and so to me that was the the interesting thing is to just take the other side say you know those two days might matter but I actually want to own you know some convexity for all the other days so it just seems too too cheap um and by happenstance you know you never know if it's gonna work not that doesn't really matter the pricing seemed wrong and the options and obviously those two days happen we're actually very benign ultimately the the two days everybody was focused on and then the the fireworks were the kind of following six to seven trading days and like you said you had to play just in that month they had to pay close attention to fomc and CPI but we'll get into that in a few minutes of like what does that look like next year how close they should or do you think we should pay attention but another one of the kind of curveballs I'll throw at you is like uh there's been a lot of Sound and Fury lately about the zero uh data exploration options and being over 50 of the market and everything do you think this is uh is there anything to this what's your take uh I think the exchanges are incredibly happy [Laughter] that's much better main reason was just if an option you know has only a couple hours left it just it's no real risk like so it's not really moving Marketplace it's either a 100 or a zero Delta and guess what like people that are selling those options aren't really Delta hedging them to go ahead and hedge that risk because it's basically unhedgeable risk or like the or you know doing it with a linear instrument would be the incorrect way to hedge that risk so yeah somebody that sells a bunch of those one day options they're either just riding it out because they have enough other things in their book to keep it balanced or you know they turn around and go buy some of the same they spread it right you know like that's the only kind of reasonable way to go ahead and hedge that risk so you know ultimately um I think it's immaterial for option pricing Market movements things along those lines um but the exchanges uh are very very happy though they're going to lean into this not only going to have like a and PM every single day expiries they'll they'll start doing like 15 minute increments there makes me think of two things one um you know I'm trying to think I think it was Horizon kinetics that came up with the idea that one of the ways to like hedge inflation was to invest in the exchanges um and you know maybe that works on well the lme like the London medals exchange or maybe some of the Japanese exchanges but as you know like you're saying basically a lot of the US exchange of Chicago and everything are really just based on you know s p e-mini options you know so that doesn't really have anything to do with commodity inflation so that's that's when we look at it's like that's where the bulk of the it's all really around e-mini SPX and and the options around those positions but also what do you think about like the uh the conspiracy theory that this is just the market makers trying to like pin the numbers on SPX I mean they they market makers don't like anything that's directional right so it doesn't make sense for their bread and butter about how they like to make money exactly so the other thing that you so we'll start thinking about now like 2023 and um in your letter you talked about this story of 2022's rates but you think maybe the story of 2023 is going to be credit and so this ties back into you know how important do you think these fomc and CPI numbers are going to be and and you've said that you believe that rates are going to be more range bound next year and why what gives you that uh belief so first off I believe uh fixed income is the most important kind of metric to pay attention to for all markets at pretty much all points in time so it's not just 2022 Jason for like my entire career I've been yelling at people like it's rates stupid I that's the most important thing so it's a it's a big shift for me to say okay great uh rates put them in your back pocket know what's going on there but let's turn our Focus to credit um my main reason for that is I do think that 2023 ultimately uh rates are going to be pretty darn range bound because you have kind of two opposing forces that are gonna kind of keep things in in a and it's like a pretty wide way you know tens I think will be three percent to four and a half percent like it's not like you know 20 basis points wide But like after moving 400 basis points last year it kind of you know feels like a reasonably tight range um and the two opposing forces are I think you know whether or not we go into recession and who knows but you know the economy's slowing so you're like okay a slower growth world is going to kind of put a a cap in in yields and so I think it's pretty tough for you know tens to go above kind of four and a half percent if you know Global growth is slowing like who that knows where to but slowing um the other side of that which I think is is at least more interesting and I'm on my view is I I think the FED is not going to adjust their stance um so that's kind of putting the the you know floor if you will on the Range and yields um because you know even even if GDP growth is negative if the front end of the curve is has a four handle on it like you're just you're not going to be too far away uh from from you know three percent intense uh the reason why I have a pretty strong belief that the the FED is is gonna kind of hold the line is credibility what they care about more than anything else is being very important they must maintain that importance and credibility or else things don't really work to their liking um because what I mean that is like tangibly they really only have two tools they can move the FED funds rate and they can buy and sell assets and both of these things have you know probably some effect on the real economy in the future probably not a lot of effect on the real economy you know immediately and you know some effect on asset prices maybe somewhat immediately over the long term but like those tools and they're they're not dramatically effective for you know enforcing change tomorrow what is very effective at forcing change tomorrow is you know we'll just throw it under the umbrella of for guidance like the the feds speak they we will do anything to save the market like that as you carries a lot of weight and that's an intangible tool um and to be able to utilize an intangible tool you just have to have full credibility you can't have anybody saying oh I'm willing to fight the FED now because I don't think they can do it then if it all falls apart they must maintain that credibility um and I think the only way for them to truly maintain that credibility is to just stay on the path say don't fight us we ain't you know changing Market you're wrong we're right and I think they're gonna be much more steadfast and be willing to make you know a policy error to maintain that importance and that credibility um why do I think that they're focused on this why do I think that they're actually nervous about um you know their credibility in the marketplace is develop uh Central you know development Market central banks had a rough 22. um you know kind of kicked off with the UK obviously it started the fiscal side of the house making a uh well just say a policy error uh adding stimulus in the face of inflation that you know created some problems uh but the the central bank over there had you know nobody listened to uh their message if you will the the Market Force is overwhelmed the central bank and that's not you know a a small economy or you know a meaningless economy like this is a developed one that people take note on and say like maybe the central banks are losing a little bit of control here um and then the other one that's you know still kind of unfolding is Japan uh I think everybody was already kind of uh run off uh to the holidays when they made their shift at the end of December but then kind of getting broken on their yield curve control moving things from 25 basis points to 50 basis points of their target the market instantly taking that 25 basis points and actually pushing it through and frankly they're they're you know tens in Japan and jgbs have been trading above that 50 basis point target for pretty much all of this year is again something that's making the FED nervous that another major Central Bank people aren't listening to them right now and are you know fighting their message is actually working and winning so um I I think they'll do anything that they can to maintain credibility even if it seems like a policy error because that ultimately is more important to them for the Long Haul there's so many things I want to touch on in there one is and hopefully we'll get to a little bit more in the UK and Japan later um but credibility this is the one I've never been able to wrap my head around in the sense that like uh you know I never personally think about what is is the Fed credible or not and also but uh but then again I'm not a fed Watcher I also happen to have a general philosophy that they're more Trend followers than than being able to do anything in markets uh you may disagree with that that's fine but then also did so do you think it's more like a Keynesian beauty contest of like if the market participants in aggregate worry about fed credibility and positioning then that's what you need to worry about not is actually at the FED credible it's like do people perceive them as credible is that what you're saying no it's right no it's you you need the people that move money to listen to them and as soon as they stop listening to them then the ability to use the intangible tool of fed speed forward guidance anything along those lines you know loses its effect meaning like if we actually get to a really bad situation that the ability for the FED to kind of put up the wall and be like we'll save everybody stop selling that doesn't work anymore and and they will do anything to make sure that they still have that ability uh to influence uh basically Market participants at a whim one of the things we heard in 2022 is like everybody's talking about oh it's one of the most telegraphed recessions in history and people are positioned for it and everything but then you hear people kind of banging on like yeah but why are high yield credit spreads so tight and so do you think that like lulled people into a false sense of security we might see that start to break out a little bit in Twin Twin three year yeah I mean so you know the first halfway said why I've gone from 15 years of saying rates rates rates and I'm like yeah you know I think rates are actually gonna be kind of boring um this year especially comparative to everybody's focus and credit is where I want to focus my attention in terms of what it's saying about the market and credit as you mentioned is is incredibly tight considering you know what we've gone through in you know 2022 and most people thinking that you know slowing economy potentially recession these should be all things that says credit it should be widening and that obviously hasn't taken place um so you're like you have you have like high yield kind of like 50th percentile historical spreads you have Market IG about the same like 40th 50th percentile and then you got long and IG like 20ish percentile so like bull market like incredibly tight um so one of the main things that has happened here and my view is just very simple flows driven um you know pricing if you will that's influenced credit dramatically over the last year and and forcing it to be much tighter than you know fundamentals could possibly argue um so the main one the main one there's two main ones on the demand side demand side all right so I think a sneaky one is is there's a decent amount of money that's been funneled from uh the government to Union pensions uh as part of many of our our you know trillion dollar uh acts that have been put in place over the last two and a half years just to highlight that sorry I don't want to interrupt you but to highlight that really quick because you were the first person I really heard talking about this is uh the March 2021 covid-19 relief bill had a section 89b that really affected union pension so I just want to highlight for people to know like this 89b rule is what uh brought all a lot of this money into pensions like you're saying that's on the demand side yeah so you know government topping up their friends pensions um but of course the government want to give money there's always rules attached to it and the rules attached to it are essentially you know they couldn't take this money and go buy Bitcoin uh they needed to go ahead and invest in something that the government deems to be safe life and what does that mean it means treasuries investment grade credit MBS so it was Auto demand of new money you know being forced into those marketplaces um another dramatic you know increase in demand over the last year is Corporate I mean public Financial stupid corporate pensions are incredibly well funded it was a fantastic year for corporate pensions and everybody's like what the heck every single asset went down like what the heck are you talking about well a pension there's two sides a coin you have assets and you have liabilities those liabilities are discounted at an A or better uh curve meaning that if interest rates or credit spreads widen but interest rates go up a lot discount rates go up a lot meaning the current present value of your liabilities Falls dramatically so um you know what happened last year sure your asset portfolio is down 20 but your liabilities were down like 35 percent for for an open Pension Plan meaning you went from being underfunded to the average corporate pension plan is about you know 100 510 funded they're fully funded um for the first time since uh 2007. so what happens if you're a corporate pension and you're fully funded and well you sell risk assets you sell equities you sell vcep or or you know pull your commitments to those privates and then you you buy whatever the assets that are the discounting mechanism of your liabilities i.ea or Better Credit um so it was a huge rotation from those you know pensions acting honestly responsibly um like hey we don't need to we don't need to outperform reliabilities anymore we're fully funded we just need to perform in line with reliability so they start buying the assets that are you know the same mechanics of the discount rate of their liabilities but they're also priced in discriminated buyers like they don't really care they just want the asset and the liability to move in lockstep in perpetuity so they never have to think about the darn pension plan that's been a weight around their neck for the last 15. um so the two huge you know demand influences on credit that help get it to the place where it is right now and again you know I kind of said Market credit both IG and high yields 50-ish percentile and long and IG is like 20th percentile that's why right you know it's like specifically pensions trying to buy long duration credit that's where the real force is coming from on the demand side so surprisingly we kind of have a funky curve that is like extraordinarily flat uh between kind of front end and long run credit uh Power Force I mean that's right not counter for us on the other side Supply is also helping credit Titan um new issuance of corporate credit just goes up every single year since it became a real Market in you know kind of late 60s early 70s um grows at kind of like a GDP plus nature and 2022 was the first year and I can't even think if there might not actually been another year but in 2022 was actually net outstanding corporate credit Sans financials fell um and I think it's actually pretty simple to think why they're not issuing a lot of additional debt if you were a CFO of a corporate you know you obviously issued debt for operations hey we're building a factory like let's go ahead and raise some money to go ahead and put you know put those bricks on in the ground but they also last you know 20 years of really low interest rates were probably borrowing money to buy back stock to increase dividends doing you know some fun Financial engineering and and that's an easier decision to make when you're borrowing 10-year paper at you know two and a half percent like you were in 2020 2021 now that you have to pay six percent it probably doesn't you know it's not as easy to say let's go borrow a bunch of money at six percent to go buy back or stock um so they've kind of stopped doing that piece of it and if you only need to issue money for operations you probably have about the same amount of maturing uh as you do that you need to raise and so it was quiet so you just you had these you know dramatic influence of increased demand of pretty price indiscriminate buyers coupled with Supply way undershooting expectations simply because it probably didn't make a ton of sense to pay six percent to buy your stock back early some easier I mean a bit more difficult excuse me sell to a board to go along that path and so it just forced creditor um lots of demand not a lot of Supply well what happens prices go up so you you segmented me perfectly to talk about the the latter of corporate paper but like I want to tie that back into it like in a weird way is like you were talking about the pensions and and the reduction on the liability side I just think it's always interesting to me is like for the last I don't know decade plus people have been banging the drum that the the pensions are underfunded they're underfunded they're underfunded you know this is going to be a disaster it's a slow moving train waiting to happen and what always surprises me or makes me kind of giggle is that the the hidden forces of underlying markets tend to correct things more than people can and so like you know everybody always talks about uh wealth inequality et cetera you know the wealth inequality previously was that it's high in the 1920s well the 29 crash rectified that wealth inequality right markets tend to mean revert and and tend to take care of those things rather than politicians with a stroke of a pen and so it's always interesting to me that everybody was you know really upset about unfunded pensions and like you're saying now they're over funded and it all they took was you know rates coming back up and a little bit of a a protracted recession in 2022 to make that happen and it kind of throws everybody out the window so part of the one that where I'm tying it back in is um understandably you know a lot of people were really banging the drum previously like they can't raise rates they can't raise rates because if you raise rates to up to two to three percent you're gonna absolutely break the economy because people can't service that debt right we start getting fours and fives and all sudden everybody had to kind of recant their statements or they say they keep adjusting their numbers higher right like it's always interesting how the prognostication changes in real time uh but part of that was uh you know as some of our friends like uh Chris Cole Mike Green have said too is like if um you know the rates get too high these corporate uh entities are gonna start defaulting on mass and it's just going to be an absolute disaster but the problem is you may be able to call that but then the timing is difficult right you can have a thesis but then getting your timing right is an entirely different scenario so one of the things you brought up that I think is interesting is like when are you you know know issuing that paper and you create ladders over time and so it really depends on when those ladders are coming due and then more importantly can you refinance or repaper those positions it's not necessarily can you afford it it's just a in a Minsky sense it's like can you roll it over refinance it but more importantly when are those ladders coming due and does that give you a better sense of when that timing gets pushed back or when you see inflection points where that timing could be risky yeah so you know uh corporates acted responsibly unlike you know our our uh government of utilizing the really low interest rates to extend maturities and so you know IG space is it really extended maturities because I think they can borrow you know 50 years if they really want to right so investment grade doesn't have anything in our face um in terms of a maturity ladder high yield because they obviously can't issue well the market doesn't like to digest really long-term paper for high yield and so their maturity ladders you know kind of start waking up in 2024 and then the meat of it's you know 25 26 so it's like it's not in front of her face um so if we're going to start seeing defaults it's not going to necessarily come from inability to refinance um that paper it's going gonna come from actually you know not making money from operations becoming cash flow negative uh from actually operating your your business and you know but why that wasn't a big deal in 2022 is inflation is is good for all those folks if you borrowed a bunch of money and then you know your revenues are going up just based on inflation maybe you're you know real value-add uh in terms of of profits hasn't gone anywhere but your nominal has probably gone up um just because of inflation so 2022 was a fine environment for even you know let's call it not fantastic operators in in the high yield space 2023 that might actually change right you know we'll we'll see what Top Line looks like but I think the surprise might be a massive decrease in growth and actually inflation or at least the ability to pass through costs on the you know you know whoever you're selling your your services to uh get their services to that is potentially the problem right is actually a massively slowing in the ability to actually continue to raise prices and maintain any sort of margins um and you know wandering into a slowing growth potential recession whatever the heck it is you know could actually cause defaults in the high yield space even though there's not a maturity wall right in front of us so that's why I'm hyper focused on credit for 2023 not only is it you know I would call it too tight from you know kind of technical matters um that are abating uh at this point in time but also we're gonna have to start actually focusing on fundamentals maybe for the first time in a while and and those fundamentals might not be saying great things for for credit uh especially as we enter the back half there Earth um just from pragmatic sense what do you what do you use to track the maturity letters using like Fred data or and what are you looking at like how do you keep track of that yeah no they're you know make sure Bloomberg you can use Fred like it's actually not too hard to digest um kind of total outstanding debt um so culmination of all those sources is is kind of what you utilize to pay attention but yeah IG everybody kind of refinanced and you know latter half of 2020 2021 the 10 plus year maturities for for like kind of like weight of of the average issuance and so again investment rate is is not going to have problems anytime soon from a refinancing standpoint high yield you know kind of centers around five-ish year issuance right so that's why you know the meat of the the latter is kind of 24 five six um because they did most refinancing and you know 20 20 21. and then like I said that gives you the Aggregate and then if you want you could be a fundamental credit person and start picking and choosing your battles and right in that credit the other the thing you mentioned that it just shocks me that I have to keep reiterating this because you would think it's patent obvious but we're talking about rates inflation uh you know recession growth all these things right they come in waves and like you know if CPI numbers come down they can come back up like if anybody studied like the 1970s the waves of inflation were crazy all the intervening years of the 70s went up it went down and came back up again and it just seems like shocking to me that I can't keep having to bring this up it's like you know if we see inflation numbers come back down everybody thinks good if everything's great maybe rates come back down a little bit everybody's going to think like real estate and all these things are great again but we could easily see like I can't call the timing but let's just say the second half of this year you know inflation numbers come back up and everybody's gonna act like they're shocked and they got caught with their pants down it's like it's the most obvious thing historically it's nothing just everything works in waves and like I don't know like is that shocking that you have to say that like it just doesn't make sense to me yeah and I think part of it too is you know after prices move up 10 and then all of a sudden your comps are effectively you know that new price like yeah you know if it was a hundred bucks and that's 110 bucks you know it would have to be 121 dollars to be the same rate so it's like you know it's it just your your comps get easier and easier that are going to naturally kind of quiet the inflation numbers for a period of time and then then we'll you know see what happens if there is another wave or not um yeah I would I would agree that the focus on a month-to-month number um is probably misplaced let's uh let's talk about this Holy Trinity I would say of correlation liquidity and volatility right like they all kind of affect each other and you know what was the more interesting thing I guess in 2022 we started seeing correlations rise obviously with stock bonds um but even on my walk this morning I was listening to another podcast but uh Dylan Grice was on Alpha exchange and he was once again talking about correlation and volatility like we usually don't see spikes involved until we see spikes in correlation but it's interesting that you know uh other people like you and Chris Cole it's ever like I think you know illiquidity's tied more to volatility than necessarily correlation but like how do you how do you square that essentially like things were more correlated in 2022 and we saw you know medium-sized ball we didn't really see too many spikes involved so if correlations uh increase in in 2023 do we need to see illiquidity before we see a spike involved or how do you think about the the combination of those three factors I think most folks would say that high correlations cause the liquidity which then likely causes a significant change in volatility is like you know you're wandering path if you will um and yeah in 2022 High correlations didn't really cause significant bouts of illiquidity and basically any asset class um you know why do I think that's the case I think probably part of it is active managers were reasonably light on risk um and comparative to their historical standards so people that can quickly adjust their portfolio um you know we're kind of well positioned uh was was probably part of it and had ample liquidity um so that that probably muted uh the impact of high correlations into illiquidity you know kind of the next piece is the amount of passive investing um as a total you know percentage of all assets is is obviously incredibly High and a passive investor or you know investment product you know it's just fully invested there's no kind of like mechanics to force it to go ahead and and you know puke assets at any point in time so that's kind of quieter on that side and I think there's been a massive increase in private Investments and private Investments you know obviously not needing to necessarily Mark themselves day to day um also kind of provides a little bit of a buffer uh from high correlations driving massive increases in illiquidity and then potentially you know eventually volatility um and and the culmination of you know people being forced to sell things to live their lives uh you know they they had a buffer in in 2022 people had a decent amount of cash and or ability to you know extend credit on credit cards and whatnot um so they really weren't you know consumers didn't become necessarily forced to liquidate you know assets which can you know cause the waterfall so I I think it was the mixture of all those kind of things why a incredibly High correlation across all assets in in 2022 didn't really Drive bouts of illiquidity that most people might probably would have assumed would have taken place do you think part of that is like you you really need to get credit markets you need to see liquid credit markets or some volatility and credit markets or some sort of defaults or scares to see those true spikes in volatility yeah no I mean I I think you know credit markets are always going to be the the core of you know experience of massive illiquidity I mean that that's what you know March 2020 was actually scaring the the Fed was credit markets and treasury markets frankly like froze that's that's what matters like you know they didn't really care about the s p moving 10 every single day they weren't happy about it but that wasn't the focus do you think that um how do you think about like the B re and stuff like do you think that's foreshadowing and especially if we have all of these financialization and markets where we're trying to turn you know illiquid non-granular you know products into liquid products like and especially on the credit side does that do you think that's foreshadowing or this is just kind of an anomaly with the with the be read situation you know I wouldn't necessarily say it's foreshadowing but it definitely you know provides a little bit of extra kindling if we ever actually get to a massive illiquidity event right so it's like you know those types of vehicles likely help um you know starve off illiquity events until you get to a place where you can't fight it anymore and then cause a much bigger explosion than you would otherwise have that's right you mentioned uh Japan earlier and so I have a couple of questions about it I don't really have too much of an opinion here in the sense that like you know moving the the yield curve control band from 25 to 50 is that just a function of basically having a new head of the boj and you just wants a little bit more wiggle room or and or is this a sign that finally the the Widowmaker short ggb trade is back on and people should be taking advantage yeah I think it's a little bit more of the latter um the the amount of asset purchases that they were doing before they you know off meeting made that change was like 5x their normal daily asset purchases um so you know I think they were they were fighting it and they could sense that they were going to lose and possibly lose in a big way so again from a credibility standpoint you can't lose like you just change to make it seem like I always wanted to do this like you didn't force me to do what I wanted to do it um so yeah I think I think they're starting to lose a little bit of control but at the same time like as you said people have been fighting them and wrong for 20 years so you know it's it's kind of easy for them to bat people back um at this stage um so they'll they'll they they have you know they have some more life within them like before and some tools that they can do to you know act like the market that influence and make decisions they they did it on their own whim um but but yeah and I think they're getting to a little bit of a inflection point and their ability to control the markets as well as they have over this whole period um and anything the main reason is you you probably you know not only are things wound to a point that it's problematic but you you don't have the monetary and fiscal side of the houses probably operating in in line with each other um because you know inflation in Japan is a is a problem like you know their citizens are getting to a point where they're probably not very happy and thus you know the people that are elected officials are not very happy and they're gonna you know not want to move in the same way potentially as the monetary side of the house um and it's and then there and there are you know you know they're an island and they import a lot of things and so it's like it becomes hairy quickly for somebody like that yeah it's outside your uh purview or mandate for what you do at convex's house but I'm just wondering is that does that short Shady GB trade start to look tantalizing to you or is it still like this is just too hard and you can't predict the forces or pressures from the people running the boj yeah I mean I'd rather participate in in markets that are are not 100 manipulated because I I I'd like to think I have some Edge I don't have any Edge there like I I know what the fair value is and it doesn't matter and then just to bring it back out because you were you were my go-to when uh you know we started seeing the wonkiness in the guilt markets and it started to affect ldi and all sudden everybody you know learned what ldi meant um but one of the things that you described it on uh as a bridge loan and I thought that was a great way of describing it it gave me um a way to frame it and to think about what actually happened what transpired and why it was resolved so quickly so I guess because you have a little bit of a background in ldi especially even on the British side so can you kind of uh give kind of quick rundown on what happened there yeah so I mean the the quick rundown we were ready to talk about U.S pensions and it was like right a great year for U.S Mansions right um it's not dissimilar over in the UK um again what they care about is do they have enough assets to service liabilities if rates are going up liabilities are falling and you know probably their assets too but all in lockstep and and they you know fine way so why became an issue you know say they were 100 funded at the start of the year and you know on paper they were still 100 funded at the end of August and at the end of September too but their assets were not necessarily in liquid things um everybody when you have a very stable stable low interest rate environment probably get a little greedy and over in the UK their pension liabilities are discounted on a guilt plus linkers curve so that's treasuries plus tips basically um type of Curves there's no credit involved in their discount rate where the US again is kind of an air better curve so it is Credit in their discount rate So in theory you shouldn't own any credit if you're 100 funny you should have some guilts and linkers everything's in lockstep but over in the UK unlike you know the US most of these pension plans are still open I.E new employee is getting added to that Pension Plan they're not going into a you know 401K type of situation it's it's still a defined benefit Society um so because the pension plans open you may be fully funded with all the people you currently have working but a new liability just showed up because you hired a new person so the reason for B being a little bit of greedy in those plans is to hope that your assets can outperform your liabilities just enough you don't actually have to contribute any additional money for that new person that's being added to the pension plan and they're not going to take massive risk but they're gonna you know over time maybe start taking a little bit of risk and so you know the risk was okay we're gonna buy you know some UK corporate credit even though it's not at our discount rate like I want that extra you know 50 basis point spread I'll buy some high grade UK credit then the UK credit Market you know isn't as attractive as the U.S credit market so like oh let's buy some U.S credits you're adding a little you know going from you know guilt to credit okay that's adding a little bit of liquidity going from you know locally domicile credit to International credit that's a little bit more the liquidity um and then they started going into privates and infrastructure and things that have you know truly no instantaneous liquidity um you know they're off-market instruments um so that became their problem um in in August and September of last year that their their assets and liabilities were still you know call one one to one approximately there so the the actual pension was fine and not being damaged but when they needed some liquidity to support um a lot of the instruments in the derivative space that they they had on in their portfolio they didn't have the natural source of it because they had moved out the illiquidity ladder all the way into you know some privates and you can't post privates to The Exchange um for for supporting the collateral for your derivatives so when things were getting hairy you know the uh Bank of England reached out and said well you know what's the problem guys and they said well listen like we're totally fine trust me we're totally fine but I I mean two weeks I need two weeks to figure out this story because you know they're like we call Blackstone they're really happy to buy all of our privates but it's going to take them a little bit of time to do their needed due diligence and be a great agree to whatever haircut that it is to get her cash out um but that's it we just need a two-week Bridge Loan and they're like all right all right for two weeks guys rather than selling things we're gonna buy everything on the planet give you the you know Headroom to go ahead and figure things out and then everything's gonna be okay um and you know they were able to find us a buyer for their liquids in that two-week period and then hey you know the problem for the moment was was solved but yeah I think that you know most people are very focused on like oh the derivatives you know mass destruction and who the heck that one percent interest rates is you know having 100 Year duration in their portfolio all that kind of stuff like that's just folks that don't understand you know Alm I have you know asset liability management like they're they're not trying to make money in absolute terms they just want their assets and their liabilities to move in locksteps so they're going to own what their you know liabilities are discounted at which in that case is a decent amount of guilt and Linker risk and that's where derivatives came to play their error was not having a liquid portfolio not not the investment strategy in terms of the ability to hedge out those liabilities it was getting greedy and turning your portfolio from fully liquid to something that's you know less liquid well that's why like you said the the honey pennies of the world it didn't lead to a Cascade of consequences because like you said it's a bridge loan for illiquid you know you know Mark to Market have assets and whether they could Bridge it over that two-week period to get better pricing but there's you brought back a lot of memories for me actually because I realized we were having I vividly remember having this conversation with you while I was in a long layover in Paris at Charles de Gaulle Airport so like it's bringing back some weird memories for me but the further Nuance of the bridge loan though that think that you highlighted that was really interesting to me is it was a it's a sizing issue as well like if you're a very large pension right you have either an internal or an external team that are really managing a lot of those liabilities those linkers and even some of the derivatives for you but if you're a smaller pension you don't get great Management on that so there are a lot of they're getting pulled into commingled funds and those commingled funds weren't having like the capital calls like say at the beginning of 2022 or or in intervening periods of saying hey with a little more cash on the books we need to adjust the book around it was more like all sudden it was like there's not a problem there's not a problem now there's a huge problem and we're all in a co-mingled fund together so we're all going down together isn't that part of the Nuance as well yeah no the the the pensioners that actually were damaged in that event were the smaller plans that invested via a commingle product right because you're again like if you're doing everything and somebody managed accounts their issue was not having enough liquid Capital to continue to support holding on to those positions because you know the whole goal here is yeah you want your assets and your liabilities to match each other you just got to be able to hold that right and right that's much easier to achieve that if you're in simply managed accounts versus in a commingled product because a commingo product says hey we need more you know collateral there's not a natural source to go ahead and Achieve that in a co-mingle product so those coming out products actually did deliver um during that event and you know probably you know sold things at potentially in opportune times and actually were damaged um so there's always you know all all good ideas also need the uh right operational structure to to achieve those good ideas in the best format and um and a lot of a lot of uh you know investment Industries and and products a comingo product is often not the the right rapper to achieve your goals exactly well unfortunately we're running up on time here and I feel like where you and I are gonna have an ongoing theme of like we just keep pushing back the food talk to next time one of these days we'll do it we'll do a food pack because or maybe we need to start a whole new podcast uh as you know I've been texting you it's been interesting uh trying all these different hummuses from uh Lebanese Israeli and like it's actually made me think about markets in the same time too is like the uh comparison is the thief of joy and as you know like in that region like there's so many different varieties coming you know intermingling of countries you know from mercantilist economies it's like it's almost impossible to compare two hummuses and I just think of like all the things you and I were just talking about I'm trying to pull on here it's like there's just so many nuances in markets and otherwise you know I could spend 10 hours talking about these things so trying to cover five topics six topics in an hour is probably a terrible idea but I want to thank you for coming on again but uh plug away again uh website LinkedIn Etc oh uh I'll be why you want the www again that was good I was just gonna set you up see if you did it yeah just uh you know find us at quebecsoft.com as I said my business partner is forcing me to use LinkedIn this year so there'll be a decent amount of rando uh posts um of you know where we're attending things things where we write things like this the you know chats um but yeah please reach out and find us in those two places yeah and I don't I'm not sure if this will be out before you know we're going to be down in Miami together in probably less than 10 days for the week uh January 30th for all the hedge fund week uh if you happen to be down there say hi give a shout out we're happy to say hello grab a coffee whatever uh said thanks for coming on thanks as always Jason bye thanks for listening if you enjoyed Today's Show we'd appreciate if you would share this show with friends and leave us a review on iTunes as it helps more listeners find the show and join our amazing Community to those of you who already shared or left to review thank you very sincerely it does mean a lot to us if you'd like more information about Mutiny fund you can go to mutinyfund.com for any thoughts on how we can improve the show or questions about anything we've talked about here on the podcast today drop us a message via email I'm Taylor at mutinyfund.com and Jason is jason.com or you can reach us on Twitter I'm at Taylor Pearson in E and Jason is at Jason Mutiny to hear about new episodes or get our monthly newsletter with reading recommendations sign up at mutinyfund.com newsletter foreign [Music] this podcast is provided for informational purposes only and should not be relied upon as legal business investment or tax advice all opinions expressed by podcast participants or certainly their own opinions and do not necessarily reflect the opinions of music fan their Affiliates or companies featured due to Industry regulations participants of this podcast are instructed to not make specific trade recommendations nor reference best or potential profits listeners are reminded that managed features commodity trading Forex Trading and other alternative Investments are 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