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John Mousseau on Risk in the Fixed Income Market (Podcast) · Masters in Business

0:02
Speaker 1: This is Masters in Business with Barry Ridholts on Bloomberg Radio.
0:08
Speaker 1: This week on the podcast, I have a special guest.
0:11
Speaker 1: His name is John Mussou and he is president, CEO
0:14
Speaker 1: and head of fixed income trading at Cumberland Advisors, a
0:18
Speaker 1: firm that runs about three and a half billion dollars
0:21
Speaker 1: in mostly fixed income products. They do equity as well.
0:26
Speaker 1: I know Moose for a long time. He is David
0:29
Speaker 1: Kotok's right hand man, and I have been fishing with
0:33
Speaker 1: Moose up in Maine at the Shadow Federal Reserve event
0:37
Speaker 1: that takes place every summer for gee the better part
0:41
Speaker 1: of a decade. There aren't many people who understands, uh,
0:45
Speaker 1: the internal plumbing and the mechanicals of fixed income the
0:49
Speaker 1: way Moose does. He really is incredibly knowledgeable and insightful.
0:54
Speaker 1: And I think if you are anything interested in fixed
0:58
Speaker 1: income bonds, munis and how they actually are are traded
1:04
Speaker 1: on Wall Street, you're going to find this to be
1:06
Speaker 1: a fascinating conversation. So, with no further ado, my Master's
1:10
Speaker 1: in Business interview with John Mussau. This is Masters in
1:17
Speaker 1: Business with Barry Ridholtz on Boomberg Radio. My special guest
1:22
Speaker 1: this week is John Mussau. He is the CEO and
1:26
Speaker 1: Director of Fixed Income at Cumbling Advisors, a bond shop
1:30
Speaker 1: that manages over three point five billion dollars in assets.
1:35
Speaker 1: He is a chartered financial analyst and has his Masters
1:39
Speaker 1: in Economics from Brown John Mussou, Welcome to a shelter
1:45
Speaker 1: in place version of Masters in Business. I know John
1:49
Speaker 1: for a long time. We fish up in Maine every
1:53
Speaker 1: year in camp Co talk. We'll come back to that
1:56
Speaker 1: a little later. Let's talk a little bit about out
2:00
Speaker 1: your career. Tell us about your first job on Wall Street. Hi, Arry,
2:06
Speaker 1: Thanks Uh. I walked in off the streets in New
2:08
Speaker 1: York in the followed nineteen eighty and answered an ad
2:12
Speaker 1: from the New York Times for the Value Line Investment Survey.
2:14
Speaker 1: They gave me a quiz and hired me as an
2:16
Speaker 1: assistant securities analyst. I remember getting the Value line um
2:21
Speaker 1: papers that you would put into a giant three ring
2:25
Speaker 1: binder on updates on different companies and different sectors. That
2:29
Speaker 1: that was a couple of years ago. You know, it
2:34
Speaker 1: ran that way for a long time before they got
2:38
Speaker 1: to the Internet age. And what you did as a
2:40
Speaker 1: securities analyst there is you really wrote script to fit
2:44
Speaker 1: the model, uh for the stocks. They had a relative
2:47
Speaker 1: value model that ranks stocks. But like I said, it
2:50
Speaker 1: was a great place to learn. Still have a lot
2:51
Speaker 1: of friends from there. Met Jeff Finnick there who was
2:54
Speaker 1: my desk mate early on. And you know, the fact
2:59
Speaker 1: of the product still out there today, says a lot.
3:02
Speaker 1: And and Vinnick ended up at a little shop call
3:05
Speaker 1: Fidelity of Memory. So yes, the little shop call Fidelity.
3:08
Speaker 1: And I can remember him saying to me we were
3:11
Speaker 1: there out over a couple of beers. He goes, moos,
3:13
Speaker 1: if I ever had it really big, I'm going to
3:15
Speaker 1: buy a hockey team. And sure enough you did, and
3:19
Speaker 1: for sure, so so what did you go from value on?
3:21
Speaker 1: What was your next stop? From there? I spent the
3:24
Speaker 1: next twelve years at combined firms of E. F. Hutton
3:28
Speaker 1: and then Shearson after they took over Hutton, and did
3:31
Speaker 1: most of my work there in the beginning years for
3:33
Speaker 1: the government bond Department in the municipal d bond bond Department,
3:37
Speaker 1: and eventually ended up doing portfolio analysis at Hutton and
3:43
Speaker 1: ended up basically running a portfolio analysis group right to
3:47
Speaker 1: where we analyze municipal bond portfolios and suggested changes, and
3:53
Speaker 1: in I went to Lord Abbott and became the director
3:57
Speaker 1: of Municipal bond Management. Was a great spot. Learned a
4:01
Speaker 1: lot from Bob Dow who ran the firm and ran
4:04
Speaker 1: the fixed income area there, and I was there until
4:07
Speaker 1: the year two thousand, and that's the year I joined
4:10
Speaker 1: Cumberland Advisors. So you end up at come when advisors
4:15
Speaker 1: in the year two thousand, why did you gravitate more
4:18
Speaker 1: towards fixed income over equities? I really always enjoyed fixed
4:27
Speaker 1: income because of the way tied together UH math and
4:31
Speaker 1: the idea that all bond prices more or less moved
4:34
Speaker 1: in the same direction, but none of them moved in
4:38
Speaker 1: the same velocity UH and depending on maturities, etcetera. So
4:42
Speaker 1: it always had a lot more appeal to me. And
4:45
Speaker 1: it's it's funny because when I started a value line
4:48
Speaker 1: and you're actually analyzing earnings of companies, UH, I was
4:52
Speaker 1: excellent at predicting earnings and still couldn't figure out why
4:56
Speaker 1: I stopped might hit the earnings, but go down or
4:59
Speaker 1: go up, and bonds always tied together much more rationally
5:02
Speaker 1: for me. So that leads to a question I've heard
5:06
Speaker 1: over the years bonds called the smart money. Why is
5:10
Speaker 1: that is it? Is it that rationality that leads people
5:13
Speaker 1: to thinking bonds are are a little less uh random
5:18
Speaker 1: or emotional than stocks are. I think the idea is,
5:23
Speaker 1: particularly with innoscible bonds. You know, it's not my line,
5:27
Speaker 1: but I thought it was a great line. They don't
5:30
Speaker 1: make you rich, but they keep you rich. And the
5:33
Speaker 1: idea of bond investing over time and the compounding of interest, uh,
5:39
Speaker 1: it's it's terrific. And you know, you go back and
5:42
Speaker 1: look back to the early nineteen eighties when interest rates
5:45
Speaker 1: are high. If you had bought something like zero coupon
5:49
Speaker 1: strips at four percent interests or thirty years, it would
5:52
Speaker 1: have been very hard to replicate that anywhere else. When
5:56
Speaker 1: I think of bonds, I think of three factors that
5:58
Speaker 1: go into the specific value of a bond. It's the
6:03
Speaker 1: credit quality, the coupon or yield, and the duration. Is
6:07
Speaker 1: it that simple or our bonds just a mathematical formula. No,
6:12
Speaker 1: There's a lot more that goes into it. It's not
6:14
Speaker 1: just credit quality. It's relative credit quality. It's not just
6:19
Speaker 1: duration as a relative duration to the market, And it's
6:22
Speaker 1: the structure of bonds to call protection or lack of
6:25
Speaker 1: call protection, a convexity comes in. I mean, that's that's
6:28
Speaker 1: really a lot of those judgments are what you would
6:32
Speaker 1: call total return bond management. And that's where David Kotok
6:35
Speaker 1: is still the chairman of Cumberland and I agreed early
6:39
Speaker 1: on it was you know, we we we saw the
6:41
Speaker 1: world the same in the world of bonds. Explain convexity
6:45
Speaker 1: of bonds positions. To me, sure convexity is is really
6:51
Speaker 1: the They call it the second derivative. So if you
6:54
Speaker 1: look at a bond and you can judge it's duration
6:58
Speaker 1: or basically how much the price changes for a given
7:03
Speaker 1: change in yield, the convexity will tell you how fast
7:07
Speaker 1: that duration is changing. It's like the it's like the
7:10
Speaker 1: equivalent of acceleration to speed. Quite interesting and and for
7:15
Speaker 1: most of my career I've heard bonds describe as the
7:19
Speaker 1: adult supervision in the room. Um, the bond vigilantes. We're
7:25
Speaker 1: gonna keep the Congress in check and make sure they
7:28
Speaker 1: didn't deficit spend too much. They were going to keep
7:31
Speaker 1: their eyes on inflation and fight that. Whatever happened to
7:35
Speaker 1: the so called bond vigilantes. Boy, that was a while ago,
7:39
Speaker 1: and and you know, if you go back, one of
7:42
Speaker 1: Bill Clinton's favorite lines was, and I'm taking out the
7:46
Speaker 1: swear words, but you know, do you mean I I
7:49
Speaker 1: really have to bow down to all the bond traders.
7:53
Speaker 1: And the answer back then from Alan Greenspan is yes,
7:57
Speaker 1: you do. And they figured out a way back then
8:01
Speaker 1: to actually lower the government deficit and actually get it
8:05
Speaker 1: to a surplus. And along the way, interest rates came down,
8:08
Speaker 1: which was really not a surprise. Now you've gone the
8:12
Speaker 1: other way and the deferences really haven't mattered, and you're
8:16
Speaker 1: at all time losing yields. So to answer your question,
8:19
Speaker 1: a lot of that has been thrown at the door
8:22
Speaker 1: his his political advisor, James Carville, I believe, is the
8:26
Speaker 1: one who said when he comes back, he wants to
8:29
Speaker 1: be reincarnated as the bond market because everybody is terrified
8:33
Speaker 1: of it. Right, maybe not this bond market, but yes,
8:38
Speaker 1: so Moose, let's talk a little bit about how the
8:41
Speaker 1: bond market has changed over the past thirty years. What
8:45
Speaker 1: are some of the big differences between and I think
8:52
Speaker 1: there's some differences and there's some similarities. Barry. I think
8:55
Speaker 1: the biggest difference, of course, is electronic trading much more
9:00
Speaker 1: prevalent on the taxable side. On the municipal side, you
9:04
Speaker 1: actually still need to talk to dealers and underwriters, and
9:08
Speaker 1: that's because of the diffuse nature of the municipal bond market.
9:12
Speaker 1: The municipal bond market is still much more of a
9:14
Speaker 1: people business. You have to kind of know where the
9:16
Speaker 1: bonds are, where the levels are, who's offering what bonds.
9:21
Speaker 1: On the corporate side, it is much more electronic oriented,
9:25
Speaker 1: block trading oriented, uh and and that's been that's been
9:29
Speaker 1: the biggest change. So a lot less people, clearly, a
9:32
Speaker 1: lot less firms, and bigger volume electronically. So so let's
9:37
Speaker 1: talk about what I think is the most fascinating difference
9:40
Speaker 1: between stocks and bonds. You know the Wilshire five thousand.
9:44
Speaker 1: The joke is it's now about three thousand stocks, and
9:47
Speaker 1: in some of the over the counter and really small
9:51
Speaker 1: caps maybe have four thousand stocks. When we look at
9:55
Speaker 1: the worlds of bonds, there's hundreds of thousands of individual bonds.
10:00
Speaker 1: It's almost as if putting together a bond portfolio is bespoke.
10:05
Speaker 1: How infrequently do these bonds trade and how unique are
10:09
Speaker 1: each of these issues that are out there? Again, it
10:12
Speaker 1: differs when you're in the world of corporates and mortgages
10:16
Speaker 1: and treasuries. It's it's a fairly defined universe of bonds,
10:21
Speaker 1: and putting portfolios together is probably a little easier than
10:25
Speaker 1: on the tax free side, where you have probably have
10:29
Speaker 1: a million different QUE SIPs out there. And that's because
10:33
Speaker 1: of the nature of many bond issues that come to market,
10:36
Speaker 1: where they have serial bonds and term bonds, and so
10:40
Speaker 1: that just the amount of issues is almost overwhelming. So
10:45
Speaker 1: in the tax free side, only a fraction of the
10:49
Speaker 1: available bonds that are out there actually trade every day.
10:53
Speaker 1: And explain what Q SIPs are for the audience who
10:56
Speaker 1: may not be on a bond desk. It's it's a
11:00
Speaker 1: uniform identification system. So each bond has its own unique identifier,
11:06
Speaker 1: which is crucial to identifying the bond itself as well
11:10
Speaker 1: as processing the trade later on. And and let's talk
11:15
Speaker 1: a little bit about processing those trades. You know, early
11:19
Speaker 1: in my career and certainly early in your career, every
11:23
Speaker 1: brokerage firm had its own bond trading desk, every bank,
11:27
Speaker 1: every insured trading was done constantly all over the place. Today,
11:31
Speaker 1: it seems, uh and and I rely on my friend
11:34
Speaker 1: David Nadig, who's been pushing this argument for a long time.
11:38
Speaker 1: Not it says all that has been replaced with black
11:41
Speaker 1: Rock and Vanguard as as the new street bond desks.
11:46
Speaker 1: Is he exaggerating or how true is that? They're They
11:50
Speaker 1: are certainly behemous out there. But look, you know you
11:56
Speaker 1: can you can look at that and say does that
12:00
Speaker 1: with your advantage or not? As as a smaller investment
12:03
Speaker 1: advisor relative to those those guys, Uh, black Rock's not
12:08
Speaker 1: going to care about a twenty five million dollar water
12:11
Speaker 1: bond from Eastern Ohio some school district. We care about
12:18
Speaker 1: million dollar water bond from eastern Ohio because it's meaningful
12:22
Speaker 1: to us. So to the extent that they've gotten too
12:26
Speaker 1: big and a lot of issues aren't relevant to them,
12:30
Speaker 1: we can take advantage of that. So I would disagree
12:32
Speaker 1: with Dave a little bit and combling, are you guys
12:36
Speaker 1: putting together bespoke bond portfolios? Are you buying bond mutual
12:41
Speaker 1: funds or bondingtfs? How do you deliver a fixed income
12:46
Speaker 1: mixed to clients? Um? Now, we we will use individual
12:51
Speaker 1: bonds as we put portfolios together, and our own our
12:54
Speaker 1: thoughts have always been that the final product looks much
12:58
Speaker 1: better when you have individual bond ones as opposed to
13:01
Speaker 1: owning mutual funds, and part of that reason is the
13:05
Speaker 1: ability to input certain yield levels and duration levels into portfolios.
13:12
Speaker 1: You know. The other part two is just talking about
13:15
Speaker 1: mutual funds in general. The difference between owning a portfolio
13:19
Speaker 1: of individual bonds and owning a mutual fund of bonds
13:22
Speaker 1: is the fact that if you want a mutual funding,
13:25
Speaker 1: your subservient to one price and one price only, and
13:28
Speaker 1: that's the price of that fund at the end of
13:30
Speaker 1: the day, or if it's an et F, the price
13:31
Speaker 1: of that et F at the end of the day.
13:33
Speaker 1: If you own individual bonds, they can be spread out.
13:36
Speaker 1: You can have some longer term bonds and some shorter
13:38
Speaker 1: term bonds. So if there's a need for cash, uh,
13:41
Speaker 1: and maybe it's not a particularly good bond market, you
13:43
Speaker 1: can find assets in the portfolio that have not been
13:48
Speaker 1: hurt price wise and use them to your advantage. So
13:51
Speaker 1: I think individual bonds offers a much greater degree of flexibility.
13:55
Speaker 1: We've had some clients say to us, I don't want
13:57
Speaker 1: to own a bond mutual funds because I'm concerned if
14:01
Speaker 1: during a bond sell off, I'm subject to the whims
14:05
Speaker 1: of what my fellow mutual fund investors are doing, and
14:10
Speaker 1: that could drive the price below either fair value or
14:14
Speaker 1: net asset value. How realistic of a threat is that
14:18
Speaker 1: to people who are bond mutual fund investors as opposed
14:21
Speaker 1: to buying individual bonds themselves. I think it's a very
14:25
Speaker 1: good point because you don't have control over that. And
14:29
Speaker 1: the route we just went through is a perfect example
14:32
Speaker 1: of that. You walked in the dor March ninth, and
14:35
Speaker 1: treasury prices were skyrocketing because of the Saudis selling of oil. Uh.
14:40
Speaker 1: That meant that a lot of the corporate and municipal
14:42
Speaker 1: bond dealers couldn't hedge anything anymore with the prices and
14:46
Speaker 1: treasures doing what they are doing. So what do they do?
14:49
Speaker 1: They backed off their prices. So then the evaluation services
14:53
Speaker 1: don't have many prices to put on that night, so
14:57
Speaker 1: they take prices down. So the poor guy who's only
15:00
Speaker 1: holdings is x y Z bond fund looks at his
15:04
Speaker 1: NAV the next day is in that ascid value and
15:06
Speaker 1: it's gone down. He says, maybe I should sell some,
15:09
Speaker 1: so he sells something. The next day, the mutual funds
15:12
Speaker 1: have to meet these redemptions by selling bonds into a
15:15
Speaker 1: market that's already of routing. So prices get on further.
15:19
Speaker 1: The next day, the same investor looks at my NAV
15:22
Speaker 1: went down further. I bet ourselves some more. So now
15:24
Speaker 1: you've gotten yourself into a negative feedback loop of selling
15:28
Speaker 1: of mutual funds. And we saw that on an absolutely
15:32
Speaker 1: gargantuant level in the middle of March and HAWD they
15:36
Speaker 1: just wrote it out for a couple of weeks. The
15:39
Speaker 1: worst of it would have passed and we would have
15:41
Speaker 1: seen some sort of recovery in the in the mutual
15:44
Speaker 1: fund and fund market. Is that a fair statement? That
15:49
Speaker 1: is a more than fair statement. And it was not
15:51
Speaker 1: only a rebound, it was a rebound of historic proportions,
15:54
Speaker 1: so the back off was also historic. He went essentially
15:59
Speaker 1: from two percent at to four percent and about seven
16:01
Speaker 1: business days six business days, and then you rebounded three
16:05
Speaker 1: quarters of that in about three business days. I've been
16:08
Speaker 1: managing money for thirty six years. I've never seen anything
16:11
Speaker 1: like it. So we have a mutual friend from Fidelity,
16:14
Speaker 1: Eric Golden, who runs a quantitatively driven fixed income portfolio.
16:20
Speaker 1: He said he saw prices do things that the models
16:24
Speaker 1: say just can't happen. Your your experience sounds like it
16:28
Speaker 1: was very similar, very similar. And and I can tell
16:34
Speaker 1: you just from I mean, having put trades on. We
16:39
Speaker 1: saw bond prices down over twenty points and certainly some
16:44
Speaker 1: discounted bonds from lower coupons. So think about a bond
16:47
Speaker 1: that came in December at a hundred cents on the dollar,
16:51
Speaker 1: that was trading at seventy five cents on the dollar
16:53
Speaker 1: in mid March, and less than a week later was
16:56
Speaker 1: being priced at par. So if you were nimble, there
16:59
Speaker 1: was that capital, there was upside to be had. Oh sure, absolutely,
17:03
Speaker 1: you know. And a total return manager is going to
17:07
Speaker 1: use that type of a distress in the market to
17:11
Speaker 1: go and change the mix of his portfolios. And in
17:16
Speaker 1: our view, that sell off that you saw in March
17:18
Speaker 1: was not credit related. It was all liquidity related. Because
17:22
Speaker 1: of what was going on in the stock market. People
17:24
Speaker 1: wanted cash. It didn't matter whether it was in a bond,
17:27
Speaker 1: mutual fund, or a a reat or or anything else,
17:32
Speaker 1: I mean, or selling gold, and by the end of
17:35
Speaker 1: that week they were also selling treasury bonds. So anything
17:37
Speaker 1: to get cash. The old line is in an emergency.
17:41
Speaker 1: You sell what you can, not what you want. And
17:44
Speaker 1: that's true about the meltdown and mutual funds. You know,
17:47
Speaker 1: a mutual fund manager won't sell what he liked us all,
17:50
Speaker 1: which might be a I'm making it up a hospital
17:53
Speaker 1: bond that he leaned the wrong way on and buying
17:55
Speaker 1: and doesn't have the greatest credit in the world. It's
17:58
Speaker 1: exactly what you said, Barry. You tell what you ken saw,
18:01
Speaker 1: which is usually a high grade bond. So earlier we
18:04
Speaker 1: were discussing the dislocation and corporates and treasuries, let's talk
18:09
Speaker 1: a little bit about the muni market. From everything I
18:12
Speaker 1: heard and saw during the beginning volatility early in March,
18:19
Speaker 1: it looked like the muni bond market had just gone berserk,
18:23
Speaker 1: maybe maybe even the most severe dislocation of any of
18:27
Speaker 1: the fixed income trading we've seen. Tell us what happened?
18:32
Speaker 1: And so far have the markets uh recovered yet? Sure? Berry,
18:37
Speaker 1: I mean, it was certainly a March was certainly historic
18:40
Speaker 1: volatility and historic loss and almost historic rebounding. You know,
18:46
Speaker 1: I still I hearkened back to March nine, when treasury
18:50
Speaker 1: prices were spiking upward and yields were dropping, and that
18:54
Speaker 1: rendered most firms out there on Wall Street impotent to
18:59
Speaker 1: actually give you a bit on bonds because they couldn't
19:02
Speaker 1: hedge anything. So prices were backed off, and that combined
19:06
Speaker 1: with the stock market that it started to roll over,
19:08
Speaker 1: partly because the price of whale was dropping and there
19:11
Speaker 1: was concerned on the economy and the coronavirus picking up,
19:15
Speaker 1: and you suddenly had a perfect storm of dropping equity prices,
19:19
Speaker 1: people looking for cash wherever it could be, and that
19:22
Speaker 1: involved the selling of bond funds and bond ETFs into
19:27
Speaker 1: a market that was overwhelmed. So when you think about
19:30
Speaker 1: bond yields moving up from two percent to four that
19:35
Speaker 1: is a historic rise in a very short period of
19:38
Speaker 1: time two basis points and essentially a doubling of yields. Uh.
19:43
Speaker 1: And like I said, most of that was almost all
19:46
Speaker 1: liquidity related and not credit related. And and and yet
19:51
Speaker 1: there are concerns out there, but of course about municipalities
19:54
Speaker 1: and how they're going to fare through this. Our viewpoint
19:57
Speaker 1: on that is that most really kind of high quality
20:03
Speaker 1: general obligation and essential service bonds are going to be fine. Uh.
20:09
Speaker 1: You know what you end up doing is you're looking
20:11
Speaker 1: at the essentiality of a service through the prism of
20:13
Speaker 1: the virus, and things look a little different if you're
20:16
Speaker 1: talking about something like a rapid transit bond or an
20:19
Speaker 1: airport bond, etcetera. But that that was not the cause
20:22
Speaker 1: of the sell off in the mutual funds. So so
20:25
Speaker 1: this wasn't a systemic issue. This was just a massive
20:28
Speaker 1: amount of volume that overwhelmed the normal liquidity that exists
20:33
Speaker 1: in the bond market. That's exactly right, And you hadn't
20:38
Speaker 1: seen that before, where the meltdown in the bond market
20:42
Speaker 1: was occurring alongside a meltdown in the stock market. The
20:47
Speaker 1: last time you really saw that was in two thousand
20:51
Speaker 1: and eight, and that was after Lehman failed, And that
20:55
Speaker 1: sell off in municipal bond funds was credit related because
21:01
Speaker 1: nobody knew whether anything was gonna pay. In other words,
21:03
Speaker 1: when when Lehman went under, it was like the thirteen
21:06
Speaker 1: strike of a clock, and people wondered, oh, does that
21:09
Speaker 1: mean my school district is not going to pay off
21:12
Speaker 1: responds or that the water authority won't pay off respons
21:16
Speaker 1: It was really overdone, But but that was the nature
21:18
Speaker 1: of that sell off. So let's look at the current circumstances,
21:23
Speaker 1: which seemed to be not comparable to anything else that's
21:27
Speaker 1: come before, including O eight oh nine. Uncle Sam has
21:32
Speaker 1: shown an ability to keep running deficits for as long
21:36
Speaker 1: and as deeply as needs. But states and cities don't
21:41
Speaker 1: have that luxury. And we know that these states, and
21:44
Speaker 1: we know that these cities, especially areas like New York,
21:47
Speaker 1: New Jersey, Washington State, wherever the virus has has hit
21:51
Speaker 1: pretty hard. We're starting to see signs that's happening in Florida.
21:55
Speaker 1: How are these states going to operate if they can't
21:59
Speaker 1: run a deficit and have hundreds of millions or billions
22:04
Speaker 1: in shortfalls? Are these states potentially at risk for defaulting
22:10
Speaker 1: on whatever general obligation bonds they've issued. It's a good question, Barry,
22:16
Speaker 1: And what you look at is really twofold one. Almost
22:22
Speaker 1: all bond issuers have debt service reserve funds. Sometimes that
22:28
Speaker 1: can be a half year, sometimes a year. It depends
22:31
Speaker 1: on the depends on the issue. Will we see credit downgrades, absolutely,
22:36
Speaker 1: you're seeing it now. Will you see invasion of that
22:41
Speaker 1: service reserves? Sure? And you're gonna see thinner debt service
22:44
Speaker 1: coverage across the board. That's a given. We don't think
22:48
Speaker 1: you're gonna see massive defaults, especially if you come out
22:52
Speaker 1: of this within the next month or two. So what
22:54
Speaker 1: it what it is is, it's just a it's a
22:56
Speaker 1: torpedo out of the side of the ship, but the
22:58
Speaker 1: ship is going to continue to sail and then you
23:01
Speaker 1: start restoring debt service. Um. We think that there is
23:05
Speaker 1: a lot of federal support for certainly some of the
23:08
Speaker 1: bigger agencies out there. Let's take a very high profile one. Uh,
23:13
Speaker 1: look at the MTA in New York City with the subways.
23:16
Speaker 1: You can certainly think of you know, m t A
23:19
Speaker 1: as as a poster child for transportation, and transportation is
23:24
Speaker 1: certainly a poster child for infrastructure, and I think that's
23:30
Speaker 1: one thing that the administration is really keen on. So
23:33
Speaker 1: I I see certainly a lot of support for that.
23:36
Speaker 1: I see a lot of State of New York support
23:38
Speaker 1: for that. So I don't expect to see a default
23:41
Speaker 1: on that. It doesn't stop bonds from trading cheaper. We've
23:44
Speaker 1: seen that for sure, and that's that includes airport bonds
23:48
Speaker 1: as well. You look at the hub airports out there.
23:50
Speaker 1: The federal government is not going to have those airports
23:54
Speaker 1: go into default because they are necessary for the restoration
23:58
Speaker 1: of the economy when we're back working hopefully a month.
24:02
Speaker 1: We normally think of equity investors as the risk takers
24:05
Speaker 1: who were more greatly compensated for assuming that risk than
24:10
Speaker 1: the traditional bond investor. But I have to ask, given
24:13
Speaker 1: what you just said, what sort of compensation are risk
24:18
Speaker 1: takers receiving in the fixed income market these days? Well,
24:24
Speaker 1: you can you can argue that um look at a
24:28
Speaker 1: lot of deals that have come in the last week
24:31
Speaker 1: or so. The long end of the tax rebond market,
24:33
Speaker 1: the high grade end is restored itself to roughly about
24:36
Speaker 1: a three percent yield. That doesn't sound particularly high and
24:40
Speaker 1: like it doesn't sound like a particularly rewarding yield if
24:44
Speaker 1: you think about the potential for downgrades down the road
24:48
Speaker 1: or a thinning of debt service coverage, etcetera. It does
24:52
Speaker 1: look relatively cheap when you compare it to a long
24:56
Speaker 1: treasury bond of one thirty five. But I would contend
24:59
Speaker 1: the treasure are probably a little overbought in here, and
25:02
Speaker 1: municipal was maybe a little cheap, and they're gonna eventually
25:04
Speaker 1: meet in the middle. I think the important part is
25:07
Speaker 1: to keep the long term really economics of municipalities in
25:14
Speaker 1: the forefront when you're investing. If you went back to
25:17
Speaker 1: the worst period in our history, which is the Great Depression,
25:21
Speaker 1: and we don't think we're going back to that. You
25:24
Speaker 1: had about municipal entities in this country stopped paying their debt.
25:29
Speaker 1: Didn't mean they went bankrupt in a legal sense, but
25:31
Speaker 1: they just stopped paying. And in the end, as the
25:35
Speaker 1: economy turned around, they all, except for a few dust
25:39
Speaker 1: bowl towns in Oklahoma, almost all paid off their debt
25:44
Speaker 1: inter ears and got current on their debt and continue
25:47
Speaker 1: to pay. And that's because of the monopolistic powers that
25:50
Speaker 1: municipalities have. If a meteor came tomorrow and hit the St.
25:54
Speaker 1: Louis Water Authority, would they stop paying their debt? Yeah,
25:57
Speaker 1: most likely when they rebuilt things and started to get
26:01
Speaker 1: debt service again, where they repay it. Absolutely So, John,
26:06
Speaker 1: and all of this, we haven't talked about the mac
26:09
Speaker 1: daddy in the room, the Federal Reserve. What is the
26:13
Speaker 1: role today of the FED in the fixed income market?
26:18
Speaker 1: Barry role is probably more important than ever and you
26:22
Speaker 1: only have to look back at the last few weeks
26:23
Speaker 1: to figure it out. Uh, you look at the FED
26:27
Speaker 1: and how did they step in on this crisis. Well,
26:29
Speaker 1: the first thing is that they fixed the short term
26:31
Speaker 1: bond market. You think about things like revenue anticipation notes,
26:36
Speaker 1: bond anticipation notes. These are the things that money market
26:39
Speaker 1: funds invest in. Some of them are non rated, their
26:42
Speaker 1: their promises to pay. The bid dropped out of the
26:45
Speaker 1: market in the middle of this crisis in mid March.
26:48
Speaker 1: What the FED did is they established credit facilities that
26:51
Speaker 1: would buy these bonds from the money market funds, these
26:54
Speaker 1: rands and tans at their cost basis, not at the market,
26:57
Speaker 1: and give them cash. So that up the money market
27:00
Speaker 1: funds in business. And you can't really get uh an
27:04
Speaker 1: improvement in equities until you improve the bond market. So
27:07
Speaker 1: their first stop was to fix the short term bond market.
27:10
Speaker 1: Then you saw the legislation come in where the Treasury,
27:15
Speaker 1: through the FED as their agent, was going to start
27:18
Speaker 1: to buy municipal bonds one out of five years that
27:22
Speaker 1: have to be investment, greater, better, not how yield. They
27:25
Speaker 1: haven't done it yet, just the fact that they established
27:28
Speaker 1: it was enough to really improve the bond market. A
27:31
Speaker 1: couple of weeks ago. Is that package is putting together.
27:34
Speaker 1: So the Fed, through either their ability to do credit
27:38
Speaker 1: facilities or their special ability to buy bonds out through
27:42
Speaker 1: six months, which they have and have not exercised, and
27:45
Speaker 1: now the ability of the Treasury to go through the
27:48
Speaker 1: FED and try to buy bonds out through five years.
27:51
Speaker 1: All of that has helped shore up the market, and
27:53
Speaker 1: it's been very important. So the mirror announcement that hey,
27:58
Speaker 1: we have the ability to buy munis if you want to,
28:01
Speaker 1: is sufficient to stabilize the bond market absolutely, and and
28:07
Speaker 1: not only is stabilized the short term market, which is
28:09
Speaker 1: also in this array, but it helped to stabilize a
28:12
Speaker 1: long term market because within that confined there is the
28:16
Speaker 1: ability to take that beyond five years. I mean, Steve
28:20
Speaker 1: Manuchan can call up J. Powe and say we want
28:22
Speaker 1: this extended to fifteen or twenty or thirty years, and
28:25
Speaker 1: they could do that. Huh. I recalled during the eight
28:29
Speaker 1: o nine crisis, the big complaint I heard from the
28:34
Speaker 1: FED haters and the people wringing their hands over the
28:36
Speaker 1: various rescue packages was that the FED is adding three
28:40
Speaker 1: trillion dollars to their balance sheet. This is going to
28:43
Speaker 1: cause all sorts of trouble. Well, here we are a
28:46
Speaker 1: decade later, what is there five trillion on the way
28:49
Speaker 1: to six trillion. What does that mean for fill in
28:54
Speaker 1: the blank, the economy, fixed income inflation, For the FED
28:58
Speaker 1: to potentially have trillions and trillions on their balance sheet, Well,
29:03
Speaker 1: what did we learn from the oh eight o nine area,
29:06
Speaker 1: and actually was essentially three rounds of quantitative easy? It
29:11
Speaker 1: never created inflation. Even though you saw the FED take
29:15
Speaker 1: their balance sheet up to what was then record levels
29:17
Speaker 1: and they were buying treasuries, agencies, and mortgages. The key
29:21
Speaker 1: to that was the fact a they were trying to
29:23
Speaker 1: keep rates lower, but it didn't create inflation. Because if
29:27
Speaker 1: they bought a hundred million dollars worth the treasuries, and
29:30
Speaker 1: they bought it from the Bank of Barry Rithholtz and
29:32
Speaker 1: deposited a hundred million dollars at two o'clock in the afternoon,
29:35
Speaker 1: the Bank of Barry Ridholts put that money back on
29:38
Speaker 1: deposit at the FED learning a quarter of percent. What
29:41
Speaker 1: it was not doing was lending the money out, So
29:45
Speaker 1: the velocity of money and the expansion of money that
29:48
Speaker 1: way was not happening. The quantitative easy was effectively keeping
29:52
Speaker 1: rates in a certain range. What could cause inflation is
29:57
Speaker 1: the two trillion plus early more money coming on the
30:02
Speaker 1: government spending side, and that's what you didn't have. I mean,
30:04
Speaker 1: you had eight hundred billion in programs back in the
30:09
Speaker 1: O eight o nine crisis that is going to be
30:13
Speaker 1: tripled or quadrupled. Here, I would remember that, remember that
30:18
Speaker 1: eight hundred billion was three billion was a temporary tax cut,
30:22
Speaker 1: three hundred billion was a temporary extension of unemployment benefits.
30:27
Speaker 1: The pure stimulative fiscal part of it was barely two
30:32
Speaker 1: hundred billion dollars, right, And you saw some other things
30:36
Speaker 1: like the BABS programs, et cetera. You might see a
30:38
Speaker 1: resurrection or something like that that's being built American Build
30:42
Speaker 1: America bonds, Build America bonds, which was really to try
30:46
Speaker 1: to get municipalities to borrow in the taxable market because
30:50
Speaker 1: the at that point treasuries were at three and long
30:54
Speaker 1: tax remonds were at six, so that it was really
30:56
Speaker 1: ineffective borrowing. So this allowed them to get a thirty
30:59
Speaker 1: five percent subsidy from the federal government, really lowered their
31:03
Speaker 1: borrowing costs to something under four percent. And they were
31:07
Speaker 1: essentially building new things. So I think about an airport
31:11
Speaker 1: building a new runway, or a state university building a
31:14
Speaker 1: new dorm where they're pointing concrete, hiring people building stuff.
31:18
Speaker 1: That was the stimulative nature of it. Whether we see
31:21
Speaker 1: something like that here. We don't know that the administration
31:25
Speaker 1: has announced a two trillion dollar infrastructure policy, but we
31:29
Speaker 1: haven't seen any particulars on it yet. I would I
31:31
Speaker 1: would think though, that if you don't get inflation down
31:34
Speaker 1: the road from this amount of government spending, then we
31:37
Speaker 1: might never see inflation. Huh. That's that's quite that's quite fascinating.
31:42
Speaker 1: So let's let's talk about the opposite of inflation. Let's
31:47
Speaker 1: talk about deflation and negative rates. When when you started
31:52
Speaker 1: your career, did you ever imagine a set of circumstances
31:56
Speaker 1: where rates could go negative? Uh? Oh, And I guess
32:00
Speaker 1: one of the nice things of having a long career
32:02
Speaker 1: is I've seen the peak and interest rates, and I've
32:04
Speaker 1: seen the loan interest rates. Uh like forever you know,
32:09
Speaker 1: you you don't think about negative interest rates when you
32:13
Speaker 1: think about textbooks back in the nineteen eighties or seventies
32:17
Speaker 1: or even even nineties. But you saw negative interest rates,
32:21
Speaker 1: and you saw them in Europe over the last year.
32:23
Speaker 1: So you get back from this particular crisis and go
32:27
Speaker 1: through last year, you saw negative rates not here. And
32:30
Speaker 1: our interest rates dropped in the US last summer, really
32:34
Speaker 1: not because the economy here is foundering, but because our
32:37
Speaker 1: rates are too high relative to what was going on
32:39
Speaker 1: around the world. UH. And all negative rate means is
32:43
Speaker 1: that you're expecting rates to go more negative, so you
32:45
Speaker 1: want to lock in something. Losing half a percent is
32:49
Speaker 1: better than losing one percent, so you want to lock
32:51
Speaker 1: that in. I think Europe was coming to the agreement
32:56
Speaker 1: that this was not good for banks. UH. And you
33:00
Speaker 1: saw a lot of noise and some movement, and before
33:03
Speaker 1: all this you would start to see rates rise. So
33:06
Speaker 1: Germany had gone from negative tenure bond rates to actually
33:10
Speaker 1: positive rates UH. In the last in the last few
33:13
Speaker 1: weeks they have gone from negative like minus point nine
33:17
Speaker 1: to up to minus point three. So I think we're
33:19
Speaker 1: gonna move out of the negative interest rate range over time.
33:23
Speaker 1: And I think the idea is if you can get
33:26
Speaker 1: back to a world where you have a steeper yield
33:29
Speaker 1: curve than the banks are in the shape to make money,
33:31
Speaker 1: and you need a decent banking system and a banking
33:34
Speaker 1: system that's in financial health and can make money to
33:36
Speaker 1: get the economy movement they used to call it the
33:40
Speaker 1: zero bound for a reason. I guess we can't use
33:43
Speaker 1: that phrase anymore. Um So, so it sounds like you're
33:47
Speaker 1: not looking at rates going negative from here, even if
33:51
Speaker 1: we have a pretty substantial rescue package. No. I think
33:57
Speaker 1: what you'll see is you will actually see rates turn positive.
34:01
Speaker 1: I think you'll see a more positive looking yield curve.
34:05
Speaker 1: And I think if all the kind of government stimulus
34:09
Speaker 1: that you see, that should produce a positive yield curve
34:12
Speaker 1: because you think you would start to build out inflation
34:14
Speaker 1: are expectations as you go further out, and that's reflected
34:18
Speaker 1: in the shape of the yield curve as well. So
34:20
Speaker 1: that leads to the obvious question, are we ever going
34:24
Speaker 1: to see inflation in our lifetime? I think so. And
34:30
Speaker 1: you know, if you look, if you look last year
34:32
Speaker 1: at the kind of the middle part of the year,
34:37
Speaker 1: you had a cover of Business Week and it had
34:39
Speaker 1: a picture of some kind of animal and it said
34:42
Speaker 1: says the death of inflation. That was good enough for
34:44
Speaker 1: me to realize that inflation is probably coming back. It
34:49
Speaker 1: takes a while, and it will take a while to
34:51
Speaker 1: build up, and I think you wonder about where where
34:55
Speaker 1: will it end up, what asset class will it end
34:57
Speaker 1: up and we've seen some of the FEDS actions in
35:00
Speaker 1: the past. It ends up and maybe small cat stocks,
35:03
Speaker 1: or it ends up in the housing market. Does this
35:05
Speaker 1: time does it end up in commodities which are are
35:08
Speaker 1: you know, it's been severely depressed. You would think that
35:12
Speaker 1: if you come out of this mess, those kind of
35:15
Speaker 1: traditional things like copper and timber and things of that
35:19
Speaker 1: nature would start to do well, and so I would
35:21
Speaker 1: start to think you'd see some inflation. And yet throughout
35:25
Speaker 1: this whole post credit crisis recovery period, we've seen a
35:30
Speaker 1: huge uptick in multi family housing construction. We've seen a
35:34
Speaker 1: lot of sectors of the economy over the past twelve
35:38
Speaker 1: years slowly come back online, and still no inflation. So
35:45
Speaker 1: what's gonna be the the spark that lights that fire?
35:50
Speaker 1: You know, it's hard to say very because I think
35:55
Speaker 1: what's gonna be going on here is a lot of
35:58
Speaker 1: it based on demographic and what you're gonna see is
36:04
Speaker 1: the millennials, who if you draw a bell cover the millennials,
36:08
Speaker 1: the biggest part of that curve is just starting to
36:10
Speaker 1: turn thirty and they're just starting to get into the
36:13
Speaker 1: years where uh they will start to spend money on
36:17
Speaker 1: family formation and all the things the baby Boomers did,
36:21
Speaker 1: except maybe a little more delayed and and a little
36:24
Speaker 1: more delayed, partly because of the financial crisis of two
36:27
Speaker 1: thousand eight oh nine. So kids will got out of
36:30
Speaker 1: college between say two thousand and eight and two thousand eleven.
36:34
Speaker 1: We're really behind the eight ball a little bit in
36:36
Speaker 1: terms of getting jobs, are getting the quality of jobs
36:39
Speaker 1: that people just a couple of years younger gut later on.
36:42
Speaker 1: So even they are now approaching that point of liftoff
36:46
Speaker 1: from a spending standpoint. And if you look at the
36:48
Speaker 1: millennials as a group, they are bigger than the Baby boomers.
36:52
Speaker 1: So I think that's where it's going to come from.
36:54
Speaker 1: Quite interesting. So normally, if we were in the Bloomberg office,
36:58
Speaker 1: I would be asking my ten favorite questions, but we
37:02
Speaker 1: don't have the full ninety minutes to do that. So
37:04
Speaker 1: I'm just gonna give you a speed rounds. Five questions,
37:08
Speaker 1: quick answers. Let's plow right through this. What are you
37:12
Speaker 1: streaming these days? Give us your favorite Netflix, Amazon Prime, Uh,
37:17
Speaker 1: Disney Plus shows. I am back watching all the Ken
37:21
Speaker 1: Burns specials on baseball, World War, Prohibition, etcetera. So you know,
37:28
Speaker 1: you're never too old to learn, and you're never too
37:29
Speaker 1: old to relearn. Huh. Quite interesting. Who were your early
37:34
Speaker 1: mentors who influenced your career? Um? Really, when I look
37:39
Speaker 1: back at a man named Billy gow At E. F.
37:41
Speaker 1: Hutton who was a public finance banker, and he really
37:45
Speaker 1: kind of took a liking to me and got me
37:47
Speaker 1: into the municipal bond area, and then later on Bob
37:50
Speaker 1: gao at Lord Abbott. Tell us about your favorite books?
37:53
Speaker 1: What are you reading? What do you like to give
37:55
Speaker 1: his gifts? I'm big into history. Um, you know, one
38:00
Speaker 1: of my favorite books was Rise and Fall of the
38:02
Speaker 1: Third Reich, which was a tumb by William Shier. I
38:06
Speaker 1: go back and read for You to Choose by Milton
38:08
Speaker 1: Freedman every once in a while to make sure I'm
38:10
Speaker 1: or he handed the right way, and I'm I'm trying
38:12
Speaker 1: to read the Ulysses Grant biography right now by Ron Turner.
38:17
Speaker 1: Quite quite interesting. A recent college graduate considering a career
38:21
Speaker 1: and fixed income comes to you and ask for some advice.
38:25
Speaker 1: What would you tell them? I would say, find a
38:30
Speaker 1: spot on any firm and do everything they asked, from
38:33
Speaker 1: sweeping the floors to uh, you know, make sure you
38:37
Speaker 1: show up the first one there every day and find
38:39
Speaker 1: a mentor. But I would give that advice to anybody
38:42
Speaker 1: that's starting out, if you can find a mentor. Uh
38:45
Speaker 1: and and even if it takes you a few years,
38:48
Speaker 1: it is well worth it because you have somebody to
38:50
Speaker 1: bounce ideas off of. And our final question, what do
38:53
Speaker 1: you know about the world of fixed income today? You
38:56
Speaker 1: wish you knew forty years ago when you were first
38:59
Speaker 1: starting out. I wish I had known the importance of
39:04
Speaker 1: international flows and currencies. Um. You know, as a as
39:08
Speaker 1: a municipal bond expert. Back forty years ago, you didn't
39:13
Speaker 1: realize the importance of international flows and how they would
39:17
Speaker 1: affect me. So the fact is that the change in
39:21
Speaker 1: the Chinese currency would affect municipal bond invest he would
39:24
Speaker 1: never occur to you. It definitely affects it today. So
39:27
Speaker 1: I think that's the one thing that I've learned quite
39:30
Speaker 1: quite interesting. We have been speaking with John Mussau. He
39:33
Speaker 1: is president, CEO and director of fixed income Trading at
39:37
Speaker 1: Cumberland Advisers. If you enjoy this conversation, well be sure
39:41
Speaker 1: and come back for the podcast extras when we keep
39:43
Speaker 1: the tape rolling and continue discussing all things fixed income.
39:48
Speaker 1: We love your comments, feedback and suggestions right to us
39:51
Speaker 1: at m IB podcast at Bloomberg dot net. Give us
39:55
Speaker 1: a review on Masters and Business at Apple iTunes. I
39:59
Speaker 1: would be remiss if I did not thank our crack
40:01
Speaker 1: staff that helps put these conversations together each week under
40:06
Speaker 1: trying conditions from various remote locations. Michael Boyle is my producer.
40:12
Speaker 1: Jolie Volmer is my audio engineer. Michael Batnick is my
40:16
Speaker 1: head of research. I'm Barry Hults. You've been listening to
40:20
Speaker 1: Masters in Business on Bloomberg Radio