Latest / Bloomberg Intelligence / Bond Market Implies U.S. Recession in Late 2018, 2019: Sri Kumar

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Bond Market Implies U.S. Recession in Late 2018, 2019: Sri Kumar · Bloomberg Intelligence

0:05
Speaker 1: Welcome to the Bloomberg p m L Podcast. I'm pim Fox.
0:08
Speaker 1: Along with my co host Lisa A. Bramowitz. Each day
0:11
Speaker 1: we bring you the most important, noteworthy, and useful interviews
0:15
Speaker 1: for you and your money, whether you're at the grocery
0:17
Speaker 1: store or the trading floor. Find the Bloomberg p m
0:20
Speaker 1: L Podcast on Apple Podcasts, SoundCloud, and Bloomberg dot Com.
0:33
Speaker 1: Very early Saturday morning, Senators Republican Senators passed an overhaul
0:39
Speaker 1: of the tax bill that may be the most sweeping
0:41
Speaker 1: legislation that we have seen in decades. Here to talk
0:45
Speaker 1: about what the economic implications are. As Street Kumar, President
0:48
Speaker 1: and founder of three Kumar Global Strategies. He is also
0:52
Speaker 1: a Bloomberg prophet and is based in Santa Monica, California,
0:55
Speaker 1: but he joins us here in our cold ear than
0:58
Speaker 1: Santa Monica, but lovely eleven three our studios three. Thank
1:01
Speaker 1: you so much for joining us. I want to start.
1:04
Speaker 1: I want to start with all of these stories and
1:06
Speaker 1: analyzes that are reading about the implications of this tax plan.
1:11
Speaker 1: Has anyone read it? I doubt it when you consider
1:15
Speaker 1: that in the last couple of hours as they were
1:18
Speaker 1: negotiating and talking, Lisai the more most important thing was
1:23
Speaker 1: as a Republican, they all had to go ahead and
1:25
Speaker 1: vote for this bill because they wanted a legislative victory
1:29
Speaker 1: before the end of the calendar year. So they got it.
1:33
Speaker 1: And I think that you hear that parts of it
1:37
Speaker 1: were handwritten, and you have seen that on TV, saying
1:40
Speaker 1: that they didn't even have time to to type it.
1:43
Speaker 1: All of this leads me to believe that people voted
1:46
Speaker 1: for a tax bill they had not fully read. All right,
1:50
Speaker 1: that said, is there a way to assess in a
1:53
Speaker 1: preliminary fashion what the implications are based on sort of
1:57
Speaker 1: bare bones assumptions of what is in the bill? Bare
2:01
Speaker 1: bones assumption And again, as you will know, there is
2:04
Speaker 1: a difference between the Senate approach and the House approach,
2:07
Speaker 1: which needs to be reconciled. But that being set aside,
2:12
Speaker 1: it doesn't look like it is going to have much
2:14
Speaker 1: of an economic impact at all in terms of stimulus.
2:18
Speaker 1: I'm not one who believes that just because you have
2:21
Speaker 1: a tax cut of some kind it is automatically stimulative.
2:25
Speaker 1: It depends on what the tax cuts are, what it
2:29
Speaker 1: is oriented to words. For example, you need employment tax
2:33
Speaker 1: credit to hire to give stimulus to hiring, and the
2:37
Speaker 1: other hand, you cannot do things which are which appeared
2:40
Speaker 1: to be done to meet some few powerful interest groups,
2:44
Speaker 1: and that's not the way you're going to get the
2:46
Speaker 1: benefit out of this tree. Let's talk about an interest
2:50
Speaker 1: group that we're fond of. Investors, what investments do you
2:53
Speaker 1: believe will prosper as a result of the bill as
2:56
Speaker 1: you know it, and what investments would you stay away from?
3:00
Speaker 1: I think clearly, overall, PIM, you're seeing that the risk
3:04
Speaker 1: on investments are benefiting today, and you are taking more
3:08
Speaker 1: of a risk. I think the market is assuming that
3:12
Speaker 1: in addition to the yell And put and the Bernankey
3:15
Speaker 1: put that they have had in the past, they are
3:18
Speaker 1: going to have some form of a Trump put as
3:21
Speaker 1: well from the fiscal side, and so they are going
3:24
Speaker 1: to have more of speculation building up. So how it ends,
3:29
Speaker 1: it's hard to say and when it will end, but
3:31
Speaker 1: I think overall, all kinds of risk on strategies are
3:34
Speaker 1: going to benefit for a while from both monetary and
3:38
Speaker 1: fiscal policy. Suggesting that they are concerned about the stock market,
3:43
Speaker 1: the President himself has said several times that the stock
3:47
Speaker 1: market going up is a sign of the success of
3:50
Speaker 1: his policies, so he's going to do everything he can
3:53
Speaker 1: to keep pushing up the equities as well. So to
3:55
Speaker 1: you and Grace Sory about the consensus that seems to
3:59
Speaker 1: be uh coming together about no recession until late early
4:06
Speaker 1: do you agree with that I have actually pulled forward
4:09
Speaker 1: my expectation for a recession, Lisa. I used to be
4:12
Speaker 1: thinking that you had a late twenty nineteen, but I
4:15
Speaker 1: wouldn't be surprised to pull it forward by close to
4:19
Speaker 1: a year to late twenty eighteen or early twenty nine.
4:23
Speaker 1: Where am I getting my information from? Just to be
4:25
Speaker 1: clear that a recession would start the recession to date,
4:28
Speaker 1: and here is where I would mention that the two
4:32
Speaker 1: to ten year treasury spread is a very important indicator
4:36
Speaker 1: to me. And look at what has happened today, with
4:40
Speaker 1: all the euphoria in the equity market, the bond market
4:43
Speaker 1: has hardly budged. The two to ten years spread remains
4:47
Speaker 1: at fifty eight and a half basis points and below
4:51
Speaker 1: seventy five basis points. The curve typically inverts about a
4:55
Speaker 1: year later. It is going down. It is narrowing at
4:59
Speaker 1: a significant rate. From about September we have narrowed quite
5:03
Speaker 1: a bit and you if you go back to Christmas,
5:08
Speaker 1: you had a hundred and thirty five basis points spread
5:10
Speaker 1: between two and ten in about twenty twenty one December
5:15
Speaker 1: last year, So you've had a significant narrowing. And I
5:20
Speaker 1: wouldn't be surprised to see if in two or three
5:23
Speaker 1: months that goes down to a very low of state
5:26
Speaker 1: twenty or thirty basis points, down from fifty eight and
5:29
Speaker 1: a half. Then you're talking about recession being a year away.
5:34
Speaker 1: So let's say maybe not twenty late twenty eighteen, but
5:37
Speaker 1: early twenty nine. Is what the bond market is telling me.
5:42
Speaker 1: Right now, what is the higher bond market telling you?
5:45
Speaker 1: The high bond markets shows me that it has stabilized.
5:49
Speaker 1: We had the spread increase in late October early November.
5:54
Speaker 1: We went up, went up from about three hundred and
5:57
Speaker 1: seventy basis points close to four hundred basis points. There
6:00
Speaker 1: was a lot of worry, and my reaction then was
6:04
Speaker 1: this is not yet time to worry or to panic
6:07
Speaker 1: about the high held bond market. The bubble will indeed
6:10
Speaker 1: get bigger. You can play the bubble for a longer
6:13
Speaker 1: period of time. And we have then since stabilized and
6:16
Speaker 1: we have gone back to seventy and the reason for
6:19
Speaker 1: that is the high held market, I believe also looks
6:23
Speaker 1: at the two to tents spread on the treasuries and
6:25
Speaker 1: says that recession is not imminent. Defaults are not going
6:29
Speaker 1: to surge right away, so we have some time to
6:32
Speaker 1: enjoy the high returns from high yield. Thank you very
6:37
Speaker 1: much for repeating with us. There's pleasure. You're very welcome.
6:40
Speaker 1: You don't just just quickly. Do you think there's gonna
6:42
Speaker 1: be really any big change in the Tacks overhaul bill
6:45
Speaker 1: between the Reconciliation Senate House. I don't believe that it's
6:49
Speaker 1: going to be much of a change, Pim. I think
6:52
Speaker 1: the Republicans are very happy at the Senate victory they
6:55
Speaker 1: had early Saturday morning, and I think this is going
6:58
Speaker 1: to be a signific week in legislative victory and the
7:01
Speaker 1: only legislative victory in the first year of the presidential administration.
7:06
Speaker 1: So I think the House, led by Speaker Paul Ryan,
7:09
Speaker 1: he's going to essentially sign off and make sure anything
7:12
Speaker 1: gets approved. So I think it's going to happen. Thank
7:15
Speaker 1: you very much. Kamar Shri Kamar. He is the president
7:18
Speaker 1: and founder of Shri Kamar Global strategies. He is also
7:21
Speaker 1: a Bloomberg prophet and he is based in Santa Monica
7:25
Speaker 1: and you can follow him on Twitter at shri k Global. Well,
7:50
Speaker 1: the pharmacy chained CVS Health we know has agreed to
7:53
Speaker 1: buy the health insured ETNA price tag about sixty billion
7:56
Speaker 1: dollars in cash and stock. It will retain its current management.
8:00
Speaker 1: This will bring together one of the largest providers of
8:02
Speaker 1: pharmacy services with the number three US health ensure. Here
8:07
Speaker 1: to help us understand this deal more is Tara La Chapelle,
8:11
Speaker 1: our deals columnist for Bloomberg Gadfly. You can follow Tara
8:15
Speaker 1: on Twitter at Tara l a c H and also
8:19
Speaker 1: with us. Michael Ray, founder, Chief Executive RX Saving Solutions,
8:22
Speaker 1: based in Overland Park, Kansas. Michael, I just want to
8:25
Speaker 1: begin with you. Does this deal give the combined entity
8:30
Speaker 1: more power over hospitals and drug makers? Absolutely? I mean
8:34
Speaker 1: the bargaining power of this company is going to be tremendous.
8:38
Speaker 1: When you look at the setup of the new arrangement,
8:41
Speaker 1: you know, CBS goes from owning providers to owning the PBM,
8:46
Speaker 1: to the pharmacy and now the payer. So it's a
8:49
Speaker 1: tremendous bargaining ship for them Tara. A lot of people
8:53
Speaker 1: are talking about this as though it's a done deal.
8:56
Speaker 1: It makes a lot of sense with respect to competing
8:59
Speaker 1: against Amazon dot Com. You think, perhaps it's going to
9:02
Speaker 1: take a really long time, and maybe that's not the
9:04
Speaker 1: worst Thingsolutely and the companies are definitely anticipating this. If
9:08
Speaker 1: you look at their press release this morning, they really
9:11
Speaker 1: played up the consumer aspect that this is going to
9:13
Speaker 1: be great for consumers, great for patients and people that
9:16
Speaker 1: have end insurance UM. So they're anticipating a long fight
9:19
Speaker 1: I think with the government over this. I mean, this
9:21
Speaker 1: is the second extremely large vertical merger we're seeing this year.
9:26
Speaker 1: UM A T and T. Time Warner of course is
9:29
Speaker 1: now UM in a lawsuit against the d o j
9:32
Speaker 1: UM trying to get their own deal through, and it's
9:34
Speaker 1: very similar. Even though they're different industries, it's similar in
9:36
Speaker 1: their respect that they are expanding into a different line
9:38
Speaker 1: of business and they're going to consolidate a lot of power.
9:41
Speaker 1: But I don't think that this regulatory process is necessarily
9:44
Speaker 1: a bad thing, because CBS needs some time to figure
9:46
Speaker 1: out how they're going to get their finances in order
9:49
Speaker 1: to pay for this right. So before we get into
9:51
Speaker 1: the financing, Michael, I just want to get your take
9:53
Speaker 1: on something Terris said, which is, the companies are painting
9:57
Speaker 1: this as a consumer positive of a fair Do you
10:01
Speaker 1: agree that necessarily it is? Uh, that's to be determined.
10:06
Speaker 1: I mean, I think that the opportunity for them to
10:08
Speaker 1: put tremendous efficiency measures in place and save the system
10:12
Speaker 1: a tremendous amount of money is there. Uh. That said,
10:15
Speaker 1: these are public companies trying to maximize profit, and this
10:19
Speaker 1: type of arrangement also provides them an opportunity to extract
10:22
Speaker 1: enormous profit. So I think that, you know, the talking
10:26
Speaker 1: points in the action will be something that will be
10:28
Speaker 1: really important to follow over time. Well, Michael, in that
10:32
Speaker 1: in that same context, if the combination goes through and
10:36
Speaker 1: they have more power over hospitals and drug makers, where
10:41
Speaker 1: they're going to get the savings from themselves in terms
10:44
Speaker 1: of their own efficiencies, or more likely perhaps from the
10:47
Speaker 1: very hospitals and the very drug makers which now really
10:51
Speaker 1: don't have I mean, it's just one big entity and
10:55
Speaker 1: they're not going to have a competitor to play them
10:56
Speaker 1: off against or Am I wrong? Right? I think that
10:59
Speaker 1: that's what you see as you'll see, just a more
11:01
Speaker 1: powerful uh, a more powerful entity from a bargaining standpoint,
11:05
Speaker 1: you gotta play ball with them. Um. So if you're
11:07
Speaker 1: if you're a hospital or if you're a drug drug maker, UM,
11:12
Speaker 1: you know you can't. You can't neglect them or or
11:14
Speaker 1: stiff farm them. They're so big that you have to
11:17
Speaker 1: you have to try to do something. So that's that's
11:19
Speaker 1: where they could extract, you know, deeper discounts. Um. Also
11:22
Speaker 1: a place where they've got kind of a captive audience
11:24
Speaker 1: where they own the whole paradigm from point of prescribing
11:28
Speaker 1: to point of fulfilling a prescription and everything in between. Uh,
11:33
Speaker 1: that's where it could be very costly for the consumer
11:35
Speaker 1: and the and the companies. At the end of the day, Tara,
11:38
Speaker 1: let's get back since we're talking about how expensive it
11:41
Speaker 1: could be potentially for consumers, are just at least the
11:44
Speaker 1: hospitals up might end up getting stiffed a little bit.
11:47
Speaker 1: Um let's talk about paying for this deal you so
11:49
Speaker 1: that it might be challenging. Why so, CVS is about
11:52
Speaker 1: a seventies six billion dollar company, I think at least
11:55
Speaker 1: before today's drop on the deal news. Um, so they
11:58
Speaker 1: didn't really have that much cash to be paying for
12:00
Speaker 1: this deal and their offer for at and I believe
12:03
Speaker 1: forty seven billion dollars of it is in cash, and
12:06
Speaker 1: a majority of that most of that is going to
12:08
Speaker 1: be through new debt that they're taking on. So at
12:10
Speaker 1: the end of the day, they're going to have almost
12:12
Speaker 1: quadruple the amount of debt that they have in combined
12:15
Speaker 1: Ebada profits from these two businesses, So it's going to
12:17
Speaker 1: be very burdensome on their balance sheet. And CBS has
12:20
Speaker 1: been a great dealmaker. They bought care Mark about a
12:22
Speaker 1: decade ago, and that was another out of the box
12:24
Speaker 1: deal that people didn't really completely buy into when it
12:26
Speaker 1: was announced. So this could be another case where they
12:29
Speaker 1: prove us wrong. But I mean, the numbers involved in
12:31
Speaker 1: here are just starring and I'm really interested to see
12:34
Speaker 1: how they're going to make it work. The math is
12:36
Speaker 1: very tricky here, and they haven't really explained that part
12:39
Speaker 1: of it yet. Michael, as the founder and the chief
12:43
Speaker 1: executive our X Savings Solutions, maybe just tell us how
12:47
Speaker 1: your company would respond to this situation and how that
12:51
Speaker 1: will affect your business. Yeah, So, I mean I think
12:54
Speaker 1: that you know, we we just completed an eighteen million
12:56
Speaker 1: dollar fundraised last week. I think that the the the
13:00
Speaker 1: focused on you know, businesses like ours to add transparency
13:04
Speaker 1: continues to grow. Um. It also gives you know, the
13:09
Speaker 1: the employers that we sell to another kind of viewpoint
13:13
Speaker 1: of someone that's that's working on their behalf. So I
13:16
Speaker 1: think that anytime there's this combination of power, there's a
13:20
Speaker 1: question of you know, okay, the efficiency could save me money,
13:23
Speaker 1: but is that what they'll really do? And I think
13:26
Speaker 1: that what we see it as is a tremendous opportunity
13:28
Speaker 1: uh to work with the market, to to try to
13:31
Speaker 1: make sure people know what their choices are from a
13:33
Speaker 1: theraceutic standpoint, and then how they can save money and
13:36
Speaker 1: where they shop and buy. That is what that pure
13:38
Speaker 1: market is what will really drive change and savings in
13:42
Speaker 1: prescription drugs. That that has to happen, in my opinion,
13:45
Speaker 1: whether it's us for the next guy Sarah pact just
13:49
Speaker 1: real quick, why can't they just incurl out of debt?
13:51
Speaker 1: Everybody else is doing it, right, I mean, I guess
13:54
Speaker 1: that's what they can point to. Everyone's doing that. But
13:56
Speaker 1: I mean, I think we're getting to a point where
13:57
Speaker 1: it needs a question is are are these decisions. How
14:00
Speaker 1: healthy are these mergers going to create value? If this
14:02
Speaker 1: deal is going to make them that much more profitable
14:04
Speaker 1: and they can pay this down quickly, fine, But I
14:06
Speaker 1: think by looking at CVS bond prices today, I mean,
14:08
Speaker 1: people are a little bit um bothered by it and
14:11
Speaker 1: want to see more language out of the company about
14:13
Speaker 1: how this is going to work out. I mean, everyone
14:16
Speaker 1: seems to think the strategic rationale makes sense, that they're
14:19
Speaker 1: buying into it, but the numbers need to work. So
14:21
Speaker 1: I'm still a little bit gubious. The numbers need to work.
14:24
Speaker 1: That's a new one. Tara Lesha Fell, thank you so
14:26
Speaker 1: much for joining us. Sara Lasha Pell, deals columnist for
14:28
Speaker 1: Bloomberg gad Flight. Also Michael Read, thank you so much
14:31
Speaker 1: for joining us. He is founder and chief executive officer
14:34
Speaker 1: of RX Savings Solutions, which is based in Overland Park, Kansas. Uh.
14:39
Speaker 1: Definitely interesting to see whether this deal goes through and
14:41
Speaker 1: if it doesn't, what Amazon dot Com will do to
14:45
Speaker 1: this entire industry. Now we turn our attention to the
15:10
Speaker 1: future of finance, the future of technology, Wall Street, who
15:15
Speaker 1: will be the Titan of Wall Street in ten years?
15:17
Speaker 1: How good can artificial intelligence get We've got a two
15:20
Speaker 1: week series on the future of investing by Bloomberg News reporters.
15:24
Speaker 1: Today's feature looks at how long until black Rock and
15:27
Speaker 1: Vanguard reached ten trillion dollars in assets? Here to help
15:32
Speaker 1: us answer that question is Rachel Evans, our corporate finance
15:34
Speaker 1: reporter for Bloomberg. Rachel, thank you very much for being here.
15:38
Speaker 1: So how long how long does it take for this
15:41
Speaker 1: do wopoly to end up with ten trillion dollars of
15:45
Speaker 1: assets under management? And that's ten trillly in a piece. Remember,
15:48
Speaker 1: so we're looking at twenty trillion overall. So the moment,
15:50
Speaker 1: we've got black Rock, which has six trillion of assets
15:53
Speaker 1: under management. They're on path to to get to ten
15:55
Speaker 1: trillion by about twenty five. Vanguard, while smaller at the moment,
15:59
Speaker 1: could actually get their quicker there on four point seven
16:01
Speaker 1: trillion at the moment. They could be there by twenty
16:04
Speaker 1: three if their current growth rates are maintained. Why why
16:07
Speaker 1: the discrepancy do you believe? I think it has to
16:09
Speaker 1: do with kind of how they're the currently position. So
16:12
Speaker 1: black Rock already has one point six trillion under management
16:14
Speaker 1: within exchange traded funds. Vangard is a little bit smaller.
16:17
Speaker 1: They were a little like to the party when it
16:19
Speaker 1: came to exchange traded funds coming out after black Rocks
16:22
Speaker 1: b D. I um, So when we see kind of
16:25
Speaker 1: the growth going forward, I think Vanguard is going to
16:27
Speaker 1: continue on that trajectory. Their growth rate has just been
16:30
Speaker 1: faster in the last few years. Rachel. Before we get
16:34
Speaker 1: into exactly the assumptions that you made in coming up
16:37
Speaker 1: with this projection, I want to just zoom out and
16:39
Speaker 1: talk about the implications of two asset managers overseeing twenty
16:44
Speaker 1: trillion dollars of assets. I mean, on one hand, this
16:47
Speaker 1: seems like it could be problematic, and the other a
16:50
Speaker 1: lot of this money is going to passive strategies with
16:52
Speaker 1: the index is being crafted by other firms. Do people
16:56
Speaker 1: talk about this as a potential sort of structural risk.
17:00
Speaker 1: So there's two areas that people tend to discuss when
17:03
Speaker 1: when worrying about kind of the impact of these you know,
17:07
Speaker 1: titans for asset management. The first is kind of a
17:10
Speaker 1: market efficiency and the argument there goes, you know, if
17:12
Speaker 1: you have so much money impassive strategies, does that warp
17:16
Speaker 1: the way in which price discovery happens within the market. Now,
17:20
Speaker 1: the evidence on this is still very nascent. I mean,
17:22
Speaker 1: if you think about the proportion of passive as part
17:25
Speaker 1: of the overall market when you look at active sorry,
17:29
Speaker 1: when you look at kind of equity funds in the US,
17:31
Speaker 1: about thirty seven percent is passively managed at the moment,
17:35
Speaker 1: but that drops to about if you look globally and
17:38
Speaker 1: at all different asset classes. So we're still relatively small
17:42
Speaker 1: part of the market as as passive goes. So it's
17:44
Speaker 1: hard to kind of drawing conclusions there. However, when you
17:47
Speaker 1: start looking at the corporate governance implications, I think that's
17:50
Speaker 1: a little bit clear at the moment. Jack Bogel himself,
17:53
Speaker 1: the founder of Vanguard, actually called Vanguard, black Rock, and
17:56
Speaker 1: State Street oligopoly last week, and he was referring really
18:00
Speaker 1: to the size of Steak, that these are three asset managers,
18:04
Speaker 1: but particularly black Rock and Banguard hold within America's largest companies.
18:08
Speaker 1: Are there to be reconciled some problems for small and
18:12
Speaker 1: MidCap companies that can't get into an index that are
18:17
Speaker 1: then not part of this wave of E t F
18:21
Speaker 1: love that we seem to have because we've got more
18:23
Speaker 1: exchange traded funds than we have stocks at the moment, right, So,
18:27
Speaker 1: the growth of indexing has been incredible like that, the
18:30
Speaker 1: number of indexes has really proliferated. A lot of that
18:32
Speaker 1: has been driven by exchange traded funds, which typically track
18:36
Speaker 1: and index um. So yeah, for for the smaller and
18:38
Speaker 1: MidCap companies out there that maybe don't qualify for an
18:41
Speaker 1: index because they're too small or they're not liquid enough,
18:45
Speaker 1: that can be a real issue. And actually we've seen
18:48
Speaker 1: some people suggest that that's one of the reasons we're
18:50
Speaker 1: perhaps seeing fewer initial public offerings at the moment. So, Rachel,
18:54
Speaker 1: let's get back to the assumptions that you made in
18:56
Speaker 1: order to sort of project out the twenty trillion dollar
18:59
Speaker 1: number for both black Rock and van Guard. What is
19:02
Speaker 1: that based on. So this looks at the annual growth
19:05
Speaker 1: rate in assets of those firms and then averages it
19:07
Speaker 1: over five years, so that the methodology behind it is
19:10
Speaker 1: relatively simplistic, But what it does is it tries to
19:13
Speaker 1: give you a sense of kind of how, based on
19:15
Speaker 1: our immediate past, the growth that we've been seeing and
19:17
Speaker 1: that the recent recent past, how that is going to
19:20
Speaker 1: translate when we look into the future. And if you
19:22
Speaker 1: look at kind of the components of of where a
19:24
Speaker 1: lot of that growth has been coming from. It really
19:27
Speaker 1: has been from this passive side. It's been from exchange
19:29
Speaker 1: trade of funds, it's been from passive index funds are
19:32
Speaker 1: really helping to boost assets of black Rock and Banguard.
19:35
Speaker 1: Is there a possibility that this will kind of be
19:37
Speaker 1: a dog chasing its own tail because you get people
19:40
Speaker 1: who say, all right, indexing makes sense, it's low cost,
19:44
Speaker 1: let's get rid of as many people as possible. And
19:47
Speaker 1: then of course that just builds on it on itself,
19:49
Speaker 1: and it really has nothing to do with the value
19:51
Speaker 1: of the underlying companies in the index. So that's definitely
19:54
Speaker 1: one of the critiques of passive investing, the sense that
19:57
Speaker 1: because everybody kind of piles into, you know, a relatively
20:01
Speaker 1: small number of index funds, but that kind of feeds
20:04
Speaker 1: on itself, and you have a certain level of momentum
20:06
Speaker 1: that kind of comes from from people putting their capital
20:09
Speaker 1: into it. The question really have really kind of sort
20:12
Speaker 1: stems from what happens when that reverses. If you start
20:15
Speaker 1: to see people putting money out of these funds, how
20:18
Speaker 1: then do they behave and are there enough active managers
20:20
Speaker 1: in the markets give you decent price Discovery. Well, we
20:23
Speaker 1: will be counting on your reporting to answer those questions.
20:25
Speaker 1: Rachel Evans, thank you so much for joining us. Rachel
20:27
Speaker 1: Evans as a corporate dance reporter for Bloomberg News. And
20:31
Speaker 1: how long Black Rocket Vantguard will take to reach ten
20:34
Speaker 1: trillion dollars in assets? This is going to be a
20:35
Speaker 1: series that we rolled out over the months to come.
21:03
Speaker 1: Let's talk taxes right now. Jeremy Swan joins us. He
21:07
Speaker 1: is managing principle for financial sponsors and financial services industry
21:11
Speaker 1: for Cone Resnick in New York City. He just pulled
21:14
Speaker 1: his head out of the hundreds of pages of the
21:18
Speaker 1: tax plan that the Senate Republicans passed early on Saturday,
21:23
Speaker 1: including some of the handwritten notes. He's a little bit
21:25
Speaker 1: cross side, but he is here. Nonetheless, Jeremy, what does
21:29
Speaker 1: this bill mean for your clients? We're talking about the
21:32
Speaker 1: private equity firms and others like them that you cater to. Sure,
21:37
Speaker 1: so if you look at the M and A markets,
21:39
Speaker 1: you look at the private equity markets, you look at
21:41
Speaker 1: the firms and how they're going to be impacted, they're
21:43
Speaker 1: really a handful of key areas within the tax policies
21:46
Speaker 1: of tax bills that are out there, and you look
21:49
Speaker 1: at interest deductibility, that can certainly put a damper on
21:52
Speaker 1: the ability to leverage up the businesses. The require you
21:54
Speaker 1: can look at carry interest in extending the epic ability
21:58
Speaker 1: of that loophole, so to speak, for three years. Um,
22:02
Speaker 1: you know, in terms of the broader markets, it's gonna
22:05
Speaker 1: challenge for the private equity firms to continue as usual. Um,
22:09
Speaker 1: you know, give the challenges the m and A market already.
22:11
Speaker 1: So I have a question because that was my assumption.
22:14
Speaker 1: But then I looked at KKR shares, Blackstone Shares, Apollo,
22:19
Speaker 1: they're all up absolutely. So when you look at the
22:21
Speaker 1: broader financial services businesses, so KKR, Apollo, Blackstone, they're really
22:27
Speaker 1: more than just private equity. If you look at the
22:29
Speaker 1: pure play private equity firms, they make their money investing
22:33
Speaker 1: in businesses, and with valuations where they are today, the
22:36
Speaker 1: only way you can get the returns is be able
22:38
Speaker 1: to have access to the to the debt markets, be
22:40
Speaker 1: able to provide debt to these businesses to get to
22:43
Speaker 1: that purchase price. The pure player is gonna have a
22:45
Speaker 1: challenge the broader firms. Like you mentioned, there's there's more
22:48
Speaker 1: to it and in terms of the benefits that they're
22:51
Speaker 1: gonna get from the overall rate reduction. You look at
22:54
Speaker 1: what could happen with you know, cash, this sitting overseas.
22:57
Speaker 1: There are a lot of different aspects to it. Well, Gereman,
23:00
Speaker 1: when you get a call from a client or even
23:03
Speaker 1: a potential client, and they ask you, do I need
23:06
Speaker 1: to change the way I do business because of this overhaul,
23:11
Speaker 1: do you just say, well, we don't know yet. Well,
23:15
Speaker 1: part of the problem is we don't know yet. When
23:16
Speaker 1: you look at the differences between the House and the
23:19
Speaker 1: Senate bills, you know, even if you're just looking at
23:22
Speaker 1: interest deductibility, you know, and the House bill you have
23:25
Speaker 1: of EVA diving, the Senate ability of event the appreciation
23:28
Speaker 1: annorization can be a significant number. And when you do,
23:32
Speaker 1: you still don't know what the over Olympic is going
23:34
Speaker 1: to be because you know, now we have the President
23:37
Speaker 1: coming out over the weekend saying well, you know, percents
23:39
Speaker 1: not necessarily where I'm gonna draw the line of sand.
23:42
Speaker 1: Maybe we know what's that impact going to have In
23:45
Speaker 1: terms of the impact on the portfolio companies of these
23:48
Speaker 1: private equity firms, when you look at the after tax
23:51
Speaker 1: return that the private equity firms would expect to see.
23:54
Speaker 1: You know, these changes could have a significant negative impact
23:57
Speaker 1: on the pure play private equity firms at the end
24:00
Speaker 1: of the day. So when the clients are asking me,
24:02
Speaker 1: you know, does this change the way we need to
24:04
Speaker 1: look at the answers, Possibly we had a wait. Hopefully
24:08
Speaker 1: it looks like we'll have an answer before Christmas. But
24:10
Speaker 1: it may change the way they need to structure deals.
24:12
Speaker 1: May it may have a significant impact in terms of
24:15
Speaker 1: how they finance all of these deals. Just to be clear,
24:18
Speaker 1: to sort of drill into the specifics of the tax plan,
24:20
Speaker 1: the provision at question here is really the one of
24:24
Speaker 1: how to determine how much companies can deduct from their
24:28
Speaker 1: taxes with respect to their interest payments on their debts.
24:31
Speaker 1: Of the words, private equity firms usually acquire companies by
24:34
Speaker 1: levering them up doing leverage buyouts UH, and they put
24:38
Speaker 1: a lot of debt on these companies, and under current
24:42
Speaker 1: tax policies, those companies don't have to pay that many
24:45
Speaker 1: taxes because they can deduct the interest payments that they
24:48
Speaker 1: make on their debt from their taxes. Under the Senate proposal, UH,
24:53
Speaker 1: they would have they would only be allowed to deduct
24:55
Speaker 1: a much smaller proportion of that interest from their taxes.
24:58
Speaker 1: Is that correct. That's correct, and it's and part of
25:02
Speaker 1: it is obviously, you know, when you look at the
25:04
Speaker 1: private equity market, you look at how they finance deals,
25:06
Speaker 1: debt can tend to be a significant portion of it.
25:09
Speaker 1: You look at the broader M and A market, So
25:11
Speaker 1: if you look at the middle market over the past year,
25:14
Speaker 1: we're at higher debt ibadah levels than you know, going
25:18
Speaker 1: back to two thousand six, you're at almost six times
25:21
Speaker 1: on every deal. And when you look at so that
25:24
Speaker 1: that's obviously gonna have an impact on the private equity deals.
25:27
Speaker 1: But when you look at the broader M and A market,
25:29
Speaker 1: you know, debt is an instrument to finance a lot
25:32
Speaker 1: of these deals, private equity or not. And if you're
25:35
Speaker 1: looking at the changes to how that interest expense can
25:39
Speaker 1: be deducted from a tax perspective, that's gonna impact the
25:42
Speaker 1: bottom line of a lot of businesses, not just the
25:44
Speaker 1: private equity backed ones. Well. One of the other businesses
25:47
Speaker 1: that may be affected as the housing industry. Because I
25:50
Speaker 1: believe that the Senator Susan Collins of Maine is on
25:55
Speaker 1: board with the overhaul bill because of concessions that would
26:00
Speaker 1: continue to allow taxpayers to write off a ten dollar
26:05
Speaker 1: limit of property taxes. So that is part of that
26:10
Speaker 1: compromise that you were just describing. Yeah, this has been
26:14
Speaker 1: a or these have been at least the two bills
26:16
Speaker 1: we've seen. It's compromise left and right. And I think
26:19
Speaker 1: where we've ended up is you look at the impact
26:23
Speaker 1: of just retaining the corporate a MT. Tell people what
26:27
Speaker 1: that's about. How it works. So if you look at
26:29
Speaker 1: if you look at the tax bill and you look
26:31
Speaker 1: at just the federal tax plan and in itself, you
26:35
Speaker 1: have your calculator, your tax rate, you look at the deductions,
26:39
Speaker 1: you come out to your you know, call it the
26:42
Speaker 1: blended tax rate or the effective tax rate that you're
26:44
Speaker 1: gonna hit with, and then that you have to look
26:46
Speaker 1: at that in the parallel system, the a m T.
26:49
Speaker 1: So with a new a m T where it's they're saying,
26:52
Speaker 1: but they're reducing the corporate tax rate and some of
26:57
Speaker 1: the deductions or credits that you typically would be able
27:01
Speaker 1: to apply. You know, let's look at the research and
27:04
Speaker 1: development tax credit. That's the one that everyone has picked
27:07
Speaker 1: up on. So you can't apply that against the a
27:09
Speaker 1: m T. So you have these businesses and this has
27:12
Speaker 1: been the Research and development tax credit is there to
27:15
Speaker 1: spur innovation in these businesses. Whether you are a clothing designer,
27:19
Speaker 1: whether you're a manufacturer, you're incentivized to be innovative through
27:24
Speaker 1: the R and D tax credit. Now, with the AMT
27:28
Speaker 1: at the same tax rate as the corporate tax rate,
27:32
Speaker 1: the R and D tax credit is virtually useless the
27:34
Speaker 1: way it's the way the tax bill is currently structured, Jeremy,
27:37
Speaker 1: Real quick, when you tell your clients the news that
27:40
Speaker 1: they may have a really hard time under this, or
27:43
Speaker 1: a much harder time, do they immediately ask you for
27:45
Speaker 1: the names of lobbyists they can call to go and
27:48
Speaker 1: make it all go away? Unfortunately? Not? Okay, yeah, yeah,
27:54
Speaker 1: really you you summed it up well. Thank you. Jeremy
27:57
Speaker 1: Swan is managing Principal Financial Sponsors and Financial Services Industry
28:02
Speaker 1: for a Cone Residing. Much appreciated. Thanks for listening to
28:13
Speaker 1: the Bloomberg P and L podcast. You can subscribe and
28:16
Speaker 1: listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast
28:20
Speaker 1: platform you prefer. I'm pim Fox. I'm on Twitter at
28:23
Speaker 1: pim Fox. I'm on Twitter at Lisa Abramo. It's one
28:27
Speaker 1: before the podcast. You can always catch us worldwide on
28:30
Speaker 1: Bloomberg Radio