April 7, 2025 • 34 mins
Bill Housey explores how fixed income investors can navigate rising uncertainty—from trade policies to inflation and beyond—in this deep dive into the bond market’s shifting dynamics.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Ryan (00:09):
Hi, welcome to this episode of the First Trust ROI
podcast.
I'm Ryan Issakainen, etfstrategist at First Trust.
Today, I'm joined by BillHousey, managing Director and
Portfolio Manager of FixedIncome at First Trust.
Bill and I are going to discussopportunities in the bond
market.
We'll talk a bit about tariffs,about interest rates and where
Bill expects the economy andopportunities to lie ahead as we
(00:31):
go through 2025.
Thanks for joining us on thisepisode.
So, bill, since election day,the market really rallied on the
equity side.
I think all risk assets caughta bit and people got really
excited.
And then there's been somepolicy uncertainty, especially
(00:52):
related to tariffs and someother maybe risks to the economy
that have entered into theminds of investors.
Where do you come down on howthe rest of this year plays out
in terms of economic growth, Iguess, but also corporate
profits?
Do you see a sharp pullback inprofits?
How are you looking at, from amacro standpoint, the economy in
(01:15):
companies?
Bill (01:16):
Sure, well, it's great to be with you again, ryan, and I
would say there's probably a lotof different directions.
We can take that and to start,I would just simply pull back
and just look at the market froma 30,000 foot lens and just say
you know, it's really beensince the fall of 2023 since
we've had any meaningfulcorrection in the market.
So the last meaningful equitycorrection was the fall of 2023.
(01:39):
If you look at the equitymarkets, I know you know things
have traded up.
We put in a new high 6,100 onthe S&P, but the reality is that
the market has really beentrending sideways for three
months and only recently have wegot into this sort of I'm going
to call it technical churnwhere we're due.
We're just long in the toothfor what I would suggest is a
(02:00):
very normal correction Now.
It might be a 15% correction.
It may be as severe as a bearbear market.
I don't think the bottom is injust yet because I don't think
there's been enough of a washout, as we've typically seen in
these types of corrections.
What we've experienced to thispoint, anyhow, has been um short
, aggressive and swift, buttypically these things will will
(02:24):
last a little bit longer andyou know you'll get some rally
and it'll pull marketparticipants back in.
So I think a lot, a lot oftimes what we typically see is
that starts that behavior, themarket begins and then the
market tries to fit narrativesto it.
Now, granted, there's a lot ofuncertainty, as you pointed out
clearly, with respect to policy,and higher uncertainty around
(02:45):
policy should absolutely equateto higher volatility.
Right, the less certain I amabout an outcome, the more
volatility that comes back intothe market.
But I would argue we've had a areal uh lapse of volatility for
a prolonged period of time.
It's good to bring healthyvolatility back to the markets
broadly and I think time thatwill play itself through.
(03:06):
So right now, when you have anadministration that's saying
over here to counterparties,we're willing to tariff, we're
willing to look for thesereciprocal trade agreements,
that's going to create a lot ofuncertainty, but eventually it
gets resolved, eventually thesethings quiet back down and we
have certainty again.
So you know, as we play throughthis period, does it create more
(03:29):
uncertainty?
Absolutely.
Does it introduce morevolatility?
It should.
Could we see a further drawdownin equity markets, which, of
course, would then spill over tothe bond market and credit
markets to some extent?
Absolutely Do.
I think it's recession-inducing.
I think it's way too early tosay that today.
I don't think we have that inthe data.
Ryan (03:45):
So interest rates have been kind of interesting, and I
say interesting no pun intended,I guess.
Bill (03:53):
Interesting interest rates .
Ryan (03:54):
They have traded between this range of at the 10 year.
What about 5%?
Have they been 5% this year yetthey're approaching 5% and then
they kind of reverse back lower.
You know we're recording thison March 20th, it's going to air
on April 7th, so we'll give yousome grace that you know what
could happen in the next coupleweeks.
(04:15):
But is that your expectation aswe go throughout the year and
beyond?
Is that sort of the range thatwe're going to continue to see
at the 10-year?
Bill (04:23):
Yeah, I think that the peak for this cycle is in and I
think we hit it in the fall of2023 at roughly 5% on the
10-year.
And since that time, what'shappened?
In May of last year, we ran to470 on the 10-year and then, by
September, we pulled all the wayback to 360.
Then this year, of course, ranback to 480 on 10s and now we're
(04:44):
bouncing around around 420 to430.
So you know, as you think aboutthe drivers of interest rates,
in my mind there's a couple ofmain headlines that have taken
place.
Number one is obviouslyinflation and number two is the
deficit.
So let's just try to unpack theequation a little bit together.
First, on inflation, you getthese tariff headlines and the
narrative is that these tariffsare going to lead.
(05:06):
You know, it's almost like,basis point for basis point
Higher tariff means higherinflation.
As far as the market narrative,that's what you read in the
popular press, that's what youhear on the talking heads every
day, but the reality is, I think, quite a bit different than
that.
It's very disruptive.
It's profit disrupting.
You know great examples in themarket recently.
You know I just read a storylast week Walmart talking about
(05:29):
its suppliers from China andsaying we will not pass on
tariffs to our customers.
So who will eat those costs?
Well, the manufacturer is goingto be forced to eat those costs
.
That's going to put theirprofits under pressure, right?
So there's definitely adecououpling of you, if you will
, from the narrative, and what'slikely to take place are
(05:49):
tariffs, a higher tax?
They are.
Are they, uh, persistentthrough time?
Well, they tend to be one timein nature, right?
What is a tariff?
If I tariff you, I put it inonce, right, you're?
If it's a 20% tariff, you'regoing to feel that 20% tariff,
but I'm not going to go to 30%the next year, 40% the next year
and 50% the next year.
(06:10):
So, by definition.
I know the Fed has mutilated theword, but it really is
transitory to a large extentbecause they are one time in
nature.
So what will matter more withrespect to interest rates is
what happens to inflationexpectations as a result of that
.
Do inflation expectationsreally start to climb or does
(06:30):
the market look through it astransitory, as a
one-time-in-nature type ofpolicy?
And again, if it isn't basispoint for basis point, and some
of this comes out in the form ofweaker profits, well, that's
growth destructive.
So you're not going to seerates moving up on that.
So there's, I think, thepossible scenarios or the
potential paths that we take forthe economy.
(06:51):
On this corporate earnings,it's a much wider set of
outcomes than higher tariff,higher prices, higher inflation.
I think that that is a verysort of remedial expectation as
opposed to what's more likely tooccur, which is a much wider,
you know sort of remedialexpectation, as opposed to
what's more likely to occur,which is a much wider, you know,
sort of standard deviationaround the set of outcomes, if
you will.
So I think that that's going todrive these rates you know to
(07:13):
be, you know, in this rangeright now.
Maybe we run back towards fourand a half percent.
I don't think we're breakingdown in interest rates.
I also don't think we'rerunning away in interest rates.
Think that there were in atighter band around that.
And you know we have anadministration that isn't
looking to grow the deficitright now.
You know the deficit, it'sclose to two trillion dollars.
We have an administrationthat's looking for pay force
(07:35):
right, if we tariff over here,we could cut taxes here, right.
They're looking for revenuesources to offset some of the
policy implementations they'relooking for.
These are not we.
We want to grow the deficitinto perpetuity.
We want trillions more ofdeficit spending.
That's not what we're hearing.
Ryan (07:52):
So you mentioned that you were talking about the
relationship between tariffs andinflation and therefore
interest rates, and I thinkthere are a lot of in the minds
of a lot of investors and evensome analysts, there is a much
closer relationship betweentariffs and inflation.
Do you think that people aremaybe overestimating the level
(08:14):
of inflation that could beimpacted by tariffs?
Bill (08:17):
Yeah well, so I'll give you an example.
So if you looked at the marketback around the time when the
Fed started cutting interestrates in September so before the
new administration the bondmarket if I looked at the TIPS
market, at that point the bondmarket inflation break-evens
were pricing around 2% inflation, pretty close to it, for the
next 10 years.
That's what the bond market'sexpectations were.
(08:38):
And around that inflationexpectation we saw the 10-year
come all the way down to 3.6%Hit fast forward.
You get a new administration,you get this tariff uncertainty,
policy uncertainty, thisnarrative around higher
inflation as a result of thesetariffs.
And what happens?
The market starts to price inmuch higher inflation
expectations.
So we ran all the way to 2.5%inflation expectations for the
(09:02):
next 10 years, not for 12 monthsbut for 10 years.
That's what was recently beingpriced in when the 10-year ran
to 480.
10 years that's what wasrecently being priced in when
the 10-year ran to 480.
Now, with a little bit ofgrowth uncertainty being
injected into the picturebecause of some of this policy
uncertainty, some of that'scoming down.
We're down to about 2.3 percentinflation expectations for the
next 10 years.
(09:23):
So it isn't to say that a tariffdoesn't put a little upward
pressure on prices.
But remember, inflation is rateof change and so I need rate of
change to continuously be goinghigher from that tariff.
So what I'm saying is that ifit's a one-time price change,
(09:44):
well that's one time in theinflation data, right?
So if oil goes from 65 to 75,well, that 10 points will come
through inflation, right.
So if oil goes from, you know,65 to 75, well, that 10 points
will come through inflation,right.
But if it stayed at 75, well,it's not inflationary.
If it goes to 85, well, thatwould be inflationary.
So we need these tariffpolicies to go up, go up again,
(10:04):
go up again, to really be morepersistent.
You can have upward pricepressure, but temporarily, of
course.
That seems natural Becauseit'll be puts and takes, right.
If you have a product that youcan't substitute anywhere else
and it has a tariff on it, well,more likely than not, there's
some pricing power there, right,they're going to try to.
(10:25):
Whoever the manufacturers ofthat product is going to try to
take price.
But there are a lot of productswith a lot of substitutes that
can be manufactured elsewhere orare manufactured elsewhere,
where they're going to have amuch more challenging time
pushing that price through.
So it really is a competitivemarket dynamic.
And that is what I think isoften lost when you think about
a tariff as being basis pointfor basis point into inflation.
(10:47):
It suggests there's nocompetitive market dynamic.
It suggests there are nocompanies like Walmart who say
we will not pass that through toour customers.
It's a much wider range ofoutcomes than I think gets
assumed or presumed in theanalysis.
Ryan (11:00):
Well, I think the other thing that's maybe missed in
that is, if I pay, in yourexample, $10, whatever, the
equation is between the cost ofa barrel of oil and what gets
passed through to gasolineprices, If I'm paying more for
gas as a consumer, I have lessto spend on something else.
That's right.
So when we're talking aboutgeneralized price movements of
(11:20):
the overall basket of goods andCPI or whatever it is, I think
there's some complexity there aswell, because you know, our
chief economist, Brian Westbury,is always talking about the
money supply and its impact oninflation.
Unless you're increasing themoney supply, I have less money
that I can spend on.
You know this other good overhere.
If I'm spending more onsomething that's a higher cost,
(11:42):
because of tariffs or whateverthe cost, that's right, Whatever
the reason, Okay.
So what do you think?
Speaking about tariffs and I'llask you a question that you can
punt on, you don't have toanswer this necessarily when you
think about what's the likelyoutcome of some of these
(12:03):
policies, do you think thatthese are intended to be
something that's more permanent,like we're talking about
putting it on and then it stayson for a long time or do you
think that these are just sortof.
The goal is to bring downtariffs across and ultimately
have freer trade.
You know, the theory isreciprocal tariffs.
(12:23):
If you tariff me 20 percent, Itariff you 20 percent, and you
say, well, we're just going todrop them all.
What's your opinion there?
Bill (12:30):
Well, I think you know, looking at it just as a market
participant, right?
Not certainly a tariff expertby any means, but understanding
that we have an administrationand a president who's a
negotiator, right, written booksabout the art of the deal, an
absolute negotiator.
He's looking to cut, in myopinion, the best deal he can
cut for the country and, like Imentioned, he has a policy
(12:53):
agenda that he wants funded andhe's looking for ways to fund
that agenda.
And he also doesn't want to see, in my opinion, american
companies that are set at adifferent standard, if you will,
in the global markets than ourcompetitors.
So if we import goods and wedon't tariff those goods, but
(13:13):
they're tariffing our goods aswe export those goods, he sees
that as incredibly unfair and islooking to level that playing
field.
And there's a whole host ofreasons why trade with China is
very different than trade withEurope or trade with Canada, for
example, who's a very closeally and a close neighbor Europe
, or trade with Canada, forexample, who's a very close ally
and a close neighbor, right.
(13:33):
So I do think that some of thisis really just important
negotiating that's going to takeplace, but it just takes place
in the open market, right.
So it seems very chaotic.
If you look at it, it's pointfor point.
Well, if you do this, we'll dothis, if we do this, you'll do
that, right.
That creates a lot of chaos anda lot of uncertainty and at the
end of the day, it's just avery public negotiation, right?
(13:53):
I?
I remember, you know, taking aclass in my mba at northwestern
and they talked about it was anegotiating class and the idea
in any negotiation is to try tospread the bid and offer as wide
as you can from one another,right?
So what happens with mostnegotiations?
People go in and negotiate Iwant in and negotiate, I want to
buy that car, I want to buythat house and they say, oh, I
don't want to go in too low, Idon't want to offend them, I
(14:16):
don't want to, right?
And the reality is you're sortof negotiating against yourself
in that situation.
Right, we trade bonds for allday long, every day.
We're always trying tonegotiate a better level of
execution.
The idea is very simple.
The wider the idea is verysimple, the wider the bid-ask
spread.
Well, think about where mostdeals finish.
They tend to finish in themiddle.
So if I have a narrow bid andoffer, if I come in close.
(14:36):
Well, where's my middle pointgoing to be?
Well, it's going to be reallytight to the what they're asking
.
But if I spread it out, I'veshifted that midpoint lower.
So a lot of what we see rightnow is a wide bid ask in
negotiation, looking for for abetter midpoint.
It just seems very chaotic whenyou're trying to track it from
30,000 feet and watching thisvolley take place.
We'll do this if you do that,and vice versa, and it just goes
(14:59):
on and on and on.
But in the end, I do think inmost of these situations or
instances there will be anegotiated outcome that our
current president is going tofeel really good about because
he's negotiating, and that'sreally going to be, I think,
ultimately where this shakes out, which I think, at least from
what we understand, some of thisshould be really good for
(15:21):
growth over time.
Might be disruptive in theshort term, but good for growth
over time.
Ryan (15:26):
So policy uncertainty, leading to maybe some risk
selling off, you think,ultimately spells maybe a
longer-term opportunity.
Is that a good summary?
Bill (15:37):
I think that, as we play this through, what we're likely
to see in the markets is anormal correction to a bear
market, which you'll see, thenarrative, the cacophony of
voices that around that as beinga, you know, recession vibe or
narrative that'll fill.
Oh risk could be slowing.
The recession risk is going upright as prices fall.
(15:59):
It's automatic that thenarrative will shift to
recession.
Risk is higher.
But again, we typically do seea good, healthy correction every
couple of years.
So it's a very normal outcomein the markets.
Doesn't mean it's the big one.
It doesn't mean it necessarilyhas to be.
So I do think that you knowthere will be consequences and
implications from some of thepolicy changes.
(16:22):
Right, if you have governmentworkers that are now being laid
off, that now have to find workelsewhere, that's going to be a
transition in the economy thatwill take time for those
employees to to find new work.
Ultimately, I think the economyis better for it.
I think companies are betterfor it.
It increases the labor supply,better talent pool for companies
to be able to hire from.
So I think, for a whole host ofreasons, it's better over the
(16:44):
long term.
Could it be disruptive in theshort term?
Sure could it be.
Could it result in slowergrowth in the economy?
Absolutely in the short term?
Sure, could it result in slowergrowth in the economy?
Absolutely in the short term.
And I think we've heard fromthe administration willing to
take some short-term pain forlong-term gain to get to the
right place.
But ultimately I don't view thiswhere corporations have
over-risked.
I don't view this scenario asthe typical business cycle where
(17:06):
companies are massivelyover-risked, they've taken on
too much debt, or that's notthis cycle.
That's not where we're at rightnow.
In fact, balance sheets lookreally healthy generally.
There's not a lot of those sameexcesses.
What we're seeing is thatsqueeze on the government side
of the economy and that's wheresome of that weakness could play
through, and that's that'sprobably going to present some
(17:29):
good opportunities.
Ryan (17:36):
Do you think we focus too much on some of these macro
issues?
I mean, our conversation hasall been about government policy
, things that are uncertain.
You are a portfolio manager, soyou actually have to make
decisions, and it's nice for meto sit in a podcast and ask you
theoretical questions, but Iguess my question for you now is
like how do you sort throughall that noise?
How do you identify the signal,what's really important and is
(17:56):
going to impact the performanceof your funds?
Bill (17:58):
Yeah, I think every day there's going to be something,
there's a headline, there'snoise, there's news, and trying
to dissect that information totry to realize or recognize what
will be the driver offundamental performance is a
very difficult game to play.
So where we focus is on thosecompanies individually looking
(18:19):
at their performance,understanding the drivers of the
business and looking toidentify companies that are
defensible in any environment,especially when you're talking
about lending the money.
Right, it's one thing if youbuy a stock, because when you're
talking about lending themmoney, it's one thing if you buy
a stock, because if you buy astock and the earnings grow and
you've taken a lot of risk, well, you're compensated for it.
If things go well, it's the wayyou expect.
(18:39):
You're going to be reallyrewarded for it.
For us, what's our best-casescenario?
We get our coupon and our moneyback If everything goes great.
So our job is to really workhard at dissecting these
companies, looking rigorously atthe financial statements,
understanding the drivers,understanding the inherent
volatility around that operatingperformance, and then the noise
(18:59):
around the periphery becomesfar less impactful because,
while that might change thespread on a given day, the price
on a given day, if we've doneour fundamental work and we can
rely on that heavily, then we're.
I can sleep at night because Iknow what I own and I know what
I expect it to do, even in thatenvironment.
And if that gets cheaper,that's a great opportunity for
(19:22):
us to try to own more so overthe last 12 months.
Ryan (19:26):
I look at ETF flows quite a bit and over the last 12
months actively managed fixedincome ETFs have accounted for
about 40% of overall fixedincome ETF asset flows.
They now represent somethinglike 17% of those assets.
I would imagine that some ofwhat you just discussed about
looking at individual companiesand their credits and their
(19:48):
creditworthiness and whether ornot you want to lend them money
has something to do with that.
But there's also the other sideof it and that is some of the
weaknesses associated withpassive fixed income investments
in particular.
Can you talk a bit about whatyou view as an active manager?
How do you identify weakness inthe passive benchmark and
exploit it?
Bill (20:09):
Well, the single greatest differentiator, I think,
relative to what we do activelyin fixed income, and it's really
important to separate fixedincome from equities because
they are different.
In fixed income, the singlegreatest differentiator is risk
management.
So in equities, I've got tomake sure I'm positioned and the
companies are growing, theequities are moving and it's a
(20:30):
totally different barometerright Market cap weighted index,
perhaps big, better capitalizedcompanies way more.
In the debt markets, theindices are simply structured by
where the debt is issued.
The more debt that's issued,the greater the weighting in the
index.
So even if you come back allthe way to something as simple
as the ag index, which is, youknow, treasuries, corporate
(20:51):
securitized debt, think abouthow treasuries have grown as
part of that composition of theag over the last 20 years, from
something like 25% of theexposure to 45% of the exposure
in the index.
Now, why has that occurred?
Well, you may have noticedthese deficits.
They have to be fundedsomewhere and they get funded by
treasury issuance.
(21:11):
So the more that our governmentborrows, the bigger the
representation in the index oftreasuries.
And does that mean that youshould own of treasuries?
And does that mean that youshould own more treasuries
because the government needsmore right.
That's really what happens inthese indices.
The greater the amount of debtthat's borrowed gets a much
larger representation in theseindices, and it doesn't matter
whether it's a safe index likethe ag, or in terms of high
(21:34):
quality investment creditissuers or high yield or bank
loan.
Where it comes down to whichcompanies have borrowed the most
.
The more they borrow, thebigger the weight in the index.
I would argue that that is avery flawed strategy for lending
money looking to the mostindebted companies, looking to
the most indebted sectors, andsaying we should give them more
because they need more orbecause they borrowed more.
(21:56):
Instead, you might want to lookat things like how well
capitalized is that company?
What's the likelihood that itpays back?
Well, how is the valuation oftreasuries against corporates,
against securitized?
All these different variables?
What part of the curve do Iwant to be positioned on?
None of that happens in any ofthese passive indices.
So for me, it really comes downto the simplicity of risk
(22:18):
management.
If you're looking at andactually doing the real work in
fixed income, it's aboutprotecting principal, capturing
income and avoiding loss.
That's the fundamental driverof what we do and that reduces
risk.
It's not an opportunity tothrottle up risk.
It's to protect principalcapture income, smooth the ride
for investors.
(22:38):
I think that's ultimately whatmost people buy fixed income for
, and so that's the real driverof that, I think.
Ryan (22:44):
That's a really good point , because I think oftentimes
people think about activemanagement as the way you add
value is by adding risk versusthe benchmark, and what you're
describing is kind of theopposite of that.
So, as you look across thespectrum of potential investment
opportunities within fixedincome at different sectors of
(23:05):
the economy, different types ofsecurities, different sectors of
the bond market, where do youthink some of the most
underappreciated opportunitiesare today?
Bill (23:13):
Well, I think a lot of the market narrative tends to shift
to spread discussions, right?
So you'll hear a lot of talkabout where spreads spreads are
tight.
Spreads are tight across fixedincome.
It's really important tounderstand that.
Spreads are really helpful inidentifying value on a given day
.
So if I compare come acorporate bond to a piece of
(23:35):
securitized debt, you know and Ican look across sectors and say
, well, look for this level ofrisk, I'm getting this type of
premium or spread in the marketfor that and I think that's
cheap, so that's really helpful.
But spreads tend to be a verypoor predictor of future returns
and, in fact, the best exampleof this.
We published a piece on this.
If you look back at high yield,going back to may of 2007, when
(23:57):
the spread was the tightest inhistory, just before the
financial crisis could youimagine like in your mind, it's
probably that's bad timing.
That's bad time.
Right, you would think it's badtiming.
But if you actually looked athigh yield, if you had purchased
it at that month when thespread was the tightest may of
2007 and you rode it through andyou looked at one year, three
(24:17):
year, five year, ten year, youknow I want to say, roughly
speaking, you know, three yearsin you average about six percent
a year by five years in Stockswere still negative.
From that point you had anegative return on the S&P 500
over five years.
The high-yield market was thenumber one performer.
It had outperformed stocks,outperformed every other fixed
income asset class and continuedto do so for a decade from that
(24:38):
tightest spread in history.
So the primary driver, or Ishould say the most important
variable if you're trying toassess future returns, is
understanding what yield I'mbuying at, more so than what
spread I'm buying at.
I think yield is a much betterforward predictor, a higher
R-squared if you will, in termsof looking at forward returns
(24:58):
relative to spread.
So as we look at the bond markettoday, well you know, if I
think about an asset class likehigh yield, where I can get 7%,
buying bonds slightly below par,taking half the risk of the
equity market in a market wherethe quality has been improving
over half, the market is doubleB.
Now that's never been the casebefore, because what's happened
(25:19):
through the proliferation ofprivate credit is these funds
have grown really large inprivate credit and they need
outlets.
They need assets to come andfind to fund with all that money
they've raised and they'retending to take some of the
weaker quality companies out ofthe public markets.
The better quality companiesstay in the public markets.
They get the best pricing, bestexecution, liquid.
(25:39):
But if you're a weaker qualitycredit and you need access to
capital and there's this bigpool of money over here in
private credit, it lines up verywell.
So it's tended to push thequality up within the high-yield
market.
So I think, as we look acrossfixed income, I like to say
(26:01):
there's no always and nevers isthe best way to think about it.
So as we look through, we'retrying to I dissect these
different parts of the market,looking at everything across the
various components of themarket and looking for the best
values, looking for where we cancapture the best level of
income with the least amount ofrisk to drive the best future
return with the least amount ofvolatility.
That's really the mathematicalequation and that iteration it's
(26:21):
happening every day, throughoutthe course of the day.
And then you go through aperiod like a market correction,
like we're recentlyexperiencing, and that will
present new opportunities for usto be looking across, maybe
taking up some of those parts ofthe market that we thought were
expensive that have nowcheapened up.
An area, for example, like highyield was really tight, widened
out on some of that recentvolatility, looked for some
opportunities in that Investmentgrade corporates.
(26:43):
The same thing we were hidingin more safe assets before that,
using securitized assets, areaslike that in the market to get
more defensive.
But that type of rotationhaving that ability I think is
really important of rotation.
Ryan (27:00):
Having that ability, I think, is really important.
So everyone has kind of overthe last couple of years now
focused on ai and new technologyand I've often wondered as a
portfolio manager, as you andyour team think about
opportunities in the market are,are you leveraging new
technology to kind of siftthrough ideas or identify
opportunities?
Bill (27:19):
it is the most profoundly impactful change that has
occurred in my career theevolution of ai and I am my eyes
are so open to this today andand it has changed dramatically
over a very short period of time.
A year ago, of course, we allknew what AI was, weren't really
sure how to use it.
(27:39):
Help me write this letter ofrecommendation, help me.
And now, as we think about whatwe're doing, I'll give you some
examples.
I think that, well, whetherit's a credit team, investment
team or whatever, I think everyteam will have data scientists
as a part of their team.
That's the professional willhave data scientists as a part
(28:03):
of their team.
That's, that's the.
You know the professional termdata scientists, what?
What I believe is that weshould empower all of our people
to be really powerful as a datascientist on top of their
current work, even as an analyst, for example, in the credit
space.
And you, I'll tell you someexamples where I was blown away
Recently, I put in a scenarioand you know, we have commercial
(28:26):
licenses with differentproducts and so we can use the.
You know AI.
And so I said hey, run, buildme a valuation table using these
five companies.
They're all public companies.
I want you to look back throughprevious business cycles and I
want you to assess the peak totrough drawdown in top line and
margins profitability and reallygive an assessment of valuation
(28:49):
multiples through time.
It built this table in twominutes and it was phenomenal.
I know the output already, Ialready know what it should tell
me and I looked at it and whatit did in two minutes would
typically take an analystpulling all the numbers, even
with automation, a lot longer.
And to be able to do that, orto say how deep can I go to see
(29:15):
more about this company, moreabout their contracts?
What's publicly available, whatused to be publicly available,
was a Google search and if Icouldn't find it, I couldn't
find it Right.
Right Now you can go a miledeep to find you know whether
it's government contracts thatthis company has, maybe it was
published somewhere and you know.
It's just the data's there.
(29:36):
It's so much more powerful.
I'm reading a book about thisright now.
I just it is incredible.
I think the efficiency gainsare going to be extraordinary
and we're just at the literallylike the very first edge of this
.
Ryan (29:50):
So it seems to me that something like this at first
maybe gives early adopters somelevel of competitive advantage,
but eventually it just becomeswhat everyone has to do to
compete.
Is that what you would kind ofexpect with this?
Bill (30:03):
Yeah, but I also think that there's an edge as well.
I think that the edge will comenot just from we can all search
the same data, we can all buildthe same valuation tables,
things like that, and do it alot more efficiently.
And I mean like in this bookI'm reading right now they're
talking about the efficiencygains are from 20 to 80 percent,
like the, you know, in theindustrial revolution, you know,
(30:26):
the steam engine was like 18percent.
So like this is incredible asfar as the potential for
efficiency gains, so I think alot of people are going to use
it.
I think it's going to maketheir work a lot easier.
But let's talk about the datawe produce.
So, as analysts, we buildfinancial models, we build
forecasts, we rate companiesinternally with our own
(30:48):
proprietary system.
What if I start to take thatdata and apply AI to that, to
then assess through that enginewhere right, where I might be
wrong in my rating, lookingacross sectors, looking across
ratings, identifying outliers,right and I think that that just
becomes really robust and thatcould be more proprietary stuff
(31:11):
that we develop, for example.
That gives you an edge, forexample, is one way where it's
something that not everybody has.
We're going to use it our way.
They might use it their way,sure, and there's just a lot of
innovation.
I think that could potentiallybe had there.
Ryan (31:23):
Yeah, really interesting and exciting things on the
horizon with technology.
All right, last question foryou, bill.
Again, the time kind of fliesby here.
I've got more questions, but wedon't necessarily have time to
ask them.
All right, you're a young BillHousie.
Before you got to be aportfolio manager, you've got
(31:47):
college age kids, so this isprobably an easy question for
you.
What advice would you give to ayoung Bill Housie starting out
in the investment industry?
Bill (31:52):
That's a tough one.
It's an easy question, I don'tknow, I don't know if it's as
easy as you think it is I likethrowing curveballs.
Ryan (31:58):
No, it's not.
Bill (31:59):
It's a tough one.
It's funny because, as youpointed out, I mean I do get
that question from my ownchildren, right, who are?
I have three that are incollege right now, all in
finance.
So we do have this discussion alot.
But I think that some of thethings we're talking about, like
this AI innovation right, andjust immersing yourself in the
(32:20):
technology right, we're older,right it's.
It's harder for us to you knowthe old dogs, new tricks, right,
it's just harder for us toadapt to these things.
So, being young and open-mindedto where you can begin to see
challenges and problems and seea technological solution to them
that we won't see, right,because we're not at the front
(32:44):
edge Like it used to just be.
Wow, these kids coming out ofschool really know how to use
Excel way better than I do.
I'm glad I got them to be ableto use that Excel Now, right,
they're using these toolsalready.
They're just so much moreempowered by it and I think that
, really, just keeping an openmind, I think it's really hard
for any young person in anyprofession, because there's a
(33:07):
lot of pressure on kids today tosuggest that they should have
all the answers like what do youwant to do?
What's your?
What do you want to work foryour first job?
Right, there's a lot ofpressure and sometimes, honestly
, it's just better for you tofigure it out, it's better to
knock around a little bit.
That's why we always like tosay we like you on your second
job, not your first job, becausego figure it out for a little
while and figure out what youactually want to do and then,
(33:29):
once you really kind of lean inthis direction, well, now you've
committed to it, now you likeit, you.
Now you like it, you know youlike it.
So I think in the beginning it'sabout having a wide horizon,
being willing to make mistakes.
The stakes are low, right, bewilling to make mistakes, be
willing to try new things, bewilling to learn new things and
just immerse yourself at everyopportunity to learn, because
(33:51):
you never know where that willcome back to help you later.
That's really the key thing.
I look back on the early jobsin my career and I think about
the tools that I use today.
At the time I had no idea wherethose things would help me
later, and they might've beenthe most frustrating parts of
those early jobs that later cameback to be real assets in
things I do today.
So you just never know wherethose experiences are going to
(34:14):
come back to help you later, andso having an open mind about
that, I think, is really themost important thing.
Ryan (34:20):
Bill, thank you for passing along some wisdom to the
next generation and thanks forcoming on the podcast once again
, and thanks to all of you aswell for joining us on this
episode of the First Trust ROIPodcast.
We'll see you next time, thankyou.
Hi, welcome to this episode of the First Trust ROI
podcast.
I'm Ryan Issakainen, etfstrategist at First Trust.
Today, I'm joined by BillHousey, managing Director and
Portfolio Manager of FixedIncome at First Trust.
Bill and I are going to discussopportunities in the bond
market.
We'll talk a bit about tariffs,about interest rates and where
Bill expects the economy andopportunities to lie ahead as we
(00:31):
go through 2025.
Thanks for joining us on thisepisode.
So, bill, since election day,the market really rallied on the
equity side.
I think all risk assets caughta bit and people got really
excited.
And then there's been somepolicy uncertainty, especially
(00:52):
related to tariffs and someother maybe risks to the economy
that have entered into theminds of investors.
Where do you come down on howthe rest of this year plays out
in terms of economic growth, Iguess, but also corporate
profits?
Do you see a sharp pullback inprofits?
How are you looking at, from amacro standpoint, the economy in
(01:15):
companies?
Bill (01:16):
Sure, well, it's great to be with you again, ryan, and I
would say there's probably a lotof different directions.
We can take that and to start,I would just simply pull back
and just look at the market froma 30,000 foot lens and just say
you know, it's really beensince the fall of 2023 since
we've had any meaningfulcorrection in the market.
So the last meaningful equitycorrection was the fall of 2023.
(01:39):
If you look at the equitymarkets, I know you know things
have traded up.
We put in a new high 6,100 onthe S&P, but the reality is that
the market has really beentrending sideways for three
months and only recently have wegot into this sort of I'm going
to call it technical churnwhere we're due.
We're just long in the toothfor what I would suggest is a
(02:00):
very normal correction Now.
It might be a 15% correction.
It may be as severe as a bearbear market.
I don't think the bottom is injust yet because I don't think
there's been enough of a washout, as we've typically seen in
these types of corrections.
What we've experienced to thispoint, anyhow, has been um short
, aggressive and swift, buttypically these things will will
(02:24):
last a little bit longer andyou know you'll get some rally
and it'll pull marketparticipants back in.
So I think a lot, a lot oftimes what we typically see is
that starts that behavior, themarket begins and then the
market tries to fit narrativesto it.
Now, granted, there's a lot ofuncertainty, as you pointed out
clearly, with respect to policy,and higher uncertainty around
(02:45):
policy should absolutely equateto higher volatility.
Right, the less certain I amabout an outcome, the more
volatility that comes back intothe market.
But I would argue we've had a areal uh lapse of volatility for
a prolonged period of time.
It's good to bring healthyvolatility back to the markets
broadly and I think time thatwill play itself through.
(03:06):
So right now, when you have anadministration that's saying
over here to counterparties,we're willing to tariff, we're
willing to look for thesereciprocal trade agreements,
that's going to create a lot ofuncertainty, but eventually it
gets resolved, eventually thesethings quiet back down and we
have certainty again.
So you know, as we play throughthis period, does it create more
(03:29):
uncertainty?
Absolutely.
Does it introduce morevolatility?
It should.
Could we see a further drawdownin equity markets, which, of
course, would then spill over tothe bond market and credit
markets to some extent?
Absolutely Do.
I think it's recession-inducing.
I think it's way too early tosay that today.
I don't think we have that inthe data.
Ryan (03:45):
So interest rates have been kind of interesting, and I
say interesting no pun intended,I guess.
Bill (03:53):
Interesting interest rates .
Ryan (03:54):
They have traded between this range of at the 10 year.
What about 5%?
Have they been 5% this year yetthey're approaching 5% and then
they kind of reverse back lower.
You know we're recording thison March 20th, it's going to air
on April 7th, so we'll give yousome grace that you know what
could happen in the next coupleweeks.
(04:15):
But is that your expectation aswe go throughout the year and
beyond?
Is that sort of the range thatwe're going to continue to see
at the 10-year?
Bill (04:23):
Yeah, I think that the peak for this cycle is in and I
think we hit it in the fall of2023 at roughly 5% on the
10-year.
And since that time, what'shappened?
In May of last year, we ran to470 on the 10-year and then, by
September, we pulled all the wayback to 360.
Then this year, of course, ranback to 480 on 10s and now we're
(04:44):
bouncing around around 420 to430.
So you know, as you think aboutthe drivers of interest rates,
in my mind there's a couple ofmain headlines that have taken
place.
Number one is obviouslyinflation and number two is the
deficit.
So let's just try to unpack theequation a little bit together.
First, on inflation, you getthese tariff headlines and the
narrative is that these tariffsare going to lead.
(05:06):
You know, it's almost like,basis point for basis point
Higher tariff means higherinflation.
As far as the market narrative,that's what you read in the
popular press, that's what youhear on the talking heads every
day, but the reality is, I think, quite a bit different than
that.
It's very disruptive.
It's profit disrupting.
You know great examples in themarket recently.
You know I just read a storylast week Walmart talking about
(05:29):
its suppliers from China andsaying we will not pass on
tariffs to our customers.
So who will eat those costs?
Well, the manufacturer is goingto be forced to eat those costs
.
That's going to put theirprofits under pressure, right?
So there's definitely adecououpling of you, if you will
, from the narrative, and what'slikely to take place are
(05:49):
tariffs, a higher tax?
They are.
Are they, uh, persistentthrough time?
Well, they tend to be one timein nature, right?
What is a tariff?
If I tariff you, I put it inonce, right, you're?
If it's a 20% tariff, you'regoing to feel that 20% tariff,
but I'm not going to go to 30%the next year, 40% the next year
and 50% the next year.
(06:10):
So, by definition.
I know the Fed has mutilated theword, but it really is
transitory to a large extentbecause they are one time in
nature.
So what will matter more withrespect to interest rates is
what happens to inflationexpectations as a result of that
.
Do inflation expectationsreally start to climb or does
(06:30):
the market look through it astransitory, as a
one-time-in-nature type ofpolicy?
And again, if it isn't basispoint for basis point, and some
of this comes out in the form ofweaker profits, well, that's
growth destructive.
So you're not going to seerates moving up on that.
So there's, I think, thepossible scenarios or the
potential paths that we take forthe economy.
(06:51):
On this corporate earnings,it's a much wider set of
outcomes than higher tariff,higher prices, higher inflation.
I think that that is a verysort of remedial expectation as
opposed to what's more likely tooccur, which is a much wider,
you know sort of remedialexpectation, as opposed to
what's more likely to occur,which is a much wider, you know,
sort of standard deviationaround the set of outcomes, if
you will.
So I think that that's going todrive these rates you know to
(07:13):
be, you know, in this rangeright now.
Maybe we run back towards fourand a half percent.
I don't think we're breakingdown in interest rates.
I also don't think we'rerunning away in interest rates.
Think that there were in atighter band around that.
And you know we have anadministration that isn't
looking to grow the deficitright now.
You know the deficit, it'sclose to two trillion dollars.
We have an administrationthat's looking for pay force
(07:35):
right, if we tariff over here,we could cut taxes here, right.
They're looking for revenuesources to offset some of the
policy implementations they'relooking for.
These are not we.
We want to grow the deficitinto perpetuity.
We want trillions more ofdeficit spending.
That's not what we're hearing.
Ryan (07:52):
So you mentioned that you were talking about the
relationship between tariffs andinflation and therefore
interest rates, and I thinkthere are a lot of in the minds
of a lot of investors and evensome analysts, there is a much
closer relationship betweentariffs and inflation.
Do you think that people aremaybe overestimating the level
(08:14):
of inflation that could beimpacted by tariffs?
Bill (08:17):
Yeah well, so I'll give you an example.
So if you looked at the marketback around the time when the
Fed started cutting interestrates in September so before the
new administration the bondmarket if I looked at the TIPS
market, at that point the bondmarket inflation break-evens
were pricing around 2% inflation, pretty close to it, for the
next 10 years.
That's what the bond market'sexpectations were.
(08:38):
And around that inflationexpectation we saw the 10-year
come all the way down to 3.6%Hit fast forward.
You get a new administration,you get this tariff uncertainty,
policy uncertainty, thisnarrative around higher
inflation as a result of thesetariffs.
And what happens?
The market starts to price inmuch higher inflation
expectations.
So we ran all the way to 2.5%inflation expectations for the
(09:02):
next 10 years, not for 12 monthsbut for 10 years.
That's what was recently beingpriced in when the 10-year ran
to 480.
10 years that's what wasrecently being priced in when
the 10-year ran to 480.
Now, with a little bit ofgrowth uncertainty being
injected into the picturebecause of some of this policy
uncertainty, some of that'scoming down.
We're down to about 2.3 percentinflation expectations for the
next 10 years.
(09:23):
So it isn't to say that a tariffdoesn't put a little upward
pressure on prices.
But remember, inflation is rateof change and so I need rate of
change to continuously be goinghigher from that tariff.
So what I'm saying is that ifit's a one-time price change,
(09:44):
well that's one time in theinflation data, right?
So if oil goes from 65 to 75,well, that 10 points will come
through inflation, right.
So if oil goes from, you know,65 to 75, well, that 10 points
will come through inflation,right.
But if it stayed at 75, well,it's not inflationary.
If it goes to 85, well, thatwould be inflationary.
So we need these tariffpolicies to go up, go up again,
(10:04):
go up again, to really be morepersistent.
You can have upward pricepressure, but temporarily, of
course.
That seems natural Becauseit'll be puts and takes, right.
If you have a product that youcan't substitute anywhere else
and it has a tariff on it, well,more likely than not, there's
some pricing power there, right,they're going to try to.
(10:25):
Whoever the manufacturers ofthat product is going to try to
take price.
But there are a lot of productswith a lot of substitutes that
can be manufactured elsewhere orare manufactured elsewhere,
where they're going to have amuch more challenging time
pushing that price through.
So it really is a competitivemarket dynamic.
And that is what I think isoften lost when you think about
a tariff as being basis pointfor basis point into inflation.
(10:47):
It suggests there's nocompetitive market dynamic.
It suggests there are nocompanies like Walmart who say
we will not pass that through toour customers.
It's a much wider range ofoutcomes than I think gets
assumed or presumed in theanalysis.
Ryan (11:00):
Well, I think the other thing that's maybe missed in
that is, if I pay, in yourexample, $10, whatever, the
equation is between the cost ofa barrel of oil and what gets
passed through to gasolineprices, If I'm paying more for
gas as a consumer, I have lessto spend on something else.
That's right.
So when we're talking aboutgeneralized price movements of
(11:20):
the overall basket of goods andCPI or whatever it is, I think
there's some complexity there aswell, because you know, our
chief economist, Brian Westbury,is always talking about the
money supply and its impact oninflation.
Unless you're increasing themoney supply, I have less money
that I can spend on.
You know this other good overhere.
If I'm spending more onsomething that's a higher cost,
(11:42):
because of tariffs or whateverthe cost, that's right, Whatever
the reason, Okay.
So what do you think?
Speaking about tariffs and I'llask you a question that you can
punt on, you don't have toanswer this necessarily when you
think about what's the likelyoutcome of some of these
(12:03):
policies, do you think thatthese are intended to be
something that's more permanent,like we're talking about
putting it on and then it stayson for a long time or do you
think that these are just sortof.
The goal is to bring downtariffs across and ultimately
have freer trade.
You know, the theory isreciprocal tariffs.
(12:23):
If you tariff me 20 percent, Itariff you 20 percent, and you
say, well, we're just going todrop them all.
What's your opinion there?
Bill (12:30):
Well, I think you know, looking at it just as a market
participant, right?
Not certainly a tariff expertby any means, but understanding
that we have an administrationand a president who's a
negotiator, right, written booksabout the art of the deal, an
absolute negotiator.
He's looking to cut, in myopinion, the best deal he can
cut for the country and, like Imentioned, he has a policy
(12:53):
agenda that he wants funded andhe's looking for ways to fund
that agenda.
And he also doesn't want to see, in my opinion, american
companies that are set at adifferent standard, if you will,
in the global markets than ourcompetitors.
So if we import goods and wedon't tariff those goods, but
(13:13):
they're tariffing our goods aswe export those goods, he sees
that as incredibly unfair and islooking to level that playing
field.
And there's a whole host ofreasons why trade with China is
very different than trade withEurope or trade with Canada, for
example, who's a very closeally and a close neighbor Europe
, or trade with Canada, forexample, who's a very close ally
and a close neighbor, right.
(13:33):
So I do think that some of thisis really just important
negotiating that's going to takeplace, but it just takes place
in the open market, right.
So it seems very chaotic.
If you look at it, it's pointfor point.
Well, if you do this, we'll dothis, if we do this, you'll do
that, right.
That creates a lot of chaos anda lot of uncertainty and at the
end of the day, it's just avery public negotiation, right?
(13:53):
I?
I remember, you know, taking aclass in my mba at northwestern
and they talked about it was anegotiating class and the idea
in any negotiation is to try tospread the bid and offer as wide
as you can from one another,right?
So what happens with mostnegotiations?
People go in and negotiate Iwant in and negotiate, I want to
buy that car, I want to buythat house and they say, oh, I
don't want to go in too low, Idon't want to offend them, I
(14:16):
don't want to, right?
And the reality is you're sortof negotiating against yourself
in that situation.
Right, we trade bonds for allday long, every day.
We're always trying tonegotiate a better level of
execution.
The idea is very simple.
The wider the idea is verysimple, the wider the bid-ask
spread.
Well, think about where mostdeals finish.
They tend to finish in themiddle.
So if I have a narrow bid andoffer, if I come in close.
(14:36):
Well, where's my middle pointgoing to be?
Well, it's going to be reallytight to the what they're asking
.
But if I spread it out, I'veshifted that midpoint lower.
So a lot of what we see rightnow is a wide bid ask in
negotiation, looking for for abetter midpoint.
It just seems very chaotic whenyou're trying to track it from
30,000 feet and watching thisvolley take place.
We'll do this if you do that,and vice versa, and it just goes
(14:59):
on and on and on.
But in the end, I do think inmost of these situations or
instances there will be anegotiated outcome that our
current president is going tofeel really good about because
he's negotiating, and that'sreally going to be, I think,
ultimately where this shakes out, which I think, at least from
what we understand, some of thisshould be really good for
(15:21):
growth over time.
Might be disruptive in theshort term, but good for growth
over time.
Ryan (15:26):
So policy uncertainty, leading to maybe some risk
selling off, you think,ultimately spells maybe a
longer-term opportunity.
Is that a good summary?
Bill (15:37):
I think that, as we play this through, what we're likely
to see in the markets is anormal correction to a bear
market, which you'll see, thenarrative, the cacophony of
voices that around that as beinga, you know, recession vibe or
narrative that'll fill.
Oh risk could be slowing.
The recession risk is going upright as prices fall.
(15:59):
It's automatic that thenarrative will shift to
recession.
Risk is higher.
But again, we typically do seea good, healthy correction every
couple of years.
So it's a very normal outcomein the markets.
Doesn't mean it's the big one.
It doesn't mean it necessarilyhas to be.
So I do think that you knowthere will be consequences and
implications from some of thepolicy changes.
(16:22):
Right, if you have governmentworkers that are now being laid
off, that now have to find workelsewhere, that's going to be a
transition in the economy thatwill take time for those
employees to to find new work.
Ultimately, I think the economyis better for it.
I think companies are betterfor it.
It increases the labor supply,better talent pool for companies
to be able to hire from.
So I think, for a whole host ofreasons, it's better over the
(16:44):
long term.
Could it be disruptive in theshort term?
Sure could it be.
Could it result in slowergrowth in the economy?
Absolutely in the short term?
Sure, could it result in slowergrowth in the economy?
Absolutely in the short term.
And I think we've heard fromthe administration willing to
take some short-term pain forlong-term gain to get to the
right place.
But ultimately I don't view thiswhere corporations have
over-risked.
I don't view this scenario asthe typical business cycle where
(17:06):
companies are massivelyover-risked, they've taken on
too much debt, or that's notthis cycle.
That's not where we're at rightnow.
In fact, balance sheets lookreally healthy generally.
There's not a lot of those sameexcesses.
What we're seeing is thatsqueeze on the government side
of the economy and that's wheresome of that weakness could play
through, and that's that'sprobably going to present some
(17:29):
good opportunities.
Ryan (17:36):
Do you think we focus too much on some of these macro
issues?
I mean, our conversation hasall been about government policy
, things that are uncertain.
You are a portfolio manager, soyou actually have to make
decisions, and it's nice for meto sit in a podcast and ask you
theoretical questions, but Iguess my question for you now is
like how do you sort throughall that noise?
How do you identify the signal,what's really important and is
(17:56):
going to impact the performanceof your funds?
Bill (17:58):
Yeah, I think every day there's going to be something,
there's a headline, there'snoise, there's news, and trying
to dissect that information totry to realize or recognize what
will be the driver offundamental performance is a
very difficult game to play.
So where we focus is on thosecompanies individually looking
(18:19):
at their performance,understanding the drivers of the
business and looking toidentify companies that are
defensible in any environment,especially when you're talking
about lending the money.
Right, it's one thing if youbuy a stock, because when you're
talking about lending themmoney, it's one thing if you buy
a stock, because if you buy astock and the earnings grow and
you've taken a lot of risk, well, you're compensated for it.
If things go well, it's the wayyou expect.
(18:39):
You're going to be reallyrewarded for it.
For us, what's our best-casescenario?
We get our coupon and our moneyback If everything goes great.
So our job is to really workhard at dissecting these
companies, looking rigorously atthe financial statements,
understanding the drivers,understanding the inherent
volatility around that operatingperformance, and then the noise
(18:59):
around the periphery becomesfar less impactful because,
while that might change thespread on a given day, the price
on a given day, if we've doneour fundamental work and we can
rely on that heavily, then we're.
I can sleep at night because Iknow what I own and I know what
I expect it to do, even in thatenvironment.
And if that gets cheaper,that's a great opportunity for
(19:22):
us to try to own more so overthe last 12 months.
Ryan (19:26):
I look at ETF flows quite a bit and over the last 12
months actively managed fixedincome ETFs have accounted for
about 40% of overall fixedincome ETF asset flows.
They now represent somethinglike 17% of those assets.
I would imagine that some ofwhat you just discussed about
looking at individual companiesand their credits and their
(19:48):
creditworthiness and whether ornot you want to lend them money
has something to do with that.
But there's also the other sideof it and that is some of the
weaknesses associated withpassive fixed income investments
in particular.
Can you talk a bit about whatyou view as an active manager?
How do you identify weakness inthe passive benchmark and
exploit it?
Bill (20:09):
Well, the single greatest differentiator, I think,
relative to what we do activelyin fixed income, and it's really
important to separate fixedincome from equities because
they are different.
In fixed income, the singlegreatest differentiator is risk
management.
So in equities, I've got tomake sure I'm positioned and the
companies are growing, theequities are moving and it's a
(20:30):
totally different barometerright Market cap weighted index,
perhaps big, better capitalizedcompanies way more.
In the debt markets, theindices are simply structured by
where the debt is issued.
The more debt that's issued,the greater the weighting in the
index.
So even if you come back allthe way to something as simple
as the ag index, which is, youknow, treasuries, corporate
(20:51):
securitized debt, think abouthow treasuries have grown as
part of that composition of theag over the last 20 years, from
something like 25% of theexposure to 45% of the exposure
in the index.
Now, why has that occurred?
Well, you may have noticedthese deficits.
They have to be fundedsomewhere and they get funded by
treasury issuance.
(21:11):
So the more that our governmentborrows, the bigger the
representation in the index oftreasuries.
And does that mean that youshould own of treasuries?
And does that mean that youshould own more treasuries
because the government needsmore right.
That's really what happens inthese indices.
The greater the amount of debtthat's borrowed gets a much
larger representation in theseindices, and it doesn't matter
whether it's a safe index likethe ag, or in terms of high
(21:34):
quality investment creditissuers or high yield or bank
loan.
Where it comes down to whichcompanies have borrowed the most
.
The more they borrow, thebigger the weight in the index.
I would argue that that is avery flawed strategy for lending
money looking to the mostindebted companies, looking to
the most indebted sectors, andsaying we should give them more
because they need more orbecause they borrowed more.
(21:56):
Instead, you might want to lookat things like how well
capitalized is that company?
What's the likelihood that itpays back?
Well, how is the valuation oftreasuries against corporates,
against securitized?
All these different variables?
What part of the curve do Iwant to be positioned on?
None of that happens in any ofthese passive indices.
So for me, it really comes downto the simplicity of risk
(22:18):
management.
If you're looking at andactually doing the real work in
fixed income, it's aboutprotecting principal, capturing
income and avoiding loss.
That's the fundamental driverof what we do and that reduces
risk.
It's not an opportunity tothrottle up risk.
It's to protect principalcapture income, smooth the ride
for investors.
(22:38):
I think that's ultimately whatmost people buy fixed income for
, and so that's the real driverof that, I think.
Ryan (22:44):
That's a really good point , because I think oftentimes
people think about activemanagement as the way you add
value is by adding risk versusthe benchmark, and what you're
describing is kind of theopposite of that.
So, as you look across thespectrum of potential investment
opportunities within fixedincome at different sectors of
(23:05):
the economy, different types ofsecurities, different sectors of
the bond market, where do youthink some of the most
underappreciated opportunitiesare today?
Bill (23:13):
Well, I think a lot of the market narrative tends to shift
to spread discussions, right?
So you'll hear a lot of talkabout where spreads spreads are
tight.
Spreads are tight across fixedincome.
It's really important tounderstand that.
Spreads are really helpful inidentifying value on a given day
.
So if I compare come acorporate bond to a piece of
(23:35):
securitized debt, you know and Ican look across sectors and say
, well, look for this level ofrisk, I'm getting this type of
premium or spread in the marketfor that and I think that's
cheap, so that's really helpful.
But spreads tend to be a verypoor predictor of future returns
and, in fact, the best exampleof this.
We published a piece on this.
If you look back at high yield,going back to may of 2007, when
(23:57):
the spread was the tightest inhistory, just before the
financial crisis could youimagine like in your mind, it's
probably that's bad timing.
That's bad time.
Right, you would think it's badtiming.
But if you actually looked athigh yield, if you had purchased
it at that month when thespread was the tightest may of
2007 and you rode it through andyou looked at one year, three
(24:17):
year, five year, ten year, youknow I want to say, roughly
speaking, you know, three yearsin you average about six percent
a year by five years in Stockswere still negative.
From that point you had anegative return on the S&P 500
over five years.
The high-yield market was thenumber one performer.
It had outperformed stocks,outperformed every other fixed
income asset class and continuedto do so for a decade from that
(24:38):
tightest spread in history.
So the primary driver, or Ishould say the most important
variable if you're trying toassess future returns, is
understanding what yield I'mbuying at, more so than what
spread I'm buying at.
I think yield is a much betterforward predictor, a higher
R-squared if you will, in termsof looking at forward returns
(24:58):
relative to spread.
So as we look at the bond markettoday, well you know, if I
think about an asset class likehigh yield, where I can get 7%,
buying bonds slightly below par,taking half the risk of the
equity market in a market wherethe quality has been improving
over half, the market is doubleB.
Now that's never been the casebefore, because what's happened
(25:19):
through the proliferation ofprivate credit is these funds
have grown really large inprivate credit and they need
outlets.
They need assets to come andfind to fund with all that money
they've raised and they'retending to take some of the
weaker quality companies out ofthe public markets.
The better quality companiesstay in the public markets.
They get the best pricing, bestexecution, liquid.
(25:39):
But if you're a weaker qualitycredit and you need access to
capital and there's this bigpool of money over here in
private credit, it lines up verywell.
So it's tended to push thequality up within the high-yield
market.
So I think, as we look acrossfixed income, I like to say
(26:01):
there's no always and nevers isthe best way to think about it.
So as we look through, we'retrying to I dissect these
different parts of the market,looking at everything across the
various components of themarket and looking for the best
values, looking for where we cancapture the best level of
income with the least amount ofrisk to drive the best future
return with the least amount ofvolatility.
That's really the mathematicalequation and that iteration it's
(26:21):
happening every day, throughoutthe course of the day.
And then you go through aperiod like a market correction,
like we're recentlyexperiencing, and that will
present new opportunities for usto be looking across, maybe
taking up some of those parts ofthe market that we thought were
expensive that have nowcheapened up.
An area, for example, like highyield was really tight, widened
out on some of that recentvolatility, looked for some
opportunities in that Investmentgrade corporates.
(26:43):
The same thing we were hidingin more safe assets before that,
using securitized assets, areaslike that in the market to get
more defensive.
But that type of rotationhaving that ability I think is
really important of rotation.
Ryan (27:00):
Having that ability, I think, is really important.
So everyone has kind of overthe last couple of years now
focused on ai and new technologyand I've often wondered as a
portfolio manager, as you andyour team think about
opportunities in the market are,are you leveraging new
technology to kind of siftthrough ideas or identify
opportunities?
Bill (27:19):
it is the most profoundly impactful change that has
occurred in my career theevolution of ai and I am my eyes
are so open to this today andand it has changed dramatically
over a very short period of time.
A year ago, of course, we allknew what AI was, weren't really
sure how to use it.
(27:39):
Help me write this letter ofrecommendation, help me.
And now, as we think about whatwe're doing, I'll give you some
examples.
I think that, well, whetherit's a credit team, investment
team or whatever, I think everyteam will have data scientists
as a part of their team.
That's the professional willhave data scientists as a part
(28:03):
of their team.
That's, that's the.
You know the professional termdata scientists, what?
What I believe is that weshould empower all of our people
to be really powerful as a datascientist on top of their
current work, even as an analyst, for example, in the credit
space.
And you, I'll tell you someexamples where I was blown away
Recently, I put in a scenarioand you know, we have commercial
(28:26):
licenses with differentproducts and so we can use the.
You know AI.
And so I said hey, run, buildme a valuation table using these
five companies.
They're all public companies.
I want you to look back throughprevious business cycles and I
want you to assess the peak totrough drawdown in top line and
margins profitability and reallygive an assessment of valuation
(28:49):
multiples through time.
It built this table in twominutes and it was phenomenal.
I know the output already, Ialready know what it should tell
me and I looked at it and whatit did in two minutes would
typically take an analystpulling all the numbers, even
with automation, a lot longer.
And to be able to do that, orto say how deep can I go to see
(29:15):
more about this company, moreabout their contracts?
What's publicly available, whatused to be publicly available,
was a Google search and if Icouldn't find it, I couldn't
find it Right.
Right Now you can go a miledeep to find you know whether
it's government contracts thatthis company has, maybe it was
published somewhere and you know.
It's just the data's there.
(29:36):
It's so much more powerful.
I'm reading a book about thisright now.
I just it is incredible.
I think the efficiency gainsare going to be extraordinary
and we're just at the literallylike the very first edge of this
.
Ryan (29:50):
So it seems to me that something like this at first
maybe gives early adopters somelevel of competitive advantage,
but eventually it just becomeswhat everyone has to do to
compete.
Is that what you would kind ofexpect with this?
Bill (30:03):
Yeah, but I also think that there's an edge as well.
I think that the edge will comenot just from we can all search
the same data, we can all buildthe same valuation tables,
things like that, and do it alot more efficiently.
And I mean like in this bookI'm reading right now they're
talking about the efficiencygains are from 20 to 80 percent,
like the, you know, in theindustrial revolution, you know,
(30:26):
the steam engine was like 18percent.
So like this is incredible asfar as the potential for
efficiency gains, so I think alot of people are going to use
it.
I think it's going to maketheir work a lot easier.
But let's talk about the datawe produce.
So, as analysts, we buildfinancial models, we build
forecasts, we rate companiesinternally with our own
(30:48):
proprietary system.
What if I start to take thatdata and apply AI to that, to
then assess through that enginewhere right, where I might be
wrong in my rating, lookingacross sectors, looking across
ratings, identifying outliers,right and I think that that just
becomes really robust and thatcould be more proprietary stuff
(31:11):
that we develop, for example.
That gives you an edge, forexample, is one way where it's
something that not everybody has.
We're going to use it our way.
They might use it their way,sure, and there's just a lot of
innovation.
I think that could potentiallybe had there.
Ryan (31:23):
Yeah, really interesting and exciting things on the
horizon with technology.
All right, last question foryou, bill.
Again, the time kind of fliesby here.
I've got more questions, but wedon't necessarily have time to
ask them.
All right, you're a young BillHousie.
Before you got to be aportfolio manager, you've got
(31:47):
college age kids, so this isprobably an easy question for
you.
What advice would you give to ayoung Bill Housie starting out
in the investment industry?
Bill (31:52):
That's a tough one.
It's an easy question, I don'tknow, I don't know if it's as
easy as you think it is I likethrowing curveballs.
Ryan (31:58):
No, it's not.
Bill (31:59):
It's a tough one.
It's funny because, as youpointed out, I mean I do get
that question from my ownchildren, right, who are?
I have three that are incollege right now, all in
finance.
So we do have this discussion alot.
But I think that some of thethings we're talking about, like
this AI innovation right, andjust immersing yourself in the
(32:20):
technology right, we're older,right it's.
It's harder for us to you knowthe old dogs, new tricks, right,
it's just harder for us toadapt to these things.
So, being young and open-mindedto where you can begin to see
challenges and problems and seea technological solution to them
that we won't see, right,because we're not at the front
(32:44):
edge Like it used to just be.
Wow, these kids coming out ofschool really know how to use
Excel way better than I do.
I'm glad I got them to be ableto use that Excel Now, right,
they're using these toolsalready.
They're just so much moreempowered by it and I think that
, really, just keeping an openmind, I think it's really hard
for any young person in anyprofession, because there's a
(33:07):
lot of pressure on kids today tosuggest that they should have
all the answers like what do youwant to do?
What's your?
What do you want to work foryour first job?
Right, there's a lot ofpressure and sometimes, honestly
, it's just better for you tofigure it out, it's better to
knock around a little bit.
That's why we always like tosay we like you on your second
job, not your first job, becausego figure it out for a little
while and figure out what youactually want to do and then,
(33:29):
once you really kind of lean inthis direction, well, now you've
committed to it, now you likeit, you.
Now you like it, you know youlike it.
So I think in the beginning it'sabout having a wide horizon,
being willing to make mistakes.
The stakes are low, right, bewilling to make mistakes, be
willing to try new things, bewilling to learn new things and
just immerse yourself at everyopportunity to learn, because
(33:51):
you never know where that willcome back to help you later.
That's really the key thing.
I look back on the early jobsin my career and I think about
the tools that I use today.
At the time I had no idea wherethose things would help me
later, and they might've beenthe most frustrating parts of
those early jobs that later cameback to be real assets in
things I do today.
So you just never know wherethose experiences are going to
(34:14):
come back to help you later, andso having an open mind about
that, I think, is really themost important thing.
Ryan (34:20):
Bill, thank you for passing along some wisdom to the
next generation and thanks forcoming on the podcast once again
, and thanks to all of you aswell for joining us on this
episode of the First Trust ROIPodcast.
We'll see you next time, thankyou.
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