Animal Spirits Podcast - Talk Your Book: Balancing Risk and Yield

Episode Date: September 2, 2024

On today's show, we are joined by Priya Misra, Portfolio Manager for the JPMorgan Core Plus Bond ETF to discuss why private credit has gotten so popular, where corporate bond spreads are today, high quality companies within the high yield category, what a soft landing means for interest rates, and much more! Find complete show notes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation.   Check out the latest in financial blogger fashion at The Compound shop: https://www.idontshop.com Past performance is not indicative of future results. The material discussed has been provided for informational purposes only and is not intended as legal or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Information obtained from third-party sources is believed to be reliable though its accuracy is not guaranteed.   Investing involves the risk of loss. This podcast is for informational purposes only and should not be or regarded as personalized investment advice or relied upon for investment decisions. Michael Batnick and Ben Carlson are employees of Ritholtz Wealth Management and may maintain positions in the securities discussed in this video. All opinions expressed by them are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. The Compound Media, Incorporated, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. For additional advertisement disclaimers see here https://ritholtzwealth.com/advertising-disclaimers. Investments in securities involve the risk of loss. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. The information provided on this website (including any information that may be accessed through this website) is not directed at any investor or category of investors and is provided solely as general information. Obviously nothing on this channel should be considered as personalized financial advice or a solicitation to buy or sell any securities. See our disclosures here: https://ritholtzwealth.com/podcast-youtube-disclosures/ Investors should carefully consider the investment objectives and risks as well as charges and expenses of the JPMorgan ETF before investing. The summary and full prospectuses contain this and other information about the ETF. Read the prospectus carefully before investing. Call 1-844-4JPM-ETF or visit www.jpmorganETFs.com to obtain a prospectus. Investing involves risks, including loss of principal. JPMorgan Distribution Services, Inc. is a member of FINRA. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is brought to you by J.P. Morgan. Today's show, we're talking about the JPMorgan Core Plus Bond ETF, JCPB. Go to JPMorgan Asset Management to Learn More. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Redhol's wealth management. This podcast is, for informational purposes only and should not be relied upon for any investment decisions. Clients of Britholt's wealth management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. Michael, we always talk about like the market, quote unquote, trying to predict what's going to happen to the Fed or whatever, you know, like the market thinks there's going to be five rate

cuts. So the market thinks this, market thinks that. The market is obviously not always right. What? Yeah, shocker. So I think this is the interesting part about thinking in terms of bonds because there is so much more of a macro component. The macro matters a lot to the stock market too, but I would argue more to the bond market. And so I think what makes the bond market interesting right now is just the fact that like thinking through the scenarios of even if you just think of the two, like the soft landing and the Fed brings rates down to three to three.

and a half or three percent or whatever, that seems like a pretty good place for bonds because you get a little kick from lower yields, right? And you still have decent yields on your products, like not bad. But the hard landing of recession, here we go. You're starting with higher yields and those rates are going to fall. You're still in a pretty good place. So I think thinking through the different scenario, the other scenario would be rates rise again because inflation picks up or whatever. But thinking through the probabilities of what could happen, fixed income seems like it's in a pretty good place right now. Yeah. Relatively higher for relatively longer? Well, I don't know. More like higher for shorter because... Well, relative to where we came from. Okay. To the past. Yeah.

And we talk about it on this show, the fact that yields in fixed income now are over, they're real, right? They're above the rate of inflation, which was not the case for a long time. You had negative real yields in fixed income. People were just kind of saying, all right, well, I'm not going to get anything in yield, but at least I'm going to be kind of safe here. And yeah, I think you have a much bigger margin of safety now than you had before. The question is, there's so many different products you can invest in in ways you can go on the, not like the yield curve, but different types of products and corporate bonds and high yields and securitized debt and asset back debt, all these different things. So on today's show, we talked to Priya Mizra. Priya is a portfolio manager

with JPMorgan covering their JPMorgan core plus bond ETF, JCPB. We get into all this with her really interesting talk. We asked her as fixed income really smart money. She gave a great answer. And so here's more with our talk with Priya Mizra from Jacob Morgan. We are joined today by Priya Mizra. Priya is a portfolio manager covering the JPMorgan Core Plus Bond ETF.

Priya, welcome to the show. Hi, thanks for having me. You sent us some background information. on yourself. I'm most curious, how did you get into the fixed income world? So fixed income, I started in 2001, straight out of school. I enjoyed economics. I enjoyed thinking about market pricing. And, you know, it sort of made sense. Fixed income was this wonderful place where you had a nice blend of macroeconomics as well as market pricing. You're trying to find inefficiencies. Or if you had a view on the macro, which was different,

from what was pricing in. That was sort of my interest. And so I actually ended up in research. I thought when I figured it all out, and, you know, 22 years later, I was still figuring it out. So it's just a fascinating market. I did start, I will say,

at a time when government bonds were not considered very exciting. Well, not that they're all that exciting now, but, you know, that was a time when we weren't in a surplus, if that's believable. But in 2000, the budget deficit was negative, meaning we had a budget surplus. And people were saying, well, there may be no government bonds in 10 years time. And here we are.

We've got enough government bonds for generations to come. So the, you know, worlds changed a lot. But fixed income just was interesting to me from what I enjoyed. And it has stayed interesting. And, you know, you never quite know what is going to bring, you know, what the day is going to bring about. So that's kept me fascinated all these years. One of the arguments Michael and I have had over the years is that people always say the fixed income is the smart money. Maybe you could expand on that for what that means, and I'm curious if you believe it.

Because there is this idea that fixed income is a smart money and the stock market is the dumb money, right? I guess in certain ways. Maybe you can let us share with us on your thoughts of the theory. So as much as my ego would like to think that as a person who's been in fixed income that is smart money, you know, I struggling with that. I do think all of us look at the same data. The market's looking at economic data, Fed speak, global macro developments, company fundamentals. We're all looking at the same data. How you interpret that data and how you think about flows, that's going to drive what happens

to market pricing. I do think in fixed income, there is this macro element, which I think maybe is a little less in the equity market. I think that's one difference. I think the macro component. So for example, when I say macro, what do I mean? I mean interest rates, FX. And interest rates, you've got interest rates from overnight rates, which the Fed controls,

all the way out to 30 year. Or if you're out of the U.S., you have 100-year bonds. So there's an element of where are interest rates today? Where will they be over time? I think there's a bigger macro component within fixed income. Because ultimately, everything is really benchmarked off the Treasury curve. So you kind of have to have that sense, which I think in equities, it tends to be, there's one equity risk premium component. And then after that it's very much the sector or the company that you're looking at. We have all of that in fixed income. But then you also have this macro component of where will 20 year interest rates be? And then, you know, or 10 year interest rates. And then we benchmark what should this, how much more should I be paid to take on a corporate risk? So I don't know about smart or dumb. I do think. it requires a lot of work and it's humbling in the market, in any market.

We do tend to focus on slightly different things. So that's where I think I find it interesting to look at both markets, if I just think about fixed income and equity, to see, is there an asymmetry there? I think we may be at that point right now where the equity market may be a little more excited about Fed eases. And the fixed income market may be saying, well, there are lags. We just live through lags. So it's not clear that if the economy is slowing, Fed eases will be enough.

So there may be some differences in terms of how the risks are being perceived. But ultimately, we're all looking at the same data and taking a view. For the last two plus years, the shape of the yield curve has been inverted, meaning that the short end rates have been higher than the long end rates. And ostensibly, that's going to uninvert or disinvert in the next couple of months as the Fed does start to finally ease. As a portfolio manager, how do you think about the dynamics of the yield curve? Sure. Great question. There's a lot of hand-wringing done around the yield curve because historically, an inverted yield curve is actually, you would argue, the single best market indicator of a recession. And here we are. Two years later, we're not in a recession right now.

So what's different? So I think there's a couple of differences. and we have to incorporate the entire, you know, macro environment. And why I say this is one of the reasons why the yield curve is inverted is that the Fed owns a large number of treasuries and mortgages. So duration risk, a large part of that duration risk has been taken by the Fed. The market, you and I, investors don't have to own it. So to some extent, that's artificially depressing, or I shouldn't say artificial, but it's a price-sensitive buyer, the Federal Reserve, that's bought these bonds.

So that's a structural reason why the curve should be flatter. Should it be that inverted? I think that's the market telling you that the Fed has taken rates into restrictive territory. We're seeing it in the data. We've heard the Fed say that it is restrictive. And so to your point on, is it disinverting? Yes, as the Fed reduces the level of restrictiveness, which they're indicating. I think the debate is not whether they will reduce.

It's how quickly. Is it a 50 basis points in September or not? how where's what's that end point but as they reduce the level of restrictiveness that front end is going to get to either some level of normal if we stay in a soft landing

we could get to let's say 3% is the Fed's estimate of neutral I think it's a fair level if we head into a recession that front end is going below that because at that point the Fed will want to decreats into accommodative territory the long end is less

impacted by that so that's when that curve disinverts So you sent us some notes on some of you're thinking about the fixed income market. And you said, and it's interesting because this is something Michael and I have been talking about a lot. You said, once the Fed starts to cut, I think money that has been in money market funds will leave due to reinvestment risk and we'll go into bonds of stocks. Now, the amount that leaves maybe will, it might depend on which scenario happens from you. You said, like, does it get to the neutral rate of three? Or does it go even lower than that because we go into some sort of recession?

Do you have a feeling because there's, I don't know, six or seven trillion dollars in money markets? I think if you add CDs in there, that's another, you know, a couple trillion dollars or something. Do you have a sense of that money, how sticky it is, and then if you think more we'll go into just bonds, if that's sort of money markets or a bond substitute? I'm curious your thoughts on that, because we've been trying to figure this out, too, and it's interesting to think through. Yeah, it feels like every investor is salivating at that thought of the $6 or $7 trillion and where it's going to end up. So a couple of points on that.

Number one, some part of that is going to be sticky. people need cash for cash management reasons, for liquidity reasons. And so a large part of that, I mean, you go back to when interest rates was zero and there was a certain amount that was lying there where, you know, and we were not talking about a recession. So is it $3, $4 trillion that's going to stay there? And remember, that number should move in line with nominal GDP. So it should not be a static number.

As the economy grows, as markets grow, that number that's the actual demand for cash should also grow. Maybe that's three or four trillion right now. We still have a few other trillion. Where does that go? Historically, so if I go back multiple cycles, you actually find that the Fed cuts in a recession, right? Soft landing cuts, what we're actually contemplating right now are very rare. It's happened only once, really, in the post-war history, which is in 95. But normally what happens is the economy goes into a recession, the Fed starts to cut rates, interest rates fall dramatically. So actually, money when it leaves and equities fall. Typically, money leaves money market funds at that point and actually goes into the equity market because equity valuations have reset. The reason this

time could be a little different, I'm nervous saying this time is different. I don't like saying it, but there are some different factors this time around, which is, number one, equities are they have not really reset lower. They are near their highs. They're at their highs. So it's hard to argue that, you know, there's a lot of value there unless you see some growth sector. The Fed is going to cut rates and the money that's sitting in that, you know,

five and a half percent overnight cash, there's going to be some reinvestment risk there because that number is going to go down. So I actually think in a soft landing, so let's say the economy stays one and a half to two percent GDP, current level, inflation slowly. gets close to that 2% level, Fed cuts to neutral rate. In that scenario, I think that non-sticky cash will go into really every asset class out there. There's going to be some in bonds. You're getting real returns in bonds. Actually, for the first time in decades, you're getting real

return, meaning you're getting returns above inflation. Some of it is going to go into equities because the economy looks strong. Some of it is going to go into alternatives. In a hard landing, it starts to look a lot different. So if the economy is slowing down much faster, I think actually more will go into bonds because at that point, you know, you can get really nervous about equity valuations and the fact that we've not really had any decline in equities,

I think then more can go into bonds, especially high quality, high grade or government bonds because the concern will be, I want the yield, but I want the safety of that money. So I think depending on the economic environment, that money moves, but yeah, you're looking at a couple of trillion that is going to start to get nervous

when that overnight yield and it may not happen in one go. I think the first rate cut actually doesn't matter. It's when you've had three or four rate cuts and, you know, I was getting five and a half in my money market fund and now I'm getting four. And when I talk to my financial advisor,

I realize, oh, I'm going to get three the Fed continues to cut rates. I think that's when it really snowballs because you start to realize that five, four, these numbers look unreal. I mean, they're unreasonable as you're looking ahead. That's when that money starts to move out.

Can you talk about the dynamic of how a lot of corporations gorged on bonds, borrowed a ton of money in 2020, 2021 where interest rates were ultra low? How much did that insulate them from needing to borrow in later years as rates went up? Obviously, small cap stocks are much more sensitive and their debt tends to be floating. But for larger corporations that were able to lock in rates, what sort of impact did that have on market dynamics? Yeah, I'm glad you bring that up because I think that's the single biggest reason why the economy has been so resilient.

And I would expand, I know you asked about corporates, and I'll get to it, but households. I think everyone was a smart CFO. If you're a household, you've got a mortgage, you refinance at a 2%, 2.5. And that's why you're noticing the housing market, I would argue, is frozen. And I'm not even sure a few cuts or 100 basis points of cuts is going to do. do a whole lot because the effective mortgage rate is a little below 4%. And current mortgage rate as of last week, six and a half. So you need a significant decline in rates for refinancing to pick up.

But corporates did the same thing. What they did was a couple of things. They certainly what they had to issue, they issued, if they had a bond maturing, they extended out so that they were locking in that funding for a longer period of time. It was very low. And remember, this was an environment. where the Fed had cut to zero, and they were doing significant QE. So they were actually impacting long-end rates, and corporates extended.

The other thing corporates did was they pre-funded. And so, and this is why we've heard, you know, this year there's been a lot of corporate issuance. Look at net corporate issuance. It has not been that high. Because companies pre-funded, if I had a bond maturing in 24, 25, I issued it in 2020. Now, it'll only last that long, which is why the lags exist of monetary policy. If the Fed doesn't cut rates, and I feel very strongly, we're in a soft landing, all markets love it.

But in order for this soft landing to remain, the Fed has to start to cut rates because that effect lasts for three years, five years. The average corporate bond issuance is seven years. If they manage to extend all the way to 10 years, not all of them issued in 10 years. So I would say the average is five to seven years. Within five to seven years, that lock-in effect goes away. And even on the household side, you know, you move, you have more kids or you downside. There are life changes happen. People move because of jobs.

That could take a while as well. But at some point when you move, that interest rate shock will hit you. So which is why I think the Fed's very smart. They are trying to start to reduce that restrictiveness now so that companies that had done that lock-in as one of the reasons why corporal balance sheets look strong because interest cost is not high. because to your point, most of it is fixed rate, it lasts, and it's helped them, it's insulated them, but not forever. And so if interest rates don't fall, I think we'll be talking about a different scenario two years from now. But I think the hope is that two years from now,

Fed funds will be lower, the 10-year will be lower. And when they have to go out and refinance, it's not going to be current level of rates. It's going to be lower. So the bond fund that you run is Core Plus, which I assume means the Bloomberg aggregate, it, and then you kind of can go a little further out on the risk spectrum. I'm curious how you think about it, because you mentioned the inverted yield curve being what some people thought was this, you know, this thing that was never wrong. The interesting part of that is that spreads never blew out for corporate or high yield bonds, really.

So I'm curious how you look at the landscape today of fixed income because the fact is that spreads are still pretty tight historically. So I'm curious how you think through that landscape of treasuries versus corporates and high yields when the spreads are still pretty low. Sure. So, you know, you're right. Spreads are tight on a historical standpoint, but I would argue that they are tight for good reason. If I look at corporate bonds, look at corporate fundamentals, extremely strong, you know, whether I look at earnings or margins or debt levels or interest coverage ratio, various metrics that we look at in the corporate sector, the risk is lower. And so that reflects why those spreads are tighter. Let's look at the mortgage sector. If I think of the broad you know, fixed income indices, you've really got the securitized and the credit. So let's look at securitized. Interest rate wall is lower.

A year ago, so in the fall of 23, we were talking about potentially the Fed hiking once more, or maybe cutting a lot because we were heading into a recession. So interest rate levels of wall are much lower now. We're not talking about rate hikes. We're talking about cuts and the Fed is sort of telegraphing these rate cuts. So I do agree spreads are tight, but for good reason, all in yields are extremely attractive. And I think that's what's attracting flows, whether it's out of cash, out of other asset classes, into fixed income, because you're looking at all in yields of five and a half, six percent for high quality spread product. But in terms of your question of, you know, relative attractiveness, I would say we think of different levels.

In terms of credit risk, I like securitized credit. There's aspects of the securized credit market where you can pick up yield over investment rate corporate market. are giving up some in liquidity, but you are picking up for the same credit risk, you're picking up more spread. So I would say parts of securitized credit make a lot of sense to us. The agency CMBS market gives you positive convexity. So it's almost like it is a mortgage product with positive convexity. So there's value there.

High quality, high yield. The high yield market today is not the high yield market from 20 years ago. I think the private credit market has reinsured the high yield market. So there's a lot of value in these high quality high yield. I think triple Cs become a lot more idiosyncratic. There's a lot of liability. Sorry, sorry to cut you off. So you think high yield is much more high quality these days or at least certain parts of it.

Yes, exactly. I think the double B, single B high yield is higher quality than before. You've had a lot of the rising stars where these double Bs are getting upgraded into the triple B. We've had a larger percentage of these upgrades happen. Part of it is because they've been helped either by fiscal stimulus or they did the lock-in effect that we were talking about earlier, that they actually managed their liability stream well. So, you know, there's a lot more rising stars than fallen angels.

But I would say we found high quality high yield and high quality IG actually gives you better risk reward than the triple B sector. You mentioned something about private credit derisking high yield, making it. it more high quality. Can you say more about that? Sure. So I think the fact, the advent of the private credit market, you know, I think there was a lot of trepidation, you know, concern. What it's doing is it's providing credit to a part of the market that was either provided credit by the bank banking system. And that changed with regulation with what happened last year with the, so there was a reduction in availability of credit there. Or it was provided.

on the high-eel market. And the advent of this new private credit market with, I guess, money that was, you know, not looking for instant liquidity. Most private credit money is sort of in there for the long haul ends up then being invested in sectors that then don't end up in the high-eel market. And as a result, what's left for the high-eel market

ends up being higher quality. So I view that the private credit market, I mean, broadly from a macro standpoint, is almost re-insuring the high-eil market. And it can explain one of the reasons why you're seeing a lot of upgrades or these rising stars may be the fact that the higher quality players ended up in the public high-eel market. And, you know, they just, their quality effectively

is getting upgraded relative to where double Bs were considered, you know, 10 years ago. So I think it's got good macro development. I wonder if that's part of the reason, maybe this is a stretch, but maybe part of the reason why spreads never blew out in high yield, like, or, I don't know, interest coverage ratios, for example, maybe higher for the current makeup of the index than it was, say, 10, 15 years ago? Yeah, I think that's fair. I mean, there are lots of things. I mean, did spreads not blow out? Because default rates, okay, let's look at default rates in the high yield market.

Historically, three to four percent in a recession, they spike. we're running at one and a half to two percent. Now, is that because the economy has been resilient. There was a lot of fiscal stimulus. There was savings in the household sector. So the consumer was much stronger. The supply side helped. Tons of labor supply.

Supply chains improved. So I think there were macro reasons for the strength of the economy. And then I think at the marginally player where defaults might have gone up, might have ended up in the private credit market. So I think there was a factor. I don't know if it was the largest factor, but I do think that, you know, and there have been,

there have been the defaults, the concerns have happened. You see it more in the distress part of the high-year market. The high-eal market, I should clarify, is bifurcated, much more now than it was 10 years ago, where you're seeing the high-quality high-eield is really trading like investment rate in my mind. And then you've got the distress sector

where, you know, that's where the problems are. So you see the 200, 300 basis point spread in the high quality sector. And then you have the thousand basis point spread in the distressed sector. And that's where it's idiosyncratic. And now that might be more similar to private credit. It's actually not an area we traffic in. I don't think it gives you the best restore what you really need to be. You need to have a seat at the table to know which companies to own within that distressed world.

When you're creating a portfolio, how do you balance this desire for going a little further on the risk curve so you can increase your yield versus the worry that, well, what if the Fed does accidentally cause a hard landing and this is not good for a certain type of bonds? How do you tow that line? Yeah, we stress about it a lot. We don't sleep well, but it is something we think we spend a lot of time thinking about portfolio construction. So let me summarize quickly, and I'm going to simplify what we do, but it's some version. of this. So we think about where are we business cycle-wise? And I think right now we would say we're in a soft landing. But in my mind, soft landing is about risk management. And then which is a bigger risk? And right now, the bigger risk would be that the Fed doesn't cut enough or early enough or quickly enough and we might end up in a hard landing. So if you think of a bimodal world of soft landing with a chance of a recession, like a sunny day with a chance.

chance of rain. How do you, you know, set up portfolio for that? Well, in the soft landing world, spreads look attractive. We talked about how they are tight, but they're giving you carry. They're giving you a spread over the index. So you think about high quality spread product, securitized, whether it's securitized credit or mortgages, high quality investment grade, high quality high yield. There's value across the board. You know, it's like, don't ask me which one I like which of my children I like more. It's hard to pick. This is the best sector because there's value across the board in terms of different sectors within high quality spread product. But then what about that chance of a recession? Well, let's think about is there

a macro hedge we can do? And this was very, very difficult for the last few years because there was no hedge. Correlations were all over the place. I would say it's different today. And what's different is the Fed's telling you, now, you don't have to read between the lines. Jeppe Owl was very clear, and has been clear, he was clear in Jackson Hole again. If things slow down, they're going to be aggressively cutting. And so that's giving you a sense of what the hedge is, which is interest rates. Owning duration or having a curve steepener would be a way you can, it's asymmetric. Meaning, if we stay in a soft landing, the tenure probably stays between three and a half and

4%. We're right there. So if he stay in soft landing, you earn carry through spread product and interest rate stay here. So that's great. What happens if things start to slow down, your spread products will naturally widen. Whether it's for liquidity or some concern of a recession, you'll start to underperform the index in some of the spread product. But that's where your interest rates start to fall as well. The tenure can go to 3% or lower. The yield curve can can steepen out because at that point we're going to expect the Fed to cut more than what's priced in right now. So I think a macro overlay, so the way we think about Core Plus and the way we've always managed it and it was very hard when correlations all over the place, but let's think

about bottom up security selection, sector selection, and then top down, what are the macro hedges that we can put in place to help in case the baseline scenario looks like it's not coming to fruition. At some point, you have to get out of the risk as well. But I think hedging of that risk, especially when it's asymmetric, I don't think interest rates can rise as much as they can fall at this point. So that's what gives us confidence in these macro overlays of, you know, I would say duration of curve right now are both good overlays for a soft landing trade. Getting back to the construction of the portfolio. So this is, the ticker is JCPB. This is J.P.B. This is J. plus bond, ETF, what are some of the parameters that you have? So is this 80% ag and you've got

20% flexibility? Like, what does that look like? Sure. So it is, I'm glad you brought up the ag. I should have mentioned that. It is style PO, which means it is benchmark to the ag. We look at the ag all day long and what are our risks relative to the ag. Now, what can we do? We can do to a few things in that. We can go up to 30% below investment grade. Now, I shouldn't say that it's just high yield bonds. It may be high yield or below investment grade securitized or below investment grade corporate credit.

Like we think of corporate credit as one allocation and there may be something below investment grade. So, but it could go at the most 30%. And then foreign bonds, it can go up to 20%. So if we think emerging markets make sense or develop markets, you know, if we had a thought process on JGBBs a few years ago, that was something that we could express so it can go up to 20%. And then we have about a year and a half max duration up or down, that we can use that level. So when I was talking about the macro

overlay of duration or curve, that would be something, this is all part of active management, where unlike the ag, which I should say, the ag only represents half of the bond market. So So, you know, the ag is not exactly representative of the bond market, but not only can we take out of sector bets relative to those numbers that I told you 30% and 20% in below investment grade and foreign bonds, we can also put on the ag has a certain duration, we can go a year, year and a half higher than that duration or below. So you're not going to see us go five years short duration or long duration. The ag is about six year duration. So within a certain range, we can and tilt the portfolio, just looking at all times.

What are the returns we're getting once we take that risk? And then what is the risk of that? And making sure that it's an asymmetric, meaning the reward is higher than the risk we're taking. At all points, we want to keep that risk reward in mind because I want to be careful. People are buying bonds because they want a hedge to their risk assets. You don't want your bond portfolio acting like a stock portfolio

or a risky portfolio. So I think that's all right at the back of our mind. it should act like a bond portfolio. You don't want people saying interest rates are falling and I'm losing money in a bond portfolio. So those are things which we have at the back of our mind, keeping that risk toward in mind. That's how we try and pull, you know, all the different levels that we have, convexity, duration, credit.

So given that we think we know the path of interest rates at the very short end, what is an investor to do in today's environment? So I think it's helpful that the Fed has endorsed, in a way, as close as they can get to, endorse the fact that they're likely to cut rates and the market may not be too far off thinking could start as early as September. And the end point after all the rate cuts, I would say there's a lot of debate around 50, 25, you know, each meeting actually take a step back. It doesn't matter.

I mean, it sounds act religious for a bond person that I'm saying it doesn't matter. But really, let's think about the totality of cuts. Just as the Fed looks at the totality of data, I look at totally, you know, overall, how many cuts are we pricing in? We are not pricing in a recession level of interest rate. And so if I look at market pricing, it's telling me this is consistent with a soft landing. So the market's pricing in cuts all the way out, gradual cuts to 3% on the funds rate. And if that's what happens, this is actually telling you that interest rate.

will probably not move a whole lot lower because it's already in the price, but it tells you it's unlikely, interest rates are unlikely to go up a whole lot, but maybe the 10-year ranges between three and a half to four. But this environment is actually positive for the economy because the Fed is taking the edge off interest rates. They had taken rates into extremely restrictive territory. They're taking it back to normal. This is actually good news for risk acids. But here's the catch in this. It's not zero interest rates. You know, think of the scenario and we all live through it painfully when interest rates were zero for a long period of time. At that point, there is more, I would say, there's misallocation and you could argue

of resources. Because when interest rates are zero, you just buy anything, buy everything. Well, when interest rates are 3%, dispersion will increase. So I would say you have to be careful what you own, make sure you know what you own, think about the debt profile, how much debt is coming up for maturity because we're not going back to zero interest rates. So think about active management or know which sectors can withstand a 3% Fed funds rate. But in general, that's a positive environment, the fact that the Fed is able to cut. If you're telling me inflation's re-accelerating, I'll have a different view. But inflation is doing the right thing. It's coming back down the Fed is, that's giving the Fed confidence to start to cut rates. And I think that's

generally a positive environment for the economy. You talked about not sleeping at night sometimes trying to predict the macro, what the Fed's going to do? And it's obviously no one knows these things, so it's hard to predict. But you have to feel a little bit better being in the fixed income space now than a few years ago just because there's yield there. And that gives you some sort of margin of safety, right? I agree. I mean, you have yield and you don't have a Fed that's behind the curve. I mean, we had a lot of headwinds to the fixed income market, I think, which is why, actually, I'm glad you bring this up because I think people have been underinvested or uninvested in fixed income because either it gave you no yield. Think about 2008 to 2015. There was no yield, really.

We're at 2% or nothing in real terms. When Fed funds is at 2 and inflation is at 2, it's a little hard to make the case that you should be in this asset class. So it was a giving you any yield, wasn't giving you any diversification either. And then we moved to a period like 2022, where my blood pressure, I think, was high the entire year because the Fed was clearly behind the curve. And it wasn't clear were they going to stop at 3%, 4%, they ended up at 5.5%. But the market didn't price that in. Remember we were pricing in, the market was pricing in, the Fed funds hiking cycle would end at 2. And then we realized, oh no, it's going to 3, 4. So, it was the fastest pace of rate increases since the 70s, very painful. We saw what happened

to the regional banks. And if the Fed hadn't come in, I give them a lot of credit. They came in multiple times last year to stop the bleeding. They did put policies in place for the banking system. And last fall, they came out and sort of told us in code word, you have to read between the lines that they are done hiking. So they tried to contain some of the market nervousness. But 22, 23, those were difficult years because we were not sure, it was not providing any hedge. So to your point, yes, today, despite all the uncertainties we live with, we have an election coming up, which could have big macro implications. I do think fixed income is giving you yield, real yield, and it's giving you diversification.

So those correlations are back and that, you know, at least you can make a case that there's place for it in any portfolio. Whatever you have, either you need the yield or you need the diversification, I would argue most of us need both. So I agree it's a better place, but no rest for the weary. We have plenty to still do. Priya, remind our audience where they can find more on the JP Morgan Core Plus Bond ETF. You can find it on the website.

JPMorgan Mass Management. You can contact your financial advisor. There's a bond fund as well as the ETF. There's everything really on the website. Perfect. Thanks for coming on the show. We appreciate it. Thanks for having me. This was fun. Okay. Thank you to Priya. Remember, check out J.P. Morgan Asset Management. To learn more about the J.P. Morgan Corp. Bond ETF.

And send us an email, Animal Spirits at the Compound News.com.