Animal Spirits Podcast - Talk Your Book: Do We Need the Federal Reserve?

Starting point is 00:00:00 Today's Animal Spirits Talk Your Book is brought to you by FM Investments. Go to FMInvest.com to learn more about their whole suite of treasury etifs and bond ETFs. That's FMInvest.com. We'll learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson 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 Ridholt's wealth management.

Starting point is 00:00:27 This podcast is for informational purposes only. and should not be relied upon for any investment decisions. Clients of Ridholt's wealth management may maintain positions in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. On today's Tucker Book, we have potentially our guest with him. He's like the five-timer jacket on SNL, right? He's probably got the most appearances. Alex Morris from FM Investment.

Starting point is 00:00:56 Came to talk about the Fed, the bond market, schools on a bunch of different things, also show us how he created AI Kevin Warsh. What else do we got? I feel like it is funny how cyclical the bond market really is, and it takes on it. I showed this on Select the other day with you. I said, when rates rise, you worry about inflation. When rates fall, you worry about recession, right? But I feel like the narratives have driven the bond market more than the bond market is

Starting point is 00:01:22 latching onto these narratives. Is that fair? The bond market is in a pretty stable place as far as I'm concerned. Spreads are low. The volatility of yields has not been that much considering where inflation sits. Yeah. Yeah. No, you're right.

Starting point is 00:01:35 It could be, could certainly be worse. Yeah, that's what I'm thinking. The bond market hasn't been, it was a source of volatility in 2022 for sure. Since then, not so much, as far as I'm concerned. It's been relatively stable. Anyway, we talked about a ton of different things concerning the bond market. How FM investments went from zero to $10 billion in a little over five years. a bunch of other stuff.

Starting point is 00:02:00 So here's our conversation with Alex Morris from Anthony Investing. Alex, great to see you. It's great being back. All right, let me ask you this. Do we need a Fed chairman? Do we need a Federal Reserve? Well, let me just say that. But not Federal Reserve.

Starting point is 00:02:18 That's crazy. Do we need the policymakers to be setting interest rates? Well, it's a question a lot of folks have asked. I mean, the experiment of central banking in the last 50 years seems to say, Yes, right? Maybe a little more than that. By the way, to your point, Michael, we're on our fourth central bank of the United States, right? We called, we had one called the first central bank of the United States. That didn't work out so well. We paid off all of our debts, actually, with Andrew Jackson. They made the second bank of the second bank of the United States. That didn't work out. So then we thought, you know, let's stop numbering this. We'll just call it the Federal Reserve. That way, if we have a few others, we don't. Well, we forget there's actually like a first one, the Zeruit Bank, Bank of North America, and articles of Confederation. So we've been trying this a lot. lot. The fear is, if you let politicians make central banking level decisions, they'll just make money free because free money gets votes, right? So you need someone to be the adult in the room to say it's time to take your medicine. And inflation has just killed empires before. And we're hoping

Starting point is 00:03:17 for better. So it's a tough question. I'd argue, yes, it seems to be working, but the very tenuous relationship between a central and independent central bank versus the legislature is hard to

Starting point is 00:03:32 square sometimes. And today, I know folks will read this after you've already had a chance to read it, but Supreme Court

Starting point is 00:03:36 said, you know, if you read Justice Thomas's dissent, he went into a lengthy discussion of this whole thing is unconstitutional, politician should

Starting point is 00:03:45 control everything at all times, which, you know, was going to throw a lot of central bank observers for a loop. Leave my knicks alone. They can't touch

Starting point is 00:03:53 that, they will not control my basketball team. That's right. Well, that they're okay with. A lot of people have said, well, why don't you just let the two years set the rates? Because if you look at it, the two year, the essentially, in the federal funds, they essentially track each other. Now, I'm sure the retort there would be like, of course, the two years following what the Fed is saying. But, I mean, it wouldn't ever be as simple as just following a market rate like that. Wouldn't that just make rates more volatile?

Starting point is 00:04:15 I think so. I mean, markets are pretty good at solving a lot of problems. And I think availability and money is also a market's issue, right? The Fed gives money to banks and goes. for lending process, but banks and independent lenders decide if you can get that money, right? So just because money in the system is available doesn't mean it's available to any of us, right, to you, as it were. The two-year, I think, the cause to your point is exactly Fed does something two-year follows because market knows that's what they can get. I think you would see more volatility, first off, which folks might not be used to, but you also need someone to stand by and inject liquidity when it's needed. And the two-year can't really do that. Independently, the private

Starting point is 00:04:54 actors don't come together when times get tough and offer to foot the bill, right? They get together and they say, great news, we're taking our chips that are remaining and going home. So the Fed has that weird, anti-profit motive to come in and actually kind of stabilize things that a market-based rate just wouldn't ever naturally have. Do you think the path of interest rates is the most important thing governing financial markets? Probably not. I mean, this is probably blasphemed me to say a little bit, particularly someone who follows this. It's a super critical factor, right? But I think probably the most important is the rule of law and belief of fair faith and good faith in the system, right? That interest rates free ride on that, right? All these other things available in money,

Starting point is 00:05:36 none of that really much matters if you don't have all the other constituent parts of a really well-functioning economy. You can look at, you know, despotic regimes across time and space. You can look at what happens in China now, right? Without that, there's just these other things just become window dressing. Thank you, Alex. I've always said that the Fed is less important than most people would assume, but I still think people draft their expectations on the Fed. So Bloomberg had this article last week saying that the debasement trade is unraveling, and Kevin Warsh is one big reason. Okay? So look at all these things and they say, hey, listen, since Warsh became the new Fed Chair, gold has fallen, Bitcoin has fallen, although everyone, it seems like every Fed chair makes Bitcoin fall now.

Starting point is 00:06:15 The Treasury curve, right, yields have fallen, and then the dollar has stabilized and increased. And they say, well, this is a worse thing. I'm just curious, do you think that people read way too closely into how much the bond market cares about things like government debt in these types of things? Because you've said, yeah, listen, inflation has brought down regimes in the past. But guess how many times that happens? Once, right? It doesn't happen all the time. So do you think that people put too much stock in that whole faith in the system and the debasement and all this?

Starting point is 00:06:45 Like, is it too much to put that on the bond market's shoulders? I mean, the bomb market certainly would say no, right? We deserve that. I think it might be too much to put on any one Fed chair shoulders. I don't think the appearance of one person who, by the way, is one vote of 19 people who are there, right, 18 dots because he opted out. But not all of them vote at any one point anyway, but he's one vote. He has a lot of ability to set policy. I'd argue the Fed share probably has more to do with regulation and some of the other more administrative tools the Fed uses to regulate bank. systems and how money moves around the world and, you know, its interaction with FinCEN, some of these other things and how it interacts with other central banks, then it does the value of Bitcoin, right? Bitcoin's going down because people just don't want to own Bitcoin. Spline demand says Bitcoin will go down. Gold, same sort of thing, right? They're not trying to do that. Yeah, the dollar to basement trade has had 10, 15 years of, you know, being top of mind in every six months. It's got a new reason why it's happening, and then it doesn't, and then it

Starting point is 00:07:45 does for a little while, and then it comes back, right? So I don't think it's the Fed. But I do think there, you know, the government debt is an issue, right? I think that there is a natural and hard limit. We're good at monitoring that, not through the Fed, but through the Treasury. How much action do we see at each of the auctions? Are they strong or are they not? Which is the public's way of saying, we believe in the direction that the government's taking, and we're willing to lend you money at this rate to do it. And here's how many of us are actually willing to make that happen, right? It's not just one person who believes it's, is that belief held broadly? I'm just curious, what does a weak auction look like?

Starting point is 00:08:19 You see the headlines. Does that mean like, oh, they were trying to borrow at whatever, 392 when it ended up being 3904? Like, what does that mean practically? We always see some difference, right? We issue these securities called when issued securities, which is a get, like, this is what we think the new on the run is going to trade at. And then we talk about whether the auction was stronger week.

Starting point is 00:08:40 You hear about it tailing in, which means you get a little more yield than you might have expected, so it was a little weaker. But there's some structural reasons that that tail tends to happen, particularly on the shore end of the curve on a regular basis. It's when the government says we need to, the true failure, right, is government says we need $50 billion from this auction and only $48 billion actually show up to bid. It's like Treasury IPOs. Yeah, it's a Treasury IPO. The Treasury does this multiple times a week and all sorts of securities. Now, they do have primary dealers who are required to take down those auctions if they don't have a bid, so they have some mechanism there. But there is a hard limit where eventually folks will just say, no government,

Starting point is 00:09:19 we're just not going to lend you money anywhere near the rate you're looking to do. And the government then has to decide, are we going to issue a 10-year bond at 10%? Or are we going to just say, whoops, you know, go back and try again. Both are fairly catastrophic, by the way. You might know know the numbers better than me, but there was a story a couple of weeks. ago about how the majority of the borrowing by the government now is just on the short end. They have just decided, listen, we can control the short-term yields and most of that money is going to be in probably like three-month T-bills, right? And I don't know what the number was, 60% maybe? Something, is that in the ballpark? It's approaching two-thirds on the short end of

Starting point is 00:09:55 the curve, yeah. Does that worry you at all? Because people say, man, that debt has to be rolled over way quicker. And you think that's actually a good thing in that, hey, yes, long-term rates are rising, but who cares to the government debt? Because we're not borrowing that much money using long-term rates anymore anyway. Mixed emotions on it. To some extent, the government has proven its ability to refinance those amounts in the short end, so I don't have like that much worry that they won't be able to. Obviously, if there were to be ruined, we would now see it come faster, right, which is probably bad. It's really more the policy. Just rip the band it off. If the, the empire is going to end, let's just do it. Get rid of everything. Try it all again, invest in

Starting point is 00:10:31 squirrel peltz and gold and lead and, you know, property in the mountains. That said, I think it's the policy implications. How do you make long-term policy decisions and spending decisions for the population, for all the citizens, if every two years you've got to refinance everything? Who's making long-term decisions? That's the problem. Nobody. The 535 elected people a mile from here in D.C. are the ones who are supposed to be doing it, and it's darn near impossible to get them to do anything. And you're seeing the Treasury markets kind of respond to that. But if we were able to meaningfully borrow for five or 10 years and then stick to the plan, I think you'd see a lot of things work better, right? Like some of the entitlement programs that are now in the crosshairs,

Starting point is 00:11:12 meaningfully so, because they're super expensive and they're getting more expensive. We've got to find a way to solve that, right? And that's how all of these items of like, we have too much debt, we spend too much money. We have to refinance money. It's cheaper to refinance it today for two or three years than today for 10 years. But we think rates are going to go down so we want to preserve that option. That feels good. But eventually you become paralyzed because you're just on this treadmill where you can't make any long-term plans. If you try to borrow for them, they're too expensive, right? I don't want to borrow this much debt. It's going to cost too much to refurbish my house. So I'm just going to keep doing incremental step improvements until eventually you realize I spent 10 times as much money doing each

Starting point is 00:11:51 project individually than if I had just moved out for six months, had them renovate the place and come back, right? Why didn't they just take the proceeds of the most recent issuance and just buy micron and extinguish all the debt? Do I have to think of everything? A lot of folks have said that. There have been conversations that the government should be a bigger holder of equities, that it's sort of a patriotic thing to do. And certainly, Norway, you know, sort of the shining example of this, you know, they had a lot of extra wealth in the sovereign wealth fund from oil proceeds. They invested in equities and other things, invested it well.

Starting point is 00:12:23 And they're a massive investor today. They own basically every single equity on the face of the planet because they have so much money. I saw it years and years ago, I think in the credits of a yearbook that they owned like two percent of everybody publicly traded company. And that was a decade ago. It's probably five percent now. whatever. Yeah, I haven't seen the latest number. It's a big number, and it's not like, it's not a rounding error number. It's like a meaningful percentage given how big they are.

Starting point is 00:12:43 I mean, they probably were inventing, and I don't know the exact, I think the Corona trades out about eight to one. So an extra order of magnitude for simplicity. So imagine how many zeros there are on every single report that comes out of that bank, right? Like the first time, as a student, you read an income statement, you have to think, oh, it says thousands, oh, it says millions. Like, for them, it must say in trillions, just to make it matter. They only eight quadrillion chrono worth of whatever McDonald's. What does the shape of the yield curve tell you about where the market is today? The market, the mom market, the economy, whatever.

Starting point is 00:13:18 I've got a add on to this one, Michael. Kind of the same, similar vein. So the 10 year in the bond yields rose a little bit, but the 10 years at 4.4%. Okay. Inflation came in at 4.2%. There's a lot of pundits who are worried about inflation, being sticky, but doesn't seem to the bond market cares. So maybe latching on to Michael's question, like, what is the bond market telling you about its current worries or tradeoffs or however we want to take that? Sure.

Starting point is 00:13:45 So, I mean, I'm one of those folks thinks inflation is worse than you think, right? And I think folks are, do you see the headline numbers? By the way, 4.2 is not two. And even if you take the new Fed shares theory of I worry about the left side of the decimal place, there's no creative rounding of two. that gets you to four, right? Last I checked. So I think there's, and most of the crops that have gone into the ground in the Northern Hemisphere have priced in high cost oil, right? Oil creates fertilizer, fertilizers need for the crops. Those are already in there. We're going to see those prices, you know, stay high through autumn harvest and there'll be more of that. I do think wage inflation's

Starting point is 00:14:19 coming around. Certainly, you know, the biggest problem now for consumers is Boise, Idaho. We can't get out enough memory. So your Apple phone is going to cost more money, right? So there are all of these late-night items there. I think the market has just said, the bond market in particular, yep, we thought things would be really bad. They're just bad, right? The bond market tends to be cynical. They didn't come out worse. And I think in general, you see the bond market will react and overreact to bad things getting worse, not just bad things staying kind of bad. They've already kind of priced into bad-based case. And they're like, well, it didn't get any worse, so we're kind of fine. We also are looking at, there's a, you know, a lot of two-year paper that's probably

Starting point is 00:14:55 going to come to market for all of the reasons that we just discussed. So there'll be some supply and demand imbalances that, you know, will be interesting to see how they work out. But I don't think the bond market is looking at every CPI print, you know, holding its breath anymore. Like the fixes it. Inflation is not too, and it's probably not going there this year. The Fed agrees. So let's stop worrying so much about it. It's still here. Do you think that tips are like kind of a wonderful deal right now then? Tips are a great deal now. I mean, statistically, if you look at it, tips versus nominal plus, you know, trying to beat the rate of inflation, you know, unless you're buying equities and taking other risk, they tend to win, you know,

Starting point is 00:15:33 most of the time. And there's some cool tools we can show you where we go through and do that analysis for you. And you can see what they do. And do they win versus their own break-even at the day that you bought them? The answer is most of the time, yes. Like, they're a great mechanism to do it. Now, that said, tips are just a little strange, right? When folks, we talk about them, folks look at the five-year or the 10-year tip, and they say, but it's coupon is like 1.875, where's my money? The answer is, well, you're getting 1.875 plus all of your inflation along the way. So that coupon's going to grow over time to get to where you need to be. And net, net, that tends to do better, certainly better than holding cash and certainly better

Starting point is 00:16:12 than gold or real estate, which always seems to let you down when you least want it to. So, Alex, when you see flows into and out of all the products that you all manage at FM, and I'm curious to get into some of them, anything that you scratch your head at? Or do you think that markets are efficient, even at that level, at the ETF flow level? You know, we're biased. We kind of look at them as the indicator species of what the market's thinking, because we see very viscerally every transaction, right? And we do a lot of tracking of it.

Starting point is 00:16:45 I mean, no surprise. A lot of assets have come in recently, and it's in the inflation and duration products, right, the Asian products, I guess, where folks who are hedging inflation by our bill and those on the curve by U2 for once who just want Fed Funds sort of metric, Ben, as you well pointed out. But then, you know, on the much further end of the space, seen a lot of action on the 30-year. Folks who just want duration are are playing the fact there's a bid on bonds, and they think rates will come down in the back end of the year, for which they're going to have. profit handsomely if that happens. So on the long end of that particular, I'm curious, do you see people popping in and out?

Starting point is 00:17:21 Or do you think that like, because nobody's trying to, nobody's trying to lock in rates for 30 years. I mean, I know that there are like corporations and maybe pension funds at are. But for an ETF, I would assume that most of this is saying interest rates are bumping up against 5% again. This always happens. And they always come down. It feels like a good risk for work to just pop in here and grab some money. I think a lot of that, that has been the. traditional use case up until, say, six weeks ago, when volumes really started to pick up,

Starting point is 00:17:51 and we started getting some field cases brought up to us and folks picking up the phone or sending an email who look to be longer-term holders, right? They're not going to be here for 10 years, right? But they're not going to be three-week, five-week, six-week traders trying to play meeting-to-meeting or interest rate move to interest rate move. This is more of a particularly since the rolling feature of always staying in the 30-year or the 20-year or the 10-year, that They're looking for a more secular downturn and rates coming down for which this is a year-to-multeyear trade as they diversify, generally away from equities, but still looking for some meaningful portfolio return. Alex, as podcast hosts, I'm generally the good cop and Michael's the bad cop. Is that fair, Michael? Sure.

Starting point is 00:18:33 Okay. So I'm going to give you a good cop softball question. So per your website, fminvest.com, you're closing it on $10 billion in assets as of close the end of the June. and the firm is still relatively new, five years old, essentially? Yeah, about six. Yeah, so what work that got you to this level in that amount of time? Like, what actually worked for you as an ETF provider? You know, we show up to a lot of places, but, you know, we have this very deep commitment to just trying to do simple things well, right? Bonds in particular are not particularly sexy to most people.

Starting point is 00:19:03 Yeah, no crazy thematic funds from you guys, right? Exactly. Just like, just do the things that we're doing for others and we were doing in our own portfolios, we're doing for ourselves. put back the security lending revenue into the fund, do these basic things that if we had billions of dollars in our PA, what would we do? Just do that.

Starting point is 00:19:19 And then the hardest part is just being able to continue to focus on making that really boring thing better without ever changing it. There are a lot of more academically pleasing ways we could do a lot of these products. We don't because that's going to change the character right they are and we don't want folks to be taking that risk. We want to just give them the government does a lot of heavys lifting for us. Let's just lean in. into that and make sure you get the best possible experience. Last year if you own T-Bill,

Starting point is 00:19:46 the return of T-bill was greater than its expense ratio by three basis points. So you got the 90-day, according to what Bloomberg thinks it is, plus three basis points back after all of our fees were paid, which is kind of the way it should be, right? Like if we did and took other risks, which we don't do, we might be able to say, well, great news, we got you five, for which we risk losing you 15, which feels like a really terrible trade. And I think that just commitment to simplicity. And being able to say this is what it does. If you want something else, you should go and find that thing. This is what it does.

Starting point is 00:20:18 It's not changing its stripes. We've got a dozen people every day who all they do is come in and try to live up to that commitment. Well, I'll do you one equal. Oh, Lord. Perhaps even better. We got an email from a listener, maybe about a year ago. Maybe two. I can't remember how long ago it was where they were misunderstanding something of the mechanics of one of the structural issues of one of your funds.

Starting point is 00:20:40 and you were happy to connect with them. I don't know if you remember what the topic was, because I certainly don't. And you knocked it out of the park. The person that emailed us was so happy that your team got on the phone and there was no negative outcome, no negative surprise.

Starting point is 00:20:56 He misunderstood something and you guys cleared it up and it was wonderful. I recall doing that. It was about inflation. It was actually one of the best questions we've ever had about how the tips market functions from the auction structure to structural cheapness. And it was an immensely detail and thoughtful question.

Starting point is 00:21:16 I remember the question that I was like, dude, I have no idea what you're talking about. Maybe Alex will talk to you. If you're able to have it, we love wonking out on this sort of stuff because it's what we do. And, you know, it's, let's face it, a lot of this stuff is really complicated. It doesn't mean it's hard to understand. It's just complicated. And I think too many folks, particularly in bond market speak, love to hide behind the jargon and some of this other stuff because it's great job,

Starting point is 00:21:39 preservation, but that doesn't help the average investor build a better portfolio. And that's our mission. Let's just build better portfolios and answer the questions as best we can. And sometimes the answer is, this is actually really complicated or complex, in which case, our response is usually, that's true. Maybe it's not for you. And we'll be the first to tell you. My general way of explaining the bond market to clients that we work with is, listen, we're not trying to guess which way inflation is going to go. We're not trying to guess which way rates are going go, we've yet to find many people who can do that consistently. We're trying to figure out where the best risk reward lies. And so I'm curious when it comes to like the risk reward side of bonds,

Starting point is 00:22:13 what is, what is something like this, the corporate or high yield spread is telling you? Because they've been pretty tight for a very long time now, it seems like. They've been really tight, and every time I think they can't get much tighter, they try to do it for us. And then, of course, you know, recently, on the opposite end of that spectrum, right, is super high yield, the CLO market, folks are like just piling into that and to private debt and some of these other things that lack some of the transparency and in character that even, you know, triple Bs tend to offer today, triple B plus space. I think the short answer is the economy, like the actual real economy of big companies borrowing is pretty good. Like all the reforms we've done over all this time,

Starting point is 00:22:52 all of the other theory of central banking and lending, everything else, it's kind of worked out. We have some companies that are pretty stable, right? If we were to go back 25 years, ago, maybe 35 years ago, the average company in the NASDAQ 100 would need to refinance before the end of the month to make sure that it could hit payroll. That's not true today. We have these hyper-scale, these like not even, you know, large cap or hyper-cap, like super hyper-cap, you know, mega-cap. IPOs coming to market. We're going to see two or three more of those, right? A trillion dollars was a lot in the equity market. You know, not five years ago. Now we're going to have see three new trillion-dollar companies just burned out of paper in the next, well, one now,

Starting point is 00:23:30 and probably two, three more for the end of the year. All of this comes down to, like, it's fueled on the whole system working together, and it seems to be working. The question is, can we just make it work so well that we can break it? Right. Like, is this the, we can't, this is why we can't have nice things moment? So the reason that, so spreads are very tight, is that why we're seeing so much money pile into things like CLOs and these types of things?

Starting point is 00:23:52 This isn't an area of the bottom market people could have invested in very easily in the, until the recent past, correct? Good. It's very hard to do. even now with the ETFs, you've got to be a little careful as to which ones you get involved in. But it's a complicated part of the market. There is a hunt for yield. You know, we try to remind folks, you're still getting pretty nice yields, right, from the treasury market and even with tight spreads from corporate and then into high yield space.

Starting point is 00:24:16 Yeah, think about where they were just five years ago. You had nothing. You had to do these other things five years ago because he got nothing. But responses, well, maybe just because you're getting something and it's pretty decent, maybe it's not time to be greedy. If you're going to be greedy, that's what your equity book should be for. There are other ways to go seek that sort of return for your portfolio, taking it, you know, particularly the more risky, the asset type that you're buying in the bond world, the more correlated they tend to be when something goes wrong, right?

Starting point is 00:24:44 And if you're buying your bond portfolio specifically for diversification, then buying things that are highly correlated to each other, even though they're different from what you're buying, more flavors of that isn't actually doing you more favors, you know? This is a, you're getting a pretty healthy return from, from the government itself, we could discuss its risk rating and whether that's warranted or not in the separate discussion from high-quality investment-grade companies. And you've been some pretty high-quality, high-yield companies. There's a lot of money to be made there on a regular basis.

Starting point is 00:25:13 You don't need to get greedy, so you probably shouldn't bother with it. I have a dumb question. I'm so ignorant to how this works. So, InVIDIA, issued bonds for the first time in a while, I think since 2021. Google is doing the same. How does this work? Like, I guess my primary question is, is it an auction similar to the way the government does it?

Starting point is 00:25:36 How much of this paper ends up inside of ETFs? Like, I have no idea how this works. So bonds go through an underwriting process, right? And don't forget, bond market three times the size of the equity market, all of it, which with the exception of some of the perps, very small percentage of them, all of it will get retired, probably in the next, on average, seven to 10 years. So it turns over a lot. So invest in banks underwrite it, and they come to folks like us and say, hey, here's what

Starting point is 00:26:01 we're offering. It's this bond, which usually have multiple tranches with different interest rates and different conditions in terms and different expected ratings to be attached to it. And we put in for it, just like an IPO. And then we are as an issue where allocated some or none of each issue. So that underwriting tends to be some amount of subscribe between not subscribe very well and oversubscribe, depending upon what type of. fund you are, what you're looking for, you want one tranche versus the other. And then it starts

Starting point is 00:26:30 to turn the secondary. But it's a very well-coordinated, underwritten process by the investment banks. And there's not so much an auction where we all show up. We just say, okay, we're interested or we're not, and they'll give feedback. Most of the more prolific folks, like in particular, the folks who offer car loans, like Ford Motor Company, those folks, they're used to doing this all the time. So there's a revolving set of investors who show up to buy those. When you get some of these headline issues, like Google issues, the most stock it's ever issued in its life, or biggest secondary issue ever. And then a bunch of other bonds, bond buyers were also paying attention. Like equity is good. That's money they could be used to pay back bondholders. We like to

Starting point is 00:27:07 see that. But now we're going to bid on whether or not we think Google is able to pay its bills back over the next five or 10 years. And, you know, the spoiler alert for everyone is. Most bond investors thought, yeah, Google was going to be able to do that. So people in the equity market are worried about like, oh my gosh, how is there going to be enough money to soak up all these IPOs, right? We have these huge companies coming to market. If all these hyperscalers decide that they're going to start, you know, instead of issuing equity, they're going to issue debt, is there enough people have to ask, is there enough money to keep this train going in the bond market? There probably has to be, right? There's certainly enough money in the

Starting point is 00:27:42 bond market, but there's also a lot of cynicism. Will they be able, because it's nice to go and buy debt, right, sell debt to individuals for short-term projects. that need to be built, right? And you can do the MPV and say, we're going to borrow it 6%. Our expected return is 10%, therefore the spread is four. This is a good trade for us. The problem is bond issuers want to make sure that that money in the back end of that model is actually going to show up, right? So you building a whole bunch of new facilities and hiring a bunch of people and developing a whole bunch of products have to actually return it. Otherwise, we're not going to get interest payments or we're not going to get paid back. So there's a gentle balance now that needs to be

Starting point is 00:28:21 done as a corporate treasurer between how do we capitalize the business? The bondholders expect to see their interest payments every three or six months like clockwork. At the end of the bond, they expect to get all of their money back, right? Subject to some of the other clever features that bonds can have. Sometimes you can pay it off early, sometimes it has auto extension. There's all sorts of other things that can be done. But it's a pretty rigorous payment. It's like your mortgage. The bank doesn't come to you and say, well, you had a really great year, so we want a little extra, but same token they say, well, you had a bad year, we're willing to cut our payments a little bit. So it's a much more strict and rigorous way for lending to be done. The good news is,

Starting point is 00:28:59 you know your exact costs from the outset. When you sell equity, you could shoot the lights out and you just gave away some of your upside. So it's how do you do those two? I think the bond market is going to be more concerned about these high cost, high life assets that take a lot of energy to go in and require a few other macro things to be right. I don't think they would question the ability, can someone build a data center? You're building a data center because you see this demand. If everyone else builds those data centers and demand doesn't actually meet up to everyone's expectations, we're all now holding debt that may not be worth what we paid for it,

Starting point is 00:29:35 so you have to sell more equity to pay us back. Are you willing to do that? And that's where this balance becomes difficult to strike. But also why I think you see hyperscalers and others, and why a lot of venture capital, There's more venture capital firms providing equity than venture debt firms providing debt. Because it's just as a project creation mechanism or funding mechanism, you have to feel pretty good about the returns to get the debt to do it. I mean, the famous story here is obviously Chobani, right, who did this through bank loans and debt as opposed to equity. And it worked.

Starting point is 00:30:08 But, you know, the small business association is littered with folks who've tried this and had it not work. So that's skepticism. I don't know that story, but I do like yogurt. Let me ask you this, Alex. Last question. I'm guessing that you saw, no, I'm guessing. You obviously saw an opportunity to come to market with a high yield bond offering, bond portfolio that you thought was better than there's two gigantic ETFs out there.

Starting point is 00:30:38 What is it about? So I'm talking about the Z-top, which I do like. It's a good ticker. The FM high yield 100 ETF, the ticker is Zetop. What are you trying to do here that is different than the more popular ones? So the popular ones are so big now. They have to buy everything, which means when there's a lot of flow, they end up buying the exact opposite of what you want them to buy

Starting point is 00:31:01 and selling things you want them to sell the least. Ztop said, well, as opposed to doing underwrite, right? Because high yield issuers, some might default. So you guys spend a lot of time working out who's who. Let's let the market do that for us. rather like, Ben, your theory of the two-year setting rates, it's what the market decides. So we're just going to buy the largest most liquid issuers.

Starting point is 00:31:18 And it turns out the market's really good in that liquidity measure at determining who's going to pay back their debt in a timely basis and who's not. So we've turned the entire market of buyers into the selectors. So we just buy the largest most liquid issuers who have the most liquid bonds. When things are going well, they tend to keep up with the market. Sometimes they're a tick behind because they're a little safer, as it were. but when the market runs, you know, away from you, they also hold their value the best

Starting point is 00:31:45 because it's the greatest, most likely, greatest chance of being paid back. And the market's the adjudicator of that, not the rating agencies, not someone else, not some analysts sitting in an investment bank. We let the market do that work for us. I love that.

Starting point is 00:31:57 That's so simple and makes a lot of sense. Before we wrap, and you guys are free to edit this out, can I show you guys something? I know that you're going to be like, oh my God, we're just trying to show his screen. But I'll let you guys. We could describe what's on the screen.

Starting point is 00:32:12 Go ahead. So we're talking about Kevin Warshu came in. You know, the laboratories here always doing something. You're going to see this later this week shortly before this drops as FM Labs. But a conversation for me and a guy who runs our communication long-term friend of mine, Jim Prosser, we say, well, Kevin's going to tell us less. And he said, well, why don't we fix that? So we built a large language model. It runs on Claude in the background.

Starting point is 00:32:37 We made an exhaustive search of all of Kevin's right. from the FMC, from, you know, this congressional testimony, everything fine. You can see 1,784 documents. And you can just ask it questions where you're talking to Kevin. The model starts at a anti-hlusination based, right? So it starts with no response and then builds a response only from the transcripts and the data that we've given. We gave it lots of economic data. But you can ask you questions like, you know, what, let me see, what is your preferred inflation?

Starting point is 00:33:10 metric, which it'll go run away. It'll do. I don't tell you like, okay, it's consulting the record. It's a little slow because it's sitting on a development box, but it does a bunch of testing. How many writings did he have that you guys put together? 1,784. Wow. Every day it updates. It goes in scrapes for everything he says and say, yeah, quick analysis. I report Kevin Ward Fuse. I'm not Kevin Warsh. That's compliance made to say that. I really wanted to do that. But you can go. It says, here's what he talks about. And it was. We'd always will give you some measure where rates were when we quote something.

Starting point is 00:33:43 Trimmed averages. He's a trimmed averages guy, me too. I thought I was the only one. He's your, no, he's your guy. Now, a lot of folks assume that he said, well, I'm really into like the Dallas feds trimmed mean equation, trim mean PCE measure, which they put out. The answer is what it kind of is.

Starting point is 00:33:58 But so down here, we tell you that. By the way, we know that context this year, but we're not going to allow what we know popular opinion is to actually get in the way of what he said. All right, when are you launching this? By the way, you are a conventional. firm super nerd. I love this. When is this coming up? This will be out before this podcast drops. That should come out the July 1st around here is FM Labs. You'll see more of us.

Starting point is 00:34:20 By the way, if I could do this for Kevin, you can imagine we could do it for others and we did. And there's going to be some pretty interesting stuff in the pipeline as we start to really get all of that together. The ghost of Alan Greenspan could be commenting on current policy. It's almost as if maybe we've done that in the background. So some cool stuff coming out around that, some other investment tools around inflation. Send us this, and we'll link to this in the show notes for sure. We'll do. It's good stuff coming, but I thought you guys would enjoy that. I like it. All right, Alex, people want to learn more about FM investments and all your ETS.

Starting point is 00:34:55 Where do we send them? FMinvest.com. It's all there. All right. Thanks, Alex. Thanks, Alex. Thanks, Alex. Thanks, as always, fminvest.com to learn more about their whole suite of funds, tools, email us, animal spears at the compound news.com. Personal emails, personal responses. See you next time.

Animal Spirits Podcast - Talk Your Book: Do We Need the Federal Reserve?

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