Animal Spirits Podcast: "Talk Your Book: 3 Reasons to Buy Bonds" Summary

Release Date: January 20, 2025

In the January 20, 2025 episode of the Animal Spirits Podcast, hosts Michael Batnick and Ben Carlson delve into the intricacies of the fixed income market, presenting a compelling case for why investors should consider adding bonds to their portfolios. The episode features an insightful conversation with Dave Braun, Managing Director and Generalist Portfolio Manager at PIMCO, who shares his expertise on the current bond landscape and PIMCO’s strategic approach.

1. Introduction to Fixed Income Investing

The episode opens with Michael Batnick addressing a common misconception among retail investors: the belief that successful bond investing hinges on accurately predicting interest rate movements and economic growth.

Michael Batnick [00:00]: "One of the big misnomers for a lot of civilians when it comes to investing is they think if you're going to invest in fixed income, you have to be able to figure out where interest rates are going…"

Instead, Batnick advocates for a risk-reward framework, emphasizing the importance of understanding the compensation received for taking on different levels of risk, rather than attempting to forecast market directions.

Ben Carlson [00:12]: "Probably the name's Bond."

Batnick further elaborates on how PIMCO evaluates various bond types based on their risk-reward profiles, rather than speculating on price movements.

2. Navigating the Current Bond Market

Ben Carlson reflects on the challenging fixed income environment of the past decade, characterized by low yields and market volatility.

Ben Carlson [02:05]: "Wait, wait, hold on. Just think about how bad it was. So no yields forever…"

Batnick likens the resilience of fixed income investors to Tim Robbins in Shawshank Redemption, symbolizing recovery through turbulent times.

Michael Batnick [02:34]: "I picture Tim Robbins climbing through the pipe in Shawshank and coming out the other side with his hands up in the air. That's fixed income investors."

3. Insights from Dave Braun on Bond Investing

The conversation shifts to an interview segment with Dave Braun, who provides a comprehensive analysis of the current bond market dynamics.

Michael Batnick [03:51]: "Dave, welcome to the show."

Braun addresses the perplexing behavior of bond yields in relation to Fed rate cuts, clarifying the distinction between different segments of the yield curve.

Dave Braun [04:07]: "The Fed only controls the front end. And what the belly and longer ends do is kind of their own beast."

He highlights the "Trump trade" and its impact on bond yields, explaining that overshooting in rates due to investor behavior creates opportunities for active management.

Dave Braun [04:07]: "We're getting paid to take more risk here than we are to take here, and I think that's the right way to think about investing in fixed income."

4. Risk-Reward Framework in Fixed Income

Braun emphasizes that PIMCO's strategy revolves around balancing risk and reward, rather than making directional bets on bond prices.

Dave Braun [07:06]: "Our base case is the Fed's going to pull the rabbit out of the hat and get the soft landing."

He articulates PIMCO’s belief in a soft economic landing and discusses the historical rarity of such scenarios during inflation fights, positioning current bond yields as highly attractive.

Dave Braun [06:19]: "We believe overall rates are very attractive right now, ... the AG is yielding around 5% now. That's the best it's been in almost 20 years."

5. Credit Spreads and Investment Strategies

The discussion transitions to credit spreads, where Braun advises caution against chasing high yields in investment-grade and high-yield sectors due to their historically low spreads.

Ben Carlson [13:20]: "How do you navigate a world in which you're getting a lot of rate from the government and not a lot of excess rate from riskier parts of the bond market?"

Braun recommends focusing on non-generic corporates and agency mortgages, which offer better risk-adjusted returns without the complacency found in more popular sectors.

Dave Braun [15:46]: "We try to do at PIMCO is go where the opportunity is, not where the comfort of a herd is."

6. Real Estate and Private Credit Opportunities

Addressing real estate, Braun expresses optimism about commercial real estate and private credit, highlighting opportunities amidst market volatility.

Dave Braun [28:33]: "Commercial real estate declines in quality have been balanced by opportunities in well-managed assets."

He underscores the importance of active management in identifying value within specific real estate segments and cautions against overexposure to over-leveraged or poorly performing assets.

7. Consumer Credit and Economic Outlook

The conversation touches on consumer credit, with Braun assessing the current strength of the consumer sector despite past vulnerabilities during the COVID-19 pandemic.

Dave Braun [18:30]: "Household leverage is very light... the consumer by and large is in very good shape."

He reassures that with low unemployment and manageable household debt levels, the consumer sector remains robust, mitigating concerns over rising defaults.

8. Historical Context: Fixed Income Challenges

Reflecting on the past, Braun compares the current fixed income environment to the tumultuous bond markets of the 1980s and 2022, asserting that today's bond market challenges surpass previous struggles.

Dave Braun [20:26]: "The Fed had to hike from zero all the way up to eventually 550. That is a perfect cocktail for the worst year in bonds."

He emphasizes that the recent rise in rates, coupled with historical underperformance, sets the stage for a favorable environment moving forward, provided rates stabilize or decline.

9. Capital Preservation, Income, and Hedging

Braun articulates three primary reasons to invest in bonds: capital preservation, income generation, and hedging against risk assets. He argues that the current high yields offer strong capital preservation and income potential, while the bond market’s dynamics provide effective hedging capabilities.

Dave Braun [22:00]: "The capital preservation characteristics look good, the income looks great, and you probably are going to see that negative correlation come back between stocks and bonds."

10. Conclusion and Key Takeaways

The episode concludes with Braun reiterating the value of active management in navigating the complex and volatile bond market. He encourages investors to leverage PIMCO's expertise to capitalize on current opportunities while maintaining a disciplined, risk-aware approach.

Dave Braun [30:18]: "This environment of high uncertainty, high volatility, high dispersion in the bond market... that's what we need as an active manager."

Michael Batnick and Ben Carlson summarize the discussion, highlighting the enhanced attractiveness of bonds in the present economic climate and encouraging listeners to explore PIMCO’s offerings for robust fixed income strategies.

Michael Batnick [31:11]: "Dave, thanks very much. This is great. Remember, check out pimco.com to learn more and email us at animalspirits@compoundnews.com."

Notable Quotes

• Michael Batnick [00:00]: "You have to think through the risk reward framework and the setup for where am I being paid to take risk."

• Dave Braun [04:07]: "The Fed only controls the front end. And what the belly and longer ends do is kind of their own beast."

• Dave Braun [07:06]: "Our base case is the Fed's going to pull the rabbit out of the hat and get the soft landing."

• Dave Braun [15:46]: "We try to do at PIMCO is go where the opportunity is, not where the comfort of a herd is."

• Dave Braun [20:26]: "That is a perfect cocktail for the worst year in bonds."

• Dave Braun [22:00]: "The capital preservation characteristics look good, the income looks great, and you probably are going to see that negative correlation come back between stocks and bonds."

Final Thoughts

This episode of Animal Spirits provides a thorough exploration of why bonds are an essential component of a diversified investment portfolio, particularly in the current economic landscape. Through the expert insights of Dave Braun, listeners gain a nuanced understanding of the fixed income market’s opportunities and risks, underscoring the value of active management in achieving optimal investment outcomes.

For more information on PIMCO’s Active Bond ETF and other fixed income strategies, visit pimco.com or contact your PIMCO advisor.