Tracy Alloway (2:48)

Absolutely. Can I say one thing about the anniversary? Yeah. So we started the podcast in November 2015. Yeah, we were going to celebrate for the month of November, but we're now in December. So are we going to make this a two month celebration?

Joe Weisenthal (3:01)

Well, you know, we're having our 10 year anniversary party in December, so I think it's allowed.

Tracy Alloway (3:05)

We'll just keep going.

Joe Weisenthal (3:08)

It's allowed to bleed the 10 years into both months. Given that we're formally celebrating in December. I think this is how I'm rationalizing this framing for this conversation. Since yes, we are no longer, we're technically no longer an anniversary month.

Tracy Alloway (3:23)

I guess it's our party and we can celebrate as long as we want.

Joe Weisenthal (3:26)

To do it however we want.

Tracy Alloway (3:27)

But you're absolutely right about the rates environment and you know, you could see that if you go back and look at some of the old episodes. The other thing that strikes me looking back at the old podcast episodes, is how many of them were about shadow banking, which of course nowadays we call private credit. And that's another thing that's changed enormously. So the private credit market now basically rivals the public credit market in terms of size and there's obviously a lot of concern about what that means, the outlook. So lots of differences.

Joe Weisenthal (3:56)

Lots of differences, yeah. Completely dramatic. And setting aside the big picture questions, there are also some small picture questions. Is maybe how you put it, immediate questions. At the time we're recording this, it looks like the December meeting is basically a lock that there's going to be a cut. But up until recently there was a lot of market uncertainty.

Tracy Alloway (4:14)

If we recorded this two weeks ago, it would have looked very different.

Joe Weisenthal (4:16)

It would have looked very different. And you know what happens after December? Highly uncertain on many dimensions. The follow through for the rate cutting cycle, there have been increases in various credit concerns of various source. We've had a few small blow ups, but you know, nothing that big. But like what Jamie Dimon called the cockroaches. We've mentioned it on the show that suddenly people are talking about credit default swaps on certain high tech companies, which is very unusual.

Tracy Alloway (4:43)

But there's Star wars meme. I haven't heard that word in a long time.

Joe Weisenthal (4:48)

That's right. But with the AI build out and how much that's getting financed by various forms of credit, suddenly people are talking about the fact that big tech companies are credits which we don't really think about very much. And so there are some big picture things, but also some things happening right here and right now that warrant further understanding and further explanation from the people who really understand it.

Tracy Alloway (5:08)

Absolutely.

Joe Weisenthal (5:09)

Well, I'm very excited to Say we really do have the perfect guest, someone who we've had on the show before, but someone we love speaking to. We are going to be speaking with Dan Iveson. He is the CIO over at pimco, which of course everybody should know about. So, Dan, thank you so much for coming back on the Outlaws podcast.

Dan Iveson (5:26)

Thanks for having me. And congratulations on the big 10 year anniversary. It's a, it's an honor to be invited back during this series of podcasts.

Tracy Alloway (5:34)

Thank you so much.

Joe Weisenthal (5:35)

Yeah, very kind of you to say. Let's start small picture. I think this, this episode will be out before the Fed meeting. The market is saying it's going to be a lockdown. They're definitely gonna cut rates. But beyond that, when you look into 2026, there's sort of two different questions. There's the ongoing uncertainty about who is going to be the next Fed chair, and then there's just the questions about how much appetite this existing committee has to continue a rate cutting cycle. So I'd love to get, you know, what are you thinking about for the 2026 and what we could be expecting?

Dan Iveson (6:09)

Sure. So, you know, we do think that the Fed's likely to cut rates at the upcoming meeting. We also think that this is a Fed that would like to get rates a bit lower into 2026. The challenge, of course, is that we expect to see a little bit of reacceleration in the economy during the first half of the year. And we also expect inflation to remain comfortably above the central bank targets. So, you know, we believe this Fed when they say they're going to continue to focus on the data, we do think the data is going to be a bit confusing. The general view today at pimco with significant uncertainty is that they probably do get rates down another half a percent or so next year, which is close to what's being priced into the market today. But again, if you see meaningful reacceleration in the growth data, and more importantly, if you see even a modest uptick in inflation, this Fed, even with a new chair, will likely be willing to remain on hold. And then I think the other point, and this came up with one of your recent guests, is that there's the front end policy rate and then there's the reaction out in longer maturities. We do think there's a chance if this Fed cuts aggressively into strengthening data, higher inflation, you may actually get a sell off in the long end of the curve. So that could be a bit self defeating. And I think something that will be a topic into next year if we do get that reacceleration that we expect.

Joe Weisenthal (7:33)

There's a lot you said there that I want to follow up on just in that one answer, but just very quickly, what is the idea or the gist behind why you expect that Q1 re acceleration?

Dan Iveson (7:43)

Yeah, a lot of it's related to significant momentum in terms of capital investment associated with AI as well as the delayed positive growth impact of the so called big beautiful bill. A lot of the corporate tax extensions happen retroactively for the consumer or the household. In many instances, you're going to begin to see the direct impact in terms of positive refunds coming into the new year. So again, plenty of uncertainty, a lot of cross currents in this economy, but we do think there's the chance that you'll get some moderate reacceleration in the first half of the year. We're looking at a growth environment for next year in the United States at least somewhere in the 1.5% to 2% type range. So again, that's an environment where from a traditional Taylor rule perspective, we don't think that the Fed needs to cut a lot more from here. Although know we do think that this Fed, particularly with new membership and a new chair, would like to get rates lower.

Tracy Alloway (8:40)

Since you mentioned the new chair, this is more of a long term thoughtful question, but obviously for the majority of your career as a bond manager, I don't think Fed independence has really been much of a concern. Right. We certainly haven't seen the degree of headlines that we are seeing lately with Kevin Hassett emerging as the the front runner for the new Fed chair position. How do you as a bond manager view that particular issue and do you have to start handicapping the way you invest because of this?

Dan Iveson (9:12)

I think to a degree. I think if you go back several decades, you can question the concept of Fed independence a little bit. And I think even from the perspective of this Fed's expanded mandate in recent years, what the market's really focused on is independence related to the setting of policy rates, which of course have a direct impact. So from that perspective, we are monitoring the situation. Like other investors, we do think less independent Fed has implications, particularly in longer maturities where you may need a bit more risk premium when you're dealing with uncertainty around Fed independence. But generally speaking, when we think about who's being considered for the Fed role, including Kevin Hassert, we do think that there'll be a general spirit of independence there. We still think the chair is one vote, so to speak, and we have A committee that will continue to focus on the dual mandate. So yes, it's a consideration, it's an input into our decisions, it's not a major concern. We do think that the group that's being considered are certainly highly qualified and will likely continue to take a sufficiently independent view regarding monetary policy.

Joe Weisenthal (10:23)

Let me ask you kind of the same question, but with a slightly different framing. It's December 2025 right now. So we've had over four years now, I think over four years now, of the Fed missing on its inflation on the 2, on getting inflation durably back to 2%. And if the Fed is going to continue cutting, as it looks like it's going to do in December, that signals a further willingness to ease policy even with inflation over its ostensible target. Setting aside the strict question of independence, do you think the Fed, regardless, even the current composition and the likely composition going to be forward, is just not going to take 2% seriously as perhaps it might have in the past?

Dan Iveson (11:11)

Yes, that's a great question. And I think that in a general sense the 2% target matters, but not so much the current inflation rate. You're absolutely right. We've been operating and living with an inflation rate meaningfully above their target for quite some time. But when you look at inflationary expectations, and I think when you talk to central bankers here in the United States as well as outside this country, the inflationary expectations piece is what's critically important. So when you look at longer term breakeven inflation rates, they've continued to be very, very well behaved. You saw a bit of an uptick at the outbreak of the war in Ukraine and then you saw an uptick around the tariff announcements earlier this year. But when you look at a 10 year tip break even rate, just to use one of several proxies, no one measure is perfect. You're down around 2.25% on CPI inflation. So to the extent that inflationary expectations remain well contained, we do think that the central bank's willing to look through some of the more higher frequency data. To the extent that you see those longer term expectations become unanchored, we do think that's a risk for a Fed that's too aggressive in cutting rates here. We do think that the mindset will change not only the mindset of the Fed, but we think the market reaction could be counterproductive, not only in terms of higher long term interest rates, but an impact on risk assets as well. So the markets have let the Fed get away with running fairly accommodated policy cutting into a 3% type inflation world because again, there are a lot of other forces at work that very well could be disinflationary over the long term. And there still is significant confidence in global central banks and being able to generally keep inflation close to the target on a longer term basis. So, you know, again, so far so good, but you know, this is all going to be a key source of uncertainty, you know, into 26 and beyond.

Tracy Alloway (13:05)

I feel like uncertainty is constantly the key word on our podcast nowadays since longer dated expectations and yields keeps coming up in this conversation. I got to ask, do you believe in the term premium? Or rather, is the term premium a useful concept to you as a big bond investor?

Dan Iveson (13:22)

It is. And you know, when we look at, you know, where we're going to invest, you know, we like to get paid for taking more risk. We do see an elevated term premium certainly relative to where we were five or 10 years ago, and that's made longer maturity investments a bit more attractive. With that said, there's lots of reasons why the term premium should be higher. Inflation is one of them. Global debt levels, US debt and deficit levels are another. And we probably live in a world today, given what's going on in terms of focusing on tariffs and bringing back supply chains to domestic markets. The need for higher risk premiums. As a firm today, we like longer maturity bonds more, but we still tend to keep our positions concentrated in shorter maturities. And we would expect over the next few years a little bit of additional underperformance in the very, very long end of the yield curve. So we do think it's important. It's interesting people focus a lot on the deficit situation in the United States. As an advantage investor, you don't want to lend to a perfect high quality credit. You don't get paid so much to do so. So in some sense we want just enough fiscal irresponsibility where we and our end investors get paid more to lend, but not so much where it becomes a concern in terms of the overall viability of the system. So we think we're in the midst of that type of market environment today. But things can go a bit too far if we don't get the deficit or the inflation situation under control over the next, you know, coupled a few years.

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Joe Weisenthal (16:50)

See mint mobile.com can you talk about the role of bonds in a portfolio again? This is something that in 2015, bonds fit beautifully into a diversified portfolio because they were paying something. But also they had that nice inverse correlation and so you got that natural hedge, etc. We haven't had that very like that beautiful inverse correlation between risk assets and bonds for a long time. Which undermines one of the cases for the diversified investor of having like a big slug of perhaps longer duration assets. How do you think in 2025, how do you sell the case that diversified investors should still keep some allocation to duration or fixed income?

Dan Iveson (17:34)

Yeah, so it's interesting, I know this is a 10 year anniversary show, so went back and looked at the performance of bonds versus other things over the last 10 years and the divergence in performance over the last decade has been remarkable and it explains a lot. If you look at the S&P 500 over the last 10 years in absolute terms, you generated a return of about 15% a year. Adjusted for inflation, I think it's up close to 12% or so. I'm rounding a little bit. When you look at the performance of the Bloomberg aggregate index over that 10 year period, the return annually has been below 2%. In absolute terms when you subtract inflation, you ended up with negative returns in bonds for 10 years. So not only has the correlation broken down but you didn't make any money in owning bonds. When you look at the starting valuations today under any type of reasonable longer term valuation framework, none of which have to mean revert quickly, but you look at a Shiller PE type arrangement or an equity risk premium type argument, you don't need a great correlation on bonds versus equities. What the relative valuations would suggest is that there's a good chance that bonds outperform stocks over the next five or 10 years or at least have returns on a risk adjusted basis very, very close to stocks. So you don't have to rest on a correlation argument. You don't have to focus on, well, bonds do well during periods where people are losing their jobs or income growth is negative. You could just from a pure valuation perspective find the asset class quite attractive, absolute and relative. I think the second point around correlations is that correlations between stocks and bonds will tend to break down when inflation's the primary risk factor. Today yes, inflation's above central bank targets but there's a lot of uncertainty on the economic side. You do have this complex economy where tremendous value within the tech sector, tremendous capital investment, yet lower income households are feeling considerable pain. If AI is very, very successful at increasing productivity, that could mean significant job loss across key segments of the economy. So the bottom line is that risks are more balanced. We don't think correlations are going to ever come back to the really, really neat clean levels a decade or so ago when inflation simply wasn't a across the global economy. But we have seen correlations improve a bit and we would expect on a go forward basis correlations to improve further. I think it's important again to look at a global opportunity set. I think that the correlation arguments are stronger in areas of the world that have the best fiscal position. But in general, not only do we think that the valuations are quite attractive, we do think the correlations will be a bit better certainly that we experience coming out of the the cold.

Joe Weisenthal (20:23)

So Tracy, 2015 bonds were an easy sell. It turns out they weren't the best investment. 2025 maybe a harder sell but the math says that now is actually the time to, to expand your exposure.

Tracy Alloway (20:34)

Well, I guess in 10 years when we do the 20 year anniversary we'll be able to to judge. But Dan, you know, since we're talking about why people should buy bonds, one of the surprising things that happened this year was we had the big tariff drama and we saw markets go down, we saw bond yields spike. Everyone was talking about the sell America trade So this idea that you didn't want to hold on to US assets because of all that policy uncertainty and now, you know, in December 2025, yields have come down quite a lot. Although I have to say the dollar is still fairly weak. You were always kind of resistant to the Sell America idea and you pushed back on it. What did you see that perhaps others didn?

Dan Iveson (21:22)

Well, again, I think a lot has to do with starting valuations. After a significant period of underperformance across US fixed income or global fixed income, you ended up with a decent valuation cushion. So I think that's always important in markets. Yes, there was news that in a narrow sense was negative for bonds and negative for U.S. bonds or U.S. assets in particular. You started with a decent yield cushion. We began the year with yields 10 year treasuries up near 5%. A 5% yield even in a 3% inflation world's not that bad. I think the second point though, we weren't overly convicted in just owning the United States. And I think if I could, probably the most important thing I can say today is that global bond investing is back. For so many years, capital is poured into the US markets, It's poured into the US markets, focusing on private credit, which has grown the most here in this country. But very, very quiet. You've seen underperformance across the global fixed income opportunity set where today, even from a US dollar based investors perspective, there's great yield, great sources of diversification. So it's not that we were insistent on just owning U.S. assets. In fact, we've gradually diversified into other areas of the market. We just thought that there was good value and good yield in the US a sufficient cushion and then by extending into these other markets a great way to generate incremental return by good old fashioned relative value trading in markets today that are less correlated than they were during those years coming out of the global financial crisis and where you just have a really, really exciting time to troll, do old fashioned trading across yield curves across markets and avoid having it.

Joe Weisenthal (23:08)

Would change because this seemed like, you know, it felt like international investing across any asset class was like a real suckers thing. It's like, oh, this is going to be the year that we're going to diversify internationally. You didn't get paid at all for it. What switch flipped such that actually both stocks too, because international equity markets have done very well and have outperformed the US which is kind of surprising in many respects. But what switch such that now there's been real opportunities to make money looking Abroad.

Dan Iveson (23:37)

Yeah. Again, valuations have improved. We talked about the real poor performance of the US bond market over the last decade. As we all know, yields were outright negative in many areas of the world. So we talk about low yields. You subtract that low inflation rate, you end up with a negative number. And big portions of the global fixed income opportunity set, you don't have to subtract anything. You started with a negative number. So a lot of this has just been the repricing of markets that started not only at low levels, but negative yield levels. Then the second piece relates to policy coming out of the global financial crisis, not only were yields low, but you had such incredible policy activism where on any signs of economic weakness, you had a massive fiscal response, a massive monetary policy response. Covid the ultimate example of that. And today, with debt levels and deficit levels where they are, policymakers don't have that flexibility. So you're back to an environment where markets increasingly have to stand on their own based on fundamentals. And that's just an exciting. It means more risk premium in markets, more term premium, higher yields with significant valuation cushion absolute in relative to what looked to be quite expensive equity markets, and then just less correlation. You have situations even over the course of the last couple of months where a political surprise in Japan or France creates lots of local volatility in those markets. Uncertainty in French politics impacts UK politics because they have similar challenges in terms of getting their deficit situation under control, control and economic productivity higher. So it reminds us a lot more like the mid-90s back before you had this massive volatility suffocation from policymakers. And again, with deficits where they are, with inflation where it is today, versus central bank targets, it's likely that over the next several years you're going to continue to be in this type of environment, good value, good relative value, and then much less correlated markets which lead to some good opportunity to generate incremental return above starting yield levels.

Tracy Alloway (25:43)

Well, we wanted to talk about private credit as well, because as we said in the intro, this is one thing that has changed quite a lot since 2015. People obviously have different characterizations of private credit, but I'm curious how you think about that space and how you would define or how you would measure things like transparency and opaqueness and customization in the credit waterfall and things like that. Because again, one person's extremely transparent market can be another person's opaque morass of potential defaults.

Dan Iveson (26:17)

Yeah. So I could talk for the rest of the show here on this topic.

Joe Weisenthal (26:22)

First, let's do it.

Dan Iveson (26:23)

Surprised it took this long to get to the private credit topic. But look, not much of this is new. When I joined Pimco back In the late 1990s, I spent the good portion of my initial time at the firm focusing on the underwriting of private assets. We call them pure privates. But these were four A2 privates that were created as part of the securities act of 1933. 144A privates which were quite popular. I think the first one was issued back in 1990. The technology that's being utilized to fund AI infrastructure today, some of these off balance sheet contingent or make whole guarantee type frameworks were around in the mid to late 1990s. The difference today is that you have this massive capital investment need. So the deals are larger, but a lot of the technology has just been dusted off, so to speak, for the new era. The other point that's important, and when we're talking about historical returns, I think this explains a lot, is that what's been so unique in terms of credit asset performance in general has been the post global financial crisis period where we haven't had a sustained period of economic weakness. In fact, one of my favorite data series is looking at how lower quality lending performed since way back during the Michael Milken days when he helped to create that market. If you go back to the early 1980s, all the way up to the global financial crisis, if you had just blindly bought the lowest quality credit that's out there, proxied by high yield senior secured loans, direct lending blend, the index, you would have ended up with only about a half a percentage point of incremental performance versus high quality bonds over that entire period. And the way it worked was that you made a lot of money. A lot of money, A lot of money, A lot of money. Then you gave it all back. Then you made a lot. A lot, a lot, a lot. Gave it all back. And we go back to the late 80s when you had that period, initial period of aggressive underwriting. You had the savings and loan crisis of the early 90s. You had the LTCM or the Asian financial crisis in the late 90s. Then the Internet bubble and the telecom issues of the early 2000s. Then of course the global financial crisis. That was a more normal credit environment. Since the GFC just blindly buying the lowest quality credit on the board, whether it's private credit or lower quality public credit, you generated 7% a year more than high quality bonds. And that explains a lot. Not surprisingly, you've seen massive growth in that area of the market. Now, weaker credit tends to perform well when stocks go up 15% a year. But again, that's where we are today. I hear all the discussion about God underwriting is worse than the public side versus the private side. The reality is when you've grown the this much, when you've lent so much money to weaker quality borrowers, when covenants have weakened, when spreads are tight, when equities have gone up consistently as much as they have, you're going to have challenges in these markets. So when we think about credit, we look at it under two continuums. One, liquidity. Certain assets are completely illiquid. The only decision you get to make is the purchase decision. So you better be right. And then at the other end of the extreme, you have very, very liquid assets. You can change your mind on a regular basis. And then you have economic sensitivity. You have assets that are very insensitive to the economy, that are very, very high quality. Then at the other extreme, you have assets with a tremendous amount of economic sensitivity, a tremendous amount of sensitivity to AI related disruption, other forms of economic weakness, unanticipated competition, and you just want to make sure you get paid enough. And with stocks near all time highs, with spreads tight, with covenants weak, there are going to be problems. And I think as an investor, you just need to acknowledge that you're not getting paid. What you got to take that risk five or 10 years ago. And you just want to be defensive, you want to be skeptical. But it's not so much private versus public. I think it's just thoughtful underwriting and just understanding that we're at a time where given the strong historical performance, given the fact that we haven't had a sustained period of economic slowing for a long time, some complacency has worked their way into these higher risk areas of the market.

Tracy Alloway (30:43)

Well, talk a little bit more about competition in private credit because I imagine it's good to be Pimco when it comes to sourcing deals and maybe negotiating the terms. But does even someone like you, a truly big bond manager, have to deal with competitive pressures where if you don't agree to one bond term, someone else will swoop in and agree to it and take it away from you.

Dan Iveson (31:07)

Absolutely. And again, I think the other point about public and private markets is that they're well integrated. We could talk about convergence a bit later, have some views there. But when an issuer looks at their options, they're going to test the public option, they'll test the private option. And there is a lot of competition, a lot of competition for market share. When you look at a lot of the managers, particularly in the private credit space, they announce very, very aggressive of growth assumptions. As an investor, sometimes I wish in certain quarters people would talk about if we can find value for the end investor, we will grow this much. All too often after a pretty bullish environment for credit, we're simply going to grow a lot. So we do see time and time again situations where you start the underwriting process, you get down to the point where it's time to get into a final round and you don't get the terms that we feel we need as extenders of credit in this marketplace. And that's just again symptomatic of the fact that there's a lot of demand for these assets and there's a lot of demand relative to the supply across many segments of the market. And that's true not only of the low investment grade risk, but it's very, very true of certain transactions with an investment grade rating, at least from a rating agency. So given tight spreads, given the competition, you just have to say no. And I'll go back to my earlier point. What's so exciting about this market today is that you do do not need to take on aggressively underwritten credit to generate return. The high quality area of the market, especially if you expand globally. If you take advantage of liquidity, which typically means flexibility for end investors, you can have a high quality portfolio where you don't have to sacrifice return. Very different than where we were 10 years ago, but again pretty exciting now where you can go up in quality without again giving up return. And in some cases I want to picking up expected return.

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Joe Weisenthal (35:23)

I want to go back to something you said and I didn't quite get it, but I think it's important and of course it's very interesting to our audience. You're talking about the AI financing and I think you said something contingent. Make whole guarantees. I don't. Tell us about these financings as you see them and what is the history, how novel are they relative to past financing or how much is it that these are? Structures that were very much in place for something else are now being reproposed into this new exciting area.

Dan Iveson (35:52)

Yeah. So I'll start with what's new, which is lending to support the growth in AI and related infrastructure. There you're talking about several trillion dollars of investment need. So that's what's new. But what's not so new is this idea that companies would like to keep a good portion of their debt off their balance sheet or come up with structures that limit their overall financial liability or give them some flexibility to manage that liability over time. And as an end investor looking to lend to those companies, it's important to acknowledge that lending against tech firms, lending against AI infrastructure, lending against AI chips is risky. That could be a real good investment if you own the equity, may not be a great investment if you own the bonds, where at most you get your coupon and you you hope to get par back at the end of the day. So a lot of the underwriting of these transactions and there have been a lot and we expect a lot more to come over the course of the next few years is to understand the form of that guarantee and understand the entity that's providing that guarantee, whether it's in the form of lease payments or other type of make whole type arrangements. And these types of structures are what have been around for many, many years. Back in the mid and late 1990s, a lot of times these would be done by Wall street financial institutions, sometimes across a segment of their business, where they would use a corporate guarantee to arbitrage a bit of the rating agency frameworks. At other times, these deals were backed by large ships, equipment, other areas of the market. So it was the same type of analysis, the same type of underwriting, a checklist, which involves a lot of lawyers to ensure that you understand the guarantee, how you have to realize on that guarantee. And that's not so different today.

Joe Weisenthal (37:44)

And just to be clear, the guarantee we're talking about here is. Okay, here is a hypothetical SPV that owns a data center and it borrows money and it finances it, et cetera. And the guarantee question is, how much will the tenant of that data center, which didn't want to have all that debt on their bottom, maybe like a Facebook or one of the hyperscalers, how much are they actually committed to being a tenant for the long term there? Basically, that's what we're talking about.

Dan Iveson (38:12)

Absolutely correct. And why it matters here is you're typically talking about investment grade rated counterparties on these transactions, where the infrastructure itself, the assets that are partially backing the deal on a standalone basis would achieve a very, very low rate. So how do you create a structure where you improve the credit quality while meeting the needs of those that are looking to borrow within this market. So again, the whole key is to make sure that something that the rating agencies may assign investment grade rating to is in fact investment grade from a fundamental credit quality perspective. And I think that's another theme in talking about private credit. There are more economically sensitive, lower quality loans. And then there's been a lot of growth. On the investment grade side. It is very, very dangerous to assume something has an investment grade rating just because the rating agencies assign a rating to it. It's critically important that you do your own credit work today. All too frequently you'll have an investment grade rating from one entity. And again, market participants for years have always joked if you can only find one investment grade rating, it's pretty fair to assume everyone else is below investment grade. So the bottom line is that there's been a lot of aggressive underwriting going on, even with instruments that carry an investment grade rating, at least from one entity. And again, when spreads are tight, when documentation is relatively weak, it's just critically important that you do your own fundamental credit work. I do think Pimco has some advantages in that area, both in terms of experience and resources. But it's super important because you're not always getting the terms that you want. When you do, you can unlock tremendous value for your clients. But this is an environment where we have to be really, really selective as a bond investor, at least.

Tracy Alloway (39:56)

Yeah. When I think back to the 2015 environment, I remember a lot of people were writing stories about the triple B bubble in investment grade. So triple B is the lowest tier of investment grade. And that had been absolutely exploding post financial crisis. And everyone, not everyone, a lot of people expected that to end in tears. And instead it ended with all those like triple B's getting upgraded and a lot of junk getting upgraded as well and having a bunch of rising stars, which I don't think a lot of people were necessarily expecting. But talk a little bit more about the rating agencies. What are the pressures that you think are perhaps driving them to rate some of these structures higher than they otherwise might be?

Dan Iveson (40:43)

Well, again, there are multiple rating agencies that have different philosophies to how they arrive at a rating. And there's going to be, you know, understandable disagreement, you know, within markets. But issuers are quite true. They're going to go to where they get the most favorable ratings. Treatment. This has always been the case. And I think the important point to note is that when stocks are going up 15% a year, when the economy's growing, when you don't have a sustained period of economic weakness, even poorly underwritten credit will mature. We experienced that in an extreme sense during the 2000s. What we try to do as active investors is to underwrite to weaker economic environments, environments where those underlying entities or the infrastructure that you're lending against go into a period of weakness. And I think that's where good fundamental credit work. In this type of environment that we're in today, that's very much driven by rating arbitrage. Seeking out investment grade ratings for an insurance balance sheet or a reinsurance balance sheet as an example, can lead at times to aggressive decisions. So it's just the nature of the fact that you have multiple agencies and some will be more optimistic in certain areas than others. But that's great. If we didn't have those sources of disagreement, there wouldn't be opportunities to generate incremental return versus passive alternatives.

Joe Weisenthal (42:07)

While we're here on credit. Actually. It was probably about a month ago or a month and a half ago. That's when we were getting all those headlines about tree calor. And that was when Jamie Dimon made the sort of famous crickets thing. I was getting really.

Tracy Alloway (42:21)

Cockroaches.

Joe Weisenthal (42:22)

Cockroaches, cockroaches.

Tracy Alloway (42:23)

I hate cockroaches and I like crickets. So I want to make that clear.

Joe Weisenthal (42:27)

Crickets are lovely. You're right. I should not associate them with credit blowups. That's completely unfair to crickets. It's fair to cockroaches. Jamie Dimon made those cockroach. I was getting worried. I saw all these heads like, oh, another entity took a hit on this. Another entity. I was like, oh, this is very familiar. I don't like, I don't like how many times that same company appears in the headlines. But we haven't gotten that much actually since then. It's not like there have been five more of those. I'm just sort of curing is setting aside some of the data center, the sexy private credit stuff that everyone's focused on. Do you think over the last several years, was there some systematically bad underwriting going on, especially over the last few years, or were there isolated cockroaches, the first cockroach before they had a chance to lay eggs and make babies?

Tracy Alloway (43:09)

The lonely cockroaches?

Dan Iveson (43:11)

Yeah, yeah. So look again, because there's been so much growth in lending to lower quality companies and again, again, the last major cycle was lending to lower quality households. There's going to be areas of excess and I think people are focused on these areas. But again, when you look at the cumulative delinquencies and losses, yes, they've increased a bit over the last few years, but these situations have been relatively isolated. But again, anytime you've had this much credit expansion, you're going to have challenges. And these challenges are happening in a relatively strong economy. So we don't think this will be a catastrophe. The word I've used is that there's likely going to be disappointment in certain areas of the credit markets that have performed exceptionally well over the last 10 to 15 years. But that shouldn't be viewed as an overly controversial statement. That's how markets work. Credit was very cheap 10 or 15 years ago. High quality bonds were very, very expensive. Today, credit spreads are near all time tights, equities are near all time highs and value at high quality bonds looks reasonable relative to their history. So starting valuations tend to be pretty big drivers of future returns. If the economy continues to grow, if stocks Keep going up 15% a year, yes, these will be relatively isolated situations. But if you get into a period of economic weakness, losses will go up and they'll likely be be some disappointment. I think that's the best way to categorize it. And then I think the second important point when you look at markets in a longer term historical context is that regulators hate bailing out the same sectors twice. Back during the GFC it was lending to the consumer, it was excessive lending from the banks that caused all of the problems, almost took down the financial system and not surprisingly the regulations towards the banks and towards consumer lending was massive. And today when you look at the world, the household balance sheet, certainly middle income and above cohort groups hasn't been this strong in several decades. There's record amounts of borrower equity in these areas of the market have been very, very strong. From an underwriting perspective, the areas that escaped the scrutiny the last time, a lot of lending to non financial corporates, a lot of this mid market private lending that came out of that period relatively unscathed from a regulatory perspective has grown a lot. So I think a lot of this just relates to longer term cycles. Pimco was talking in a much different way back in 2005 and 2006 where we were screaming from the rooftop saying that what was going on was so irrational that there were major problems ahead. That's not where we are. And that's why I sometimes sound a bit more negative than we are. I think that the idea of disappointment is the way people should think about some of these areas of the credit markets. And the good news is you don't have to accept disappointment. You can simply accept the fact that you had a great performance run and that by going up in quality, expanding into a global opportunity set that hasn't been sufficiently embraced just yet. Perhaps owning a little bit of non dollar exposure gets you the same place with much more resiliency, much more downside protection and a lot more liquidity or flexibility to change your mind in the in, in, in in the future as well.

Tracy Alloway (46:30)

Since you brought up household balance sheets, can you talk to us a little bit about your housing outlook? Because I believe Pimco has been pretty bullish on mortgages recently. But at the same time we've seen a slight slowdown in the housing market. But then again we still have long term structural tailwinds such as a massive under supply of homes in the U.S. where do you see that going in the coming years? Particularly you know, if we were to see inflationary pressures start to pick up and those longer end yields start to rise.

Dan Iveson (47:04)

Yeah. So we are very bullish on housing related investments in the United States as well as in other areas around the world. Agency guaranteed mortgages still trade at very wide spreads relative to corporates even in an absolute sense we think it's a very high quality liquid area of the market. That again makes a lot of sense to own across a variety of different mandates. We also like lending in the non guaranteed area against the house simply because borrowers have record amounts of equity.

Tracy Alloway (47:34)

So when you lend again, collateral. Yeah, that's what it sounds like. You love collateral.

Dan Iveson (47:39)

Yeah, we like good documentation and good collateral. You know, at least all else equal. But you know, it's not a major bet bet on the directionality of homes. When you're lending against a household that has 70 percentage points of borrower equity, your home can go down quite a bit and you're very well protected. That same dynamic exists over in the uk, across Europe and even in other parts of the world. So again regulators don't like bailing out the same sectors twice. That's pretty good asset allocation advice. It's quite straightforward. But also you have have much better fundamentals across households. But to your specific question around housing, it's a tough situation. We do think that homes are going to remain elevated from a valuation perspective and affordability is going to remain quite constrained because there's no easy answer. You bring the mortgage rate down, the home price goes up, affordability doesn't change in a meaningful sense. What we really need in this country and other parts of the world world are more homes, more housing units. And again because of a lot of the post global financial crisis regulation, it's been real hard to build new homes. So our base case view is that home prices are going to moderate here on a national level you could see at least in real terms some steady declines over the course of the next several years in certain markets that are a bit overextended, a bit more volatility. But we do think that that home prices are going to remain elevated from a historical perspective just because of the fact that people have locked in very, very low mortgage rates 30 years, not just 5 or 10 years which were mortgage durations popular pre GFC. So you're not going to see too much turnover. And unfortunately that means that homes for a lot of younger Americans are going to remain out of reach. But again, again maybe some incremental benefit, maybe this administration get mortgage rates down a bit through some Creative policy the next couple of years, by the way, we'd like that given pimco's current positioning. But again, without building new homes which are going to take many, many years, there's no easy solution.

Joe Weisenthal (49:51)

I want to go back, you mentioned this idea. There's an optimal amount of fiscal profligacy from the perspective of the bond invest investor. Maybe you want them to push it a little bit because then you get paid a little bit for taking it on. But obviously you don't want them to push so forth where you get some fiscal dominance spiral leading to higher and higher inflation. You want to find that sweet spot. You know, I mentioned we were talking a little bit about politics earlier about whether independent central bank can be sustained. But when you look abroad, you know, it seems like in a lot of pretty major. We're not the only country that's having political volatility these days. People are concerned about the approach that the new Japanese PM is going to take. And so we know that rates are higher in Japan, France, very indebted country. They seem to have like a new government every two weeks. I like lose track of all the times their government collapses and so forth. The uk, very indebted country. The moment anyone takes office, their approval ratings plunge to negative 30 or whatever. There's a lot going on on the political front and that sort of determines, determines whether countries are even, it's even possible to run what might be more responsible fiscal policies. Is that something that, I don't know, keeps you up at night is the right term. But is that something that's a big part of your work is trying to understand, especially when you think abroad, understand the political dynamics in all these countries that are happening right now?

Dan Iveson (51:10)

Yeah, absolutely. And we get together once a year, talk about the outlook for economies and markets over a five year type timeframe. And one of our advisors, I think put it well, was that we used to live in a world where economic outcomes would drive politics. If economies were strong, politicians usually ended up in a good situation.

Dan Iveson (51:35)

They'D stay in office. Today it feels like it's a bit reversed where political priorities, geopolitical tensions are driving economics. And I think you see that to a degree with tariff policy, you see it to a degree with various forms of reshoring, you see it in terms of these populist tendencies across markets. So they're all very, very important and a lot more important than they were in the past. And I think it takes a lot of humility from someone like myself and others that grew up doing discounted Cash flow analysis and derivative pricing, as opposed to understanding the political economy. So we think that that's important, both from the perspect, gaining an edge in markets, but also understanding that sometimes we'll be wrong. And when you're running the debt levels that countries are running or deficits in overall debt levels, there's going to be some unpredictability. And that's why this idea of looking to exploit a global opportunity set, prudent diversification, targeting some countries outside the U.S. that aren't running 6, 7% deficits. And there are high quality countries out there, Australia being an example, Germany being another example. Even the United Kingdom, although they have a lot less policy flexibility than we do, given that they're a smaller open economy with their own currency, offer attractive yields. So this is less about picking your favorite country, from our perspective. It's more looking to take advantage of attractive opportunities around the globe with some tilt towards those countries that are balancing their budget and that do have a better overall fiscal picture. And we haven't talked about emerging markets, but there are a few emerging markets that this cycle got ahead of inflation that have been in some sense more fiscally prudent than their developed market counterparties and that have very, very high yields, even adjusted for inflation rates. So even some diversification in some of the higher quality areas of the emerging markets, from our perspective, represents real good value or real good sources of diversification and return versus some of these assets here in the United States that have performed real well, well historically, but where, when you look at, you know, the likelihood for forward performance, just, just look a little bit less interesting.

Tracy Alloway (53:51)

Actually, this reminds me thinking back to 2015. 2015 was actually a big year for Pimco because it was your first full year without Bill Gross. Right. Who left in late 2014.

Joe Weisenthal (54:03)

Oh, yeah, that's right.

Tracy Alloway (54:04)

Can you talk to us perhaps how, how the culture of Pimco has changed over the past 10 years and how you would describe that evolution. Cause I imagine it's been a long time. It must have shifted a little bit.

Dan Iveson (54:17)

Yeah, look at the way Bill left the firm wasn't ideal to say the least, but Bill left us in an incredibly strong position. He created a lot of the frameworks that we still use today to make decisions. Bill was a strong personality, but he believed in teamwork and believed that investing was a team sport, so to speak. So from that perspective, there didn't need to be a lot of, of change or certainly not radical change. But over this period, markets have become so much more specialized client Needs have evolved over time. The introduction of a more sizable private opportunity set has been important. Technology, big data, using trading techniques, portfolio trading and other automated type trading strategies are all critically important. So. So we're a much more specialized firm today, which is a function of again evolving client needs, but also just the realities of this world that we live in today where data is abundant, much less expensive to access. So from that perspective we've needed to adapt. We've become even more global, so we tend to utilize regional committees and regional decision making structures. But a lot stayed the same, at least in terms of mindset. And we try to really leverage the history and the experience the firm has had managing and navigating through more challenging markets. 22 was rough for both stocks and bonds, but in general the environment's been reasonably forgiving. But you can always get into these tougher periods. And again, we try to use these structures that Bill put in place and Bill deserves a tremendous amount of credit for.

Joe Weisenthal (56:03)

It's funny, in your last answer there, there were like five things you said that could merit full follow ups or even full follow up episodes like about changing client needs over time or what happens when the cost of data goes from costly to fairly affordable, et cetera. All those sort of interesting things. But just my last question and it sort of relates to technology. You know, when it comes to AI in investing thing, we've talked a little bit more on the short term like high frequency side and the sort of models that they use and the signals that they use and how that sort of relates to AI and their application. But for a firm like Pimco, and when you're thinking about longer term holding periods and you want to have some a good collateral and good documentation, et cetera. Currently, today, have you found ways to apply cutting edge, edge AI technology to the process of good security selection?

Dan Iveson (56:59)

We have and we're finding ways to utilize the technology at an accelerating rate. We do some of this in some of our more quant focused strategies where we look to use AI to actually drive alpha. But just AI as a tool to drive efficiency has been will be critically important to managing an investment platform. Just the ease in which you can access data that you can use AI to help support overall analysis, both at the company level, the individual investment level, but even coming through economic history and understanding some of these geopolitical trends and themes that are hard at least intuitively to grasp are going to be critically important. In fact, before our discussion today, spent considerable time with our head of technology and our head of implementation talking about various firmwide initiatives. And I think the only other point point is my own use of AI, both at home and at the office has gone up almost exponentially over the last year or two. And I'm the last person you want to rely on to understand this technology. It's the younger folks that we hired over the last year that are helping us with a lot of this perspective. So this is going to be quite disruptive, probably productivity enhancing at the economy wide level, but it's also going to lead to considerable disruption and it's important that we don't get disrupted and that we use this technology to drive client returns. But you know, it's going to be important in so many ways and we're really, really embracing it here here at Pimco.

Joe Weisenthal (58:32)

Dan Iveson, thank you so much for coming on odd lots. That was a fantastic conversation. Really appreciate you taking the time and we're going to check back in with you in 2035 and see how well you got, how well one got paid for taking on a little bit of duration here.

Lowe's Narrator (58:47)

Great.

Dan Iveson (58:47)

Joe and Tracy, thanks again and congratulations on the, the, the big milestone.

Tracy Alloway (58:51)

And thank you so much, Dan. Really appreciate it.

Dan Iveson (58:54)

Thank you guys.

Joe Weisenthal (59:07)

Tracy, I thought that was great. I really, I really enjoyed talking to Dan. Fantastic overview.

Tracy Alloway (59:12)

Yeah. So a couple things stood out to me. So number one, the idea of no more free lunch in credit, although people have been talking about that for a while now and obviously with the rate environment changing, you can see that argument. The other thing that I really liked was his description of policymakers don't want to bail out the same thing twice.

Joe Weisenthal (59:31)

Yeah, that's interesting framework or way to think about it.

Tracy Alloway (59:34)

Yeah, absolutely. And it kind of reminded me of there's another person in credit who, who used to tell me a line about how he invests, which is follow the bad guys. Right. So like the guys that blew up in one part of the market usually, you know, start doing something, they're gonna.

Joe Weisenthal (59:53)

Get their act together. Wait, are you saying they're gonna get their act together or they're gonna do something?

Tracy Alloway (59:56)

No, I'm saying they move to the new thing and then it blows up. And so if you can just identify the bad guys and just follow their career trajectories, just short everything the bad guys do.

Joe Weisenthal (60:07)

I love that, I love that take. You know, it was really, I had not realized that stat he said about how little you got paid for taking, for buying poor credits up until the gfc.

Tracy Alloway (60:19)

Yeah.

Joe Weisenthal (60:19)

And then post GFC is just totally flipped that you just got you should just go as far out on the credit risk curve as you possibly can. And you've just walloped anything safe. And I knew that I guess on some level, but the extreme of that statistical divergence. But, you know, you have to think we had that. Well, it was more than a hiccup in 2020, but we did bounce back very fast from it. So really what we are looking at is, you know, well over 15 years now of the lines just going up, and you have to think about what are the things that accumulate over that time or the patterns that accumulate, or the habits, et cetera. And this idea that there's a lot of safety at the far end of the risk curve curve and that people don't care and that maybe now some of the perception that there's safety at the far end of the risk curve and how much that's been burnished into people is very interesting.

Tracy Alloway (61:10)

Absolutely. The other thing he said that I thought was very poignant was the idea of you have all these private credit firms starting up and promising these astonishing returns for investors. And he made the point that you can't just say you're going to make all this money in private credit because, like, those deals might not be out there and available to you. You have to do it on a risk or value adjusted basis. And as. As I say that, I see a headline in Bloomberg about Capital Group getting into private credit as well. So. So this is the thing. Like, it's a booming market. There are a lot of competitive pressures both on the lender side and also on the credit rating side. And you can see people really scrambling to get into the market and accumulate as much as they can. And. And so the temptation, of course, is to, you know, accept lower terms, accept lower quality.

Joe Weisenthal (62:03)

Totally.

Tracy Alloway (62:04)

All right, shall we leave it there?

Joe Weisenthal (62:05)

Let's leave it there.

Tracy Alloway (62:05)

All right. This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

Joe Weisenthal (62:11)

And I'm Joe Weisenthal. You can follow me at thestalwart. Follow our producers, Carmen Rodriguez at carmenarmon, Dashiell Bennett at Dashbot, and Kale Brooks at Kalebrooks. For more Oddlaws content, go to bloomberg.com oddl odd lots, we have a daily newsletter and all of our episodes, and you can chat about all of these topics 24. 7 in our Discord. Discord. GG odd lots.

Tracy Alloway (62:31)

And if you enjoy Odd Lots, if you're enjoying these anniversary episodes, then please leave us a positive review on your favorite podcast platform and Remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg channel on Apple Podcasts and and follow the instructions there. Thanks for listening.

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