Are you still backing AI data centers? Do you back neocloud business models?

That's different.

Neoclouds are tenants.

We're backing long-term projects.

And...

The creation of the data centers.

Yes, and we're trying to do it in places which are less crowded, where there are inhibitions to the construction of too many data centers.

So do you expect more rate hikes? Do you think that's appropriate for the economy or for where we are with what's happening with AI? Right.

What is going on? What is the bond market telling us right now?

We never know exactly what the market is saying.

The market doesn't tell you what it's saying.

It only does something, and you can, uh, infer from what's going on around you what the causes might be.

When rates go up, what it-- other than when government puts them up, what it basically means is that people want more yield from a given investment.

Now, why might they want more yield? The obvious reason is because if they think if they lend you a hundred dollars today, when you pay them back in thirty years, it'll buy less.

And so they need a purchasing power protection or inflation premium in the yield, uh, to, to, uh, compensate for that.

Um, I, I guess what I would ask you is w- what could those consequences be? What would it look like? Is it possible maybe that the yields would be the thing that whips our leadership into shape in terms of being more fiscally responsible?

What happened

there? Well, I mean, when I start something, I get attached to it.

And it was very enjoyable, although not painless.

because when I got there for the summer job in 68 or for the full-time job in 69, um, the bank was a practitioner of what was called nifty 50 investment.

Now, most of the banks were the big investors of the day.

You know, there were no KKRs.

There were no, uh, Blackstones, there were no, there was barely, well, Vanguard didn't exist.

Throughout your whole career, do you have a decision that you're just proudest of or just brings a smile to your face every time you think about it?

What's the temperature of today's market?

Well, you know, the market has run into some trouble in the last maybe two months.

You know, here's what happens.

The market gets ahead of steam based on optimism.

It gallops ahead on further good news.

One or two negatives come in, but the market finds it very easy to reject those and exclude them from their thinking.

Part of it is because the general trend is still positive, but part of it is because of something called cognitive dissonance.

But that's not true for many investments that have the scintillating character that you're describing today.

If you were gonna teach me and Sam, if we said, "Hey, me and Sam want to do this podcast for thirty years," or, you know, I have a business partner, Ben, I want to be in business with him for thirty years, what do we got to get right to do that?

Well, it's a great question, Jon, it's very important.

Uh, Bruce and I have been partners for thirty-nine years this month, and it's one of the greatest things in our lives.

Uh, after, I think we would both say that after family and, and maybe some good friendships, uh, it, it's really the best thing we've had.

We've worked together closely for all that period.

We've obviously produced a lot of success, had a lot of fun, uh, have, have never had a fight.

We have intellectu-intellectual disagreements, but we've never had a fight, probably because, uh, neither of us is really a financial maximizer, and a lot of fights, uh, are probably about money.

Uh, do, do you guys hang out? What's, uh, what's he like? You know, give me some, some Warren Buffett stories from, from your, uh, your life, your experience.

Quel est ton avis sur le marché des marchés actuellement

? Andy, pour moi, si tu veux gager les conditions dans le marché de l'économie et utiliser cela pour inférer ce que l'avenir prend.

Et je ne parle pas de l'avenir l'année prochaine ou la semaine prochaine, je parle des deux à quatre dernières années, disons, à terme intermédiaire.

Je pense que l'indicateur le plus important est de comprendre si le marché est actuellement conduit par l'optimisme ou le pessimisme.

Tout le reste étant égal, quand c'est conduit par l'optimisme, on obtient des prix plus élevés relativement à la valeur intrinsèque, ce qui implique des revenus moins élevés relativement à l'avantage.

Et je pense qu'il n'y a pas d'argument que pour la plupart, je dirais depuis octobre le 1er 2022, qui est une date spéciale pour une raison, c'est quand la FED a devenu davish.

Dans ce période, qui est maintenant en cours de trois ans et trois quarts de temps, L'optimisme a été dans l'ascension.

Où pensez-vous que nous sommes dans ce cycle avec les marchés de crédit? Et qu'est-ce que vous pensez que Kevin Warsh va faire? Et qu'est-ce que Kevin Warsh devrait faire? Et Bruce, par ailleurs, je vais vous poser les mêmes deux questions sur l'équité et la dette, alors

I guess my question to you, what kinds of indicators do you find to be most informative or most valuable when you're assessing the exuberance and the value of stocks and bonds and everything in the markets today?

We start with the traditional indicators of valuation, like the P.E. ratio, whether it's the Shiller CAPE ratio or the traditional S&P P.E. ratio.

And, you know, those things showed the market to be, I used the expression a year ago, lofty but not nutty.

You know, the non-Shiller P.E. ratio is about 23 or so today.

The 80-year average is 16.

So we're roughly 50% higher today.

But in 2000, I think it was 32.

Sure.

I guess my question to you, what kinds of indicators do you find to be most informative or most valuable when you're assessing the exuberance and the value of stocks and bonds and everything in the markets today?

We start with the traditional indicators of valuation, like the P-E ratio, whether it's the Shiller-Cape ratio or the traditional S&P P-E ratio.

And, you know, those things show that the market to be, I use the expression a year ago, lofty but not nutty.

You know, the non-Shiller PE ratio is about 23 or so today.

The 80-year average is 16.

So we're roughly 50% higher today.

But in 2000, I think it was 32%.

How long do you

If you look at Switzerland, 61% to 31%.

Nobody anticipated the tariffs that were announced on April 2nd.

The tariff on China will now go up to 125%.

Reduced, increased again, and, and business has a hard time coping with that.

I started by asking legendary investor Howard Marks what fueled the rise of private credit.

Private credit has probably always existed, which is to say the making of loans, that's what banks do, and there's been non-bank lending forever.

Direct lending is just one subset under the broad heading of private credit.

Direct lending is the label that has been given to private loans made by non-bank lenders to mid-size private equity deals.

And the private equity business has existed and run on the use of other people's money to lever up returns on equity on the purchase of companies.

And in the global financial crisis, banks lost a lot of capital and were chastened and became more harshly regulated, and the regulation was designed to reduce the banks' riskiness so that they wouldn't ever have to be bailed out again.

So they couldn't lend as much for levered transactions.

And while Marks is somewhat more cautious, he thinks experiencing a full credit cycle may ultimately lead to a healthier investment environment for direct lending and private credit more broadly.

Typically, by the way, for a credit fund, uh, to have a demonstrable problem, the equity needs to get wiped out first.

Right.

Well, when you hear the word private, the main distinction is that there is no market where these things are traded, so there's no market price to use as a reference point.

And th- these things have to be valued by third parties daily, weekly, monthly, whatever it is.

And that's an imprecise product.

And by the way, the job of the valuer is not clear.

Uh, am I s- if, if, if you have a fund and I'm supposed to value the portfolio, am I supposed to value these things at what they're worth? What I could sell them for? What I could sell half for? What I could buy them at? Am I supposed to reflect the ups and downs of psychology, or just the fundamentals? So th- the price is, by definition, wrong, and if people can get, can get out at that price, the other people in that fund may be benefiting or hurt.

Okay.

Got it

... is, is, is the, is the real long term, and I'll tell you in a, in a minute how I get there.

But my favorite cartoon, I have a file of cartoons from over the years.

My favorite one, there's a guy, he's got his...

It is a car pulled over to the side of the road.

The guy's in a phone booth, so you know it's an old, uh, cartoon because there are no more phone booths.

And there's a fa-- there's a factory going up in the background.

Uh, can you unpack that idea a little bit? I just, I just sort of butchered it.

Do you recall investors' initial aversion to the likes of high-yield bonds and distressed credit?

Sure, Harry.

As you say, what Armand recounts is really the timeline of my involvement in the investment management.

And when I joined it in 1969 at First National City Bank in the equity research department, As Armin says, companies lacking an investment-grade rating, that is to say not AAA, AA, AA, or BBB, virtually could not borrow in the public bond market.

I moved to the bond department at Citi in 1978 to manage a convertible bond portfolio.

And in August of 78, I got the phone call that changed my life from the head of the bond department.

He said, there's some guy named Milken or something in California.

When we say mispricings equals mistakes or derived from mistakes, what do we actually mean there?

Yeah.

And I said, "Because the, the, the epicenter was across the street, uh, at 23 Wall, J- JP Morgan headquarters." Um, and, uh, Andrew does a great job of describing the, what led up to it and what resulted, and sums up beautifully in his afterword.

Uh, and he, he says, "The lesson to be taken away is, uh, you know, uh, how carefree, how optimistic do you get, how carefree do you behave when everything's going well? Because that is what determines your ability to survive when things go poorly, as they eventually will." By the way, when things are going well, everybody says, "It's different this time.

There's never gonna be another recession.

There's never gonna be another correction or crash," or what have you.

And, and, a- and there always is, because they're brought upon, brought about not by, uh, physical developments, but by, uh, investor psychology and its excesses.

So, uh, I think that in the, in the, uh...

Maybe, but I, it doesn't seem that way.

[chuckles]

Uh, so I can imagine the jobs eliminated-... and I, I'm not imaginative enough to, to think of all the jobs that will be, that newly created.

So I see a net decline in jobs, and, um, and, and I, and I do worry about that.

Um, AI is, uh, similar to the technological bubbles that I've seen, and, and the technological bubbles probably go back all, all the way to the railroads, you know, 140, uh, years ago.

Um, but the power of AI relative to the predecessor technologies, I think, is vastly higher.

The speed of innovation is vastly faster.

I think innovation- I think a- if you look at the, uh, Claude and, uh, uh, all the coding models and the way they've progressed-

How-

And we'd just love to get your thoughts on those structural changes and the impact they've had on your thinking.

You're quite right.

When I started, it was actually the beginning.

In 1976, I think it was impossible for a company without an investment grade rating to issue a bond.

And in 77, 78 is when it became possible.

A few people had the idea that regardless of the rating, if the bond paid enough interest to compensate for the risk, it might be a good investment.

So at the time, it was a small universe.

We'd love to get your thoughts on situation private equity as compared to all credit.

How concerned are you that we get a Federal Reserve that's more accommodative for a variety of reasons that leads to even more risk-taking? This idea that not only did the Fed cut rates, indicated more rate cuts, but also is adding to its balance sheet in a way that could potentially prop up demand.

Well, uh, uh, you know, I was thinking about this when I was waiting to, to see you today.

Uh, you know, uh, most of the people listening to this, uh, program, uh, including me and you, uh, are interested in the free markets, and we think free markets should set the prices of things.

Uh, and, uh, uh, uh, the Fed manipulations are a, a form of price controls.

You know, they control the price of money.

And, uh, if, if the, if the Fed puts money artificially cheap, then it induces behavior like risk-taking.

It, it, it forces people into riskier activities because the returns on safe activities are so low.

jobs.How do you see this playing out? How are you kind of grappling with this when you look at investments, when you look at fiscal deficit, when you look at the backdrop for the financial system?

How concerned are you that we get a Federal Reserve that's more accommodative for a variety of reasons that leads to even more risk-taking? This idea that not only did the Fed cut rates, indicated more rate cuts, but also is adding to its balance sheet in a way that could potentially prop up demand.

Well, I was thinking about this when I was waiting to see you today.

Most of the people listening to this program, including me and you, are interested in the free markets.

And we think free markets should set the prices of things.

And the Fed manipulations are a form of price controls.

They control the price of money.

If the Fed puts money artificially cheap, then it induces behavior like risk taking.

How do you see this playing out? How are you kind of grappling with this when you look at investments, when you look at fiscal deficit, when you look at the backdrop for the financial system?

And so you aren't properly hedged against that situation because you're underestimating the chances that a bad thing will happen in the future because nothing bad is happening now.

Well, I think that's right.

And Nassim Nicholas Taleb used the example, and fooled by randomness, he compared investing to Russian roulette.

in which there's a gun that has six chambers in the cylinder.

One of them has a bullet.

You spin this cylinder, you pull it to your temple and you pull the trigger.

And you hope it's one of the five that doesn't have a bullet.

And you're sort of looking at what you see and you don't necessarily know for sure.

What do you think of that? Does that tell you we are late in this cycle one way or another or not?

No, not at all.

Not at all.

There are defaults all the time.

You know, I was one of my lucky breaks was being asked to start Citibank's high yield bond activities in 1978, which was the beginning of the high yield bond world.

And one of the things about investing or life is that it's great to be in at the beginning.

So I've been involved in high yield bonds.

Correct me if I'm wrong, but my main question here for you is what on earth is driving it to have quite such extraordinary performance of late?

Take us back to the experience of writing that memo and going against a market that was pure exuberance at the time, right?

Well, the idea came in the fall of 99 when I was reading a book called Devil Take the Hindmost, A History of Financial Speculation by Edward Chancellor.

And it talked about past bubbles and talked about, in particular, about the South Sea bubble in which the British government granted an exclusive license to something called the South Sea Company for trade with what I think turned out to be South America.

And sounding familiar to today, the government had a deficit and they had trouble meeting the deficit and funding it.

And so they figured they'd make a lot of money if they created the South Sea Company.

People thought it was a get-rich-quick scheme, so they jumped on board and they traded it.

But as I read the book, I saw things going on and I said, this is what's happening today.

Intellectual humility.

And I don't know how you would deem sentiment, but there's certainly a lot of enthusiasm around technology like AI.

Are we in that moment? There's enthusiasm.

There are high valuations.

I don't know enough about tech stocks or stocks in general or AI specifically to know whether the valuations are excessive.

My response to date has been that the valuations are not crazy.

High, but not crazy.

And when things are either high or low, but not crazy, you can't make an observation that has a high likelihood of being correct.

Right now, even in today's environment?

Yes.

Thank you.

But, you know, interestingly, I wrote a memo called Sea Change, December of 22, saying that, you know, anybody who's come into this business since 1980 has only seen declining or ultra low interest rates.

And I think that's over.

And I note in particular the period from the beginning of 09, when the Fed took the Fed funds rate to zero to fight the global financial crisis, the end of 21. when it gave up on inflation being transitory and decided it had to raise rates to fight inflation.

Over that 13-year period, remarkably, the Fed funds rate, which is our primary barometer of short rates, was zero most of the time.

So people are biased to think in line with what they have lived through recently.

You're not saying run for the hills, but there are some, you know, I would say red, orange lights flashing at least, Howard.

our

clients.

How many? Crickets.

Well, you know, in 1990, 100.

Wow.

Okay.

You know, and by mail, of course.

Maybe that's not as crazy in the financial world, but that sounds crazy to me.

I wanna start, we want to start, with a central question that you pose yourself: Why are asset prices so strong in the face of what you view as net negative developments? Howard, can you share your thoughts with us?

Uh, I'm glad to be with you this morning.

Of course, as y- as the quote you just put up on the screen, uh, indicates, um, you know, it...

this is all just feeling, and, and, uh, and, uh, an, an opinion.

None of this is factual.

But it, uh, it does seem that, that stocks are expensive relative to what I call fundamentals, or what you might call reality.

And, uh, you know, uh, uh, the outstanding reason, I think, is that, um, you know, there hasn't been a serious market correction in 16 years, so, uh, people get out of the habit of, uh, of, of thinking about market corrections.

I mean, does that sort of question what it means for it to be defensive when the valuations are high there as well?