Well, it's a global move to start with. We have rates rising all across the developed world with the exception of Switzerland. Rates are rising. Even in Japan, I think we're getting above 3%. People thought the Japanese yield would never go up because it was being so carefully controlled, but the weakness in the yen led to just somewhat of a change in policy. One of the things that's really driving all of this is just the supply of bonds. There's this huge amount of issuance that's going on because the budget deficit just keeps growing and there's no end in sight. You know, now we're going to build two more army bases in Greenland. I don't know what they're going to cost, but I remember the Bagram base that we gave up in Afghanistan when we evacuated from there was something like $300 billion. So, we've got that happening and then we've got all this AI and AI-adjacent issuance, which is either — I've seen different estimates for the coming several months, but it's like $900 billion or $1.4 trillion. And you know, this is really putting pressure on investors' appetite. And for the first time, we've started to see some initial signs. I wouldn't say they're terribly convincing, but there's initial signs of credit tearing. In particular, if you look at the AI names and you compare them to everything in the corporate bond market other than AI, you see a very different complexion. In the investment grade market, the non-AI investment grade bonds are basically on their tight spreads. They're in the 70s over Treasuries, but the AI bonds over the past — I'd say it's been going on there for about eight months to a year — they've widened by about 60 basis points on the AI names. And that may or may not be a credit concern in terms of analyzing credit. I think it's more due to the fact that investors are skeptical of the ratings that are being assigned to some of these AI-adjacent bonds. Notice that when SpaceX came out and borrowed money, it kind of surprised people that right after the IPO, they borrowed like $85 billion or something and they got a triple-B-minus rating, which as we all know is the lowest tier of investment grade. And as long as you have an investment grade rating, you get preferable capital treatment by insurance companies. And the market instantly rejected — almost instantly — that triple-B-minus rating. And the bonds are trading like a single-B type of credit. And if we move over to the high yield category, we've seen much wider widening out in the AI bonds. If you look at the non-AI high yield bonds, they're out a little bit, but not very much. They're kind of in the context of where they've been for the past year. But the AI bonds are out by 150 basis points as of last week. I haven't gotten the recent quote. I've been traveling, but 150 basis points. So, they're trading like they're some far down to the junk category. Not like the Oracle bonds, I think, were rated double-B or double-B-minus and they're trading like a couple hundred basis points wider. That is more, I think, because these ratings are being challenged. The ratings are coming from sort of non-traditional rating agencies and some of them seem to be rating an awful lot of bonds relative to the size of their staff. And so I think the market knows that these ratings might be inflated, but beyond that, the market is assuming, I think accurately, that there's going to be a lot more issuance of these types of names and that's in conjunction with the Treasury issuing. I don't think it's a coincidence that Scott Bessent signaled Operation Twist the very day after the national debt on the official debt clock crossed above $40 trillion. I was doing an interview with a podcaster earlier this year and we were talking about $4 gasoline and how that was a psychological level and it sure seemed out — that seems out to have been right for the past six months or so. When the price of gas goes below $4, people don't seem to be that concerned about it, but now I think it's up at about $4.40 on a national average. We're probably at $7 now in California. I haven't been there in a couple of weeks. It'll be interesting to see what the price level goes to. So, you know, this is a lot of consternation that's going on out there. The $4 level on gas turned out to be significant and the 40 — when I was talking about that six months ago on this podcast, I said, you know, 40 trillion on the national debt, which we're going to get to by the end of the year, might turn out to be a psychological level. And it sure seems to be the case. All of a sudden, it's very much in the news that we're over 40 trillion and now we're at 41.1 trillion is where the debt ceiling is and we're going to have to do something on the debt ceiling yet again. Another fight over that which doesn't do the markets any good. But here we are, you know, we're in this seasonal period for some unknown reason. September and October seem to be seasonally weak. And this turned out to be a really bad September. Not — still a few trading days to go, but bond yields on the 10-year Treasury and the long bond are up by about 45 basis points in the last month. And so we've seen bond returns on sort of like the Bloomberg Agg index go from pretty, you know, okay, kind of like zero types of returns or maybe negative a half or something now down to about minus three and a half on investment grade bonds, which is really putting pressure, not surprisingly, on the valuations of equities. The S&P 500 as of July 31st, the most recent number I have, had a CAPE ratio of 42.04, which is one of the highest of all time. And with rising interest rates, that CAPE ratio becomes more and more challenged to sustain. And if you look back historically going back a long, long time period, if you look at 10-year returns after certain CAPE ratios, when you're up at this level, in fact, if you're above 35 on the CAPE ratio, you basically have never had a forward real rate of return from the S&P 500 that's positive. It's negative all the time. And there's several data points around this 42 area that we are on the CAPE ratio for the S&P. And those data points, the forward 10-year real rates of return for the S&P 500 after registering a 42 type of CAPE ratio have been something about minus 6 and I think the best one is minus 5. So this is the environment we're in. At least bonds are not as ridiculously overvalued as they were five years ago where we have huge negative real rates. Now at least the real rate with bond yields at five are positive. But historically, you know, when you're in an environment where people are questioning the way the debt's being managed like it was in the 80s and in the early 90s, investors typically wanted at least a 200 basis point real rate of return. And you know, the inflation rate right now is kind of running at — there's a lot of different series out there, but let's just say it's three to pick. I think a number that's probably a little lower than the inflation rate really is. That would mean 5% on say the 10-year Treasury. Well, that's where we are. We're at 5.14. But if the inflation rate — you know, if the deficit keeps going, keeps troubling people's ideas about financial market pricing, my viewpoint, I think I want at least 250 basis points or maybe even 300 basis points of real rate of return to be interested in say the 30-year Treasury bond. And if the inflation rate is at three, that would mean a 6% 30-year Treasury bond. And that seems, you know, like if you'd said that to people a couple years ago, they would have thought that would never happen. But we are at 5.44 and it is the highest rate in essentially 20 years. And so the path of least resistance appears to be up given particularly that the commodity complex continues to just boom. The number one performing asset class year to date is, if you just use traditional indices, is the Bloomberg commodities index. It's beaten all stock markets. It's beaten, you know, all US bond sectors. So I mean there's a real boom in the commodity market. That's great for commodity investors. Not so great for gold owners because gold is kind of stuck in the water after its huge rally last year into the first quarter of this year. But the price of oil just doesn't drop. And we're always looking for, you know, some magical thing's going to happen and the war is going to end and oil is going to go down and maybe it will. But we've depleted our strategic petroleum reserve in the United States by a very large amount. And we can't deplete it very much more because you can't take all the oil out of the strategic reserve. The oil becomes corrupted once it gets down to a certain level. And so you're going to have to refill the strategic reserve. And it's not just the United States. If we look at global oil reserves, they're at the lowest level in decades on just a number of barrels units. Then compare that to the population which has grown over decades and the usage of petroleum which with the population growth has grown over the decades and this is a very low level of reserves. So while oil might drop if there's good news on the war and so forth, I don't think it's going to drop down to 50 or 60. I think that the governments would want to start refilling that petroleum reserve. I don't know. I don't know what the number is. I'm not a policy maker, but I would say probably at 70. So it might drop, but it's not going to drop to pre-war levels. And we haven't seen the blast radius from these elevated oil prices really expand the way it will in the weeks and months ahead. We've got, you know, the price of fertilizer is likely to go up. We've seen shipping rates skyrocketing. I mean, some shipping corridors are up 400%. So, I don't see the real case for this 2%. And I pointed it out at the pre-Fed press conference last week. You know, the dots, the SEP says the PCE is supposed to end this year at 3.7%. That's the committee's median guess. And at the end of 2027, they're saying it's going to be at 2.3. And that's a 1.4% decline. And I don't know what is the logic for that decline. Either it's not just going to magically happen. And inflation is not just going to magically go down with the commodity prices kind of complex where it is right now. So to get to 2.3, I would think you'd have to hike. And of course now the bond market with this huge move in rates here in the month of September has gone from — I mean in January, remember, the bond market was looking for two cuts in the Fed funds rate this year. And I said after the Fed press conference, I said, 'If that's what you're betting on, you're backing the wrong horse because there will be no rate cuts in 2026.' And now, of course, we're looking at two rate cuts this year — rate hikes, I always say cuts, rate hikes this year, in October, maybe, and in December. And some people poo-poo the idea of October because it's close to the midterms, but I think that's just a ridiculous argument. And the popular — there's early voting. People are voting right now. I know it might look bad politically, but I don't think that's a real election mover. So, the Fed's probably going to raise rates a couple more times. And the 2-year Treasury is at 4.9, which sort of suggests that the Fed funds rate should be, you know, sort of at about 4.5% and it's only at four at the high rate of the band. So then I started where should the 10-year Treasury yield be based upon some indicators that have been helpful over the past — when I say the past, I'm talking the past 40 years going back to 1986. It's weird how in the old days we used to just use nominal US GDP as a starting point for where perhaps the 10-year Treasury yield should be. And right now the 10-year Treasury yield is at 5.15. GDP — nominal GDP right now, the seven-year average of it, which is what we use, nominal GDP is now 6.1% and this quarter's GDP looks like on a real basis is likely to be — you know, on GDP now we're up in a five handle. So it seems like 6% is not unreasonable to think about for the US 10-year. But a model we came up with back 10 years ago to factor in the fact — the idea that US rates were positive when $19 trillion of other bond yields were manipulated to negative levels. We started to average US nominal GDP with the German Bund 10-year. And using that model, it says the 10-year Treasury should be at 5.9 — sorry, 4.9 right now. So under the GDP model, the 10-year looks a little elevated right now, but not by a lot. Maybe by 25 basis points or so, but using nominal GDP might go up to six. I would not be a buyer of long-term Treasuries unless the yield were about 6%, maybe even six and a half on the 30-year Treasury. We've seen the yield curve flatten a lot now the Fed has gotten more into a tightening mode. We've seen the curve flatten a lot. The 2s30s was up at 130 basis points and today it's at about 55. So that's flattened quite a lot which makes the long end really even less attractive. So that's kind of my take on where we are. We've been sort of feeling defensively about all markets since the end of July, middle of August really, largely due to valuation. I talked about the CAPE ratio, largely due to — before this move up in bond yields, they looked quite unattractive. So we were — and also the seasonals are just bad as I referenced earlier. There's nothing weird about this September-October period. So not that surprising that we're seeing negative returns here in the month of September. So, I'll just stop there and let you take us where you want to go.
Well, what I've done when it comes to like the bond piece — I break asset allocation into four pieces. Equities, you know, regular fixed income, which means like Bloomberg-oriented type of thinking, and then real assets, and then finally dry powder. In stocks, really all I'm really looking for is to get out of the epicenter of this overvaluation. At this point, starting really two weeks ago, I really went to nothing in a market-cap-weighted concept. So instead of being, you know, 40 to 50% concentrated in AI and AI-adjacent stuff which is really driving overvaluation, you have equal-weighted. So you have almost no AI and AI-adjacent stuff. So I'm not very conservative in that category. When it comes to fixed income, I have a barbell approach which is kind of unusual. Well, it's an approach I had started using really for the first time in my career and that is to take something that's really safe and has no corporate bonds in it. It's just government securities and securitized products and mortgage-backed securities. About what's risk-free right now are mortgage-backed securities that are non-guaranteed that were issued five years ago or more because the home price appreciation — while home prices are moderately falling now, the home price appreciation on the underlying mortgages under these pools that are five years or more old, they're up like at least 50%. So if somebody bought a house at 100 and took out an $80 loan, well the house is now worth about 150. So you have an LTV that's nearly 200%. So no one is going to default. You'd have to be dumb as a rock to default. A $150 house where your mortgage is $80. I mean, no one's going to do that. So you're getting a spread. On the good days, it might be 130 basis points. When spreads are particularly tight, it might be 120 or so, 115. But that's a — I believe that's truly a risk-free spread above Treasuries. So the Treasury bond market in sort of that five-year area is at 5%. So you can get up around 6 and a quarter, 6.30 in what I think is a risk-free asset. So that's one of our significant holdings there. The other risk-free asset which we don't own a lot of simply because it's really not — it's not good convexity so much are AAA CLOs which have been popular recently now that people are thinking about the Fed hiking rates. It's not surprising that they want floating-rate assets that are at the top of the capital structure. So AAA CLOs — if they take losses, we're in really big trouble. Not that that's a proper analysis, but I really don't think AAA CLOs are going to take any losses. They certainly didn't in the GFC. So you're getting there, you know, maybe it's 100 basis points or 110 basis points over SOFR. But again, these are significant spreads of, I think, the risk-free assets. And that is local currency emerging market, which is again something I haven't done in a long time. Local currency emerging market has a double benefit. It's actually the top-performing bond sector year to date in traditional sectors. It's not up very much. It was up about 4%, but with this rout here in September, they're up about maybe one, one and a half percent, local currency emerging market. But you also have the benefit of should the dollar decline, you're going to get a currency benefit. But at any rate, you've got a positive rate of return. And there's almost nothing in the bond market with a positive rate of return. Most things, as I said, are down three and a half. Some are down four and a half percent. So you have to play defense there. Some real asset investing, 20% of a portfolio. I think 10% should just be in a commodity fund. And then with the recent weakness in gold — but now with the decline, I think that's time to increase it perhaps for long-term accumulation purposes. And so we're looking for things that will protect for higher rates. I've been steadfast in my statement going back six years. I think 2020 was the secular bottom in rates. Now that they're up 500 basis points, that's not a controversial statement anymore. But I think the fundamental mistake people are making is from the experiences they've had, particularly for people who have been in the business maybe 20 or 25 years, they actually think that rates are high right now. They feel like this is some really — I hear people talking about this great buying opportunity to get 5% on Treasuries. I mean it's a lot better than three, of course, and the inflation rate is not at two, but at least it's sort of stable. It won't really start dropping probably until the second quarter of next year when we have some high numbers rolling off on the year-over-year basis. But 5% rates is just not that high. I think that people have been jaded by the years — say the last, I don't know, I guess it was 20 years before 2020 where rates were at zero and people think that rates are at zero or the long bond sub-2% is some sort of natural state of affairs, but it's not. And I think that what's been perplexing and confounding investors when it comes to say private credit, private equity, they keep saying, well, when rates come down, we'll be able to exit, we'll be able to not keep doing these extensions and continuations. Our clients want their money back and we can't liquidate. We've got, you know, trillions of dollars of trapped private companies and so forth. But the rates aren't going to come down like that. That was abnormal. That was an abnormal condition. I think the interest rates at five are completely understandable based upon nominal GDP and the nominal GDP and German 10-year yield model. They're totally reasonable and GDP seems to be going up and it might be going up on inventories which makes me worry about inflation reigniting because when I was a kid, I remember that people, including my family, would start to feel like prices are heading higher and they would want to buy in advance. And there was a good example of that last week. I mean it's just one example but it is interesting. Costco raised the price of their Kirkland brand motor oil last week by basically 100%. They doubled it and at the same time they told their customers that they were rationing it. You only can buy a certain quantity of the motor oil every month or so. And I think what Costco was figuring — and I think they're smart to do this — is that when you double the price of something, people will say, 'You know what? I keep hearing about the gold price is like $100 and they already doubled the motor oil. Maybe they'll double it again.' And so people start to hoard. They start to say, 'I'm going to buy in advance.' And I've noticed that there's been an increase in consumer spending in recent GDP — now revisions higher — and also in inventory building which suggests also that perhaps consumers are buying early in anticipation of higher prices and perhaps retailers are hoarding inventory thinking, well, I'll buy it now and maybe I'll be able to sell it at a higher price come the turn of the year or something like this. So I'm not of the belief that — you know, people talk about how it's all real rates and inflation expectations haven't really changed and certainly when you compare TIPS to nominals you can draw that conclusion, but I don't really buy into that. I think that the expectations that people have when you look at consumer sentiment indices, University of Michigan and the Conference Board and so forth, I think we're starting to see some movement higher on inflation expectations. So, I think it's a time period where you've done well in equities this year. You've done very well in commodities. You haven't done anything good in bonds at all except for maybe local currency emerging market. So you have to — I'm still on the side that long rates' path of least resistance is up until such time as Operation Twist kicks into high gear which has not happened and $6 billion of buybacks is like a day of the deficit. It's like nothing, but they do have the wherewithal to control interest rates. We saw that in the 1940s into the mid-1950s in the United States. We saw it for decades in Japan and then after all that work to try to keep their yields contained, they couldn't do it anymore and now they're joining the party of higher interest rates. So yeah, I'm still conservative on credit. I'm still conservative on duration.
