Talk Your Book: Investing in Treasuries During a Debt Crisis

0:00Today's Animal Spirits Talk Your Book is brought to you by US Benchmark series. You can go to USTreasuryETF.com to learn more about their targeted ETFs. I think they have three-month, six-month, 12-month, two-year, three-year, five-year, seven-year, 10-year, 20-year, 30-year. The whole yield curve. It's at USTreasuryETF.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management.

0:36This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:50Welcome to Animal Spirits with Michael and Ben. This conversation with Alex Morris was recorded in the, not lobby, what do you call that? that area. The foyer? It's definitely not the foyer. That's in a house. I don't know. Kind of a hallway. We were supposed to be doing it outside and weather intervened. We were supposed to do it by the pool. We had our nice new animal spirits, Tropical Brothers shirts on. The best part about it all, we walk across the, we're walking across from the bathroom. There's a huge open area of these tables. And we see two gentlemen across the way, also wearing Tropical Brothers shirts.

1:23And I immediately, I pointed. Those are our guys. And one of them was Alex, who is on the show and they were good sports about it and wore their shirts and we were supposed to be outside, didn't work out. We still got our Miami vices to drink while we were recording live, but we got to do a live show and it was great, right? I thought as far, sometimes it's a little harder to do those live shows did in person because there's just a different energy, especially when - Well, especially when there's people staring at you that are standing. So if we were on stage, it would have been, you know, whatever, we've done that before, but this is a bit of a different, but I think we did okay.

1:59All right. Getting to the product real quick. So we're talking to US Benchmark Series. What they do is they have targeted maturity, fixed income ETF. So if you want just to own the 10-year inside of an ETF, you can do it, which sounds like, how did that not exist? Because there was no yield to be had, so it didn't matter. In fact, it is mind-boggling that the ticker T-bill was available, given that there's people that sit on tickers. T-B-I-L was available, which just speaks to where we came from, a world with zero interest rates and nobody wanted it. So we are in a much different environment today, that's for sure.

2:33Well, so we talked to Alex Morris, who helped founder the company, and he said last year at the conference we were at, they rolled out the product. Or they basically rolled out the idea. It hadn't even been opened yet. Now they have more than a billion dollars. And it is one of those, oh, why didn't I think of that? Why didn't anyone else ever think of this? And it really makes a lot of sense. And so we had a great talk with him about the debt ceiling and how treasuries are paid out and how the whole thing works and how DC is involved. And it was, you think of treasuries as being a little more boring, obviously, than the stock market.

3:05This was still a very interesting conversation. Agreed. So with that, here is our conversation with Alex Morris. We are rejoined today by Alex Morris. Alex is the founder and CIO of FM Investments. Excuse me, Alex, good to see you again. Good to see you guys. All right, let's do the origin story. What brought me here? Yeah. How? Why? When? Yeah, this is what happens when you're supposed to be a doctor and you kind of get lost on your way to med school. I'm an engineer twice over, which is amazing that they let me out of the house or I leave. And I told my parents I wasn't going to go to med school and looked at me like, well, what are you going to do with your life?

3:41I'm like, oh, well, go find myself in Southeast Asia. And when they told me I had to pay rent and I was broke, I ended up getting a job in finance because they're the only folks who are available to people who missed all of the big meetings in life. So I ended up at a hedge fund. We started it from zero dollars, raised about three billion dollars in 18 months. It's kind of frightening. It's like being on a skateboard with a rocket strapped to your back. How did you raise so much money so quickly? Ponsor scheme? No, it was actually just a lot simpler. Big pension funds with folks who had had a prior hedge fund that blew up, you know, close that down, new name, new logo, move down the street, open it up with some of your friends and off you go.

4:19So these guys would run a long short equity fund for a long time, shut it down after a decade, had their family offices, thought they'd give it a go, brought us on. And, you know, we raised money from like the Australian pension fund and like these massive allocations. And it was a great time to be in global macro. And it worked. So from there, how did you get into the ETF industry? Take a hop to come to a private bank in California from a friend's dad who gave me a job at a good time and then did a small turn in investment banking. And then ultimately found myself in Washington, D.C. because I met a girl and fell in love.

4:54And she called my bluff or I called hers and we're married now and have two kids. And the only people I really knew in D.C. who weren't in like a family business were these folks out at Fortigent. It's a family office group and called them up, basically showed up unannounced. They took my meeting because we'd kicked them out of the hedge fund like four years earlier where we're like, we don't need you to fleece Americans. We'll do that all on our own for two and 20. We don't need to split it with you. They took the meeting to yell at me. And two weeks later, they offered me a job to run capital markets, which didn't exist.

5:24We built that, sold it to LPL. Turns out I'm not a great employee in a big organization, big shock for those who know me. And from that, then did my contract, left and started this firm with the idea that they're really good portfolio managers out there. The folks we know are good at managing stocks and bonds, but they're not really good at running businesses. So what if we just did all that other stuff for them? And we did. Along the way, I met a guy named Pete Baden and his partner, Judd Hennessy. We started this group called Genoa together. And then Pete came to me one day with a kooky idea.

5:57At the back end of it, we created the benchmark series. When was this kooky idea? It was about February of last year. And then at this conference, the Inside ETF Conference 2022, We came, previewed it. Folks didn't laugh us out of the room. So we filed for our first ever ETF, kind of working out what is an ETF. So you came to the conference with$0 in assets last year. $0, a good idea, and not even a fully vetted PowerPoint. And when did you get your first check in the mail to start funding things? August 9th of last year. And how much money is in the benchmark series today? Almost 1.6 billion.

6:32All right. Incredible. So everything in life is about timing. It's all about timing. Especially with ETF launches. Because if you did this, if you had this great idea in 2018, you'd be out of business. Yeah, we wouldn't have made it past the first day of trading. So what was the first product that really started to get traction? T-Bill was probably the first, still the biggest today. It was when it came out, sort of immediately got action to the point that most folks didn't believe that it was real, and then just took off. And T-Bill is what? T-Bill is the 90-day on-the-run product. So So it was high yield.

7:04It was in the right part of the curve at the right time and delivered on its promise every day. So where is the most money now in terms of your products? Still in T-bill. So T-bill, then U2, then U10, and then sort of, oh, that's probably not true. It's probably the short end. T-bill, U2, the six-month, which is X-bill, and the 12-month, which is O-bill. All right, let's zoom out and let's do a little bit of macro stuff. My first question on this topic is, is the Fed done manipulating interest rates? manipulating. Compliance is not going to like that one. I mean, if you believe Governor Bullard today, the answer is no.

7:40What did he say? He said there's two more coming this year. Now, he also hadn't been in the news in a while, so that's pretty much his shtick, is talk about interest rates going to the moon, so he gets airtime, but they're probably not done. I mean, whether it's one more just to prove that they have, you know, the chutzpah to do it, I wouldn't be surprised if we saw a little more action from them before we're through. So we don't know for sure, but why do you think the long end of the curve has remained so anchored and hasn't moved as much if the Fed's been jacking up short term rates? They just don't believe them or they don't think inflation is here to stay.

8:13Why have 10 and 20 and 30 year rates not come up as well? I think that the generous view is long term. Folks believe the Fed gets this under control, right? You'd only really want to see the 10 year in five, six, seven, if you really thought we had long-term problems. So the market seems to be pricing a short-term problem. Now whether or not you agree that the Fed can get this under control and the central banking experiment works will be determined. And if you look at the one month today, you could be believed if you didn't buy into that argument. The last two times the Fed hiked, so what month?

8:47So there was one in May. What was the last one? March? March. The last two times that they hiked 25 basis points, immediately the two-year took a nosedive. Yep. Which is like just the market was like, you know when mom burgundy says I don't believe you? Right. That was the bond market. But today, not to be too short-term, but both the two-year and the 10-year, which have been going sideways since the middle of March, are both breaking out to the upside. Do you think that's because the market is now saying, okay, rates are going to be higher for longer? Do you think that's because economic data is still strong and maybe we're not going to a recession?

9:24What do you think the bond market is saying? Can I just flag the fact that Michael is doing technical analysis on interest rates? And I just wanted to say I'm not. I'm just pointing it out. I don't know if that's part of your process. I'm just looking at the charts, my friend. It's fair. I think that one is not to do with the long term, but everything to do with June 1st. Now folks have gone from being Fed watchers to what is Speaker McCarthy and President Biden doing hour by hour. what are they eating for dinner? Are they going to meet in secret? You're just seeing lots of folks worried about will the US default on June 1st?

9:57Or now it turns out it might be June 6th and then maybe June 15th. Oh, so you think the rate rises are because of the debt stuff? I think that debt stuff is driving everything on the curve and everything to do with the Fed. Look at the one month right here. So I've got the one month pulled up and it has to be positioning because this thing crashed to like below 3.5 % in a matter of weeks. and then three weeks later, it's at 5.7. So that initially is people front running it and then selling it. Yeah, they're afraid that they're not going to get their interest payments. Right, people don't want to be in one month T-bills right now because they're worried something could happen and they don't get paid back.

10:32If they were worried, wouldn't it be a lot higher than 5 %? Look at how much it took off though. I mean, you need a lot of people to be really worried to move the one month that far because there's a lot of one month bills out there. But I mean, the other question is, if you're really worried about not getting paid, shouldn't you be getting out of the dollar entirely? Like, we shouldn't be arguing about whether it's 3, 5, 10, or 20. It should be infinity, right? Like, I hear a bunch of folks talking today, you know, last few weeks about, oh, well, if the government misses a debt payment, it's going to be on this side of the curve, not there, which is kind of ludicrous, because a defaulted debt is a defaulted debt.

11:04Like, if we're talking about a company that went, you know, bankrupt, we wouldn't be talking about, do we want to own their 10 or their 20-year debt? We'd be like, why do I own this at home? That's true. If you own a six-month T-bill, who cares versus a one-month? So this is window dressing, then? A little bit. I think it's just there's some latent fear. Folks are driving yields up, particularly on the short end, because the thought is, well, that's the one that always has to be paid back most immediately. You've got a little more time to pay back your existing 90 days in your one year. And you only make interest payments twice a year on everything else.

11:31So you've got a little more time. Have you seen that in your flows where money's coming out of the short-term T-bill funds? Money just keeps coming into the short-term funds. And we've actually seen the last two weeks money come into the middle and the long end of the curve. We launched the 30-year fund a couple of weeks ago, and now all of a sudden money's coming in to the very, very far end for the duration lovers who just are betting on price movement. So Ben's made the case that staying ultra short is a no-brainer, given the shape of the curve. And I think that's mostly true. However, there is real risk that if the curve uninverts, that there'll be reinvestment risk at the short end, obviously.

12:11Of course. And you're not going to get the benefit of price appreciation if the rates come down in the middle of the curve or the long end of the curve. That's true. And if you look at the way we stay on the run, you know, we're constantly reinvesting in that. So your duration will naturally stay where it is or extend from, you know, versus holding on to it. But like if we pulled up the market timing Hall of Fame, we'll be nobody there. Right. Just be three of us looking around. And, you know, it's hard to really call that. particularly when you're working with just the sheer size of what the Fed does.

12:45There's$31 trillion in debt out there. There's only$5 trillion in cash money in the economy. So you need to move a lot of money to really injure this, but you need just a few stupid statements by politicians before everyone freaks out. So we're talking about what is causing these different differences in rates at different maturities. The bond market is typically known as the smart money. Do you think it's harder to follow the bond market now in terms of macro signals because the Fed is so involved? I think it's probably always been hard. I mean, it's still an OTC market. We're trading bonds today the same way we were in like, you know, 1600s Amsterdam, you know, right next to the tulip bulbs.

13:24And sure enough, they seem to be a little bit alike. But I think the Fed's, you know, yield curve control, which it's not doing directly in the same way Bank of Japan did, but through influence and through messaging has certainly influenced it. But if you look at new issues in the debt market, they're just not anywhere near what they were a year or two years ago. I mean, it's not that credit has dried up, but it's really come down. On the corporate side? On the corporate side, so just pure credit. I mean, the ABS world is still present, but mortgages are far less plentiful than they used to be.

13:55It turns out, folks want to buy big houses when you can get a three-handle or a two-handle. They don't want to do it at six or seven. So you're starting to see some of the credit tightening just coming to that market in general. Some of it is like if you looked at just the yield curve, you'd say it's so inverted that this has to be a recession. But if you looked at spreads, you'd say, wait, this isn't look all that bad. So someone has to be wrong. Well, someone will ultimately be wrong, or we'll find out that it will be a recession that we can't detect. We call it recession because we call it recession.

14:27NEBR gets together, a bunch of folks in Cambridge, Massachusetts say, hey, it's a recession. But if it just rolls its way slowly through parts of the economy, and they never actually get that critical mass, you kind of get the same effect. And we're in a potentially recession where everyone has a job. So how can you have a recession when everyone is employed? Yeah, I think you can't have one in the aggregate, but I suspect it can hit - Like pockets? Yeah, individual sectors of the economy. It's not a great day. We've seen that already. Yeah, it's not a great day to be in big tech. Right. That used to be, they were hiring people to hire people to hire more people.

14:59And those folks are all gone. And big tech's talking about cuts. The investment banks, they've cut pretty heavily, but they hire fast and they fire fast. So can't really take much out of that signal. Getting back to the product, which is you're targeting the maturities on the yield curve, whether it's one month, three year, 12 month, whatever. Well, what are the products? So there's the 90 day, the six month, 12 month, two, three, five, seven, 10, 20 year. Okay. That's a lot of decisions for an advisor to make who I assume is responsible for driving most of these flows at this point. That's probably right.

15:36Why should an advisor target a specific part of the curve versus being quasi agnostic to say like, all right, I want to be in the belly, but like, I don't know that I want like the three or the five or the this, the, that, like why target an actual maturity as opposed to being more diversified? So we think advisors should be diversified. We just want to give them the tools to target those most liquid chunks. So if you want to be in the belly, there's no reason why, as an advisor, you shouldn't pick what percentage, even if it's just a third three, a third five, and a third seven. What is the belly, three to seven?

16:08Yeah, three to seven. Once you get 10, 10's kind of the edge, and then 20 and 30, the long bonds that behave on their own little world. And the 20 year is kind of a unique animal that every decade or so, the Fed decides to stop, or the Treasury decides to stop issuing. So So some days it's there, some days it's not. There's a lot of, there's no, the uninversions or the decline. Is uninversion a word? I think so. All right. They're like snowflakes. Not all of them are the same or none of them are the same. That's probably right. So if you were to anticipate a recession or a softening economy or the Fed cutting or rates coming down or whatever, maybe you would say like, okay, give me all of the duration, right?

16:46Yeah, you'd go long duration. However, that's not necessarily where the most juice is going to be. It might be that you get this sort of weird un-inverting where it happens like at the three or more than say the 20 year. Yeah. I mean, the question, just given how strange the curve looks now, right? Like it's not purely inverted. It's got kind of a hump on one end is, is this sort of like, you know, large meal making its way through the boa constrictor where the lump just kind of makes its way through the belly of the curve until eventually it comes out the back end. But that's, that's a condition we've never seen before.

17:18We're used to the curve kind of just being on a pivot point or a teeter totter. And this one looks like it's going to take a different shape as it works its way out of this. And look, June 1st comes around. We're not out of the woods, necessarily. We still have to contend with high interest rates that will be high for the next year. And yes, it's been a pretty abrupt ride to get here. But the only thing that we don't know different from getting here is what it's like to stay here. Because the market seems to be pricing in a pretty late 2023, early 2024 set of cuts. they get pretty much back to zero or certainly to two.

17:53And that would be a pretty abrupt drop as well. Usually, that's the kind of thing that happens because of a recession. So are advisors asking you for guidance on how they should think about allocating? Or are you not having those conversations? Advisors certainly ask. Retail investors ask. And our answer is really facts and circumstances based. There's not like one size fits all. That's why we built all 10. Decide where you need to be and where in the market you are. And we hear great arguments for every side of the equation here, like things that say you should go long duration, some that say you should stay ultra short.

18:26Some who say, you know, they should just pack up, invest in lead and squirrel pelts and homesteads in Montana and just quit this whole thing altogether. So it's hard to say. I think most folks who come to us, though, and are asking for on the more cash proxy side, push them to the short end. and folks who are planning on something happening, encouraging them to extend duration out into the middle and not to go full into the middle or far into the curve, but get ready to do that and start edging into that as time unfolds. Ben had a good theory today that we were talking about, about why the Fed might cut that has nothing to do with the overall health of the economy.

19:02Ben, lay it out with your tinfoil hat, please. I was looking at the actual interest expense that the government is paying. And it's gone parabolic because rates are so much higher. They paid zero forever. Now, if you divide it by any sort of asset or GDP or whatever, it doesn't look nearly as bad as it did in the past. But if you just look purely at interest expense, it just did this. And I just don't know how long politically that can last where people are going to say interest expense is making up a bigger and bigger part of the budget. Can we keep rates at 5 % or 6 % if that's happening? It's a good point.

19:39I guess the question would be, if we drop rates, though, and inflation takes off, we'll have the same effect. Because we still have to pay government employees, and they have cost of living adjustments based on CPI. We still have to pay vendors who are going to jack their prices up, right? F-18s and F-35s are going to become that much more expensive, and we're going to need a lot of them. So I think you're probably right that that would happen. I just don't know what the net effect would be. And the question would be, could we just stop spending as much? That's really the argument going on today is, is it possible for a government, this government in particular, to say, hey, maybe we don't need that.

20:17They're very good at saying yes. They're very bad at saying no. You're talking about the US consumer too, I think. The other thing is, so you mentioned the inflation side of things. You don't have the tips yet. Maybe that'll come someday for you. I don't know if you can talk about that. But a lot of advisors I know were thinking that they had inflation all figured out. And in 2020, I saw ahead of things. I'm moving all my fixed income from treasuries or corporates to TIPS. And then when rates rise in 2022, TIPS got just smushed, right? Almost just as bad as regular treasurers. And people thought, wait a minute, I thought I was getting inflation protection.

20:54Inflation took off. My TIPS got killed. Maybe you can talk about the difference between the inflation protection of TIPS and the bond part of TIPS, which obviously the bond part seemed to win out when rates rose. Yes. I mean, the idea that the government gave you a free ride when CPI went up was always a little weird, right? I mean, and you had a bunch of phantom income that happened along the way. So the TIPS market also went soft because it required other people to want to buy them. And other folks, I think, just stopped believing that they were going to get all of that upside that they were promised, and they would get it for the foreseeable future.

21:28And in the interim, the government collected its tax on it. So it was pretty happy. Like it didn't, it didn't worry about that outcome because it only promised you the interest payments and the rest was on the come. And most of those tips are pretty long dated. So they had another seven, eight years where they had to pay the piper on it. That's the interest rate risk was the thing that people didn't really think through, right? Right. Because a lot of those tips funds, if you're not in the short duration tips, they're long duration. So if the rates can go up, they're going to get killed. They did get smashed.

21:53Yeah. I want to talk about the potential ramifications of a default. But before we get there, so remind me if I forget to ask you that. If we were to look at your flows, would we learn anything about what the market was doing? Like, do you think that you could look at your flows and then guess the market did this or that? Or is it sort of not random, but is it not that, I don't know, is there no signal there? It's probably not much. I mean, if you looked at volume, you could probably pick out days around the FOMC meetings a little bit. So does volume pick up around that before, after, during? Right before, during, it's pretty quiet.