Episode 387: The Overvalued Junk-Bond Market Still Has Pockets of Opportunity
On this week's Stansberry Investor Hour, Dan and Corey welcome Martin "Marty" Fridson back to the show. Marty is an author and expert in the field of high-yield bond investing. He is also a senior analyst at Porter & Co.'s Distressed Investing newsletter.
Marty kicks off the show by discussing the top-down view of the high-yield market. He comments that right now, there is a very small risk premium. Marty breaks down the factors that he uses in his model of fair value and concludes that the high-yield market is extremely overvalued. At the same time, the market is forecasting a higher default rate than credit-ratings agency Moody's. Marty also gives his opinion on whether we'll see a recession, what it means that the inverted yield curve has not yet resulted in a recession, and why he's less critical of the Federal Reserve than other investors...
When people talk about policy errors, you have to keep in mind that Fed policy famously works with a lag... You have many variables, many of which aren't even known and which don't even necessarily act in a consistent way over time.
Next, Marty explains that the current situation of the federal-funds rate and the 10-year U.S. Treasury yield moving in opposite directions is not rare. He says it happens 40% of the time. This segues to a discussion about what's happening with the junk-bond market... including companies potentially having to roll over their debt to higher rates... and private credit lenders now competing with high-yield bond buyers. Marty then names which sectors present attractive buying opportunities today...
Currently, diversified financial services, energy, building materials, homebuilders and real estate, and utilities are all in that category of being cheap despite improving outlooks... Those are areas where you should generate some superior returns.
Finally, Marty goes further in depth about his quantitative model and what data it draws upon to find attractively priced distressed debt. He then explains that because high-yield bonds aren't very liquid, exchange-traded funds centered around these investments tend to have a lot of variance in performance. This can have serious consequences in times of extreme market disruption. As Marty says...
The underlying securities are less liquid. And particularly for an open-end mutual fund that faces daily redemptions, that could become a significant issue. It would take a very severe market disruption, sell-off, loss of liquidity, and so on before it really became material, but it is a possibility that the managers have to be conscious of and protect against.
Click here or on the image below to watch the video interview with Marty right now. For the full audio episode, click here.
(Additional past episodes are located here.)
Dan Ferris: Hello, and welcome to Stansberry Investor Hour. I'm Dan Ferris. I'm the editor of Extreme Value and the Ferris Report, both published by Stansberry Research.
Corey McLaughlin: And I'm Corry McLaughlin, editor of the Stansberry Daily Digest. Today we talk with legendary high-yield bond investor, Marty Fridson.
Dan Ferris: Yeah. Marty is an old friend and he is, how do we say, for decades now he's been known as the dean of high-yield investing. He's my go-to source about high-yield bonds and rates and bonds generally. So let's do it. Let's talk with Marty Fridson. Let's do it right now.
Corey McLaughlin: For the last 25 years, Dan Ferris has predicted nearly every financial and political crisis in America, including the collapse of Lehman Brothers in 2008 and the peak of the Nasdaq in 2021. Now he has a new major announcement about a crisis that could soon threaten the U.S. economy and can soon bankrupt millions of citizens. As he puts it, there is something happening in this country, something much bigger than you may yet realize and millions are about to be blindsided unless they take the right steps now.
Find out what's coming and how to protect your portfolio by going to www.americandarkday.com and sign up for his free report. The last time the U.S. economy looked like this, stocks didn't move for 16 years and many investors lost 80% of their wealth. Learn the steps you can take right away to protect and potentially grow your holdings many times over at www.americandarkday.com.
Dan Ferris: Marty, welcome back to the show. It's always good to see you.
Marty Fridson: Yeah. Great to be here. Nice to see you.
Dan Ferris: It's been a while. It's been four years since 2020, August of 2020 since you were here. A lots happened since then. The has turned upside down since then.
Marty Fridson: To say the least. Yep.
Dan Ferris: All right, Marty. I got a tweet for you. I just put this out less than an hour ago, and I put a link to the ICE BofA High Yield Index option-adjusted spread from the Federal Reserve educational website there. And it indicates that at 2.73, 273 basis points, that's the second lowest going back to September of 1997 and it was lower one month, May 2007, in all that time. Is that top down view of the high-yield world worth anything to you?
Marty Fridson: Well, it is very small risk premium by historical standards. More important is that if risk is below average then it makes sense for the risk premium to be below average. So what I do is to create a model of the fair value based on factors that historically have driven it and those are specifically credit availability, which is measured by the number reported by the Fed Senior Loan Officer Survey, the percentage of banks that are currently tightening credit minus the percentages that are using credit.
There are two economic indicators which are capacity utilization and industrial production and you might say, "Why not unemployment and GDP, the obvious ones?" I'd say, "Well, this is not Marty Fridson's idea of how the world ought to work. It's just empirically, based on the evidence, what has the strongest correlation." Then the default rate, which is a backward-looking number. So it's limited value, but it has some correlation. Then the five-year treasury yield, because the spread is inversely correlated with the underlying treasury yields.
And then finally you have a dummy variable for quantitative using because everything else, if the Fed is intervening in the long-term bond market, which is not currently doing, but if it is then that also has an effect on the market. But right now, as of month in, the spread was 183 basis points tighter than the fair value calculated by that model and the – that compares to a one standard deviation of 133 basis points. The point of all this being that it is – the high-yield market is extremely overvalued by these measures and that's been true since almost continuously since the middle of 2023.
Dan Ferris: OK. So we are at a historically extreme moment. Is there – what does a guy like you do? Are you just on vacation the whole time? What does a guy like you do at a time like this? Does that mean there's nothing to buy in high yield?
Marty Fridson: No, because the clients who use my high-yield research by and large have mandates that require them to be in the high-yield market. In other words, their end investors, pension plans, endowments, what have you, have said to them, "We want to have X percent of our portfolio in high yield. We'll make the asset allocation decision. Your job is to outperform the benchmark that's been assigned to you within that index."
So it's very important to say, "All right. If the high-yield market has a negative 5% return over the next 12 months," that's not a forecast, but just as an example. If it has a negative 5% return and we return zero we're heroes. So what we want from Marty Fridson is give us some advice on which industry sectors, which quality sectors. If we invest across regionally tell us whether emerging markets, whether European high-yield debt is relatively attractive right now and so forth. So there's always work to be done.
Dan Ferris: OK. It actually reminds me of somebody else who has dealt in this space named Howard Marks and me made the case in a similar way a couple years ago. I forget when it was exactly. He said, "Carefully we proceed and then it is what it is." That was what he said. It is what it is. So you got to do what you got to do. Is there – right now – so I would guess when spreads are tight, that tells me maybe – you tell me – that investors perceive the conditions, as we said, very sanguine, very safe.
Is there a danger, in your mind, that, for example, take a really important variable like default rates, what is the likelihood in your mind that people are really underestimating where default rates could be however far out means something to you, a year, six, 12 months farther?
Marty Fridson: Yeah. Another analysis I do suggests that the market is actually forecasting a slightly higher default rate than Moody's, which is one of several models. I think Moody's forecast based on a consensus forecast of the economy, let me say that their base case tends to be in line with some of the consensus economic forecast whether by design or elsewhere. The market, as tight as it is, is actually forecasting a slightly higher default rate because that forecast is a function of the percentage of issues in the high-yield index that are trading at distressed levels, which is at a very low level by historical standards currently about half of the median level. But nonetheless, when you're at a low percentage of issues trading at distressed levels, a fairly high percentage of them are expected to default.
In other words, the ones that are trading at distressed levels very much deserve to be there whereas there are times when you have – in the recession you have typically about 30% of all the issues trading at distressed levels, and a lot of them are there for technical reasons, not because they're really at a high risk of fault within 12 months. So I think the question you ask, the likelihood of the default rate being significantly higher than investors currently expect 12 months from now is really a function of economic surprises if it turns out to be that the economy – if we go into recession, which is very clearly not the consensus forecast right now, despite the fact that we've only recently come out of the longstanding inverted yield curve and all recessions have been predicted by an inverted yield curve.
In other words, the short-term rates being higher than the long-term rates, there have been some false signals that were not followed by recessions, but those were comparatively mild and short-lived inversions. Here we had an inversion that went on for two years, got to an extreme level. So far, no signs – well, depending. If you look at some forecasters they do find in the data indications that yes, we are headed still for a recession, but that's become a much less common view over the last few months and now with the Fed uneasing track, that view of things has become even less prominent.
Corey McLaughlin: Yeah. Marty, that was one of the questions I had for you. The inverted yield curve, I know you write about it. What do you make of the fact that we haven't had quote, unquote, an official recession after it's been inverted for two years? You could go back to 2022, early 2022 and say we had a technical recession two straight quarters. Does that matter to you? Just where do you see the economy in general going right now?
Marty Fridson: Yeah. I say I don't feel I have a special expertise in economic – macroeconomic forecasting. I follow the –
Dan Ferris: That's OK, Marty. Nobody does.
Marty Fridson: Yeah. Well, no. That's right.
Corey McLaughlin: Yeah. Doesn't seem [crosstalk]
Marty Fridson: So I of course follow with interest and I'm interested in insights that are provided by others about it. Right now I would say that it's – I think I actually once did a report. I didn't name the account that's involved, but I called one Dr. Glass Half Empty and one Dr. Glass Half Full and showed how in the exact same release on labor statistics at a time one was able to create a very negative picture and the other a very positive picture. So I take all that with a bit of a grain of salt, but I would say right now it's – I soften the view.
During the inversion of the yield curve I was emphasizing the fact that recessions haven't started until the yield curve ceased to be inverted. So the fact that it had gone on as an inversion for a long time wasn't an argument to say, "Well, this is for the first time ever a sign or that we won't have a recession following a sustained inverted yield curve," but there is always a first time, possibility of a first time. We may dodge the bullet.
Dan Ferris: Yeah. Everywhere I look among people who do seem they think they have an expertise in macroeconomic forecasting you just see over and over again it's pretty good consensus. No landing. Not even soft landing. Just no landing. There's no sign of a recession anywhere. So I love the confidence, and of course, most people make the opposite mistake. They'll say, "Well, I predicted nine of the last two recessions," or something.
And that – any kind of a consensus always worries me, but hey, nobody wants a recession, right? So I certainly hope they're all right. The reasons for it seem pretty good. Do you feel – I've heard again, this is like the economist thing that you described. People are black and white on this, both sides. Do you feel that the Fed has – they hiked too quickly or some people are saying they shouldn't be cutting now, et cetera. So which – do you come down on either side of that where you say, "Well, they hiked too quickly and they" – or are you more saying, "Well, no. They shouldn't be cutting so much"?
Marty Fridson: Well, I had an opportunity to present to Alan Greenspan on one occasion when he was Fed chairman. I told him that, "You've got the toughest job in the world because whatever you do, you're going to get critics on both sides." And they'll speak very adamantly about that and say in so many words that the Fed is really stupid or ill-informed. The ill-informed part is hard to believe because I've got to think that they've got the best information of anyone out there.
The point I think to keep in mind in that, when people talk about policy errors, you have to keep in mind that Fed policy famously works with a lag. Milton Friedman really emphasized this point. So when you say what is the impact, I know their analogy – well, the impact – it's hard to tell what the impact really was because other things happen. I like to make the analogy of one of the easiest jobs – taking nothing away from these people, but in a sense – in one sense an easy job is the guy who puts flooring in the swimming pool because the only thing you have to worry about is putting in too much or doing it at a time when the temperature is outside – the air temperature is outside the proper range.
If you get those two things right you will get the desired affect a million times in a row. I use that to contrast with the Fed's job where you have many variables, many of which aren't even known and which don't even necessarily act in a consistent way over time. So in that environment you're going to take a policy move with massive uncertainty. So I tend not to be critical of the fact. I genuinely believe they're doing the best job they can.
Really, I wrote about this comment after the Fed made it's half point cut on September 18. You had people saying – this is not at all to make a political statement on my part, but there were people, including one United States senator that I noticed saying, "Oh, the Fed was trying to put its hand on – thumb on the scale and tilt the election towards the incumbent party." And there's been this idea that always regardless of which the incumbent party is that the Fed is somehow always bias toward supporting the incumbent party.
And I really don't believe – certainly nothing that happened on September 18 was going to affect the real economy in time to sway the election. The result was that long-term interest rates went up and with them mortgage rates, which certainly wasn't a way to win votes to the incumbent party to cause mortgage rates to go up. So I tend to be on the side of saying I have confidence they're doing the best job they can. There may be mistakes in the sense with the benefit of hindsight largely, but no. So I don't really agree with others who say, "Well, they were too slow to stop raising rates, too fast, or too aggressive in lowering rates." It's just really hard to tell what the impact is going to be at a point in time.
Dan Ferris: Yeah.
Corey McLaughlin: One thing the long-term – one thing that 50-point cut did do is what you said, the longer-term yields rising. J. Powell, just yesterday as we're recording this, said he thought that was – it's more an indication of growth expectations and other factors than inflation expectations. I'm curious your thoughts on that and if how that – it's another macro question, but how that maybe impacts your how you go about trying to find opportunities weighing those factors as well, whether it's inflation, whether it's growth.
Marty Fridson: Yeah. Well, let me just say before I answer that directly, let me just say that the Fed funds rate change and the 10-year treasure yield going in opposite directions happens about 40% of the time on a month-over-month basis. There is a statistically significant bias toward them going in the same direction, but 40% of the time going the opposite direction suggests this is not wildly anomalous.
Corey McLaughlin: Unusual.
Marty Fridson: I think that hasn't been brought out enough. So it's interesting that he – Powell attributed it to growth expectations, and I hope that's right, that it really is a function of there's going to be growth there for a demand for capital and the cost of that capital going up and the market foreseeing that. I think there is – again, it's very hard to talk about this without sounding political about it, but if the president elect is serious about the extent of the tariffs he wants to impose, I have a hard time finding how that won't be inflationary.
He's argued that it won't be – I think there is some good commentary coming out now. I think your viewers can judge for themselves on that, but I think the record has been that those costs have been passed along to consumers. So I think that that is likely a factor in it, but again, Jerome Powell has a huge staff of economists working for him and I'm sure he has some good support for making that statement that is certainly going to be listened to and paid close attention paid to.
Dan Ferris: Yeah. It's a good point about the 10-year versus the short-term rates moving in different directions. I haven't heard anyone tell me that it was 40% of the time, which is not insignificant. You – yeah.
Corey McLaughlin: Almost 50.
Marty Fridson: [Crosstalk] you also asked how this would affect my analysis and rates going up certainly isn't helpful. The high-yield market and we talked about distressed bonds as well as a segment within the speculative grade or usually referred to by the president as junk bonds because that fits into the headlines more easily than high yield. But it's certainly not a help that companies could be faced with having to roll over their existing debt into higher rates.
Now the good news is that it's not the case as you sometimes might infer from reading the media coverage that all of the data is coming to in the next six months and the cost of debt is going to go up immediately by a hundred basis points. The reality is that companies do by and large manage their debt responsibly. They have their maturities spaced out. So if a chunk of it comes due and that's at a higher cost, their overall cost of debt doesn't go up by a whole lot because of that one piece of it coming to over a long period of time, many years, their rates would go up significantly.
That also suggests they have time to adjust for that such as reducing their amount of debt. Some of the leverage ratios went up during this period of very low rates, which again, some of the media tried to make a big case about it being very negative. The fact is the cost of that was lowered so companies could support larger components of debt in their capital structures. Now whether they will go and do the responsible thing as they see rates going up and lower their debt will matter on a case-by-case basis by the company and that will certainly be a factor that I look at.
I think the most important factor will be the availability of credit. One important development over just the last few years is the private credit lenders, funds that provided credit historically to small and medium sized companies have now been so successful they've raised so much money they've been able to go in and compete directly with the high-yield bond market and the syndicated loan market. And that – what they do in particular is offer more flexible terms.
They may get actually a premium rate for doing that, but they offer a lot of flexibility. They can act swiftly so crises can be averted at companies that suddenly run into a problem for what reason, whatever reason. They're also good at finding loopholes in the existing credit agreements that enable them to come and get ahead of the existing lenders and they're standing in the capital structure. That all works to the benefit of the issuers, not to the hires of high-yield bond necessarily, but will get some companies over humps that might otherwise result in them going as far as defaulting on their debt.
Dan Ferris: OK. So this is a good place to maybe transition a little bit from top-down thinking to bottom up. You mentioned that your model was indicating that bonds were, I think you said it was 183 basis points over fair value more than standard deviation.
Marty Fridson: Well, tighter than.
Dan Ferris: Tighter. Sorry. Tighter. So if that's your main selection criteria or it's presumably a very important one, it is what it is and you got clients to serve, what do you do? How do you proceed?
Marty Fridson: OK. Well, from the very bottom up we also have a model on security selection that is based on financial ratios. It's a proprietary model, but I myself would be skeptical of a black box thing. So we got TSG, also known as the Spalding Group, to attest to our back-tested results on this model. That firm is basically – the main business is validating the performance rector presented by asset managers who say, "Oh, we beat the index by so many basis points over a period of TSG confirms according to standards promulgated by the chart of Financial Analyst Institute that those performance numbers are accurate." So we got them to do a test for this model. So we provide that.
Currently there are 147 issues that are significantly undervalued again using a cutoff, and I apologize to anyone not too familiar with some of the statistical jargon, but those that are achieved by one standard deviation or more and that full list is available to the subscribers for Fridson Vision High Yield Strategy each month, each report, which comes out biweekly. Once a month we highlight a few issues to show that they're not just the bonds that are trading at normally wide spreads.
We have bonds that are trading at narrower spreads than even this very narrow spread of the index as a whole right now that still show up and significantly undervalued according to this model. Now moving up from that bottom, we do analysis based on sectors. So right now, for example, we look at industries and we evaluate them in two ways. The first way is how are they trading relative to their peer group within the 20 largest industries in the high-yield universe.
To do that we do something that I think is unique to my work because for a long time I struggled with the fact that, "Well, how can you say that one industry is cheap relative to the other based on the difference in their spreads when one is mostly double-B companies and one is mostly triple-C companies?" So I came up with a methodology and with the help of some very bright people in an internship program at the Masters of Quantitative Finance Program at Fordham University, which is a really excellent program.
My toughest thing is picking a candidate from the ones who applied because they're all so good. With their help I do that analysis where I equalize for the difference in ratings mix. Kind of a laborious process, but the upshot of that is that I can say this industry on a rating-for-rating basis is cheap or expensive relative to that peer group. Then the other thing I look at is what the rating agencies are saying about their rating outlook because for every high-yield issuer, Moody's, S&P, and Fitch have rating outlooks that are saying the rating is likely to be stable or improving or declining over a period, something like a year and a half.
They don't take that exclusively, but people figure that's about the time frame they're looking at. Currently there are five industries that are in the northwest quadrant of the graph that emerges from that, meaning that they're trading cheaper – cheap to their peer group, even though the rating agencies say their credit quality is improving, which is anomalous. Usually there are a couple of industries in that period because the market by and large agrees that these are improving or deteriorating industries.
Currently diversified financial services, energy, building materials, home builders and real estate, and utility are all in that category of being cheap despite improving outlooks. I think there's a thread through there of several of those of being interest rate related and investors may be shying away from those because they feel they'll be hurt by rising interest rates if that turns out to be the case. But those are areas where you should generate some superior returns.
Right now with spreads very tight there are not a lot of things that are out of line. One exception is that we would underweight emerging markets high-yield debt if you're, again, across regional investor. Europe is not out of line right now and we'll see a great opportunity in terms of the triple Cs as opposed to the double B's and single B's. It is interesting that although they're not cheap enough to be over weighted right now, you never had the double-B, single-B confined spread as narrow as it is with the triple C and lower spread as wide as it is and by a good margin.
What that says to me is that investors are saying, "We went through a long period where yields on bonds were so low we couldn't justify owning them." Thank goodness we can now get back to running something like a balanced portfolio, which is the prudent thing to do over time to have a mixture of equities which benefit from economic growth, bonds which give you protection on the downside in a recession. We'd like to have some reasonable mix between those so we can do that again. Well, we'll have to look the other way about the narrowness of the risk premiums because they aren't too good right now, but it's good to have bonds back in the portfolio.
That doesn't mean we're going to go crazy and buy those bottom tier triple C and lower rated bonds. We're going to stick to the so-called quality within the junk sectors, again, as the press likes to refer to it. So I think that is a really telling message about the current market and getting back to some of what you were talking about what investors think, what are they confident. They're not so confident that they want to buy the bonds that are at a serious risk of default. So bonds rated double B don't default, not while they're rated double B.
Few exceptions where there was a financial reporting fraud or something like that, but by in large the rating agencies despite a lot of criticism of them do get bonds down to at least the triple-C category, often double C, even lower than that before they go into default. So the fact that investors are shying away from triple C and lower rated bonds at present means that they're not as complacent about credit quality as might appear just from the raw spreads.
Dan Ferris: So my kneejerk reaction to that is I want to look at single B and triple C to see if there's a bargain in there somewhere. Is that a dangerous –
Marty Fridson: Well, my company bases. Yeah. They're certainly going to be. Again, it may turn out that way. The triple Ccs and lowers will outperform in a rally and in a period of spread tightening and they could get back to that all time low of 241 that you mentioned back in 2007. They're as today at 200 – the overall spread on the high-yield index that you mentioned is 273 basis points. So I would say the odds, I would think, are against rally. Now if spreads stay and yields stay roughly where they are, triple Cs will outperform simply because they have a higher yield.
So there are several scenarios you could draw. But within the triple-C category there are individual issues that are substantially undervalued right now and that often has to do with they performed poorly in a recent period. So we're not going to get into that one again even if we can present a strong fundamental case. It's just something we got burned on. We just don't want to touch that again for a while.
Dan Ferris: Right. So let me ask you this. If you look at something and your models and your selection and everything says, "Well, this spread is very tight, but we view it to be undervalued," what are those other variables? Are they quality variables about the business? What are they that sort of override the spread, if you will?
Marty Fridson: Yeah. Well, the model is a strictly quantitative model. I would say some people would be comfortable with that, but I would point out that the late Jim Simons performance record was twice as good as Warren Buffett's. That was done with purely quantitative nothing.
Dan Ferris: That's right.
Marty Fridson: He had a big team of PhDs working for him. So I wouldn't dismiss it out of hand as an approach.
Dan Ferris: Oh, no.
Marty Fridson: So that particular work is strictly quantitative and it's based purely on financial ratios. So numbers coming out of the income statements, balance sheets, cash flow statements of the companies. We have our own formula for that tested by what has worked. Again, that is proprietary. That's not the only work that I'm involved in. When it comes to looking at distressed credits in particular, those with spreads of a thousand basis points or more above treasuries and in some cases looking at companies in default that should come out of it with good recoveries for the bond holders who stand ahead of the shareholders and how the assets get distributed.
In that work, the statistics will only carry you so far. You really do have to get down into the nitty-gritty of the company's fundamentals, their operations. That can be a function of sometimes you have a company that looks pretty sketchy going out and having some big debt maturities coming out four or five years down the road and some real questions about whether they can make it. In the meantime, they have some debt coming due two years from now where they actually have enough cash on hand right now to cover that. Something could go drastically wrong over the next two years. So there's always risk.
If you get involved in these distressed issues you certainly want to spread your risk around and have a portfolio of these issues rather than put all your eggs in one basket. Surely although that's good advice in general in the market. So yes. You do get into other more qualitative factors.
Dan Ferris: OK. I just thought of a question that I'm sure our listeners will be very interested in. They're individual investors. They're buying stocks for their own accounts. Presumably they're not son of Marty Fridson and they don't high yield inside, upside down, and backwards. So a typical thing I'm sure many of them do when they want this exposure is they go to one of these two biggie TF's. The tickers are HYG and JNK. I wonder if I could say if you only had two or three things or one thing to tell them about those two ETFs by way of warning or recommendation or anything, what would you tell them about those?
Marty Fridson: Well, I think that you do get benefit of diversification. There are going to be some expenses associated with it. But I think come to think of it I should do more of a correlation with the indexes. This is great talking to people because my best ideas for studies come from these kind of conversations. I'm just not smart enough to come up with all the good ideas on my own. When I worked on Wall Street I used to make road trips to visit our institutional customers and on the plane back I would often, "I heard that same question in three different places on this trip. There are probably others wondering the same thing."
Then I would put out a study and I'd get feedback saying, "Wow. This is exactly the topic we were planning to discuss at our Monday morning meeting and you covered it." My hope was that my competitors didn't figure out my secret, which was actually listening to what the customers say. Heaven forbid you would do that.
Corey McLaughlin: Yeah. Talking to people.
Dan Ferris: Oh, yeah. It's on Wall Street.
Marty Fridson: But the other point I would make about the ETFs is that unlike an index – you can buy an index of the S&P 500 which will exactly replicate what is in that index. High-yield bonds are not anywhere near as liquid as the stocks that you see in the S&P 500, the large cap stock where there's at any given instance there's an active market. There are bids and offers above and below the market. You can get an immediate execution.
So it is possible for index managers or the ETF managers to precisely replicate what's in those indices. That's just not feasible in high yield. So there are always going to be a representation of what's in the index. They could do a pretty good approximation by the distribution by industry and quality and so forth. It won't exactly replicate it. So you are going to have some variance even prior to expenses between what that index will return and what the high-yield index. That could wind up being in a certain period a positive area. You do better for that reason.
Dan Ferris: Right. I saw a fellow do a presentation one time about – he was talking about how the sausage is made or whatever and he was talking about bond funds generally. Part of the argument he was making was that he had some concerns and one of them was, if I understood it right, basically you've got this highly liquid thing. I'm looking at these two ETFs while we're talking on the screen. That's what I'm looking at here while you're talking. They trade millions of shares. JNK just traded 3.4 million shares average volume. They're hugely liquid, but the underlying contents – the underlying contents of an S&P 500 fund is pretty liquid. It's highly liquid. This underlying contents is less liquid. I don't remember his whole argument, but I remember that being a concern and I'm wondering if that ever troubles you about these ETFs?
Marty Fridson: Yeah. No. It's an excellent point. It also points to another reason for variance between the ETF and the index performance, mainly that they have to buy and sell these securities where the index doesn't have to. There's no transaction cost and you can have fairly wide bid/ask spreads particularly on the lesser quality, smaller size issues. So the transactions that are required to maintain the mix within those portfolios will detract somewhat from the performance, but you're right.
The underlying securities are less liquid and particularly for an open-end mutual fund that faces daily redemptions, that could become a significant issue. It would take a very severe market disruption sell off, loss of liquidity and so on before it really became material, but it is a possibility that the managers have to be conscious of and protect against and not get too cute about it, let's say, about what they offer and cutting it too close where they don't have that cushion to account for that.
With ETFs there is a redemption and renewal process that is open to selected large investors where they can come and add – so it does enter into that process as well. I would say within a reasonably wide range of performance it's not going to become a practical issue. Like a lot of things in the market you have to think about what could happen under very extreme circumstances and be conscious of that factor.
Dan Ferris: OK. We actually – we're at the point where I want to ask you my final question, which you've answered it before. As always, I feel like we could sit here and pepper you for three hours because you're the expert's expert. This is something we don't normally discuss. For now I'll just give you my final question. This is for our listeners. So if you could – if you've already said the answer to the final question, just feel free to repeat it. That's no problem. The final question is always the same for every guest no matter what the topic. It's simply if you could leave our listeners with a single thought today, what would that be? What would you like it to be? Take your time.
Marty Fridson: Yeah. No. My one thought that I'd like to leave your listeners with is that you do have to take a long-term view. I know that's a cliché. Perhaps investors get tired of hearing it, but it really is true. The high-yield market is subject to fairly significant moves over short run periods in response to events that wind up not having a lot of real consequences over any extended period. It's very clear that if you try to time the market to that extent, absent a really major view about something that's going to be a multiyear trend in the market, which you may or may not be right about, but perhaps you could justify on the strength of very strong evidence.
Reacting to short-term developments, I've done work on this. I've shown very clearly that you subtract. Active managers wind up underperforming the index because of this very reason that they do try to outcast the market about these short-term moves. So things that look very important today, I think it's a good exercise to go back over some of those news reports and see a year later whether people are still talking about it, whether it really wound up making a difference.
So I think that's one of the most important things. It doesn't apply only to high yield, but given the swings because of the illiquidity we were talking about earlier, you can have swings that very definitely exaggerate the underlying significance of the event that triggered that move.
Dan Ferris: Timely advice. Many people said, "If so-and-so gets elected I'm going to sell it all," and they said it in 2016, in 2020, in 2024. It's the wrong thing every time. Great message. Thank you very much. Thanks for being here, Marty. It is always a great pleasure to speak with you.
Marty Fridson: Yeah. It's always fun being on the show and hope to be back again sooner than four years from now.
Dan Ferris: Sooner than four years. You have my word. Sooner than four years.
Corey McLaughlin: Yeah. Please. Yes.
Marty Fridson: Great.
Dan Ferris: All right. Throughout history gold has been the most secure, least volatile, most international, and least political form of money. When market uncertainty is high many investors look for save haven outlets including billionaire investors like hedge fund founder Ray Dalio and John Paulson, who have recently loaded up on gold. After climbing past $2,700 an ounce, we can see gold reach as high as $3,000 an ounce by the end of 2025 or higher.
Find out the best strategies for investing in gold when you go to www.2025GoldSurge.com and sign up for our free report. You'll discover the easiest ways to buy gold before it rallies and the number one pick for this current gold bull run from our analyst team. Learn more and get your free report at www.2025GoldSurge.com.
All right. It's always great to hear from our old friend and previous podcast guest, Marty Fridson. What a smart guy, huh? I always feel like he's one of the people we could talk to for three hours and it would be really compelling.
Corey McLaughlin: I agree. Yeah. We could have talked a lot more about – and maybe we will in another episode about everything he knows about high-yield bond investing and he's the dean, right? He was referred to as the dean in high-yield bond investing and that was 25 years ago when I believe he got that nickname. Yeah. I could learn a lot from him, personally.
Dan Ferris: Yeah. We didn't even talk about really much about picking stocks, which he's got a book. He's got one of the Little Book series and it's The Little Book of How to Pick Top Stocks, I think it's called. We could probably do a whole show on equities with him, too. So it's really great. He's a huge – he's like a huge finance intellect, but a really down-to-earth guy who's just a lot of fun to talk to as well. I'm so glad we could find that combination.
Corey McLaughlin: Yeah. Right. The farthest from braggadocio you could find. Super nice guy. Down to earth. Realizes that he obviously knows a lot but isn't going to say that he knows everything of what's going to happen in the future. So I think that alone is a great attitude to have. I was interested – I'm glad when I asked about the longer-term treasury rates going higher, his comment about how it's not totally unusual that they are and that he hopes it's the case that it's for growth, as Powell said last week, and not inflation.
Dan Ferris: Yeah. What'd he say? Like 40% of the time is pretty normal for what's happening.
Corey McLaughlin: Yeah. Forty percent of the time, which I agree. I hadn't heard anybody say that and people I've been following. So interesting.
Dan Ferris: Yeah. It's similar to when people talk about VIX versus the S&P 500 and then you learn that 20% of the time they go the same direction. So it's not always what you think, but yeah. Great guy. Head full of data. Head full of brilliant insights about – from the top down and the bottom up of high-yield bonds and rates generally. Just I think I'll stop trying to say how wonderful he is and just say how grateful I am that he was here because if you listen to the interview you know what I'm saying. Can't wait to have him back and it definitely, I promise you, everyone, it will not, absolutely not be four years. I'm hoping it'll be six to 12 months that we can get him back in here and ask him what he's doing.
All right. That's another interview and that's another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as we did. We do provide a transcript for every episode. Just go to www.InvestorHour.com. Click on the episode you want, scroll all the way down, click on the word Transcript and enjoy. If you like this episode and know anybody else who might like it, tell them to check it out on their podcast app or at InvestorHour.com, please. And also, do me a favor, subscribe to the show on iTunes, Google Play, or where ever you listen to podcasts.
While you're there help us grow with a rate and a review. Follow us on Facebook and Instagram. Our handle is @InvestorHour. On Twitter our handle is @Investor_Hour. Have a guest you want us to interview? Drop us a note at Feedback@InvestorHour.com or call our listener feedback line, 800-381-2357. Tell us what's on your mind and hear your voice on the show. For my co-host, Corey McLaughlin, until next week. I'm Dan Ferris. Thanks for listening.
Announcer: Thank you for listening to this episode of the Stansberry Investor Hour. To access today's notes and receive notice of upcoming episodes go to InvestorHour.com and enter your e-mail. Have a question for Dan? Send him an e-mail, Feedback@InvestorHour.com. This broadcast is for entertainment purposes only and should not be considered personalized investment advice. Trading stocks and all other financial instruments involves risk. You should not make any investment decision based solely on what you hear. Stansberry Investor Hour is produced by Stansberry Research and is copyrighted by the Stansberry Radio Network.
Opinions expressed on this program are solely those of the contributor and do not necessarily reflect the opinions of Stansberry Research, its parent company, or affiliates. You should not treat any opinion expressed on this program as a specific inducement to make a particular investment or follow a familiar strategy, but only as an expression of opinion. Neither Stansberry Research nor its parent company or affiliates warrant the completeness or accuracy of information expressed on this program and it should not be relied upon itself. Stansberry Research, its affiliates and subsidiaries, are not under any obligation to update or correction any information provided on this program.
The statements and opinions expressed on this program are subject to change without notice. No part of the contributor's compensation from Stansberry Research is related to the specific opinions they express. Past performance is not indicative of future results. Stansberry Research does not guarantee any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment discussed on this program. Strategies or investments discussed my fluctuate in price or value. Investors may get back less than invested. Investments or strategies mentioned on this program may not be suitable for you.
This material does not take into account a particular investment objective, financial situation, or needs and is not intended as a recommendation that is appropriate for you. You must make an independent decision regarding investments or strategies mentioned on this program. Before acting on information on the program, you should consider whether it is suitable for your particular circumstances and strongly consider seeking advice from your own financial or investment advisor.
[End of Audio]