Morningstar - Fall 2019 - 57

continuing to play. The Fed, and other central
banks, gave us some signs that they want to keep
the music playing going forward.
But we should remember that the people who
work at the Fed, and the Bank of England, and the
European Central Bank-they're just people.
Their analysis isn't necessarily any more valid than
the analysis that goes on anywhere else, given
how quickly data travels these days. It's not
like it was in the 1980s, when people who were
insiders to the Fed got information that really
made a difference.
The Fed can't get this inflation thing right. They
can't figure out how to get inflation going,
and I would argue that if we do get inflation
going, they won't know how to stop it. This is not
a science at the end of the day. What we're
seeing here is just people grasping psychologically
to keep the optimism going, because
that's where you make 7% returns in high yield.
Bush: Sonali, you've said that "late cycle" doesn't
mean "end cycle." How do you tell when to worry?

Sonali Pier: The U.S. expansion will reach
10 years in July. If we look at it from a length
perspective, it certainly stands out. But if
we look at it from a cumulative growth perspective,
we're actually below some of the larger
expansions historically. And we're not seeing the
signs of overheating in specific segments
of the market, as we did before the great financial
crisis. While it makes sense to be concerned,
that doesn't mean that the expansion
couldn't go on for a few more years, with bouts
of volatility along the way.
Bush: Mike, you've talked about political risks.

Mike Collins: To Laird's point, the markets have
talked themselves into this Goldilocks environment: moderate growth; really moderate, if not low,
inflation; and easy central bank policies. And
accordingly, things are starting to price that way.

If we're in this nirvana for an extended period,
then equity multiples can go up another turn
or two and high-yield spreads can probably tighten
another 50, 100 basis points. Even investmentgrade corporate spreads can grind tighter. The
problem is, when you start pricing in nirvana, you

[W]ith the advent of ETFs ... forced selling
might be even more extreme.
Mike Collins

better watch out. Things will come out of the blue
to surprise you. And sure enough, in the last
couple days, we've had the North Koreans lobbing
missiles, and we're sending battleships to Iran.
And, of course, the trade wars are heating up with
China. We're always very skeptical about the
Goldilocks/nirvana framework, because it can be
disrupted really quickly. Keeping powder dry in
a low-vol, tight-spread, high-valuation environment
is the right thing to do.

2007 Revisited?
Bush: Laird, when you were in our offices a couple

of months ago, you said that some things are starting
to feel like 2007.

Landmann: It's the rating agencies taking a pass
on leverage. IBM IBM increased their leverage
considerably with the Red Hat deal, and they only
got a one-notch downgrade for it. In past
cycles, they would have gotten much more
extreme treatment. That's what 2007 was all about,
but with subprime. It was a different type of
debt cycle, but it was accommodated by the same
agents who make money by getting this debt
issued. They don't own the risk of the debt. The
risk goes to us and, via us, to you.

You had the PetSmart/Chewy CHWY forced tender
recently, where bondholders are having their
rights taken away. We've seen ABS [asset-backed
securities] deals, where people are taking
defaulted consumer loans and resecuritizing them

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Morningstar - Fall 2019

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