Moneybeat: Crowding out

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MARY REICHARD, HOST: Coming up next on The World and Everything in It: The Monday Moneybeat.

NICK EICHER, HOST: Time now to talk business, markets, and the economy with financial analyst and advisor David Bahnsen. David heads up the wealth management firm, the Bahnsen Group, and he is here now. Good morning, David.

DAVID BAHNSEN: Well, good morning, Nick. Good to be with you.

EICHER: Well, David, last week we talked about rising long-term interest rates, and you argued that federal debt was not the explanation for the recent spike in Treasury yields, pointing instead to the enormous amount of borrowing by big tech companies that are now doing the big AI buildout.

And then, in the course of answering that question, you promised a deeper dive Dividend Café on that topic. It came out on Friday.

We’ll link to it in the episode notes, but David, as I read it, something caught my attention. You argue in the Dividend Café that borrowing is already crowding out other borrowers, even though the productivity gains that might justify that crowding out are still unproven. So, where do you see that crowding out effect showing up elsewhere in the economy, where are you seeing it?

BAHNSEN: Well, the issue I think you’re bringing up is more about what it’s done to bond yields. To that, the AI hyperscaler story has now put out, let’s call it, $200 billion of debt this year at the longer end of the curve. All these new loans and bonds, but there’s no commensurate $200 billion increase above and beyond what was already there in terms of appetite for debt.

There’s a certain amount of market force activity that’s organic and natural. It is not necessarily a negative in the way the governmental crowding out is inherently negative, but in the short term, it’s just a tautology to say that there is not 200 billion new dollars in planet Earth, and yet 200 billion, which is a lot of money, went into debt for AI companies, which means it didn’t go into something else, and every day, projects and investments are competing for investor dollars, and capital has a way of migrating to its most rational use. There’s nothing wrong with this, but when you get a big excess of investment in one area, and it means something else was underinvested. Historically, we’ve seen that leave a hangover.

My favorite example was in the dot-com moment with all the silliness of dollars that ended up getting set on fire with some of the internet companies. We were very underinvested in biotech and healthcare, life sciences, they weren’t attracting capital to go make new drugs and treatments, and so they ended up having to do all these kind of inefficient mergers to compete, and then all of a sudden you had a resurgence later when new capital could come into it. three or four years after the dot-com meltdown.

Right now, we can talk about the dollars going into AI, but we can’t talk about the dollars not going into something else because it’s invisible until later. But it is something I’m paying attention to because historically you have to.

EICHER: Well, David, interestingly, there was a piece over the weekend in the Wall Street Journal about stocks of smaller companies having fallen for five straight weeks, and one reason the journal said is this rising cost of borrowing you’ve just described, and maybe that’s an example of the crowding out that you’re talking about. Smaller businesses often depend on loans, not equity.

Higher interest rates can make it a lot harder for them to expand or even refinance existing debts, but in that Dividend Café again, you’re pointing out something curious to me.

The big stock market indexes still look relatively healthy, mostly because of this handful of giant tech companies holding up so well. And you pointed to an irony that these tech companies are helping to push interest rates higher with all their borrowing, yet investors seem to regard those stocks as the safer place to put money than stocks in other businesses. So why do investors seem to think these tech companies won’t be hurt by higher interest rates that they are helping to create?

BAHNSEN: Well, they don’t think they’ll be hurt by higher interest rates, and they don’t think they’ll be hurt by anything, and that’s the bigger risk is that there’s always a parking lot. There’s this thing we call Tina. There is no alternative where what’s the default place people go to with money and treasury bills. In the ’70s it was gold, the money markets and cash. There’s various safe havens people will go and they go look stuff seems overvalued. Something seems wrong. What have you.

Bond yields are putting downward pressure on valuations, and yet right now there. And the reason to answer your question is because for a few years it hasn’t, and there’s trillions of new dollars that have come in. So this particular class of investor, in their own lived experience, doesn’t know any better. But they will find out, my friend, and they will not like the lesson they find out.

But the notion of treating risk assets that trade at 20, 30, 40 times earnings-that they’re just a sort of safe haven to hang out in while you look for something else is one of the greatest signs you will ever see of complacency in capital markets of an apathy about risk and it is unfortunately how people end up getting burned flying way too close to the sun.

EICHER: Well, David, I want to make a radical shift here. I’d like to talk about the war in Iran and the effect on energy prices because I’m seeing reporting that crude oil shipments through the strait largely have recovered, but there’s still a very serious problem sourcing diesel fuel because refineries and other parts of that fuel supply system have been damaged or disrupted, and we see reporting the Trump administration has arranged a deal with Russia to bring in diesel after temporarily easing some sanctions as the trade. So help us understand why this has been judged necessary? If crude oil is moving again, why is it that diesel is still in such short supply that the U.S. would make a deal like this with an adversary like Russia?

BAHNSEN: Because when people talk about crude moving again, they’re not talking about the unbelievable cost right now for transport and insurance. That even though there is ability now to move some of it for now at this time, there’s also vulnerability about how long that will last.

But the refined products are not able to participate, and diesel is a finished product, and so to the extent that you have significant constraint about refined product flows, I think it’s still less than 20% of pre-war levels, and so that’s the issue is that you can get crude out, but the refiner cost, those spreads, the insurance, the shipping—it’s an entire bottleneck supply chain story nowhere near resolved.

EICHER: All right, David Bahnsen, founder, managing partner, and chief investment officer of the Bahnsen Group. David writes weekly at dividendcafe.com, and for WORLD Opinions, we have links to David’s latest Dividend Café we referred to earlier, and some of the reporting that we discussed today. Just tap the episode headline in your podcast player to open the episode notes. You’ll find those links there if you’d like to dig a little deeper. David, thank you. We’ll talk next time.

BAHNSEN: Thanks so much, Nick.

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