AI Financing Is an Arms Race, Says GoldenTree's Tananbaum

Key Concepts

• Total Return Credit: An investment strategy focused on generating both income (yield) and capital appreciation within credit markets.
• Distressed Debt: Debt of companies experiencing financial difficulty, often trading at significant discounts.
• Illiquidity Premium: The additional return expected for investing in assets that cannot be easily sold or converted to cash without a significant impact on price.
• Mid-Cycle Dynamics: The phase of an economic cycle characterized by moderate growth and stretched valuations, where credit returns often underperform equities.
• Disintermediation: The removal of intermediaries in a supply chain or industry, often caused by technological shifts (e.g., newspapers being replaced by digital media).
• Technical Factors: Market conditions related to supply and demand, liquidity, and trading flows rather than fundamental business performance.

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1. Market Perspective and Strategy

Steven Tannenbaum emphasizes that credit markets are currently highly competitive and frustrating for managers. Because equities have participated significantly in market rallies while credit has languished in the low single digits, investors are feeling anxious.

• The "Movie" Framework: Tannenbaum views investments as "short movies." He analyzes the premise of a trade by asking: "If this happens, who will I sell this to, and why will they buy it?" This involves predicting market liquidity and understanding the mindset of other participants.
• Liquidity Management: During crises (like COVID-19), Tannenbaum notes that many funds sell their most liquid assets first. He advocates for selling semi-liquid products early, as they may become impossible to exit if market conditions deteriorate further.

2. Current Positioning in Credit

Tannenbaum maintains a cautious stance on credit for the remainder of the year, noting that the current environment is historically difficult for the asset class.

• Valuation Mismatch: Credit is currently priced as if defaults will remain low and corporate earnings will be stable. Investors are not being compensated for the risk of earnings disappointments, whereas the equity market still rewards positive earnings surprises.
• The "Higher for Longer" Thesis: Tannenbaum believes inflation remains the biggest market risk. He argues that the market is underestimating the duration of high oil prices, noting that mid-cap oil companies and suppliers are pricing in $70–$75 oil, suggesting a cynical view that current price levels won't last. He views this as a potential opportunity.

3. Sector-Specific Opportunities

• Cable and Telecom: Tannenbaum identifies a disconnect between public equity valuations (hitting 52-week lows for companies like Comcast and Charter) and their debt. He views the debt of these companies as potentially attractive compared to the equity.
• Healthcare: He highlights companies like Tenet as offering reasonable value, noting that credit markets could theoretically finance the entire market cap of such firms, providing a safety floor.
• AI Infrastructure: While acknowledging the "arms race" in AI, Tannenbaum is wary of over-investment, comparing it to the historical failure of undersea cable projects. He remains "agnostic" but deliberate, looking for assurances from users committed to these projects.

4. Private Credit and Asset-Backed Securities

Tannenbaum finds the best value currently in private asset-backed securities.

• Market Dynamics: With "anxious" capital (open-ended private credit funds) exiting the market, more deliberate players are finding better entry points.
• Illiquidity Premium: He estimates the current illiquidity premium at a "six or six and a half out of ten," suggesting it is above average but not extreme.

5. Methodologies and Frameworks

• The "Disintermediation" Lens: To evaluate the long-term viability of industries (like software or AI), Tannenbaum uses a historical framework of media evolution. He tracks how industries like radio and newspapers moved from nominal growth to marginal status as they were disintermediated.
• Nimbleness: Tannenbaum argues that in less liquid instruments, one must assume they cannot be nimble. Therefore, the focus must be on asking the right questions and focusing on key variables rather than trying to trade in and out of positions.

6. Notable Quotes

• "If you're thinking of investments as maybe as short movies and how's a movie going to end? And if your premise is if this happens and this happens can I sell Who am I going to sell it to? And why are they going to buy it?"
• "Lower prices brings in illiquidity, higher prices brings in confidence."
• "History would have a bad record in terms of over-investment for industries that have very high payouts, whether it's riverboat gambling to something like undersea cable."

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Synthesis and Conclusion

The main takeaway is that the current market environment is a "mid-cycle" phase characterized by stretched valuations and narrow opportunities. Tannenbaum advocates for a deliberate, eclectic approach—avoiding the "frustration" of broad credit indices by focusing on specific, out-of-favor sectors (like mid-cap oil or specific cable/healthcare debt) and private credit. He warns against the "arms race" mentality in AI infrastructure, suggesting that while the short-term yields may be attractive, the long-term precedent for such massive capital expenditure is poor. Success, in his view, comes from understanding the "why" behind buyer behavior and maintaining a long-term, skeptical perspective on market consensus.