Speaker 1: Our guest is James Zabante, Managing director and chief investment
Speaker 1: officer at Center Asset Management. So it's good to remind
Speaker 1: listeners here, James, it's pushing pull in the markets. On
Speaker 1: the one side, the negative side, the yield curve deeply
Speaker 1: inverted another week manufacturing report. On the other it's the
Speaker 1: picture that the stock market is seeing peak inflation, peak
Speaker 1: fed hawkishness, better earnings, and at least at the moment,
Speaker 1: fewer recession concerns. It's a sort of crystallized conversation like
Speaker 1: Morgan Stanley on one side, JP Morgan on the other, Uh,
Speaker 1: how do you see it? Do you do you see
Speaker 1: a muddling through option? It's possible if we're able to
Speaker 1: avoid a severe recession. And you know, the real question
Speaker 1: we all have to ask ourselves is to the stock
Speaker 1: market bottom in June or is this just a bear
Speaker 1: market rally again? I think it remains to be seen
Speaker 1: whether or not the recession, which likely began in the
Speaker 1: first quarter of two thous in twenty two, um, you know,
Speaker 1: is going to have the depth that past recessions have had.
Speaker 1: But I think one thing that is very important to
Speaker 1: point out is people's belief that the FED. You know,
Speaker 1: I think always said that one of the most dangerous
Speaker 1: statements is don't fight the FED, and that the FED
Speaker 1: easing is omnipotent. The problem is that it's an asymmetrical meaning,
Speaker 1: meaning that it's good advice to temper bullishness when the
Speaker 1: feed is tightening, but not very good advice to get
Speaker 1: bullish when the feed is easing. We're simply done raising
Speaker 1: rates due to the lag of impact the FED policy.
Speaker 1: I mean, some of the worst market drawdouns have occurred
Speaker 1: when the FED is easing and lowering rates two thousand
Speaker 1: and eight, two thousand nine, two thousand one, two tho
Speaker 1: two being examples. Alright, So given all of that, James
Speaker 1: David here by the way, I mean, it's hard also
Speaker 1: not to be invested. I guess if the even if
Speaker 1: the assumption is even the closest extreme, the most extreme,
Speaker 1: say recession on had perhaps with that exception, where do
Speaker 1: you want to be exposed? Is right now in his equity,
Speaker 1: where do you want to accumulate? We remain, you know,
Speaker 1: fully invested. However, I mean, one of the gifts I
Speaker 1: think has been that we saw the vics fall below
Speaker 1: that psychological level of twenty last week and today it
Speaker 1: closed at or near that level. You know, we frequently
Speaker 1: employed tailheages protected put options on our American funds, and
Speaker 1: last week we actually reintroduced them on the entire notional
Speaker 1: value of our underlying stockholdings. You know, I always say
Speaker 1: it's you buy flood insurance when it's sunny outside, and
Speaker 1: we continue to feel that the year two thousand, two
Speaker 1: thousand two analog is the most appropriate. And when you
Speaker 1: look at back at that period, there were three episodes
Speaker 1: of fall two thousand, summer of two thousand one, and
Speaker 1: late spring two thousand two, and the vics fell blow twenty,
Speaker 1: but the market thereafter fell the new load sometimes sharply.
Speaker 1: So we're staying fully invested, but protected against that kind
Speaker 1: of trapdoor risk off draw down episode like we saw
Speaker 1: back in July two thousand and two and other moments
Speaker 1: in time. I wanted to pick up when the last
Speaker 1: thought you ended on in terms of the downside protection
Speaker 1: UH might be valuable for a lot of people out there.
Speaker 1: I'm just looking at price SMP up and give us
Speaker 1: a sense of how expensive protection is right now and
Speaker 1: where you want to protect yourself at what level? Well,
Speaker 1: I think you want to protect yourself for a deep
Speaker 1: drawn down. I mean right now, you could get almost
Speaker 1: out of the money put options on an SMP five
Speaker 1: hundred with six month maturity for essentially one of the
Speaker 1: net asset value of underlying holdings, which is very attractive. Again,
Speaker 1: you know, using the analog that you want to buy
Speaker 1: flood inshirts when it's sunny outside. When volatility is at
Speaker 1: these levels, that is the opportune time to hedge if
Speaker 1: you feel that indeed there is the potential for those
Speaker 1: kind of trapdoor environments. Uh uh in terms of draw
Speaker 1: down on the horizon. So again, I think that's how
Speaker 1: you want to basically use opportunity. But that being said,
Speaker 1: I'm of the belief that volatility is in a new
Speaker 1: regime um in that sense, meaning that the historical trigger
Speaker 1: to potentially loosen or sell options is when the VIX
Speaker 1: has reached thirty five over normal market cycles, I think, uh,
Speaker 1: I think forty five is the new thirty five. And
Speaker 1: in terms of you know, downside, you know twenty five
Speaker 1: is the new twenty to a certain degree. But this
Speaker 1: has been I think a technical rally within a bear
Speaker 1: market that has provided an opportunity for risk a wear
Speaker 1: strategies like ours to be able to use hedges while
Speaker 1: still maintaining a fully invested posture. It seems hard to
Speaker 1: believe that this FED wants to to do what Vulcar did.
Speaker 1: They seem to be a bit more dovish than you know,
Speaker 1: what Vulcar eventually had to be. Uh. Is it possible
Speaker 1: that the Fed is already less aggressive because we are
Speaker 1: the market is already talking about fifty to seventy five,
Speaker 1: not seventy to d This Fed cannot be vulcar ish. Um,
Speaker 1: it's impossible because you know the amount of interest paid
Speaker 1: on the national debt it was you know, five sixty
Speaker 1: billion or so dollars last year including government transfers. Um.
Speaker 1: You know that alone is of what income taxes were
Speaker 1: for the fiscal year two thousand twenty one. But the
Speaker 1: you know, the the average indust rate paid on the
Speaker 1: debt in two one was one and a half percent.
Speaker 1: So if the FED actually genuinely wanted to be Vulcar
Speaker 1: risk in terms of what it wanted to do with
Speaker 1: indust rates and get near the CPI level or even
Speaker 1: near the PC level, it would simply crowd out all
Speaker 1: other spending. And there there is no appetite to basically
Speaker 1: reduce defense spending, medicare spending, or anything else or blow
Speaker 1: out the budget at this point in time. Yeah, that
Speaker 1: that's very right, dal Real on the ideal side, Um,
Speaker 1: did local get too much credit? I mean it was
Speaker 1: a deep recession, millions of people tossed out of work. Yeah,
Speaker 1: I mean he crushed inflation. And some people say that
Speaker 1: it ushered in decades of steady growth and low inflation.
Speaker 1: But didn't globalization and technology play even a bigger role
Speaker 1: in that? I agree? People forget you know, farmers, um,
Speaker 1: you know, coming with mass tractor demonstrations in Washington, d C.
Speaker 1: In the early nineteen eighties. Uh, factories of car factories
Speaker 1: just shutting down because of the you know, the uneconomic
Speaker 1: environment from industrates, housing markets is simply collapsing. You know,
Speaker 1: everything always looks nicer when you look back in history,
Speaker 1: you know, whether it's a deep recession or going to
Speaker 1: basic training. I mean, these are things that you know,
Speaker 1: people always have to look back on. And at some point,
Speaker 1: and Elizabeth Warren had a editorial in the Wall Street
Speaker 1: Journal talking about this very fact. At what point do
Speaker 1: we sit here and say do we want to you know,
Speaker 1: basically destroyed growth for the benefit of inflation. UM. You know,
Speaker 1: it's solely basically take into consideration mistakes that have may
Speaker 1: have been made in the past by the FED to rectify.
Speaker 1: So that takes us into the almost the core question.
Speaker 1: I mean, is a recession necessary or how do you
Speaker 1: define what might be necessary? Let's put it that away,
Speaker 1: because I don't want to get stuck into the concept
Speaker 1: of a recession, because technically, I mean, let's call it
Speaker 1: spade a spade. It was two quarters of contraction, wasn't it.
Speaker 1: That's right? And but the trend is continuing down. And
Speaker 1: if you look at forecasting mechanisms like E C R, EYES,
Speaker 1: leading indicators, the I S, m UM, they're all pointing
Speaker 1: to recession. That we're already in the recession and it's
Speaker 1: potentially going to be getting deeper. And if you start
Speaker 1: to look at the things that you know are eminent
Speaker 1: from a recession, profit marchin compression, UM, layoffs and others,
Speaker 1: I think we're probably one or two quarters away from
Speaker 1: that happening. I think the one thing that could be
Speaker 1: the saving grace is that UM and what could allow
Speaker 1: quick exit from recession is the low level of tangible
Speaker 1: capital investment this ycle, which historically has been an overhang
Speaker 1: on top of the elevated inventories. This cycle, most of
Speaker 1: the excess and excess investment went into intangibles which simply
Speaker 1: go up and smoke, leaving losses, you know, but little
Speaker 1: excess capacity, so that you know, n f t of
Speaker 1: a monkey is probably not going to sit there and
Speaker 1: be excess capacity at some point in the future. Okay,
Speaker 1: I said, I wanted to bring it around to China. Um,
Speaker 1: we have very very low confidence in consumers now and
Speaker 1: housing crisis, and you know, there's a lot of policy
Speaker 1: involved in this. I raised the the notion of it
Speaker 1: being an own goal in our conference call earlier, and
Speaker 1: I mentioned that just before the break. What do you
Speaker 1: think I mean, should we read that China's weakness is
Speaker 1: mostly self inflicted and maybe doesn't spread as much to
Speaker 1: the outside world as something I think it needs to
Speaker 1: be monitored very closely, because the real estate market, which
Speaker 1: is really the source of the problems, needs to be
Speaker 1: monitored because it's a key component of internal growth, particularly
Speaker 1: as you know, the reopening UH and easing of travel restrictions.
Speaker 1: Although pointing positively, you're not in strong enough direction to
Speaker 1: overwhelm what's happening in real estate, and from that perspective,
Speaker 1: you know, the FED should really be sending gift baskets
Speaker 1: to the PBOC in China, which has helped to do
Speaker 1: its own job in depressing commodity prices and input costs. Um.
Speaker 1: So we're gonna have to wait and see though if
Speaker 1: lowering rates and the the sharp move downward in the
Speaker 1: all shore land is something that you know, does trigger
Speaker 1: a more risk averse move by Chinese investors, both in
Speaker 1: real property and in the stock market. So at the
Speaker 1: end of the day, though this is positive and helping
Speaker 1: the FED, but from a global perspective in terms of growth,
Speaker 1: is definitely something that needs closely looked at and simply
Speaker 1: from an asset allocator perspective, And I guess this really
Speaker 1: also depends on what your mandate is a fund manager.
Speaker 1: I mean, just generally, what do you think about the
Speaker 1: pricing and this Chinese market, will equity market almost distressed
Speaker 1: credit market, don't get me started, right, I mean, is
Speaker 1: there is there's almost an opportunity of a lifetime here
Speaker 1: if you believe, of course, China will eventually get itself
Speaker 1: out of this. You know, one of the things that
Speaker 1: we've been doing. And we do have a global list
Speaker 1: and infrastructure strategy, and we have been actually adding to
Speaker 1: various Chinese stocks Ali Baba on the just pure you know,
Speaker 1: valuation perspective and turnaround. But I think most of the
Speaker 1: opportunities in some of the real assets sectors, utilities, water
Speaker 1: and other things are things that one needs to potentially
Speaker 1: at least if you're gaining a foothold in China, where
Speaker 1: you want to go first because very strong dividends. And
Speaker 1: I guess if we could go back to you know,
Speaker 1: how quickly is the US economy decelerating? I think even
Speaker 1: the stock market acknowledges a slowdown, but they're thinking slow down,
Speaker 1: not recession. How how quickly do you think the downward pushes?
Speaker 1: There's the real issue, And with regard to the market
Speaker 1: is um you know, will the aggregate drop in revenue
Speaker 1: and profits overwhelmed the benefits of potentially lower interest rates
Speaker 1: or the FED is simply easing up on tightening, and
Speaker 1: I think you always have to step back. You know.
Speaker 1: Remember in terms of evaluation of the market, the PE
Speaker 1: ratio is a function of interest rates or the lower
Speaker 1: the better and growth the higher. The better. Um, you know,
Speaker 1: lower declining growth can overwhelm you know, interest rates. And
Speaker 1: we still think that you know, the peak and the
Speaker 1: market back in January two thwenty two. You know, in
Speaker 1: terms of evaluation measures, that that exceeded the extreme speck
Speaker 1: in two thousand. It's not going to simply end in
Speaker 1: a whimper. And uh, we're gonna likely see a significant
Speaker 1: D rating forward. And only if we're able to have
Speaker 1: a very quick reversal over sssionary conditions will that potentially
Speaker 1: not occur and we could essentially achieve you know, the
Speaker 1: elusive soft lending that no central bank in the world
Speaker 1: has really ever been able to accomplish. Yeah, I think
Speaker 1: we gotta go. David. Fortunately, good solution here with James.
Speaker 1: James Abatti, thank you very much, Managing director and chief
Speaker 1: investment Officer at the Center Asset Management