WEBVTT - James Abate on the Markets (Audio)

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<v Speaker 1>Our guest is James Zabante, Managing director and chief investment

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<v Speaker 1>officer at Center Asset Management. So it's good to remind

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<v Speaker 1>listeners here, James, it's pushing pull in the markets. On

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<v Speaker 1>the one side, the negative side, the yield curve deeply

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<v Speaker 1>inverted another week manufacturing report. On the other it's the

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<v Speaker 1>picture that the stock market is seeing peak inflation, peak

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<v Speaker 1>fed hawkishness, better earnings, and at least at the moment,

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<v Speaker 1>fewer recession concerns. It's a sort of crystallized conversation like

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<v Speaker 1>Morgan Stanley on one side, JP Morgan on the other, Uh,

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<v Speaker 1>how do you see it? Do you do you see

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<v Speaker 1>a muddling through option? It's possible if we're able to

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<v Speaker 1>avoid a severe recession. And you know, the real question

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<v Speaker 1>we all have to ask ourselves is to the stock

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<v Speaker 1>market bottom in June or is this just a bear

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<v Speaker 1>market rally again? I think it remains to be seen

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<v Speaker 1>whether or not the recession, which likely began in the

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<v Speaker 1>first quarter of two thous in twenty two, um, you know,

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<v Speaker 1>is going to have the depth that past recessions have had.

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<v Speaker 1>But I think one thing that is very important to

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<v Speaker 1>point out is people's belief that the FED. You know,

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<v Speaker 1>I think always said that one of the most dangerous

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<v Speaker 1>statements is don't fight the FED, and that the FED

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<v Speaker 1>easing is omnipotent. The problem is that it's an asymmetrical meaning,

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<v Speaker 1>meaning that it's good advice to temper bullishness when the

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<v Speaker 1>feed is tightening, but not very good advice to get

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<v Speaker 1>bullish when the feed is easing. We're simply done raising

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<v Speaker 1>rates due to the lag of impact the FED policy.

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<v Speaker 1>I mean, some of the worst market drawdouns have occurred

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<v Speaker 1>when the FED is easing and lowering rates two thousand

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<v Speaker 1>and eight, two thousand nine, two thousand one, two tho

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<v Speaker 1>two being examples. Alright, So given all of that, James

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<v Speaker 1>David here by the way, I mean, it's hard also

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<v Speaker 1>not to be invested. I guess if the even if

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<v Speaker 1>the assumption is even the closest extreme, the most extreme,

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<v Speaker 1>say recession on had perhaps with that exception, where do

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<v Speaker 1>you want to be exposed? Is right now in his equity,

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<v Speaker 1>where do you want to accumulate? We remain, you know,

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<v Speaker 1>fully invested. However, I mean, one of the gifts I

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<v Speaker 1>think has been that we saw the vics fall below

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<v Speaker 1>that psychological level of twenty last week and today it

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<v Speaker 1>closed at or near that level. You know, we frequently

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<v Speaker 1>employed tailheages protected put options on our American funds, and

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<v Speaker 1>last week we actually reintroduced them on the entire notional

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<v Speaker 1>value of our underlying stockholdings. You know, I always say

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<v Speaker 1>it's you buy flood insurance when it's sunny outside, and

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<v Speaker 1>we continue to feel that the year two thousand, two

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<v Speaker 1>thousand two analog is the most appropriate. And when you

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<v Speaker 1>look at back at that period, there were three episodes

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<v Speaker 1>of fall two thousand, summer of two thousand one, and

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<v Speaker 1>late spring two thousand two, and the vics fell blow twenty,

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<v Speaker 1>but the market thereafter fell the new load sometimes sharply.

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<v Speaker 1>So we're staying fully invested, but protected against that kind

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<v Speaker 1>of trapdoor risk off draw down episode like we saw

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<v Speaker 1>back in July two thousand and two and other moments

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<v Speaker 1>in time. I wanted to pick up when the last

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<v Speaker 1>thought you ended on in terms of the downside protection

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<v Speaker 1>UH might be valuable for a lot of people out there.

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<v Speaker 1>I'm just looking at price SMP up and give us

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<v Speaker 1>a sense of how expensive protection is right now and

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<v Speaker 1>where you want to protect yourself at what level? Well,

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<v Speaker 1>I think you want to protect yourself for a deep

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<v Speaker 1>drawn down. I mean right now, you could get almost

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<v Speaker 1>out of the money put options on an SMP five

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<v Speaker 1>hundred with six month maturity for essentially one of the

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<v Speaker 1>net asset value of underlying holdings, which is very attractive. Again,

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<v Speaker 1>you know, using the analog that you want to buy

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<v Speaker 1>flood inshirts when it's sunny outside. When volatility is at

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<v Speaker 1>these levels, that is the opportune time to hedge if

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<v Speaker 1>you feel that indeed there is the potential for those

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<v Speaker 1>kind of trapdoor environments. Uh uh in terms of draw

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<v Speaker 1>down on the horizon. So again, I think that's how

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<v Speaker 1>you want to basically use opportunity. But that being said,

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<v Speaker 1>I'm of the belief that volatility is in a new

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<v Speaker 1>regime um in that sense, meaning that the historical trigger

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<v Speaker 1>to potentially loosen or sell options is when the VIX

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<v Speaker 1>has reached thirty five over normal market cycles, I think, uh,

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<v Speaker 1>I think forty five is the new thirty five. And

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<v Speaker 1>in terms of you know, downside, you know twenty five

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<v Speaker 1>is the new twenty to a certain degree. But this

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<v Speaker 1>has been I think a technical rally within a bear

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<v Speaker 1>market that has provided an opportunity for risk a wear

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<v Speaker 1>strategies like ours to be able to use hedges while

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<v Speaker 1>still maintaining a fully invested posture. It seems hard to

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<v Speaker 1>believe that this FED wants to to do what Vulcar did.

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<v Speaker 1>They seem to be a bit more dovish than you know,

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<v Speaker 1>what Vulcar eventually had to be. Uh. Is it possible

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<v Speaker 1>that the Fed is already less aggressive because we are

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<v Speaker 1>the market is already talking about fifty to seventy five,

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<v Speaker 1>not seventy to d This Fed cannot be vulcar ish. Um,

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<v Speaker 1>it's impossible because you know the amount of interest paid

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<v Speaker 1>on the national debt it was you know, five sixty

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<v Speaker 1>billion or so dollars last year including government transfers. Um.

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<v Speaker 1>You know that alone is of what income taxes were

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<v Speaker 1>for the fiscal year two thousand twenty one. But the

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<v Speaker 1>you know, the the average indust rate paid on the

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<v Speaker 1>debt in two one was one and a half percent.

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<v Speaker 1>So if the FED actually genuinely wanted to be Vulcar

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<v Speaker 1>risk in terms of what it wanted to do with

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<v Speaker 1>indust rates and get near the CPI level or even

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<v Speaker 1>near the PC level, it would simply crowd out all

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<v Speaker 1>other spending. And there there is no appetite to basically

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<v Speaker 1>reduce defense spending, medicare spending, or anything else or blow

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<v Speaker 1>out the budget at this point in time. Yeah, that

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<v Speaker 1>that's very right, dal Real on the ideal side, Um,

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<v Speaker 1>did local get too much credit? I mean it was

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<v Speaker 1>a deep recession, millions of people tossed out of work. Yeah,

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<v Speaker 1>I mean he crushed inflation. And some people say that

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<v Speaker 1>it ushered in decades of steady growth and low inflation.

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<v Speaker 1>But didn't globalization and technology play even a bigger role

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<v Speaker 1>in that? I agree? People forget you know, farmers, um,

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<v Speaker 1>you know, coming with mass tractor demonstrations in Washington, d C.

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<v Speaker 1>In the early nineteen eighties. Uh, factories of car factories

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<v Speaker 1>just shutting down because of the you know, the uneconomic

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<v Speaker 1>environment from industrates, housing markets is simply collapsing. You know,

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<v Speaker 1>everything always looks nicer when you look back in history,

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<v Speaker 1>you know, whether it's a deep recession or going to

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<v Speaker 1>basic training. I mean, these are things that you know,

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<v Speaker 1>people always have to look back on. And at some point,

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<v Speaker 1>and Elizabeth Warren had a editorial in the Wall Street

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<v Speaker 1>Journal talking about this very fact. At what point do

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<v Speaker 1>we sit here and say do we want to you know,

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<v Speaker 1>basically destroyed growth for the benefit of inflation. UM. You know,

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<v Speaker 1>it's solely basically take into consideration mistakes that have may

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<v Speaker 1>have been made in the past by the FED to rectify.

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<v Speaker 1>So that takes us into the almost the core question.

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<v Speaker 1>I mean, is a recession necessary or how do you

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<v Speaker 1>define what might be necessary? Let's put it that away,

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<v Speaker 1>because I don't want to get stuck into the concept

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<v Speaker 1>of a recession, because technically, I mean, let's call it

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<v Speaker 1>spade a spade. It was two quarters of contraction, wasn't it.

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<v Speaker 1>That's right? And but the trend is continuing down. And

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<v Speaker 1>if you look at forecasting mechanisms like E C R, EYES,

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<v Speaker 1>leading indicators, the I S, m UM, they're all pointing

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<v Speaker 1>to recession. That we're already in the recession and it's

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<v Speaker 1>potentially going to be getting deeper. And if you start

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<v Speaker 1>to look at the things that you know are eminent

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<v Speaker 1>from a recession, profit marchin compression, UM, layoffs and others,

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<v Speaker 1>I think we're probably one or two quarters away from

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<v Speaker 1>that happening. I think the one thing that could be

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<v Speaker 1>the saving grace is that UM and what could allow

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<v Speaker 1>quick exit from recession is the low level of tangible

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<v Speaker 1>capital investment this ycle, which historically has been an overhang

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<v Speaker 1>on top of the elevated inventories. This cycle, most of

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<v Speaker 1>the excess and excess investment went into intangibles which simply

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<v Speaker 1>go up and smoke, leaving losses, you know, but little

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<v Speaker 1>excess capacity, so that you know, n f t of

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<v Speaker 1>a monkey is probably not going to sit there and

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<v Speaker 1>be excess capacity at some point in the future. Okay,

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<v Speaker 1>I said, I wanted to bring it around to China. Um,

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<v Speaker 1>we have very very low confidence in consumers now and

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<v Speaker 1>housing crisis, and you know, there's a lot of policy

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<v Speaker 1>involved in this. I raised the the notion of it

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<v Speaker 1>being an own goal in our conference call earlier, and

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<v Speaker 1>I mentioned that just before the break. What do you

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<v Speaker 1>think I mean, should we read that China's weakness is

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<v Speaker 1>mostly self inflicted and maybe doesn't spread as much to

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<v Speaker 1>the outside world as something I think it needs to

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<v Speaker 1>be monitored very closely, because the real estate market, which

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<v Speaker 1>is really the source of the problems, needs to be

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<v Speaker 1>monitored because it's a key component of internal growth, particularly

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<v Speaker 1>as you know, the reopening UH and easing of travel restrictions.

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<v Speaker 1>Although pointing positively, you're not in strong enough direction to

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<v Speaker 1>overwhelm what's happening in real estate, and from that perspective,

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<v Speaker 1>you know, the FED should really be sending gift baskets

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<v Speaker 1>to the PBOC in China, which has helped to do

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<v Speaker 1>its own job in depressing commodity prices and input costs. Um.

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<v Speaker 1>So we're gonna have to wait and see though if

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<v Speaker 1>lowering rates and the the sharp move downward in the

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<v Speaker 1>all shore land is something that you know, does trigger

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<v Speaker 1>a more risk averse move by Chinese investors, both in

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<v Speaker 1>real property and in the stock market. So at the

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<v Speaker 1>end of the day, though this is positive and helping

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<v Speaker 1>the FED, but from a global perspective in terms of growth,

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<v Speaker 1>is definitely something that needs closely looked at and simply

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<v Speaker 1>from an asset allocator perspective, And I guess this really

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<v Speaker 1>also depends on what your mandate is a fund manager.

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<v Speaker 1>I mean, just generally, what do you think about the

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<v Speaker 1>pricing and this Chinese market, will equity market almost distressed

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<v Speaker 1>credit market, don't get me started, right, I mean, is

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<v Speaker 1>there is there's almost an opportunity of a lifetime here

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<v Speaker 1>if you believe, of course, China will eventually get itself

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<v Speaker 1>out of this. You know, one of the things that

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<v Speaker 1>we've been doing. And we do have a global list

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<v Speaker 1>and infrastructure strategy, and we have been actually adding to

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<v Speaker 1>various Chinese stocks Ali Baba on the just pure you know,

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<v Speaker 1>valuation perspective and turnaround. But I think most of the

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<v Speaker 1>opportunities in some of the real assets sectors, utilities, water

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<v Speaker 1>and other things are things that one needs to potentially

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<v Speaker 1>at least if you're gaining a foothold in China, where

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<v Speaker 1>you want to go first because very strong dividends. And

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<v Speaker 1>I guess if we could go back to you know,

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<v Speaker 1>how quickly is the US economy decelerating? I think even

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<v Speaker 1>the stock market acknowledges a slowdown, but they're thinking slow down,

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<v Speaker 1>not recession. How how quickly do you think the downward pushes?

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<v Speaker 1>There's the real issue, And with regard to the market

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<v Speaker 1>is um you know, will the aggregate drop in revenue

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<v Speaker 1>and profits overwhelmed the benefits of potentially lower interest rates

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<v Speaker 1>or the FED is simply easing up on tightening, and

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<v Speaker 1>I think you always have to step back. You know.

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<v Speaker 1>Remember in terms of evaluation of the market, the PE

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<v Speaker 1>ratio is a function of interest rates or the lower

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<v Speaker 1>the better and growth the higher. The better. Um, you know,

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<v Speaker 1>lower declining growth can overwhelm you know, interest rates. And

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<v Speaker 1>we still think that you know, the peak and the

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<v Speaker 1>market back in January two thwenty two. You know, in

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<v Speaker 1>terms of evaluation measures, that that exceeded the extreme speck

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<v Speaker 1>in two thousand. It's not going to simply end in

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<v Speaker 1>a whimper. And uh, we're gonna likely see a significant

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<v Speaker 1>D rating forward. And only if we're able to have

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<v Speaker 1>a very quick reversal over sssionary conditions will that potentially

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<v Speaker 1>not occur and we could essentially achieve you know, the

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<v Speaker 1>elusive soft lending that no central bank in the world

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<v Speaker 1>has really ever been able to accomplish. Yeah, I think

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<v Speaker 1>we gotta go. David. Fortunately, good solution here with James.

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<v Speaker 1>James Abatti, thank you very much, Managing director and chief

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<v Speaker 1>investment Officer at the Center Asset Management