Speaker 1: Let's got the James Abatte, managing director and chief investment
Speaker 1: officer at Center Asset Management. So we mentioned that the
Speaker 1: Jolts survey was pretty frisky, James, but the prices paid
Speaker 1: component in the I s M was was way down.
Speaker 1: So I guess the main takeaway is the same. It's
Speaker 1: a solid economy. And a question could be, then is
Speaker 1: there enough momentum in inflation coming down to to cheer
Speaker 1: the bulls or is it is it time for the
Speaker 1: bearers to to continue to reign supreme. You know, it's
Speaker 1: a little too early to tell. I mean, as you
Speaker 1: point out, you know, the I s M Index, which
Speaker 1: is to the stock market as important as the Department
Speaker 1: of Labor's monthly payroll number is to the bond market.
Speaker 1: It's literally the most important top down indicator. So the
Speaker 1: manufacturing index came in at fifty point zero two, which
Speaker 1: means we're literally catering on recession, but the directional momentum
Speaker 1: is still down, and you know, from that perspective, I think,
Speaker 1: you know, we have to egency. But as you said,
Speaker 1: the saving grace and that was that the inflation index
Speaker 1: was below fifty, giving some indication, but that tends to
Speaker 1: be more geared towards producer prices rather than consumer prices.
Speaker 1: And unfortunately, what we've seen lately is a sharp increase
Speaker 1: in services inflation, and I think a lot of it
Speaker 1: has to do with significant decline in productivity that was
Speaker 1: witnessed James the ultimately we were not getting huge wage increases.
Speaker 1: You know, that's is a fact from the data that
Speaker 1: we've been looking at. And that would also then mean
Speaker 1: that perhaps what inflation is doing at the moment is
Speaker 1: perhaps I want to use those words transitory. It's not
Speaker 1: as not as actually deeply as embedded, and it has
Speaker 1: not as much momentum as people are looking at with
Speaker 1: the policy response that we have, oh well, with the
Speaker 1: fact that productivity falling so rapidly. Let's not forget that
Speaker 1: the latest reading was minus four. That's the lowest number
Speaker 1: we've seen in seventy years. Um. So from perspective, when
Speaker 1: you think about what the FED has to do, you know,
Speaker 1: there's never been an environment really when the FED is
Speaker 1: raised interest rates. We've brought on a recession where productivity
Speaker 1: didn't go up. Companies have taken the steps to right
Speaker 1: size their operations. You know, we're in a very sticky
Speaker 1: place here, and I think actually stagflation is the more
Speaker 1: likely outcome here. The bears have had the wind in
Speaker 1: their sales this year and probably feeling pretty smug. But
Speaker 1: since June the SMP is actually a little bit higher.
Speaker 1: UM So I suppose the question is what is this
Speaker 1: transition to next? Yeah, that's that's that's the million dollar question, right.
Speaker 1: So bear markets have three stages. There's usually that sharp
Speaker 1: down effect, which was the d rating that we experienced
Speaker 1: in the first half of the year. You get a
Speaker 1: reflective rebound, which we enjoyed over the summer months. But
Speaker 1: then if you have a bear market, you have a
Speaker 1: drawn out fundamental down. Yea. So it seems like we're
Speaker 1: we'll have to continue in a moment James almost treading
Speaker 1: a lot at the moment, James Abatte from Center Asset Management,
Speaker 1: up against the clock, James, you know we've been talking
Speaker 1: about the day to that jold state that we're talking
Speaker 1: about some of the other Um. I suppose fasts affecting
Speaker 1: what's going on in the economy, but tepically, how do
Speaker 1: you see things panning out? Because we left on a
Speaker 1: note where you use the s word stagflation, The reason
Speaker 1: why I use stagflation is that I think one of
Speaker 1: the things that is a problem right now with most
Speaker 1: analysts is that they suffer from recency bias, meaning that
Speaker 1: they're still looking at the two thousand eight two thousand
Speaker 1: nine global real estate and financial crisis rather than dot
Speaker 1: com bus is a you know, a good analog. I
Speaker 1: think what people have to remember is that the important
Speaker 1: distinguishing characteristic of that O eight oh nine period that's
Speaker 1: overlooked by most in the financial and analysts and media
Speaker 1: world is that the misallocation of capital back then leading
Speaker 1: to that crisis was not confined just to real estate
Speaker 1: and excessive balance sheet leverage at the financial sector, but
Speaker 1: also who included the energy and resources industries that underwent,
Speaker 1: you know, an excessive period of investment to feed the
Speaker 1: growing industrialization of China in the mid two thousands. You know,
Speaker 1: right now we have a misalignment of capital spending cycle
Speaker 1: with the stock market or consumer business cycle, meaning that
Speaker 1: my fear is that the wholesale destruction that we may
Speaker 1: see from the wealth effective cycle will be as intense
Speaker 1: as it was during the dot com bust, but the
Speaker 1: inflationary declines that emanated from the excessive tangible capacity that
Speaker 1: came online proceeding the two thousand two thousand nine recession
Speaker 1: and the energy and resources industries is not evident today,
Speaker 1: so it's not going to provide the disinflationary benefits to
Speaker 1: interest rates. Yeah. So, I mean it feeds into what
Speaker 1: what is the biggest unintended consequence from this most recent dislocation,
Speaker 1: you know, from this relocation is that we stay in
Speaker 1: an environment where pricing become the dominant variable, you know,
Speaker 1: in the marketplace, and almost we go back to a
Speaker 1: period of time where in the worst case scenario, if
Speaker 1: you think about the price to earnings multiple being kind
Speaker 1: of a inverse relationship of you know, interest rates and risk,
Speaker 1: you have an environment where interest rates stay high and
Speaker 1: continue to basically reflect that higher inflation, but also you
Speaker 1: get people's risk appetites declining, so you get a compounding effect,
Speaker 1: which means the PE multiple continues to fall in the SMP. Yeah,
Speaker 1: I mean, we see you're looking more at I suppose
Speaker 1: at the end of the day, the the e if
Speaker 1: earning is fool, but you know, what did you make
Speaker 1: of the earning season thus far? Then you know that's
Speaker 1: exactly the point and our thesis going into the year
Speaker 1: was that basically you're can have a broad D rating
Speaker 1: in stock. So what you wanted to do is find
Speaker 1: companies that could generate high earnings growth and that's why
Speaker 1: you've seen energy. Um you know, the EPs growth rate
Speaker 1: and energy I think was like eighty or some out percent,
Speaker 1: but that had offset a ten percent decline in the
Speaker 1: PE multiple even for the energy sector. So when you
Speaker 1: look at the smp F I've ventured as a whole,
Speaker 1: you know, if you look at the total return year
Speaker 1: to date, you know about it as a decline in
Speaker 1: the PE multiple with just about four percent of it
Speaker 1: being positive EPs growth. But most of that came from
Speaker 1: you know, energy, staples and utilities, nowhere else really, So
Speaker 1: so the problem for the average investor is that even
Speaker 1: even if they thought, well, okay, if that's the case,
Speaker 1: then I can go to the bond market and have
Speaker 1: a mix of corporates and UH and sovereigns. But you're
Speaker 1: saying that inflation will stay high. So that's going to
Speaker 1: erode those yields. Yeah, absolutely, because I mean people again
Speaker 1: with the recency bias, this inverse correlation that exists between
Speaker 1: stocks and bonds has only been the case, and you
Speaker 1: know in evidence since two thousand and two, you know,
Speaker 1: prior to that and for the majority of the past
Speaker 1: one years, stocks and bonds moved together based upon inflation.
Speaker 1: So I think when you look at the where we
Speaker 1: are today, you know, the problem is people look at
Speaker 1: price momentum and trend following is the deal and end all.
Speaker 1: But when you look at long term perspectives of history,
Speaker 1: you know, the big money is usually made when you
Speaker 1: can anticipate regime changes. And we're in the midst of
Speaker 1: that regime change that you know started this past year.
Speaker 1: Uh well, just so what do you do then, I mean,
Speaker 1: that's the final question, it's the big one. Well, let's
Speaker 1: just let's let's just look at the stock market. Right.
Speaker 1: Everybody's talking about how great the tao had a month
Speaker 1: in October, right, it was the best months since nineteen
Speaker 1: seventy six. You know, the problem is if you look
Speaker 1: in nineteen seventy seven, it was a terrible year for
Speaker 1: the markets and the SMP felt you know, seven out
Speaker 1: of the first ten months of the year ended with
Speaker 1: a loss. Um. You know, that's had small caps did
Speaker 1: very well. So I think doing the underestimate the ability
Speaker 1: of stock picking, sector rotation and other things, but basically
Speaker 1: try to limit your market your market risk at least
Speaker 1: a positive a positive finish up there, James, thank you
Speaker 1: so much. Always always a pleasure, James about it. The
Speaker 1: Managing Director, Chief Investment Officite Center Asset Management