WEBVTT - James Abate on the Markets (Audio)

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<v Speaker 1>Let's got the James Abatte, managing director and chief investment

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<v Speaker 1>officer at Center Asset Management. So we mentioned that the

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<v Speaker 1>Jolts survey was pretty frisky, James, but the prices paid

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<v Speaker 1>component in the I s M was was way down.

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<v Speaker 1>So I guess the main takeaway is the same. It's

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<v Speaker 1>a solid economy. And a question could be, then is

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<v Speaker 1>there enough momentum in inflation coming down to to cheer

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<v Speaker 1>the bulls or is it is it time for the

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<v Speaker 1>bearers to to continue to reign supreme. You know, it's

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<v Speaker 1>a little too early to tell. I mean, as you

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<v Speaker 1>point out, you know, the I s M Index, which

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<v Speaker 1>is to the stock market as important as the Department

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<v Speaker 1>of Labor's monthly payroll number is to the bond market.

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<v Speaker 1>It's literally the most important top down indicator. So the

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<v Speaker 1>manufacturing index came in at fifty point zero two, which

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<v Speaker 1>means we're literally catering on recession, but the directional momentum

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<v Speaker 1>is still down, and you know, from that perspective, I think,

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<v Speaker 1>you know, we have to egency. But as you said,

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<v Speaker 1>the saving grace and that was that the inflation index

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<v Speaker 1>was below fifty, giving some indication, but that tends to

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<v Speaker 1>be more geared towards producer prices rather than consumer prices.

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<v Speaker 1>And unfortunately, what we've seen lately is a sharp increase

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<v Speaker 1>in services inflation, and I think a lot of it

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<v Speaker 1>has to do with significant decline in productivity that was

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<v Speaker 1>witnessed James the ultimately we were not getting huge wage increases.

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<v Speaker 1>You know, that's is a fact from the data that

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<v Speaker 1>we've been looking at. And that would also then mean

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<v Speaker 1>that perhaps what inflation is doing at the moment is

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<v Speaker 1>perhaps I want to use those words transitory. It's not

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<v Speaker 1>as not as actually deeply as embedded, and it has

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<v Speaker 1>not as much momentum as people are looking at with

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<v Speaker 1>the policy response that we have, oh well, with the

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<v Speaker 1>fact that productivity falling so rapidly. Let's not forget that

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<v Speaker 1>the latest reading was minus four. That's the lowest number

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<v Speaker 1>we've seen in seventy years. Um. So from perspective, when

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<v Speaker 1>you think about what the FED has to do, you know,

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<v Speaker 1>there's never been an environment really when the FED is

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<v Speaker 1>raised interest rates. We've brought on a recession where productivity

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<v Speaker 1>didn't go up. Companies have taken the steps to right

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<v Speaker 1>size their operations. You know, we're in a very sticky

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<v Speaker 1>place here, and I think actually stagflation is the more

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<v Speaker 1>likely outcome here. The bears have had the wind in

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<v Speaker 1>their sales this year and probably feeling pretty smug. But

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<v Speaker 1>since June the SMP is actually a little bit higher.

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<v Speaker 1>UM So I suppose the question is what is this

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<v Speaker 1>transition to next? Yeah, that's that's that's the million dollar question, right.

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<v Speaker 1>So bear markets have three stages. There's usually that sharp

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<v Speaker 1>down effect, which was the d rating that we experienced

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<v Speaker 1>in the first half of the year. You get a

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<v Speaker 1>reflective rebound, which we enjoyed over the summer months. But

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<v Speaker 1>then if you have a bear market, you have a

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<v Speaker 1>drawn out fundamental down. Yea. So it seems like we're

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<v Speaker 1>we'll have to continue in a moment James almost treading

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<v Speaker 1>a lot at the moment, James Abatte from Center Asset Management,

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<v Speaker 1>up against the clock, James, you know we've been talking

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<v Speaker 1>about the day to that jold state that we're talking

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<v Speaker 1>about some of the other Um. I suppose fasts affecting

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<v Speaker 1>what's going on in the economy, but tepically, how do

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<v Speaker 1>you see things panning out? Because we left on a

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<v Speaker 1>note where you use the s word stagflation, The reason

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<v Speaker 1>why I use stagflation is that I think one of

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<v Speaker 1>the things that is a problem right now with most

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<v Speaker 1>analysts is that they suffer from recency bias, meaning that

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<v Speaker 1>they're still looking at the two thousand eight two thousand

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<v Speaker 1>nine global real estate and financial crisis rather than dot

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<v Speaker 1>com bus is a you know, a good analog. I

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<v Speaker 1>think what people have to remember is that the important

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<v Speaker 1>distinguishing characteristic of that O eight oh nine period that's

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<v Speaker 1>overlooked by most in the financial and analysts and media

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<v Speaker 1>world is that the misallocation of capital back then leading

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<v Speaker 1>to that crisis was not confined just to real estate

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<v Speaker 1>and excessive balance sheet leverage at the financial sector, but

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<v Speaker 1>also who included the energy and resources industries that underwent,

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<v Speaker 1>you know, an excessive period of investment to feed the

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<v Speaker 1>growing industrialization of China in the mid two thousands. You know,

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<v Speaker 1>right now we have a misalignment of capital spending cycle

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<v Speaker 1>with the stock market or consumer business cycle, meaning that

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<v Speaker 1>my fear is that the wholesale destruction that we may

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<v Speaker 1>see from the wealth effective cycle will be as intense

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<v Speaker 1>as it was during the dot com bust, but the

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<v Speaker 1>inflationary declines that emanated from the excessive tangible capacity that

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<v Speaker 1>came online proceeding the two thousand two thousand nine recession

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<v Speaker 1>and the energy and resources industries is not evident today,

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<v Speaker 1>so it's not going to provide the disinflationary benefits to

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<v Speaker 1>interest rates. Yeah. So, I mean it feeds into what

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<v Speaker 1>what is the biggest unintended consequence from this most recent dislocation,

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<v Speaker 1>you know, from this relocation is that we stay in

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<v Speaker 1>an environment where pricing become the dominant variable, you know,

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<v Speaker 1>in the marketplace, and almost we go back to a

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<v Speaker 1>period of time where in the worst case scenario, if

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<v Speaker 1>you think about the price to earnings multiple being kind

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<v Speaker 1>of a inverse relationship of you know, interest rates and risk,

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<v Speaker 1>you have an environment where interest rates stay high and

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<v Speaker 1>continue to basically reflect that higher inflation, but also you

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<v Speaker 1>get people's risk appetites declining, so you get a compounding effect,

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<v Speaker 1>which means the PE multiple continues to fall in the SMP. Yeah,

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<v Speaker 1>I mean, we see you're looking more at I suppose

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<v Speaker 1>at the end of the day, the the e if

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<v Speaker 1>earning is fool, but you know, what did you make

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<v Speaker 1>of the earning season thus far? Then you know that's

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<v Speaker 1>exactly the point and our thesis going into the year

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<v Speaker 1>was that basically you're can have a broad D rating

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<v Speaker 1>in stock. So what you wanted to do is find

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<v Speaker 1>companies that could generate high earnings growth and that's why

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<v Speaker 1>you've seen energy. Um you know, the EPs growth rate

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<v Speaker 1>and energy I think was like eighty or some out percent,

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<v Speaker 1>but that had offset a ten percent decline in the

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<v Speaker 1>PE multiple even for the energy sector. So when you

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<v Speaker 1>look at the smp F I've ventured as a whole,

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<v Speaker 1>you know, if you look at the total return year

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<v Speaker 1>to date, you know about it as a decline in

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<v Speaker 1>the PE multiple with just about four percent of it

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<v Speaker 1>being positive EPs growth. But most of that came from

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<v Speaker 1>you know, energy, staples and utilities, nowhere else really, So

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<v Speaker 1>so the problem for the average investor is that even

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<v Speaker 1>even if they thought, well, okay, if that's the case,

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<v Speaker 1>then I can go to the bond market and have

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<v Speaker 1>a mix of corporates and UH and sovereigns. But you're

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<v Speaker 1>saying that inflation will stay high. So that's going to

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<v Speaker 1>erode those yields. Yeah, absolutely, because I mean people again

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<v Speaker 1>with the recency bias, this inverse correlation that exists between

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<v Speaker 1>stocks and bonds has only been the case, and you

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<v Speaker 1>know in evidence since two thousand and two, you know,

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<v Speaker 1>prior to that and for the majority of the past

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<v Speaker 1>one years, stocks and bonds moved together based upon inflation.

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<v Speaker 1>So I think when you look at the where we

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<v Speaker 1>are today, you know, the problem is people look at

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<v Speaker 1>price momentum and trend following is the deal and end all.

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<v Speaker 1>But when you look at long term perspectives of history,

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<v Speaker 1>you know, the big money is usually made when you

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<v Speaker 1>can anticipate regime changes. And we're in the midst of

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<v Speaker 1>that regime change that you know started this past year.

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<v Speaker 1>Uh well, just so what do you do then, I mean,

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<v Speaker 1>that's the final question, it's the big one. Well, let's

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<v Speaker 1>just let's let's just look at the stock market. Right.

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<v Speaker 1>Everybody's talking about how great the tao had a month

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<v Speaker 1>in October, right, it was the best months since nineteen

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<v Speaker 1>seventy six. You know, the problem is if you look

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<v Speaker 1>in nineteen seventy seven, it was a terrible year for

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<v Speaker 1>the markets and the SMP felt you know, seven out

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<v Speaker 1>of the first ten months of the year ended with

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<v Speaker 1>a loss. Um. You know, that's had small caps did

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<v Speaker 1>very well. So I think doing the underestimate the ability

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<v Speaker 1>of stock picking, sector rotation and other things, but basically

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<v Speaker 1>try to limit your market your market risk at least

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<v Speaker 1>a positive a positive finish up there, James, thank you

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<v Speaker 1>so much. Always always a pleasure, James about it. The

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<v Speaker 1>Managing Director, Chief Investment Officite Center Asset Management