James Abate on the Markets (Audio)

fewer recession concerns. It's a sort of crystallized conversation like Morgan Stanley on one side, JP Morgan on the other, Uh, how do you see it? Do you do you see a muddling through option? It's possible if we're able to avoid a severe recession. And you know, the real question we all have to ask ourselves is to the stock market bottom in June or is this just a bear

market rally again? I think it remains to be seen whether or not the recession, which likely began in the first quarter of two thous in twenty two, um, you know, is going to have the depth that past recessions have had. But I think one thing that is very important to point out is people's belief that the FED. You know, I think always said that one of the most dangerous statements is don't fight the FED, and that the FED

easing is omnipotent. The problem is that it's an asymmetrical meaning, meaning that it's good advice to temper bullishness when the feed is tightening, but not very good advice to get bullish when the feed is easing. We're simply done raising rates due to the lag of impact the FED policy. I mean, some of the worst market drawdouns have occurred when the FED is easing and lowering rates two thousand and eight, two thousand nine, two thousand one, two tho

two being examples. Alright, So given all of that, James David here by the way, I mean, it's hard also not to be invested. I guess if the even if the assumption is even the closest extreme, the most extreme, say recession on had perhaps with that exception, where do you want to be exposed? Is right now in his equity, where do you want to accumulate? We remain, you know,

fully invested. However, I mean, one of the gifts I think has been that we saw the vics fall below that psychological level of twenty last week and today it closed at or near that level. You know, we frequently employed tailheages protected put options on our American funds, and last week we actually reintroduced them on the entire notional

value of our underlying stockholdings. You know, I always say it's you buy flood insurance when it's sunny outside, and we continue to feel that the year two thousand, two thousand two analog is the most appropriate. And when you look at back at that period, there were three episodes of fall two thousand, summer of two thousand one, and late spring two thousand two, and the vics fell blow twenty, but the market thereafter fell the new load sometimes sharply.

So we're staying fully invested, but protected against that kind of trapdoor risk off draw down episode like we saw back in July two thousand and two and other moments in time. I wanted to pick up when the last thought you ended on in terms of the downside protection UH might be valuable for a lot of people out there. I'm just looking at price SMP up and give us a sense of how expensive protection is right now and

where you want to protect yourself at what level? Well, I think you want to protect yourself for a deep drawn down. I mean right now, you could get almost out of the money put options on an SMP five hundred with six month maturity for essentially one of the net asset value of underlying holdings, which is very attractive. Again, you know, using the analog that you want to buy

flood inshirts when it's sunny outside. When volatility is at these levels, that is the opportune time to hedge if you feel that indeed there is the potential for those kind of trapdoor environments. Uh uh in terms of draw down on the horizon. So again, I think that's how

you want to basically use opportunity. But that being said, I'm of the belief that volatility is in a new regime um in that sense, meaning that the historical trigger to potentially loosen or sell options is when the VIX has reached thirty five over normal market cycles, I think, uh, I think forty five is the new thirty five. And in terms of you know, downside, you know twenty five

is the new twenty to a certain degree. But this has been I think a technical rally within a bear market that has provided an opportunity for risk a wear strategies like ours to be able to use hedges while still maintaining a fully invested posture. It seems hard to believe that this FED wants to to do what Vulcar did. They seem to be a bit more dovish than you know,

what Vulcar eventually had to be. Uh. Is it possible that the Fed is already less aggressive because we are the market is already talking about fifty to seventy five, not seventy to d This Fed cannot be vulcar ish. Um, it's impossible because you know the amount of interest paid on the national debt it was you know, five sixty billion or so dollars last year including government transfers. Um. You know that alone is of what income taxes were

for the fiscal year two thousand twenty one. But the you know, the the average indust rate paid on the debt in two one was one and a half percent. So if the FED actually genuinely wanted to be Vulcar risk in terms of what it wanted to do with indust rates and get near the CPI level or even near the PC level, it would simply crowd out all other spending. And there there is no appetite to basically reduce defense spending, medicare spending, or anything else or blow

out the budget at this point in time. Yeah, that that's very right, dal Real on the ideal side, Um, did local get too much credit? I mean it was a deep recession, millions of people tossed out of work. Yeah, I mean he crushed inflation. And some people say that it ushered in decades of steady growth and low inflation. But didn't globalization and technology play even a bigger role

in that? I agree? People forget you know, farmers, um, you know, coming with mass tractor demonstrations in Washington, d C. In the early nineteen eighties. Uh, factories of car factories just shutting down because of the you know, the uneconomic environment from industrates, housing markets is simply collapsing. You know, everything always looks nicer when you look back in history, you know, whether it's a deep recession or going to basic training. I mean, these are things that you know,

people always have to look back on. And at some point, and Elizabeth Warren had a editorial in the Wall Street Journal talking about this very fact. At what point do we sit here and say do we want to you know, basically destroyed growth for the benefit of inflation. UM. You know, it's solely basically take into consideration mistakes that have may have been made in the past by the FED to rectify. So that takes us into the almost the core question. I mean, is a recession necessary or how do you

define what might be necessary? Let's put it that away, because I don't want to get stuck into the concept of a recession, because technically, I mean, let's call it spade a spade. It was two quarters of contraction, wasn't it. That's right? And but the trend is continuing down. And if you look at forecasting mechanisms like E C R, EYES, leading indicators, the I S, m UM, they're all pointing to recession. That we're already in the recession and it's

potentially going to be getting deeper. And if you start to look at the things that you know are eminent from a recession, profit marchin compression, UM, layoffs and others, I think we're probably one or two quarters away from that happening. I think the one thing that could be the saving grace is that UM and what could allow quick exit from recession is the low level of tangible capital investment this ycle, which historically has been an overhang

on top of the elevated inventories. This cycle, most of the excess and excess investment went into intangibles which simply go up and smoke, leaving losses, you know, but little excess capacity, so that you know, n f t of a monkey is probably not going to sit there and be excess capacity at some point in the future. Okay, I said, I wanted to bring it around to China. Um, we have very very low confidence in consumers now and housing crisis, and you know, there's a lot of policy

involved in this. I raised the the notion of it being an own goal in our conference call earlier, and

I mentioned that just before the break. What do you think I mean, should we read that China's weakness is mostly self inflicted and maybe doesn't spread as much to the outside world as something I think it needs to be monitored very closely, because the real estate market, which is really the source of the problems, needs to be monitored because it's a key component of internal growth, particularly as you know, the reopening UH and easing of travel restrictions.

Although pointing positively, you're not in strong enough direction to overwhelm what's happening in real estate, and from that perspective, you know, the FED should really be sending gift baskets to the PBOC in China, which has helped to do

its own job in depressing commodity prices and input costs. Um. So we're gonna have to wait and see though if lowering rates and the the sharp move downward in the all shore land is something that you know, does trigger a more risk averse move by Chinese investors, both in

real property and in the stock market. So at the end of the day, though this is positive and helping the FED, but from a global perspective in terms of growth, is definitely something that needs closely looked at and simply from an asset allocator perspective, And I guess this really also depends on what your mandate is a fund manager.

I mean, just generally, what do you think about the pricing and this Chinese market, will equity market almost distressed credit market, don't get me started, right, I mean, is there is there's almost an opportunity of a lifetime here if you believe, of course, China will eventually get itself out of this. You know, one of the things that

we've been doing. And we do have a global list and infrastructure strategy, and we have been actually adding to various Chinese stocks Ali Baba on the just pure you know, valuation perspective and turnaround. But I think most of the opportunities in some of the real assets sectors, utilities, water and other things are things that one needs to potentially at least if you're gaining a foothold in China, where

you want to go first because very strong dividends. And I guess if we could go back to you know, how quickly is the US economy decelerating? I think even the stock market acknowledges a slowdown, but they're thinking slow down, not recession. How how quickly do you think the downward pushes?

There's the real issue, And with regard to the market is um you know, will the aggregate drop in revenue and profits overwhelmed the benefits of potentially lower interest rates or the FED is simply easing up on tightening, and I think you always have to step back. You know. Remember in terms of evaluation of the market, the PE ratio is a function of interest rates or the lower the better and growth the higher. The better. Um, you know,

lower declining growth can overwhelm you know, interest rates. And we still think that you know, the peak and the market back in January two thwenty two. You know, in terms of evaluation measures, that that exceeded the extreme speck in two thousand. It's not going to simply end in a whimper. And uh, we're gonna likely see a significant

D rating forward. And only if we're able to have a very quick reversal over sssionary conditions will that potentially not occur and we could essentially achieve you know, the elusive soft lending that no central bank in the world has really ever been able to accomplish. Yeah, I think we gotta go. David. Fortunately, good solution here with James. James Abatti, thank you very much, Managing director and chief investment Officer at the Center Asset Management