Chris Hyzy: Thanks, everybody, for joining this week's Street Talk Call. This call today will be more about a dialogue/more about a discussion overall as to what we are calling what's next at least in our opinion. What chain of events do we see unfolding given everything that has occurred in the last 10 plus days, but also everything that we have witnessed in terms of the rolling cycle that has occurred throughout the tail end of ’21, into all of ’22, and then as we've opened up this year in ‘23. So, we'll go through the chain of events, we'll talk about what's coming next at least in our opinion, we'll talk about how that fits into the overall medium to long term which we still feel is the next leg of the bull market. Obviously, there's a major stopping point before all that occurs and we'll talk about it. We're going to use the concept of two birds that rarely are seen, but we'll try to put it into perspective this concept of being an ostrich or an owl. The ostrich is a bird obviously that is rarely seen, but it's flightless. We know it buries its head in the sand, it’s one of the heaviest birds - it’s not the heaviest - and it's the fastest bird on land. To be an ostrich today, at least as it relates to the markets and portfolios, you'd have to look away from everything that's going on, you'd have to run away from everything that's going on, and you almost not being able to fly away from everything that's going on. We'd rather take the position of an owl, the owl being one that has binocular vision, one that actually has silent flight and taking advantage of areas as they present themselves an overall 360° almost movement of looking around, and tends to stand upright looking for the next opportunity. So, we want to be the owl side of the bird family versus the ostrich side of the bird family. So put that into perspective, what do we mean by that? The chain of events that occurred most recently – obviously, the failed banks that occurred that had very unique consequences and characteristics to them, one of which was a non-diversified or a very concentrated deposit base; another of which was an overwhelmingly large, if not almost the entire deposit base, being uninsured for one in particular; A couple of other banks that actually had exposure to very speculative assets; and then overall just general lack of stellar risk management overall. There's a number of other characteristics that you can add into that equation. They tended to be small, but they had a wide-reaching effect and they had a very interesting client base. On the flip side, when you look at the financial system in and of itself, there's a lot of discussion out there that talks about, “I remember when-” the global financial crisis of late ‘07, all of ’08, and into early ‘09 and the workout phase that occurred after that and a lot of the regulations that were put in place. At least in my opinion, the way to think about back those days is more about, “What was the asset in question?” The asset in question started with mortgages. It became in the derivatives market. It filtered into synthetic structures and in some cases double synthetic structures. It ultimately begets significant counterparty risk across the globe. There was a number of different financial players, if you will, tied to each other. This time around it started as more of a liquidity crisis - and there are some concerns out there that can this turn into a credit crisis? A credit crisis ultimately can develop in certain areas, but system wide we do not see that. System wide default, system wide failures as it relates to how the system works relative to 2008 - 2009 is very different - very different - than it is today. Today's capital levels in the largest financial institutions are very high, significantly higher than they have been in the past, and overwhelmingly higher them back of ’08- ‘09. The assets in question right now are treasuries, agencies, and others. They just happen to be under pressure based upon the significant rise in interest rates, but those are treasury assets, these are not junk related assets and at the same time, they're not synthetic assets or derivatives called into question. Very different. Also, you have very diversified deposit bases in the larger financial institutions and you get marked to market and finally you get stress tests, all of which were not around back then. So, the system is doing what the system is designed to do, which is make sure that it continues to function in a very high manner. Number one, keep liquidity going and when the tools are needed by the Federal authorities whether it's treasury, FDIC, and/or central banks, the central bank tool belt and the playbook from yesteryear can be brought out much quicker today - matter of days, some cases a week versus a matter of years like 15 years ago. So here we are. We're about 10 days in, still a lot of concern, a lot of volatility - that's natural. There's a lot of analysts out there that are looking for not only what's next, but what look alikes are out there - that's also natural. We have all eyes on Fed communication and the Federal Reserve’s move yesterday. So, let's talk about that. Previous to the last 10 days or so the focus was on price stability. To a certain degree, the secondary mandate or the adjacent mandate being full employment was still also a mandate by the Federal Reserve but first and foremost, the primary mandate overwhelmingly right now is to break the back of inflation still remains. The Federal Reserve has told us that every meeting for the past year. I'll go back to March of 2022 right before and right around the first hike that occurred. Chair Powell discussed his favorite gauge that he looks at to determine whether or not we go into “recession” and what the overall economic environment is telling us or at least will tell us. He looked at the three-month to 18 months yield curve and at the time it was not inverted. Right now, that inversion is the widest it’s been, indicating that a recession is in the cards even though the Fed continues to hike largely speaking because of trying to make sure that there is discernible pressure downward on inflation. So, if you mixed that type of scenario or thinking with what's going on in the banking and the liquidity crisis that we saw in the smaller institutions overall, what we're witnessing is what comes next. What comes next is likely to be higher lending standards, more regulations at the lower institutional level, overall lower lending velocity, potentially higher costs to shift capital from one part to another, and certainly liquidity spigots that were out there in the private sector not necessarily drying up, but actually becoming more conservative. All of that, at least in our view, lends itself to a much slower growing environment, could potentially pull forward the recession that's been delayed that everyone's been discussing, and it could also slow down the flow of capital from the government sector into the private sector overall. That's our way of saying there is a cost to all this and the cost ends up being slower growth. So, if that's the case, then inflation in the coming months not only should continue to trend downward like it has been, but pick up speed and accelerate. You could actually see what we have been discussing for quite some time, which is one of the bigger surprises for this year actually be much lower inflation. Now, it appears that that's going to be accelerated largely speaking because of what has just unfolded and that is fast tracking it. It was our belief prior to the recent chain of events that one of the bigger surprises would be a sharply lower inflation because the money supply turned negative. When the money supply turns negative, we’ve long said that means there's less money to do things with, and that ultimately drives the secular trend in inflation both up and down. So we have negative money supply growth ultimately lending itself to significantly and significantly inverted yield curves in the areas that are most watched by the Federal Reserve. We’ve got a higher cost of capital that was just bumped up 25 basis points by the Fed, 50 basis points by the European Central Bank, and another 25 basis points today in the UK, as well as in Switzerland you'll see potentially 50 basis points if it's not already happened. So, we've got central banks focusing on price stability trying to use communication to focus on financial stability and here we are. So, in our opinion, what comes next? The focus by equity market participants is going to be shifting from the current liquidity concerns over the next couple of weeks to over the next few months and into next year - what's the earnings impact? What's the economic impact of these new chain of events? Has this not only pulled forward the recession, has it pulled forward what we have all been waiting for is the final earnings deterioration in this cycle? That's our belief that yes, it does pull it forward. Now, the consumer’s still relatively healthy, still has excess savings. The service economy is still producing some jobs. That's likely to start to slow down. You're seeing some slow down a little bit right now, but still decent spending overall. Business confidence is okay. The European community has averted a recession so far as well and there's a warmer winter and much lower oil and gas pricing subsidizing spending in the two largest regions still. So, the recession may not happen tomorrow, but it’s certainly in our opinion being pulled forward. We still believe in a medium type of landing, not a soft landing, not a hard landing. A soft landing would indicate that we would just blow by. The breeze would blow by the woods and we'd walk through it. A hard landing would imply that something systemic in nature continues and we don't see that either. A medium landing is one in which the unemployment rate goes up. You start to see claims go up first. You start to see more layoffs and across different sectors, not just in one or two sectors. You start to see the vacancy rate/the number of job openings started to lower per number of future employee able to fill that. So the vacancy rate at [one nine] goes down lower, claims go up, more layoffs occur, and you start to reset the pool of labor cycle. That ultimately should filter into lower margins which filters into at the same time lower volumes, less pricing power, lower earnings. So, the question that equity investors are going to have to grapple with is what is that overall earnings deterioration? At this point it is our belief it's still 10% year over year to the downside. Nothing more than that. If it's more than that, that means it's not necessarily a medium landing, it is a harder landing and there needs to be another input that comes in that slows growth down even further than what we're seeing right now. We'll talk about that at the end of the opening comments. At the same time, what the equity investor, the asset management community, the investor itself - both institutional and private, and the larger global asset allocators around the world are going to have to think about, “What areas can protect earnings the most?” not necessarily, “What areas can grow their earnings the most?” This is going to be an environment where indigenous stories begin to filter through. What company is best managed? What sector? What industry group can hold the margins better at a higher cost of capital, tighter financial conditions, less spending, less confidence? It’s not the type of environment where the highest growth earnings are going to dominate, it’s more about protection. That's why the owl is the way to think about this versus the ostrich. So, we have to be ready on the protection side and be ready on the advancement side as we work through the cycle and look all around for opportunities when the market gives us to rebalance and when the market gives us to reposition portfolios. So the equity markets right now have done their job. They've corrected to a valuation level that is decent. When you back out the highest market caps of the S&P 500, the top five or so you're looking at a market that's below 15 times. So now you're going to switch into what is the base? It’s the base of earnings correct? If our calculations are correct, the long-term bull market begins again in 2024 and it's on the basis of earnings climbing, not necessarily a liquidity fueled valuation rise/PE multiple rises every year in and year out type of long term bull market. This might be a slower growing on an annual compounded total return basis bull market, but in our opinion it could be more solid and it's because it's earnings and profits driven in a more consistent, less volatile way overall. When I say less volatile, I don't mean by the Chicago Board Options Exchange, VIX Index volatility, but the earnings stream being less volatile than what we've recently witnessed. So, we'll get there over time. For now, it's about understanding liquidity, the flow of capital, what's happening overall in financial conditions to keep the system continuously functioning, and then over time in the coming weeks we'll see how the rest of the banking situation unfolds. Moving into fixed income - very different story. The fixed income markets don't believe overall that things are as great as the equity markets. The fixed income market is telling us the recession is upon us or right around the corner. The fixed income markets are giving us the opportunity to use the front end of the curve short term yields as a cash flow producer. They’re giving us the opportunity to save. They’re giving us the opportunity to produce cash flows like we haven't in years past to be able to use those cash flows to buy into equities as we bottom out. So that's how we look at the different stories that fixed income is telling versus equities and we want to use those two asset classes for what they are best at. Fixed income for cash flow overall, fixed income for conservative allocations to certain parts that are producing income streams, and then equities for longer term growth depending on where we are from one month to the next. So, to think about what the Fed did yesterday is more about continuing to break the back of inflation. Chair Powell did a very good job, at least in our opinion, talking about financial stability and talking about their so-called dual misunderstood mandate, price, and financial stability at the same time and then ultimately we had other stories that came in that talked about deposit insurance not happening across the entire banking sector and that took the market down yesterday. We are not interested in one day to the next in terms of market action. What we're more interested in is overall what are the next 6, 12, 18 months, 2 -3 years look like? We’ll get through this. The liquidity situation we're in right now is filtering itself through. We believe over the next couple of weeks volatility will calm down and then focus again will shift all to earnings and that's where we will focus much of our insight on future calls - what do earnings look like? How are they tracking overall? And whether or not certain gauges are telling us that the recession is here. As it relates to just overall the environment, I mentioned before that flexibility is imperative. Being an owl relative to an ostrich is imperative. Active positioning – what does that actually mean? If you own passive vehicles, indexed vehicles, in your portfolio, that doesn't mean it's not active. You're making an active decision there as to use certain solutions to build a portfolio - that's number one. On top of those solutions the active positioning between equity and fixed income is an active decision and then as you build around core portfolios, there's active positioning in individual areas within industry groups that are going to not only drive growth but protect earnings in a more assertive way. You're seeing growth outperform value right now on the premise that interest rates are coming down. That did not happen last year. We all saw what growth did, but it's not all growth. It's a very high-quality growth, the more conservative growth, the areas that are cutting costs aggressively to protect their free cash flows. Those are the areas that are outperforming in the growth arena and they happen to be the mega growth arena. It's not the long duration growth arena that are not producing profits. Those are still very vulnerable. So, we have to be careful about just designating something as all growth versus all value. The areas within value that are working are the areas that are providing the yields, the areas that are providing more protection of earnings, the areas that are of low value, but not as economically sensitive. So, we now have to look within growth and look within value and that brings me to the US versus non-US, large cap versus small cap and mid cap type of positioning. US versus non-US - non-US has outperformed. It's been a flow driven outperformance at least in our opinion. Global investors around the world were woefully under allocated for a decade plus in non-US relative to the US and that was the right call and the obvious call. Now there's been some switching over to it. The driver of that has been the reopening of China - number one, the warmer winter in Europe and you put those two stories together, as well as the belief that the dollar is now going into a weaker cycle. Those three components are lending itself to more outperformance non-US relative to the US. The other reasoning has to do with the overall value backdrop. Those markets are more value intensive relative to growth and therefore you've got the double whammy. If you were woefully under invested in value and non-US, you're now moving money that way if you're a global asset allocator. So, it's been flow driven starting late last year and into the first part of this year. The question is does it have legs? In our opinion right now it's going to be very choppy. It'll be a horse race in our view for outperformance between the US and non-US and the reasoning is relatively simple, markets and economies overseas are less flexible, not as resilient. The US went into this cycle first. They'll come out of it first. You have to be ultra tactical in the non-US markets and very nimble to be able to catch the peaks and valleys and we are not at that point yet in our view. We are watching it. It’s still on our watch list. For us to look for an upgrade in that arena, we would have to be of high conviction that we're heading into a consistently weaker dollar cycle and that could happen once the Fed pauses which could be right around the corner, so we'll stay tuned on that one. They are also very economically sensitive driven. So, if we are going into a tougher recession than what is believed, those markets will not likely outperform so we have to weigh that as well. In terms of large versus small, we believe that small caps looking out three, four, five years, perhaps even a decade - another area significantly under allocated, significantly underperform but you need to get through the recessionary type of winds/the recessionary environment before small caps can consistently outperform. So again, another area on our watch list not yet ready to upgrade. Growth versus value - we talked about that. That is a mixed bag still. We still believe a good, diversified mix between the two makes sense, but now you have to look at a binary view of growth and a binary view of value. When you look at a cross section of all equity assets, the one thing that's ringing true throughout this entire last part of the cycle before we go back into early cycle is quality, high quality. How do you test high quality? You can test it through earnings variability, low earnings variability is high quality. Solid balance sheet, high free cash flow - high quality. So, it becomes an individual company or industry group that has high quality characteristics relative to the overall market. Let's talk a little bit about fixed income. We talked about using the curve. The short end of the curve is your cash flow. It'll be time to consistently extend duration in the coming months. We have used episodes in the past to do that when yields ultimately get too far ahead of themselves. In fact, we had a 150-basis point move in the two-year yield in the last two weeks. That is unprecedented. We had a 75-basis point move or so in the 10-year, so this curve steepened a little bit on this latest situation and then also the spread came down between the twos and tens but the spread between three months and 18 months is at its widest level. So, there's a lot of things going on in the bond market. The bond market’s telling us a particular story - that the Fed is doing something different. So, the Fed is acting right now on data and thinking through how their previous hikes are going to ultimately impact. There was a change to the dialogue in the communication yesterday that said, “Future hikes may be needed,” versus, “We are going to continue to maintain hikes.” There's a big change of wording there, so there's a big bet in the marketplace that the Federal Reserve is one more and done or in fact done for now. We'll see how that unfolds. More importantly for us again, it's the economic impact of higher lending standards, tighter financial conditions, potentially higher regulation over the next 18 months. What does that do to the flow of capital? Who are the new providers of capital into the venture capital space, the high growth space? Does it get picked up in the private sector, the shadow banking sector? Does the larger banking arenas take over where the smaller banks were? The same thing in office and commercial real estate. What's the difference between core real estate and opportunistic? All of these things are going to be on our checklist from this point forward and what happens with rent rolls, what happens with the higher the cap rates, and how that feeds into the growth curve of the overall US and global economy. So, if you put all this together, it’s important to keep at the top of the list, “Be an owl around earnings,” and that's what we're going to do to give us clues as to future changes to tactical asset allocation. Right now, we remain risk budget neutral between equities and fixed income. We think there's equal risk adjusted return prospects at least for the shorter term and we'll adjust our tactical asset allocation when the data changes and when we have higher conviction one way or the other. On the watch list continues to be those items I mentioned. Overall, we still believe that two to three opportunities present themselves between now - so give or take when the Fed pauses – and the end of the first quarter next year when we have full look through as to when the earnings bottom. All of that should provide us much more attractive levels to come back into the markets if you're underweight equities and you have building cash positions. Those two to three episodes on a dollar cost averaging basis set the tone for the next bull market in our opinion. For now, fragile environment, more volatile. Let's get through the liquidity situation we're in right now, see where earnings come out in the next quarter, ultimately look for a Fed pause, look for two to three opportunities, and we're going to maintain our owl approach relative to the ostrich. That’ll do it for upfront comments for today. Thanks for listening.
Operator: Please see important disclosures provided on this page.
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Chris Hyzy: This is Chris Hyzy, Chief Investment Officer, for the market update for the first day of the spring, March 20th. To start, here's the quick latest on the banking events. UBS buys Credit Suisse for $3.2 billion with liquidity and loss protection from the Swiss Government and Swiss national banks over the weekend. [Asset] sales have begun at two of the small banks that we’ve all been reading about that has failed previously also over the weekend. Importantly, to make extra liquidity available in the global markets, the large central banks around the world are increasing dollar swaps - in other words, dollar funding - to daily operations from weekly operations in order to create further stability. Equity prices across the banks particularly in Europe and the United States are somewhat stable this morning to slightly up, but areas and overall stress still remain high. Debt crisis in European banks are settling at levels above their lows over the weekend as investors parse through the Credit Suisse sale. A lot of questions remain regarding the payouts or lack thereof in some specific securities in the capital structure of European banks. In the meantime, spreads remain near their widest levels for both a sample of US regional banks and Credit Suisse US dollar holding company bonds. This is on the back of the S&P downgrade to a regional bank in the United States over the weekend to double notches below and now at a high yield status well again over the weekend. Simply put, markets remain on high alert. Now switching to the second order effects. What's next for growth, inflation, and markets? From our perspective, what are the collateral effects that are also important for US regional banking areas that we've already witnessed? If regional banking issues are a ring fence with tightening of lending standards and a slowdown in credit creation overall would be consistent with our B of A Global Economics team baseline outlook for a mild recession in the US economy at the end of this year. Our B of A Bank Research team believes the Fed will impose stricter liquidity and capital requirements on a larger subset of banks leading to the tightening lending standards which ultimately leads to, in our opinion, a somewhat deflationary type of backdrop in the short to medium term. Therefore, more pronounced financial stress could also lead to Fed cuts and even a return to the zero lower bound if financial stress spread but this is not our base case at this time. We continue to monitor credit spread, funding spreads, and debt prices of financial firms in order to assess the level of overall trust in the system as events continue to unfold. In terms of the equity markets, we continue to expect markets to remain stuck in a grinded out pattern while [new flow] remains cloudy on both the financial and economic front. We emphasize high levels of diversification, exposure to higher quality areas overall. While the situation remains uncertain, we expect financial stress to stabilize in the coming few weeks then the question should switch towards the economic impact and the eventual economic landing. We expect three episodes of market weakness with small rallies in between. Longer term investors looking to dollar cost average high cash positions and are significantly underweight equities at this time should have better opportunities in the late spring/early summer and again in the fall in our opinion. For now, we let the volatility subside. That'll do it for today. Thanks for listening.
Operator: Please see important disclosures provided on this page.
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Chris Hyzy: Thanks, everyone, for joining this Street Talk Call for March 16th. Lots to discuss today. We're going to try to take it up from the top-down situation and also bottom-up. We recently released a report literally an hour or two ago titled: The Steps to Eventual Stability and we highlight in there five particular steps that all types of so-called systemic perceived crises or just financial crises in general. It's all about confidence, it's all about trust, it's all about liquidity. The knee jerk reaction here is to go back some 15 years ago and even before that, 16 years ago in 2007 when we all started to witness some of the credit spreads, some of the overnight funding spreads, start to widen out and at the time it was a big head scratcher back then as to like, “What is actually going on?” and there was talk of an impending recession. If you remember back in ’07 heading into ’08, back then there was number one, a very different type of foundation than you see today, which is the banking system. The banking system did not have the capital it has today, particularly the large strategic investment banks; significantly more capital on hand; a much cleaner and tighter and higher quality balance sheet also on hand today versus back then. Off balance sheet items are virtually non-existent today versus back then. The interconnectedness of the broker dealer networks are very different today than back then. Now, there's still counterparty risk today. That’s just simply doing business with one another, but it's a very different type of controlled counterparty risk albeit there's still a lot of unknowns and that's one of the reasons why markets are still fragile, they're likely to remain that way in the coming couple of weeks, and you're going to see volatility chops from one day to the next where you might open up significantly down, close the day up, or vice versa. This is all about portfolio repositioning. I'll go through the steps in just a few minutes, but I also want to talk about this particular chain of events and the uniqueness of it. We've highlighted this on previous calls, but the uniqueness of this is not only from a liquidity perspective and confidence and trust and the type of assets, but simply put, it’s a liquidity event that's going on right now, very different than back in ’07, ’08, ‘09 which was a credit event. A credit event has to do with the quality of the assets for sure and at the same time also has to do with the impending connectedness on counterparties in terms of leverage. It's very different this time. What we've witnessed is uniqueness in a particular situation in the United States where it relates to the concentrated deposit base of one particular bank and then ultimately the asset liability mismatch, the ability to fund yourself in the short term and then ultimately buy or invest longer term and as interest rates went up, obviously those assets on a marked to market basis were corrected. Those are high quality assets. Those are very different than the assets that we all saw back in the ’07, ’08, ‘09 arena which in some cases were synthetic packaged and in some cases junk assets relative to the higher quality assets right now i.e. treasuries, agencies, and mortgage backed securities. It doesn't make it necessarily any better in the short term as it relates to, “What is the unknown?” There's still sentiment here, and so we would view this particular episode that's going on right now concerning - number one. Number two, more of a sentiment contagion than as it relates to a credit or an overall counterparty risk around the world contagion albeit there’s going to be a lot of talk about that. Number three, this is more of a liquidity versus a credit event. So, what do you do with this? This is where it gets interesting. First and foremost, I think we're going to have to take a look at three different areas of interest to assess. In other words, how long this is likely to last and how do we get to the other side? So, we outlined some steps in this report called: The Steps to Eventual Stability. Number one, the first step is liquidity. You saw that over the weekend. A liquidity facility was put in place. Just to be specific here, it was called Bank Term Funding Program. You could bring your assets to the window and those assets you lend off of, the Federal Reserve will lend off those assets to the tune of a one-year term at par, so basically they're saying no discount. That also can be leveraged to a certain degree as to what type of assets you bring in for an eligible institution. If you think about it, that is the cost of backstopping insured and uninsured deposits. It's a mixture of the insurance you pay as a depositor plus a so-called term lending facility that is there if an institution needs it to make sure that they don't have to go out and sell assets to raise capital. That is a liquidity event versus an asset credit event, which ultimately could subsidize future growth. Now, we'll talk about the potential impact on the economy in just a minute. So thankfully there was liquidity facility put in place here in the United States – number one. Number two, you saw it kind of filter over into Europe with one of the weakest players in Europe that has been the case for the better part of a decade or more, and that weaker player in Switzerland needed a $50 billion plus backstop from the Swiss national Federal lending facility overall and that money is there also to protect against the balance sheet. That is more of a liquidity backdrop. When you take a look at liquidity coverage ratios across the strategic investment banks, they’re very, very healthy, capital levels healthy, and in Europe to some degree a little bit tougher, a little bit tougher restrictions. In fact, a majority of the banks in Europe – less number of them, but a majority of the banks if not all of them have gone through very highly restrictive type of capital requirements and liquidity coverage ratios etc. It’s one of the reasons why initially the European banks were outperforming significantly. So, what we're watching closely is the regional banking equity shares. There’s a lot of discussions perhaps a lot of these banks will have to raise capital in the equity markets that might make it diluted to shareholders. We'll see how that all goes, but with each and every passing day with the understanding of what this liquidity facility is in the United States and also the willingness by the European Central Bank to be there and other central banks to provide the needed liquidity - not without penalty, but the needed liquidity - should help calm down the markets in the next one to two weeks. So, step one, liquidity – there. Longer term is a little bit more important. Once we get through that bridge period of short-term liquidity presented to itself by central banks, then you switch into, “All right. Who's going to be the liquidity provider in the future once that ends?” That tends to be the private sector. That's where the investor comes back in. There will likely be major changes to who those investors are, but with opportunity - when the opportunity is there, that's where the capital will come. There used to be a statement that was said long ago. “Liquidity will always go to the greatest risk adjusted return. You just got to give it time.” We think similar prospects will happen this time around in the private market. Assets will likely correct to levels that become attractive again on a valuation basis and on a post pandemic, but more importantly, a free cash flow basis. As that happens, with a slightly lower cost of capital given where yields have gone to, we expect the private markets to begin to re-liquefy themselves again, but this is one step at a time. First and foremost, bridge period of loan financing coming from central bank authorities and that has happened. So, step one - we're there. Step two, we're going to need to see clear communication across the board not just from Federal authorities or governmental institutions, but also the private sector. We have a March 22nd meeting coming up by the Federal Reserve in the United States. We have the European Central Bank meeting today. We're going to get more clear communication about the mandate. In the short term, the mandate should shift to a certain degree more towards financial risk protection and away from inflation risk protection, but central banks will likely clearly communicate that they have a double mandate and they will do everything in their power to make sure that they try to walk that double mandate. The shift in the next few weeks - at least possibly maybe the next two to three months - we're more than likely to be an increasing focus clearly on financial risk. So wouldn't be surprised if central banks, after their next move, paused, [assess] exactly the long and variable lag of previous hikes, assess the quantitative tightening, and tightening of financial conditions impact, and then ultimately re-kickstart their hiking program if needed once financial conditions settle down again or financial market risk settles down again or the long and variable lag could come through and showcase, at least in our opinion, that inflation is actually coming down. Forward looking inflation is still very much within the Fed's target. Backward looking inflation is not. When those two things converge, that's where central bank policy ultimately indicates that the pause is the right way to go. So, we've got some time here. Over the next two to three months the inflation dynamics should become more in favor of forward looking inflation what they're telling us and flashing certain signals that it's coming down relative to backward looking type of inflation statistics. So it wouldn't surprise us at all if there was a pause, but still our B of A Global Research Economics Team is expecting a 25 basis point hike literally next week. So clear communication - that’s ongoing. That can't stop. That has to go throughout all the meetings that we see whether it is on the economy, whether it's on leverage, whether it's on the banking system or literally reserves and central banks around the world and that also goes into the corporate profit. Corporate profits, in our opinion, and corporations will likely begin to put a lot of things in the kitchen sink that they weren't going to do, but they're going to do it this time around because the environment is telling them that if there's going to be negative estimate revisions, let's get it out of the way, let's clear the decks, and let's move forward. The investment community will likely give corporations a pass that are going to do that. That could come in the form of cost cutting. It could come in the form of simply negative estimate revisions down to much lower levels so we can re-kickstart. We expect that to happen throughout the back half of the year. Clear communication - step two - very important. Step number three - portfolio repositioning to subside. We're seeing it in front of us right now. There's a lot of repositioning going on. We've been witnessing this for the better part of six months. A big movement initially from growth to value-based sectors and industry groups and companies and then a shift back. Once interest rates were starting to come down and yields were starting to come down in the back half to begin the year, you started to see the growth side of the equation which overcorrected to a certain degree start to outperform. Now you're seeing the growth stocks outperform because the view is that growth is going to be much lower than expected because of the situation that has unfolded, so the growth side of the equation is picking back up and the yield side and conservative side is also picking back up because as bond yields come down, some higher dividend yielding equities that are in the more conservative sectors like utilities are beginning to outperform. So, you're seeing a ton of portfolio repositioning. You’re also seeing de-risking at the same time for global asset allocators around the world, systematic institutional investors as well, and even on the momentum side so that’s why you get very big swings in the market from day to day. It’s very headline risk type of market, fragile market, but at the same time, you see a lot of portfolio repositioning. When do we expect this to subside? In the next earnings quarter we should have a much better outlook on inflation, Fed policy, and the next earnings announcements and the prospective earnings announcements as to what companies are going to do. My expectations in the chief investment office here that we expect portfolio repositioning to subside in the next three months to help us have a little bit less of a volatile backdrop. Step number four, understanding the impact of all this. The knee jerk reaction is to say that things have changed forever. You're starting to hear that out in the halls. You’re starting to hear that on the business media and in the headlines. Things have changed forever all the time. When you go through systemic events, when you go through liquidity crises, when you go through very nervous timeframes, when you go into recession, and when you go into a whole new cycle there’s new leaders, there's new innovation, there's adjustments everywhere. First and foremost, the US economy is extremely resilient. Particularly coming out of the pandemic, the US consumer is very resilient. The job market with low labor pool is still going to be an issue in the years ahead, but again, as Millennials and the Gen. Z cohort continue to age, that labor pool should start to widen out. That also gives companies time to automate the areas that are commoditized, the areas of jobs that simply can be handled by frankly automation or robots. Those are all things and adjustments that need to take place. Re-shoring, on shoring, away from a global interconnected supply chain for everyone. That's not necessarily de-globalization, but it's re-globalization. It's a change to how we do business today, but it's not going from one side of the boat to the next, but you're going to hear a lot about that. The impact of what the chain of events that is still unfolding and once we stabilize is still going to be things like tighter lending standards, higher regulation on the smaller banking franchises, but it also creates bigger opportunities frankly for the areas that are healthy, higher quality. Even though lending velocity is likely to come down in general because we could be going into a mild recession sooner rather than later, coming out on the other side in a much better shape is what we foresee and that lends us to believe that a lot of the higher quality areas throughout the marketplace/throughout the economy will be those providers of capital in a very, very strong way. It'll be a change to how things are done to a certain degree, but it's not going to push it backwards at least in our opinion. It will be an adjustment as to how things get done and again, higher quality relative to lower quality is the way we would think about it. Also, it could bring forward the earnings recession that everyone's been talking about that has been delayed. Largely speaking, because companies will use this as an opportunity to put everything in there, clear the decks, and start anew and that lends itself to slower growth, estimate revisions going down one more time, and then ultimately most likely tighter regulation, higher lending standards, and that means financial conditions are going to remain tight for a period of time. We expect this to cease and start to subside itself heading into 2024, but we've got some frankly wood to chop before we get there but understanding the impact is likely to be between now and the end of the year, “What ultimately happens to profit forecasts, economic forecasts, etc. and also inflation?” All of which could bring forward what we've all been waiting for, which is that move into recessionary times which also brings forward the bottoming overall and also brings forward the turn. So that brings us to step number five. This is when the reset ends. What's the reset? The first reset is you need liquidity. The second is how does portfolio repositioning subside? The third is understanding the overall impact of growth. Once you have all that, the reset ends at least in our view and you could start to see what's on the other side. Now, here's where it gets interesting, “What's on the other side?” is one thing. “What are the leaders to help us get to the other side and through and grow the other side?” is another thing and that's still, in our opinion, is the old economy sectors - it's parts of technology, it's a good portion of the industrial base, it’s the changes to how small businesses will receive their capital and funding of the future. The knee jerk reaction is to suggest that venture capital is going to go backwards, that the high growth sector, the innovation sector, the pre-IPO sector of our economy is going to grow a lot slower in the years ahead. The knee jerk reaction is to suggest that in some cases the game is over. That's simply not how commerce works. That's not how the capital flow works. Ultimately, you get through the challenges. The opportunity set becomes wide again. It may be in different areas and different providers of capital, but overall, this is a bridge period that we have to work through but once we come out on the other side, markets tend to climb the wall of worry. As the reset ends that's what we expect and we expect another long-term bull market to be born once again this time led by earnings, not by PE multiple expansion. Long term bull markets that are led with a tailwind by earnings and profits that ultimately grow again lend itself to a little bit more of a consistent bull market, a longer one at least in our view, and less volatility overall. Now, the volatility might be a little bit higher than what we're all used to because we don't have 0% interest rates anymore, but the choppiness of the movements should be less. So less episodic volatility, perhaps a higher level of volatility because yields are higher, cash yields are higher, and ultimately an understanding of where we're headed is higher, but when you think through the next decade, when you think through the next five, or six, seven years, the prospects haven't changed. The prospects still are, “Where's the growth? Who's going to be the profit drivers? How do we invest in those areas?” and most importantly without question at least in our opinion is at the top of the mind is a diversified portfolio. We firmly believe, although it's been called into question so many times in so many cases over so many decades, that a diversified portfolio, rebalancing mechanisms when things get tough or when things get too good, is a solid investment process. Having a plan, being ready, and as we get to the other side, we're starting to invest in those areas that will be the new leaders. If you do it on a dollar cost averaging basis as cash flow comes into the portfolio, you end up getting attractive price movements for you as you're reinvesting. We don't try to time markets. That's for somebody else. We believe time in the markets is the way to think about it. We believe now is the time to let the dust settle. Let things stabilize a little bit. Let's make sure that we're out of this liquidity type of so-called crisis market environment as we get through that, which we think in the next one to two weeks we’ll start to see more clarity on that. We also believe that those facilities will remain if needed and at the same time, we think that yields are now going to come down a little bit closer to where current yields are, allowing some of those assets that did correct to revalue themselves upward. As that happens, we need to be ready, we need to reset expectations, and make sure we have plans to reinvest again. For now, we are neutral equities. We are neutral fixed income. We believe in diversification at its highest level. We want to say higher quality, stick to cash flow where you can, and as we come out on the other side, look for new growth leaders. So that'll do it for the upfront comments for today. Thanks for listening.
Operator: Please see important disclosures provided on this page.
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