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.
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