What kind of recession do we need to see to get to that base case that you have a three thousand
First off that's not our base case. It's our bear case. Your bear case assumes a recession that we're still not quite there yet. And
when it really counts for is a mild recession that does not account for you know a financial crisis or some sort of big
action on the back end of this because that's not really how we're set up. Meaning the banking system is very secure. There
is a lot of capital still out there even corporates right against consumer balance sheet is actually in decent shape. So
it'll be a mild recession if we get one and we think the odds are increasing for sure into later this year next year. And so
we can get through that. And the 3000 target really does not assume a deep deep cut. We're assuming about one hundred ninety
five fewer dollars in earnings for next year. That's right. That's what a mild recession would bring. And then you take a
multiple of about 15 of fortune 15 times on that. And that's how you get to those numbers. Now a fair point and I'm sorry about
the bear case versus bad base case. How much percentage now would you give to that bear case if you just see the recession
ISE end of this year early next year increasing. Yes. So typically you know when we do this framework the variable base
is usually sort of 60 percent based 20 percent on the tails. And no doubt that the you know the downside case is increasing
probability is probably something like 50 percent for the bear case now probably 35 percent I'm sorry 50 percent for the base
case. I apologize 35 percent for the bear and 15 on the bull. And the bull really is getting pretty unlikely. The bull case is
sort of this Goldilocks outcome seems unlikely. But you know we'll adjust our targets and that's it. That's what we do. It's
probability adjusted. The reason we wrote the note this week Alex because as you've been saying in this segment you know
that's the number one question we've been getting from clients that we just wanted to put a framework around it for them how to
think about it so they can you know invest appropriately. Because look we've done a lot of price damage right. We want to
be investing into the price damage but we think it's too premature if the risk of recession is still increasing. So
therefore as you move further away from say thirty five hundred which we are now thirty eight hundred is kind of where we are
today. The risk reward is pretty poor. And that's really the bottom line conclusion. We're trying to kind of thread a needle
here and we're never going to call the bottom. Exactly. We're trying we're trying to do is put a risk reward framework around
it for clients so that they can take the proper action at the right time. What's so interesting to me is the ferocious move in
the bond market in many ways one of the selling pressure in the bond market. Higher yields had already happened last couple of
weeks. Just today we get this terrible PMI number out of Europe and the UK and the US and we see an enormous rally in the bond
market. Yields really lower three year yield now 20 basis points lower. And I wonder what you think the reaction function is
going to be from the bond market to the equity market when we seem to be front running a lot of this.
You know this has been one of the things we've actually underestimated this year. You know we started buying bonds in
our asset allocation back in April thinking the worst was kind of behind us that you know the bond market had already priced in
the recovery as far as it was going to go. And we underestimated how far a 10 year could go. So in some ways we saw an overshoot.
This is kind of resetting back towards 3 percent on a 10 year which I would say kind of reflects more of our fundamental
outlook quite frankly on our general view that the Fed has probably already done enough to slow the economy enough to kind
of achieve their goals. Either we're going to get a soft landing or we're going to get a recession is one of the two. But I mean
mortgage rates at 6 percent. It's kind of all you need to know to suggest that the Fed's already gone far enough to slow the
economy in a meaningful way. So does that mean the base case you guys don't expect more rate hikes are just not the kind of 75
bibs that the rest of the market is expecting. No I make it perfectly clear. I mean we would expect the Fed to go forward on
its path. We don't. We don't think they're bluffing. However I do. So I would strongly suggest that the market is pricing in
the continuation of that lasting longer than what reality is going to be. In other words I'm skeptical as to whether the
terminal rate is really going to be 350 or 4 percent. I think it's going to be well well below that. OK. Fair point. So then
let's get to the equity allocation. So how do you make money then in this environment. How do you protect yourself. And then
what do you buy in a discount. Yes. So we've been positioned defensively all year as you noted. I mean we've been probably
more bearish than most. It's worked quite well. There's two search. There's two things I've been working this year
defensively oriented stocks and energy. We've been more neutral on energy because what's happening now. Right. Energy eventually
is going to figure out that growth is slowing too. And actually that the crude market does that look pretty good to me on a
technical basis. So I think energy looks a little bit dangerous now and worry that we're going to fare back into those defensive
areas. And quite frankly we may see a bit back into some of the high quality longer duration growth stocks. If rates if rates
come down here OK because we know recession. Not inevitable yet. So we may see people come back
into trying to buy these you know higher quality large cap tech names if rates are coming down in the absence of evidence that a
recession is imminent that we think that would be a counter trend trade but that could work in the short term. And then and
then the real factor this working Alex is operational efficiency with the markets paying for right now is companies that can
deliver on cash flow and earnings in this difficult environment. And so that that's that's a that's a factor that we've been
tracking closely as working quite well. Yeah. Mike let's getting into that because you guys get a screen for that because the
rhetoric is we're going to see earnings downgrades because of margins like sales can hold up for example but the margin
pressure is just too great. And then you're gonna see the downgrades. What does have that pricing pressure. Real power I
should say. It's not about pricing power so much. It's more about who can just get the sales in the door and then to the
bottom line efficiently. So the companies that screen well are ones that have low inventories to sales growth low CapEx to
sales and then low employee costs as a percentage of cost of goods sold. You know I can't name names specifically here but
you know basically it's it's it's not quite a quality screen. It once again it's more about companies that are being very
judicious with the revenues that are coming in the door and doing a good job of managing the business. And so that can be
you know companies within the same sector. Quite frankly there's better operators and those are the ones that are working right
now. Mean last question Mike as you look at the market and tumultuous few months that we've had where are we already
pricing in your base case. Like where have you been hit hard enough.
Yeah I mean that's what we're trying to figure out now. And we've been most bearish on consumer goods consumer cyclicals
some of the technology conflicts because that's where the over earning was the greatest. But let's be honest I mean those
stocks have come down quite a bit. So I don't think you can make a wholesale call yet either sector. But it does absolutely names
within those buckets where we feel we're looking for our stocks that have not only seen a price degradation but have also seen
the earnings come down. We want to see both. And I think the third factor is they've got to be profitable. Right. We don't
think we're going to go back to this environment for anytime soon even even if we avoid a recession even if we have a
recession recovery. We think this era of paying for kind of profitless growth that that's a that's a trend that's not going
to come back in favor. And unfortunately a lot of those types of companies in the technology space should be really careful with
that. I would say you know one area that looks close like homebuilders are trading with very low multiples. You know if
rates are gonna start peaking out here you know you want to be buying homebuilders into a recession if it comes. So maybe it's
a little bit premature. But some of those things are looking kind of interesting to us just on valuation alone and the damage
that's already been done.