Paul Britton, CEO of $9.5 billion derivatives firm, says the market hasn’t seen the worst yet
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The market has seen huge price swings this year – whether it’s stocks, fixed income, currencies or commodities – but volatility expert Paul Britton doesn’t think it’s going to end. there.
Britton is the founder and chief executive officer of the $9.5 billion derivatives firm, Capstone Investment Advisors. He sat down with CNBC’s Leslie Picker to explain why he thinks investors should expect an uptick in related headlines, contagion worries and volatility. in the second half of the year.
(The section below has been edited for length and clarity. See the section above for the full video.)
The person who chose Leslie: Let’s start – if you could show us how all this market volatility is affecting the real economy. Because it seems somewhat different right now.
Paul Britton: I think you are absolutely right. I think the first half of this year is really a story about the market trying to re-evaluate growth and understand what it means to have a 3.25, 3.5 adjustment to the deposit rate of Fed. So really, it’s a matter of the market determining what it’s willing to pay and its future cash flow position when you enter a 3.5 handle when valuing a stock. So it’s a story, what we say is two halves. The first half is the market for determining multiples. And obviously, it wasn’t really a panic or panic in the market, obviously apart from the events that we see in Ukraine.
Selector: There really hasn’t been any kind of horrifying disaster this year. Do you expect to see once the Fed continues to raise interest rates?
Britton: If we had this interview earlier in the year, remember, when was the last time we talked? If you were to say to me, “Oh, Paul, how would you predict market volatility when the broader underlying markets are down 15%, 17%, 20%-25% at most?” I will give you a much higher level than their current position. So I think it’s an interesting dynamic that happened. And there are many reasons too boring to go into detail. But in the end, it’s really an exercise for the market to determine and reach an equilibrium in terms of what it’s willing to pay, based on this unusual move and interest rates. And now what the market is willing to pay from a future cash flow point of view. I think the second half of the year is a lot more interesting. I think it’s ultimately the second half of the year – around the balance sheet trying to identify and account for a real, unusual move in interest rates. And what does that do to balance So Capstone, we believe that means that the CFOs and, ultimately, the balance sheet of the company will determine how they will perform. based on a new certainty rate we have not seen for t 10 years. And most importantly, we haven’t seen a rate increase in the last 40 years.
So I struggle – and I’ve been doing this for a long time – I struggle to believe that it won’t attract certain operators that haven’t drawn up their balance sheets, haven’t done it yet. debt settlement. And so, whether it’s in the limited lending space, whether it’s high interest rates, I don’t think it’s going to affect the big, multi-cap credit companies, IG. I think you’ll see some surprises, and that’s what we’re preparing. That’s what we’re preparing because I think it’s phase two. Phase two could see a credit cycle where you get these idiosyncratic moves and events that, for those who like CNBC and those who watch CNBC, will probably be surprised by some of these surprises and that can cause a change in behavior, at least from a volatile market point of view.
Selector: And that’s what I’m referring to when I say we haven’t really witnessed a cataclysmic event. We’ve seen volatility for sure, but we haven’t seen a major strain in the banking system. We haven’t seen waves of bankruptcies, we haven’t seen a full-blown recession – some argue the definition of a recession. Are those things coming? Or is it just that this time is fundamentally different?
Britton: Ultimately, I don’t think we’ll see – when the dust settles, and when we meet, and you’re talking in two years’ time – I don’t think we’ll see a significant increase in numbers. number of bankruptcies and defaults, etc. I think you’ll see, in every cycle, you’ll see headlines on CNBC, etc., that will make investors question whether there is contagion in the system or not. Which means if a company rolls out something that really wows investors, whether it’s the possibility of not being able to raise financing, increasing debt, or the possibility of them having some cash problems. , then investors like me, and you’ll then say, “Wait a minute. If they’re having problems, then that means other people in that sector, that space, that industry are doing the same thing. having the same problem? And should I recalibrate my positions, my portfolio to make sure there’s no contagion?” So in the end, I don’t think you’ll see a hit large increase to the default amount, when the dust has settled. What I think is you’ll see a period where you start seeing a lot of headlines, simply because it’s an unusual move in interest rates. And I struggle to see how that won’t affect everyone, every CFO, every US company. And I don’t buy this view that every U.S. company and every global company has their balance sheets in such perfect condition that they can sustain the one rate hike we’ve been given. [been] experiencing right now.
Selector: What does the Fed have about recourse here? If the scenario you outlined happens, does the Fed have any tools in its toolkit right now that can get the economy on track?
Britton: I think it’s an extremely difficult job they are facing right now. They have made it very clear that they are willing to sacrifice growth at the expense of ensuring that they want to extinguish the flames of inflation. So it’s a very large plane they’re managing and from our point of view it’s a very narrow and very short runway. So to be able to do that successfully, that’s definitely a possibility. We just think it [an] it’s not likely that they’ll land perfectly where they can bring down inflation, make sure they get the criteria and supply chain dynamics back on track without ultimately creating too much demand destruction . What I find more interesting – at least we’re debating internally at Capstone – is what does this mean from a forward-looking point of view of what the Fed is going to do from a medium to long term perspective? In our view, the market has now changed its behavior and from our point of view makes a structural change… I don’t think their intervention will be as strong as it used to be 10, 12 years after GFC. And most importantly for us, we look at it and say, “What is the actual size of their response?”
So many investors, many institutional investors, talk about what the Fed has said, and they have been very comforting over the years, that if the market is faced with a catalyst that needs appeasement, need stability pumped into the market. I’m going to make a strong case that I don’t think that’s the thing – what’s been described is clearly what the Fed has made – I think it’s a lot further down the line and more importantly, I think the size of that intervention – so in essence, the size of the Fed – will be significantly smaller than it has been historically, simply because I don’t think any central bank wants to return to this situation with inflation said to be on the run. So that means, I believe that the boom-bust cycle that we’ve been through in the last 12-13 years, I think eventually that behavior has changed and central banks will have more likely for markets to determine their equilibrium and eventually freer markets.
Selector: And so, given this whole context – and I appreciate you providing a possible scenario we can see – how should investors position their portfolios? Because there are a lot of factors in the game, and there is also a lot of uncertainty.
Britton: That’s a question we ask ourselves at Capstone. We run a large complex portfolio of many different strategies, and when we look at the analysis and determine what we think some of the possible outcomes are, we all put came to the same conclusion that if the Fed hadn’t intervened as quickly as it used to. And if the interventions and the size of those programs are going to be smaller than they were in the past, then you can draw a few conclusions, ultimately telling you that, if we have an event and we get If you get a catalyst, the volatility you will be exposed to will simply be higher, because of that, an intervention will be further and further away. So that means you will have to maintain volatility longer. And finally, we worry that when you do the intervention, it will be smaller than what the market had hoped for, and so that will also cause a greater degree of volatility.
So, what can investors do with it? Obviously I’m biased. I am an options trader, I am a derivatives trader and I am a volatility expert. Therefore [from] My view I look at ways to try and build in bearish protection – options, strategies, volatility strategies – in my portfolio. And finally, if you don’t have access to those types of strategies, then you should think about running your scenarios to determine, “If we make a sale, and we get the volatility higher volatility perhaps what we have experienced before, how can I position my portfolio?” Whether it’s using strategies like minimal or multiple volatility more defensive stocks in your portfolio, I think they’re all good options. But the most important thing is to do the work to be able to ensure that as you are running your portfolio through different types of cycles and scenarios, you are comfortable with the end result.
