Paul Britton, CEO of a $ 9.5 billion derivatives firm, says the market hasn’t seen the worst

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The market has seen huge price swings this year – be it stocks, fixed income, currencies or commodities – but volatility expert Paul Britton doesn’t think it ends there.

Britton is the founder and CEO of the $ 9.5 billion derivatives company, Capstone Investment Advisors. He sat down with CNBC’s Leslie Picker to explain why he thinks investors should expect an increase in the amount of troubling headlines, contagion concerns and volatility in the second half of the year.

(The below has been edited for length and clarity. See above for the full video.)

Leslie Selector: Let’s start – if only you could give us a read on how all this market volatility is taking the real economy into account. Because there seems to be some difference right now.

Paul Britton: I think you are absolutely right. I think the first half of this year was really a market story trying to reevaluate growth and understand what it means to have a level on the Fed funds rate. So actually, it was a market math exercise to determine what he is willing to pay for and a future cash flow position once he enters a level of 3.5 when evaluating the shares. So, it was kind of a story, what we say is two halves. The market determined the multiples in the first half of the year. And there hasn’t really been a huge amount of panic or fear within the market, of course, outside of the events we see in Ukraine.

Selector: There hasn’t really been this kind of cataclysm this year, so far. Do you expect to see one as the Fed continues to raise interest rates?

British: If we had this interview earlier this year, remember, when did we last talk? If you said to me, “Well, Paul, where would you predict that volatility markets are based on broader base markets down 15%, 17%, down to 20% -25%?” I would have given you a much higher level on where they are currently at right now. So, I think an interesting dynamic has happened. And there are all sorts of reasons that are too boring to go into detail. But in the end, it was truly an exercise for the market to determine and strike the balance on what it is willing to pay, based on this extraordinary move and interest rates. And now what the market is willing to pay from a future cash flow perspective. the second half of the year is much more interesting. I think the second half of the year is ultimately about settling around balance sheets trying to determine and account for a real and extraordinary movement in interest rates. And what does this do to balance So, Capstone, we believe this means that CFOs and ultimately corporate balance sheets will determine how they fare based on a certainly new level of interest rates that we have not seen for the last 10 t years. And most importantly, we haven’t seen the speed of these rising interest rates over the past 40 years.

So, I struggle – and I’ve been doing it for so long now – I struggle to believe that this won’t catch some traders who haven’t pulled out their balance sheet, who haven’t discovered debt. And so, whether it’s a leveraged lending space or a high-yielding space, I don’t think it’s going to impact the big multi-cap IG lenders. I think you will see some surprises, which is why we are preparing. This is what we are preparing for because I think it is phase two. Phase two could see a credit cycle, where you get these idiosyncratic moves and these idiosyncratic events, which for the likes of CNBC and CNBC viewers, perhaps they will be surprised by some of these surprises and which could cause a change of heart. behavior, at least from the point of view of market volatility.

Selector: And that’s what I was referring to when I said we haven’t seen a catastrophic event. We have certainly seen volatility, but we have not seen huge amounts of stress in the banking system. We haven’t seen waves of bankruptcies, we haven’t seen a full blown recession – some argue over the definition of a recession. Are these things coming? Or is it just this time fundamentally different?

British: In the end, I don’t think we’ll see – when the dust has settled, and when we meet, and you’ll talk in two years – I don’t think we’ll see a noticeable increase in the amount of bankruptcies and defaults etc. What I think you will see, in each cycle, that you will see the headlines on CNBC etc, will make the investor wonder if there is contagion within the system. This means that if a company publishes something that really scares investors, whether it’s the inability to raise finance, increase debt, or the ability to have a problem with cash, then investors like me, and You’re then going to say, “Wait a second. If they have problems, does that mean other people within that industry, that space, that industry are having similar problems? And I should readjust my position, my wallet to make sure they don’t. is there a contagion? ” So ultimately, I don’t think you’ll see a huge increase in the amount of defaults when the dust has settled. What I think is that you will see a period of time where you will start seeing numerous stocks, simply because it is an extraordinary interest rate move. And I struggle to see how this won’t impact every person, every CFO, every US company. And I don’t share the idea that every US company and every global company has their balance sheet in such perfect condition that it can sustain an increase in interest rates that we have. [been] experimenting right now.

Selector: What does the Fed have in terms of appeal here? If the scenario you outlined holds true, does the Fed have the tools in its toolkit right now to be able to get the economy back on track?

British: I think it’s an incredibly difficult job that they have to tackle right now. They have made it clear that they are willing to sacrifice growth at the expense to make sure they want to extinguish the flames of inflation. So, it’s a very large plane that they’re running and from our point of view, it’s a very narrow and very short runway. So being able to do it successfully is definitely a possibility. We just think it is [an] unlikely chance they’ll nail the landfall perfectly, where they can dampen inflation, make sure they get the criteria and dynamics of the supply chain back on track without ultimately creating too much demand destruction. What I find most interesting – at least that we discuss internally at Capstone – is what does this mean from a future perspective of what the Fed will do from a medium to long term perspective? From our point of view, the market has now changed its behavior and this from our point of view involves a structural change … I don’t think their intervention will be as aggressive as it once was in the last 10, 12 years after the GFC. And the most important thing for us is that we look at it and say, “What is the actual size of their response?”

So many investors, many institutional investors, are talking about the Fed put, and over the years they have been very happy, that if the market is faced with a catalyst that needs calm, it needs stability injected into the market. . I will strongly state that I don’t think that put was – what has obviously been described as the Fed put put – I think it is much more out of business and, more importantly, I think the size of that intervention – so, in essence , the size of the Fed put – will be significantly smaller than it has historically been, simply because I don’t think any central banker wants to get back into this situation with inflation likely on the run. So, what that means is that I believe this boom bust cycle we’ve been through for the past 12-13 years, I think that behavior has eventually changed and central banks will be much more able to let the markets determine their equilibrium and the markets. in the end they are freer.

Selector: And so, given all this context – and I appreciate you outlining a possible scenario that we might see – how should investors position their portfolios? Because there are many factors at play, including a lot of uncertainty.

British: This is a question we ask ourselves in Capstone. We manage a large complex portfolio of many different strategies and when we look at the analysis and determine what some possible outcomes are, we all draw the same conclusion that if the Fed does not act as quickly as it once a. And if the intervention and size of those programs will be smaller than they historically were, then you can draw a couple of conclusions, which ultimately tell you that, if we get an event and we get a catalyst, then the volatility level at to which you will be exposed will simply be higher, because in this case, an intervention will be further away. Hence, this means that you will have to sustain volatility longer. And in the end, we worry that when you get the intervention, it will be smaller than what the market was hoping for, and therefore that will also cause a greater degree of volatility.

So what can investors do about it? Obviously I’m biased. I am an options trader, I am a derivatives trader and I am a volatility expert. Like this [from] my point of view I look at ways to try to build downside protection – options, strategies, volatility strategies – within my portfolio. And ultimately, if you don’t have access to these types of strategies, then he’s thinking of running your scenarios to determine: “If we get a sell off, and we get a higher level of volatility than we may have experienced before, how can I position my wallet?” Whether it’s using strategies like minimal volatility or more defensive stocks within 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 when you run your portfolio through different types of cycles and scenarios, you are comfortable with the end result.


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