Simplify Asset Management Chief Strategist and Portfolio Manager Michael Green and Heritage Capital President Paul Schatz join Yahoo Finance Live to weigh in on the state of the markets, the odds of a recession, and what to expect from markets in 2023.

Video Transcript

- I want to bring in Michael Green. He's Simplify Asset Management Chief Strategist and Portfolio Manager. Mike, it's great to see you here. So let's talk about maybe the gains that we are looking at today and comparing that to some of the losses that we've seen over the last couple of trading days. What's your big takeaway from the action that we have seen most recently?

MICHAEL GREEN: Well, I think part of what's happened is that simply by underperforming so much on a month to day basis, we are set up for a rebound. Anyone who is rebalancing a portfolio going into the end of the month that was trying to maintain an allocation between bonds and equities has just seen equities significantly underperform.

And as a result, you head into the end of the month, you start thinking about how do I close out this month with my portfolio allocations as you'd expect? And the sensitivity of the market you saw today I think it was a reaction to that.

- Wanted to mention the R word here. That's the recession and the possibility there of. A lot of market indicators saying there's going to be one in 2023. You're liking this period to an analog. That's the 2000 to 2001 era. Just wondering what similarities you're seeing?

MICHAEL GREEN: Well, the biggest one that I think we're seeing is that we have largely seen a correction on the basis of the high flying, richly-valued names. We're not seeing any indication that markets are really trying to price in a recession, per se, by letting the more cyclical or more levered components of portfolio of the market really deteriorate. Things like credit spreads, et cetera didn't widen out this year.

The underperformance largely appears tied to the Fed's actions-- hiking interest rates, damaging bonds. And going back to that rebalancing characteristic I was talking about, if you were long a portfolio, let's use math simple-- let's say running a 60/40 bond equity portfolio or a 60/40 equity bond portfolio-- at every step in the process this year, the Fed hammered the bond market through interest rates being higher and faster than was anticipated. That, in turn, I think has manifested itself in equities having to be sold. If bonds fall, you have to reduce your equity allocations.

What we have not seen is any indication that markets are starting to price in a significant downturn in terms of the risks of individual companies failing, or struggling to refinance, et cetera. In fact, many of the companies that are highly exposed to things like credit markets themselves are not showing any forms of relative distress. In some ways, they've actually outperformed on a year-to-date basis.

- So Mike, what does all this mean just for asset allocation heading into the new year? Investors who have been a bit scarred by what has played out over the last 12 months, what should they be doing now to best position themselves for 2023?

MICHAEL GREEN: So my bias is, as we head into 2023, we really want to be focusing on true quality aspects, companies that have high, stable profit margins that have very low needs to refinance themselves or tap into the credit markets.

Because the real risk that we have is that products that have historically been thought of as near-cash instruments. So things like REIT funds that offer significant cash flow characteristics or the ability to sell those funds, we're now starting to see components of gating and loss of liquidity in those vehicles. That's suggesting that cash is really becoming an issue for many asset allocators.

In my conversations with institutional asset allocators, they're explicitly struggling to raise cash in this environment as there's demand for cash coming from everything from companies trying to refinance, to private equity firms increasing the equity allocations, and a lack of liquidity events throughout the year are all putting pressure on institutional and retail accounts in terms of the quantity of cash that's in the portfolio.

- All right, I want to bring in now Paul Schatz, Heritage Capital President. Thank you for being here today. We had some technical difficulties. Glad you could make it.

We were talking about-- or I was talking about the Santa Claus rally a little bit ago. Love seasonality plays. What can you tell us about what we might expect for the new month and year?

PAUL SCHATZ: Always good to be with you. Sorry for the technical issue. From a seasonal basis, this is the strongest time of the year. So let's remember Santa Claus rally started at the close last Thursday. It's the last five days of the year, the first five of the new year. That's it. There's nothing more to be said about that.

You know, Santa is limping along. Obviously today gives him a little bump. But look, the real money's not coming back in, are not going to leave the market until we get into January and earnings season.

So you're still in a super favorable time of the year. I've done a ton of data mining on this. And the next seven months, I think don't think have been down since the 1940s. The period from the mid-terms until the first half of next year, kind of the same thing. Third year of a first-term president, you've got-- it's the best set-up we've had just from a numbers standpoint. You haven't been down since Germany invaded Poland in '39.

And people will say, look, the fundamentals are terrible. You've got the Fed raising rates. You've got inflation. You have recession coming. That's all well and good. But every time you've had a big mid-term year decline-- you know, 2018, 2002, you know, 1974, 1994, and so on and so forth, they all have led to these monster years that we're coming into.

And it's because so much gets priced in the year before. And people say, well, we haven't priced it enough yet. Look, the NASDAQ's going to be down 35%-ish. So is it 2008 again or 2001, 2002? I don't think so.

I think next year, regardless, is an up year. And it could surprise an awful lot of people. Wall Street couldn't be more negative. So when do they ever get it right en mass? They don't. So I think next year, regardless of how rough the first quarter is, we're going to be up significantly.

- Well, Paul, talk about what that significantly exactly means. You're looking at the S&P at the levels today. Obviously, been under a tremendous amount of pressure off, what, 19% in 2022.

When you look out into 2023 at the end of the year, where do you think we'll be?

PAUL SCHATZ: Well, I'll say this-- a lot depends on which scenario unfolds. So the base case is we're going to have a mild recession. We have a mild recession, stocks go up 15% to 20%. No recession, 20% to 30%. A deep recession-- which I don't think-- I think that's pretty unlikely. But even if we have a deeper recession, stocks will be up mid-single digits.

Again, to me, it all boils down to, are stocks going to react negatively when we get the barrage of Q4 earnings coming out in January? And the key is, are our stocks are going to sell off on the bad news? Everyone knows earnings are going to be weaker. And everyone knows companies are going to pre-announce.

If the market doesn't get hit by the bad pre-announcements, I will tell you that all the negative scenarios are factored in for 2023. And it's going to be a fun year. I mean, who's left to sell?

- Hopefully not too many people. I hope it's a fun year, too. And we've got to leave it there. But really, thank you two both for coming by here, Michael Green and Paul Schatz.