WEBVTT - James Abate on the Markets (Radio)

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<v Speaker 1>Our guest is James Zabante, Managing director and chief investment

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<v Speaker 1>officer at Center Asset Management. James. A debate has raged

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<v Speaker 1>through the weekend about whether the FedEx story the FedEx

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<v Speaker 1>News was company specific or canary in the coal mine.

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<v Speaker 1>Can we say it's both? Yes, absolutely. I think we

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<v Speaker 1>are getting the indication with FedEx's announcement that we're going

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<v Speaker 1>into the next D rating stage of the stock market.

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<v Speaker 1>We're now moving away or compounding the D rating from

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<v Speaker 1>interest rate increases and risk premiums increasing to now the

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<v Speaker 1>EPs D rating stage where companies are going to in essence,

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<v Speaker 1>fess up that earnings are not going to be as

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<v Speaker 1>strong as expected. You still have consensus SMP earnings, you know,

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<v Speaker 1>positive for the fourth quarter and heading into two thousand

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<v Speaker 1>and twenty three. So something's got to break here. And

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<v Speaker 1>I think we're still, you know, early on in this

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<v Speaker 1>bear market. Let's remember, you know, we're only about six

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<v Speaker 1>months and about twenty percentage points down from where the

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<v Speaker 1>fifty day moving average crossed the two hundred day moving

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<v Speaker 1>average and holding with the two thousand to two thousand

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<v Speaker 1>to analog. You know, that time period where the fifty

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<v Speaker 1>was below the two hundred was almost two and three

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<v Speaker 1>quarters years and the market was down thirty and there's

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<v Speaker 1>a lot of consistencies between now and back then. James,

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<v Speaker 1>Are you suggesting that the benchmarks at amendment pricing in

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<v Speaker 1>a recession then no, not, not not even close. I

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<v Speaker 1>think you still have the d rating stage coming where

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<v Speaker 1>earnings need to come down. I think one of the

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<v Speaker 1>most useful exercises that we do is look at EPs

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<v Speaker 1>trends and margins from standard deviation perspective, and what that

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<v Speaker 1>does is it highlights you know, first off, companies are

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<v Speaker 1>much more efficient than they've been over the course of history.

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<v Speaker 1>But the abnormality of uh, this positive standard deviation on

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<v Speaker 1>earnings and margins over the last few years is starting

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<v Speaker 1>to come down eqickly as productivity is starting to wane. James,

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<v Speaker 1>how much of that has been skewed by the amount

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<v Speaker 1>of chab by backs that have been taking place? Then well,

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<v Speaker 1>I think, you know, buy backs or something that has

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<v Speaker 1>distorted EPs, and it's been a contributing factor. And unfortunately,

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<v Speaker 1>the new tax regulations which have been put in place

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<v Speaker 1>actually our net of issuance of securities that are going

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<v Speaker 1>to be offered in terms of options, So you know,

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<v Speaker 1>to the extent where the the government, where the Congress

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<v Speaker 1>could have done something genuinely to curb in essence, the

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<v Speaker 1>financial shenanigans that we see is simply just a transfer

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<v Speaker 1>of wealth from shareholders to corporate executives. Unfortunately, they didn't

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<v Speaker 1>take advantage of that. So so the FED sort of

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<v Speaker 1>missed this story last year. Does it look like they've

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<v Speaker 1>missed it this year? Will this be a case for

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<v Speaker 1>the Fed of be careful what you wish for? Yeah?

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<v Speaker 1>You know, Unfortunately, the FED has created such an amount

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<v Speaker 1>of volatility by keeping interest rates at zero and essentially

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<v Speaker 1>monetized the debt that was used to you know, both

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<v Speaker 1>of the economy during the pandemic. Unfortunately, if you kind

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<v Speaker 1>of look at it, the Fed's kind of like the

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<v Speaker 1>arsonist who works as a volunteer fireman to fix the

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<v Speaker 1>damage that they do. Because as a FED we've been

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<v Speaker 1>talking a little bit about that as well. Certainly, Yeah, James,

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<v Speaker 1>that the thing is that about inflation shore it was

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<v Speaker 1>a supply shock to begin with, moving into the demand

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<v Speaker 1>side of things, But how far is it and longer term,

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<v Speaker 1>how far is that the nature of inflation changing structurally?

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<v Speaker 1>I think that's really a key point that the FED

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<v Speaker 1>needs to be aware of because obviously, as you point

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<v Speaker 1>out rightly, the FED can only really control the demand

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<v Speaker 1>side of the equation. UM. I mean, they're on their

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<v Speaker 1>way to what seems to be a four percent terminal rate,

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<v Speaker 1>which will probably put mortgage rates near seven percent, which

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<v Speaker 1>is going to do quite a bit of damage to

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<v Speaker 1>the housing market. They've inverted the curve under you know,

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<v Speaker 1>any maturity, which is going to start having an impact

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<v Speaker 1>on profitability in the financial services sector. UM. When you

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<v Speaker 1>look at the supply side, I think one of the

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<v Speaker 1>things that we've you know, I have concern about, UM,

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<v Speaker 1>is that the recent sell off that we've had in

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<v Speaker 1>a lot of industrial commodities, oil being most important, is

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<v Speaker 1>that you've seen companies with very very low capital spending

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<v Speaker 1>plans actually now start to even pull them back further

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<v Speaker 1>or question, UM, you know whether or not in the

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<v Speaker 1>out years that they will be increasing. So when you

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<v Speaker 1>look at the very simple financial ratio, the asset replacement ratio,

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<v Speaker 1>which is nothing more than capital spending divided by depreciation

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<v Speaker 1>for the aggregate SMP energy sector, that's at the lowest

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<v Speaker 1>level we've seen in more than two decades. So you know,

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<v Speaker 1>basically these couples aren't spending money to add capacity. Yeah,

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<v Speaker 1>I could have implications for future growth. But if we

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<v Speaker 1>look at the problem of inflation, we've had low interest

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<v Speaker 1>rates for a long time and we didn't have a

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<v Speaker 1>big spike up in inflation. Could you argue that it

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<v Speaker 1>was more of the fiscal side, the federal government transfer

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<v Speaker 1>government transfers that contribute more to this than the feds

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<v Speaker 1>low interest rates. But I mean, it doesn't change the

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<v Speaker 1>story that the FED missed it, missed it last year.

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<v Speaker 1>I think they're intertwined, right, because the only way you

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<v Speaker 1>can adopt modern monetary theory or debt monetization by the Fed,

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<v Speaker 1>is to have exceptionally low interest rates because in essence,

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<v Speaker 1>at at the governmental level Congress that is, you know,

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<v Speaker 1>they feel that they can borrow with impunity because in essence,

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<v Speaker 1>the cost of increasing the debt. Like Dick Cheney said,

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<v Speaker 1>you know who cares about the deficit? Well, you start

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<v Speaker 1>caring about it when interest rates go from zero to

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<v Speaker 1>four or five. Yeah, Well this is it, isn't it.

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<v Speaker 1>And that's when people do start caring. And as you mentioned,

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<v Speaker 1>morgage rates going up as much as they likely to

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<v Speaker 1>as well, that's gonna all hurt and might feed through

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<v Speaker 1>into of course what people vote. And we have the

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<v Speaker 1>midterms coming up at Democrats surprisingly turned the tables on

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<v Speaker 1>the Republicans in the posit have been looking at. But ultimately,

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<v Speaker 1>is that the ruling party which ends up all U

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<v Speaker 1>should I say, the ruling party in the White House

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<v Speaker 1>which ends up paying the price electorally? Your thoughts? Yeah,

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<v Speaker 1>I think you know we're clearly in nation divided. Um,

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<v Speaker 1>I think it's likely that the House will turn Republican,

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<v Speaker 1>maybe not to the same margin that its expected a

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<v Speaker 1>little bit, but you know, unfortunately, I think all of this,

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<v Speaker 1>you know, who expected Biden to be this erashmustlike figure

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<v Speaker 1>who would reconcile things and bring calm to the country.

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<v Speaker 1>Unfortunately's only he's only inflamed the uh, the kind of

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<v Speaker 1>you know, the temperature that inherited from from President Trump.

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<v Speaker 1>So you know, I don't see where this goes in

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<v Speaker 1>terms of a better place. I think we just continue

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<v Speaker 1>to be in a in a you know, one side

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<v Speaker 1>versus the other with with an essence, you know, escalation

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<v Speaker 1>almost James, You're always discerning, but you seem more bearished

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<v Speaker 1>now than I can remember. In a while. You know,

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<v Speaker 1>it's it's it's a point in time. But because I

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<v Speaker 1>think people are of the expectation that, um, you know,

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<v Speaker 1>once the FED is done, you know, the assumption is

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<v Speaker 1>that the FED is going to go seventy in September,

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<v Speaker 1>fifty in November December, which gives us a terminal rate

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<v Speaker 1>of about four percent, which is in essence what the

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<v Speaker 1>one year Treasury note is right now. Where I'm concerned

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<v Speaker 1>about is on the earning side, and that's really in

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<v Speaker 1>the Fed excent news that we talked about before. I

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<v Speaker 1>think it's just an indication of where we are. I

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<v Speaker 1>think the other thing that's causing me great concern is

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<v Speaker 1>the geopolitical risk. Um. You know, people are reading some

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<v Speaker 1>of the success and perhaps the meetings with Putin z

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<v Speaker 1>in Um, you know, with regard to Russia and China,

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<v Speaker 1>maybe maybe Russia is giving China advance notice that it's

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<v Speaker 1>about to escalate the conflict in Ukraine. So that's something

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<v Speaker 1>no one really has talked about. James, always a pleasure.

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<v Speaker 1>Thank you so much for joining us. James about it there,

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<v Speaker 1>Managing director in chief Investment at Center Asset Management,