Speaker 1: Our guest is James Zabante, Managing director and chief investment
Speaker 1: officer at Center Asset Management. James. A debate has raged
Speaker 1: through the weekend about whether the FedEx story the FedEx
Speaker 1: News was company specific or canary in the coal mine.
Speaker 1: Can we say it's both? Yes, absolutely. I think we
Speaker 1: are getting the indication with FedEx's announcement that we're going
Speaker 1: into the next D rating stage of the stock market.
Speaker 1: We're now moving away or compounding the D rating from
Speaker 1: interest rate increases and risk premiums increasing to now the
Speaker 1: EPs D rating stage where companies are going to in essence,
Speaker 1: fess up that earnings are not going to be as
Speaker 1: strong as expected. You still have consensus SMP earnings, you know,
Speaker 1: positive for the fourth quarter and heading into two thousand
Speaker 1: and twenty three. So something's got to break here. And
Speaker 1: I think we're still, you know, early on in this
Speaker 1: bear market. Let's remember, you know, we're only about six
Speaker 1: months and about twenty percentage points down from where the
Speaker 1: fifty day moving average crossed the two hundred day moving
Speaker 1: average and holding with the two thousand to two thousand
Speaker 1: to analog. You know, that time period where the fifty
Speaker 1: was below the two hundred was almost two and three
Speaker 1: quarters years and the market was down thirty and there's
Speaker 1: a lot of consistencies between now and back then. James,
Speaker 1: Are you suggesting that the benchmarks at amendment pricing in
Speaker 1: a recession then no, not, not not even close. I
Speaker 1: think you still have the d rating stage coming where
Speaker 1: earnings need to come down. I think one of the
Speaker 1: most useful exercises that we do is look at EPs
Speaker 1: trends and margins from standard deviation perspective, and what that
Speaker 1: does is it highlights you know, first off, companies are
Speaker 1: much more efficient than they've been over the course of history.
Speaker 1: But the abnormality of uh, this positive standard deviation on
Speaker 1: earnings and margins over the last few years is starting
Speaker 1: to come down eqickly as productivity is starting to wane. James,
Speaker 1: how much of that has been skewed by the amount
Speaker 1: of chab by backs that have been taking place? Then well,
Speaker 1: I think, you know, buy backs or something that has
Speaker 1: distorted EPs, and it's been a contributing factor. And unfortunately,
Speaker 1: the new tax regulations which have been put in place
Speaker 1: actually our net of issuance of securities that are going
Speaker 1: to be offered in terms of options, So you know,
Speaker 1: to the extent where the the government, where the Congress
Speaker 1: could have done something genuinely to curb in essence, the
Speaker 1: financial shenanigans that we see is simply just a transfer
Speaker 1: of wealth from shareholders to corporate executives. Unfortunately, they didn't
Speaker 1: take advantage of that. So so the FED sort of
Speaker 1: missed this story last year. Does it look like they've
Speaker 1: missed it this year? Will this be a case for
Speaker 1: the Fed of be careful what you wish for? Yeah?
Speaker 1: You know, Unfortunately, the FED has created such an amount
Speaker 1: of volatility by keeping interest rates at zero and essentially
Speaker 1: monetized the debt that was used to you know, both
Speaker 1: of the economy during the pandemic. Unfortunately, if you kind
Speaker 1: of look at it, the Fed's kind of like the
Speaker 1: arsonist who works as a volunteer fireman to fix the
Speaker 1: damage that they do. Because as a FED we've been
Speaker 1: talking a little bit about that as well. Certainly, Yeah, James,
Speaker 1: that the thing is that about inflation shore it was
Speaker 1: a supply shock to begin with, moving into the demand
Speaker 1: side of things, But how far is it and longer term,
Speaker 1: how far is that the nature of inflation changing structurally?
Speaker 1: I think that's really a key point that the FED
Speaker 1: needs to be aware of because obviously, as you point
Speaker 1: out rightly, the FED can only really control the demand
Speaker 1: side of the equation. UM. I mean, they're on their
Speaker 1: way to what seems to be a four percent terminal rate,
Speaker 1: which will probably put mortgage rates near seven percent, which
Speaker 1: is going to do quite a bit of damage to
Speaker 1: the housing market. They've inverted the curve under you know,
Speaker 1: any maturity, which is going to start having an impact
Speaker 1: on profitability in the financial services sector. UM. When you
Speaker 1: look at the supply side, I think one of the
Speaker 1: things that we've you know, I have concern about, UM,
Speaker 1: is that the recent sell off that we've had in
Speaker 1: a lot of industrial commodities, oil being most important, is
Speaker 1: that you've seen companies with very very low capital spending
Speaker 1: plans actually now start to even pull them back further
Speaker 1: or question, UM, you know whether or not in the
Speaker 1: out years that they will be increasing. So when you
Speaker 1: look at the very simple financial ratio, the asset replacement ratio,
Speaker 1: which is nothing more than capital spending divided by depreciation
Speaker 1: for the aggregate SMP energy sector, that's at the lowest
Speaker 1: level we've seen in more than two decades. So you know,
Speaker 1: basically these couples aren't spending money to add capacity. Yeah,
Speaker 1: I could have implications for future growth. But if we
Speaker 1: look at the problem of inflation, we've had low interest
Speaker 1: rates for a long time and we didn't have a
Speaker 1: big spike up in inflation. Could you argue that it
Speaker 1: was more of the fiscal side, the federal government transfer
Speaker 1: government transfers that contribute more to this than the feds
Speaker 1: low interest rates. But I mean, it doesn't change the
Speaker 1: story that the FED missed it, missed it last year.
Speaker 1: I think they're intertwined, right, because the only way you
Speaker 1: can adopt modern monetary theory or debt monetization by the Fed,
Speaker 1: is to have exceptionally low interest rates because in essence,
Speaker 1: at at the governmental level Congress that is, you know,
Speaker 1: they feel that they can borrow with impunity because in essence,
Speaker 1: the cost of increasing the debt. Like Dick Cheney said,
Speaker 1: you know who cares about the deficit? Well, you start
Speaker 1: caring about it when interest rates go from zero to
Speaker 1: four or five. Yeah, Well this is it, isn't it.
Speaker 1: And that's when people do start caring. And as you mentioned,
Speaker 1: morgage rates going up as much as they likely to
Speaker 1: as well, that's gonna all hurt and might feed through
Speaker 1: into of course what people vote. And we have the
Speaker 1: midterms coming up at Democrats surprisingly turned the tables on
Speaker 1: the Republicans in the posit have been looking at. But ultimately,
Speaker 1: is that the ruling party which ends up all U
Speaker 1: should I say, the ruling party in the White House
Speaker 1: which ends up paying the price electorally? Your thoughts? Yeah,
Speaker 1: I think you know we're clearly in nation divided. Um,
Speaker 1: I think it's likely that the House will turn Republican,
Speaker 1: maybe not to the same margin that its expected a
Speaker 1: little bit, but you know, unfortunately, I think all of this,
Speaker 1: you know, who expected Biden to be this erashmustlike figure
Speaker 1: who would reconcile things and bring calm to the country.
Speaker 1: Unfortunately's only he's only inflamed the uh, the kind of
Speaker 1: you know, the temperature that inherited from from President Trump.
Speaker 1: So you know, I don't see where this goes in
Speaker 1: terms of a better place. I think we just continue
Speaker 1: to be in a in a you know, one side
Speaker 1: versus the other with with an essence, you know, escalation
Speaker 1: almost James, You're always discerning, but you seem more bearished
Speaker 1: now than I can remember. In a while. You know,
Speaker 1: it's it's it's a point in time. But because I
Speaker 1: think people are of the expectation that, um, you know,
Speaker 1: once the FED is done, you know, the assumption is
Speaker 1: that the FED is going to go seventy in September,
Speaker 1: fifty in November December, which gives us a terminal rate
Speaker 1: of about four percent, which is in essence what the
Speaker 1: one year Treasury note is right now. Where I'm concerned
Speaker 1: about is on the earning side, and that's really in
Speaker 1: the Fed excent news that we talked about before. I
Speaker 1: think it's just an indication of where we are. I
Speaker 1: think the other thing that's causing me great concern is
Speaker 1: the geopolitical risk. Um. You know, people are reading some
Speaker 1: of the success and perhaps the meetings with Putin z
Speaker 1: in Um, you know, with regard to Russia and China,
Speaker 1: maybe maybe Russia is giving China advance notice that it's
Speaker 1: about to escalate the conflict in Ukraine. So that's something
Speaker 1: no one really has talked about. James, always a pleasure.
Speaker 1: Thank you so much for joining us. James about it there,
Speaker 1: Managing director in chief Investment at Center Asset Management,