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