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MR. MICHAEL CEMBALEST:  Good morning, everybody.  This is the mid-October Eye on the Market.  Just a few quick topics as we buckle ourselves up for the election.  The first page this week deals with the question of pre-election processing of absentee ballots.  And the reason that's important is if Biden wins Florida and Texas, you could have a winner announced on election night.  But if Trump holds those states, as he did last time, and it comes down to some of the Midwestern swing states, it could be a while before the winner is known. 

And the reason is because a couple of important states like Pennsylvania and Wisconsin share an unholy trinity.  One, they don't have experience with large numbers of absentee ballots.  Two, they don't allow any pre-election processing of absentee ballots.  And three, there swing states with large numbers of electoral votes at stake.   And both Ohio and Michigan are very similar in terms of rules that don't really allow a lot of substantial pre-election processing of these absentee ballots.

We get into a gruesome discussion here on the bottom of the first page on the process of counting absentee ballots and why it takes so much time.  But the bottom line is, trust me on this, it does take quite a bit of time to process this stuff.  And so far there have been over five million absentee ballots admitted nationally, compared to just 75,000 by this point in 2016.  So it may take a few days for a winner to be announced. 

And there's a page here for anybody that wants to subject themselves to abject cruelty.  We have a chart here that shows a combination of absentee and mail-in voting experience in 2016, whether it's a swing state, the number of electoral votes, a code on absentee ballot processing rule, and another code on absentee ballot counting rule.  So if you're a glutton for electoral punishment, you can take a look at this chart.  But the bottom line is that Michigan, Ohio, Wisconsin, and Pennsylvania may be the source of some substantial election-related delays.

The next thing we discussed this week is a Rorschach test where you look at an inkblot and you see what does this mean to me?  We have a Rorschach test on COVID here.  There's a chart showing that the big sky states in the US, Idaho, Montana, the Dakotas, Wisconsin, Wyoming have infection rates that are ten times higher than the three Canadian provinces that are directly adjacent to them.  Their population densities are the same, generally the same; they're testing at roughly the same rate.  And it's an interesting exercise to think about why the infection rates are ten times higher and mortality rates six to seven times higher in the US, in these states than in the adjacent Canadian provinces, which is kind of remarkable.  

The bottom line is the US is still dealing with some residual infections.  The level of mortality is obviously much lower than it was in the spring, but we're starting to see a trend where rising infections in young people who make up a larger component of recent infections are translating into rising infections in older people and rising mortality in older people.  It's already happening in Spain, again at a much lower level than it did in the spring, but there are some potential shoes to drop here as we go through the winter months.  The good news is places in Latin America, infections are now rolling over from very high levels.  And there's even some good news in Italy, which is not experiencing any kind of infection spike seen in the rest of Europe.

So let's talk more about politics and the election.  In recent Eye on the Market notes, we have this chart that shows, roughly speaking, a plan that raises, you know, 3 to $4 trillion in taxes on the wealthy and on the corporate sector from Biden's agenda and spending close to 8 trillion.  So the implication is that two things, number one, Biden's agenda involves a lot of stimulus for the US economy, because it's a big gap between 4 trillion in taxes and 8 trillion in spending, and also adds a lot more to the federal debt by the end of the decade.

Now, we've been focusing on this because of the rising market-implied probabilities of Democratic sweep.  Now, that said, we've now gotten some estimates of a second Trump term in terms of what that would do to spending and debt.  And the deficit impacts of both candidates' plans are not that different.  This is from the Committee for a Responsible Federal Budget.  Now, I don't know how much of a second term Trump agenda would ever get passed because of the likelihood the Democrats retain the House.  But for the record, the Trump administration plan, which calls for lower taxes, more spending on military and infrastructure and space travel, lower drug prices, and reduced spending on immigrants, so that all translates into a lot of fiscal stimulus as well.

And so I think right now that's been well-received by the equity markets, that both candidates would keep those fiscal taps flowing.  And the markets also believe that there's a willingness by the Federal Reserve to keep a lid on interest rates if the debt markets ever revolted.  It is interesting to notice that rising Democratic sweep odds have not derailed the S&P's rise.  If anything, a brief decline in the odds of a Democratic sweep in early September actually coincided with a little bit of a setback in the market.  

So one of the interesting things has been the tendency for the market this year to latch onto the deficit financing and stimulus proposals by the administration in a positive way and overlook some of the tailwinds, I'm sorry, headwinds associated with much higher levels of taxation.

There are a few other interesting trends that are being priced in as Democratic sweep projections rise.  One is a faster resumption of global trade and lower trade tensions with China.  And we can see this in the outperformance of stocks with exposure to those factors.  The mega cap tech and social media stocks have finally stopped outperforming the rest of the market.  This could reflect greater antitrust scrutiny from a Biden administration, as well as the beneficial impact of Biden spending plans on the laggard value sectors of the economy. 

And then for everybody concerned that higher capital gains tax rates could result in a temporary market selloff as everybody runs for the hills to take advantage of lower rates, there's little evidence that that actually did happen in 1986 or 2012, when capital gains tax rates were increased.

Just a quick comment, some clients have asked about what's going to happen to the carried interest loophole that allows private equity sponsors to have their incentive fees treated as long-term capital gains?  The Biden administration doesn't need to have an explicit point of view on this loophole, because since they're planning on unifying capital gains at ordinary income rates at the same level for people with adjusted gross income over $1 million, the point is moot.  The carried interest loophole can be left in place, but the capital gains tax rates will be the same as the ordinary income ones.  So the Biden administration can sidestep the issue entirely through the approach they're using on unifying tax rates.

The last comment of the week is on vaccine timing.  A lot of public companies have benefitted from Federal Reserve programs on credit availability and cost.  Small and medium-sized businesses, particularly the virus-sensitive ones, are suffering from tighter credit conditions.  From various surveys, it looks like most of them can survive for another three to six months before experiencing severe cash flow shortfalls. 

But at that point, there are some big questions to ask.  So the whole concept of timing of a vaccine is of critical importance for some of these virus-sensitive businesses, many of which our clients own, since that's what's really needed for normalizing consumer behaviors to pre-COVID levels.  So we get into some of the issues this week at the end on vaccine timing. 

I'm going to skip for now some of the issues around how vaccine's not a foregone conclusion, and some of them may be approved with only 50 to 60% efficacy.  The bigger issues are the US ranks in the bottom third, the bottom of the third quartile globally, with respect to trust and in use of vaccines.  So even if a vaccine is approved, only roughly 27% of respondents in a recent poll said they would get the vaccine as soon as it's available.  Another 44% said they'd wait for a while, and the rest wouldn't get it at all.  And the problem with this is if you're part of the cohort upon whom the vaccine doesn't work, right, because as I said, the FDA would approve something with 60% efficacy, if you're part of the 40%, your chances of getting the disease are much higher if the overall adoption rates are low.

But the big issue here is a lot of vaccine companies took funding from Operation Warp Speed, and therefore the US government is going to own in the US and distribute a lot of the supplies.  And their prioritization is going to be healthcare workers first, and then 60 million essential service workers in food and agriculture, transportation, education, energy, wastewater, law enforcement, and then people with high-risk medical conditions, and then everybody else.  

So what does this translate into?  My belief is that if a vaccine is approved by year end, the US is going to end up treating healthcare workers in Q1 of next year, and that most of the remaining populations will not be inoculated until Q3 of 2021.  And while the markets will probably price in the benefits of an approved vaccine upfront, the actual benefits in terms of economic activity and consumer behavior, returning to quote/unquote normal, is probably going to have to wait until true herd immunity is reached through a combination of antibody prevalence resulting from the disease survivors and the people that get vaccinated.  

So anyway, that's the story.  We're all buckling up to prepare for a potentially sloppy few days following the election.  But the big picture is that the US economy appears to be doing okay with or without a second stimulus bill.  And we expect overall levels of economic activity to reach pre-COVID levels by the summer of last year.  So that's it for today, and we'll talk to you next time.

FEMALE VOICE:  Michael Cembalest's Eye on the Market offers a unique perspective on the economy, current events, markets, and investment portfolios and is a production of J.P. Morgan Asset and Wealth Management.  Michael Cembalest is the Chairman of Market and Investment Strategy for J.P. Morgan Asset Management and is one of our most renowned and provocative speakers.  For more information, please subscribe to the Eye on the Market by contacting your J.P. Morgan representative.  If you'd like to hear more, please explore episodes on iTunes or on our website.  

This podcast is intended for informational purposes only and is a communication on behalf of J.P. Morgan Institutional Investments Incorporated.  Views may not be suitable for all investors and are not intended as personal investment advice or a solicitation or recommendation.  Outlooks in past performance are never guarantees of future results.  This is not investment research.  Please read other important information, which can be found at www.JPMorgan.com/disclaimer-EOTM.