百万与万亿

FEMALE VOICE:  This podcast has been prepared exclusively for institutional, wholesale, professional clients, and qualified investors only as defined by local laws and regulations.  Please read other important information which can be found on the link at the end of the podcast episode. 

MR. MICHAEL CEMBALEST:  Greetings, everybody.  This is Michael Cembalest with the February Eye on the Market podcast, in which I'm going to answer some of the questions we've been getting on the Coronavirus, US equity market concentrations in the mega cap stocks, which have been soaring, the Democratic healthcare plans after the Iowa caucuses, and just a couple of brief comments on student loans.

So a few weeks ago, as everybody knows, scientists who studied the transmission of animal-borne illnesses to humans were ringing alarm bells about the Coronavirus, based on the infection rates, flight bookings, train bookings, car trips, and all sorts of estimates of disease parameters on transmission mortality.  And in mid to late January, the team of scientists that I've been tracking at York University in Toronto had an estimate as high as 163,000 infections in Wuhan alone and a mean reproductive number of 6.5, which is very high compared to SARS, MERS, and swine flus and things. 

But at the time, they also modeled what would happen if there were very aggressive policies on quarantine of infected individuals and suspected infections and contact-reducing policies in terms of how that affected both infected and asymptomatic individuals, which they thought could sharply reduce the infection rates.  And that seems like exactly what's happened.  Their projection from yesterday is down from 163,000 in Wuhan to about a total projected cumulative cases closer to 20,000 to 25,000, out of a population in Wuhan of 11 million.  And they expect a peak daily infection rate to occur in Wuhan within a week. 

Now infection rates in other large Chinese cities are probably one to two weeks behind Wuhan.  So by the time this is done, we're probably looking, we could be looking at 150,000 to 300,000 infections in China, and with the range affected by travel bands and contact rates and things like that.  And so obviously a huge hit to Chinese growth and economic activity in the first quarter, but not the global pandemic that it looked like it was in mid-January.  And obviously we'll have to see what happens; we'll continue to track this.  But it does seem as if the policies that a lot of these virus scientists were recommending that China pursue in mid-January they finally have adopted, which should contribute to at least a slower acceleration and probably a peak infection rate in late February or early March throughout all of China.

Now growth tends to rebound one or two quarters after these outbreaks.  That's the good news.  The bad news is compared to SARS and other periods in the past, China is gargantuan now compared to what it was then, many multiples higher in terms of passenger car sales, the weight in the emerging markets, equity markets, smartphone sales, computer sales, air travel, crude oil consumption, international tourism.  So China is three, four, five, ten times what it was in 2002. 

So I think it's going to be difficult to pinpoint exactly what the economic impact is going to be in China and the world.  It makes sense to sharply mark those down for Q1, but if a global pandemic is avoided and right now that's what it looks like, one would expect a growth rebound to take place in Q2 and parts of Q3, and for the world to regain the trend growth that existed in late December and early January, which was a world that was improving, but slowly.

The second topic that we discussed in this week's Eye on the Market has to do with the remarkable concentration of US equity markets in a few mega cap stocks, the ones you're familiar with, Apple, Microsoft, Google, Amazon, Facebook, and Visa, and how these firms now contribute more to returns and to overall market cap than they have since the year 2000.  And so this kind of concentration in market valuations and returns requires us to have a view on their valuations, particularly after the run that we've just seen over the last few months.  And we've got a whole table of statistics in here. 

The bottom line is that investors are paying a premium of about 1.4 times the market for these stocks, based on their higher sales growth and margins, versus the market.  That premium, believe it or not, is up from parity in 2010.  That's how cheap they used to be and is at its highest level since then.  But this 1.4 times premium is more or less the premium that existed for several years before the financial crisis, and this premium peaked at 1.8 to 2 in the late nineties.  Now nobody should ever invest solely based on comparisons to the most mispriced period in history.  So I guess the way we would summarize this is the opportunity to buy these mega cap stocks at valuations similar to the markets gone, but the premium hasn't reached absurd levels yet. 

The challenge is now we've had this rally since Labor Day.  We're monitoring four big headwinds.  There's antitrust and DOJ investigations on at least half of these companies.  There's digital service taxes in France and other European countries.  There's a lot of overlapping hedge fund ownership.  And then lastly and the one that we explored in the outlook, all these big mega caps are very sensitive to changes in spending by these young unprofitable companies, the fast-growing public and private companies, which we call the YUCs that we talked about in the outlook.  And the market seems to be taking a much closer focus on these YUCs and closer focus meaning less appetite to finance them.  So I think the sweet spot opportunities for these mega caps has probably passed, and at this point, I would expect a fair bit of volatility at least over the next 12 months as we sort out all the issues around antitrust, digital service taxes, and things like that. 

Okay, so in the wake of the Iowa caucus, I wanted to spend time in the Eye on the Market this week on the Democratic healthcare plans.  And to do that, I'm going to rely on a really detailed and fascinating analysis from the Committee for Responsible Federal Budget, which a lot of you will know about is made up of politicians from both sides of the aisle that are retired and now can speak freely about all sorts of fiscal issues like healthcare. 

And here's the bottom line.  There are some charts in here that show this, but under all of the plans, and when I say all, I'm talking about Biden, Buttigieg, Warren, and Sanders, so those are the four plans we looked at, under all four plans, tens of millions of uninsured Americans would obtain healthcare coverage.  Now in the case of Sanders and Warren, this would be financed with trillions of dollars in new budget deficits even after trillions in taxes and worker and employer contributions.  Biden and Buttigieg's plans achieve around half the decline in the uninsured population, but at a fraction of the cost, and fraction meaning less than 10% in terms of measured in new deficits and new taxes.  And in the wake of the Iowa caucus, I think this is going to be an issue that people are going to want to keep tracking. 

And so we go into all the grisly details here.  These estimates are hard to do.  You've got to estimate prescription drug savings.  You've got to incorporate whatever caps people have on healthcare costs growth.  You've got to look at increased taxes on personal and corporate income and contributions, non-healthcare spending cuts.  And you even have to look at this thing called a revenue feedback effect, which is if all of a sudden, companies and individuals are no longer subject to employer-provided healthcare costs that are deducted from their paychecks, their pre-tax income goes up, and therefore has a positive revenue feedback.  So there's a lot of stuff that goes into making these forecasts, but after all the years of reading everything I've seen from the CBO and the OMB, nobody does this better than the Committee for Responsible Federal Budget. 

So the bottom line again is that the Warren and Sanders plans are estimated to add somewhere between 6 and $13 trillion to the ten-year budget deficit, even after the imposition of trillions in income, capital gains, payroll, wealth, and estate taxes.  So that's something that needs to be looked at pretty closely.  We also get, and by the way, the Sanders plan on its own would double the current estimate of the deficit.  We also get, I don't want to go into too much detail, but we discuss how quickly a new Democratic administration and Senate majority, if we get one, could reverse the corporate tax cuts. 

The bottom line is difficult to do under regular rules.  They could rely on reconciliation rules that only require a simple majority.  They wouldn't be able to make any changes after the ten-year budget window.  And presumably they would just raise corporate and personal taxes and increase spending by an equal amount, so it doesn't change the budget window.  The thing that's more interesting to me is how easy it would be for Democrats to raise payroll taxes and subject all earned and unearned income to taxation above a certain level, like 250,000.  And that gets into the whole question of the filibuster.  If Democrats get rid of the filibuster, practically anything could be passed by a simple majority, and Harry Reid, who is the former Senate majority leader, and other progressives are now arguing that the filibuster should be scrapped for that specific purpose, to ensure passage of a progressive agenda, if they end up controlling all three branches of government. 

So that's essentially what we all have to watch as these things play out, is how likely is it that a Democratic, unified government, if one would happen, would decide to abandon the filibuster.  Some people, including some people I talk to in our own government relations group, believe that the moderate Senate and the House Democrats might be reluctant to support all of the big tax increases associated with some parts of the progressive agenda.  But I'm not so sure.  Unified governments sometimes push people to vote for legislation if they think it's their only window in a generation to get something done.  In any case, take a close look at the Eye on the Market today, 'cause we walk through the Congressional and legislative logistics behind what it would take to make those changes to payroll taxes and corporate taxes. 

The last topic for today is last fall, Jamie asked me whether I had ever done any work on student loans.  And I said not really.  And he said, "Well good, so now you can do that."  And so I spent a few weeks pulling together for him a deep dive report on student loans, including an assessment of what went wrong and what could be done next.  I've summarized the 20-page piece in this week's Eye on the Market on just a couple of pages.  And some of the conclusions might surprise you.  According to a comprehensive and really ground-breaking study from Brookings Institute, the primary problem is not one of high and rising costs, in terms of the problems with the system.  Once you take institutional aid and federal grants into account, net college costs are 30 to 45% lower than the gross stated costs. 

The bigger issue is where students have been studying.  The policy changes which allowed that shift to take place and the labor market outcomes, in the year 2000, the top ten schools that made up most student debt were for the most part pretty selective four-year colleges, Penn State, Ohio State, NYU, Temple, University of Minnesota.  By 2014, the top ten list, DeVry, Walden University, Strayer, Kaplan, Argosy, Ashford, all of these for-profit schools instead.  And these for-profit schools also tend to have much higher degrees of reliance on federal student loans. 

So you might say to yourself well what's the problem with for-profit colleges?  Let me tell you.  They have much lower graduation rates.  Their students face much higher rates of unemployment, and much lower median earnings than the entire rest of the system.  And therefore they default on the loans at much higher rates.  And this is known inside the student loan community, 'cause there was also a spike in the for-profit share of student loans in the late 1980s that led to a spike in defaults almost immediately.  And just to put some numbers on it, graduation rates for public and nonprofit regular schools, anywhere from 50 to 70%.  For-profit schools, 20 to 30%.  Median earnings for selective four-year colleges are double what they are for the for-profit colleges.  Unemployment rate, 20% versus 6% for the regular selective universities. 

And finally what this all boils down to is you read so many things in the press about default rates around 10%.  What's really going on with that number?  The default rates are much closer to 5 or 6% for regular selective and somewhat selective colleges and 25 to 30 to 35% default rates for the for-profit colleges and the certificate-based two-year colleges. 

So instead of blowing up the entire system and redesigning it from scratch and spending almost $1 trillion writing off all student debt, I think it makes sense to preserve the part of the system that's working now for borrowers.  And there's a lot of stuff that we discuss in here, like designing a system where student loan repayments are linked to post-graduation income and not automatically fully amortizing, amounts get automatically withheld from each paycheck, you can introduce risk-based underwriting based not on the individual, but on the school.  There's a lot of things like that that can be done.  But to spend somewhere between 1 to $1.5 trillion writing off all student debt, and making tuition free at public universities appears to collide with other competing priorities in infrastructure, healthcare, and renewable energy.  So I think it makes sense to preserve the part of the system that's working and address at a much lower cost the part of the system that isn't. 

So that's the story.  You can read about all these topics with links to all of the things you want to look into in detail.  Thanks very much for listening, and we'll talk to you again in March.  My plan is that the next Eye on the Market will be our annual energy paper where we're going to touch on among other things, what's going to happen to US energy independence.  Thank you, bye.    

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 JPMorgan Asset and Wealth Management.  Michael Cembalest is the Chairman of Market and Investment Strategy for JPMorgan 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 JPMorgan 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 JPMorgan Institutional Investments Incorporated.  Views may not be suitable for all investors and are not intended as personal investment advice or as solicitation or recommendation.  Outlooks and 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.

[END RECORDING]