Pillow Talk

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A new slide has a digital art illustration of brown, grizzly, and polar bears flying through the air and tumbling onto a collection of fluffy white pillows. Text, 2024 Outlook, Pillow Talk. Michael Cembalest, Chairman of Market and Investment Strategy, J.P. Morgan Asset and Wealth Management. January 2024.

JPMorgan Chase Bank N.A. and its affiliates (collectively, quote, "JPMCB", unquote) offer investment products, which may include bank-managed accounts and custody, as part of its trust and fiduciary services. Other investment products and services, such as brokerage and advisory accounts, are offered through J.P. Morgan Securities LLC, quote, JPMS, unquote, a member of FINRA and S.I.P.C.. JPMCB and JPMS are affiliated companies under the common control of JPMorgan Chase & Company, Views expressed herein may differ from other JPMorgan Chase & Company affiliates and employees. This constitutes our judgment based on current market conditions and is subject to change without notice. This has not been prepared with any particular investor in mind, and it may not be suitable for all investors. Investors should speak to their financial representatives before engaging in any investment product or strategy. This material should not be regarded as research or as a J.P. Morgan Research Report. Outlooks and past performance are not reliable indicators of future results. Copyright 2023 JPMorgan Chase & Company, All Rights Reserved. Investment products. Bullet, not F.D.I.C. insured, Bullet, no bank guarantee, Bullet, may lose value. Michael Cembalest speaks in front of a background of shelves filled with ornate ledgers.

(SPEECH)

Good morning, everybody. Welcome to the 2024 Eye on the Market Outlook Podcast, which is entitled Pillow Talk. Some of you may remember that Pillow Talk was the name of a movie from the 1950s with Doris Day and Rock Hudson. If you haven't seen it, there was a Rock Hudson documentary that came out last year that's worth seeing.

Anyway, pillow talk here refers to the picture I have, with a bunch of bears falling into some pillows, which is a metaphor for the increasing talk about soft landing from a hard landing and from a bear market to a non-bear market. And a lot of that talk accelerated at the end of the year when the Fed signaled that they would, in fact, be easing monetary policy in 2024, some of which was predicted, but not quite as much as what's predicted right now, after some of those Fed announcements.

So I want to walk you through some of the topics that we covered in the outlook, some of which we'll discuss on the podcast today and some of which we'll discuss on a couple of podcasts being rolled out over the next couple of weeks.

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The slide transitions to a list of topic bullet points.

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So what are the topics? Let's say we cover some really important leading indicators, which I think had a large role to play in the Fed changing its tune, the uninflation monitor that also is tied into the same thing.

We take a look at equity markets in the US and the issue around the mega-cap stocks which continue to dominate markets, an antitrust monitor which we'll discuss in this week's podcast, the latest on Europe and Japan, which are going in opposite directions, at least from the perspective of equity investors, a global fixed-income monitor, some additional comments on US federal debt sustainability, information on the US consumer, a section on China, and then we have a deep dive on weight-loss drugs.

I've been working on this for a little bit. And I thought it was interesting to include it here in the outlook instead of having it on a standalone basis. Maybe we'll issue it on a standalone basis later in the year. And then in honor of Byron Wien, who passed away last year at the age of 90, Byron used to publish a top-10 surprise list every year. In his honor, I'm going to do one this year as well.

So let's get into the details here.

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A new slide is titled Equities and Recessions. Text, Equities tend to bottom first during recessions. A chart with an X-axis labelled Months since beginning of recession, ranging from negative 6 to positive 32 months, has timelines for seven different recession events, respectively labelled COVID, GFC, DotCom, 1990's S&L, 1980's double dip, '70s stagflation, and Eisenhower, from top to bottom. To the right of the graph is a legend titled, Symbols, Time of worst reading, with symbols for Equities, I.S.M. survey, GDP, payrolls, S&P earnings, housing starts, High Yield default rates, real estate delinquencies, and end of recession. The symbols are placed in their respective positions to indicate their respective times of worst reading along each of the seven timelines. For all recessions except the DotCom, the red diamonds representing equities are all relatively towards the left compared to most or all of the other indicator symbols. Text, Source, B.E.A., Census, N.A.R., Shiller, Bloomberg, S&P slash Dow Jones, JPMAM, 2023. Past performance is not indicative of future results.

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The first chart we have in the outlook is by far the messiest chart I have ever created. But it's worth it. I promise, it's worth it because what it shows is the seven post-war recessions that took place and the sequencing of when things hit bottom, whether they were the equity markets or payrolls or housing starts, default rates, the ISM surveys, GDP. And what you can see here is that with the exception of the.dot.com cycle in 2001, equities bottomed way before the worst readings on the other stuff.

So obviously, everybody's recession forecast-- or most recession forecasts for 2024 are going down with the Fed, easing. But even if there is a recession, I think the important point is that equities tend to bottom way before a lot of the other economic and market data that people tend to focus on, which I think is really important to understand as we head into the next year.

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A new slide has a chart titled, Text, Modest weakness, Coincident and leading economic indicators, percent, Year over year. Its x-axis runs from 1970 to 2023 and its y-axis from negative 10% to positive 10%. It features a solid blue line labelled, coincident indicators, left hand side, and a dashed gold line labelled Leading indicators, right hand side. The two lines are well correlated, and the dashed gold line generally makes movements slightly before the blue line. In the most recent years of the graph, however, the leading indicators are declining sharply, towards roughly negative 8 percent Year over year, while the blue line is still hovering at roughly positive 3 percent. Text, Source, Conference Board, J.P.M.A.M., November 2023.

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Now there are 20-- or at least 22 different leading indicators that we follow on a weekly basis. I just wanted to share two of them that are sending a consistent signal, which is that the coincident indicator, which tells you what's happening right now, looks fine. But the leading indicators look weak. They don't look catastrophically weak. They don't look as weak as they looked in 2020, during COVID.

They don't look as weak as what they did during the 1970s. And they certainly don't look as weak as they did in 2008-2009. But they look like-- they're signaling a run of the mill decline in US economic activity which is consistent with a recession.

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A new slide titled Modest Weakness has a chart titled, Fed funds, effective corporate tax rate, unemployment, productivity growth, right arrow, corporate profits, percent Year on Year. The x-axis ranges from 1998 to 2003 and the chart features a solid blue line labelled Corporate profits model and a dashed gold line labelled Leading Indicator model, 18 month lead. . The two lines are fairly well correlated, and the peaks and troughs of the gold line tend to lead the blue line slightly. To the far right, the gold line is pushing towards negative 15%, while the blue line is dipping slightly below the x-axis. Text, Source, Piper Sandler, Q3 2023.

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And then there's another model that we tend to look at, that looks at a few different variables. And then we extrapolate it out for 18 months. And it does suggest that there will be decline in corporate profits this year. And so both of those models are pointing to modest weakness, maybe a very modest recession. Other leading indicators we look at, particularly some that we like a lot, which is the relationship between manufacturing new orders and inventories, is actually getting better on the margin.

So the big picture here is, it looks like an economic slowdown in the first and second quarter of next year, maybe something like half a percent to 1% growth. I have seen recession forecasts of minus 1%. And I've also seen a bullish GDP forecast for next year of 2%. So the numbers are all over the place. To us, it looks like some modest weakness next year, certainly in the first half of the year, in the neighborhood of a half a percent to 1% GDP growth.

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A new slide is titled, Why hasn't the increase in Fed policy rates caused a US recession? It has two charts. The one at left is labelled, Corporate net interest costs stable despite rising funds rate. It has an x-axis ranging from 1970 to present and features a solid red line labelled, Corporate net interest payments as a percent of after-tax NIPA profits, with a y-axis ranging from 0 to 120%, as well as a dashed black line labelled, Fed funds rate, with a y-axis ranging from 0 to 20%. Periods of recession are shaded in gray, and the lines appear broadly correlated. At the far right, the dashed black line is spiking from 0% in 2020 towards 6% while the solid red line is continuing to decline from about 35% in 2020 towards about 10%. Text, Source, Bloomberg, JPMAM, Q3 2023.

The chart at right is labelled, US corporate sector financial balance, % of corporate gross value added, 4-quarter average. It has an x-axis ranging from 1960 to present with periods of recession shaded in gray, and features a solid blue line labelled, Gross savings less capital transfers, capital expenditures and foreign profits retained abroad, with a y-axis labelled from negative 6% to positive 4%. Most troughs of the line coincide with the periods of recession and those that do are marked with red arrows. Text, Source, Federal Reserve, B.E.A., JPMAM, Q3 2023.

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Now the two biggest reasons, I think, why we haven't had a recession yet in spite of a whole lot of Fed tightening is shown in a couple of charts we have in the outlook, one of which looks at corporate interest payments and the other one looks at the corporate-sector financial balance. So normally, two things happen when the Fed raises rates. Number one, it catches the corporate sector off balance.

And the corporate sector typically, heading into a recession, is over spending in terms of cash-flow generation relative to its capital expenditures. And so all of a sudden, Fed tightening knocks the corporate sector for a loop. They have to tighten their belts really tightly. And that contributes to the recession. And on top of that, corporate interest payments go up a lot because of rising interest rates.

Well, this time neither of those two things is happening. This time corporate cash flow is in surplus as the Fed tightened. And for whatever reason, most of which has to do with the Fed-- with most companies having termed out their duration of their debts-- rising interest rates has not yet led to an increase in net interest payments as a percentage of profits. It's remarkable. We have a chart in here that shows just how unique that is.

It could have something to do with the fact that this was-- people had 10 years to, during a period of financial depression, to term out their debt maturities. And so finally they did. Now usually recessions begin around seven quarters after the first Fed hike. And that's where we stand right here, as 2024 begins. And so we don't know for sure that there's not going to be a recession and if there were one, it might not have already happened. It might be happening over the next two, three quarters. But again, right, now I think it's roughly a 50/50 call. And if it does happen, it's a mild one.

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A new slide is titled, Text, CMBS delinquencies remain low for all but regional malls and office. It has a chart labelled, CMBS delinquencies by property type, with an x-axis running from 2001 to present and a y-axis labelled from 0% to 25%. It features seven colored lines, respectively labelled Regional malls, Retail, Hotel, Retail excluding regional malls, Office, Multifamily, and, Industrial. The lines are all declining after a spike around 2020 except for the orange regional malls line, which has returned above 20%, and the blue office line, which is trending upwards beyond 5%. Text, Source, Moody's JPMAM, November 2023.

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What's notable is for all of the consternation about commercial real estate, if you look at that cash flows and NOI and delinquencies, it's really just the regional malls and commercial urban office space that are getting crushed. The delinquency data is actually getting much better for hotels, industrials, multifamily, and even retail once you strip out the regional malls. And so we have a chart in here on that. It is consistent with an economy that has some real isolated weak points, namely regional malls and office, but where the rest of it is doing OK.

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A new slide titled, Delinquencies rising for subprime auto and credit cards, has a chart titled, US 90+ days loan delinquency transition rates. It has an x-axis ranging from 2004 to 2024 and a y-axis ranging from 0% to 6% and features five colored lines respectively labelled Subprime auto loans, credit cards, auto loans, first mortgage, and second mortgage. At the far right of the chart, only subprime auto loans and credit card delinquencies are still rising significantly, above and approaching 4%, respectively. Text, Source, Experian, S&P Down Jones Indices, JPMAM, July 2023.

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And similarly, in households, the scary cycles are when all the delinquency rates go up together. What we have now is a weird one, where subprime auto delinquencies are off-the-charts bad. But subprime auto is about 20% of the overall auto-origination market. So that's not terrible.

And credit card delinquencies are weakening. But prime auto loans and first and second mortgage delinquency rates are very well behaved and as tight as they've been over the last decade. So again, isolated pockets of weakness but nothing really systemic at this point.

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A new slide labelled, Inflation Monitor, Mission mostly accomplished, has a chart titled, US consumer price inflation measures, percent, 3 month annualized change. Its x-axis ranges from 1985 to present and its y-axis from 0 to 9%, and it has three tightly correlated lines respectively labelled as Cleveland Fed median CPI, Atlanta Fed sticky CPI, and Cleveland Fed trimmed mean CPI. All three lines spike during Covid but are returning to points closer to their 2020 values.Text, Source, Bloomberg, JPMAM, November 2023. To the right of the chart is text. Bullet, Falling supply chain pressures. Bullet, Rising auto inventories. Bullet, Falling used vehicle values. Bullet, Declines in timely measures of residential rent inflation. Bullet, Residential real estate supply coming online, particularly in multifamily.

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Now as tarnished a phrase as "mission accomplished" has been historically in the United States, I think the Fed's mission is mostly accomplished. When we look at different cuts on CPI-- and we show three of them here-- and then we look at falling supply-chain pressures, rising auto inventories, falling used-vehicle prices, declines in very timely measures of residential rent inflation, and also very large amounts of multifamily supply coming online, I think the Fed's justified here in pivoting and thinking about easing rather than tightening.

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A new slide labelled Wage inflation has a chart labelled Wage inflation measures, percent, running from 1985 to present with a y-axis labelled from 0% to 8%. It has a blue line labelled Negotiated raises, average year 1 raise in union contracts, a gold line labelled Atlanta Fed Wage Tracker, and a red line labelled Employment Cost Index Year over year wages. The first two indicators have recently peaked or plateaued around 7%, while the third has recently peaked around 5%. Text, Source, BLS, Bloomberg Law, JPMAM, Q3 2023. To the right is text. Bullet, observed declines in, bullet, temporary help, bullet, manufacturing and overtime hours, bullet, unit labor costs, Quote Job switcher versus job stayer unquote, premium, bullet, share of private industries with rising employment, bullet, voluntary quits rate. Bullet, Rising female labor force participation.

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Similarly, the wage-inflation numbers, those are the things that concern me more. A few months ago, I thought we maybe would be in a situation where consumer prices are falling but wages are really sticky and aren't falling. They've started to roll over-- from high levels, yeah-- but they're starting to roll over.

And then importantly, we're seeing a ton of data, most of which supports the fact that there's weakness in the labor market, declines in temporary help, manufacturing hours, unit labor costs, job-switcher premiums, like how much people get paid when they go from one job to another. Female labor force participation rates are rising. So a bunch of indicators suggest that wage inflation is going to be rolling over as well. So in terms of what the Fed is up to, I think they're justified in thinking about easing.

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A new slide labelled P/E multiples has a chart titled S&P 500 valuations, forward P/E multiple, ranging from 1995 to present and with a y-axis ranging from 12 to 24x. It has a blue line, labelled S&P 500, market-cap weighted which is recently creeping up towards a value of 19x, and a gold line, labelled S&P 500 equal-weighted, which is recently creeping up towards a value of 16x. Text, Source, Factset, JPMAM, December 26, 2023. To the right is text, Bullet, Single digit earnings growth, bullet, single digit returns on the median stock, bullet, compelling valuations in industrials and energy, bullet, continued outperformance of the megacap stocks absent a sharp shift in antitrust enforcement.

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Now where does that leave the equity markets? The equity markets are-- they're not as expensive as they've been but again, they shouldn't be because now we're in an environment of positive real interest rates again. So those crazy high multiples in 2020 and '21 no longer make any sense at all.

And whether you're looking at the market cap, weighted S&P, or the equal-weighted S&P, the multiples are a little on the high side. To us, 2024 looks like a year with single-digit earnings growth, single-digit returns on the median stock. And if we have to go hunting for sectors, valuations in industrials and energy look interesting. And there's nothing, I think, that's going to stop the mega-cap stocks other than a large shift in antitrust enforcement, which we'll talk about in a minute.

But the bottom line here is that the rally towards the end of the year ended up with the market's pricing in a very soft landing already. So I think there's a lot of soft-landing good outcomes that are already priced into the markets.

All things considered, based on our views on growth, profits, and interest rates, a diversified portfolio with a US, tech, industrial and energy-tilted equities, long-duration municipals and treasuries and high-grade bonds, rather than high-yield, and a decent slug of cash seems to make the most sense heading into 2024.

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A new slide titled The Magnificent Seven has a chart titled, Market cap of largest 7 companies in S&P 500, percent of total index market cap ranges from 1996 to present and has a y-axis labelled from 12% to 30%. Starting around 14% in 1996, it peaks at 22% around 2000 before falling again until 2017, after which it surges up to 28 today. Text, Source, FactSet, JPMAM, December 26, 2023.

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We spent lots of time looking at the Magnificent Seven. And wish you didn't have to. And but we do. And those are the largest seven companies in the S&P. It reminds me-- when I joined JP Morgan in 1987 and then I worked in emerging markets, the emerging markets, fixed-income markets at the time, were so dominated that basically, Brazil, Mexico, and Argentina was all that really mattered. And all the other countries that they tried to stuff up in the index weren't large enough to affect anyone's portfolio.

We're getting close to that in the S&P 500. We're now at the highest-ever market cap, almost 30%, coming from just the largest seven companies.

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To the right of the chart is text, Bullet, S&P 500 2023 Year-to-date return, 26%. Bullet, Mag 7 2023 Year-to-date return, 78%. S&P 500 ex-Mag 7 Year-to-date return, 15%.

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And if you think about returns last year, the market did great. The market was up 26%. But you had 78% coming from those seven stocks and 15% from the rest.

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A new slide titled Free Cash Flow Machines has a chart titled, Magnificent 7 growth in free Cash flow versus the rest of S&P 500, Index, 100 equals January 1, 2018, 90-day smoothing. It ranges from 2018 through the present and features a blue line labelled Magnificent 7 and a gold line labelled S&P 500 ex-Mag 7. The blue line peaks around 200 in mid-2022 before shooting up to around 230 at present. The gold line plateaus around 160 in mid-2022 before drifting back down to around 150 at present. Text, source, Bloomberg, JPMAM, December 27, 2023.

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And then we have a whole bunch of charts in here that look like the one we're showing here, which is these Magnificent Seven stocks generate tons of free cash flow compared to the rest of the market, whose cash-flow generation has basically been flat over the last 18 to 24 months, and rising for the big seven.

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A new slide title Valuations adjusted for earnings growth has a chart labelled, Valuations of Magnificent 7 versus median S&P 500 stock. It ranges from 2013 to present and has a y-axis labelled from 0.4x to 2.0x. It features a red line labelled Relative P/E and a blue line labelled Relative P/E ratios adjusted for long term earnings growth expectations. The red line begins at 0.8x in 2013 and peaks near 1.9x in 2022 before falling to 1.4x, then finally rebounding to 1.7x today, while the blue line begins at 0.5x in 2013 and peaks around 1.4x in late 2022, before falling back to 0.9x today. Text, Source, GS Global Investment Research, JPMAM, November 2023.

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So one of the things that we're very attentive to is, are these Magnificent Seven stocks getting too expensive and are going to come back to Earth, like an Icarus moment? If you look at their relative PE versus the market, it looks like they're getting more expensive. But because of the nature of these companies, I think you have to look at them and adjust the relative PE ratio by their relative earnings growth.

And if you do that, they don't look at a line, in which case, the higher valuations is a reflection of much higher earnings growth, both historical and expected. So that's why we spend so much time thinking about antitrust issues, because to me, that's really the one issue that could change the dynamic of profitability that these large companies have been benefiting from over the last decade.

And we have an antitrust monitor in the outlook. If you're not familiar with some of the concepts I'm about to rattle off, you probably should be because of how important they are.

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A new slide is titled, Antitrust Monitor. If you are not familiar with these issues, you should be. It contains 9 bullet points which Michael Cembalest addresses.

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So in the antitrust monitor, we get into the issue of traffic-acquisition costs, which are the tens of billions of dollars a year that Google pays to Apple in exchange for having prime placement on those devices of Google search engines and play stores and things like that.

We get into the question of Google Play Store and Google Play billing policies on android phones, which was the topic of some lawsuits recently. Epic Games won a major judicial ruling against Google just this month, in December 2023, that is still reverberating but was quite a shock.

Google was forced to settle with 38 state attorney generals last month as well, where some restrictions are going to be imposed on them regarding their ability to ensure that other phones, android phones, can't come equipped with other app stores and other billing services.

A judge ruled that Apple is, in fact, exercising monopoly power and does, in fact, earn super-competitive commissions, but has some pro-competitive justifications for what it's doing.

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Text, Bullet, Google and Apple, injunctive relief versus damages. Bullet, Meta, personal social networking market, Instagram and WhatsApp. Bullet, Amazon, Prime customers, Amazon fulfillment and anti-discounting tactics. Bullet, T-Mobile, Sprint acquisition and AT&T slash Verizon subscriber class action suit.

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And there are also lawsuits going on with Meta, Amazon, and T-Mobile from the Department of Justice and the Federal Trade Commission relating to monopolistic behavior and personal social-networking markets, Amazon fulfillment services, anti-discounting tactics, class-action suits. And so it's four pages. It's worth a read, I think, because it does get into the issues that affect the core dominance of these large-cap stocks.

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A new slide titled Europe has a chart labelled, Europe P/E discount versus US. Relative P/E discount based on forward earnings. It ranges from 2006 to present and has a y-axis labelled from 0% to negative 40%. It features a gold line labelled Bloomberg and a blue line labelled Datastream, which are tightly correlated. Both begin in the 10% to 15% range in 2006 before dropping to the 25% to 30% range circa 2009. They then rebound towards the 2006 figures around 2015 before continuously declining to the negative 35% to 40% range now. Text, Source, Bloomberg, Datastream, JPMAM, December 1, 2023.

(SPEECH)

Now on the other hand, let's go to a place where it doesn't have any dominant large-cap technology stocks, which is Europe. I'm on strike in terms of writing a long section on Europe. It under performed the US again in 2023 by around 7%. It is now trading at almost a-- depending on how you measure it-- a 35% or 40% PE discount to the US.

And since 2014, this has been a one-way elevator down. And this has been the mother of all value traps. One day this will end. And one day it will make sense to be long Europe and short the US. After the history of certainly the last decade and the last 25 years or so, I don't think it's a good bet to think that 2024 is going to be that year.

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A new slide is titled, Japanese corporate governance reforms create a better foundation for investing. It has a table titled, Room for Japan to, quote, equitize, unquote. The table has two columns comparing the U.S. and Japan on 7 criteria, including 10-year dividend payout ratio, 70% versus 30%, cash % of market capitalization, 7% versus 21%, share of companies trading below book value, 4% versus 50%, corporate buybacks as % of market capitalization, 2.0% to 3.5% versus 0.7% to 1.4%, Household equity allocation 40% versus 11%, pension equity allocation 40% versus 25%, and household cash allocation 15% versus 55%. Text, Source, Bridgewater, JPMAM, December 2023.

(SPEECH)

Japan, on the other hand, is enacting all sorts of corporate-governance reforms that do create a better foundation for investing. And we have a table in the Eye on the Market that looks at just the stark difference between equity penetration of households and pensions and payout ratios and companies that trade below book value. You think about this. 4% of the US market cap trades below book value. In Japan, it's 50%.

And so we have this table that looks at some of these statistics. There's a lot of room from very low levels for Japan to enact some corporate-governance policies to try to re-equitize its society. It's aggressively trying to do that. We're seeing more outside directors. We're actually seeing the Tokyo Stock Exchange threaten to delist companies that don't take steps to trade above book value. So Japan had a good year last year.

But this one does seem like it has some legs.

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A new slide is titled The low spark of high yield bonds. At left is a chart labelled, US high yield bond spreads, JPDFHTI index spread versus U.S.T., basis points. It ranges from 1995 to present and has a y-axis labelled from 200 to 1400. The line begins around 400 in 1995 before spiking above 1000 in the early 2000s, exceeding 1400 during the Great Financial Crisis, then proceeds through a series of further peaks and troughs to finish below 400 at present.

(SPEECH)

We have a section in here called The Low Spark of High-Yield Bonds. If anybody gets the reference, that's a reference to a Traffic song from 1971 with Steve Winwood.

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To the right is, text, Compared to prior cycles, bullet, stronger interest coverage, better double B slash triple C mix, bullet, lower share of private equity borrowers that are associated with lower recovery rates, bullet, higher share of secured debt, bullet, less use of payment-in-kind bonds. High yield energy spreads are roughly the same as the broad High Yield market but reflect a more profitable universe whose weakest links have mostly defaulted already. The double B slash triple C energy mix is now 63% slash 5%.

(SPEECH)

High-yield bond spreads are low, close to the lowest they've been since 2009. We just want to make sure people understand that there are some reasons for that. Interest coverage is still pretty strong. The split between double B's and triple B's is a little better now. Fewer of the borrowers are private equity borrowers that tend to be associated with lower recovery rates in case of default. There's more secured debt. There's very little use of any PIK-bond-- Payment In Kind bonds. So compared to prior cycles, the spreads are a lot lower. But the risks are somewhat lower. So we thought that was worth mentioning.

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A new slide is titled, Treasury bond issuance, demand and the 10-year Treasury. It has four charts. The top left is labelled, Bond issuance versus budget deficit, percent of GDP. It ranges from 2005 to present and has a y-axis labelled from 0% to 20%. It features a red line labelled budget deficit and a blue line labelled net bond issuance. These lines are tightly coupled and spike during the Great Financial Crisis, then more sharply again during COVID. They remain tightly coupled until late 2022, when the budget deficit begins to increase to the 6 to 8% range while the net bond issuance crashes to the 0 to 2% range. Text, Source, US Treasury, JPMAM, November 2023.

The top right chart is labelled, US T-Bill share of US debt, percent. It ranges from 1995 to 2023 and has a y-axis labelled from 5% to 30%. It begins near 25%, spikes to 35% during the Great Financial Crisis, then, declines to 10% in 2016 before spiking again to 25% during Covid, falling to 15% in 2022, and recovering past 20% today. Text, Source, US Treasury, JPMAM, November 2023. The lower right chart is labeled, Bank purchases of treasuries, percent of GDP. It ranges from 1970 to 2025 and has a y-axis labelled from negative 2% to positive 5%. It shows several large spikes, but none beyond 3% until it spikes beyond 4% during COVID. It then declines to a trough of negative 1% in 2022 to 2023. Text, Source, Federal Reserve, JPMAM, Q3 2023.

Finally, the bottom left chart is labelled Federal reserve Balance Sheet, percent of GDP. It ranges from 1991 to today and has a y-axis labelled from 0% to 40%. It hovers around 5% until the Great Financial Crisis, then spikes as high as 25% in 2023 and ultimately beyond 35% during COVID before declining below 30% today. Text, Source, Bloomberg, JPMAM, November 2023.

(SPEECH)

The big issue here for fixed-income markets is what happens to the 10 year. So obviously we've had a big rally in the 10 year. The simplest way to think about it, our view, is that the 10 year will range from 4% to 5% in 2024. I'd be really surprised, without a deep recession, of a trade much tighter than that. If it does break out of that 4% to 5% range, my sense is that it might trade slightly above 5% because of bond issuance, which has lagged the budget deficit.

And we have a chart in the outlook that shows that the Treasury has fallen behind on issuance. It's at a very high level in terms of the T-bill share of total debt. The Fed's buying less. And the banks are buying less because they're already overloaded with too many underwater treasuries. So all things being equal, some of the financing pressures, I think, might push 10-year treasuries back closer to 5%, at which point, I think they would represent pretty good value.

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A new slide is titled China, Really bad timing. It features a chart labelled, China's index weight, performance and Policy changes. It ranges from 2005 to present and features a blue line labelled, Rolling 3 Year performance of China versus World equities, left hand side, with y-axis labelled from negative 100% to positive 350%, and a brown line labelled, China weight in MSCI EM, right hand side, with y-axis labelled from 0% to 45%. A dashed vertical line at 2021 is labelled, Xi's progressive authoritarianism begins. The blue ling begins around 50% in 2005 before spiking to 300% around 2008, then declining towards a minimum of negative 50% around 2015 before recovering slightly above 0% in the late 2010s. It then heads firmly negative to below negative 50% after 2021. The brown line begins at roughly negative 2% in 2005 and rises steadily to peak above 40% around 2020 before declining sharply to just above 30% today. Text, Source, Bloomberg, JPMAM, December 22, 2023.

(SPEECH)

So to close, I just want to talk about China for a minute. So I have some colleagues who I've worked with for many years that go to our Investment Committee gatherings. And we'll talk about the tremendous opportunity that may be brewing in China. It's been a train wreck of epic proportions for equity investors. And it has been hit with really bad timing. And there's a chart in here that-- I think it makes sense to look at and think about.

Over the last decade or so, as Chinese growth slowed, MSCI made the decision-- because they're the ones that make the decisions about index weights and countries-- they increased the China's weight in the emerging-market index from, let's say, 15% to 40%. So by the beginning of 2021, China represented 40% of the entire emerging-market equity index. So anybody that was anywhere close to index following would have owned tons of Chinese stocks at that point.

And right then, at that 40% index weight, is when China's Progressive Authoritarianism program began. And It started taking pot shots at industry after industry and company after company. And then the US trade war got worse. And over that time, China has under performed world equities by more than 50%. The numbers are just eye-poppingly bad. Since January 2009, US is up over 100%. Europe is up 60%, trailing. China is down 17%. So this is a train wreck.

And now the US Select Committee on Strategic Competition Between the US and China-- they don't pass legislation. But they're laying out a roadmap. The last bastion of partisanship left in the United States Congress are policy policies targeting the Chinese Communist Party. And there's bipartisan agreement for more tariffs, tighter restrictions on Chinese imports, more restrictions on high-tech exports to China, prohibitions of trade with a broader group of Chinese companies.

(DESCRIPTION)

Text, Equity returns since January 2019, U.S. 107%, Europe 58%, China negative 17%.

(SPEECH)

And then just last week or so, China enacted another policy which drove $0.10 stock down 10% in a day. So this is the ultimate value opportunity. For the last few years, it's been a terrible value trap. And we're monitoring the economic data, which is getting less bad. But at this point, it looks like China would have to do something really unorthodox in order to change sentiment around its economy, international investors, and sentiment about its markets.

Incoming FDI actually went negative last year for the first time in China. So when incoming FDI is negative, that means people are actually selling their investments and taking their money and going home. So I think it's important to monitor anything that gets this cheap.

But I'm not seeing too many catalysts right now. If you had a 5 or 7-year horizon and you believed that China was going to be forced to take steps to reintegrate its markets with the rest of the world, it's worth a look. But the way things stand right now, it's difficult sledding there.

(DESCRIPTION)

Text, A new slide is titled, Stay tuned for additional podcasts on weight loss drugs and my top ten surprises for 2024. It features a 3D cartoon image of a rotund light-colored character in a black bowtie and tophat sitting at a honky tonk piano with a band in the background.

(SPEECH)

So thanks for listening to this first of three podcasts. Stay tuned. The next one is going to be a deep dive on some research we've been doing around weight-loss drugs, how they work, who pays for them, what are their impact on co morbidities, how durable is the weight loss, and then what are the impacts on consumer behavior and equity markets as a result of higher adoption rates. And so thank you very much for listening. And we will see you next time. Thank you.

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(DESCRIPTION)

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(SPEECH)

Good afternoon, everybody, and welcome to the "Eye on the Market" podcast. This is the second of three podcasts linked to our 2024 Eye on the Market outlook. This second podcast is all about weight loss drugs and is entitled The Fats Dominoes.

Now, I know that some of you listen to this podcast, but some of you also watch it. So we've got some visuals I'll be describing in here. If you happen to be listening to the podcast, you can see all of these visuals in the actual Eye on the Market outlook.

And the cover page here shows a large, obese domino playing a piano, which is, of course, a reference to the famous piano player, Fats Domino, from the 1950s and '60s. And I thought about calling this the Fats Dominoes because I wanted to look at the impact-- the domino impacts of these drugs on consumer behavior and the stock market, as it relates to the weight loss drugs but also the price of stocks related to drugs that treat the adjacent conditions and stocks related to unhealthy foods. So let's dive in. Shall we?

(DESCRIPTION)

Estimates of US average monthly total GLP 1 prescriptions. 100 agents, 100 billion by 2030, Roche slash Carmot. A graph depicts US average monthly total GLP-1 Prescriptions by the millions, from the years 2008 to 2030. A solid blue line and solid gold line slowly increase from just above zero. By 2024, the Blue line, which represents Type 2 Diabetes, raises to 4 billion. A projection past 2030 splits the blue line in two. A JPM measure of Type 2 Diabetes reads 12 million, while a Cowen estimate measures at 10 million. A gold line, which represents obesity remains at zero, begins to raise to roughly half a million by 2024. The gold line splits into two dotted lines, with the JPM Obesity prediction exceeding 10 million past 2030. The Cowen prediction rises above 4 million.

Vertical dotted lines mark the introduction of various drugs. Victoza approval occurs in 2010. Trulicity Saxenda approval occurs after 2014. Ozempic approval occurs in 2018. Wegovy approval occurs in 2021. Mounjaro approval occurs after 2022. Zepbound obesity approval occurs just before 2024. Text, Source, TD Cowen, JP Morgan Equity Research, December 2023. Projections start in 2023.

(SPEECH)

So you can see here, whether it's TD Cowan, or Goldman, or JP Morgan, the projections for prescriptions for these GLP drugs as a general class are skyrocketing. They're still kind of low right now, let's say 4 million monthly prescriptions for type 2 diabetes and less than half a million a month for obesity. But there are 100 different pharmaceutical agents under development right now, in addition to the ones that have already been approved.

The general market size in terms of sales is projected to be about 100 billion by 2030. And I thought it was interesting that, recently, Roche pre-empted an IPO by a company called Carmot and bought them for $2.7 billion. And I think you're going to see more of the big pharma companies try to get involved in this space through acquisition.

So here are the big seven questions that we thought were important for investors to understand. First of all, who pays, because that impacts the size of the market. How well do these drugs work for weight loss, and what are their side effects? Do they really reduce comorbidity conditions as much as advertised?

How do they work, and what are the most important trials that could increase the size of the market? Can they be used to treat addiction? What about the issue of injectable versus oral drugs, and then lastly, and maybe most importantly, how do these GLPs affect consumer behavior and, therefore, equity markets linked to them? So we're not going to go through the whole thing. That's what the Eye on the Market document is for, but I just wanted to highlight a few of the main points.

(DESCRIPTION)

Who pays? Potential user base of GLPs by coverage type. Number of people, millions. 40% of employers with health insurance coverage. Medicare, CBO and comorbidities. A graph depicts two bars. For Type 2 diabetes, roughly 7 million will have private insurance, 10 million will have Medicaid and 26 million will have Medicare. For obesity and overweight, roughly 8 million will have no insurance, 80 million will have private insurance, 107 million will have Medicaid and 140 million will have Medicare. Text, Source TD Cowen, November 15, 2023.

(SPEECH)

The who pays thing, I started with who pays, because that's really going to determine the size of the market. And the biggest bucket is, of course, private insurance. A lot of companies are going to try to provide this. Around 40% of all employers have coordinated health insurance coverage. So it would make sense for the drug companies to work with them, rather than the 60% of employers that are self-insured, because they'd have to go company by company.

A lot of companies are saying things like, well, if you've already demonstrated that you've done the following other protocols, we'll provide it. We'll only provide it for a brief period of time. We'll only provide it if you are demonstrating progress. Right?

So because of the cost of the drug, I have a feeling that both the companies and the health insurance companies are going to try to put some roadblocks in the way. The big issue is Medicare, because Medicare is where you would presume a lot of older patients that are overweight and have severe comorbidity conditions would need this drug. Right now, legally, they can't.

The CBO analyzed it and still believes that it would be a net cost to the federal government to pay for this drug, and they've done an open solicitation publicly, asking for more information from the medical community to try to tempt them to change their minds. Like prove to us that Medicare coverage of these drugs would be a net reduction in taxpayer expenses. In other words, we will save money on all these other long-term conditions.

And so some of the most aggressive forecasts of GLP uptake are from analysts who believe that these drugs are not just going to be seen as obesity drugs but will eventually be branded as and consumed as and defined as cardiovascular drugs as well. We're a long way from there right now, but that's what some people are projecting over the long run. But the who pays thing is a big issue due to the cost of the drug, and I think a lot of these questions are still undetermined.

How well do these things work for weight loss? Obviously, it depends. There's been a lot of different trials. I would say, the trials generally ranged from 5% to 15%.

(DESCRIPTION)

How well do GLPs work for weight loss? Weight loss observed in clinical trials. Compares to 25 to 30 percent for bariatric surgery. Increased with dosage time, maxes out at 40 weeks. A bar graph depicts blue bars as approved medications, gold bars as Phase three trials and red bars as phase 1 or 2 trials. Gold bar Retatrutide, LLY ranks at 24% loss of body weight. Blue bar Zepbound LLY measures 21%. Blue bar Wegovy NVO and gold bar Cagri Sema NVO both measure 17%. Three gold bars Oral Semaglutide NVO, Survodutide BI slash ZEAL, and Oral Or foglipron LLY all measure 15%. Red bar AMG 133 AMGN measures 14%. A list of 16 other medications prove gradually less effective. Text, Source TD Cowen, November 15, 2023.

(SPEECH)

General weight loss caps out at 15% ago, after around 40 weeks, and then flatlines.

That compares to 25% to 30% weight loss for bariatric surgery, but obviously, that is a much more complicated medical procedure to undergo that has all sorts of other complications associated with it. So most of the academic research I read, this is really the first wave of weight-loss drugs that appear to "work," quote, unquote. And so this is pretty impressive, and there's obviously a lot more of these compounds that are still being tested.

(DESCRIPTION)

Change in body weight during and after treatment. So far side effects are modest. Rare instances of inflamed pancreas. A graph compares placebo against Wegovy. The percent change in body weight during treatment goes down for both placebo and Wegovy. Placebo patients lose about 3% of body weight around 30 weeks. Once treatment discontinues at 68 weeks, their body weight raises to its initial level by 120 weeks. Wegovy users consistently lose body weight throughout treatment. By week 68, they lost on average 17% body weight. Once treatment discontinues, they gain back weight until week 120, where their weight gain plateaus at minus 6% of their original weight. Text, Source DOM Journal of Pharmacology and Therapeutics, April 2022.

(SPEECH)

The issue is, as you might imagine, once you stop taking them, you generally gain almost all the weight back, and any of those other co-morbidity conditions that you were also benefiting from, those would also revert back to the baseline conditions that existed before you started taking the drugs. So so far, there may be some lingering behavioral benefits for people that get off the drug. But so far, this is not a cure, and this is the kind of thing where you are on these drugs forever, if you choose to take them.

The side effects so far are pretty modest, in terms of nausea and things like that and vomiting in some people. Around 10 to 20% of the people in some of the trials dropped out because it was uncomfortable. There are rare instances of inflamed pancreatitis and things like that, and I would just generally caution people that some of the weird interactions of these drugs don't really get discovered until after the drug is approved, and it's being used in the general population. But again, the point is, that if you're taking these drugs, you're on them forever. That's potentially good news for the drug companies in terms of sales but also bad news, because it means that certain people are just never going to be able to afford the kind of treatment.

(DESCRIPTION)

Primary cardiovascular composite end point. Percent, cumulative incidence. Both the placebo and Wegovy, semaglutide begin at zero percent on the graph. As the months since randomization pass, both lines travel upward. The placebo line ascends at a steeper incline than the Wegovy line. By the end of 48 months, Placebo remains at roughly 9.5% while Wegovy measures 8%. A gap measures a 1.5% difference between the two final end points. Text, Source, Eric Topol, Scripps Research, November 2023.

(SPEECH)

So do GLPs reduce comorbidity conditions or not? There's a lot of work being done to study this. In the big study that came out last year, they tested for two or three years, double-blind, randomized trial, a placebo group, and then the other group was taking Wegovy. The molecular compound is semaglutide.

And the results were interesting, because when I read the Sell Side Wall Street research, it was like, wow, a 20% improvement, that's amazing. And then when you read the academic research and the research from the scientific drug development community, they were like, well, yeah, it was 20%, but the incidence of these cardiovascular events dropped from 8 to 6 and a half on a cumulative basis, over the entire trial. So a 1.5% incidence reduction from 8%, yeah, it's 20%, but in absolute terms, it's modest.

And it took three or four years of the drug treatment to develop this benefit. So there's still a lot of questions here about the comorbidity benefits. It's not clear to me that the Wegovy trial is going to be enough to convince the CBO to change its mind about the long-term net cash flow benefits to the Treasury for covering these drugs.

They did show much greater success in terms of early onset diabetes, reducing those kind of risks. So we'll see, but the important thing to note is that the first set of trials here did, specifically measuring cardiovascular outcomes, did not generate a massively positive result. They were kind of OK.

(DESCRIPTION)

What are the most important trials that could increase the size of the market? A table indicates Cardiovascular for or foglipron, survodutide, Cagri Sema, and tirzepatide. For obstructive sleep apnea, it marks tirzepatide and Retatrutide. For chronic kidney disease it marks tirzepatide, Retatrutide and semaglutide. For advanced liver disease it indicates Survodutide, tirzepatide and semaglutide. For knee osteoarthritis it marks Retatrutide and semaglutide. For Alzheimer's disease it marks semaglutide with the specification of oral use. For Peripheral arterial disease it marks semaglutide. For heart failure, HF pEF it marks Tirzepatide and semaglutide. The name Lilly appears under Or foglipron, tirzepatide and Retatrutide. Boehringer appears below Survodutide. Novo appears below Cagri sema and semaglutide.

(SPEECH)

There's a lot of trials-- pardon me-- a lot of trials ongoing for all sorts of conditions, not just cardiovascular ones-- sleep apnea, kidney disease, liver disease, osteoarthritis. To me, the interesting one is that these drugs appear to work not just through your stomach, by slowing gastric emptying and making you feel less hungry, but they're also doing things to your brain pathways to reduce inflammation. And if that's the case, there may be some other benefits for Alzheimer's and Parkinson's, and so these drugs are being tested right now for those kinds of things as well. So those studies will be really interesting to watch.

(DESCRIPTION)

Text, Source, Goldman Sachs, JPMAM. We capitalize brand names and show molecular compounds as lower case. Boehringer refers to a partnership between Boehringer Ingelheim and Zealand Pharma. GLPs appear to work through brain pathways to reduce inflammation. If so, this could be a promising indicator for potential use of GLPs to treat conditions that involve inflammation such as Alzheimer's and Parkinson's.

(SPEECH)

Any single breakthrough on any of those trials that would end up with the GLPs being categorized not just as weight loss and diabetes drugs but also to treat some of these other conditions would be would be kind of remarkable.

(DESCRIPTION)

Consumption of sweet alcohol by mice taking GLPs. The Placebo consumed roughly 6.7 grams of alcohol per kilogram of body weight. Five bars measure semaglutide dose in milligrams per kilogram of body weight. Those who took a 0.001 dose consumed 4.4 grams. A 0.003 dose resulted in 2 grams. A 0.01 dose resulted in 1.5 grams. A 0.03 dose resulted in 0.7 grams, and a 0.1 dose resulted in 0.9 grams. Text, Source, Journal of Clinical Investigation, Chuong et al, May 2023. Semaglutide reduced bine-like alcohol drinking in mice. GLP treatments significantly reduced alcohol consumption in monkeys, reduced cocaine seeking in rats and reduced oxycodone seeking in rats. Positive results on GLPs plus nicotine patches.

(SPEECH)

They also show some promise, believe it or not, in reducing addiction. So these experiments must be insane to carry out. But they do things like they take two groups of monkeys, and then they give one of the groups of monkeys access to alcohol for four hours a day-- like I can't imagine the protective gear that you'd have to wear in order to be carrying out these experiments-- but they give one group of monkeys access to alcohol for four hours a day, and then the other group of monkeys they don't. And then after about two weeks, they start treating the one group of monkeys with a placebo and another group of monkeys with these GLP drugs.

And what they find is that the monkeys that had been treated with the GLP drugs have significantly reduced inclination to consume alcohol. Which is amazing, because I didn't think you could you could really convince a monkey to reduce its consumption of anything. And they carried out the same experiments and found reduced cocaine seeking in rats, oxycodone seeking in rats, and binge drinking and mice, if you can imagine.

We have a chart that shows that the more GLPs the mice consumed, the less alcohol they consumed relative to their body weight. So again, fascinating experiments to carry out. In terms of humans, there were some positive results on a study that looked at GLPs combined with nicotine patches to reduce smoking. So I thought that was interesting.

(DESCRIPTION)

What share of the GLP market will be injectable versus oral? Physician survey of T 2 D treatment type. A graph depicts in 2026, Existing GLPs will account for 42% of use while next generation injectable GLPs will account for 30%. Oral GLPs will measure in at 28% of use. In 2028, both Existing and Next Generation Injectable GLPs will account for 35.5% of use while oral GLPs will account for 29%. In 2030, Existing GLPs will reduce to 28% while Next gen and oral GLPs increase to 38% and 34%, respectively. Text, Source, Survey conducted by JP Morgan Equity Research in February 2023. More side effects, more of the active ingredient.

(SPEECH)

The whole injectable versus oral, obviously, in pill form, they're easier to take. They're easier to distribute. They're easier to store.

The problem is you need more of the active ingredient, and that's common to a lot of different drugs in the oral version versus the injectable version. And the incidence of side effects and the efficacy in terms of weight loss was not quite as big. That said, the projections from the medical community is that, within the next few years, eventually, oral GLPs will be about a third of all of the GLPs out there.

(DESCRIPTION)

How do GLPs impact consumer behvior and equity markets? Year-on-year change in projected units of consumption by household. Meat snacks, GLP Users minus 27%, total US minus 2 percent, difference minus 26%. snack seeds, nuts, trail mixes GLP users minus 31%, total US minus 5%, difference minus 25%. Popcorn for GLP users minus 27%, total US minus 4%, difference minus 24%. Crackers for GLP users minus 25%, total US plus 1%, difference minus 23%. Chips for GLP users minus 19%, total US minus 1%, difference minus 18%. Packaged portable sweet snacks for GLP users minus 11%, total US plus 3%, difference minus 15%. Baking and cooking minus 8%, total US plus 5%, difference minus 13%. Increasingly smaller differences appear between packaged cookies, soft drinks, canned, pasta and noodles, deli and prepared foods, and in-store bakery consumption. Text, Source, JP Morgan Global Equity Research, Numerator, JPMAM, September 17, 2023.

(SPEECH)

So the important part is, what do these things do to consumer behavior to patients with different medical conditions and, therefore, to the equity markets? And so there was a study that JP Morgan equity research did in coordination with this with this consulting firm, and it was interesting. They, instead of just asking people-- because people have insufficient recall-- they actually, for some period of months, aggregated people's supermarket checkout bills and scanned them in with all the codes and things like that. And so they had a good read on about 500 families about what kind of stuff they were consuming and how much of it they were consuming.

And then they split the group to see what happened to the group where people, family members, started to take GLPs. And as you can see here, massive declines, 20 to 30%-- crackers, popcorn, meat snacks. Meat snacks is I think like a synonym for Slim Jims, which may possibly be one of the most unhealthy snacks you could possibly eat.

And then 10% to 15% declines in cookies and soft drinks and and deli foods and things like that. So that's pretty remarkable, and so it was it's not surprising that, once these kinds of studies got out there, you saw a knee-jerk reaction last year, in the late fall, where beverages, food retail, different sugar, not just sugar but alcoholic beverages, the stocks really started to underperform the market pretty substantially. Fast foods and stuff and the GLP companies skyrocketed.

(DESCRIPTION)

The GLP-1 effect on equity sectors and industries. Eight sectors all start on January 2023 at zero percent. GLP 1 manufacturers sharply rise to 60% by November 2023. Calorie rich slash fast food raises to 30% by July, dips down to 15% by October and then rises to 40% by December. Beverages, beer jog between zero to 21% throughout the year. Orthopedic devices stagger between 13% and minus 10% throughout the year. Beverages, sugary jog between plus 5% and minus 17%. Exposed food retail moves up to 5%, then sharply declines below minus 20% by the year end. Insulin pumps reach a high of 5%, then sharply drop to minus 50% by October. They raise to minus 17% by year end. Beverages, spirits trend downwards to minus 20% by year end. Text, Source Bloomberg, JPMAM, December 26, 2023.

(SPEECH)

And then, towards the end of the year, some of the sectors that sold off started to recover and, in particular, insulin pumps and things like that. And so it's hard to say. I think it's possible that the market just moved too fast.

And at the end of the fall, the markets were effectively pricing in an even more aggressive and rapid uptake of these drugs in the population than even some of the Wall Street forecasts, and it seems like that some of that changed. I think what's important is I do think that it pays to watch the beverage and caloric fast food space closely, but coincident with changes in coverage. And I know the market's a discounting mechanism, but unless we can see some kind of distant pathways for higher insurance coverage and Medicare coverage, I think some of these things are premature.

And then the last thing, which I think is equally important, is there's a lot of concern that the stock prices of companies that have drugs and treatments for the things that are adjacent to obesity, whether sleep apnea, osteoarthritis, things like that, that those stocks are going to get pummeled. And I think it's important to understand that the universe of people that have osteoarthritis, for example, or cardiovascular problems, only a small subset of those people are obese. So even if the GLP drugs are taken by all the obese people, and even if the GLP drugs are perfectly curative, like so everybody that takes them is cured, there's still a very large group of people that have cardiovascular risks, osteoarthritis, fatty liver disease, things like that, that are not obese that the drug companies will still be treating.

And so we've seen, over the last three four years, examples of when the markets, whether it's renewable energy or hydrogen or things like that, where the markets price in adoption rates that are way more rapid than what ends up turning out to happen, and I think there may be some examples of that here. So I think it makes more sense to have long positions in the drug manufacturers because of the market size growing. I think that makes more sense than to try to speculate on the shorts at this point, because there's not enough information available about coverage. Anyway, that's the end of our second of the three podcasts, and we'll be back next week sometime with a podcast on the top 10 list that we included. So long.

(DESCRIPTION)

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(SPEECH)

Good morning, everybody. And welcome to the third and final podcast for our 2024 outlook, which was entitled Pillow Talk. I'm going to walk through the top 10 list just to give you a quick rundown of what was on that list and why it was there.

(DESCRIPTION)

Top Ten list on what MIGHT happen, not what will happen.

(SPEECH)

Before doing anything else, I just want to make it clear-- two things. One, I'm doing this for one time and one time only as an homage to Byron Wien, who published a top 10 list for 30, 40, years whether he was at Morgan Stanley or Blackstone. I had a lot of respect for Byron.

And I never paid that much attention to the articles that came out on how accurate his top 10 list was because I think these things are meant to be projections of things that could happen, not things that will happen. And our industry is so dominated by consensus I think it's healthy to think about the kind of things that could happen and not necessarily what are central scenarios are.

So with that, let me get started.

(DESCRIPTION)

Text, 1, The dollar. A line graph titled, Share of global foreign exchange reserves by currency, showing year from 1973 through 2023 on the x-axis and percent on the y-axis, for US dollar, RMB, A-U-D, C-A-D, CHF, JPY, GBP, Europe and other. The US dollar makes up most of the bottom 2/3 of the graph, while Other and Europe are the second largest, splitting the top third of the graph in about half, and the others are slivers. Text, Source: International Monetary Fund, JPMAM, Q3 2023. Despite all the hand-wringing about the weaponization of the US dollar via US sanctions, the trade weighted dollar ends 2024 plus or minus 7% from where it began. Furthermore, the dollar will retain its roughly 50% share of global trade invoicing.

(SPEECH)

And number one, one of the most common themes I read all year long last year was the sanctions that the United States and other countries are putting on Russia is going to contribute to the de-dollarization of the world, whether it's the Saudis accepting RMB from China for oil and that the emerging world and the BRICS are going to rush rapidly into de-dollarization as much as they can.

Well, maybe. But I'm not seeing a ton of evidence for it yet. And despite all the hand-wringing about the weaponization of the dollar through sanctions, I don't think the dollar is going to end up more than plus or minus around 7% from where it began in 2024. And

(DESCRIPTION)

A bar chart titled, The international role of the US dollar, which shows percentages for various categories. The bars are colored blue for US dollar share of global markets, blue with a dot pattern to show the percent of which are offshore, and gold for US share. Cross-border loans, about 50% US dollar share of global markets, of which about 30% is offshore. International debt securities are just under 50%, about 80% of which are offshore. FX transaction volume is about 90% US dollar share of global markets. Official FX reserve is 60%, trade invoicing is 50%, SWIFT payments are just over 40%. The US share of world trade is about 12%, and the US share of Global GDP is about 25%.

(SPEECH)

I don't think you're going to really see much of a change on this chart that we're showing here, which is the dollar share of around 50% of global trade invoicing, even higher amounts of FX transaction volume, official FX reserves, Swift payments, cross border loans, international debt securities. The dollar is still at least 50% of each one of these things. And I expect it to stay there.

Second

(DESCRIPTION)

Text, [2] Antitrust: the DoJ/FTC will win one. Google: Traffic Acquisition payments for default status on devices, Google Play, Store policies on app distribution and in-app payments. Amazon: restricting eligibility to preferred placement in front of Prime customers only to sellers using Amazon's fulfillment service, and utilizing anti-discounting tactics to punish sellers for offering lower prices on other platforms. T-Mobile: Did its $26 billion merger with Sprint reduce competition in the retail mobile wireless market, allowing AT&T and Verizon to charge higher prices. Meta: did its acquisitions of Instagram and WhatsApp give it monopolistic control of the personal social networking market.

(SPEECH)

one. We had a long section on antitrust risks in the outlook. And the reason is because of just how dominant the big tech companies are in the markets, which we talked about in the last podcast. I think the DOJ and FTC are going to win one. And I don't know which one. And there's four big ones, Google, Amazon, T-Mobile, and Meta. Just as a reminder, the Google antitrust lawsuit has to do with the traffic acquisition payments that it makes for default status on devices and other restrictions that it applies related to the Google Play Store so that in-app purchases have to go through the Google Play Store. That's the Google issue.

Amazon restricts eligibility for sellers in front of Prime customers to those sellers willing to use Amazon's fulfillment service. We'll see how the courts rule on that. And then there's this question about whether or not T-Mobile's $26 billion merger with Sprint reduced competition in the wireless market to the point that AT&T and Verizon responded by charging higher prices. I think those are the big three. I don't think the Meta case-- that there's a lot behind it.

Third.

(DESCRIPTION)

Text, 3, Biden and the 2024 election. A line graph titled, 2024 election, assuming Biden vs. Trump: Average age of both candidates as a % of prevailing non-infant male life expectancy. The graph has a dot labeled with each presidential race from 1790 to 2030. The first, Adams vs. Jefferson is just above 0.9. The peak of the graph is Taylor vs. Cass at 1.1, and the lowest point is Kennedy vs. Nixon at about 0.65. Biden vs. Trump in 2020 is just above 1.0, and Biden vs. Trump in 2024 is just below 1.1. Text, Source: Social Security Administration, CDC, "Decennial Life Tables for the White Population of the United States, 1790 to 1900," JD Hacker, JPMAM, 2023.

(SPEECH)

Look, the projection or the top 10 risk that Biden could drop out of the election between Super Tuesday and the general election, I'm not going out that far on a limb politically. I'm going out far on a limb genealogically. There's a chart that we had in the outlook that I'm showing here on the screen. For those of you watching the video, the Trump-Biden combination is the second oldest group of people ever to run for president even after adjusting for the shorter lifespans that used to exist. And we looked at every presidential pair going back to 1790.

These are two really old guys, both of whom are older than average male life expectancy. So it's not really going out that far on a limb to project that one or both of them would have to drop out of the race for health reasons. I think it could be Biden for other reasons that we discussed in the paper. But this is more an exercise in trying to understand how the political process works and how the conventions process works and how committees get to name candidates at certain stages in the process even though they haven't been vetted through primaries.

And so that's what that section was all about. And it actually had a link to our November paper that discussed that.

(DESCRIPTION)

Text, 4, Level 5 autonomous driverless car backlash is coming. A photo shows a car in the middle of the street blocking a fire truck. A line graph titled LiDAR stock basket. Text, Index (100 equals December 2019). Companies: Aeva, Cepton, Innoviz, Luminar, Microvision, Ouster, Velodyne Lidar. The line starts at 100 at 2020. The jagged line peaks at about 750 just after 2021, then it is a jagged but downward trend ending at 100 in 2024. Text, Source: Bloomberg, JPMAM, December 27, 2023.

(SPEECH)

The level five autonomous car backlash is coming. There's only a couple of places in the United States, Austin and San Francisco, obviously, that allow this kind of thing. And as we discussed in the paper, these vehicles have been blocking emergency responders, running people over.

And the same way that people gradually soured on those horrible urban scooters, I think there's going to be a similar backlash coming for these autonomous cars. Remember, autonomous cars have had a very checkered history. About 7 or 8 years ago, all the major car company CEOs, including Tesla, projected that by 2024 significant portions-- 30%, 40%, 50%-- of their sales would be level five autonomous cars. That is not happening.

The LiDAR stocks have collapsed. And really, the only application that I've seen of successful autonomous vehicles is in kind of protected standalone industrial sites where you have these industrial trucks that are moving things from one place to another.

(DESCRIPTION)

Text, 5, Losses on leveraged loans will rise versus private credit in the next recession. A bar chart titled, BSL Market much less protective than private credit on key covenant features which become even more important in times of economic distress, Percent. The bars show, Inside maturity sublimits: 73% broadly syndicated loans, 14% private credit. Reallocation allowances: 67% broadly syndicated loans, 14% private credit. Asset sale prepayment step-downs: 60% broadly syndicated loans, 11% private credit. 200% contribution clause: 67% broadly syndicated loans, 0% private credit. No IP blocker: 33% broadly syndicated loans, 0% private credit. Text, Source: Moody's Investor Services, October 2023. Also, always-on maintenance covenants and caps on EBITDA add-backs.

(SPEECH)

The fifth one that we talked about this in December in the alternatives review-- for the last few years, the losses on leveraged loans and private credit have been very similar. I think in the next recession, whenever that happens to take place, the losses on leveraged loans are going to be a lot higher. And just the underwriting standards in the loan markets have been generally terrible.

And we walked through kind of these maturity sublimits, reallocation allowances, prepayment step downs, no IP blocker. All of this is complicated legalese for the leveraged loan lender community sacrificing the terms and covenants that it used to have and which the private credit industry still tends to apply. EBITDA add-back restrictions are another example of where the leveraged loan industry allows a lot more creative underwriting and lending for purposes of leverage than the private credit market. So that's prediction number five.

(DESCRIPTION)

Text, 6, Argentine dollarization will probably fail if attempted. Milei proposals/milestones so far: Privatization of airlines, energy, rail, media, water and sewer. $20 billion cuts in public spending. Liberalize energy prices, food prices, labor markets and healthcare prices. Eliminate 9 out of 18 ministries. End incentives for industrial development in disadvantaged areas. Fire 5,000 government employees. No restrictions on foreign land purchases. Legalize crypto for contract payments.

A graph titled, Institutions, labor market flexibility, business freedoms and business dynamism. Text, Score, 0 to 100 (100 equals highest). It shows a blue dot for largest economies, beginning with USA at 85 and ending with B-R-A at about 57. It shows a gold square for Currency pegs to the US dollar. It begins with HKG at around 82 and ends with A-R-G at around 54. Text, Source: World Economic Forum, World Bank, Fraser Institute, WSJ, JPMAM, 2023.

(SPEECH)

Another one that the press picked up for whatever reason is that I believe that Argentine dollarization would probably fail if attempted. Again, this is not a very bold prediction. Dollarization or linking to any currency is extremely difficult if the central bank of the currency you're linking to doesn't adjust its policy rates to account for your existence. So it's very hard to dollarize.

And the countries that do it successfully, like Hong Kong and the UAE and Qatar and Oman and the Saudis, generally benefit from very, very large foreign exchange reserves, commodity-related resources, and they have a certain degree of business dynamism and labor market flexibility that allow them to adjust to changing conditions. Argentina doesn't have that. It is still highly Perónized, referring to the Perón era.

And look, the milestones that Milei has accomplished or proposed so far are impressive. Privatization of airlines and energy, rail, and sewer, cuts in public spending, liberalizing energy prices, eliminating ministries, ending incentives for industrial development, firing government employees. If you're the IMF or the American Enterprise Institute or the Cato Institute, this is right out of your preferred playbook. And so some of these things may result in a boost in private sector activity and greater efficiencies. I just don't think dollarization would succeed and would probably fail within a few months or a year of being implemented.

(DESCRIPTION)

Text, 7, Ukraine war drags on, US funding impasse will be resolved by agreement on border security. A line graph titled, Total US Customs and Border Protection Enforcement Actions, Number of actions, millions. The line begins in 2017 at 0.5 million, climbs steadily to about 1.1 million in 2019, goes back down to about 0.7 million in 2020, then climbs steadily up to about 3.2 million by 2023. Text, Source: US CBP, JPMAM, FY 2023 (October 2022 to September 2023.

(SPEECH)

The seventh one is on Ukraine, the prediction that the war drags on-- well, not a prediction. The risk that the war drags on but that the funding impasse with the US is eventually resolved. If you define the existence of a sovereign entity as a country that controls its borders, you can have a legitimate discussion now about whether or not the United States has lost that sovereign control.

And I think when you look at the number of actions taken by the border, the customs and border protection agencies, they are just skyrocketing. I think that in an election year is going to put a lot of pressure on the Democratic Party to find some kind of solution that breaks the funding impasse on Ukraine.

And

(DESCRIPTION)

US regional bank price to book remains stable despite all the obstacles and. The speaker's video blocks the text at the end of the title. Text, Regional bank rescue: in some ways, unprecedented. Fed: for the first time, banks can post collateral at the Fed and borrow 100% of par value even if the security is worth less (Bank Term Funding Program). FDIC: SVB depositors were bailed out despite it being a venture capital piggy bank. SVB deposits rose and fell with the IPO calendar; only 3% of its deposits were fully insured; it offered venture loans in exchange for deposit exclusivity; its average account balance was greater than $1 mm; its average uninsured account balance was greater than $4 mm; and its top ten depositors had $13 billion in uninsured deposits, all of whom were bailed out despite the long history of losses imposed on uninsured depositors in FDIC resolutions.

(SPEECH)

then prediction eight.

(DESCRIPTION)

A line graph titled, US regional banks versus European banks. Price to book ratio. It has lines showing the price to book ratio from 2008 to 2024 of US Reg (KBW), US Reg (S&P 500), EU (Eurostoxx), and EU (MSCI). The EU lines are higher than the US lines from 2008 to 2009, then the US begins to pull away, peaking much higher than EU around 2017. Text, Source: Bloomberg, JPMAM, December 2023.

(SPEECH)

If there was ever a reason why some people might be worried about regional banks, it would be now. Obviously, there's a lot of pressure. They've been the big lenders in terms of construction loans and office loans. But I think that there's a chance that the regional banks do pretty well and that their price to book values remain stable despite all the obstacles.

When SVB went under a few months ago, there was a temporary period when the price to book ratios of the US regional banks converged with Europe. They've since widened back out again. And part of the reason for this being on a top 10 list is when you look at the support that the regional banks in the US have, it's kind of remarkable. For the first time ever all banks, including the regionals, can post collateral at the Fed and borrow 100 cents on the dollar, even if the security is worth less than par. That's the bank term funding program.

And then-- I have a lot of respect for Tim Geithner and all the work that was done after the financial crisis to solidify the banking system, but we were told at the time never again. No more bailouts of irresponsible investors and lenders. If there was ever a case where the federal government could have argued that uninsured depositors should take a hit, it's Silicon Valley Bank.

It was basically a venture capital piggy bank. The deposits there rose and fell with the IPO calendar. Only 3% of their deposits were fully insured. It offered venture loans in exchange for deposit exclusivity. The average account balance was over a million. And the average uninsured account balance was over 4 million. The top 10 depositors had 13 billion in uninsured deposits. The list goes on.

There's also a long history of losses imposed on uninsured depositors when the FDIC works out of bank. And yet, despite all of that, all of the uninsured depositors in Silicon Valley Bank were bailed out. That leads me to believe that the combination of FDIC help and these Fed facilities are there to sustain and help the regional banks deal with a lot of the pressures they're under. And I think because of that the regional banks are going to do OK.

(DESCRIPTION)

Text, 9, Electricity and gas outage risks due to underinvestment. NERC cites peak loads rising at "an alarming rate" due to electrification, coinciding with increasingly intermittent new sources of generation (wind and solar power) and 80-110 GW of nuclear and fossil fuel generation retirements by 2033 which is about 7% of current installed capacity.

A line graph titled, Generation capacity buffer during peak summer demand, anticipated reserve margin. It has lines labeled, from generally highest to generally lowest, ERCOT (Texas), PJM (Mid-Atlantic), Southeast, California, SPP (Plains), New York, Northwest, New England, MISO (Midwest). Each line has a general gentle downward trend from 2024 to 2023. Text, Source: "2023 Long-Term Reliability Assessment," NERC, December 2023.

(SPEECH)

We're going to talk about this in much more detail in the energy paper, which comes out in early March. But the ninth topic on the top 10 list was the risk of electricity and natural gas outages in major urban centers. Part of what's happening is that electrification is rising at the same time that nuclear power and fossil fuel capacity are being retired. And so you're electrifying the grid at the same time you're introducing more renewable intermittent renewables on it.

And in NERC's long-term reliability assessment there, they're showing a decline in the reserve margins, which basically is the amount of spare capacity you have to deal with a surge in power demand during storms, whether it's a winter storm or a summer storm. And so the risk of these major urban events is rising. And as I mentioned, we'll talk about that more in the energy paper in March.

And then the

(DESCRIPTION)

Text, 10, Inhalable COVID vaccine coming. The COVID wave this winter is much milder than the prior three, particularly for those below 75; most of the rise in hospitalizations is attributable to the over 75 cohort. There's also evidence that the monovalent XBB.1.5 booster works: the Netherlands reports about 70% XBB vaccine efficacy rates with respect to risk of hospitalization and ICU admission even for older people. However, the XBB booster doesn't do much to prevent transmission; at best it might suppress infection risk by 30% to 40% in the first month and then its efficacy vs. infection declines. What's needed: an inhaled vaccine to produce mucosal immunity, block infection and reduce transmission. Several inhaled administered proteins are under development and have already elicited robust immune and T cell responses against COVID in non-human primates.

(SPEECH)

10th topic was on the inhalable COVID vaccine. So far the COVID wave this winter is much milder than the prior three. And most of the hospitalization risk is exclusively attributable to people aged 75 and over. There's evidence that the latest booster-- XBB the booster-- works reasonably well against hospitalization risk, something around 65% to 70% efficacy versus hospitalization when compared to the risk of being unvaccinated or having one of the older vaccines.

That said, the current booster doesn't really do much at all to prevent transmission. At most, it might suppress your infection risk by 30% to 40% in the first month. And then the efficacy versus infection declines. What a lot of scientists have highlighted is that we need an inhaled vaccine that produces mucosal immunity to block infection in your nasal system instead of blocking it when it's in your lungs.

So some of these inhaled proteins are under development. The news is good. And I think there's a good chance that one of these things gets approved for use late in 2024. I've got an Eye on the Market coming out next week-- I think on the 23rd of January-- that's going to get a little bit more into some of the science around vaccine safety, the history of vaccines, the FDA, and a look back at COVID lockdowns, which in retrospect are looking very, very troublesome in terms of the costs being imposed on the generation of students, some of whose math and reading skills are set back a couple of decades. So anyway, so more on all of that next week. Thank you for listening. And see you soon. Bye.

(DESCRIPTION)

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