Economy & Markets Dec 7, 2021

2021 Holiday Eye on the Market: The Middle Ages

Michael Cembalest Chairman of Market and Investment Strategy for J.P. Morgan Asset & Wealth Management

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On equity markets, the Lombards, SPAC investors, Bone-setters, George Washington, COVID bots and Omicron

We started out 2021 optimistic on equities given our outlook on economic growth, earnings growth, limited new equity supply, low interest rates and the arrival of mRNA vaccines. We underestimated just how much the reopening would boost earnings, which exceeded our expectations across the developed world. Earnings growth accounts for all of the developed world equity market gains in 2021 as P/E multiples fell markedly. By the way, that US-EM equity barbell vs Europe-Japan worked again this year; resistance to the barbell is futile. The selloff in China shows few signs of relenting as more Chinese companies prepare to delist, and as China has now expanded the regulatory powers and reach of antitrust regulators.

As always, developed world governments and central banks are doing their part to support this, prolonging the largest fiscal and monetary experiment since the Lombards created banking in the Middle Ages. I get asked a lot how Western gov’t debt burdens are going to be resolved in the long run. I have some theories but intend to retire long before I see if they’re correct or not. Hard to say for sure, the rise in cryptocurrency values from $250 billion before COVID to $2.5 trillion today has a lot to do in my view with the chart below on the left showing the destruction of the post-war compact between governments and savers.

For a year of high returns on US stock markets, there was still plenty of pain to go around. As shown in the chart, a fairly large share of stocks fell at least 35% from their highs in 2021. The last time this kind of thing happened (rising markets and a large share of stocks losing 35% or more): 1998 and 1999. These repriced stocks are a broader warning regarding ultra-high valuations, and the risk of holding stocks that rely excessively on liquidity, momentum and crowded trades. For a complete list of US stocks with market capitalization of over $10 billion that declined by 35% or more this year from peak levels, see the PDF version of this note. There are a lot of “household” names in there, including Viacom (-69%), Altice (-64%), Teladoc (-64%), Zoom (-56%), Anaplan (-48%), Global Payments (-45%), Scotts (-45%), Citrix (-44%) and Paypal (-39%).

Along the way in 2021, we made some pit stops in this piece ¹. A few related exhibits appear below.

January: the 12th Amendment and the Electoral Count Act in the context of the Joint Session of Congress
February: a thorough trashing of the SPAC market for institutional and retail investors
March: an update of our concentrated stock research, a project first launched in 2004
May: our 11th annual energy paper which focused on the four main challenges to decarbonization
June: our 4th deep dive analysis of private equity and venture capital returns
September: an analysis of goods and labor supply chain delays and how long they would take to resolve
October: update on the US states with the most underfunded pension and retiree healthcare plans
November: the commodity price shock and the imbalance between supply and demand policies

This month, I’m working on the 2022 Eye on the Market Outlook which comes out Jan 1. In addition to the global market section, we will cover:

the landscape for dividends and yield-oriented investors
China’s investment prospects after the regulatory purge
US office market fundamentals which are already improving despite COVID and low office utilization rates
potential upside for timber investors in a world searching for real sequestration benefits
Brexit and the high price of national sovereignty
the latest evidence on ESG investing and portfolio impacts
infrastructure investing in regulated electricity distribution, solar power generation and liquid bulk storage
some underwhelming news on fintech lending behavior during COVID
cybersecurity investing, where the presence of malignant forces increases potential returns for investors

More on the Middle Ages. I’m writing the 2022 Outlook from a basement apartment where I have been for the last 6 weeks, recovering from an accident which resulted in the x-ray below of my reconstructed leg. I was engaging in activity typically associated with younger people. The outcome was not unusual; middle-aged people have similar lifestyles and injury patterns to younger people but have higher/longer hospital charges, injury complications and ICU stays that are more similar to the elderly².

While this has been a regrettable incident, I’m fortunate to have access to 21st century medicine. In the Middle Ages, surgical techniques were different. Bone-setters would use devices to realign fractured limbs, which were then covered with bandages dipped in egg whites, milk or mulled wine, and then inserted into large wooden splints made of tree branches. Subsequent growth deformities would sometimes occur and in case of infection, limbs might have to be amputated. Pain medication: ice (when available), alcohol (usually gin) and laudanum (opium). Ether was not widely used until the 1800’s.

Sources: Hospital for Special Surgery (x-ray); “Armamentarium Chirurgiae”, Ioannis Sculteti, 1693; and “A General System of Surgery in Three Parts, Containing the Doctrine and Management of Wounds, Fractures, Luxations, Tumors, and Ulcers of All Kinds”, Lorenz Heister (University of Altdorf), 1768

Medical knowledge improved during the 18^th century. George Washington mandated that all Continental Army troops be inoculated against smallpox in 1777 and 1778 using a crude process called variolation, without which the outcome of the war might have been different. Smallpox effectively disappeared in Boston once a vaccine was developed in 1800. It wasn’t until the 1940’s that life expectancy began to rise more rapidly, largely due to mass production of antibiotics discovered a decade earlier.

Fast forward to 2021 and the COVID pandemic. Dr. Atul Nakhasi, physician and policy advisor to the Los Angeles Health Department, wrote a post on LinkedIn in October. He talked about caring for unvaccinated COVID patients in their 20’s and 30’s who were on ventilators, and how they regretted not getting the vaccine. I used to think LinkedIn was less prone to this, but Dr Nakhasi’s post attracted a flurry of critical responses. The barrage included comments about creeping socialism, how CDC treatment protocols are killing people, how drug companies prefer more sick people since they make more money that way, how doctors are being “held at gunpoint” and arrested if they say anything negative about the vaccine, that vaccines are more dangerous than the disease itself, that vaccines don’t work, that they cause fertility problems, that more people die of the flu than from COVID, that most deaths are vaccinated people and that deaths are being miscategorized since doctors have a financial incentive to inflate COVID deaths since they make more money that way.

Maybe some of these responses were from bot accounts designed to sow dissension in the West; according to a 2021 report from the EU External Action Service, that’s exactly what state-sponsored operatives have been doing via social media ³ . Furthermore, a May 2021 piece in the Journal of Medical Internet Research found that two thirds of all bots were discussing COVID in some way ⁴ .

I understand those who started out skeptical in the Greek sense of the word (“skepsis” = investigation), since COVID is the first disease for which mRNA vaccines are being widely used. But for the record…

[A] Overall death rates in the US have been much higher than normal, and COVID is the only rational explanation for that. You can ignore people who ramble on about miscategorized death certificates.

[B] Estimates for COVID’s infection fatality rate (the chances of dying if you get it) vary but no matter which one you use, they’re all much higher than the infection fatality rate for the flu. The range: 18x-84x higher.

[C] How many unvaccinated people are actually dying of COVID vs those dying from the flu? We can estimate this for the 20 states reporting such data. In these states, unvaccinated COVID deaths per day have been ~18x higher than the number of unvaccinated flu deaths per day, and the year isn’t over yet. The details: just for the period from April 4 to October 2, around 7 people per mm unvaccinated against COVID died every day in these states, compared to 0.4 daily deaths per mm people that were unvaccinated for the flu. For the flu, we are using the three years before COVID as a baseline.

[D] While there are signs of fading mRNA efficacy vs infection, efficacy remains high vs hospitalization, ICU admission and death, particularly with a booster. You’re taking much greater chances by being unvaccinated, and that’s before incorporating risks of long COVID conditions. The chart below is through October and does not include the November COVID wave. New risks for the unvaccinated: based on data from South Africa, Omicron looks to be much more contagious than the Delta variant, and has resulted in greater reinfection rates among unvaccinated COVID survivors. There are preliminary signs of less disease severity, particularly among vaccinated people but the data is still very recent. See our COVID web portal for more on the Omicron variant.

[E] mRNA vaccines prevent negative COVID outcomes far more often than they cause myocarditis. See COVID portal Section 1 for information on the massive number of infections, hospitalizations, ICU admissions and deaths prevented by mRNA vaccines compared to cases of myocarditis that they cause.

If you are going to ignore all of this, you might as well transport yourself back to the Middle Ages and take your chances there with a cocktail of leeches, hydroxychloroquine and zinc. To all of our clients, vaccinated or not, I wish you all a safe and happy holiday season.

Michael Cembalest

You can find all of these pieces on the Eye on the Market landing page.
“Injury patterns and outcomes in late middle age”, Stephen Gale et al, East Texas Medical Center, March 2018
“EEAS Special Report Update: Short Assessment of Narratives and Disinformation around the COVID-19 Pandemic”, European Union External Action Service April 28, 2021
“Bots and Misinformation Spread on Social Media: Implications for COVID-19”, Journal for Medical Internet Research, Brenda Curtis (National Institute on Drug Abuse/NIH) et al, May 2021

Listen to the Podcast

Podcast

[START 837336: 12-6-2021 MIDDLE AGES]

FEMALE VOICE 1: 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.

[MUSIC]

MR. MICHAEL CEMBALEST: Hello, everybody, and welcome to the Holiday 2021 Eye on the Market. This one's called the "Middle Ages," for reasons you'll see in a minute. Well, that was an interesting year. We started out optimistic on equities, given our outlook on economic growth and leverage in corporate profits, limited new equity supply, lower interest rates and the idea that the COVID would have its impact reduced somewhat by vaccination.

We underestimated just how much operating leverage there was that companies would experience earnings growth shattered our expectations across the developed world, whether it was Japan, or Europe, or the United States, and equity markets rose handsomely in a lot of places despite declining PE multiples.

And by the way, for those of you keeping score at home, that barbell of U.S. and emerging markets overweight versus Europe and Japan worked again this year, despite the problems with China. Resistance is futile on that front.

As always, the legislatures and central banks were doing their part to support all this. We are now seeing, again, the largest monetary and fiscal experiment since the Lombards created banking in the Middle Ages. I get asked a lot how these debt burdens are going to be resolved in the long run. I have some ideas, but I will be retired long before I see if they're right or not.

It's hard to say for sure, but when you look at the expansion of Central Bank balance sheets--and there's no way I can convey this on a podcast. You actually have to look in the piece at the chart. When you see the rise in government debt and central bank balance sheets, it's kind of not surprising that cryptocurrency values rose from $250 billion before COVID to $2.5 trillion today.

In any case, in the piece this week we make brief mention of some of the topics that we discussed and the Eye on the Market this year is kind of a year-end review. We started out the year in January, walking through the specifics of the 12th Amendment and the Electoral Count Act because of the joint session of Congress.

We've talked about stock markets, concentrated stocks. We had our deep-dive energy paper. We look at private equity and venture capital returns, goods and labor supply change delays and how long they take to revolve, unfunded retire health can [phonetic] and pension issues of U.S. states, and then we spent a lot of time on the commodity price shock and the imbalance between supply-and-demand policies.

There's a great chart in this Eye on the Market that you've got to see. It shows the collapse in capital spending by S&P 1200 energy companies, which is a global basket. Since 2015, capital spending by those companies is down 75%, so that's fine. That reduces the supply. What about demand for fossil fuels? They're basically unchanged since 2015.

So there are some important questions to ask here. We either need to stop the capital spending decline by these energy companies or we radically need to accelerate the decline in both the emerging and develop world and fossil fuel use. And it's not clear on the policy front that that gap is going to be closed.

I apologize for the sirens. I live in Brooklyn and it kind of goes with the territory. Okay, so the sirens are gone.

I'm working on the Eye on the Market outlook for 2022. It comes out on January 1st. In addition to all the market stuff we're going to talk about what to do if you're a yield-oriented investor and looking for dividends. We're going to take a look at China. Is China's investment prospects--I don't think this regulatory purge is over.

U.S. office market fundamentals are already improving, despite very low office utilization rates. We'll look at that. We're going to look at potential upside for timber investors in a world searching for real sequestration. Briefly, we'll talk about Brexit, which we haven't talked about in a while.

And we take a look at infrastructure investing, which I think is really interesting, and things like regulated electricity distribution, solar power generation and liquid bulk storage. We take a look also at cybersecurity investing. One of the things that's most interesting about COVID's long-term impact is the substantial increase in products and services around the world that are now being offered digitally compared to pre-COVID.

That, of course, increases all sorts of cybercrime and opportunity for investors in cyber-security. And then, finally, some underwhelming news on what the fintech industry did during COVID. You will be both disgusted and amazed.

Anyway, so I'm writing this outlook from a basement apartment. As many of you know, I had an accident and--let's see--I had a tibia plateau fracture and torn meniscus. I was engaging in activity that's typically associated with younger people. And in the Eye in the Market this week, I get into the specifics of how happy I am to have access to 21st century medicine.

In the Middle Ages they would have bonesetters that would use these devices with cranks to realign your fractured limbs, and then they would dip the bandages in egg whites or milk and put them in a splint made of tree branches. And obviously, sometimes you would have growth deformities from this, and in case of infection they might have to amputate your limb. So I am happy to have access to 21st century medicine.

Medical knowledge improved during the 18th century, and this is a particularly interesting case given what's going on in the world right now. Everybody's hero, George Washington, mandated that the Continental Army be inoculated against smallpox in 1777. They didn't have vaccines yet, but they had this crude process called variolation. And if he hadn't done that, the Continental Army might well have lost the war.

Smallpox disappeared in Boston around 1800, when there was a vaccine development. And when you look at the history of life expectancy since the 1700s, it wasn't really until the 1940s when life expectancies in the developed world began to rise more rapidly, mostly due to mass production of antibiotics that were first discovered in the 1930s.

And I talk about the Middle Ages and some of this stuff with George Washington and bonesetters, 'cause let's fast-forward now to 2021 and the COVID pandemic. There was this guy; his name is Dr. Atul Nakhasi. He's a physician and policy advisor to the L.A. Health Department. And he wrote a LinkedIn post in October and he talked about caring for unvaccinated COVID patients in their 20s and 30s who are on ventilators and how they regretted not getting the vaccine.

I used to think LinkedIn was less like Twitter, but apparently it's not, when you look at the posts that people made in response to Dr. Nakhasi using these examples. People accused him of being creeping socialist. They talked about how CDC protocols are the things that are actually killing people in the first place; how drug companies prefer when more people sick, 'cause they make more money; how doctors are held at gunpoint and arrested if they say anything negative about vaccines; that vaccines are more dangerous than the disease itself; that the vaccines don't work; they cause fertility problems; less dangerous than the flu, etc. etc.

And that was kind of interesting to read. My first thought is that some of these responses were from bot accounts designed to sow dissention in the West. There was a study from the EU External Action Service that demonstrated that that's exactly what operatives have been doing on social media, which is to discredit the efficacy of Western vaccines.

And there was a piece in the "Journal of Medical Internet Research," that founds that two-thirds of all bots were discussing COVID in some way. But a lot of these responses appeared to be real ones.

I understand people that started out skeptical about the mRNA vaccines. COVID's the first disease for which the mRNA vaccine approach is being widely used. From the very beginning, I was hoping to take Novavax. I was hoping that the subunit protein vaccines, otherwise known as recombinant protein vaccines, would be approved early on, and those are the kinds of vaccines that all of us have taken our whole lives.

But it's taken, as usually does, it has taken the recombinant protein vaccines a much longer period of time to be approved, as they usually do.

Anyway, for the record, five things. Number one, overall death rates in the United States have been much higher than normal. COVID is the only rational explanation for that. So if anybody tells you that, you know, there's miscategorized death certificates, just ignore them. Number two, estimates for COVID's infection fatality rate--in other words, what's the chance of dying if you get it--are kind of all over the place. But no matter which one you use, and we plotted 12 of them that we found, they're all much higher than the infection fatality rate for the flu and the range is anywhere from 20 to 80 times higher.

Now, how many people are actually dying of COVID versus dying from the flu, which is a function of the infection fatality rate and the frequency of the disease in getting it. There's actually 20 states in the U.S. that report that data. And in these states the unvaccinated COVID deaths have been about 8 times higher than the number of unvaccinated flu deaths, and the year isn't even over yet.

So that data is just for the period of April through October, and we're using for the flu the three years before COVID as a baseline. So no, you know, anybody saying that COVID is less dangerous than the flu just simply doesn't feel like looking at information.

Number four, the mRNA vaccines are not 100% effective. They were never advertised to be, but while there are signs of fading efficacy versus infection. The evidence from the U.S. and other countries shows very high efficacy of mRNA vaccines versus hospitalization, ICU admission and death. Particularly if you get booster shot, you are taking much better chances by being unvaccinated, and that's even before incorporating the risk of long-COVID conditions.

We have some charts in here. I don't know how to make this any simpler than it already is. The charts have one line for unvaccinated and another one for fully vaccinated, in terms of infection and mortality and you can look [phonetic] for yourself.

Of course, like everybody else, we're looking at and examining the data out of South Africa regarding Omicron cases and hospitalizations. It's really soon in the process. There is uncertainty around the timing of some of those original infections, so estimates of transmissibility are still very fuzzy.

Hospitalizations are rising, but there's a gap between the private and public hospitals in South Africa. We need to have a couple of weeks of patients here before you start interpreting some of this stuff. And also, within a couple of weeks Pfizer and Moderna should have completed their in vitro tests regarding the efficacy, at least in vitro, of their vaccines against this variant.

And then number five, the mRNA vaccines prevent negative COVID outcomes far more often than they cause myocarditis, and we have some data in here as well on that.

Anyway, if you're going to ignore all this information, you might as well just transport yourself back to the Middle Ages and take your chances there with a cocktail of leeches and hydroxychloroquine and zinc.

Anyway, to all of our clients, whether vaccinated or not, I wish you all a very safe and Happy Holiday season and you will hear from us next around the timing of the 2022 Eye on the Market outlook, which comes out on January 1st. Have a great Holiday Season.

FEMALE VOICE 1: Michael Cembalest, 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 renown 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 a 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 837336: 12-6-2021 MIDDLE AGES]

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