Economy & Markets

Help Wanted

Topics: Labor shortages, the issue of Taiwan and an update on the most over-indebted US states 

We expect semiconductor, vehicle and other goods bottlenecks to resolve themselves in the months ahead, and interpret declining business surveys as the result of a temporary supply shock and not a sign of inadequate demand. As a result, growth should rebound in 2022, and positions that benefit from reflation should benefit (energy, value and cyclicals). However, while goods bottlenecks will dissipate, the US will still face tight labor markets and rising wages that are at odds with current Fed policy

Our prior note looked at semiconductor, vehicle, goods, shipping and other physical bottlenecks that are leading to lower growth forecasts for the next 2 quarters. We’re starting to see signs of improvement: a small decline in anchored LA/Long Beach containerships, freight rates falling from peak levels, a decline in commercial rail delays from 14 days in August to 3.5 days and a 20% increase in Taiwanese production of 8-inch wafers typically used in automotive systems since January of this year. Bottlenecks should continue to gradually improve over the next few months. As a reminder, the fundamental catalyst for the current situation is the surge in goods spending in the US and Europe relative to services, an abnormal pandemic-related change that supply chains were not ready for. Combine the semiconductor intensity of Western goods imports with high levels of COVID restrictions in Asia, and you have the ingredients for a massive supply shock. As mRNA vaccination rates rise in Asia and community spread declines, a relaxation in worker density and other COVID protocols should follow. 

Line chart shows the surge in US goods spending, shown as the difference in rolling 5-quarter growth rates, calculated as the growth rate in goods minus the growth rate in services. Chart shows that since the 1950s, the growth rate of goods relative to services has remained between -10% and 5-10%. However, the growth rate surged to 20% in 2021.
Line chart shows the surge in Europe goods spending, shown as the difference in rolling 5-quarter growth rates, calculated as the growth rate in goods minus the growth rate in services. Chart shows that since 2002, the growth rate of goods relative to services has remained between -4% and 2%, however it surged to nearly 14% in 2021.
Chart shows lockdown stringency vs vaccination rates for developed and emerging market countries. Lockdown stringency is shown on the y-axis as an index, where 100 represents the highest level of lockdown. Unique people vaccinated as a % of the population is shown on the x-axis. Chart shows how COVID restrictions in many Emerging Market regions remain high as vaccination rates are low. In developed countries like the US and Sweden, restrictions are lower as vaccination rates are higher.
Line chart shows the container freight rate from China to LA/West Coast shown in US$ per 40ft box and anchored containerships since January 2019. While the freight rate remained around $2,000 per 40ft box since 2019, in late 2020 the freight rate began increasing. The Freightos China to West Coast freight rate steadily increased to just over $20,000 per 40ft box, though it has recently declined to around $17,000. The WCI Shanghai to LA index increased to its latest value of around $13,000. Anchored containerships have also steadily increased from historically low levels, with around 60 containerships anchored at the latest point in October.
In the US, in-person spending on pandemic-sensitive services is recovering alongside oil and airline spending; the outlier is white collar office utilization rates, the most vaccine-resistant variable of all. All things considered, we expect normalization of US and European goods spending relative to services in the months ahead, which should reduce physical bottlenecks further.
Line chart shows social distancing spending (card present transactions only) shown as the spending change vs 2019. In early 2020, the change in spending vs 2019 declined to -70%. Since then, it has steadily increased to its latest value at around 10% above its 2019 level.
Line chart shows office utilization rates by metro area based on keycard/fob data. Utilization rates for all cities fell from 100% to 10-20% in early 2020. Since then, utilization rates have steadily increased. Cities in Texas (Austin, Houston, Dallas) have seen utilization rates increase to around 50%, while Philadelphia, DC, LA, Chicago, NYC, San Jose, and San Francisco have utilization rates between 20-35%.
US labor markets, however, may not normalize so quickly. Company surveys show all-time peaks regarding plans to raise worker compensation since they’re having trouble filling jobs, and regarding plans to raise prices. Wage increases are now eating into overall business optimism; historically, the chart on the lower right tends to track changes in S&P margins reasonably well, although not all the time.
Line chart shows small business with hard to fill job openings, shown as the % of small business survey respondents. Since 1985, the % of businesses with hard to fill job openings has oscillated between 10% and 40%. However, recently this percentage has increased to 50% in September 2021.
Line chart shows US small businesses raising worker compensation, shown as the % of small business survey respondents. Chart shows that the % of businesses has generally remained between 0% and 25%, but as of September 2021 has risen to 30%.
Line chart shows the net percentage of small business survey respondents planning to raise prices from 1990 to 2021. Current levels are at all-time highs.
Line chart shows the small business optimism index less firms planning to raise wages on the left axis and the % forward EBIT margin change over the last 12 months on the right axis. Optimism – planned wage increases can be used as a proxy for margins expectations and implies a decline over the next 12 months.

Where have all the workers gone? That’s a good question. Let’s use estimates to add up all the workers missing from the labor force since the pandemic began.1

  • The impact of COVID unemployment (UI) benefits on labor force participation is still unclear. While benefit expiration in July and August led to an increased job finding rate among unemployed workers, it did not lead to higher labor force participation. In any case, let’s start with the estimated number of people receiving UI benefits as of September 1 that exceeded their prior salaries (2.7 million out of 5.3 million UI recipients)
  • During the pandemic, 1.5 million more people retired than usual compared to what was a steady linear trend beforehand. There’s some research indicating that rising stock markets and housing prices boost retirement rates, but the sudden spike in retirements starting in March 2020 suggests that COVID is the main catalyst here
Bar chart shows that about 2.7 million people have exited the labor force as a result of earning more from unemployment benefits than in prior jobs.
Bar chart shows that there are about 1.5 million people who have retired in excess of the normal amount, thus exiting the labor force, in addition to the 2.7 million people earning more from unemployment benefits than in prior jobs.
  • Visas granted to immigrants and non-immigrant temporary workers collapsed during the pandemic. While visas are starting to recover, the pandemic decline resulted in ~700,000 people missing from the labor supply. Visa shortfalls during the pandemic add to a backlog of around 1 million people waiting to receive employment-based visas. More immigration data: highly educated immigrants who qualify for green cards wait an average of 16 years before receiving them. Also: Trump cut the number of family preference green cards, which increased availability of employment-based green cards by 122k. But only 40k were granted by the September 30 deadline; the rest may be lost for good absent Congressional action
  • An increase in self-employment also plays a role. While such individuals are still in the labor force, self-employment spiked by 800,000 once the pandemic hit. The largest job switching categories: people leaving manufacturing and agriculture for construction and transportation (i.e., ride-hailing). So, the shortages you read about regarding goods and food production are in part attributable to this trend
Bar chart shows that there has been a decline of about 700,000 temporary worker and immigrant visas, resulting in a cumulative worker shortage of 4.9 million people.
Bar chart shows that there has been an increase of about 800,000 self-employed workers, resulting in a cumulative worker shortage of 5.7 million people.

Everyone else. Another 1.7 million people left the labor force during the pandemic for reasons other than those stated above. This category includes:

  • Some of the 3 million respondents to a September Census household survey saying that concerns about getting or spreading COVID are why they’re not working (this is around half the pre-vaccine level from 2020, but still a large number)
  • Some of the 4 million people citing child care constraints in the same survey, even after the reopening of schools (i.e., people not working due to providing care for children not in school or daycare). This figure declined by roughly half once schools opened in September
Bar chart shows that there has been an increase of about 2.7 million other labor force departures, resulting in a cumulative worker shortage of 7.4
Line chart which shows the amount of workers who are currently planning on re-entering the labor force. The chart shows that more than 6 million workers are looking for a job.

According to BLS surveys and our estimates, ~2 million people out of the 7.5 million missing workers intend to search for work again at some point, and we do expect increased labor supply by year-end. But it might not be enough to restore the pre-COVID balance of supply and demand in the labor market, which was already pretty tight. As a result, wage pressures and labor shortages may be an endemic feature of the post-COVID US economy and put pressure on the Fed by the middle of next year. Note: on the issue of job mismatches, the latest data suggest that this is more of a geographical problem than an industry problem right now, with the largest worker shortfalls relative to vacancies in North Carolina, Georgia, Indiana and Wisconsin.

By the way, the Fed staff and FOMC participants revised up their near-term inflation forecasts but continue to expect inflation to moderate in 2022. The staff forecasts that inflation will fall back below 2% in 2022 and only return to 2% in 2024. I disagree with them. As a reminder, Fed forecasts for policy rates ended up being wrong for most of the last decade:

Chart shows the Fed projections vs actual Fed funds rate, shown as two series: the median FOMC projection of the Fed Funds rate (at each FOMC meeting) and a series showing the effective Fed funds rate. The chart shows that the median FOMC projection of the Fed Funds rate has been consistently higher than the effective funds rate since around 2018.

The market cap of the World Semiconductor Index finally surpassed the market cap of the World Energy Index in 2020, an indication of a world that’s more reliant each year on technology.  Taiwan has the largest global share of semiconductor capacity at 21%, including a 50% share of higher value added logic chip capacity; and Taiwan’s TSMC has a market cap that is more than double Intel.  The likely US response to any actions by China that constrict Taiwanese semiconductor supply would be a lengthy and expensive effort to rebuild US semiconductor production capacity (now just a 12% share), rather than a defense of Taiwan itself.

A lot of clients have asked about Taiwan given increased sabre-rattling by China. The latest: China sent a record number of jets into Taiwanese air space, President Xi said that complete reunification of the motherland “must and will be fulfilled”, and also warned that the Chinese people have a glorious tradition in opposing separatism. Taiwan’s defense minister said that tensions with China are at their worst in 40 years.

To be clear, the US is not obligated by treaty to defend Taiwan from attack. A Sino-American Mutual Defense Treaty was put in place in 1955 and did obligate the US to defend Taiwan, but this treaty was abrogated permanently by the US in 1979 in exchange for China establishing diplomatic relations with the US, and Chinese support for American actions in Communist Afghanistan (when the US was arming the Afghan mujahideen). The Sino-US mutual defense treaty was replaced by the Taiwan Relations Act of 1979, which instead obligates the US to provide Taiwan with “sufficient defense capabilities”. While US arms sales to Taiwan of $11 billion in 2019 were the highest on record, this may not amount to much if a military conflict occurs.

After normalizing for wage differences and purchasing power, China’s military spending is ~90% of US levels. As part of a special section in this year’s Outlook, I spoke with the author of a RAND Corporation report on Chinese military capabilities. The RAND analysis indicates that China has changed the balance of power in the region, substantially eroding the ability of the US military to defend Taiwan even if it chose to.

The second chart below shows the evolution of US air superiority against Chinese surface to air missile systems. The area above and to the left of each curve represents RAND estimates of how often US forces would prevail as a function of US aircraft missile range and detectability. For example, in 1996, only highly detectable US aircraft with shorter range missiles would lose in battle. By 2017, US aircraft needed to be much less detectable and more weaponized due to improvements in Chinese air defense systems. Similar findings: the share of Chinese ships destroyed by US submarines in a 7 day campaign scenario fell from 100% in 1996 to 40% by 2017, and the estimated US air force fighter wing capacity required to defeat China in an attrition battle rose by 7x. Since the RAND publication was released, China has added more destroyers, cruisers, aircraft carriers and assault ships; hypersonic and intermediate range missiles; anti-submarine warfare; and long range bombers.

Stacked bar chart which shows China and US military spending broken out by category. The chart includes spending on hardware, structures and personnel. China’s defense budget as reported is around $150 billion, significantly lower than the US budget of $500 billion. However, after adjusting China’s defense budget for PPP and US wage levels the budget is closer to $475 billion.
Line chart which illustrates modeled estimates of US aircraft vs Chinese air defense systems over time. The chart shows predicted outcomes for 1996, 2003, 2010 and 2017 based on the aircraft’s weapon range and the detectability of the aircraft by Chinese radar systems. Anything above/left of the line indicates that the US aircraft would win and anything below/right of the line indicates that the Chinese air defense system would win. For example, in 1996 aircrafts would win with short range weapons (below 50 km) and high levels of detectability, whereas in 2017 US aircraft need to have very low levels of detectability or very long range weapons (150-200km) in order to win.

See Appendix for additional semiconductor facts and figures

COVID has not turned into the municipal disaster that many feared a year ago. State revenues have been more resilient than expected, and according to the National Association of State Budget Officers, 38 states reported FY2021 general fund revenues above initial forecasts. The March 2020 CARES Act provided $150 billion to state and local governments; another $125 billion was authorized in December 2020; and in March 2021, Biden’s American Rescue Plan made another $350 billion available to states and local entities. From a big picture perspective, a lot of state and local financial burdens were shifted onto the Federal government. While less explicit than a Federal bailout of underfunded pensions, the 2020/2021 acts were still wealth transfers from citizens of less indebted states to citizens of highly indebted states.

That said, we wanted to take a look at the most indebted states right before COVID began (which is the latest data available from state consolidated annual financial reports). As a reminder, our IPOD ratio looks at the share of state revenues required to service bonded debt and to amortize all unfunded pension and retiree healthcare obligations over the next 30 years assuming a discount rate/investment return of 6%. As you can see below, most ratios improved since our last analysis in 2017, some substantially.

The reasons for improved ratios differ by state and include rising asset values, tax increases, reductions in retiree healthcare plan coverage, a cap on salaries used for pension accruals and contributions to underfunded plans (see Appendix for more details). The Illinois improvement is impressive; but how many times can you increase state taxes on companies and individuals? In 2020, Illinois recorded its 7th straight year of population loss, the most since World War II and the second largest of any state in raw numbers or % of population. Illinois is the only state whose population loss accelerated each year for the past seven years.

The bottom line: highly indebted states (most of which are controlled by DEM legislatures and governors) still have to dedicate almost a third of state revenues to unfunded pension and retiree healthcare obligations2 despite the best of all possible market environments to drive asset values higher. While financial repression and Federal transfers have given these states a reprieve, a diversified municipal portfolio is still highly recommended for residents of these states, even at the expense of paying state taxes on out-of-state bonds.

Stacked bar chart which shows the % of state revenues required to pay the sum of interest on net direct debt, the state’s share of unfunded pension and retiree healthcare liabilities and defined contribution plan payments assuming a 6% return and 30 year level dollar amortization versus what the states are currently paying as of 2017 and 2020. Most of the states included need to pay a much higher % of revenues under our assumptions versus what they are currently paying. However, most states have made improvements over the last three years.

Appendix

Semiconductor facts and figures [SIA Semiconductor Factbook, IC Semiconductor Research, TrendForce]

  • Semiconductor categories include microprocessor and logic devices (42% of sales); memory storage devices (25% of sales); devices that translate light, voice and touch analog signals into digital signals (13% of sales); and discrete optoelectronics and sensors generally used to generate or detect light
  • While the US has 47% market share of global semiconductor revenues, only ~40% of US production capacity is located in the US.  The rest is located in Singapore, Taiwan, China, Europe and Japan
  • Taiwan has the highest share of semiconductor capacity at 21%, followed by Korea at 20%, Japan and China at 15% and the US at 12%.  Taiwan also a 50% share of higher value added logic chip capacity
  • Taiwan also controls 60% of the semiconductor foundry market by revenue, which refers to outsourced semiconductor production (for companies like AMD, Apple, Qualcomm, Nvidia and Huawei)
Line chart which shows semiconductor manufacturing capacity by region as % of global capacity. The chart includes China, Taiwan, South Korea, Japan, US and Europe since 1990 with estimates from 2021-2030. The chart shows that as of 2020, Taiwan has the highest share of global capacity at 21% and Europe has the lowest at ~9%.
Line chart which shows the market capitalization of Taiwan Semiconductor Manufacturing Company and Intel since 2004. In 2004, Intel was 5x larger than TSMC. However, since then TSMC has grown much faster than Intel and the two companies has similar market caps in 2017. TSMCs market cap has tripled since 2007 to more than half a trillion dollars, more than double that of Intel.

State specific catalysts for changes in municipal IPOD ratios, FY2017 to FY2020

  • Illinois: a state personal tax increase from 3.75% to 4.95% and a corporate tax increase from 5.25% to 7.00% helped propel revenues higher by 44%. Furthermore, pension service costs declined due to a cap on the salary used for state pension accruals
  • New Jersey: large decline in current pension service costs due to changes in benefit terms (interest credited for first two years of time period from termination to retirement instead of the entire period); reduced health care plan coverage terms
  • Hawaii: Revenues increased by 10% annually, more than the median state and much faster than pension payments growth
  • Kentucky: Large decline in current period service costs for the Kentucky Teachers Plan (for reasons that are not entirely clear)
  • Pennsylvania: Faster revenue growth than pension payments growth, and reductions in OPEB plan coverage
  • West Virginia: A State Senate bill now requires the state to make a large annual contribution to the state retiree healthcare plan (which boosted the funding ratio from 21% to 38%)

1 “Will Worker Shortages Be Short-Lived?”, Joseph Briggs, Goldman Sachs, October 4, 2021.

2 While unfunded pensions are not explicitly cross-defaulted with general obligation bonds, our research indicates that in almost every case when pensions or retiree healthcare obligations were restructured by cities, bondholders suffered writedowns that were just as large or even greater. Examples include Central Falls RI, Harrisburg PA, Vallejo CA, Jefferson County AL, San Bernardino CA, Stockton CA and Detroit MI.

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FEMALE VOICE :

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

 

MR. MICHAEL CEMBALEST:  

Good morning, everyone, and welcome to the Eye on the Market podcast for October. Last time, we looked at the semiconductor vehicle and other goods' bottlenecks, which we expect to resolve themselves in the month ahead. We interpret declining business surveys that we're seeing right now as the result of a temporary supply shock and not a sign of inadequate demand. As a result, we think growth will pick up next year, and a bunch of cyclical and energy positions should benefit from that.

 

However, while the goods' bottlenecks will probably dissipate, we're looking at extremely tight labor markets and rising wages that I don't think are going to clear up so quickly and that are also at odds with current fed policy.

 

So, on the first page of today's note, we take a look at really the fundamental catalyst for the weird situation that we're in right now, which is the surge in goods' spending relative to services in both the U.S. and Europe. In other words, once the pandemic hit, people started buying a lot more stuff than services.  That stuff tends to be very semiconductor intensive, and then you've got a massive supply shock, given the degree to which goods spending is highly reliant on imports from Asia, where the lower vaccination rates and lower efficacy of the Chinese vaccines have led to more severe worker density protocols and things like that. But, again, over the next few months, we expect those things to dissipate. 

 

What is not going to dissipate so quickly, however, are the tightness in U.S. labor markets. Some of the surveys are off the charts in terms of difficulty filling jobs, plans to raise worker compensation, wages, wage increases eating in to overall business optimism. 

 

In today's note, we walk through where all the workers have gone, or a list of the categories, with respect to workers that have left the labor force. So, let's take you through them. The first big category is a controversial one, but it's the universe of workers who, at least as of early December, had been receiving, for some period of time, benefits that were higher than their prior salaries. So, this number is estimated to be between 2.5 to 3 million people. Now, those excess benefits are coming to an end right now, but it may take some time before those people feel a full economic incentive to go back to work.  And, remember, as we discussed last time, the foreclosure and eviction moratoria are still in place in a lot of cities and states around the country.

 

You've also got about 1.5 million people, more than usual, that retired during the pandemic. It was a pretty steady linear trend beforehand. But, about 1.5 million people left the labor force and retired. There's some research that rising stock markets and housing prices allowed them to do that. But, when you look at the timing of when those retirements occurred, COVID was the primary catalyst for making them quit in the first place, or retire in the first place.

 

Then, you've got about several hundred thousand people, at least, maybe almost a million, of missing immigrants and non-immigrant temporary workers.  VISAs granted to them collapsed during the pandemic, and while some of those VISAs are starting to recover, there's a huge hole in the labor force from all of those VISAs that weren't given for such a long period of time. 

 

There's a lot of strange things going on in the immigration system. Trump had cut the number of family preference green cards, and that simply increased the availability of something called employment-based green cards, but only around a third of them were granted by the September 30th deadline, and the rest may be lost for good, if Congress doesn't act. 

 

Another category is an increase in self-employment. While these people are still in the labor force, around 800,000 people left things like manufacturing and agricultural jobs for individual construction jobs and ride hailing. So, when you read about shortages in goods and food production, part of it's attributable to this increase in self-employment. 

 

Then, the last category is a hodgepodge of 1.5 million people that left the labor force for all sorts of other reasons. Some of them because they can't get childcare, even with schools reopening, some of them because they're concerned about getting COVID. 3 or 4 million people each have cited in some census surveys that those two things are affecting their ability and/or inclination to go back to work. 

 

Now, about 1 to 2 million—if you add up all those categories, it's about 7 million. 1 to 2 million of those people are indicating that they plan to re-enter the labor force fairly quickly.  But, that said, you're still missing a few million people, and so we do expect an increased labor supply over the next few months, but it might not be enough to restore the pre-COVID balance of supply and demand in the labor market, which was already pretty tight.

 

So, wage pressures and labor shortages may be an endemic feature of the post-COVID economy and put a lot of pressure on the fed by the middle of next year, if we're looking at still a 0% funds rate and a 4-5% consistent wage inflation.

 

Now, by the way, the fed and both the staff and the FOMC participants expect inflation to moderate in 2022, and the staff is actually thinking that inflation will fall below 2% next year. I disagree with them, for all of the obvious reasons.

 

The second topic this week is Taiwan. It fits in the Help Wanted scheme, because there's a lot of presumption that the U.S. would help Taiwan in any kind of military conflict with China. I don't think that's the case, but let's go through the details. The reason everyone's so focused on this, the market cap of the world's semiconductor index is now higher than the market cap of the world energy index, in indication that the world's becoming a lot more reliant on technology than traditional energy, notwithstanding the energy supply issues that we're having right now, which we'll discuss in a future Eye on the Market. 

 

Taiwan's TSMC has a market cap that's double, more than double, that of Intel.  So, there's a lot of focus right now on what happens to global semiconductor supply chains, with respect to this whole China-Taiwan issue. My perception is any developments, whether now or in the future, that constrict Taiwanese semiconductor supply would end up with a multi-pronged and costly and lengthy effort by the U.S. to rebuild its own semiconductor production capacity, rather than to defend Taiwan itself. 

 

So, what's going on? Well, China has been sending a couple hundred jets in to Taiwanese air space. President Xi said that complete reunification of the motherland must and will be fulfilled, and he also warned the Chinese people have a glorious tradition in opposing separatism. Taiwan's defense minister said tensions with China are at their worst level in 40 years. 

 

To be clear about this, the U.S. is not obligated by treaty to defend Taiwan.  There was, past tense, a Sino-American mutual defense treaty that was put in place in 1955, which obligated the U.S. to defend Taiwan. But, this treaty was abrogated permanently by the U.S. in 1979, in exchange for China establishing relations with the U.S. and also, believe it or not, in exchange for Chinese support for what the U.S. was doing in Afghanistan, where the U.S. was arming the Afghan Mujahidin. 

 

Anyway, this Sino-U.S. mutual defense treaty was replaced by the Taiwan Relations Act of 1979, and all that does is obligate the U.S. to provide Taiwan with "sufficient defense capabilities." Arms sales from the U.S. to Taiwan last year of $11 billion were the highest on record, but I don't think that's going to amount to very much, if a military conflict were ever to occur.

 

If you look at the data for China, and you adjust their military spending for wage and purchasing power, it's around 90% of U.S. levels.  Earlier this year, I spoke with the team at the Rand Corporation that specializes in analyzing the balance of power in the region, specifically China, Taiwan, and the U.S., and since 1996, China has radically changed the balance of power in the region. We have a couple of charts in here that show that, and we've written about this before.  Essentially, China has been investing in destroyers, cruisers, aircraft carriers, intermediate range missiles, antisubmarine warfare, long-range bombers, and what was in 1986 an almost impossible task for China to impose its will in a 7-14 day campaign to take Taiwan was, as of 2017, all of a sudden a 50-50 proposition, and the gap between China and Taiwan and the U.S. just continues to grow.

 

As one example, in 1996, around 100% of Chinese ships were estimated to be destroyed by U.S. submarines in a 7-day campaign, and that number is now less than 40%. So, that's why, as far as I can tell, at least in my opinion, the most likely response that the U.S. would ever mount here would be some maybe military aid to Taiwan, but the more practical response would be to try to increase its current 12% manufacturing capacity for semiconductors up to some higher number.

 

The last topic for this week on Help Wanted refers to some of the highly indebted states in the United States that have not just a lot of bonds outstanding, but a large pile of unfunded retiree healthcare and pension obligations. These states got a lot of help from the federal government.  So, COVID hasn't turned in to the municipal disaster that many people, including me, feared that it might. Around 40 states are now reporting general fund revenues for 2021 above their initial forecast. And, if you add up the March 2020 CARES Act, an extension authorization of December 2020, and then the American Rescue Plan, there's something like $600-700 billion were transferred from the federal government to the states.  While less explicit than a federal bailout of underfunded pensions, the Acts from the last couple of years were essentially still wealth transfers from citizens of less indebted states to citizens of highly indebted states. 

 

So, we wanted to at least take a look at the most indebted states right up until COVID began, which is he last data that's available from a lot of the state consolidated annual financial reports. Again, I think the data, as of right before COVID began, is probably a good proxy for where they are now, given all the aid that's been channeled to the states. And, we have this iPod ratio, where we look at the share of state revenues required to service debt and amortize all the unfunded pension retiree healthcare obligations over the next 30 years, using our assumed investment return of 6% on diversified defined benefit plan portfolio.

 

So, as shown in the chart, almost all the ratios have improved substantially since our last analysis. Why wouldn't they have? Asset values for public and private equity have gone up a ton. And, as everybody knows, a lot of the municipal, state, and local plants are huge investors in private equity. There have been some tax increases. There have been reductions in retiree healthcare plan coverages, salary accrual caps, contributions to underfunded plans, etc., etc. 

 

Now, the big, big mover here is Illinois. But, even after the tax increase that they passed, they're still looking at something like a third of all government revenue having to go to pensions. I don't think that's very sustainable, and Illinois also has just recorded its seventh straight year of population loss, and a population loss that's accelerating each year. 

 

So, the bottom line for us is that the most indebted states, many of which, by the way, are controlled by democratic legislatures and governors, still have to dedicate almost a third of their revenues to unfunded pension and retiree healthcare obligations in order to service them, despite this very favorable market environment. I think financial repression and federal transfers have given these states a reprieve, but for residents of these states, a diversified municipal portfolio is still highly recommended here, even at the expense of having to pay state taxes on out-of-state funds.

 

So, that is the end of this week's Eye on the Market. Our next piece will be our Thanksgiving Eye on the Market, sometime in mid-November. Thanks for listening. See you soon.  Bye. 

 

FEMALE VOICE:  

Michael Cembalest, Eye on the Market, offers a unique perspective on the economy, current events, markets, and investment portfolios, and is a production of JP Morgan Asset and Wealth Management. Michael Cembalest is the chairman of Market and Investment Strategy for JP Morgan asset management, and is one of our most renowned and provocative speakers. For more information, please subscribe to the Eye on the Market by contacting your JP Morgan representative. If you'd like to hear more, please explore episodes on iTunes or on our website. This podcast is intended for information purposes only and is a communication on behalf of JP Morgan Institutional Investments Incorporated. Views may not be suitable for all investors and are not intended as personal investment advice or as solicitation or recommendation. Outlooks and past performance are never guarantees of future results. This is not investment research. Please read other important information, which can be found at www.JPMORGAN.com/disclaimer-eotm.

 

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In the United States, bank deposit accounts and related services, such as checking, savings and bank lending, are offered by JPMorgan Chase Bank, N.A. Member FDIC.

JPMorgan Chase Bank, N.A. and its affiliates (collectively “JPMCB”) offer investment products, which may include bank-managed investment 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 (“JPMS”), a member of FINRA and SIPC. Annuities are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPM. Products not available in all states.

In Luxembourg, this material is issued by J.P. Morgan Bank Luxembourg S.A. (JPMBL), with registered office at European Bank and Business Centre, 6 route de Treves, L-2633, Senningerberg, Luxembourg. R.C.S Luxembourg B10.958. Authorized and regulated by Commission de Surveillance du Secteur Financier (CSSF) and jointly supervised by the European Central Bank (ECB) and the CSSF. J.P. Morgan Bank Luxembourg S.A. is authorized as a credit institution in accordance with the Law of 5th April 1993. In the United Kingdom, this material is issued by J.P. Morgan Bank Luxembourg S.A., London Branch, registered office at 25 Bank Street, Canary Wharf, London E14 5JP. Authorised and regulated by Commission de Surveillance du Secteur Financier (CSSF) and jointly supervised by the European Central Bank (ECB) and the CSSF. Deemed authorised by the Prudential Regulation Authority. Subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details of the Temporary Permissions Regime, which allows EEA-based firms to operate in the UK for a limited period while seeking full authorisation, are available on the Financial Conduct Authority’s website. In Spain, this material is distributed by J.P. Morgan Bank Luxembourg S.A., Sucursal en España, with registered office at Paseo de la Castellana, 31, 28046 Madrid, Spain. J.P. Morgan Bank Luxembourg S.A., Sucursal en España is registered under number 1516 within the administrative registry of  the Bank of Spain and supervised by the Spanish Securities Market Commission (CNMV). In Germany, this material is distributed by J.P. Morgan Bank Luxembourg S.A., Frankfurt Branch, registered office at Taunustor 1 (TaunusTurm), 60310 Frankfurt, Germany, jointly supervised by the Commission de Surveillance du Secteur Financier (CSSF) and the European Central Bank (ECB), and in certain areas also supervised by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin). In Italy, this material is distributed by J.P. Morgan Bank Luxembourg S.A– Milan Branch, registered office at Via Cordusio 3, 20123 Milano, Italy and regulated by Bank of Italy and the Commissione Nazionale per le Società e la Borsa (CONSOB). In the Netherlands, this material is distributed by J.P. Morgan Bank Luxembourg S.A., Amsterdam Branch, with registered office at World Trade Centre, Tower B, Strawinskylaan 1135, 1077 XX, Amsterdam, The Netherlands. J.P. Morgan Bank Luxembourg S.A., Amsterdam Branch is authorized and regulated by the Commission de Surveillance du Secteur Financier (CSSF) and jointly supervised by the European Central Bank (ECB) and the CSSF in Luxembourg; J.P. Morgan Bank Luxembourg S.A., Amsterdam Branch is also authorized and supervised by De Nederlandsche Bank (DNB) and the Autoriteit Financiële Markten (AFM) in the Netherlands. Registered with the Kamer van Koophandel as a branch of J.P. Morgan Bank Luxembourg S.A. under registration number 71651845. In Denmark, this material is distributed by J.P. Morgan Bank Luxembourg, Copenhagen Br, filial af J.P. Morgan Bank Luxembourg S.A. with registered office at Kalvebod Brygge 39-41, 1560 København V, Denmark. J.P. Morgan Bank Luxembourg, Copenhagen Br, filial af J.P. Morgan Bank Luxembourg S.A. is authorized  and regulated by Commission de Surveillance du Secteur Financier (CSSF) and jointly supervised by the European Central Bank (ECB) and the CSSF. J.P. Morgan Bank Luxembourg, Copenhagen Br, filial af J.P. Morgan Bank Luxembourg S.A. is also subject to the supervision of Finanstilsynet (Danish FSA) and registered with Finanstilsynet as a branch of J.P. Morgan Bank Luxembourg S.A. under code 29009. In Sweden, this material is distributed by J.P. Morgan Bank Luxembourg S.A., Stockholm Bankfilial, with registered office at Hamngatan 15, Stockholm, 11147, Sweden. J.P. Morgan Bank Luxembourg S.A., Stockholm Bankfilial is authorized and regulated by Commission de Surveillance du Secteur Financier (CSSF) and jointly supervised by the European Central Bank (ECB) and the CSSF. J.P. Morgan Bank Luxembourg S.A., Stockholm Bankfilial is also subject to the supervision of Finansinspektionen (Swedish FSA). Registered with Finansinspektionen as a branch of J.P. Morgan Bank Luxembourg S.A. In France, this material is distributed by JPMorgan Chase Bank, N.A. (“JPMCB”), Paris branch, which is regulated by the French banking authorities Autorité de Contrôle Prudentiel et de Résolution and Autorité des Marchés Financiers. In Switzerland, this material is distributed by J.P. Morgan (Suisse) SA, which is regulated in Switzerland by the Swiss Financial Market Supervisory Authority (FINMA).

In Hong Kong, this material is distributed by JPMCB, Hong Kong branch. JPMCB, Hong Kong branch is regulated by the Hong Kong Monetary Authority and the Securities and Futures Commission of Hong Kong. In Hong Kong, we will cease to use your personal data for our marketing purposes without charge if you so request. In Singapore, this material is distributed by JPMCB, Singapore branch. JPMCB, Singapore branch is regulated by the Monetary Authority of Singapore. Dealing and advisory services and discretionary investment management services are provided to you by JPMCB, Hong Kong/Singapore branch (as notified to you). Banking and custody services are provided to you by JPMCB Singapore Branch. The contents of this document have not been reviewed by any regulatory authority in Hong Kong, Singapore or any other jurisdictions. You are advised to exercise caution in relation to this document. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. For materials which constitute product advertisement under the Securities and Futures Act and the Financial Advisers Act, this advertisement has not been reviewed by the Monetary Authority of Singapore. JPMorgan Chase Bank, N.A. is a national banking association chartered under the laws of the United States, and as a body corporate, its shareholder’s liability is limited.

With respect to countries in Latin America, the distribution of this material may be restricted in certain jurisdictions. We may offer and/or sell to you securities or other financial instruments which may not be registered under, and are not the subject of a public offering under, the securities or other financial regulatory laws of your home country. Such securities or instruments are offered and/or sold to you on a private basis only. Any communication by us to you regarding such securities or instruments, including without limitation the delivery of a prospectus, term sheet or other offering document, is not intended by us as an offer to sell or a solicitation of an offer to buy any securities or instruments in any jurisdiction in which such an offer or a solicitation is unlawful. Furthermore, such securities or instruments may be subject to certain regulatory and/or contractual restrictions on subsequent transfer by you, and you are solely responsible for ascertaining and complying with such restrictions. To the extent this content makes reference to a fund, the Fund may not be publicly offered in any Latin American country, without previous registration of such fund’s securities in compliance with the laws of the corresponding jurisdiction. Public offering of any security, including the shares of the Fund, without previous registration at Brazilian Securities and Exchange Commission— CVM is completely prohibited. Some products or services contained in the materials might not be currently provided by the Brazilian and Mexican platforms.

JPMorgan Chase Bank, N.A. (JPMCBNA) (ABN 43 074 112 011/AFS Licence No: 238367) is regulated by the Australian Securities and Investment Commission and the Australian Prudential Regulation Authority. Material provided by JPMCBNA in Australia is to “wholesale clients” only. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Corporations Act 2001 (Cth). Please inform us if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future.

JPMS is a registered foreign company (overseas) (ARBN 109293610) incorporated in Delaware, U.S.A. Under Australian financial services licensing requirements, carrying on a financial services business in Australia requires a financial service provider, such as J.P. Morgan Securities LLC (JPMS), to hold an Australian Financial Services Licence (AFSL), unless an exemption applies. JPMS is exempt from the requirement to hold an AFSL under the Corporations Act 2001 (Cth) (Act) in respect of financial services it provides to you, and is regulated by the SEC, FINRA and CFTC under U.S. laws, which differ from Australian laws. Material provided by JPMS in Australia is to “wholesale clients” only. The information provided in this material is not intended to be, and must not be, distributed or passed on, directly or indirectly, to any other class of persons in Australia. For the purposes of this paragraph the term “wholesale client” has the meaning given in section 761G of the Act. Please inform us immediately if you are not a Wholesale Client now or if you cease to be a Wholesale Client at any time in the future.

This material has not been prepared specifically for Australian investors. It:

  • May contain references to dollar amounts which are not Australian dollars;
  • May contain financial information which is not prepared in accordance with Australian law or practices;
  • May not address risks associated with investment in foreign currency denominated investments; and
  • Does not address Australian tax issues.
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JPMorgan Chase Bank, N.A. and its affiliates (collectively "JPMCB") 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 ("JPMS"), a member of FINRA and SIPC. Annuities are made available through Chase Insurance Agency, Inc. (CIA), a licensed insurance agency, doing business as Chase Insurance Agency Services, Inc. in Florida. JPMCB, JPMS and CIA are affiliated companies under the common control of JPMorgan Chase & Co. Products not available in all states. Please read the Legal Disclaimer in conjunction with these pages.

INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT FDIC INSURED • NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, JPMORGAN CHASE BANK, N.A. OR ANY OF ITS AFFILIATES • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED

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