Michael Cembalest Chairman of Market and Investment Strategy for J.P. Morgan Asset & Wealth Management Mar 22, 2022
Surveying the Damage: Russia’s recurring war on Ukraine, equity market declines and the opportunity for bottom-fishing investors, the energy price surge/recession outlook in Europe, the impact of rising metals prices on EV battery costs, the COVID situation in Hong Kong and the latest on ivermectin
Russia’s invasion of Ukraine is projected to result in one of the largest refugee crises in decades with 4-5 million people displaced 1;long-lasting water, air and ground pollution in Ukraine; and 90% of Ukraine’s population facing poverty and extreme economic hardship if the war drags on to the end of 20222. For anyone surprised that Russia is imposing this brutal misery on Ukraine, don’t be: there’s ample precedent for it. As shown below, the Holodomor famine imposed by Russia on Ukraine in the 1930’s dwarfs other famines in terms of severity and is another example of Russian subjugation of Ukraine by any means necessary3.
How bad is the selloff? Tracking opportunities for bottom fishing investors
The first chart sends a consistent message on US equities4: a large correction took place, and if there is no US recession, the March 8th low was probably a market bottom as it is similar in magnitude to other large selloffs. If there is a US recession, the average stock decline from peak levels suggests further downside. I consider recession risk to be a close call given rising energy prices, rising credit spreads, rising wages, supply shortages that are now exacerbated by the war and a rapid about-face from the Fed designed to cool things down via higher interest rates (including one or more 50 basis point hikes this year). But I believe the US will make it through without a recession. The second chart is another barometer for bottom-fishing investors: it shows how the average stock sold off much more sharply than its respective index. Since March 8th, the US equity indices shown below have risen by 6%-9%.
How bad is the European growth outlook?
Europe is one of the most efficient places on earth regarding energy consumed per unit of GDP (see first chart). Unfortunately, current energy and other producer price increases in Europe are so large as to overwhelm most energy efficiency gains. This has been a large commodity shock: a basket of energy, industry and precious metals, agriculture and livestock is up ~80% since the fall of 2019, similar to the commodity price shocks during the 1973/1974 OPEC oil embargo era and the second oil shock in 1979/1980.
As shown below, European electricity and natural gas prices have quadrupled. In addition, Europe is facing a massive producer price shock: the second chart shows the gap between producer and consumer prices. At some point, the surge in producer prices in Europe either gets absorbed by companies through lower margins, reduced hiring and less capital spending, or it gets passed on to consumers, triggering higher CPI and tighter policy from central banks. Since 1948 when the data begins, the US has not experienced anything like the producer price shock that Europe is experiencing now. It looks like a recession in Europe will be the inevitable result. European equities are priced at ~13x with earnings expected to be flat in 2022; during European recessions, earnings can fall 25% with P/E ratios falling below 10x. So, it’s hard to argue that Europe is very good value here unless there is an unexpectedly quick end to the Russian invasion of Ukraine.
How bad are rising metals prices for the EV industry?
There are wild short squeezes and mayhem reportedly taking place in nickel markets, so current price levels may not last long. But if metals price increases since early 2020 are sustained, what could happen to EV prices due to rising battery costs? Using metals composition of EV batteries from Argonne National Labs and the latest metals prices (including an assumed post-squeeze decline in nickel prices to $26,500 per metric ton), I took a look. I analyzed a hypothetical 60 kWh battery across three chemistry types: Lithium Nickel Manganese Cobalt (NMC), Lithium Nickel Cobalt Aluminum (NCA) and Lithium Iron Phosphate (LFP). The table shows battery chemistry by auto manufacturer; LFP batteries are used by Tesla and Chinese EV makers, while the rest mostly use NMC at least for now. LFP batteries are typically cheaper but have lower energy densities. China manufactures most LFP batteries while Samsung and LG Chem produce most NMC batteries.
Estimated LFP battery costs have risen by ~$500 since January 2020, mostly due to rising copper prices; this increase seems manageable as a % of vehicle cost. In contrast, estimated NMC and NCA battery costs increased by ~$1,500 since January 2020 with a large part of that increase occurring this year due to rising nickel and cobalt prices. For all EVs, there could be another $500 EV cost increase due to incremental copper and aluminum used for non-battery purposes in excess of amounts needed in internal combustion engine cars.
The bottom line: there may be some sticker shock for EVs reliant on nickel and cobalt, but not for EVs using LFP chemistry. Of course, EV owners would save even more on fuel if the gap between gasoline and electricity costs per mile is sustained 6 I’ve been a skeptic on US EV adoption rates (just 2% of sales last year), and now there’s another headwind that NMC-EVs face that might require even more generous Federal subsidies.
How bad is the COVID situation in Hong Kong? And a comment from Mister Ed on ivermectin
I wrote in February about a market research firm I subscribe to whose principal researcher does not believe in the efficacy of COVID vaccines. Their founders are French but are based in Hong Kong given what they often criticize as creeping French government control of industry (yes, the ironies are too numerous to mention). In any case, if his vaccine skepticism is influenced by the situation in Hong Kong, he should take a closer look.
Current Hong Kong COVID mortality rates are ~4x peak US levels which took place last year. There are two primary reasons for this, in my view. First, as shown in the table, for some strange reason, vaccination rates in Hong Kong are inverted relative to risk (age). In other words, middle aged people are vaccinated at a much higher rate than older people. Second, around half of the people in Hong Kong are vaccinated with CoronaVac, a vaccine produced by Beijing-based Sinovac. Among those over 80, CoronaVac is only 45% effective against mortality7. I don’t have a direct comparison for 80+, but the latest mRNA vaccine efficacy metric for the 65+ US population is 70%-80% according to Oakland’s Public Health Institute.
China is reportedly working on its own mRNA vaccine which is still in Phase III trials. One such Chinese company was added to the US Federal Trade restricted list given its alleged use of biotechnology to support activities such as “brain control weaponry” (!!). Separately, BioNTech and its Chinese partner have completed their own trials but their mRNA vaccine has not been approved yet by Chinese authorities.
The latest on ivermectin: “Neigh”, says Mister Ed
A recent clinical trial in Brazil evaluated the effects of ivermectin when administered to those who tested positive for COVID and were at risk of severe disease. Half of the ~1,400 patients were prescribed ivermectin for three days, and then tracked for 28 days to determine whether they were hospitalized and if they cleared the virus faster than patients who received placebo pills. The trial concluded that ivermectin did not improve patient outcomes, either in terms of reduced hospitalizations or increased speed of recovery8.
As a reminder: ivermectin is a horse de-worming drug but is also a very effective drug for humans infected with certain parasites (its creators won the Nobel Prize for it in 2015). When used for parasitic treatment, ivermectin is given as a one-time dose; the “ivermectin for COVID” crowd are often taking it twice a week even though there is no safety data on prolonged use.
None of my analysts understood the Mister Ed reference since they did not know who he was. The cultural divide between my generation and theirs is unbridgeable. Maybe it’s time for me to be put out to pasture.
1 This 4-5 million figure for Ukraine refugees compares to the following from the UN High Commissioner for Refugees: Syria 6.7 mm, Venezuela 4.0 mm, Afghanistan 2.6 mm, South Sudan 2.2 mm and Myanmar 1.1 mm
2UN Development Program press release, March 16, 2022
3See “Mass Repression and Political Loyalty: Evidence from Stalin's Terror by Hunger”, Rosenas (NYU) and Zhukov (University of Michigan), 2019 and Anne Applebaum’s “Red Famine” (2017)
4Charts sourced from JP Morgan Global Markets Strategy, March 17 Equity Market Update
5The largest 5 stocks are now Apple, Microsoft, Google, Amazon and Tesla. The remainder are comprised of large cap pharma/biotech, mega-banks, specialty retail, interactive media, food/beverage and even some energy companies.
6Assuming 25 mpg for a gasoline car, 3 miles per kWh for an EV, $4 gasoline, 14 cents per kWh for electricity and 11,000 miles driven per year, EV owners would save ~$1,250 per year in fuel expenses. Comparing this annual amount to the incremental upfront cost of an EV over a gasoline car yields the payback period.
7 “China’s COVID vaccines have been crucial – now immunity is waning”, Mallapaty (Nature), October 14, 2021.
8TOGETHER trial, Edward Mills (McMaster University) and Craig Rayner (Monash University), March 2022