In this week’s Eye on the Market, we review topics from our recent client Zoom calls:

  • The risk of inflation
  • COVID news of the week: US spending rebound, Europe, Second Waves and Oxford vaccine Phase II/III trials
  • The debate on whether lockdowns help or hurt: be careful what you read
  • The exploding US Federal debt and the Eisenhower blueprint
  • Biden’s taxation and spending agenda

Read more here.

Line chart which illustrates gross federal debt held by the public as a percentage of US GDP from 1940 to 2020. Gross federal debt increased significantly during WWII to 106% of US GDP, but decreased approximately 50% in just a decade after WWII ended. Gross federal debt has steadily increased since the 2008 global financial crisis to approximately 80% of US GDP. The Congressional Budget Office estimates that gross federal debt held by the public will reach 101% of US GDP by the end of 2020, and will reach 108% of US GDP by the end of 2021.

ANNOUNCER:  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 afternoon, this is Michael Cembalest with the late May "Eye on the Market" podcast.  I had a few things I wanted to discuss with you this time, most of which are a review of the topics we've been discussing on some of the Zoom calls we've been having with clients.  And so just to tick through the topics:  we're going to talk about inflation, some COVID news of the week related to U.S. spending, second waves of infection and the Oxford vaccine.  I want to discuss briefly this whole debate about whether or not lockdowns hurt or help. 

And then on the intersection between politics and economics we're going to talk about the exploding U.S. federal debt, the precedent from Eisenhower and Biden's tax and spending agenda as it stands right now. 

So real quick:  on the risk of inflation, a lot of clients have been asking about this and here's how I've been answering it.  Heading into this year the U.S. had experienced an entire decade of negative short term interest rates for only the second time since 1830, and the U.S. was also running a massive fiscal deficit in spite of full employment, which usually doesn't happen, and still there was no inflation overshoot. 

In the 2020 outlook we theorized on all the reasons why, related to globalization, industrial robots, bargaining power, the impact of online retailing.  But the bottom line on inflation is if we didn't see it in the U.S. during the prior decade, which was one of the loosest monetary and fiscal periods in history, I'm not sure why it would show up now.  I'm actually much more concerned about deflation, given the restructuring wave on corporate balance sheets. 

So for some real quick COVID news of the week:  U.S. real-time spending, our new tools show that social distancing spending on things like retail, lodging, restaurants, theme parks and theaters and things like that are actually improving a lot at a rapid pace since March lows in reopened states with low virus infection levels.  That's why we needed to splice all of this spending data, not just look at the national data, which is a mix of different states and different situations.  But when you look at what happens in states that reopened and their infection rates fall, those spending levels tend to improve much more quickly which I think is a good sign.

Another good sign is, with the exception of New York and New Jersey, the median ICU utilization rate for ICU beds is just seven percent.  And so it does seem as if—we don't know what kind of second waves may or may not happen, but it does seem as if there's ample health care capacity in a lot of states to deal with second waves if they occur.  So far we're only picking them up in West Virginia and Arkansas, based on our definitions.  And we know it's not herd immunity at work, given the serology testing results.  So the lack of second waves in the U.S. so far is either the result of a time lag, meaning it'll show up eventually, or that weather factors, individual variation and susceptibility, social distancing, and a bunch of other factors are suppressing the transmission of the disease.  Results are similar, by the way, in Asia and Europe:  limited second waves so far.  And for all the topics we just discussed in sections one and two of our coronavirus web portal you can go into all the detail that you want. 

And then one last COVID news of the week topic:  the U.S. biomedical research and development authority (BARDA) provided over a billion dollars to AstraZeneca and Oxford to support their phase two and phase three studies:  three hundred million doses would be secured for the U.S., with the first doses delivered as early as October, I'll believe it when I see it, if the trials are successful.  So far the only thing Oxford has released is the results of its monkey trials and the reception was mixed there, which we get into a section four on the web portal.  And they haven't released the results from phase one, but presumably they were okay or else they wouldn't be proceeding with phase two and phase three.

So now let's talk about this question and debate very briefly of whether or not lockdowns did any good.  There's an understandable effort underway to figure out if the lockdowns did any good and what impact did they have on COVID mortality rates and how did they affect other diseases and life-threatening conditions.  These are really complicated questions; historically they've taken months if not years to analyze, and they result in peer-reviewed studies that analyze all the counterfactuals.  Until then you should be very cautious when somebody pings some newspaper hyperlink at you, referring to some guy that's figured out already that lockdowns had no more mortality benefit for the countries that used them.

Here is some grade school logic:  a) Germany experienced lower infection rates than Italy; b) Italy had more stringent lockdown policies than Germany, therefore c) lockdown policies had no benefit for Italy.  Anybody that's taken a high school logic class will see that while a) and b) are true, c) doesn't necessarily have to follow from a) and b).  The bottom line is you can only understand Italy's lockdown benefit from the dynamics of Italy's own health care and demographic situation and you can't infer anything from Germany.

There's a paper that's been circulating and have been cited publicly by research groups within other parts of JPMorgan that makes the assertion that lockdowns had no beneficial impact in Europe, and people from other research groups within JPMorgan have been all over the press touting this thing.  First of all, its author was an oceanographer at Woods Hole, and I have no reason to doubt that he is an excellent oceanographer.  But we have to have some discipline in a pandemic that scientists from other disciplines shouldn't just be airlifting in with observations on things that they don't work on full-time. 

Even more important than that, I asked a mathematical biologist who's specialized in virus disease research to look at this paper and they had a whole bunch of concerns about its methodology, its conclusions and its assumptions; I list them on page three of the "Eye on the Market" that's coming out this week and it's a laundry list of things that didn't make sense to them.

So I have no objection to the concept, in principle, that we will eventually learn that lockdown costs exceeded their benefits, whether economically or even within the health care sphere.  But to convince me it's going to take properly peer-reviewed research, not some random missives on the internet that people find not newspaper articles and not driveby opinions from people airlifting in from other disciplines.  And so you can take a look and judge for yourself as whether the concerns raised by the people that I showed this article to are legitimate or not.  As far as I'm concerned it doesn't hold a lot of water and lacks the same amount of discipline as that whole BCG vaccine thesis we saw about a month ago.  An of course all of the nonsense about the benefits of hydroxychloroquine as a treatment for COVID.

The last topic for this week has to do with a little bit of history and current policy as it relates to the federal debt.  So on page four of the "Eye on the Market" this week there's a chart that shows the history of the federal debt going back to the late 1930s, and anybody that's looked at this chart knows the contour, which is there was this enormous spike in the federal debt associated with World War Two.  It came down sharply by the end of the 1950s, was more or less unchanged until the financial crisis and then shot up again for a variety of reasons, and now with the virus-related spending we'll be re-reaching those World War Two levels either in 2020 or in 2021. 

So the question is how did this happen, not so much the rise recently but how after World War Two did the U.S. reduce its debt ratio almost by half in a single decade, because those policies might be things that we'd want to think about.  And as we show here—and this is something that I first wrote about a couple of years ago, during the 1950s they did not cut spending, there were no sharp increases in tax collection, the Fed did not engineer negative interest rates to starve savers to jump start growth, and they also didn't inflate its way out.

And so if they didn't raise taxes, and they didn't cut spending, and they didn't inflate their way out, and they didn't engineer negative real interest rates, how did the debt to GDP ratio fall?  Well, the simple answer is the debt itself didn't fall, what the United States did was to adopt a very aggressively pro—growth policy to grow the denominator.  So debt stayed the same, but the debt-to-GDP ratio fell, the United States grew by almost four—and—a—half percent in real terms over the entire decade, with modest inflation of just two percent.  But the combination of those real and nominal growth numbers cut the real debt to GDP ratio in half. 

And when you look at the blueprint of what was done during the Eisenhower Administration, in general, although not across the board, there were a bunch of, for the most part, pro—business policies.  And so:  lower taxes on small business, elimination of double taxation, which led to subchapter S, accelerated depreciation to promote investment, write off of R&D, reduced taxes on profits earned abroad, elimination of wages and price control, agricultural price supports, reduced tariffs.

Now one thing they did do is they had a very aggressive and vigorous anti—trust policy that was applied to both vertical and horizontal mergers in an effort to limit some of the monopolies that had emerged during the war.  And Eisenhower and his people were pretty aggressive about maintaining vibrancy across lots of different sectors at different levels of the economy, both in the private and public markets.

And for all the hyperbole about the changing personal tax rates, even Saez and Piketty and Zucman acknowledge that the taxes on the top one percent were only about five to seven percent higher back then than they are now.  And so while some of these Eisenhower policies might not make sense for a population that's older, and some people argue that a Keynesian approach makes more sent to get rid of this debt, when you look back at how the United States reduced its debt the Eisenhower blueprint is really the only one that we have, and in general is best described as a pro—business, pro—growth policy that also sticks to capitalism with a small "c" and is aggressive about prosecuting and eliminating situations where you have monopolies and price fixing. 

So that brings me to the last comment, which is I was talking to my 25—year—old son about the election, and he mentioned that some of his friends were very reluctant to vote for an established candidate like Biden.  And I actually wonder whether his friends have read Biden's policy positions and not just looking at Twitter and things like that.  Biden's got a very progressive economic agenda as it relates to taxation:  no more income cap on the payroll tax; in other words, above $400,000 of income the payroll tax would be infinite, or applied to an infinite level of income; tax capital gains as ordinary income; further limitations on itemized deductions; no secret ballot worker elections to strengthen unions; federal government can negotiate Medicare drug prices; minimum level of corporate taxes; limited tax breaks for real estate and fossil fuels; base-broadening measures.  These are a lot of the very progressive positions that the Progressive wing and the Democratic Party has wanted to get onto the core platform of presidential candidates for a long time and now they're here.  And so I wonder whether my son and his friends have taken a close enough look because I think these positions are extremely progressive.

And in terms of polling there has been a pretty clear shift since February in favor of Biden in the swing states.  And so that's interesting to note.  In terms of the impact for investors I'm not really that concerned about wealth redistribution per se because shifting a dollar from wealthy people to less wealthy people tends to increase spending, right, because people that have less money have higher propensities to spend.  So I don't think the market is going to be very concerned about redistribution of wealth per se. 

The bigger issue for investors is the change in corporate tax rates, and you could easily see 200 to 250 points on the S&P wiped out if you were to reverse all of the corporate tax cuts.  And the other thing for investors to think about that we end this week's piece with is some history on anti—trust.  And when you look at the collapse in Department of Justice anti—trust investigations over the last 40 years and in particular on the tech sector you could see some pretty substantial changes if there's an anti—trust revival and how that would impact the part of the market that has been leading both with respect to market capitalization and performance and also with respect to sales and earnings growth.

So that's the "Eye on the Market" for this week, and I look forward to speaking with you again soon.  Thank you.

ANNOUNCER:  Michael Cembalest's, "Eye on the Market" offers a unique perspective on the economy, current events, markets and investment portfolios and is a production of JPMorgan Asset and Wealth Management.  Michael Cembalest is the chairman of market and investment strategy for JPMorgan Asset Management and is one of our most renowned and provocative speakers.  For more information please subscribe to the "Eye on the Market" by contacting your JPMorgan representative.  If you'd like to hear more please explore episodes on iTunes or on our website. 

This podcast is intended for informational purposes only and is a communication on behalf of JPMorgan Institutional Investments, Inc.  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