Michael Cembalest Chairman of Market and Investment Strategy for J.P. Morgan Asset & Wealth Management Jul 13, 2021
Topics: Delta variant; the Fed as firefighter and arsonist; US-China economic divorce picks up steam; a unified theory of the US, China, wages, inflation, the WTO, opioids and investment portfolios for 2022 and beyond
“If you’ve ever desired a vacation on a ventilator in the ICU, then not getting vaccinated is probably for you”
Craig McCoy, former paramedic and president of Mercy Springfield Communities Hospital, Springfield Missouri
I led an internal discussion recently on the Delta variant for our asset management business. The details can be found in Section 1 on our virus portal here. Main messages: while the Delta variant has caused a small number of breakthrough hospitalizations and deaths for vaccinated people, the main risks overwhelmingly affect unvaccinated and immunocompromised people with no or insufficient antibody responses. From an investor’s perspective, developed world equities should be able to withstand the Delta variant; a chart we added on economic throw-weight (trade, FDI and portfolio flows), vaccination and mortality by country explains why.
One important chart to watch is the first one from the UK: so far, a large spike in Delta infections has not led to a surge in overall hospitalization or mortality. However, this masks what’s happening to unvaccinated people over 50 in the UK: 14% of such Delta infections ended up in the hospital and almost 4% died1, figures which are 4x higher than for vaccinated people over 50. The good news: in the UK, 96% of people over 50 are vaccinated, reducing the size of its at-risk unvaccinated population. However, in the US age 50+ vaccinations are ~75% nationwide (lower in many rural counties), resulting in larger populations of at-risk people; and in hotspot states (AR, FL, LA, MO, NV, WY), hospitalizations are rising more rapidly than in the UK.
Even so, my primary message to the group was that the US reopening train has left the station and that the Delta variant is unlikely to have a durable impact on US equity markets. Federal and local governments are unlikely to reimpose mobility restrictions to protect a cohort that is mostly unprotected by its own volition. The policy borrows from Genesis 4:9: “you are not thy brother’s keeper if he chooses to expose himself to COVID”, irrespective of whatever his reasoning may be. A February NYT article2 described how younger generations are bearing unacceptable sacrifices to protect older ones. I doubt the NYT would have published this while Trump was President, for fear of being seen as aligning itself with his Administration’s views. But with a new administration in DC, I suppose it’s safer to make one’s intergenerational prosperity preferences clearer.
Charts: 96% vaccination rate of people over 50 explains the gap between UK infections and deaths; in the US, the reopening train has left the station irrespective of Delta variant outbreaks
I read something recently which referred to the Fed as both firefighter and arsonist. That’s a good description: resuscitating private sector demand while simultaneously destroying decades of underwriting and investment discipline in the process. The firefighting resources the Fed is using: the easiest monetary policy in US history other than during wartime; and a symbiotic relationship with the US Treasury which now entails the Fed buying the entire stock of net Treasury issuance. You have to see it to believe it.
US-China economic divorce picks up steam, but is that what’s negatively affecting Chinese tech stocks?
The 25% decline in Didi’s stock has refocused investors on the US-China economic divorce. However, it’s important to understand that there’s still plenty of normalcy in the US-China economic relationship. China’s share of US imports is only modestly below 2018 levels, US stocks exposed to the trade war are doing fine vs the market, US semiconductor exports to China are still rising despite Huawei, US investors continue to accumulate more Chinese stocks and bonds, and unlike Russia, China has not engaged in economic warfare via its US Treasury holdings. Only bilateral FDI flows appear to be suffering from changes in national security policy.
That said, the Biden administration has unleashed an alphabet soup of China-targeted policies:
Executive Orders restricting China’s access to US sensitive data via consumer apps and restricting US investment in Chinese companies affiliated with its military; Holding Foreign Companies Accountable Act (de-listing of Chinese companies non-compliant with SEC data requirements); CHIPS Act and 5G Emergency Appropriations ($ for US semiconductor companies); Endless Frontier Act ($ for STEM R&D); Strategic Competition Act (CFIUS oversight of mergers and gifts by Chinese entities to US institutions); Homeland Security and Governmental Affairs Committee Provisions (“Buy America” requirements for iron and steel in US infrastructure projects); Meeting the China Challenge Act (sanctions for cyberattacks, IP theft and economic espionage); Uyghur Forced Labor Prevention Act (sanctions on US and Chinese companies knowingly using forced labor or conducting surveillance)
China’s possible partnership with the Taliban in Afghanistan won’t play well in DC either. Even so, many US initiatives are meant to boost US competitiveness and only a couple target Chinese companies in the MSCI China index, and usually impact smaller ones. In fact, the largest risks facing Chinese tech stocks and ADRs come from China rather than the US. Chinese regulators have implemented guidelines aimed at curbing monopolistic practices, limiting lax underwriting activities, policing data privacy, censoring content, addressing worker mistreatment and reforming entire industries like fintech and education. While the timing of enforcement actions on Didi suggest that there’s a message to US politicians in there as well, domestic policy concerns were the driving factor behind China’s decision to order mobile stores to remove Didi’s ride-hailing app.
On top of all that, China just proposed new rules to require companies with more than 1 million users seeking to list in foreign countries to undergo a cybersecurity review due to the risk that data and personal information could be “affected, controlled, and maliciously exploited by foreign governments”. This review will look into possible national security risks as well.
Whether new risks facing Chinese tech stocks are due to the US-China policy war or to Chinese domestic policy actions, large Chinese tech stocks now face hurdles that suggest the need for lower valuations than their US counterparts (they now trade at roughly the same level, as illustrated below).
The Pig and the Snake: a unified theory of the US, China, wages, jobs, inflation, opioid use, the WTO and investment portfolios for 2022 and beyond
The US economy is booming: capital spending and hiring tailwinds should last a few more months at least. There are some wacky inflation readings on the high side, but most professional economic forecasters and market-based inflation expectations are looking past them (the spike in used car prices is one example).
To be clear, rising wages are a positive development for the US economy but there are levels at which the Fed’s zero rate policy becomes inconsistent with them. To bring the whole US-China-wage-inflation discussion full circle consider the following, illustrated below:
- In 2001, the West allowed China into the World Trade Organization…
- After which China immediately launched a massive and unprecedented intervention in its currency markets to prevent appreciation and boost its manufacturing and export shares….
- Which allowed China to mount the greatest economic boom in post-war history…
- Flooding the US with cheap goods (the US import price index from China is at the same level as in 2004)…
- But which contributed significantly to an acceleration of US manufacturing job losses…
- And a collapse in the US of the share of gross profits accruing to labor vs capital…
- Whose aftershocks include the opioid epidemic, rising polarization and growing wealth inequality
1 "The Delta variant in the UK: how is it going?", David Mackie, J.P. Morgan Economic Research, July 6, 2021. See Table 3 for all the Delta impact data by vaccination status and age.