Eye on the Market: "Good luck with that"
TIME: 10.28

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[Transcript]

MR. CEMBALEST: Greetings everyone, this is Michael Cembalest with the Holiday Eye On The Market for 2018.  Just a quick couple of comments on market issues before we get to the topic of the day.  We expect GDP growth and profits to rise again next year, but in most business cycles, asset prices tend to peak a year or so before corporate profits and the economy do.  We discussed this in October, we’re going to talk about it again in our 2019 outlook, which comes out on January 1st.  And so I think that’s something pretty important to think about, even though we’re going to have another year of, let’s call it, two and a half to three percent growth in the U.S. and eight to 10 percent corporate profits growth.

That doesn’t necessarily tell us enough about what asset prices are going to do.  Stock bond mixes, returned anywhere from minus three to plus one percent this year and I don’t think next year is going to be that much different.  Right now it looks like something between minus and plus five percent for diversified stock bond mixes in 2019.  So we’ll talk about that more in the 2019 outlook.  At this time of year I depart from standard investment commentary to do something a little different and thank you to Mary for letting me do that. 

And this holiday on the mark- Eye On the Market’s a note to my spouse on the 2020 Presidential election.  So if politics raises your blood pressure to unacceptable levels, please terminate this podcast immediately and read one of the other links that we have in here on our Energy Paper, our Private Equity Paper or our Muni Paper.  So the context around this note to my spouse is that she has a vision or a hope; I’m not sure what to call it.  But it goes like this, in 2020 a moderate defeats the President to the GOP Primary, a moderate wins the democratic primary and with both candidates reflecting the values of her father who was raised in rural Indiana in the 1930’s, he served as- he- head of surgery for the 121st Medevac Hospital in Korea, he was the chief of general surgery at Northwestern Hospital and he was also a team doctor for the Chicago Cubs.  Anyway with respect to my spouse’s vision for 2020, my response to her is the same as her response to me from time to time, which is “good luck with that.”  And the reason I say that is if the political pendulum does swing, it may swing pretty far.  And we have a chart in here to explain what I mean by that.  There have been around 11,000 members of congress and 1,200 senators since 1787 and there are databases that calculate for every single politician, their ideological intensity - how often do they vote with their block or against their block?  How often do they vote along party lines?  How often do they cross party lines?  And we went back and started with the Coolidge administration of the 1920’s and went all the way to today and we calculated for each administration its ideological intensity.  How conservative and how liberal was it?  And of course, as you’d expect, it’s swing- the pendulum swings back and forth as you go from Coolidge to FDR and Truman, back across to Eisenhower, back over on the other side to Kennedy and Johnson, Nixon and Ford, Carter, back over to Reagan, back over to Clinton, etcetera, etcetera. 

And what the chart highlights is that, there’s a couple of things, first the Trump dot in the chart is the most ideologically conservative dot on the chart on the right side of the chart.  And the 2020 progressive candidates Warren, Sanders, Harris, Booker and Gillibrand represent the left most dot on the chart.  So in other words, the ideological conservatism of the Trump Administration is to the right of anything we have seen I the last hundred years.  And the progressive candidates are more ideologically liberal than anything that we’ve seen in the last 100 years, even to the left of Roosevelt and Truman in their administration. 

And just another quick word on methodology, each administration’s score is based on the voting histories of members of the executive branch that have them.  And the voting histories of prominent members of congress that supported the administration, in terms of its major legislative initiatives and its political and governing principles.  So you can see below the chart we list each administration and who the members of congress and the executive branch were on which we based the dot.  And this is based on data that’s been used in peer viewed papers on public policy and legislation since the early 1980’s and is currently maintained by UCLA’s Vote View Project. 

Anyway the reason the chart matters, I think, is another picture that we have in here, that if you go back to 1950, and you track the percentage of moderates in the House of Representatives and then you look at what subsequent tenure U.S. GDP Growth was, they track pretty closely.  And as the percentage of moderates went down in the House, the subsequent ten-year growth rate of the U.S. went down.  Now of course before anybody starts texting me, the decline in post war growth was heavily impacted by falling birth rates and rising longevity, and then there have been some Fed studies that made that clear. 

But I'm convinced that the collapse in the political center played a role as well, because we’ve ended up with a lot of one-sided policy making that gets implemented and repealed as the pendulum swings.  Think about things like net neutrality and then other issues that get left unaddressed because the political divisions are too wide.  And we- I would like to see, along with a lot of other people I know, a return of some of the moderates, but now is not the time that that’s going to happen.  The erosion of political norms and constitutional conventions now taking place are pretty extreme; so are the reactions to them and the bottom line is that makes life difficult for moderates in either party these days.

So hence this note with these charts and a warning to my spouse about 2020 and the choice that she is likely to face, in my opinion, is going to be very different than her preferred scenario.  In any case, I ended this 2018, with a long term look forward; our Chairman Jaime, asked me to put together for him a presentation on what he thinks of as negative productivity agents.  What are the things that in the long term whoever wins in 2020, the executive branch and legislators will eventually have to grapple with, things like crumbling transportation and electricity infrastructure.  The U.S. has the lowest level of high speed rail practically in the developed world.  We have coastal exposure to storm surges.  We have subpar reading and math scores.  We have the highest litigation costs in the world.  We have land use regulation all over the place that is negatively impacting labor mobility and housing.  We have arbitrary state licensing requirements that negatively affect growth in employment.  We badly need immigration reform.  And we also happen to lead the developed world in obesity, gun violence, incarceration and opioid use.  So Jaime asked me to put together a presentation on what some of the issues and options are and we have a link to that presentation in the note. 

The challenges are complex and I think what history tells us, as certainly this suggests that we have in here, is that in the past the extremists were less able to solve these kind of problems on their own. 

One last thing on a note to my spouse, I miss your father a lot, he liked fishing, and pie and diners and he disliked parties, and he disliked small talk and fine restaurants.  He bought a car, in I think, five minutes once, because he hated shopping.  And when your mother threw out his old tweed caps and bought him a new one for Christmas, he told your brother John to go out and throw the new cap away and retrieve the old ones from the bottom of the garbage, so he could keep wearing them.  And the, I guess, the tagline of that is I apologize to you in advance, but I think I am gradually becoming your father.

So that is our Holiday Eye On The Market summary for 2018.  Take a look at the chart in here on the pendulum of Presidential Administration’s with a look at 2020 and the attached piece.  We will have our Eye On The Market 2019 podcast as well as the piece itself coming out on January 1st and I wish everybody a healthy and happy holiday season.  Thank you and goodbye. 

DISCLOSURE:  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 JP Morgan Asset and Wealth Management.  Michael Cembalest is the Chairman of Market and Investment Strategy for J.P. 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 J.P. Morgan 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 J.P. Morgan Institutional Investments Incorporated, a member of FINRA, views may not be suitable for all investors and are not intended as personal investment advice or as 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.

 

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There were positive gains in US growth stocks this year while almost everything else was flat/down; the chart below tells the story. While we expect US GDP and profits to continue to rise in 2019, in most business cycles, asset prices peak a year or so before corporate profits and the economy do. In other words, a rising economy and rising profits often don’t translate into rising asset prices this late in the cycle, particularly with the US President channeling Andrew Jackson and Hoover instead of Reagan (see links below). We will review all of this in our 2019 Outlook, released as usual on January 1st. The biggest binary issue for investors: the long-term US trade and political conflict with China, since I can imagine a substantial market recovery or decline based on how it plays out. Looks like a low single-digit return year in 2019 at best, after -3% to 1% returns on diversified stock-bond mixes in 2018.

At this time each year, I depart from standard investment commentary to write something different. This year, the Holiday Eye on the Market is a note to my spouse on the 2020 US Presidential election. Please skip this note and read one of the pieces below if politics raises your blood pressure to unacceptable levels. Happy New Year.

Select Eye on the Market topics, 2018

How business cycles end, and the twilight of the largest monetary intervention in history

2018 Eye on the Market energy paper: fact and fantasy along the road to de-carbonization

On private equity dry powder: implications for investors of growing committed and unspent capital

The State of the States: the full cost of unfunded pension and retiree healthcare obligations

Midterms: adjusted for economic and market conditions, the worst incumbent House loss in 100 years

Trumpism for Investors: Themes and parallels to prior US Presidents, from Jackson to Bush

2018: US growth stocks up, almost everything else flat/down as the global stimulus cycle comes to an end

“Good luck with that”

I know you have a vision, a hope, I’m not sure what to call it, that goes something like this: in 2020, a moderate defeats the President in the GOP primary and a moderate wins the Democratic primary, with both candidates reflecting the homespun values of your father, raised in rural Indiana (Kewanna, pop. 600) in the 1930s before serving as head of surgery for the 121st medevac hospital in Korea, the Chief of Surgery at Northwestern Hospital and as one of the team doctors for the Chicago Cubs. My response? As you say to me in moments of my own delusions: “good luck with that.” If the political pendulum swings, it may swing pretty far. The chart shows the degree of liberalism/conservatism by administration since 1924. Given the ideological intensity of the Trump administration and of progressives in the Democratic Party, you may face a choice in 2020 that reflects the extremes of the last 100 years rather than the middle, at least as it relates to the liberalism/conservatism measure shown below.1

The political ideology of Presidential administrations, and a look at 2020. This chart plots the degree to which specific presidential administrations (1928-2020) are judged liberal or conservative.

Who's included in each administration's score

2020 Ultra-progressives: Warren, Sanders, Harris, Booker
2020 Progressives: S. Brown, Giilibrand, Merkley
2020 Moderates: Bennet, Biden, Casey, Klobuchar, O'Rourke
Trump admin: Cotton, Graham, Hatch, McCarthy, Meadows, Paul, Perdue, Ryan, Scalise, Sessions
Obama admin: Biden, Durbin, H. Clinton, Kennedy, Kerry, Obama, Pelosi, Reid, Waxman
GWB admin: Ashcroft, Blunt, Cheney, DeLay, Kyl, McConnell, Santorum
Clinton admin: Bentsen, Carper, Chiles, Gephardt, H. Ford, Nunn, Robb
Reagan/Bush admin: Baker, Bush, Dole, Kemp, Latta, Laxalt, Lugar, Michel
Carter admin: Bayh, Byrd, Hawkins, Mondale, O'Neill, Wright
Nixon/Ford admin: Ford, Lott, Percy, Rhodes, Sandman, Scott, Wiggins
JFK/LBJ admin: Bolling, Humphrey, JFK, Johnson, Mansfield, McCarthy, McCormack
Eisenhower admin: Dirksen, Dulles, Flanders, Nixon, Saltonsall, Smith, Taft
FDR/Truman admin: Barkley, Black, Byrns, Garner, Guffey, McCormack, Robinson, Sabath, Truman
Coolidge/Hoover admin: Curtis, Hawley, Longworth, Moses, Tilson, Watson

Methodology: Each administration's ideology is based on politicians we selected (left), which include members of its Executive Branch with Congressional voting histories, and prominent members of Congress that supported major legislative initiatives of that administration, and/or defended its political and governing principles. The dots show the average for the group, and were computed using Nokken-Poole first dimension Voteviewdata, sourced below. In general terms, Voteview scores reflect the ideological intensity of politicians by looking at how frequently they voted with their bloc . Please see appendix for details. Data: Jeffrey Lewis, Keith Poole, Howard Rosenthal, Adam Boche, Aaron Rudkin and Luke Sonnet (2018).Voteview: Congressional Roll-Call Votes Database. Michael Cembalest, J.P. Morgan Asset Management, 2018.

What the chart measures. The underlying data measure the liberalism or conservatism of politicians based on their voting patterns in Congress, and have been used since the 1980s in peer-reviewed studies on public policy, the legislative process and polarization (see p4). The chart conveys the intensity with which each Administration and its prominent supporters in Congress adhere to a liberal or conservative ideology, and the frequency with which they break from the party line. The chart is not meant to establish a moral, social or ethical equivalence between observations at equal distances from zero. That’s not something that can be captured in a chart, and is a judgment made in the hearts and minds of voters.

Why the gap matters. Look at the next chart. The United States was more prosperous when there were more moderate politicians around. Yes, post-war growth declined mostly due to falling birthrates and rising longevity.2  But I’m convinced that the collapse in the political center played a role as well, leading to one-sided policymaking that gets implemented and repealed as the pendulum swings, and issues left unaddressed since the divisions are too wide. I’d like to see a return of the moderates like your father, but I don’t think it will happen anytime soon now that the furies have been unleashed.3 The erosion of political norms and constitutional conventions now taking place, and some of the reaction to it, makes life more difficult for moderates in both parties.4  Hence this note about 2020 and the choice you may face compared to your preferred scenario.5

Moderates in Congress and GDP growth that followed. This two-line graph draws a link between GDP performance and the percentage of moderates in the House of Representatives, 1950-2017.

The decline in congressional problem solving chart

Whichever party wins in 2020, legislators will eventually have to grapple with issues constraining US growth. Our chairman (Jamie) asked me to work on a project assessing “negative productivity agents”: crumbling transportation and electricity infrastructure, the lack of high speed rail, coastal exposure to storm surges, healthcare costs, sub-par reading and math scores, the world’s highest litigation costs, the economic cost of racial inequality, land use regulation and its adverse impact on labor mobility and housing, the negative impact of arbitrary state licensing, the need for immigration reform, the sad fact that the US leads the developed world in obesity, gun violence, incarceration and opioid use, and the projection from the CBO that by 2030, 100% of Federal tax revenues will be needed to pay entitlements and interest, with nothing left for discretionary spending. You can read the presentation here. The challenges are complex; the chart above suggests that in the past, moderates did a better job of solving them.

Appendix: the Political Pendulum chart

Voteview methodology, our chart and further reading on polarization

  • “Voteview” data is derived from a spatial model of parliamentary voting, and assigns liberal/conservative scores to every politician since the first Congress in 1789 based on their voting records. It has been used in peer-reviewed studies of polarization and Congressional history since the 1980s. The project began with pioneering work done by Keith Poole at the University of Georgia and Howard Rosenthal at NYU/Carnegie Mellon (“The Polarization of American Politics”, 1984), and is now maintained by UCLA’s Department of Political Science.
  • Using Voteview data, I computed a liberal/conservative score for each administration based on the average score of politicians most closely aligned with it: (a) members of its Executive Branch with their own voting histories, and (b) prominent supporters in Congress that helped pass that administration’s major legislation, and/or that defended its political and governing principles. The judgments on which politicians to include are my own (the names I selected appear below the chart), and any historian’s lists could differ; I think they represent each administration’s political orientation reasonably well.
  • There are good resources to read on the issue of polarization and its impact on American society, and on the ability of American democracy to withstand the current unorthodoxy. Some recommendations: Nolan McCarty at Princeton, Jack Balkin at Yale, Neil Siegel at Duke, David Spence at the University of Texas and Norm Ornstein at the American Enterprise Institute.

On the selection of prominent members and supporters for each administration

  • The rightward migration of the red dots in the chart since the 1950s is notable. So is the outlying moderation of the Clinton administration, which sprung from the now-defunct Democratic Leadership Council’s desire to reverse the poor performance of progressive Democratic Presidential candidates in 1972, 1980, 1984 and 1988.
  • The decision to define someone as a Congressional supporter is subjective. Eugene McCarthy, for example, was an opponent of the Vietnam War whose political movement was reportedly a key factor driving LBJ not to run for a second term. However, McCarthy was also a key ally to JFK and LBJ in passing the landmark Great Society legislation of the 1960s, and has therefore been included as one of their prominent ideological supporters in Congress.
  • Congressional supporters were hardest to develop for Jimmy Carter, given his Administration’s well- publicized battles with his own party, including House Speaker Tip O’Neill. These conflicts culminated in a decision by Senator Ted Kennedy to run against President Carter during the 1980 Democratic primary. Carter’s battles with Democrats in Congress are described by historians as contributing to the poor ranking of his presidency.
  • If the Nixon administration’s less extreme ideological position surprises you, there are plenty of Nixon quotes illustrating how he felt about the Goldwater wing of the Party: “A Republican can’t stray too far from the right wingers because they can dominate a primary and are even more important in a close general election. The far-right kooks are just like the nuts on the left...There’s only one thing as bad as a far left liberal and that’s a damn right-wing conservative.” [Presidential Studies Quarterly, former Nixon aide John Whitaker, Winter 1996]. Ironically, Goldwater was the one who delivered the news to Nixon in 1974 that the majority of Republicans would no longer would not stop his impeachment and conviction if he remained in office.

1 According to Brookings, 44% of House primary candidates identified as Progressive this year (up from 29% in 2016), and the Congressional Progressive Caucus is now the largest Democratic caucus with close to 100 members. In 2018, for the first time in the history of the Gallup poll, more Democrats aged 18-29 had a positive view of socialism than of capitalism.

2 See “Why Does Economic Growth Keep Slowing Down?”, Federal Reserve Bank of St. Louis, February 9, 2017.

3 I miss your father. He liked fishing, pie and diners, and disliked parties, small talk and fine restaurants. When your mother threw out his old tweed caps and bought him a new one for Christmas, he told your brother John to throw out the new cap and retrieve the old ones from the trash. He bought a new (brown) car in less than five minutes since he hated shopping. He got sick on vacation but never at work. I apologize in advance but I am gradually becoming him.

4 See “Political Norms, Constitutional Conventions, and President Donald Trump”, Indiana Law Journal, 2017, Siegel (Duke); and “The Trump Presidency and American Democracy: A Historical and Comparative Analysis”, Perspectives on Politics, Oct 2018, Lieberman, Mettler, Pepinsky, Roberts, and Valelly (Johns Hopkins/Cornell/Swarthmore)

5 Even so, I doubt you will spend much time deciding whom you will vote for.