FEMALE VOICE:  Investment products are not FDIC insured, not a bank guarantee, and may lose value.  Please read other important information which can be found on the link at the end of the podcast episode.

[Music playing]

MR. MICHAEL CEMBALEST:  Good morning.  This is Michael Cembalest with the Eye on the Market podcast.  For those of you that missed it in late January, we sent out a brief note on the politics of wealth and income redistribution, with a focus on some of the rather questionable arguments that are being thrown around from time to time, so we thought that it was worth a look. 

This morning I wanted to just give you a brief update on an Eye on the Market that we are publishing today that takes a look at the market rebound from December lows.  For those of you that remember, the day after Christmas in the morning, we sent out a bear market barometer that highlighted how stock and bond valuations had collapsed well below median versus history and that in the past markets typically rallied after these kinds of declines. 

One of the things that we focused on in seeing value for long-term investors was the fact that a lot of fast money accounts were shorting equities in the days before Christmas in very thin markets.  And as you can see now on one of the charts in our piece, as those shorts have been covering, the markets have been rebounding.  And in fact, the market rebound has been faster than any other prior bear market in the post-war era. 

What is interesting also to note is the complete lack of real money participation in this rally since December.  If you take a look at valuations, they are now around median.  They were in the 80th and 90th percentile versus history at their peak in 2018.  They collapsed to well below median by the day after Christmas and are now, as I mentioned, roughly average. 

The Fed has also been encouraged by its own research and bludgeoned by the President into bringing its rate hikes to an end for now.  That’s been helpful to markets.  I do think that as the labor markets continue to tighten—we had U.S. job openings hit an all-time high in December.  And I do think the Fed will face some tougher choices later in 2019, and that one or maybe two more hikes is coming in this cycle.  

And then the last reason that we cited for the possibility of a market rebound is the shrinking universe of publicly traded companies which you can see, based on looking at the S&P divisor which is a measure of the stock of U.S. investable supply.  That kind of technical backdrop doesn’t prevent the market from declining, but it does contribute to favorable conditions after a selloff when institutional investors rebound. 

So where do we go from here?  We would expect another positive market bump from any agreement that ends up postponing, or canceling, or downplaying the imposition of 25% tariffs on another 200 billion to 400 billion of Chinese imports, even as the U.S. perceives its strategic rivalry with China in different ways.  If you have a chance, take a look in this piece is—in this week’s piece, there are some very aggressive use of export controls potentially coming, one example of which is the concept of “deemed exports.”

So if a Chinese national is working in a U.S. company and learns about information on projects related to certain foundational and emerging technologies, like advanced computing, advanced materials, machine learning, that can be a deemed export, which falls afoul of this new act.  So I think there are some very long-range consequences to this Export Control Reform Act which was signed last year and which could be very damaging to global trade and to a lot of U.S. tech companies.

But in the short term any agreement that postpones or cancels another round of tariffs will probably be welcomed by the markets.  After that, I think the market rally pauses here because we still have to get through the question of tariffs on European and Japanese auto parts, and then more importantly there are a lot of signs of slowing corporate profit growth in the U.S. and around the world. 

If you take a look at leading indicators for earnings and earnings breadth and a bunch of other signs, it’s actually quite possible that after last year’s spectacular 20% to 25% earnings growth year, we could have slightly negative earnings growth in 2019, versus 2018.  So we don’t see the risk of a recession this year, we feel pretty good about our call to overweight the U.S. in emerging markets versus Europe and Japan which is working again this year.  But it looks like global earnings and GDP growth is slowing a bit, and I think the equity market rally takes a pause once it digests some positive good news on the U.S.-China trade front. 

One last thing that may be of interest to New Yorkers, I presented with Mary at our investor summit in Miami last week, and after seeing all of the sports owners and athletes in attendance it dawned on me that being a New York sports fan was a pretty difficult thing for the last few years. 

So I pulled some data that shows that since 1950, the New York sports team winning percentage across the four major sports has only been lower a single time, and the same goes for playoff appearances.  So if it feels like it has been a tough stretch, I now have some empirical data to back you up.  Thanks for listening, and I will talk to you again next time.

FEMALE VOICE:  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 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.


Topics: the market rebound from December lows, next steps in the China-US rivalry, a question for Marco Rubio, and some charts for New Yorkers

Short people.  At 8 am on December 26th, we sent out a “Bear Market Barometer” that highlighted how stock and bond valuations had fallen well below median vs history, and that in the past, markets typically rallied after such sudden declines.  We wrote that investor pessimism was priced in, and that late December prices offered good value for long-term investors, particularly given the surge in “fast money” accounts shorting equities in the days before Christmas in very thin markets.  As you can see in the first chart (based on data from our Prime Brokerage business), as the shorts have been covering, equities rebounded quickly; more quickly, in fact, than after any prior post-war bear market.  The second chart reinforces the lack of any “real money” participation in the rally so far, which is remarkable.  The third chart illustrates how stock and corporate bond valuations are now around median, following the highs and lows of 2018.

Two-line chart showing the negative correlation between the S&P 500 and short interest, from June 2018 to February of 2019.

Two-line chart illustrating that recent gains in the S&P 500 have not been matched by flows of funds to equities.

Bar graph showing valuations for five equity and bond categories at their 2018 peaks, on December 26, 2018 and current as of February 11, 2019.

Line chart suggesting that policy rates 50 to 80 basis points above inflation may be sufficient to achieve equilibrium.

A lot of additional market support now comes from the Fed, which brought its hikes to an end and is apparently prepared to wait and see what happens.  I ascribe this newfound Fed patience to a combination of (a) wonky Fed research shown above which suggests a decline in the required real rate of interest to something like 50-80 bps, and (b) excessive Fed fear of market gyrations/harassment by the President.  Real Fed policy rates are still slightly below its modeled equilibrium levels, and if labor markets continue to firm (US job openings hit an all time high in December), the Fed will face some tougher choices later in 2019.  We think one more hike is coming.

We also cited a technical reason for a market rebound: the shrinking universe of publicly traded equities. This kind of technical backdrop doesn’t prevent the market from declining, but does contribute to favourable conditions after a selloff when large institutional investors rebalance.

Line chart tracing the percentage rise and fall of equity supply, 1997–2018.

Bar chart showing China’s year-by-year influence on U.S. GDP, 2015–2019 (est.).
We also expect a positive market bump from more China fiscal stimulus, and any agreement that postpones or cancels the imposition of 25% tariffs on $200-$460 bn of Chinese imports, even as the US pursues its strategic rivalry with China in a different manner (see page 3).  After that, the equity rally may pause, given uncertainties around possible tariffs on European and Japanese auto/parts exports, and slowing corporate profit momentum.  As shown below, leading indicators for US earnings and earnings breadth are weakening.  It’s possible that the S&P will experience slightly negative earnings growth in 2019 vs 2018, with the low quarter in Q2.

Two-line chart showing the close correlation between year-over-year predictions of leading earnings indicators and actual performance of the S&P 500, 1989–2019. Current predictions are for little or no growth in 2019.

Line chart showing the percentage of companies making earnings revisions (number of positive revisions minus number of negative revisions), 2010–2019.

Bottom line: we’re not making any major changes to our recommended investment strategy for 2019, which entails normal allocations to risk. The December selloff was a very good time to put money to work, and markets have rallied substantially since then, bringing valuations back to roughly median.  We do not see significant risks of US recession this year, but expect earnings growth to slow sharply from its 2018 pace as US GDP growth slows to 2% by the end of the year.  However, a dovish Fed and China stimulus may end up pushing valuations back up towards 2018 highs, despite whatever destabilizing implications such policies may have in the long run, in which case equity investors would continue to earn positive returns through the end of 2019.  As stated in the Outlook, we prefer Emerging Markets to Europe as a deep value opportunity; our frequently discussed US-EM equity overweight vs Europe-Japan is outperforming again this year.  If the trend holds, it would be the 10th out of the last 13 years to do so.

Next steps in the China-US rivalry: more aggressive use of export controls

The US is preparing much more aggressive use of export controls to deny Chinese firms access to US technology.  These controls restrict sales across borders, including by companies in other countries whose products include US components.  Even transfer of information to foreign nationals can be considered “deemed exports”; in other words, Chinese nationals working in the US for US tech companies may have to be segregated from projects related to “emerging” and “foundational” technologies as defined by the Department of Commerce.  Proposed examples: biotech, neurotech, advanced computing, machine learning, robotics, hypersonics, advanced materials and surveillance, etc.  

Based on Export Control Reform Act (HR 5040), Gavekal Dragonomics Research

A question for Marco Rubio

When a corporation uses profits for stock buybacks, it's deciding that returning capital to shareholders is better for business than investing in their products or workers

Marco Rubio, December 2018

The question is rhetorical, but here goes.  Marco Rubio has proposed changing US tax laws so that every time a company buys back stock, an imputed dividend would be received by all shareholders, which would be taxed at whatever rate their dividends happen to be taxed at1.  The underlying presumption is that companies buy back stock instead of hiring people and investing in plant/equipment, so the government should discourage buybacks to promote employment and investment.  Let’s leave the corporate finance arguments aside for a moment (although most economists I know say that companies have every incentive to grow, particularly given the cut in corporate tax rates).  More practically, just what data is Senator Rubio looking at which indicates weakness in hiring or in capital spending?  The US just recorded the largest number of US job openings on record in December, and as shown on the right, all major categories of US non-residential investment are growing, many at a faster pace than before 2016 given the post-election change in the regulatory environment, and DESPITE a trade war which the GOP in the Senate has done little to effectively deter.  Just asking.

Line chart showing the percentage of open jobs, 2000–2018.

Line chart showing the percentage growth of five categories of fixed investments, 2011-2017.

New York: not such a wonderful town, for sports fans

I presented our market outlook with Mary at our Investor Summit in Miami last week, and saw some successful sports team owners and athletes in attendance.  It then dawned on me that it has been a very tough stretch for NY sports fans, even for the ones like myself who are not picky and root for all of the state’s major professional teams.  I pulled some data together to see if the performance drought in 2017-2018 was as bad as I had suspected, and it was.  Since 1950, the NY sports team winning percentage has only been lower one time (in 1966-672), and the recent collapse in the number of NY teams appearing in the playoffs is the worst since the 1950’s and 1960’s, before the Nets and Islanders even existed, and when the Mets and Jets were still expansion teams.

Line chart showing the blended winning yearly percentage of all New York’s major sports teams, 1950-2018.

Line chart showing the number of playoff appearances by all major New York sports teams each year, 1950–2018.
How much are New Yorkers paying to see this kind of performance?  A lot or around average, depending on which permutation of NY teams you’re talking about.

Bar chart comparing 2018 ticket prices for 4-sport (MLB, NBA, NFL, NHL) cities.