Eye On The Market podcast

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Logo: J.P. Morgan. Text: Eye on the Market.

A split screen shows a slide presentation on the left and Michael Cembalest speaking to us seated in his office to the right. The slide shows an eerie illustration of six ghosts looming outdoors in the snow with a barn in the background. Text: December 2024, The Year of Living Dangerously.

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Good afternoon, everybody. This is Michael Cembalest with the December 2024 On the Market Podcast. This one's called The Year of Living Dangerously. It's our last podcast for the year.

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2025 Outlook, January 1st. The Alchemists: Trumpism Part 2, the Fed and Markets. The Golden Goose: AI adoption, trends, and milestones. What nuclear renaissance? Wake me up when we get there. DOGE Quixote: the billionaires' quest to reduce US government spending. China: the liquidity trap and the Thucydides trap. Dr. Seuss Goes to Europe. Crypto update: Maltese Falcoin revisited. Top Ten List for 2025 and a scorecard on 2024's list.

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On January 1, as always, we'll have our outlook for the new year and we'll be covering-- it's called The Alchemists. We'll be covering Trumpism Part 2 and its impact on the Fed and the markets, some issues around AI, the next gen nuclear Renaissance, some issues around Doge, an update on China and Europe, a revisitation of our crypto piece from February '22, and what we got right, what we got wrong, plenty of both, and then a top 10 list for this year and a scorecard on last year's list.

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2024 as it started. Neil Gorsuch leads a policy debate about Chevron deference. A pie chart titled, Federal court cases deciding Chevron deference, number of cases, January 2022 to January 2024. About 2/3 of the pie is labeled, Agency given Chevron deference, 47. The remaining 1/3 is labeled, Agency denied Chevron deference, 21. Text: Source: Bloomberg Law, January 2024.

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So this was a strange year. The year began with Neil Gorsuch leading a policy debate about Chevron deference, in which deference is given to government agencies in terms of interpreting government legislation. As you can see here, over the last few years, before the case was overturned, agencies were given deference around 2/3 of the time.

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Text: 2024 as it ends: Neil Gorsuch talks about Peanut the squirrel at a Heritage Foundation Dinner. A photo of someone holding a squirrel wearing a cowboy hat. Text: Orphaned, adopted, lived for 7 years, trained, seized and then euthanized by the New York State Department of Environmental Conservation.

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And then the year ended with Neil Gorsuch talking about Peanut the squirrel at a Heritage Foundation dinner.

As you may know, Peanut the squirrel was orphaned, adopted, lived for seven years, trained, seized, and then euthanized by the New York State Department of Environmental Conservation. So interesting, Neil Gorsuch bookends to 2024.

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Let it ride. A table titled: S&P 500: Two consecutive 20%-plus years and what followed. It shows four sets of four-year stretches from 1927 to 1998, each with a percentage underneath. 1927 is 29%, 1928 is 33%, then 1929 is negative 8%, then negative 28% in 1930. Other sets, from 1935 to 1938 and 1954 to 1957, show the same pattern, two high then two low. The last set, 1995 to 1998, shows 35, 21, 29, and 24% respectively. The last two dates in the table are 2023 at 20% and 2024 at 27%. Text: Source: Shiller dataset, JPMAM, 2024.

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Another interesting thing about 2024, we're on track for two consecutive 20% plus years for the S&P 500. That's only happened four times since 1871, and only during the bull market of the late '90s did the good times continue.

So some interesting things that we'll be discussing in the Eye on the Market outlook on Jan 1st in terms of our outlook for the next year. In terms of this Eye on the Market, I wanted instead to talk about the fact that I was recently visited by six ghosts and they wanted to talk to me about predictions, allocations, apparitions, interventions, expurgations, and ablations. And by the way, plenty of people believe in ghosts. According to a YouGov survey, about 40% of Americans responded by saying they believe in ghosts and 20% said they've actually had an actual encounter with a ghost. So there you go.

Anyway, the first ghost that visited me warned me not to make predictions. And

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Text: Ghost #1: Don't make predictions. Fed dot plot. 23% accuracy rate of Professional Forecasters since 1968. 25% to 35% overestimation of stock prices by sell side analysts. Futures markets are generally poor predictors of future spot rates.

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this ghost pointed to the horrible track record of the Fed's dot plot its inception in 2012, the less than 25% accuracy rate of professional forecasters, which is an economics group since the late 1960s. At least 25% overestimation of stock prices by sell side analysts. There's a long history of difficult predictions, but it's too late. I already made a predictions list last year.

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A table titled: Scorecard on 2024 Predictions, with two columns, Ranking and January 1 2024 prediction. The predictions are ranked 1 through 10. Six rankings are in green, three are in yellow, and one is in red.

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Here is a rough schematic of how it turned out six right, three to be determined, and one wrong. The ones I got right were on the dollar, Department of Justice winning antitrust case, Biden withdrawing, little recovery in Lidar stocks, and self-driving cars, Russian invasion drags on, US regional bank stocks do well, to be determined, issues around private credit leverage loans, Argentine dollarization, and an inhaled COVID vaccine. And what we got wrong was electricity outages related to outdated grid infrastructure. So anyway, that was the first ghost.

The

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Text: Ghost #2: Allocations to Mag 7 stocks and hedge funds. A scatterplot titled, Active manager Mag 7 weightings vs performance, excess return vs S&P 500, January 2023 to June 2024, with Average Mag 7 over/underweight percentage on the x-axis and percents on the y-axis from negative 25% to 15%. The dots are color-coded to differentiate monthly reporters and quarterly reporters. The dots have a general upward trend. The majority of the dots are in the negative percentages for both axes. Text: Source: Morningstar, JPMAM 2024.

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second ghost warned me not to be underweight the Mag seven stocks. And on that front, within the average large cap portfolio, I agree. At least over the last 18 months, it's been very difficult to outperform the S&P if you weren't at least neutral, if not overweight, the Mag Seven stocks, we have a few couple of charts in the Eye on the Market this time that look at the average Mag Seven overweight and then individual overweights to the individual Mag Seven stocks. And the cluster of all the managers that we look at from the Morningstar Universe indicate that it was almost impossible, not impossible, but very, very difficult to outperform the benchmark unless you at least remark weight some of these stocks. So no argument there.

The other thing that ghost warned me about was the risk of investing in hedge funds.

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Hedge funds. A scatterplot titled, 20-fund composites vs benchmarks [HFR], Annualized excess return vs T-bills since September 2019. It has annualized excess return volatility on the x-axis from 4 to 18% and percents from 0 to 12 on the y-axis. The scattered dots each represent Hedge fund composites, 20 HF each. The squares that are plotted along an upsloping line represent Benchmark: S&P 500/Bloomberg Aggregate Bond Index. Text: Source: JPMAM, HFR, August 2024.

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Individual hedge funds, I would say yes. But this is an update of an analysis that we did last year. And I think the results are kind of remarkable, which is, we create 20 fund composites, like randomly construct weighted composites of 20 hedge funds drawn from the HFR Davis.

And then we look at their returns and volatilities over the last five years compared to a stock bond benchmark and over 80% of the composites outperformed. And I think it's really interesting, given all the negative things that you read about hedge funds to see how that came out. So again, we update this chart each year and these numbers continue to look pretty good. And if you want to learn more about this analysis, we described it last year in the alternatives review.

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Ghost #3: Apparitions in private credit. A bar chart titled, Outstanding US private debt vs commercial and industrial (C&I) loans, US dollars billions. The chart has the years from 2010 to 2024 across the x-axis, with two bars for each year, one shorter bar representing private debt and a taller bar representing C&I loans. Dollar amounts from $0 to $3,000 are along the y-axis. The bars all have an upward trend, the distance between the private debt and C&I loans bars getting smaller in the last few years. Text: Source: Cai et al, Federal Reserve Board, FDIC, Empirical Research, 2024.

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All right. The third ghost warned me about other ghosts in private credit, and specifically ghosts related to pay in kind income, which is income that's not really there, kind of like a ghost. So as you can see here, the private credit markets have tripled in size over the last five years and are now almost 70% of the entire banking sector, commercial and industrial loan volumes. And every time more capital floods into a space, underwriting standards decline. It's just a truism in the investment industry.

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Apparitions. A line graph titled, PIK income of BDCs, PIK income as a % of total investment income, with the years 2019 to 2025 on the x-axis and percents from 3 to 9 on the y-axis. One wavy line represents Fitch BDC Universe. It begins at 4% in 2019, dips to 3.5% in 2020, and ends at 9% in 2024. Another wavy line, representing Moody's BDC universe, begins at about 5.25% at the end of 2020 and ends at about 7.5% in 2024. Text: Source: Fitch, Moody's, JPMAM, Q1 2024.

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There was a report recently from. JP Morgan's investment banking credit research group. I thought it was a very good report. And here, you couldn't see that the pick income of BDCs, which are the primary way that people invest in private credit, the pick income as a share of total investment income is going up, which means that the pay in kind income where borrowers aren't really paying you back interest, they're just adding to the principal is rising, even though we've been in pretty benign economic conditions. So this tells you about stress in the private credit space.

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Apparitions. A bar chart titled, PIK income of major BDCs, Q2 2024, PIK income as a % of net investment income (net of cash expenses). It has 23 bars representing different BDCs in descending, beginning with the tallest on the left, Prospect, at about 38%, and ending with the shortest, Apollo, at about 2.5%. Text: Source: JP Morgan Global Credit Research, JPMAM, October 2024.

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And the other thing that I thought that they did that was really interesting was they looked at the pick share of income, looking at it after subtracting cash expenses. So what's the real cash coverage of the dividend of the major BDCs. And here you can see, as of the second quarter of this year, there were some very high numbers on this page of anywhere from 15% to 35% pick share. So again, something to pay attention to if you're investing in private credit.

And

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Apparitions. A table titled, The economics of bank lending. Showing the loan to middle market company and BDC loan percentages of various items: SOFR overnight rate, Spread, Default rate, Recovery rate, Expected loss, Spread on debt funding, Tax rate, Operating expenses, Risk weight, Capital (% of assets). The last row, Return on equity, has 18% for the loan to middle market company column and 46% for the BDC loan column.

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what I liked was a research paper I found which explained why banks are so anxious to lend to BDCs instead of lending to the underlying middle market companies that the BDCs are lending to. And here you can see that the ROE, return on equity for one of these loans, goes from 18% to 46% from a bank's perspective, as they shift the loan from the Middle, market company to the BDC itself. And that has to do with lending to a more diversified entity and lower expected losses and higher expected recoveries in the event of default. So anyway, I thought that was interesting.

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Text: Ghost #5: people are easily offended. A line graph titled Google Ngram: easily offended, Target phrase as a percent of total phrases in English Google Books. It has years from 1800 to 2000 across the x-axis in 50-year increments and percentages on the y-axis from 1.0E minus 6% to 5.5E minus 6%. The line jags up and down from 3.5 to 5.0 in the 1800s, then trends downward, touching the x-axis at around 1920. In the 1900s, it jumps between just under 1.5 to 1.0. It begins sloping up around 1980 and slopes up to 5.5 by 2024. Text: Source: Google, 2024.

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Then the fifth ghost came along and warned me not to write about certain things in the Eye on the Market. And the ghost warned me that in this day and age, people are easily offended. And I was. I was curious to see whether or not people are really more easily offended than they used to be. And there was an academic paper on this topic.

And what they did was they showed a Google Ngram. A Google Ngram is a program that looks at a certain phrase as a percentage of all the phrases that have ever appeared in English language books, documents, and research materials. And as you can see from this chart, we're at the highest rate of people being easily offended or at least talking about it since the early 1800s. So

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Text: Expurgations: Why Europe is incapable of defending itself, The Chicago Doom Loop, On the dismal rankings of US commercial ports and union opposition to any port automation, Mexico is a Failed State, Wealth destruction, Cathie Wood and ARK Investments, Should the US defend Taiwan?, Legalizing sports gambling was a mistake, Corruption and money laundering in European football, COVID's laboratory origins, don't understand Sneex and apparently neither does anyone else, Israel and Gaza, Kash Patel, Trump nominee to run the FBI.

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I put in the Eye on the Market a list of topics that I decided not to write about because they were potentially offensive.

But I put in some links to information in case you're interested in reading about them. The topics include why Europe is incapable of defending itself, what's going on in Chicago's Doom Loop, the dismal rankings of US commercial ports and resistance to automation, Mexico as a failed state, Cathie Wood and ARK Investments, US Defense of Taiwan, The mistake of legalizing sports gambling, sneaks, sorry to people that own them, Israel and Gaza, and then Trump's nominee to run the FBI. So if you're interested in any of those topics, you can certainly read about them with the links that I've put in the piece.

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Ghost #6: take better care of yourself.

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And then the last ghost came to me and suggested that I take better care of myself, and I'll explain why in a second.

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A photo of a younger Michael seated on a couch with his arm around a woman. They're both smiling and holding drinks.

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I want to start with this picture. This is a picture of Rachel and I back in the early 1990s when we met. And like most people in the early 1990s, we met at work. This is a really interesting paper from the proceedings of the National Academy of Sciences that tracks how heterosexual couples have met over the last 70 years and regularly met at work at the peak of people meeting at work. And at its peak in 1990, around 20% of people met at work.

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Text: Ablations. A line graph titled How heterosexual couples meet, 1940 to 2019. It has the decades from 1940 to 2020 on the x-axis and percents from 0 to 40 on the y-axis. There are lines representing via friends, via family, primary/secondary school, bar or restaurant, as coworkers, college, church, neighbors, and online. The Online line begins at 0 in 1980 and stays close to 0 until the early 90s, then slopes upward to 40% by 2019. The other lines have a general slow downward trend, except bar or restaurant, which begins at 10% in 1940 and reaches about 28% by 2019. Text: Source: Proceedings of the National Academy of Sciences, 2019.

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At the time most people met through friends and if not there, they met at a bar or a restaurant or maybe by family members. As you can see from the chart, all categories of coupling have declined relative to everything moving online. And one of the ways that I met Rachel was, she was more senior than I was and a lot more well-traveled and sophisticated. And so I wrote a program in Lotus 1-2-3 keystroke macros that did some basic trigonometry to create a surface plot.

That was all I had going for me. But miraculously it worked.

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Ablations. A line graph titled, Revenue share of spreadsheet market, 1988 to 1997, with a line each for Excel, Lotus 1-2-3, and Quattro. Quattro stays near the bottom of the graph. Lotus begins in 1988 at about 70% then trends downward in a wavy line to just under 10% in 1997. Excel begins at 10% in 1988 and slopes up in a less wavy line to just over 90% by 1997. Text: Source: Stan Liebowitz (UT Dallas), 1999.

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And now a lot has changed since then, as you can see here. When I created that program, Lotus actually had a 70% market share of the spreadsheet market, and then within the decade, basically went to zero as Microsoft took over. In any case, Rachel comes from a long line of hardcore Chicago Democrats and Chicago Democrats are pretty hard core.

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Cook County Chicago. A line graph titled, Democratic Share of Presidential Vote by County, 2000 to 2020, % of presidential vote that was Democratic. It has lines for six counties. The Cook County line at 70-75% is above the other five lines, which range from 40 to 60%. Logo: US News and World Report.

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Over the last two decades, the citizens of Cook County in Chicago or ages from have voted anywhere from 70% to 75% for Democratic candidates for president. And even at the University of Chicago, which people always tell me is a very free thinking, nonpartisan kind of place. I thought this was interesting.

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Text: Between 2015 and 2023, University of Chicago faculty have donated about $80,000 to Republican candidates and PACs, about $2,400,000 to Democratic candidates and PACs.

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Between 2015 to 2023, 97% of University of Chicago faculty donations went to Democratic candidates and PACs, while 3% went to Republican candidates and PACs. So I think the University of Chicago's reputation for non-partisanship needs to be severely questioned.

Anyway, so anyway, as Rachel is a hard core Democrat, I was not surprised that in November, I kept hearing these strange noises from the other room, and I knew that every time I heard a gasp, it was because another Trump nominee had been named.

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A still from the movie "It's a Wonderful Life," where Jimmy Stewart holds up a little girl in front of a Christmas tree as Donna Reed smiles up at her.

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And I started thinking every time I heard this gasp, it reminded me of the end of It's a Wonderful Life, where the little girl says, every time you hear a bell ring, an angel gets its wings. Except this time it wasn't an angel and it wasn't a bell. It was a Trump nominee.

Anyway, so. I had to go in for a cardiac ablation the week before the election. I'd been having trouble with stairs this year. I hadn't been taking care of myself as much as I should have. And I knew that I was going to be on my own because Rachel was going to go that day to Philadelphia and Pitts-- and some other places in Pennsylvania to ring doorbells for Kamala Harris. So do I was on my own at the hospital for this ablation.

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A cross-section diagram of the heart with insets showing atrial fibrillation between ablation and after. Text: Atrial Fibrillation before ablation: Impulses escape into the atrium. After ablation: Impulses cannot pass the ablated tissue.

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And ablation procedures are interesting. They use typically heat or short bursts of energy to create scar tissue in your heart to prevent the arrhythmia that's affecting you. Medical research papers estimate the success rates at 60% to 90% So far, so good for me. And the idea is that the bad impulses won't be able to pass through the ablated scar tissue that gets created.

So anyway, the night after the procedure, I was put in a room and I was sharing with another person. And at about 1:00 AM, this guy started screaming in a language I didn't understand. And it turns out, I called the night nurse that he was sleep screaming and he was mostly screaming about how angry he was at his wife. And then she told me that I had nothing to worry about. But I was in the next bed, so didn't get very much sleep.

And I was really-- I remember thinking about 5:00 in the morning, I was really looking forward to getting out of the hospital and getting back to work and starting my 37th year at JP Morgan, which is why I'm recording this podcast. So anyway, those are the six ghosts that visited me. I wanted to wish everybody a Happy New Year and a happy holiday season.

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Text: Happy New Year. An illustration of browns and polar bears falling from the sky onto a pile of soft pillows on the ground below. A

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And I'll close with this picture of the falling bears from the outlet cover last year. I'm thankful for the fact that at least so far, we've had the kind of soft economic landing that we had predicted a year ago.

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We go back to the illustration of six ghosts looming outdoors in the snow. Text: December 2024, The Year of Living Dangerously.

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Thanks for listening and keep an eye out for the Eye on the Market outlook and the associated podcasts, which will come out as usual on January 1. Bye.

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Logo: J.P. Morgan.