Quiet Flows the Don

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MR. MICHAEL CEMBALEST: Good evening, everybody.  It's Sunday night, November 8th, and this is the election version of the Eye on the Market.  I haven't recorded a podcast in a while.

Like the rest of you, I've been kind of busy and also transfixed on what's been going on, so I want to just walk you through quickly where we are.

We've been sending a lot of information out, you know, on the market-wise in terms of what we think about the election.  And we had a piece last Friday on the, um -- the constitutional challenges that could be filed and some court history, um, and then an explanation of that an American Horror Story approach where state legislatures decide to send in competing slates of electors so the electoral college has two slates for the single state, et cetera.

So -- and those are all remote scenarios, but I thought it was important to at least spend some time walking through the logistics of them so that people understood.

Anyway, we have a piece coming out tomorrow called "Quiet Flows the Don" and, you know, I've been waiting to use that for a while.  I was a Russian Studies major in the 1980s and that's a 19th century epic novel about some Cossacks.  And it happens to fit here, uh, "Quiet Flows the Don."

When you look at the election from an investors' perspective, it does look like much more of a referendum on the president himself than on the policy issues that divide Democrats and Republicans.  I'll explain why in a minute.

First, and this chart you've seen from us a few times.  For the first time in 100 years a challenger has unseated an incumbent president at a time of strong economic and market tail ends.  And we have this chart that shows how we compute that, but it's pretty straightforward.  When you look at Hoover and you look at Bush Sr., and you look at Carter, uh, and you look at Ford.  Um, those are presidents that ran as incumbents during very weak periods both in terms of markets and economics.

Trump's tail runs were much higher and, uh, well, he's the first president -- he's the first incumbent president in a hundred years or so to lose, uh, at a time of strong tail ends.  And the last guy that did was Howard Taft who was so fat they had to bury him in a piano case, um, or so the rumor goes.

So -- so what Biden's accomplished is impressive simply, you know, if for no other reason than for the, uh -- the rarity that such an outcome actually happened.

But again when you look at the full scope of the federal and state results, and we don't know which way the Senate is going to go yet, but if we assume the Democrats and Republicans split those two open -- open runoff seats in Georgia, and some other assumptions on some unseated House seats, uh, this -- this is not -- this was not a clear referendum, uh, in terms of policies between Democrats and Republicans.

We put this chart together that looks at the history of the partisan balance in all of the federal and state government positions.  In other words, the House, the Senate, gubernatorial positions, and then the state legislatures, right?  The state Senates and the state Houses, sometimes called assemblies.

Forget about a blue wave.  According to this index we've put together, the Democratic tide actually went out a little bit.  The, uh -- the Democratic component of this index actually fell a little bit when you -- when you kind of keep track of all the different things that happened at the federal and the state level.

So that's pretty much telling us that we are in for a period of divided government, and the investor playbook that we need to come up with has to be geared towards that. 

And, uh, now again, just to be clear, Democrats could pull off victories in Georgia and, um, they could decide to jettison the filibuster whose usage been rising pretty steadily over the last 50 years.  We have a chart on that in the 'Eye on the Market' coming out tomorrow.  So those things could happen.

You know, jettisoning the filibuster, when you've got a 50/50 split in the Senate and you're relying on the VP for a tiebreaker, would be a pretty bold thing to do. 

Uh, um, in any case, since the summer of this year, the markets have been favoring a Biden portfolio that was betting on a blue wave, and it's been pummeling a Trump portfolio as well.  And so now, if we get divided government, the path forwards may benefit a purple mix of both this Biden and -- and Trump portfolio and we can kind of walk through the sectors that we feel strongest about.

I'll pick through a few of them here.  We're still -- regardless of the outcome, we're optimistic on -- on renewable energy.  There's probably not going to be a Green New Deal.

But the president, because of the powers invested in the executive branch, can still increase the cost of capital in oil and gas.  They can disallow further LNG export permits.  They can tighten fracking and methane rules, particularly on public lands.  They can increase climate risk disclosure requirements, reinstate the cap-phase standards which Trump softened in the Spring.

So there's a lot of things that Biden can do here and his people can do here to effectively increase the costs of capital for oil and gas relative to the cost in capital of additional renewable penetration of the grid.

So, um, you know, for what it's worth, I still think owning some renewable energy, particularly if it sells off here, would be -- would be interesting.

Infrastructure, if there's one point of agreement between both parties, it's the need to reinvest in some very dilapidated U.S. transportation and maritime infrastructure.  I think you could get a modest bill in 2021.  I don't know if it's a trillion dollars.  You know, we've been spending too many trillions of dollars this year, um, but I still think that's -- that's something interesting.

Where we're less optimistic is on the China trade war.  I think Biden's likely to go very slowly here.  I don't think he's going to remove these Trump tariffs during his first 18 months in office.

China is only 25 to 50 percent compliant with the Phase One trade deal purchases from the U.S.  And, um, whether it's for human rights reasons or mercantilism reason, the anti-China policies are now pretty bipartisan in Washington.

And now that we don't think we're going to get a big corporate tax hike, there are companies that benefitted from tax hikes in 2017 that -- that will continue to do so.  And, you know, we tracked those stocks.  They got hurt this year as people, uh, started to price in the probability of the corp -- the huge corporate tax hike.  That doesn't look like it's happening now.

And, um, with all the money that's being spent, we're -- despite the surge in Covid, still anticipating a decent global economic rebound in 2021 so companies with high levels of international sales should do well also.

We're not quite ready to embrace large cap pharma yet.  The, uh, the bipartisan prescription drug bill is possible.  And also the executive branch can implement demonstration projects that effectively bring Medicare Part D drug prices back down to international levels. 

So, um, large cap pharma, in spite of all the fantastic work they're doing on the, on the vaccine trials, are, um -- are in the jailhouse in terms of public opinion, kind of just only ahead of banks maybe.

So -- and then we're neutral on the anti-trust targets.  I mean the worst -- the most punitive outcomes for the big four - Facebook, Apple, Amazon, Google - are probably off the table.  And if you want to see what those, uh -- what those worst case scenarios were or the House Judiciary report wanted to -- you know, all sorts of rules, merger prohibitions, breaking the big companies up, prohibitions on the use of bargaining power, and new anti-trust laws, forced data sharing; all sorts of stuff like that.  I don't think that -- that House Judiciary report is going to go anywhere on anti-trust.

Even so, there is still the Justice Department case that was just filed against Google.  Um, as we discussed in a piece a couple of weeks ago, um, based on the payments that Google makes to certain, uh, web browser developers and device manufacturers and, um, people like that, I -- I do think there is an interesting case there.  We'll see how it gets adjudicated in court.

And there could be a case pending versus Facebook as well, so we're kind of neutral on these anti-trust targets.  The worst outcomes for them are probably off the table, but there still could be some, um -- some difficult scenes that they'll be facing in 2021.

So, um, in general where do we go from here?  A client asked me to pull this table together on equity returns, whether there are Republican -- whether the president was Republican or Democrat, and whether or not they have control of Congress and, you know, which party had control of Congress and things like that.

The highest returns in the post-war era happened during grid lock periods when there was a Democratic president, but I don't think the table is worth very much.  The sample sizes are small and basically the return differences reflect mostly when recessions hurt and how the Fed happened to react to them.

So unless you think the presidents and Congress caused recessions, or they should get the benefit for narrating a recovery, um, most of those returns by party-affiliation, you know, charts, is garbage.

So let's focus on the business cycle.  Right now the U.S. and a lot of Europe are in a race against time.  The U.S. employment situation is definitely improving.  Um, only about half the increase -- the remaining increase of unemployment is permanent.  The other half is still temporary.

And, you know, we think we could be at 5 percent unemployment by the end of next year.  Uh, and -- and when you look at the number of unemployed people relative to job openings, this is -- it's much better than in prior recessions and it's a sign that when and if we get through this Covid thing, it could be a very strong and rapid recovery in employment and wages.

But, you know, the race against time is getting kind of short.  Covid infections, hospitalizations, deaths are rising again.  I am still sitting here in my undisclosed bunker with, uh, not allowing my kids to come out right now.  Um, you know, I'm taking the necessary precautions as a person who's 58 and has some co-morbidity issues.

And so what's going on here with Covid infections and hospitalizations and everything, this is increasing the chance of lockdowns which would really jeopardize the employment and spending recovery that we're seeing.

And it highlights the importance of three vaccine steps that are all different, critical hurdles on the road to herd immunity.  We need vaccine approval, we need vaccine distribution, and we need vaccine acceptance.

Those are three different things, but you need all three of them.  We talk about them extensively -- extensively on our webcasts and on the coronavirus web portal so I'm not going to do all that again here.

Um, I think given the election I'll close with the following.  You know, a greater adherence to scientific principles in Washington can only help on this vaccine acceptance issue.  And, uh, I think a decision by Trump not to fire Dr. Fauci, which he's threatened to do, could be helpful as well in terms of maintaining some level of acceptance for -- for science and for vaccines in particular.

The United States ranks in the bottom, uh, third globally with respect to vaccine adherence, belief, trust in science, and things like that.  So, um, if the world is going to get back to normal, it's gonna take a really long time to get there through herd immunity.

We saw some data a couple -- well, uh, last week from the CDC that by early August most states, other than New York and a couple of other northeastern states, were still below 5 percent in terms of antibody testing.  In other words, the serology tests they did showed that we are still a really long way away from herd immunity.

So we need vaccine approval, we need vaccine distribution, and we need vaccine acceptance.  And hopefully in something that's -- that's something that the new administration in D.C. will work on on promoting all three of those.

So thank you for listening and I look forward to speaking to you again next time.

FEMALE VOICE 1: 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 JP Morgan Asset Management and is one of our most renowned and provocative speakers.

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