Michael Cembalest Chairman of Market and Investment Strategy for J.P. Morgan Asset & Wealth Management Dec 7, 2021
On equity markets, the Lombards, SPAC investors, Bone-setters, George Washington, COVID bots and Omicron
We started out 2021 optimistic on equities given our outlook on economic growth, earnings growth, limited new equity supply, low interest rates and the arrival of mRNA vaccines. We underestimated just how much the reopening would boost earnings, which exceeded our expectations across the developed world. Earnings growth accounts for all of the developed world equity market gains in 2021 as P/E multiples fell markedly. By the way, that US-EM equity barbell vs Europe-Japan worked again this year; resistance to the barbell is futile. The selloff in China shows few signs of relenting as more Chinese companies prepare to delist, and as China has now expanded the regulatory powers and reach of antitrust regulators.
Line chart shows the y/y % change in trailing 12-month earnings for the S&P 500 and the Stoxx Europe 600. Chart shows that earnings recovered from negative growth in 2020 to 40% earnings growth for the Stoxx Europe 600 and around 35% earnings growth for the S&P 500 as of Q3 2021, with both expected to increase further by year-end.
Bar chart shows the 2021 equity return decomposition for the US, the Eurozone, UK, Japan, EM and China. Equity returns are broken down into earnings, dividend, currency and multiple return with total return shown as a dot on each bar. Chart shows that earnings were the main driver of equity returns across the developed world, in spite of a decline in P/E multiples and currency returns.
As always, developed world governments and central banks are doing their part to support this, prolonging the largest fiscal and monetary experiment since the Lombards created banking in the Middle Ages. I get asked a lot how Western gov’t debt burdens are going to be resolved in the long run. I have some theories but intend to retire long before I see if they’re correct or not. Hard to say for sure, the rise in cryptocurrency values from $250 billion before COVID to $2.5 trillion today has a lot to do in my view with the chart below on the left showing the destruction of the post-war compact between governments and savers.
Line chart shows developed world government debt and central bank balance sheets, with government debt shown as % of GDP and central bank balance sheet shown in trillions of US dollars. Since 2009, both government debt and central bank have steadily increased, and in 2020 both measures spiked to their highest levels.
Line chart shows cryptocurrency market cap, shown in trillions of US dollars since 2016. Cryptocurrency market cap has increased from zero in 2016 to over $2.5 trillion as of November 2021.
For a year of high returns on US stock markets, there was still plenty of pain to go around. As shown in the chart, a fairly large share of stocks fell at least 35% from their highs in 2021. The last time this kind of thing happened (rising markets and a large share of stocks losing 35% or more): 1998 and 1999. These repriced stocks are a broader warning regarding ultra-high valuations, and the risk of holding stocks that rely excessively on liquidity, momentum and crowded trades. For a complete list of US stocks with market capitalization of over $10 billion that declined by 35% or more this year from peak levels, see the PDF version of this note. There are a lot of “household” names in there, including Viacom (-69%), Altice (-64%), Teladoc (-64%), Zoom (-56%), Anaplan (-48%), Global Payments (-45%), Scotts (-45%), Citrix (-44%) and Paypal (-39%).
Dot plot shows the share of poorly performing stocks vs the overall market return. Onthe y-axis is the % of companies with returns of -35% or worse, shown as annual data since 1990. The x-axis shows the Russell 3000 annual total return. Generally, years in which the Russell 3000 had high returns saw a low % of companies with returns of -35% or worse. However, 2021 has a fairly large share of stocks which had returns of -35% or worse. The chart shows that rising markets and a large share of stocks losing 35% or more also occurred in 1989 and 1999.
Along the way in 2021, we made some pit stops in this piece1. A few related exhibits appear below.
- January: the 12th Amendment and the Electoral Count Act in the context of the Joint Session of Congress
- February: a thorough trashing of the SPAC market for institutional and retail investors
- March: an update of our concentrated stock research, a project first launched in 2004
- May: our 11th annual energy paper which focused on the four main challenges to decarbonization
- June: our 4th deep dive analysis of private equity and venture capital returns
- September: an analysis of goods and labor supply chain delays and how long they would take to resolve
- October: update on the US states with the most underfunded pension and retiree healthcare plans
- November: the commodity price shock and the imbalance between supply and demand policies
Line chart which shows global fossil fuel use versus capital spending by S&P Global 1200 Energy companies. The chart shows that while capital spending by energy companies has fallen significantly, fossil fuel use has been relatively flat.
Line chart compares US buyout and VC median direct alpha by vintage year. Venture capital has outperformed buyout since 2010, with the exception of the most recent vintage year shown (2017).
Stacked bar chart which shows the % of state revenues required to pay the sum of interest on net direct debt, the state’s share of unfunded pension and retiree healthcare liabilities and defined contribution plan payments assuming a 6% return and 30 year level dollar amortization versus what the states are currently paying. All of the states, except West Virginia, would need to pay a higher % of revenues under our assumptions.
This month, I’m working on the 2022 Eye on the Market Outlook which comes out Jan 1. In addition to the global market section, we will cover:
- the landscape for dividends and yield-oriented investors
- China’s investment prospects after the regulatory purge
- US office market fundamentals which are already improving despite COVID and low office utilization rates
- potential upside for timber investors in a world searching for real sequestration benefits
- Brexit and the high price of national sovereignty
- the latest evidence on ESG investing and portfolio impacts
- infrastructure investing in regulated electricity distribution, solar power generation and liquid bulk storage
- some underwhelming news on fintech lending behavior during COVID
- cybersecurity investing, where the presence of malignant forces increases potential returns for investors
More on the Middle Ages. I’m writing the 2022 Outlook from a basement apartment where I have been for the last 6 weeks, recovering from an accident which resulted in the x-ray below of my reconstructed leg. I was engaging in activity typically associated with younger people. The outcome was not unusual; middle-aged people have similar lifestyles and injury patterns to younger people but have higher/longer hospital charges, injury complications and ICU stays that are more similar to the elderly2.
While this has been a regrettable incident, I’m fortunate to have access to 21st century medicine. In the Middle Ages, surgical techniques were different. Bone-setters would use devices to realign fractured limbs, which were then covered with bandages dipped in egg whites, milk or mulled wine, and then inserted into large wooden splints made of tree branches. Subsequent growth deformities would sometimes occur and in case of infection, limbs might have to be amputated. Pain medication: ice (when available), alcohol (usually gin) and laudanum (opium). Ether was not widely used until the 1800’s.
Sources: Hospital for Special Surgery (x-ray); “Armamentarium Chirurgiae”, Ioannis Sculteti, 1693; and “A General System of Surgery in Three Parts, Containing the Doctrine and Management of Wounds, Fractures, Luxations, Tumors, and Ulcers of All Kinds”, Lorenz Heister (University of Altdorf), 1768
Medical knowledge improved during the 18th century. George Washington mandated that all Continental Army troops be inoculated against smallpox in 1777 and 1778 using a crude process called variolation, without which the outcome of the war might have been different. Smallpox effectively disappeared in Boston once a vaccine was developed in 1800. It wasn’t until the 1940’s that life expectancy began to rise more rapidly, largely due to mass production of antibiotics discovered a decade earlier.
Bar chart which shows Smallpox deaths per 100,000 people per year in Boston from 1702 to 1830. The chart illustrates how after Washington’s inoculation mandate, Smallpox deaths in Boston fell to close to zero.
Line chart showing male life expectancy in France since 1740. The chart shows that life expectancy steadily rose from 1800 to around 1940, with a few sharp drops caused by the Napoleonic wars, War of 1870, WWI and WWII. However, after 1940 life expectancy began to rise more rapidly, largely due to mass production of antibiotics.
Fast forward to 2021 and the COVID pandemic. Dr. Atul Nakhasi, physician and policy advisor to the Los Angeles Health Department, wrote a post on LinkedIn in October. He talked about caring for unvaccinated COVID patients in their 20’s and 30’s who were on ventilators, and how they regretted not getting the vaccine. I used to think LinkedIn was less prone to this, but Dr Nakhasi’s post attracted a flurry of critical responses. The barrage included comments about creeping socialism, how CDC treatment protocols are killing people, how drug companies prefer more sick people since they make more money that way, how doctors are being “held at gunpoint” and arrested if they say anything negative about the vaccine, that vaccines are more dangerous than the disease itself, that vaccines don’t work, that they cause fertility problems, that more people die of the flu than from COVID, that most deaths are vaccinated people and that deaths are being miscategorized since doctors have a financial incentive to inflate COVID deaths since they make more money that way.
Maybe some of these responses were from bot accounts designed to sow dissension in the West; according to a 2021 report from the EU External Action Service, that’s exactly what state-sponsored operatives have been doing via social media3. Furthermore, a May 2021 piece in the Journal of Medical Internet Research found that two thirds of all bots were discussing COVID in some way4.
I understand those who started out skeptical in the Greek sense of the word (“skepsis” = investigation), since COVID is the first disease for which mRNA vaccines are being widely used. But for the record…
[A] Overall death rates in the US have been much higher than normal, and COVID is the only rational explanation for that. You can ignore people who ramble on about miscategorized death certificates.
[B] Estimates for COVID’s infection fatality rate (the chances of dying if you get it) vary but no matter which one you use, they’re all much higher than the infection fatality rate for the flu. The range: 18x-84x higher.
Line chart shows actual US deaths from all causes per week vs the threshold for excess deaths from all causes from 2017 to 2021. Since the COVID-19 pandemic began, actual deaths have exceeded the excess death threshold, especially during COVID waves
Scatter plot shows the estimated infection fatality rate according to flu and COVID studies. COVID infection fatality rates range from 0.3% to 1.75% according to study location, while flu infection fatality rates range from 0.0% to 0.1%.
[C] How many unvaccinated people are actually dying of COVID vs those dying from the flu? We can estimate this for the 20 states reporting such data. In these states, unvaccinated COVID deaths per day have been ~18x higher than the number of unvaccinated flu deaths per day, and the year isn’t over yet. The details: just for the period from April 4 to October 2, around 7 people per mm unvaccinated against COVID died every day in these states, compared to 0.4 daily deaths per mm people that were unvaccinated for the flu. For the flu, we are using the three years before COVID as a baseline.
[D] While there are signs of fading mRNA efficacy vs infection, efficacy remains high vs hospitalization, ICU admission and death, particularly with a booster. You’re taking much greater chances by being unvaccinated, and that’s before incorporating risks of long COVID conditions. The chart below is through October and does not include the November COVID wave. New risks for the unvaccinated: based on data from South Africa, Omicron looks to be much more contagious than the Delta variant, and has resulted in greater reinfection rates among unvaccinated COVID survivors. There are preliminary signs of less disease severity, particularly among vaccinated people but the data is still very recent. See our COVID web portal for more on the Omicron variant.
Line chart shows the age adjusted deaths for the unvaccinated population vs the vaccinated population for the 20 US states which report this data from April 2021 to October 2021. Mortality levels are much higher for the unvaccinated population throughout the entire chart.
Line chart shows infection levels vs days since the start of each COVID wave in Gauteng, South Africa. Omicron appears to be much more contagious than previous waves in May 2020, October 2020, and April 2021 given infection levels are near 9,000 after only 30 days. The first two waves never reached this level, and the April 2021 wave reached 9,000 infections after about 70 days.
[E] mRNA vaccines prevent negative COVID outcomes far more often than they cause myocarditis. See COVID portal Section 1 for information on the massive number of infections, hospitalizations, ICU admissions and deaths prevented by mRNA vaccines compared to cases of myocarditis that they cause.
If you are going to ignore all of this, you might as well transport yourself back to the Middle Ages and take your chances there with a cocktail of leeches, hydroxychloroquine and zinc. To all of our clients, vaccinated or not, I wish you all a safe and happy holiday season.
Michael Cembalest
1 You can find all of these pieces on the Eye on the Market landing page.
2 “Injury patterns and outcomes in late middle age”, Stephen Gale et al, East Texas Medical Center, March 2018
3 “EEAS Special Report Update: Short Assessment of Narratives and Disinformation around the COVID-19 Pandemic”, European Union External Action Service April 28, 2021
4 “Bots and Misinformation Spread on Social Media: Implications for COVID-19”, Journal for Medical Internet Research, Brenda Curtis (National Institute on Drug Abuse/NIH) et al, May 2021