Absolute Value

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RECORDED VOICE:  This podcast has been prepared exclusively for institutional, wholesale professional clients, and qualified investors only as defined by local laws and regulations.  Please read other important information which can be found on the link at the end of the podcast episode.

MR. MICHAEL CEMBALEST:  Good morning everyone and welcome to the mid-April Eye on the Market podcast.  Three topics this week, I want to just give you a general sense for our overall market views, we’re going to talk about the value recovery, and then we’re going to talk at the end about COVID herd immunity, a path to normalcy, and rising concerns about some of the blood clot risks from vector vaccines.

So first topic that we discussed is how unusual this cycle is with respect to how fiscal stimulus sits alongside private sector activity.  In the prior three or four cycles, the government steps in with fiscal stimulus when private sector demand is weak and then starts pulling the stimulus back as private sector demand recovers.  This time’s different.  This time, private sector demand is recovering sharply at the same time that the government’s got the pedal on the metal with respect to fiscal stimulus.  So this is somewhat unusual to have these things moving in the same direction. 

This policy to go for growth is definitely getting traction in the equity markets.  Over the last five months, global equity funds have seen around $570 billion of inflows, which is more than the past 12 years combined, which is kind of amazing.  The S&P is up 11% already this year, mostly driven by surging value stocks, which we’ll talk about.  I can imagine a slow grind higher in the months ahead.  The biggest risk is for me, another rise in inflation expectations.

And some of what we look at here is there is a whole bunch of coincident leading indicators that are at or close to all-time highs.  When you look at home sales, spending potential of consumers, business inventories, global manufacturing and service sector surveys, job openings, Chinese shipping activity, there is a massive global boom underway, obviously the result of pent-up demand from the pandemic.  And ordinarily this kind of a rebound would be a very powerful signal for stocks.  This time it’s partially offset, not totally, but partially offset a little bit by rising inflation expectations.  We’re going to have some rising input costs from higher wages and raw material prices and also rising corporate taxes, which we discussed last time.

So the net impact of all of these positives and negatives is I can imagine the market grinding a little bit higher in the months ahead.  There was recently a rollover in some of the most cyclical, low quality, and small cap names, which is another sign that some of these good omens are partially priced in already.

The second topic, I’m not going to go through too much detail in this podcast, but the second topic is we take a look at the value rally.  There’s two very, very different ways to look at value stocks.  One is how do value stocks do versus growth stocks, and the answer there has generally been terrible.  But then there’s another way to look at it, which is really important in the money management industry, which is how is value as an investment factor doing?  And there the story is much better.  So in other words, if you are picking from among sectors, so you’re picking healthcare or tech or financials or real estate or consumer discretionary, how are you doing if you’re using value metrics like price to book and price to cash flow as a stock picking tool within each one of those sectors?  And there the news is better.

So we walk through a whole bunch of charts; a lot of investors are interested in these topics.  The bottom line is that value has trailed growth on an absolute basis, mostly because growth stocks have been surging rather than value stocks necessarily underperforming.  Value multiples have actually been rising in recent years.  It’s just that the growth multiples went up more.  And with respect to value as a stock selection tool, there the news is much better.  And we kind of show that with the exception of 2018 and 2019, value as a stock picking tool has worked pretty consistently since the mid to late 1990s.  So you can take a look at that, and we get into that discussion as well.

So let’s talk about COVID for a little bit.  Let’s start with the bad news, although I think everybody kind of understands this.  It’s unlikely that textbook herd immunity is going to happen.  Textbook herd immunity is called sterilizing herd immunity, where you effectively eliminate community spread through both vaccination and prior exposure.  This time around, I don’t think we’re going to get there.  The hesitancy of certain people to get vaccinated, the constant emergence of new variants, reduced vaccine efficacy, particularly with respect to the South Africa and Brazil variants, delayed vaccinations of children and other younger individuals, very low vaccination rates in emerging countries, a lot of whom are adjacent to developed market countries, and an uncertainty on how long vaccination protection lasts and whether you can spread it symptomatically even after you’re vaccinated, all of these things combined, I think textbook community, herd immunity is going to be difficult to reach.  It looks like COVID’s going to become an endemic disease like the flu and will have to be treated accordingly.

Now, the good news is you can still have a return to normalcy as long as prior exposure plus vaccinations can drive infections and hospitalization and mortality down sufficiently on a sustained basis.  And I think we can get there.  We’re looking for signs of what total seroprevalence levels are needed.  And seroprevalence is a term that refers to non-vaccinated individuals who were exposed and got sick and everybody that was vaccinated.  And so we have a bunch of charts where we’re starting to track these things.  And we put vaccinations on the X-axis, and then we look at infections, hospitalization, mortality on the Y-axis to see how far out on the vaccination axis do you need to go before some of these other COVID metrics collapse.  And Israel is really the only place where it looks like it’s happening on a sustained basis across the board, and it looks like zero prevalence levels.  They are somewhere between 65 and 70%, which is more or less what Fauci and other people at the CDC have been saying from the beginning.

Now you can still, and it’s notable that in a whole bunch of places, whether we’re talking about Chile or Minnesota or Michigan or Uruguay, we’re seeing places where at 30 to 35% vaccination rates, plus another 5 to 10% of the population that is unvaccinated but was exposed before, you’re still having rising infections.  So for anybody that thought that you could achieve some kind of herd immunity below 50% or below 40% seroprevalence, that doesn’t seem to be the case.  That said, there are some meaningful declines in mortality and hospitalization that have occurred at 30 to 40% vaccination rates.  And so it’s a mixed bag.  It doesn’t seem like you get herd immunity at those levels, but you do get substantial declines.  Now at what level do you get kind of a full reopening with no restrictions, unclear.  But we’re starting to track these things and this information, and these charts appear in the Eye on the Market today.

And then just a few last comments on what’s happened with J&J.  As a reminder, the only vaccines that have been approved so far in the developed world are genetic vaccines.  You’ve got Pfizer and Moderna; those are the messenger RNA vaccines.  And then you’ve got J&J and AstraZeneca, which are the Trojan horse vector vaccines.  And I call them Trojan horse vaccines because they use some unrelated virus, in one example, a chimp virus, to deliver the generic instructions to the body’s cells to actually fight COVID. 

And it now looks like the vector vaccines are resulting in some adverse events in very rare circumstances.  The rate so far, I think, is one out of 170 million in Europe and one in a million in the US.  That said, these adverse events are pretty severe.  People are getting different kinds of thrombosis.  There’s two of them we discuss today.  These kind of things can lead to pulmonary embolisms.  In one study, 11 patients in Europe had some of these events and six of them died.  And the technical name that the scientists are now talking about here is vaccine-induced immune thrombotic thrombocytopenia. 

So the European health authorities more broadly as well as the WHO have concluded that okay, the benefits outweigh the risks, given the risks of COVID for older people, so people over 60 or 55 should still get it.  People younger shouldn’t.  Some countries have halted vaccinations altogether, like Norway.  So now we’ve got in the U.S. a pause because of the six cases of thrombosis that occurred out of six million doses so far.  Our best guess is that like Europe, eventually J&J will be unpaused, and there will be an age restriction where only people over let’s say 60 will get it. 

J&J has not been hugely important.  It’s only 1 or 2% of the 35% of the U.S. population that’s been uniquely vaccinated so far.  And I think the production schedules for Pfizer and Moderna will be sufficient to meet whatever demand exists in the developing world this summer.  As a matter of fact, in the U.S., we think that declining demand is going to be an issue before the J&J availability issues become a constraint.

So the bigger issue is what does this latest development do to vaccine hesitancy, and there it’s impossible to say.  Obviously going to track it, and we’re tracking all of these vaccine numbers very closely.  The more of an impact this has on vaccine hesitancy, the more the risk that the community spread will be sustained, and from time to time, there will be some kind of outbreak.  But broadly speaking, our 50% of population vaccination timelines for the US, the UK, Canada, Europe, Australia, Japan are broadly unchanged, mostly because the Pfizer and Moderna production schedules were supposed to provide the bulk of vaccination coverage for the summer anyway.  And an adverse event in the, in the messenger RNA vaccines would be of much greater consequence for the developed world than issues with these vector vaccines.  So anyway, take a look.  Good to talk to you again, and you will next hear from me in early May with the annual Eye on the Market energy paper.  Thank you very much for listening, bye.

RECORDED 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.  Views may not be suitable for all investors and are not intended as personal investment advice or 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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