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Letters to the Editor

Letters to the Editor. To start, some comments on mega-cap stocks and artificial intelligence during the narrowest market leadership on record. Then, since it’s the beginning of summer, it’s time for some of my unsolicited letters to Barron’s, MSNBC, the “No Labels” US political movement, the Federal Housing Finance Agency, the Urban Institute, the National Housing Conference and Jeep. Apologies in advance to all recipients.

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FEMALE 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.

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MR. MICHAEL CEMBALEST: Hello and welcome to the June Eye on the Market podcast. This one’s called Letters to the Editor for reasons I will explain. In the first part of the piece this week we talk about something everybody’s talking about which is the dominance of these mega cap stocks again this year which are up around 80% while the rest of the market is up like 1%.

So the largest 7 companies now represent the highest share of overall market cap on record. The percentage of stocks beating the S&P over the last three months, on a 3-month basis, is around 10% which is even lower than the narrow market leadership in March of 2000.

So this is a very narrowly driven market. What’s driving this is—the good news is NVIDIA and Meta earnings have sharply increased which is driving part of what’s going on but there’s a lot of multiple expansion across the board with NVIDIA, Apple and Microsoft priced at the high end of their historical ranges.

So there’s a lot of mega cap bullishness in the market right now. A lot of that is fueled by this perception of AI exposure. We took a look at one of the indicative AI ETFs. It’s called Dollar Sign Chat Generative AI. It’s up 70% this year. Of the two-thirds of the stocks in this ETF that actually have earnings, they traded at about a PE of 30 which is not crazy for these kind of growth stocks. The issue is that the other third of them have infinite PEs ‘cause they have no earnings at all or trivially positive earnings that create nonsense PEs.

So there’s a lot—the large langue model revolution is going to have to live up to the high end of expectations to justify this. You know earlier this year we looked at how these models were doing compared to some complicated challenges in terms of linguistics and math and biology and physics and logic and image recognition. And this project was updated— it’s a multi-firm effort with over 200 tasks. As of last summer it was still performing well below the average human far below the best human.

But a few months is a long time in this space. And GPT 4 has improved a lot even compared to GPT 3.5. And you know I believe some of the potential for productivity gains and job force reductions here. You know a lot of large language models, even if they’re just conventional wisdom machines, there’s billions of dollars of market cap and millions of employees in industries which traffic in the packaging and emission of conventional wisdom every day.

So just be aware that the AI hype machine is in full swing right now alongside whatever real productivity gains all of this may ultimately result in.

Anyway. We have some charts in here to kind of put some pictures around that.

So it’s… it’s the beginning of summer so it’s time for some of my cranky, unsolicited letters to various organizations. And that’s what the rest of the Eye on the Market and this podcast are about.

My first letter is to Barron’s which wrote tons of really bullish articles on cell and gene therapy investments at the peak in biologic stocks in 2021. And then the sector completely imploded. And we scanned all 3,600 ETFs in the U.S. and biotech was on a very short list of things that soared and crashed the most. Barron’s is now writing that given how hard the sector has fallen it could be a good time to buy. I understand the general sentiment. I’m always more interested in something after a fall than at its peak.

My concern is that during the peak in biotech stocks in 2021, where are all of the other Barron’s articles on some of the challenges and risks associated with investments in cell and gene therapies. These things represent just 1% of all drug sales and drug trials. 90% of the trials are just Phase 1 or 2 and unlikely to be commercialized.

The approval timeframe process for this stuff is much longer than regular drugs which is already 9 years. The success rates are low. The prices for some of these things are over $2 million since they target such small populations. And there are some risks associated with the viral vectors used to deliver some of these treatments.

So I just don’t recall Barron’s ever writing about any of that. Now. Some more of these things may be approved in the U.S. and Europe this year. The first CRISPR treatments for sickle cell and some other diseases may be approved. Some of the ones up for review target larger populations like macular degeneration. I’m sure a lot of people listening to this podcast know somebody that suffers for (sic) that.

And there’s also some really good news from the structural biology, essentially researchers are finally able to use artificial intelligence to identify potential pathways to treat things like liver cancer. Predict the three dimensional structure of the protein that’s associated with it. And then develop a pathway, a compound, to treat it. And they did that within 30 days.

So the speed of some of these things is unprecedented. But the bottom line is that as the paper of record on financial markets, the track record for Barron’s here in promoting this sector corresponded way more with the peak in these stocks than with the trough. And that’s something that they should be paying attention to just as much as any investor would.

My next letter is to the people that produce a lot of the MSNBC shows. I don’t watch them. My wife, Rachel, wants me to watch them with her but I generally refuse to do it. They had some coverage recently of the natural gas stove issue. And they were mocking and dismissing the idea that the government is coming for your gas stoves.

Now while that language is somewhat hyperbolic, New York did pass a law that will ban natural gas in new buildings as early as 2026 for stoves, furnaces and heating. Los Angeles has passed a similar law. And Denver, San Francisco, Seattle have enacted natural gas bans for heating although they may allow stoves. And this is a real thing. This wasn’t just culture war material which is what all of the MSNBC hosts described that it was.

This is a huge opportunity missed here, right? Because if somebody says, oh my god, the government is coming for your stoves, you could go—you could discuss the improvements in heat pumps and induction stoves and how they contribute to decarbonization. You could talk about all the federal and state subsidies for people that purchase them. You could talk about how heat pumps are already overtaking gas furnaces in the U.S. You could talk about possible strains on the grid from electrifying heating and transportation at the same time. And you know you could talk about some of the legislation that’s been passed in certain states to preempt laws that prohibit gas.

But you know the bottom line was this was a huge opportunity missed here. The quotes that we include from some of these MSNBC hosts was—were things like, well, you know, the people that watch those shows have been addicted to the culture of lies and conspiracy theories. Maybe at times that’s true but on this issue it wasn’t and this was a huge opportunity missed and a mistake.

Another letter I wrote was to something called the No Labels Movement. The No Labels Movement is a movement that plans to run a unity ticket after Super Tuesday primaries if they believe they can win and if they believe that most—that both major party nominees are !unpopular!. Well that’s a lot of ifs and that’s a lot of subjective judgements.

Third party candidates can change very close elections and we have some charts in here that show over the last 50 years or so a bunch of times when just a few percent of a third party candidate’s votes switching to the second place candidate could have shifted the outcome in that state.

The other thing to think about is if a mildly successful unity ticket were able to get enough electoral votes that prevented the other two parties from reaching 270, we would have what’s called a 12th amendment contingent election which would be held. And every state delegation to the House would get one vote. So Alaska would get one vote and California would get one vote. And presumably those votes would be decided based on the partisan balance within those House delegations.

And currently, there are 26 House delegations controlled by the GOP, 21 by Democrats, and 3 ties. So if you ended up with a contingent election scenario, if the composition of the House in 2024 is the same as it is today, the GOP would control this outcome. So the bottom line here is that as tempting as it is to think about unity tickets and this No Labels Movement, history suggests that this movement will either have to exercise a lot of discipline and not run a unity slate at the 11th hour despite all the time and effort they spend on it or they might move forward in an environment of a lot of uncertainty with all sorts of potential, unanticipated electoral outcomes.

We cite some research here showing what could have happened in certain years if the votes shifted by certain candidates and certainly the year 2000 is a good example of that. If both Nader and Buchanan hadn’t run, Gore wins Florida and the presidency based on the model distributions of those votes. And that wasn’t the only year that something like that could happen.

We also have a page in here on some good news if you’re concerned about the process. One of the things you might remember from 2020 is that there was a lot of unsubstantiated assertions about the powers of the vice president at the joint session on January 6th.

There were some electrical count act reforms passed at the end of last year that clarifies that the role of the vice president is purely a ceremonial one and makes all sorts of other changes to the process which you can read about which make it effectively harder for Congress to disregard legitimately submitted slates. And it makes it harder for the state legislatures to submit bogus slates. So for anybody concerned about the process in the last election, these election—these electoral count act reforms passed late last year are a good thing.

The longest letter I wrote is to the Federal Housing and Finance Administration. I’m not going to go into too much detail here. They reacted very negatively to some press articles that commented on the fact that the—basically the fees that are charged for when people take out a GSE-eligible mortgage. There are subsidies in those, in those fees where higher quality borrowers at times are financing lower quality borrowers and riskier loans.

The FHFA strongly disagrees with that. I strongly disagree with the FHFA. And for anybody interested in the intestinal details of how the GSEs function and how the—and how these fees changed and what happens with private mortgage insurance and fee waivers and things like that, enjoy. I wrote a 3- page letter here.

I do conclude though with something that everybody should be aware of which is there is a lack of affordable homes. And if you’re trying to solve the problem with not enough affordable homes, I think that more supply is a better solution than more subsidies for people to buy those expensive homes.

And why is there a lack of affordable homes? There’s a chart in here that will--is simply amazing. Small homes, less than 1,400 square feet, used to be 35% of all housing completions. Certainly that’s the number they were when I was in college.

Now they’re 7%. They went from 35% to 7% of housing completions because of all sorts of large lot zoning rules, restrictions on multifamily housing, regulatory costs, community litigation. That’s the stuff. That’s hard work but that’s—those are the kind of structural reforms which are needed to get rid of the logjam in housing supply in both rural, suburban, and urban locations. So there’s some charts and data on there.

And then to conclude, pardon me, to conclude I wrote a letter to Jeep about my new Wrangler plug-in hybrid. I loved my 2012 Jeep Wrangler. It aged out. I drove it pretty hard and it was time to get a new car. And instead of buying a regular internal combustion engine version, Rachel convinced me to get the 4-door plug-in hybrid which has been a bumpy ride so far with two recalls, a failed electric battery and things like that.

So you can read about the details. I’m a big fan of plug-in hybrids since I don’t have access to a wall charger in New York City. And given the potential for these things to reduce emissions if you religiously charge them, but they have to stay out of the shop.

Anyway, thank you very much for listening. Take a look at the note. Lots of fun charts and there’s even a mention of Dua Lipa [phonetic] at the end of the piece. So thanks for listening and I’ll see you next time.

FEMALE VOICE: Michael Cembalest, 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 as 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-eotf (audio cuts off on last syllable).

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