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Michael Cembalest introduces the 2021 Outlook: The Hazmat Recovery
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MICHAEL CEMBALEST: Greetings, everybody, and welcome to the 2021 Eye on the Market Outlook Podcast. The outlook this year is titled the Hazmat Recovery. In addition to continued monetary and fiscal stimulus, we’re going to be getting some vaccine airdrops this year, and as we discuss in the executive summary, by late summer, we expect the global economy to be back close to pre-COVID levels of activity, given the vaccination timelines that we see. Most developed countries have vaccine capacity that they’ve contracted four that’s roughly 1 and a half to 2 times the size of their vulnerable populations, already by Q2, and then later in the year, being able to vaccinate the rest of the populations that choose to get one, so we think by April or May, we’ll start to see some substantial mitigation and sustained mitigation of the hospitalization and mortality surges that we’ve seen over the last couple of months.
China is already booming again, and other signals we’re seeing in terms of leading indicators, like the copper market, are pointing to much stronger global growth in 2021. One of the key things to remember about pandemics is that historically, like natural disasters, they can generate deep recessions, but the recoveries tend to be much faster than ordinary recessions, and you can look at things like employment and production and consumer spending and capital spending, and we show some examples of how much faster the recoveries tend to be when pandemics and natural disasters occur, compared to typical recessions, and so we’re expecting US unemployment to end 2021 at about 5 percent, and one of the key messages here is that there’s an enormous amount of pent up unspent consumer spending that we think will be unleashed, and that the Fed won’t be doing very much to constrain it.
There’s a lot to talk about this year, there are some important issues that hinge on the Georgia Senate runoff outcomes, for example, if Democrats take both seats, there are some important decisions on budget reconciliation in the filibuster that will have enormous impacts on what Biden’s achievable agenda turns out to be. In the executive summary, we talk about that in some detail, but in any case, the corporate sector has been pretty resilient to this pandemic. For example, in Q3, S&P earnings were only down 8 percent or so, compared to the 25 percent that they were projected to be down, and the details are important. Airlines, other travel-related businesses, and the energy sector accounted for almost the entire earnings contraction in the quarter, so in addition to seeing unemployment at about 5 percent at the end of next year, at the current pace of improvement, we also think the S&P 500 earnings per share should be back to pre-pandemic levels, maybe by Q3 or Q4 of 2021.
All of that said, it is hard to escape the pervasive impact of zero interest rates on the investment landscape. We have a chart in here that we’ve shown you all before on how the last decade has seen the longest sustained period of negative real policy rates in recorded history, other than during the Civil War, World War 1, and World War 2, and so that has resulted in very high equity valuations compared to history, and a lot of money flowing into anything that has any kind of a yield, so we believe that the equity melt-up which took place at the end of 2020 will limit market gains in the US to roughly 10 percent in 2021. The consensus is very bullish, which does set the stage for corrections and profit-taking from time to time.
In this piece, we do spend some time on the issue of market concentration and antitrust risk. It’s impossible to ignore this issue. Since 2016, five stocks, and you all know what they are, have represented a disproportionate share of market cap and total returns. They’re a lot more profitable than their 1990s counterparts, but we’re concerned about some of the antitrust risks at home and digital service taxes abroad, and that’s one of the reasons that we’re a little bit more neutral on those stocks for 2021. As an alternative to them, we review some of the secular, high-growth stocks that don’t have quite as much antitrust baggage, that look a lot more interesting.
It’s hard to wrap up the entire outlook in just a few minutes on these kinds of podcasts, but I’ll give it a shot. It’ll probably take three to four months, as we said, for vaccinations to permanently shift developed world hospitalization mortality curves down, given the complicated logistics involved, and since the US is really nowhere near herd immunity. I think the latest data from the CDC show that most states have antibody presence of 10 percent or less.
Even so, we do think that there’s an enormous amount of pent-up spending potential that’s going to be unleashed, and one of the key charts in the outlook here compares potential spending to actual consumption growth, and we’re now looking at one of the largest gaps in the last 50 years or so. We don’t think the Fed is going to short-circuit this. I think after a decade of being wrong about growth, inflation, and policy rates, the Fed is going to wait to see a four-alarm fire of inflation before they decide to ever raise rates again.
So, it looks like a year of roughly 10 percent equity market gains in the US, with bouts of profit-taking along the way, given how bullish the consensus is, and again, we’re going to have to see what happens with the runoff elections and decisions on budget reconciliation in the filibuster to understand really what Biden’s true agenda is going to be.
We spent some time this year on some special investment topics that I’d like to just walk through for a minute, given how important they are. We take a close look at China, its trade and military conflicts with the US are at the highest level in years, at the same time that its weight in global equity and fixed income indices is set to rise, and so global diversified investors have to grapple with that, and we walk through some of the choices involved. We also revisit the reasons for the consistent outperformance of US equities versus Europe and Japan, the impact of negative rates on European banks, and then for investors looking for value, we walk through some of the few sectors left in the US that haven’t recovered yet, and emerging markets, which we prefer to Europe, given what looks like favorable valuations, cheaper currencies, and much lower balance of payments risks.
As I mentioned, we do spend a lot of time on antitrust issues facing the US mega-cap stocks, as well as some of the digital service tax risks that those companies face overseas, and then for investors that are struggling with the impact of zero interest rates, we look at hybrid investments as a means of boosting returns, and when we talk about hybrid investments, we’re talking about certain kinds of structured credit, we’re talking about mortgage REITs, equity REITs, we’re talking about collateralized loan obligations, things like that, and that’s really kind of the last stop on the train in a rapidly shrinking set of portfolio choices for yield-oriented investors, and we conclude the special topic section with some discussions on the US debt, the increase in the federal debt is probably permanent, and what the implications for things like gold, so take a look at the outlook.
We’re also going to be having a webcast in early January that you’ll all be invited to participate, as we kind of walk through some of these things in a little bit more detail, and one last comment we provided in an extra supplement today, which is a--this was the email, it’s not on the landing page, it’s a two-page primer on the joint session of Congress on January 6th, which is shaping up to be one of the more contentious events in US presidential history over the last hundred years or so, so we thought it was a good idea for everybody to be able to understand the rules of engagement at this January 6th joint session of Congress, because a lot of what’s out there in the press is either incomplete or actually misleading, so thank you very much for being loyal listeners of the podcast and readers of the Eye on the Market, and I actually hope to be back on the road, both seeing clients and fishing, sometime in April or May, fingers crossed. Thank you very much, everybody.
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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