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MR. MICHAEL CEMBALEST:  Good morning everybody, this is the late March Eye on the Market podcast.  Topics this week all have to do with surveying the damage, surveying the damage from Russia’s war on Ukraine, surveying the damage to equity markets and some bottom-fishing opportunities for investors, surveying the recession outlook in Europe due to rising energy prices, surveying the impact of rising metals prices on EV battery costs, and surveying the damage in Hong Kong from the COVID situation. 

     So I just want to start for a minute on Russia’s invasion of Ukraine.  This is creating one of the largest refugee crises in decades.  There’s going to be some long-lasting water, air, and ground pollution in Ukraine, and 90% of the people that live there could face poverty or hardship by the end of the year. 

If anybody is surprised that Russia is imposing this kind of misery on Ukraine, you shouldn’t be.  There’s ample precedent for it.  We spent some time looking through the history of famines.  And the famine imposed by Russia on Ukraine for political reasons in the 1930s dwarfs other famines in terms of severity and is a previous example of Russian subjugation of the Ukraine by any means necessary. 

It’s kind of remarkable to see this chart.  The death rate from the Russian-imposed famine on the Ukraine dwarfs the Irish potato famine, the North Korean famine, famines in India, and even the Great Leap Forward famine in China in the late 1950s.  Larger numbers of people died in China from that famine, but on a rate per thousand people, the Ukraine famine imposed by Russia was the worst one. 

So as we wrote in the last two notes, I’m dubious of Europe’s ability to sharply reduce its energy reliance on Russia.  I mean the things that would need to be done, rapid LNG buildouts of gasification of liquid faction facilities, solar, wind, and heat pump adoption that’s way above trend, exploiting non-existent hydrogen infrastructure and rebuilding or regaining access to shuttered nuclear facilities, all those things are very difficult to do.  But if Russia pulled it off, but if Europe were able to pull this off, Russia’s share of world GDP would shrink even further below the roughly 2% level that it’s at now.  We have a chart in here that shows Russia and the USSR share of world GDP since 1820.  And without European purchases of Russian energy, Russia could easily just turn into a vassal state that provides energy just to China.

In terms of surveying the damage to equity markets, there was a bunch of research that was done by J.P. Morgan’s investment bank last week, and I thought it was pretty good, so I replicated some of it here.  The charts all send a consistent message.  There was a very large selloff that took place.  And if there’s no recession in the United States, the March 8^th low is probably the bottom.  If there is a recession, the average stock market decline would suggest further downside. 

But I consider the recession call to be a close one.  I still think the US will make it through without a recession.  For sure growth is going to take a hit, energy prices are going up, credit spreads, wages, supply shortages, and rising interest rates.  There’s no question that housing is going to slow markedly.  But something in the neighborhood of 1.5 to 2% seems like the kind of growth shock the US will experience here.  And if that’s the case, March 8^th may have been the bottom for this particular selloff. 

And the opportunities in individual stocks are even more pronounced at the index level for a lot of large and small-cap, and NASDAQ stocks are down 35, 40, 50, 60% way more than the indexes themselves.  And hedge fund leverages come down; futures positions of long-only asset managers have come down.  So most of the signals that we look at have come down.  The only thing that hasn’t come down that much is the PE ratio of the 25 largest stocks in the market.  The mega-cap stocks, of course the valuations have declined but are still expensive on any kind of historical basis.  So for anybody looking to do bottom fishing, it looks like the opportunities are outside those mega-cap names.

We’ve got some information here on credit spreads as well.  Similar message, while spreads have widened, they are nowhere near the levels that are seen during recessions.  Now if you are really interested in aggressive bottom fishing, the Chinese equity markets are pricing in probably more bad news than any place.  There’s a chart that we show here that tracks the China Internet Index, kind of looks like the NASDAQ from 1999 to 2004. 

The Chinese equity drawdowns have been pretty severe.  They have been tightening monetary, fiscal, and regulatory conditions for the last year and a half.  So they’ve got some accumulated stimulus ammunition if they choose to use it.  And I think they will since the Communist party has established around a 5.5% growth target for the year, and I don’t see how they’re going to reach that unless they start to deploy some stimulus.  So in addition to some of the beaten down names in US markets for the intrepid, there appear to be some opportunities in China as well, although it would probably take 18 to 24 months to figure out after the fact if that made any sense. 

One place I would not be tempted to bottom fish is Europe.  Europe is almost certainly headed for recession.  Now Europe is one of the most energy-efficient places on earth if you look at energy consumed per unit of GDP.  Europe in general is lower than China, lower than the US, lower than Canada, lower than Japan.  Europe is a very energy-efficient place per unit of growth.  Unfortunately, the commodity price shock has been so huge that it’s overwhelmed the benefit of those energy efficiencies.  And no matter how energy efficient you are, if electricity and natural gas prices are going to quadruple, you’re going to have a problem.  And that’s what’s happened in Europe. 

They’re also facing a massive, massive producer price shock.  And there’s a chart in here that shows that producer prices have soared something like 25% higher than consumer prices.  In other words, that gap has to go somewhere.  So either companies are going to take a huge hit in terms of declining margins, hiring, and capital spending, or they’re going to have to pass that onto consumers and trigger higher CPI and tighter policy from the ECB. 

So I look back to 1950.  The US has never experienced anything like the producer price shock that Europe is experiencing right now.  And the recession in Europe is likely to be the inevitable result.  Europe has sold off.  It’s priced at about 13 times earnings, with earnings expected to be flat this year.  But during European recessions, earnings can fall 25%, and PE ratios can fall below 10.  So it’s hard to argue that Europe’s a good value here unless there’s an unexpectedly quick end to the conflict in Ukraine. 

We’ll go into more of the details in the energy paper later this year.  But one of the consequences of Russia’s invasion has been a surge in metals prices.  Everything from lithium to nickel, aluminum, copper, iron, steel have all gone up by 50% or 250% since January 2020.  And there’s this page in this week’s Eye on the Market that looks at the impact on theoretical battery prices for electric vehicles and how those increased metals prices would eventually feed through - -.  And we look at different auto manufacturers, different battery compositions, and there are some big differences there.  For example, Tesla in China use a lithium ion phosphate battery that does not have nickel and cobalt in it.  So those battery prices haven’t gone up as much as they have for some of the other auto manufacturers. 

The bottom line is that depending upon the battery chemistry, the metals prices have created either a $500 or $2,500 increase in the estimated economic cost of a vehicle.  And maybe plus a few hundred dollars more for incremental copper and aluminum that has nothing to do with the battery, but gets used a lot in EVs compared to traditional cars. 

So another headwind essentially for EV adoption.  Of course most EV owners could expect to save a lot of fuel costs if gasoline and electricity prices stay where they are.  Using some standard assumptions on mileage, miles driven, electricity costs, gasoline costs, EV owners would typically save somewhere between 1,000 and $1,500 a year in fuel expenses.  So if you compare that to the incremental cost of an EV up front over a gasoline car, you can figure out the payback period. 

But the bottom line is that there has been for some of the EVs, the ones that use the nickel, manganese, cobalt oxide battery approach, there’s been a bit of a price shock here that might have to be addressed through even more general, generous federal subsidies in both the US and in Europe in order for those EV adoption rates to stay on trend. 

The last two topics this week have to do with COVID.  One of the big shock, I mean the chart here, you just have to see it to be believe it, for the last two years, Hong Kong COVID mortality was basically nonexistent.  We didn’t even plot it because it was so close to zero.  And now the COVID mortality rate in Hong Kong has soared and is now around four times higher than the peak mortality rate in the US that took place a little over a year ago, which is wild. 

So how do you explain this?  Well to me, I think there’s two factors going on.  First, for some reason, and no one’s been able to explain to me, vaccination rates in Hong Kong are inverted relative to age.  In other words, the middle-aged people are vaccinated at a much higher rate of about 90 to 93%, and it drops all the way to 35% for people 80-plus.  So how do you end up with a public health service that does that?  It’s very strange. 

Second, about half the people in Hong Kong are vaccinated with CoronaVac, which is a vaccine produced by a Chinese company called Sinovac.  According to some research we’ve seen, CoronaVac’s only 45% effective against mortality, which is 30 to 40% lower than the efficacy rates seen for the mRNA vaccines.  So low vaccination rates of old people and less effective vaccines explain part of it.  But I don’t know that I would be able to explain all of it given the increasingly difficult information flow issues going on in Hong Kong and China as well.

So China is reportedly working on its own mRNA vaccine, still in phase three trials.  Interestingly, one of the companies involved was added to the US federal trade restricted list given its alleged use of biotechnology to support brain control weaponry.  So it’s a strange world that we live in. 

Last quick COVID topic for the week is on ivermectin.  You’re probably aware of ivermectin.  It’s often used as a horse deworming drug but is also an effective drug used for humans that get infected with certain parasites.  The thing is when it gets used for parasitic treatment, it’s given as a one-time dose.  And the people using it for COVID are taking it twice a week, even though there’s absolutely no safety data on that kind of protocol. 

Anyway, so a recent clinical trial in Brazil evaluated ivermectin versus a placebo and found absolutely no benefit in terms of patient outcomes of reduced hospitalizations or increased speed of recovery.  So I was willing to be open-minded about it pending a broad study.  But now that one’s been completed, I think we have the answer that ivermectin is not super-helpful.  And so I mentioned to my team that the verdict should be described as a neigh from Mr. Ed.  They completely didn’t know who Mr. Ed was, which is maybe a sign that it’s getting close for me to think about retirement.  Anyway, thank you very much for listening, and I’ll talk to you next time, thank you.      

FEMALE 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 J.P. Morgan Asset and Wealth Management.  Michael Cembalest is the Chairman of Market and Investment Strategy for J.P. Morgan Asset Management and is one of our most renowned and provocative speakers. 

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