Good afternoon, everybody. This is Michael Cembalest with the December 2024 Eye on the Market podcast. This one's called The Year of Living Dangerously. It's our last podcast for the year on January 1st. As always, we'll have our outlook for the new year, and we'll be covering—it's called The Alchemists—will be covering Trumpism Part Two and its impact on the Fed and the markets.
Some issues around AI, the next-gen nuclear renaissance, some issues around Doge. An update on China and Europe, a revisitation of our crypto piece from February 22 and what we got right, what we got wrong, plenty of both. And then a top 10 list for this year and a scorecard on last year's list. So this was a strange year.
The year began with Neil Gorsuch leading a policy debate about Chevron deference in which deference is given to government agencies in terms of interpreting government legislation. As you can see here, over the last few years before the case was overturned, agencies were given deference around two-thirds of the time. And then the year ended with Neil Gorsuch talking about Peanut the squirrel at a Heritage Foundation dinner.
As you may know, Peanut the squirrel was orphaned, adopted, lived for seven years, trained, seized and then euthanized by the New York State Department of Environmental Conservation. So interesting, Neil Gorsuch bookends to 2024. Another interesting thing about 2024, where we're on track for two consecutive 20% plus years for the S&P 500, that's only happened four times since 1871, and only during the bull market of the late 90s did the good times continue.
So some interesting things that we'll be discussing in the Eye on the Market Outlook on Jan. 1st is for us our outlook for the next year. In terms of this Eye on the Market, I want instead to talk about the fact that I was recently visited by six ghosts, and they wanted to talk to me about predictions, allocations, apparitions, interventions, explanations and ablations.
And by the way, if plenty of people believe in ghosts, according to a YouGov survey, about 40% of Americans responded by saying they believe in ghosts, and 20% said they've actually had an actual encounter with a ghost. So there you go. Anyway, the first ghost that visited me warned me not to make predictions, and pointing, this ghost pointed to the horrible track record of the Fed stock plot since its inception in 2012, that less than 25% accuracy rate of professional forecasters, which is an economics group since the late 1960s, at least 25% overestimation of stock prices by sell-side analysts.
You know, there's, there's a long history of difficult predictions, but it's too late. I already made a predictions list last year. Here is a rough schematic of how it turned out six right, three to be determined, and one wrong. The ones I got right were on the dollar. Department of Justice winning antitrust case. Biden was drawing a little recovery in light. Our stocks in self-driving cars.
Russian invasion drags on. U.S. regional bank stocks do well—to be determined. Issues around private credit, leverage loans, Argentine dollarization and an inhaled COVID vaccine. And what we got wrong was electricity outages related to outdated grid infrastructure. So anyway, that was the first ghost. The second ghost warned me not to be underweight the Mag Seven stocks. And on that front, within the average large-cap portfolio, I agree.
At least over the last 18 months it's been very difficult to outperform the S&P if you weren't at least neutral, if not overweight. The MAG Seven stocks, we have a few, couple of charts in the Eye on the Market this time that look at the average Mag Seven overweight, and then individual overweight to the individual Mag Seven stocks, and the cluster of all the managers that we look at from the Morningstar universe indicate that it was almost impossible, not impossible, but very, very difficult to outperform the benchmark unless you at least were market weight some of these stocks.
So no argument there. The other thing that ghost warned me about was the risk of investing in hedge funds, individual hedge funds. I would say yes, but this is an update of an analysis that we did last year. And I think the results are kind of remarkable, which is we create 20 fund composites, like randomly constructed composites of 20 hedge funds drawn from the edge of our Davis.
And then we look at their returns and volatilities over the last five years compared to a stock/bond benchmark, and over 80% of the composites outperformed. And I think it's really interesting, given all the negative things that you read about hedge funds, to see how that came out. So you know, again, we, we update this chart each year, and these numbers continue to look pretty good.
And if you want to learn more about this analysis, we described it last year in the alternative review. All right. The third ghost warned me about other ghosts in private credit, and specifically ghosts related to pay in kind income, which is income that's not really there. And I'm like a ghost. So as you can see here, the private credit markets have tripled in size over the last five years and are now almost 70% of the entire banking sector, commercial and industrial loan volumes, and every time more capital floods into a space, underwriting standards decline.
It's just a truism in the investment industry. There was a report recently from J.P. Morgan's Investment Banking Credit Research Group I thought was very good report. And here you can see that the income of BDCs, which are the primary way that people invest in private credit, the pick income as a share of total investment income going up, which means that the pay and kind income where borrowers aren't really paying you back interest, they're just adding the principal is rising.
Even though we've been in pretty benign economic conditions, so this it tells you about stress in the private credit space. And the other thing that I thought that they did that was really interesting was they looked at the picture of income, looking at it after subtracting cash expense. So what's the real cash coverage of the dividend of the major BDCs?
And here you can see as of the second quarter of this year, there were some very high numbers on this page of anywhere from 15 to 35% picture. So again, something to pay attention to at you're investing in private credit. And what I liked was a research paper I found which explained why banks are so anxious to lend to BDCs instead of lending to the underlying middle-market companies that the BBQs are lending to.
And here you can see that the early return on equity for one of these loans goes from 18 to 46%. If our banks, from a bank's perspective, as they shift the loan from the middle-market company to the BDC itself, and that has to do with lending to a more diversified entity, and lower expected losses and higher expected recoveries in the event of default.
So anyway, I thought that was interesting. Then the fifth ghost came along and warned me not to write about certain things in the Eye on the Market.
And the ghost warned me that in this day and age, people are easily offended. And I was I was curious to see whether or not people are really more easily offended than they used to be. And there was an academic paper on, on this topic. And what they did was they showed a Google Ngram. A Google Ngram is, is a, is a program that looks at a certain phrase as a percentage of all the phrases that have ever appeared in English language books, documents and research materials.
And as you can see from this chart, we’re at the highest rate of people being easily offended or at least talking about it since the early 1800s. So I put in the Eye on the Market, a list of topics that I decided not to write about because they were potentially offensive, but I put in some links to information in case you're interested in reading about them.
The topics include why Europe is incapable of defending itself, what's going on, and Chicago's doom loop, the dismal rankings of U.S. commercial ports and resistance to automation. Mexico as a failed state. Cathie Wood and Ark Investments. U.S. Defense of Taiwan. The mistake of labeling. Legalizing sports gambling sneaks, you know, sorry, the people that own them. Israel and Gaza.
And then Trump's nominee to run the FBI. So if you're interested in any of those topics, you can certainly read about them with the links that I put in the piece. And then the last ghost came to me and suggested that I take better care of myself, and I'll explain why in a second. I want to start with this picture.
This is a picture of Rachel and I back in the early 1990s when we met, and like most people in the early 1990s, we met at work. This is a really interesting paper from the proceedings of the National Academy of Sciences that tracks how heterosexual couples have met over the last 70 years. And Rachel, I met at work at the peak of people meeting at work, and at its peak in 1990, around 20% of people at, at work at the time, most people met through friends, and if not there, they met at a bar or restaurant, or maybe by family members.
As you can see from the chart, all categories of coupling have declined relative to everything moving online. And the one of the ways that I met Rachel was, you know, she was more senior than I was and a lot more well traveled and sophisticated. And so I wrote a program at Lotus 1-2-3, keystroke macros that did some basic trigonometry to create a surface plot.
It was all I had going for me, but miraculously it worked. And now a lot has changed since that. And as you can see here, when I created that program, Lotus actually had a 70% market share of the spreadsheet market, and then within the decade basically went to zero as Microsoft took over. In any case, Rachel comes from a long line of hardcore Chicago Democrats.
And Chicago Democrats are pretty hard core. Over the last two decades, the citizens of Cook County in Chicago, where Rachel's from, have voted anywhere from 70 to 75% for Democratic candidates for president. And even at the University of Chicago, which people always tell me is a very freethinking, nonpartisan kind of place, I thought this was interesting, nice. Between 2015 to 2023, 97% of University of Chicago faculty donations went to Democratic candidates and PACs, while 3% went to Republican candidates’ PAC.
So I think the University of Chicago's reputation for non-partisanship needs to be severely questioned anyway. So anyway, as Rachel, as a hardcore Democrat, I was not surprised that, that in November I kept hearing these strange noises from the other room, and I knew that every time I heard a gasp it was because another Trump nominee had been named.
And I started thinking every time I heard this gasp. But it reminded me of the end of It's a Wonderful Life, where the little girl says every time you hear a bell rings, a bell ring, an angel gets his wings. Except this time it wasn't an angel and it wasn't a bell. It was a Trump nominee. Anyway, so I had to go in for a cardiac ablation of the week before the election.
I'd been having trouble with stairs this year. I hadn't been taking care of myself as much as I should have, and I knew that I was going to be on my own because Rachel was going to go that day to Philadelphia and then Pits… and Pits, and some other places in Pennsylvania to ring doorbells for Kamala Harris. So I knew I was on my own at the hospital for this ablation, and ablation procedures are interesting there.
They use heat, typically heat or short bursts of energy to create scar tissue in your heart to prevent the arrhythmia that's affecting you. Medical research papers estimate the success rates at 60 to 90%—so far, so good for me. And the idea is that the bad impulses won't be able to pass through the ablated scar tissue that, that gets created.
So anyway, the night after the procedure, I was put in a room, and I was sharing with another person. And at about 1 a.m., this guy started screaming in a language I didn't understand. And it turns out I called the night nurse. He was sleep screaming and he was mostly screaming about how angry he was at his wife.
And so, and then she told me that I had nothing to worry about, but I was in the next bed, so I didn't get very much sleep. And I was really, I remember thinking about five in the morning, I was really looking forward to getting out of the hospital and getting back to work, and starting my 37th year at J.P. Morgan, which is why I'm reporting this podcast.
So anyway, those are the six ghosts that visited me. I wanted to wish everybody a Happy New Year and a happy holiday season, and I'll close with this picture of the falling bears from the Outlook covered last year. I'm thankful for the fact that at least so far, we've had the kind of soft economic landing that we had predicted a year ago.
Thanks for listening, and keep an eye out for the Eye on the Market Outlook and the associated podcast, which will come out as usual on January 1st. Bye.
Good afternoon, everybody. This is Michael Cembalest with the December 2024 Eye on the Market podcast. This one's called The Year of Living Dangerously. It's our last podcast for the year on January 1st. As always, we'll have our outlook for the new year, and we'll be covering—it's called The Alchemists—will be covering Trumpism Part Two and its impact on the Fed and the markets.
Some issues around AI, the next-gen nuclear renaissance, some issues around Doge. An update on China and Europe, a revisitation of our crypto piece from February 22 and what we got right, what we got wrong, plenty of both. And then a top 10 list for this year and a scorecard on last year's list. So this was a strange year.
The year began with Neil Gorsuch leading a policy debate about Chevron deference in which deference is given to government agencies in terms of interpreting government legislation. As you can see here, over the last few years before the case was overturned, agencies were given deference around two-thirds of the time. And then the year ended with Neil Gorsuch talking about Peanut the squirrel at a Heritage Foundation dinner.
As you may know, Peanut the squirrel was orphaned, adopted, lived for seven years, trained, seized and then euthanized by the New York State Department of Environmental Conservation. So interesting, Neil Gorsuch bookends to 2024. Another interesting thing about 2024, where we're on track for two consecutive 20% plus years for the S&P 500, that's only happened four times since 1871, and only during the bull market of the late 90s did the good times continue.
So some interesting things that we'll be discussing in the Eye on the Market Outlook on Jan. 1st is for us our outlook for the next year. In terms of this Eye on the Market, I want instead to talk about the fact that I was recently visited by six ghosts, and they wanted to talk to me about predictions, allocations, apparitions, interventions, explanations and ablations.
And by the way, if plenty of people believe in ghosts, according to a YouGov survey, about 40% of Americans responded by saying they believe in ghosts, and 20% said they've actually had an actual encounter with a ghost. So there you go. Anyway, the first ghost that visited me warned me not to make predictions, and pointing, this ghost pointed to the horrible track record of the Fed stock plot since its inception in 2012, that less than 25% accuracy rate of professional forecasters, which is an economics group since the late 1960s, at least 25% overestimation of stock prices by sell-side analysts.
You know, there's, there's a long history of difficult predictions, but it's too late. I already made a predictions list last year. Here is a rough schematic of how it turned out six right, three to be determined, and one wrong. The ones I got right were on the dollar. Department of Justice winning antitrust case. Biden was drawing a little recovery in light. Our stocks in self-driving cars.
Russian invasion drags on. U.S. regional bank stocks do well—to be determined. Issues around private credit, leverage loans, Argentine dollarization and an inhaled COVID vaccine. And what we got wrong was electricity outages related to outdated grid infrastructure. So anyway, that was the first ghost. The second ghost warned me not to be underweight the Mag Seven stocks. And on that front, within the average large-cap portfolio, I agree.
At least over the last 18 months it's been very difficult to outperform the S&P if you weren't at least neutral, if not overweight. The MAG Seven stocks, we have a few, couple of charts in the Eye on the Market this time that look at the average Mag Seven overweight, and then individual overweight to the individual Mag Seven stocks, and the cluster of all the managers that we look at from the Morningstar universe indicate that it was almost impossible, not impossible, but very, very difficult to outperform the benchmark unless you at least were market weight some of these stocks.
So no argument there. The other thing that ghost warned me about was the risk of investing in hedge funds, individual hedge funds. I would say yes, but this is an update of an analysis that we did last year. And I think the results are kind of remarkable, which is we create 20 fund composites, like randomly constructed composites of 20 hedge funds drawn from the edge of our Davis.
And then we look at their returns and volatilities over the last five years compared to a stock/bond benchmark, and over 80% of the composites outperformed. And I think it's really interesting, given all the negative things that you read about hedge funds, to see how that came out. So you know, again, we, we update this chart each year, and these numbers continue to look pretty good.
And if you want to learn more about this analysis, we described it last year in the alternative review. All right. The third ghost warned me about other ghosts in private credit, and specifically ghosts related to pay in kind income, which is income that's not really there. And I'm like a ghost. So as you can see here, the private credit markets have tripled in size over the last five years and are now almost 70% of the entire banking sector, commercial and industrial loan volumes, and every time more capital floods into a space, underwriting standards decline.
It's just a truism in the investment industry. There was a report recently from J.P. Morgan's Investment Banking Credit Research Group I thought was very good report. And here you can see that the income of BDCs, which are the primary way that people invest in private credit, the pick income as a share of total investment income going up, which means that the pay and kind income where borrowers aren't really paying you back interest, they're just adding the principal is rising.
Even though we've been in pretty benign economic conditions, so this it tells you about stress in the private credit space. And the other thing that I thought that they did that was really interesting was they looked at the picture of income, looking at it after subtracting cash expense. So what's the real cash coverage of the dividend of the major BDCs?
And here you can see as of the second quarter of this year, there were some very high numbers on this page of anywhere from 15 to 35% picture. So again, something to pay attention to at you're investing in private credit. And what I liked was a research paper I found which explained why banks are so anxious to lend to BDCs instead of lending to the underlying middle-market companies that the BBQs are lending to.
And here you can see that the early return on equity for one of these loans goes from 18 to 46%. If our banks, from a bank's perspective, as they shift the loan from the middle-market company to the BDC itself, and that has to do with lending to a more diversified entity, and lower expected losses and higher expected recoveries in the event of default.
So anyway, I thought that was interesting. Then the fifth ghost came along and warned me not to write about certain things in the Eye on the Market.
And the ghost warned me that in this day and age, people are easily offended. And I was I was curious to see whether or not people are really more easily offended than they used to be. And there was an academic paper on, on this topic. And what they did was they showed a Google Ngram. A Google Ngram is, is a, is a program that looks at a certain phrase as a percentage of all the phrases that have ever appeared in English language books, documents and research materials.
And as you can see from this chart, we’re at the highest rate of people being easily offended or at least talking about it since the early 1800s. So I put in the Eye on the Market, a list of topics that I decided not to write about because they were potentially offensive, but I put in some links to information in case you're interested in reading about them.
The topics include why Europe is incapable of defending itself, what's going on, and Chicago's doom loop, the dismal rankings of U.S. commercial ports and resistance to automation. Mexico as a failed state. Cathie Wood and Ark Investments. U.S. Defense of Taiwan. The mistake of labeling. Legalizing sports gambling sneaks, you know, sorry, the people that own them. Israel and Gaza.
And then Trump's nominee to run the FBI. So if you're interested in any of those topics, you can certainly read about them with the links that I put in the piece. And then the last ghost came to me and suggested that I take better care of myself, and I'll explain why in a second. I want to start with this picture.
This is a picture of Rachel and I back in the early 1990s when we met, and like most people in the early 1990s, we met at work. This is a really interesting paper from the proceedings of the National Academy of Sciences that tracks how heterosexual couples have met over the last 70 years. And Rachel, I met at work at the peak of people meeting at work, and at its peak in 1990, around 20% of people at, at work at the time, most people met through friends, and if not there, they met at a bar or restaurant, or maybe by family members.
As you can see from the chart, all categories of coupling have declined relative to everything moving online. And the one of the ways that I met Rachel was, you know, she was more senior than I was and a lot more well traveled and sophisticated. And so I wrote a program at Lotus 1-2-3, keystroke macros that did some basic trigonometry to create a surface plot.
It was all I had going for me, but miraculously it worked. And now a lot has changed since that. And as you can see here, when I created that program, Lotus actually had a 70% market share of the spreadsheet market, and then within the decade basically went to zero as Microsoft took over. In any case, Rachel comes from a long line of hardcore Chicago Democrats.
And Chicago Democrats are pretty hard core. Over the last two decades, the citizens of Cook County in Chicago, where Rachel's from, have voted anywhere from 70 to 75% for Democratic candidates for president. And even at the University of Chicago, which people always tell me is a very freethinking, nonpartisan kind of place, I thought this was interesting, nice. Between 2015 to 2023, 97% of University of Chicago faculty donations went to Democratic candidates and PACs, while 3% went to Republican candidates’ PAC.
So I think the University of Chicago's reputation for non-partisanship needs to be severely questioned anyway. So anyway, as Rachel, as a hardcore Democrat, I was not surprised that, that in November I kept hearing these strange noises from the other room, and I knew that every time I heard a gasp it was because another Trump nominee had been named.
And I started thinking every time I heard this gasp. But it reminded me of the end of It's a Wonderful Life, where the little girl says every time you hear a bell rings, a bell ring, an angel gets his wings. Except this time it wasn't an angel and it wasn't a bell. It was a Trump nominee. Anyway, so I had to go in for a cardiac ablation of the week before the election.
I'd been having trouble with stairs this year. I hadn't been taking care of myself as much as I should have, and I knew that I was going to be on my own because Rachel was going to go that day to Philadelphia and then Pits… and Pits, and some other places in Pennsylvania to ring doorbells for Kamala Harris. So I knew I was on my own at the hospital for this ablation, and ablation procedures are interesting there.
They use heat, typically heat or short bursts of energy to create scar tissue in your heart to prevent the arrhythmia that's affecting you. Medical research papers estimate the success rates at 60 to 90%—so far, so good for me. And the idea is that the bad impulses won't be able to pass through the ablated scar tissue that, that gets created.
So anyway, the night after the procedure, I was put in a room, and I was sharing with another person. And at about 1 a.m., this guy started screaming in a language I didn't understand. And it turns out I called the night nurse. He was sleep screaming and he was mostly screaming about how angry he was at his wife.
And so, and then she told me that I had nothing to worry about, but I was in the next bed, so I didn't get very much sleep. And I was really, I remember thinking about five in the morning, I was really looking forward to getting out of the hospital and getting back to work, and starting my 37th year at J.P. Morgan, which is why I'm reporting this podcast.
So anyway, those are the six ghosts that visited me. I wanted to wish everybody a Happy New Year and a happy holiday season, and I'll close with this picture of the falling bears from the Outlook covered last year. I'm thankful for the fact that at least so far, we've had the kind of soft economic landing that we had predicted a year ago.
Thanks for listening, and keep an eye out for the Eye on the Market Outlook and the associated podcast, which will come out as usual on January 1st. Bye.
