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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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Good morning, this is Michael sembelis with the May 202026 eye in the Market podcast. This one's called Abandoned Ship, which I'll explain shortly. As you can see here, there's an image of a bunch of well dressed elephants jumping off the SS 2026 midterm ship into the ocean, which is the theme of part of this discussion. I've been traveling a lot recently. I was in Scottsdale and someplace called the Salamander Hotel in D.C. and then I was in Bozeman and then Miami and then Laguna Beach. I still don't know where exactly that is, and then Los Angeles. And so I was thinking of getting this motorized suitcase, but then I decided that I would look completely ridiculous. I decided against it and I'm continuing to walk through airport journeys. In any case, this Eye on the Market is kind of a compilation of a lot of the different topics that I've been talking about. The clients recently, the midterm elections, relevant barometers, and then all the issues around Congressional Congressional redistricting, the spring thaw and U.S. economic conditions, U.S. earnings and economic resilience, and the issue of energy intensity, a rationing timeline with the straight of Hormuz. I'll explain what I mean by that. An update on hyperscaler earnings, tech valuations, debt financing, some issues around data center build out issues, and then an idea called the Gulf Super Express, which will probably never happen but is worth reviewing just in case it does so before we get started. A couple weeks ago we published a piece on Mythos, given its exceptional ability to wreak havoc by identifying software vulnerabilities, and then the race between patching and hacking. Last week JP Morgan published a really interesting, well researched note, Sinead Bessembank, on the cybersecurity vulnerability of operational technology such as aircraft autopilot systems, factory robots, power grid controls, railway track shifting systems, things like that. It's a very sobering read, but I think it's worth the effort. Okay, so what is abandonship all about? So you probably have heard that so far 36 House Republicans have decided not to run for reelection this fall. It's the highest number on record since the Data begins in 1930, so almost 100 years. And so can we infer anything from this? Well, when the number of GOP retirements is low, let's say less than 10. Usually there's not much going on in the next election when the retirements have been between 10 and 20, it's a mixed bag. Sometimes Republicans lose seats, sometimes they gain seats. But when more than 20 Republicans retire from the House, it is historically been a signal that they are about to get routed in the midterm elections. And so we have a chart here that shows that trifecta of different conditions in terms of GOP retirements and what tends to happen in the subsequent election. So you can take a look at that. But some of these, some of these dots imply pretty large losses for the GOP in the midterms. We'll see. Some of the challenges the GOP will be facing, of course, is an outright decline in blue collar employment, which I think would be very disappointing to the administration since that was a priority of theirs. So blue collar employment in terms of utilities, transportation, natural resources, mining, extraction, construction, manufacturing, these things are absolute declines in employment since Trump was inaugurated. Everybody knows there's been huge increases year to date in terms of commodity prices. Natural gas has gone down. But the rest of the entire suite of commodities, oil related commodities and refined products, fertilizers, propylene, methanol, sulfur, jet fuel, shipping fuel, fertilizer, you name it, have gone up quite substantially, anywhere from 40% to 120%. And inflation expectations are unsurprisingly rising. They were declining coming into the end of last year. The war has reversed some of that. So now you're starting to see inflation expectations pick up. And there's some other things going on that, that voters may also focus on. There are soaring ACA premiums. So from 2019 to 2025, the ACA marketplace for healthcare insurance had annual premium increases that were at most 7%, usually closer to 4 to 5%. In 2026, they're going to go up 26% the premiums on an absolute basis. And when you couple that with the loss of the enhanced premium tax credit, it's going to result in an effective 114% increases. 114% annual increase in premiums for the ACA enrollees. So those are some pretty eye popping numbers. As you all know, as soon as RFK Jr gets sworn in as Secretary of Health and Human Services, we have the outbreak of a measles epidemic. So that's just a coincidence. And then there are some very strange doings at the Department of Justice that are starting to yet surface as well that I thought would be interesting to talk about. We have a chart in here that looks at going back to 2004, the number of cases terminated each year by the Department of Justice. Sometimes the Department of Justice terminates cases because they go stale. Sometimes they terminate them because their priorities are shifting compared to prior administrations. But there was a by far, by more than a factor of two, the largest spike in case terminations by the Department of Justice under the last year or so. And the weird thing is that when you look at by category, the administration reduced the terminated immigration cases, right, because it was picking up prosecutions of immigration. But they increased the pace of case terminations. Labor racketeering, national security, terrorism, organized crime, white collar crime, drugs, corruption, civil rights, you name it. Every single other category listed showed an increase in declined cases. 300 cases involving material support to foreign terrorist organizations, 60 union corruption and labor racketeering cases, 5,000 cases of money laundering and federal drug law fir violations. So some very strange doings at the Department of Justice that are also kind of swirling around the midterm elections. Now, the Republican party has tried to change some of the math through redistricting. And this is very much of a process. And we have a chart in here that keeps tabs on what's happened so far. So the gop, and I remember all of these redrawn districts don't automatically become either Republican or Democrat. They midterm results. You know, the people vote in the midterms. But you know, the issue is the way that those new districts are drawn presumably will result in the assumed gain for the, for the parties that redraw them. So Texas picks up five, North Carolina picks up one. Ohio picks up two. Missouri may pick up one, subject to some state supreme court challenges. Then on the Democratic side, California picks up five, Utah picks up one. The reasons we explain in the piece, I don't want to go through it now. And then you had the Virginia referendum, which could pick up four seats. DeSantis has recently had a new map proposed that the state ledger approved last week. But Florida has an explicit prohibition on partisan gerrymandering. So that's going to go straight to this, to Florida, straight Supreme Court. And then in Tennessee and Louisiana there might be one seat each that flips to the GOP based on the decision of the Supreme Court last week related to the Voting Rights Act. And they where they decided that using race as a purpose for creating these so called majority minority districts is unconstitutional. And so Tennessee and Louisiana each may rush to redo their primaries in redrawn districts. We'll see what happens. The bottom line from all of this is that in the worst case, the GOP probably loses a seat on that, and in the best case, could pick up as much as nine, and then the swing is somewhere in there. I did want to talk for a couple minutes about Virginia because there may be a really kind of embarrassing unforced error that Democrats made in Virginia as it relates to the referendum. Let me just spend a minute on that because I think it's interesting. So Virginia's state constitution is similar to California's, and it includes protections against partisan gerrymandering. And so in Virginia, the normal rule is that you need a bipartisan commission to propose new maps and they can only meet once a decade. So just like California, Virginia held a referendum. So voters could say, yeah, we want to keep these provisions, but we want to temporarily or suspend them until the end of the decade so that the legislature instead of a bipartisan commission, can redraw the maps and can do it in a very partisan way. So the new congressional map in Virginia would replace the 6 democrat, 5 republican balance with something like 10 to 1. So but on the referendum ballot, unlike in California, Virginia added the phrase that they were doing this to restore fairness, and they put that language actually on the ballot. And so that's raising issues. Fairness to whom? Right. Like other redistricting efforts all across the country by both parties, these measures don't advance fairness in that state because they create legislative balances that are much more extreme than the voter population balances by party. And there are legal questions regarding the use of that fairness language on the referendum itself that the Virginia Supreme Court may now evaluate. And that's one of the reasons that a state trial court enjoined state officials from certifying or prevented state officials from certifying the results. We'll see what happens. Maybe they just let it go through. They could require them to hold it again. But this does seem like something of an unforced error by the state of Virginia to include that kind of language on the ballot itself. Okay, so let's go to the next topic. The what's a little surprising about so many House Republicans bailing is that the economic data, not, not necessarily the labor market data, but the economic data is a lot more resilient than expected. And we have a series of charts at the eye of the market that we always that we have in our Trump tracker that shows this. So a weekly we had, there's a weekly index that tracks the economy comes out of the Dallas Fed looks pretty good. Surveys of business cycle indicators and things like the Empire Manufacturing Survey, regional Surveys, conference board, consumer confidence, Dallas Fed, things like that. That looks pretty good. My favorite indicator is this thing called manufacturing orders less inventories. It measures the pace at which manufacturing orders for new equipment are outstripping inventory growth. And that looks pretty good. A measure of flatbed trucking demand is picking up or whatever that's worth. Some people like that loan demand at the banks is rising and so the number, there's a lot more people banks reporting an increase in loan demand and then just basic durable goods orders or end shipments are also rising. So the US Economy is actually proving to be pretty resilient in the face of this war. Now, along with that resilience has come some inflation measures which are no longer falling. And so in the next time the market in June to celebrate the new Fed chair, you know, good luck to him. Some, some. What's that phrase that some don't wish for something? You may get it. The new Fed chair is going to be stepping in right around the time that higher oil prices are set to produce to boost producer prices. There's an inflation surprise index in the US that's going up. And the new Fed chair is also going to have to deal with rising prices. Paid data and then core PCE is rising again. Now I saw some recent commentary where the new Fed chair says, you know, we should probably use trimmed PCE to be tracking inflation. That's the one inflation measure that happens to be going down right now. The problem is that was an abysmal measure. If you were trying to use it to track the inflation surge that took place under Biden, which presumably all these Trump people are still criticizing, that would have been an abysmal way to try and track the Biden inflation era. So interesting that they have cherry picked the one area that is currently showing lower inflation. We'll see how that works out. Anyway, that's for the June eye on the market. It's not just the US economy that's been proving resilient. It's also S and P earnings. And that's really, I think, the best explanation for why you've had this V shaped recovery and the equity markets recently. Now, you know, while the, while the commodity shock from the war is still playing through, there's other forces upsetting it. Lower tariffs, particularly after the Supreme Court decision, individual tax cuts, corporate tax cuts, all of those things are providing stimulus of roughly 2% of GDP this year. As for Q1 earnings, so far around half of the companies have reported sales growth of 10%, earnings growth around 20 to 25%. Positive news on surprises and only a handful, literally a handful of companies have revised their 2026 earnings guidance down so far despite of the war. So this looks pretty resilient in terms of an earnings picture. Now of course, one of the reasons for that is the primary driver are technology related issues, which we'll talk about in a few minutes. But I did want to show this one chart because I think it's really important and we've been talking about this ever since the war started. And in our energy paper in March. Gasoline prices still matter, right? The US Is a commuter society. We don't have very good public transit. A lot of people drive, they drive SUVs and other cars primarily that have pretty crappy gas mileage. We don't have a national large gasoline tax, etc. Etc. That all set. The oil intensity of the United States is either half or 20% of what it was when I started working at JP Morgan almost 40 years ago. And we have a chart in here that looks at the oil intensity of GDP which is down by half since then and better. The oil intensity of S and P and economy wide profits is down anywhere from 75 to 80%. And so I think that's an important way of understanding why the economy and the stock market might be more resilient to oil shocks than it has than it would have been in 10 years ago, 15 years ago, or 20 years ago. And as semiconductor consumption continues to rise and as energy efficiency and fuel switching continue, I would expect these oil intensity numbers to continue to fall in the years ahead. So this is one way of understanding why profits and growth may be more resilient to these oil shocks in the United States than you might have thought. Now that said, the coast is not entirely clear because what's happening is the world is facing the prospect of declining global oil inventories and you can't draw them down past a certain level. So we have a chart in here that looks at global oil and refined product inventories that have ranged somewhere in the neighborhood of eight and a half, eight to eight and a half billion barrels over the last few years. And global oil and refined product inventories refers to oil that's sitting around in storage tanks, in terminals, in pipelines, in floating tankers, or in the strategic reserves. Now they're being drawn down by a bay 8 million barrels day. And by June or July sometime you may hit an operational stress point. And for those of you that work in the oil and gas industry or the pipeline industry, you'll understand you can't let the Pressure in oil and gas pipelines fall below a certain level or else you kind of lose the ability to have it function properly. And so by June or July we're going to start hitting globally some operational stress points below which I think it would be difficult for inventories to continue to be drawn down. And if that's the case, if the strain of Hormuz has reopened by then, you're going to start seeing more fuel rationing, primarily in Asia and Europe. But that's going to have some economic aftershock effects for the US as well. Now if the strait's not open by September, then you're definitely going to hit some kind of flood or a little bit below 7 billion barrels where you'd really start to see a lot of demand destruction. So putting a rough timetable on it where we're sitting right now, you know, the administration has about a month and a half to try to get the straight reopen before you start seeing more severe economic consequences from the best we can. Now you remember a few minutes ago I talked about how the oil intensity of GDP has gone down. Well, and of profits. That's because the AI intensity of GDP and profits has gone up. And we, I, we have this table in here that we had in the beginning of the year since Jack, since Jack GPT was launched at the end of 2022, there's about a 42 AI related stocks include some of the turbine manufacturers and other companies that, that feed off of the AI ecosystem. These 42 companies in the S&P 500 have accounted for 75 to 85% of the price returns, earnings growth, capex and R& D growth in the entire S&P 500. So this is an unbelievably concentrated bet that's taking place in the US the latest earnings from the hyperscalers and things like that suggest that corporate adoption of AI and agentic AI is generating some revenue growth. The productivity numbers are generally moving in the right direction. So the AI trade is very much alive and well. What's interesting is as we've been talking about the damage that the agentic AI programs like Claude and OpenAI have crushed some of the software stocks to the point where there was a huge drawdown in broader technology PEs of almost 40%. At its worst level still, the PEs are still down 30%. And this is the amazing thing. You're not going to believe this chart until you see it, but if we look at all these different sectors and regional markets, US technology stocks have the lowest ratio of price to Earnings divided by earnings growth. Right. So this is what's called a PEG ratio and it has to do with what's the PE divided by earnings growth, what's the price you pay for earnings growth. And tech at this point looks to be the cheapest on this entire chart. Now some of these stocks are now cheap for a reason, because some of the SaaS vendors stocks are going to find it very difficult to recover. But as we've written about before, we think there's been too much selling and that there's going to be more resilience in that sector that's been priced in so far. But I thought it was interesting to look at just how cheap the tech sector has become on with using this particular lens. The latest, the latest projections from the hyperscalers is 2026. The next 12 months or so is the last huge surge in capital spending, R and D before it starts to level out in 2020, 2027. But just to be clear, these companies are spending 40, 50 and 60% of their revenues on capital spending. I think that's, that's gargantuan. That compares to the average tech stock in, in the S&P 500, which spends 18% of its revenues on capital spending in R and D. So that's just kind of amazing. And because of those soaring expenditures in terms of capital spending, the hyperscaler free cash flow margins are starting to come down. I think the markets will have some patience here, but at some point these projected free cash flow margins are going to have to pick back up again. I wanted to spend a minute on something because we're getting a ton of questions on this and it's an example of something where I think that this issue was less of a problem than it's often made out to be. So we are among the first people to show this chart which is, yes, there's an enormous amount of hyperscaler debt financing going on until the fourth quarter of 2025. You didn't really see Google and Microsoft and Meta and Amazon and Salesforce issuing lots of debt. And then all of a sudden in the fourth quarter of last year and in the first quarter of this year, we're starting to see literally hundreds of billions of dollars of hyperscale or debt issuance to finance data centers. But if we use a lens of looking at the amount of debt you have relative to your cash flow and in debt, we're including bonds and loans and triple net leases and all that kind of off balance sheet stuff too. Oracle is still the outlier. Oracle is still the company that has a much higher ratio of debt to cash flow than even the median, the median, the S and P. Whereas the rest of them, even Meta and Microsoft and Apple and Google, these numbers are pretty low. And so even with all the, in other words, even with all the borrowing that has taken place, their ratios of debt to cash flow are still pretty low because they're so profitable and they have a lot of cash and marketable stock securities on their balance sheet to offset that. And we've shown this chart before. But the biggest difference between the dot com boom and today is in both of those periods you had a spike in capital spending. The difference was last time capital spending got financed with debt and this time it's still mostly being financed with internally generated cash flow. And that's the reason why credit spreads other than Oracle. Right to special case. That's the reason why credit spreads for the other hyperscalers are still pretty tight and trading in investment grade levels. Okay, just a couple more things on AI and and, and data centers. The the latest data from the Census Bureau as of January shows that electric power generation in, in construction spending and data center construction spending are continuing to go up and up and up. The question is can it really continue at that pace? And are there any things that suggest that we may see a partial slowdown? And I think we are starting to see signs of a possible slowdown. And there, there are some people that did some satellite and other measurements of all the data center capacity that's supposed to be worked on in 2027 and way more than 50% of it. There's no construction observed. Now sometimes it's permitting that permitting issues that are temporary. But other times it's because they can't get the necessary combustion turbines, they can't get the enough skilled labor, they can't get the transformers to connect it to the grid. And so some of these equipment labor and permitting issues are beginning to get in the way of the, of the pace of the, of the data center construction build out. And as a reminder of all the 47 categories in the producer price report, the second highest level of inflation that we've seen is in transformers and power regulators. So this data center build out has really created some supply chain bottlenecks that may now start slowing the pace of data center expansion. And just since 2022. Right. And so three and a half years, the delivery time to get one of the generation step up transformers that's, that's needed to connect these things to the grid has risen from about a Year to three years. So that's not even for a turbine, that's just for the transformers. Now these kinds of problems can be solved with additional investment, productive capacity, capacity. Question is who's going to do that? And, and, and right now we're not seeing the supply chains increase that rapidly. Okay, last topic. I read this interesting paper from the, so Rice, Rice University. By the way, when I grew up, people used to call Rice Harvard of the South. I don't know if they continue to do that. I have no idea if it's accurate. But let's just, you know, I like to always assume that it is. So Rice University has this thing called the Baker Institute for Public Policy and they issued a report, they went into some detail on something called the Gulf Super Express. Now I don't know that this is ever going to happen because it would require a lot of coordination between the Gulf countries. And you just saw the Emirates pull out of opec. So maybe now's not the best time for me to be writing about this. But, but the, the region, if decides to cooperate, can reduce the Iranian threat by essentially building a pipeline from Basra and southern Iraq all the way to the Indian Ocean along the coast of Oman. And it would bypass, it would, it would bypass the Strait of Hormuz, it would bypass the Bab Al Mandeb Strait where the Houthis are active. It would, would mean they wouldn't have to go through the, the Red Sea and the Suez Canal and they would just be able to go straight to Asia and India. And some of the numbers are interesting, right? So they, they specked out two 56 inch pipelines that could carry 10 million barrels each, a spur to a local port, a lot of storage capacity. Their, their capital cost estimates would include both passive and active defenses, a strategic long lead equipment reserve in case something was damaged. And the cost for this entire multi country project would be about 55 billion, which is around what Saudi Arabia has spent on the NEOM project so far. I'm not sure that much to show for it. And it would take, let's call it five years to build. Now if it did cost that much, at its full capacity of $10 million barrels a day, you'd end up with about $55 per barrel per day. And that would rank at the lower end of real pipeline costs within a universe of all the pipelines that have been built around the world since the year 2000. So this could be done at a cost competitive basis. Now obviously shipping oil first through a pipeline and then through a VLCC tanker would cost more than than just shipping it through the tanker. But if you can't ship it through the tanker because Iran's going to close the straight, then it's a moot point, isn't it? So anyway, I thought this was interesting and there are options for the region to try to reduce their exposure to Iran and its influence over the Gulf. And I think chances are better than 5050 that either this project or something like it at some point starts to get built in a region. So anyway, that that's enough for today and thank you for listening. And again, in in June we're going to take a look at the challenges facing the new Fed Chair. And then in July we'll have a special Let me get this word right semi Quincentennial Eye on the market looking at us at the dollar, US equities and US fixed income at a time of the 250th anniversary of the United States. So thank you for listening and I'll see you next time. Bye.
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Michael Semblist'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 Semblist is the Chairman of Market and investment strategy for J.P. morgan Asset Management and and is one of our most renowned and provocative speakers. For more information, please subscribe to the Eye on the Market by contacting your JP Morgan representative. If you would 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 JP Morgan Institutional Investments, Inc. 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.