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Podcast Announcer
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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Michael Semblist
Good afternoon everybody. This is Michael sembelist with the 2025 on the market Outlook podcast. Happy New Year everybody. The Outlook this year is called the Alchemists for reasons that I will explain in a minute. First, just want to mention this is the 20th anniversary of the Eye on the Market. I launched it in January of 2005. It was meant for clients that consume information on either a BlackBerry or a Palm Pilot. It didn't have any charts or graphs or tables or footnotes or anything. It was text only. A lot of things have changed since then. It's been an amazing journey. I've enjoyed working on it. I've learned a lot. I'd like to thank Jamie and Mary for supporting me in this effort, particularly when I write about controversial topics and this year is no exception. So on to the Outlook itself. I have a section on the Alchemists, which is about Trump's impact on markets. We have a section on AI adoption trends and milestones given the MAG7's importance to the markets. A section on nuclear power. Wake me when we get there. A section on Doge called Doge Quixote, which refers to the billionaire's quest to reduce government spending. An update on China and the Liquidity trap. A section called Dr. Seuss goes to Europe. We revisit the crypto markets given the rally since our Maltese Filecoin piece in February 2022, and discuss the sky high returns that donors have gotten on their crypto political donations. And then a top 10 list for 2025 following on last year's top 10 list, which was the first time we did that anyway. So I'd like to thank GPT again for some fantastic cover art. This is a depiction of Trumpism as alchemism. And what what's going on here is you've got a guy in a red hat and he's mixing together eight different things. Deregulation, deportations, tariffs, tax cuts, government cost cutting, oil and gas crypto, the medical freedom movement, and agency purges. And then the question is posed, what could possibly go wrong? I also think we try to address what could possibly go right.
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Co-host or Analyst
There's a lot more detail that we go through in the actual outlook in the executive summary.
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Michael Semblist
Let me just give you a a.
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Co-host or Analyst
Brief description of it here. We start with this. What are the Alchemists trying to change if you take them at face value. What they're trying to change is this chart. And this chart shows that for the better part of 80 years, consumer spending, GDP growth and industrial production went up together like three doves flying in the same direction. Or geese or. I'm not a bird person. Then as soon as China joins the World Trade Organization in the year 2000, we get what I call the silence of the plants. That's a Cleary Starling reference where industrial production flatlines while consumer spending and GDP keep growing. There are some other ominous inflection points, negative for the United States that also took place around the same time that China joined the World Trade Organization. Rising manufacturing job losses in the US A follow labor share of gross profits, rising suicide rates in the US and rising non metro, meaning rural poverty rates in the US So that's what the Alchemists claim they're trying to change. What kind of tailwinds are they trying to create? Well, more inbound foreign direct investment into the United States, part of which is already happening. A slowdown in the breakneck pace of regulation which was taking place under the Biden administration that we've showed charts on and discussed many times. Freeing up bank capital by ending the Basel III discussions, which could presumably lower the cost of credit. Increasing oil and gas production to bring down energy prices.
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Michael Semblist
Although I think when you look at.
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Co-host or Analyst
The electricity prices in many parts of the country, the renewable transition is irreversible and is driving those energy prices up and then building on a rebounding capex and confidence outlook and also a recovery that we're seeing in venture capital markets, which we spend some time on in.
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Michael Semblist
The executive Summary as well.
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Co-host or Analyst
So those are the tailwinds that I think it's fair to say the Alchemists are trying to create. Now, what headwinds are the Alchemists likely to face with their set of policies? Well, as everybody has discussed, possible inflationary consequences, not just from tariffs themselves, but from the retaliation that the United States would face with whether it was a China tariff, a universal tariff, any kind of tariff. And by the way, of the 10 states that import the most amount of goods relative to their gdp, eight of.
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Michael Semblist
Them are red states.
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Co-host or Analyst
Tightening the labor supply through deportations and things like that have potential consequences for both wage inflation and Fed policy that I'm not sure that the administration would like now to be clear. And we talk about this in multiple places. The Biden administration oversaw the largest uncontrolled, unmanaged and unsupervised migration surge on record. And even the Brookings institution at one point argued that the borders needed to be closed for some period just to absorb the immigration that had taken place. But that said, tightening, tightening labor supply too much will have consequences for wage inflation and Fed policy. And then we already have Trump's inheriting large budget deficits despite almost full employment. And then from a policy perspective, the Republicans have almost zero room for defections in the House because they've only got a 219 to 215 lead. The Gates seat will have a special election sometime in March. They'll lose a couple of seats in Florida. Bottom line is they really have no room for defections in the House. And then I won't go into too much detail. We have a page on this. Suffice to say the medical freedom movement that RFK Jr supports on occasion is not a confidence builder in the concept of US Exceptionalism. So how do we see what the market verdict on this mix of headwinds and tailwinds is? My favorite barometer is a 10 year treasury and so far the news is not great.
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Michael Semblist
If you look at the last seven.
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Co-host or Analyst
Tightening, sorry, easing cycles from the Fed in the United States going back to the 1980s, typically what happens is the Fed starts to ease and the 10 year treasury either stays around flat or and or comes down. This is the first time in 35 years or so that the 10 year treasury has gone up and stayed there after the first Fed cut. So the early verdict from the bond markets on this mix of alchemist policies is not great and suggests that the productivity benefits from tax cuts and deregulation may not be enough to offset the inflationary consequences of tariffs and deportations and some of the other things that they're planning on doing. So ultimately again, the 10 year treasury.
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Michael Semblist
Is going to be the best barometer.
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Co-host or Analyst
In my opinion of this mix of policies.
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Michael Semblist
And the Fed Fund futures markets are.
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Co-host or Analyst
Sending a similar signal.
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Michael Semblist
A year ago the markets were pricing.
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Co-host or Analyst
In a funds rate that would fall below 4%. That's not the case anymore. The latest Fed Fund futures markets are.
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Michael Semblist
Projecting the Fed won't be able to.
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Co-host or Analyst
Ease more than down to 4% or.
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Michael Semblist
So, and I'd be surprised if they even were able to get there sometime in 2025. Equity investors are more optimistic. The Conference Board survey of households expecting higher stock prices in 12 months is at an all time high, even higher than it was in the mid to late 1990s and there are some technicals that support that equity supply is very tight. In other words, this looks at secondary and primary issuance net of buybacks and net equity supply, particularly in the US is actually declining. So there's a scarcity value to public equities, if you can believe that. So from a technical perspective, that's supportive. But U.S. equity markets are pretty expensive. We all know this. And at least on a valuation basis. Now, markets can still go up when valuations are high, but we're in the mid to upper 90s in terms of percentiles for many different ways that you could look at the valuation of US stocks, median PEs, forward PEs, trailing PEs, enterprise value to cash flow, price to book price to sales, you name it. Most of the valuation indicators are on the high side. And we've also had two 20% plus years in a row. That's only happened 10 times since 1871. And only during the 1990s bull market and the roaring 20s around 100 years ago, did the good times keep going. So my takeaway from this, and you can read this in the executive summary of the outlook, which goes obviously to a lot more interesting detail, is I think that there's a steep curve here for the alchemists in terms of trying this policy mix of deregulation tariffs and cost cuts and tax cuts and crypto and things like that. They've got a very limited margin for error given how much of an equity one we've already had and how high valuations are. So I expect US equity markets to end the year 2025 higher than when they began. But I expect the Alchemist to break something and I don't know what, and I don't sit and they do either. But they've got their sights set on everything from the FBI to Medicare to border policy to the Defense Department to weapons procurement. I think they're going to break something. And so I expect a correction of some kind of 10 to 15% from whatever value it's at in sometime in 2025. That's not that infrequent a thing. It happens in around one third of all years. But I am expecting a correction to take place and then for equities to end up modestly higher by a few percent at the end of next year compared to we are right now, just to be clear, the deregulatory efforts that the administration, the incoming administration is talking about, they do have a long history of increasing business spending, capital spending, business confidence. I started writing about deregulation over 20 years ago, and here's a chart from the archives of behind the Market that looked at the Clinton deregulation of telecommunications and electricity markets and the resulting increase in non residential business investment, which is essentially a capital stock increase. Peter Orszag at Brooking has written about the benefits of deregulation on multiple occasions at Brookings. He was at, I think, either the CBO or the OMB for a while. And so I'm a believer in the benefits of deregulation. And then after the election, there was a surge in the number of small companies responding positively by saying that they're now planning on some additional capital spending over the next few months compared to what they were at before the election. But, you know, tariffs and.
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Co-host or Analyst
Shrinking the.
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Michael Semblist
Labor supply and some of the other issues that the alchemists are planning I think will offset some of this. So it's a really interesting policy mix. It's certainly not anything that anyone has tried in 70 or 80 years. And again, the executive summary of the outlook gets into the details of this policy mix and what its implications for markets might be. We've also got a long section on AI and adoption and milestones and things. I'm just going to share a few comments here. The US Exceptionalism that you read about in the equity markets, you can back that up with numbers. And I thought this was an amazing chart. It comes from Mike Goldstein and his team at Empirical Research and it shows the free cash flow margins by decade for the 10 largest stocks. So you might think the 10 largest stocks always make a lot of money, but that's true. But the 10 largest stocks make a lot more money now than they did in the past. This goes back all the way to 1950 and shows the free cash flow margins for the 10 largest stocks in each decade. And this crop of US exceptional large companies with free cash flow margins above 25% are setting all time highs here. Now the rest of the S and P has been treading water. And when you decompose earnings per share growth of the Mag 7 versus the S&P 500x Mag 7, you get kind of a mixed picture here. The S&P 500x Mag 7 had an earnings boost that took place in 2022, but it was mostly just a reversal of the declines that took place during the pandemic. Only the Mag 7 has been consistently generating since 2017 some pretty impressive earnings growth. So this is a very bifurcated market. And unfortunately the implication is that very diversified investors that have been investing in, let's say, let's say an equal weighted S and P have struggled with that. And it's really important to understand this AI boom because we're now Looking at something which has only happened I think twice in the last 50 years or so, which is when one specific company or small group of Companies capture a 15% or so share of all the capital spending that's taking place in the economy. I mean, that's kind of an amazing thing to think about, one company or a gaggle of companies capturing 15% of all capital spending. And in 2026, that's what's projected to happen. With Nvidia's data center. Revenues are supposed to roughly be equal to 15% of all capital spending in the economy. The only thing we can compare that to is IBM's mainframe peak in the late 60s and then obviously the dot com bubble in 2000. And so we spend a lot of time looking at this particular issue of the hyperscaler revenue gap. Now what does that mean? Well, the hyperscalers, I mean I don't have a lot of concerns about Nvidia. Their gross margins and everything look fantastic and their order book looks amazing. The CEO has described the order book for their new black belt GPUs as insane. The issue is who's making all that money? Well, it's the hyperscalers. Google, Microsoft, Meta, Apple, Oracle, Tesla, et cetera.
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Co-host or Analyst
And.
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Michael Semblist
They eventually have to earn a return on all that GPU expenditure capital spending. And if you factor in their GPU purchases, the implied overall data center spending that goes with that, and the gross margins that they typically would need to earn, these companies are missing about $400 billion in annual revenue. So the markets have been very patient so far because we're in the very early stages of this AI adoption boom. But at some point, I think in the next 18 months, markets are going to start asking some very tough questions. And if these hyperscalers don't start earning some of this $400 billion to sustain their gross margins on all this capital spending. And our growth managers are watching this closely. Hyperscaler capital spending and R and D as a share of revenues has been creeping up for the big four Meta, Microsoft, Alphabet and Amazon and starting to get into pretty eye popping territory where capital spending in R and D is approaching 35% of revenues. And as we all know, these models just keep getting more expensive and energy intensive to train. And almost any chart you look at on this has to be plotted in log scale because of the amounts of time, effort and money that are being poured into these, into training these models. Now the good news is the surveys of companies that are ultimately going to pay the hyperscalers for all of these AI programs. We're starting to see the first crop of surveys of how those Gen AI applications are working out. And as you can see in this.
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Co-host or Analyst
Chart here, and we go into more detail in the piece.
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Michael Semblist
90% either exceeded or met expectations. So that's a positive sign. Some of the other surveys we walked through in the piece look at timelines of Gen applications, but I think it's a pretty notable thing that the early crop across multiple sectors of Gen AI projects have exceeded or met expectations of people investing in them. That's a good sign. That doesn't tell you how much money they're ultimately going to be spend on it, but it's a good sign. But I just want to remind everybody of this time capsule that I put together recently from our archives. If you go back to the year 2000 and you look at Corning's order book, they built a lot of fiber. Now, ultimately all that fiber was used, right? None of it was wasted. Ultimately, all that fiber got used. But because of the overbuilding, it took Corning around 20 years to get back to the nominal revenues in their optical communications business that they had in the year 2000. And similarly, if you look at a chart on undersea fiber optic cables deployed per year, it took until 2020 to exceed the 20, the year 2000 level after a collapse. The reason I'm mentioning this is when, when you have an overbuilding episode, even if all of that capital stock ultimately ends up getting used, sometimes it can take a long time to absorb it. And then obviously there is a lot of implications for the companies that spent that money along the way. Now, one of the issues that I'm fascinated by are all the green power commitments from a lot of these data centers and hyperscalers in terms of the energy intensity. Now, sometimes people make too much out of this power demand coming from data centers. Over the next decade, I expect much bigger power demand numbers from electrication of vehicles and electrication electrification of home heating through heat pumps, which will also be adopted by industry and commercial applications and office buildings. And there's also a lot of different forecasts for data center demand. But one of the most incredible, meaning not believable things about this is that nuclear power is going to play a role. I just don't see it. There's been a boom recently in the performance of Nuclear Exposed and Nuclear Pure Play shares. I'm going to take the other side of this one, just as a bit of background. OECD nuclear power. You know, the OECD used to dominate nuclear power during the 50s, 60s, 70s, and then started sliding in the 80s. And by the time you get to the late 1990s and from then until now, nuclear development is essentially something that belongs to and is done in developing economies and not developed ones. And you can see why. If you look at the cost gap here, I'm looking at the capital cost of four plants that were recently completed in the west, because that's all there have been over the last 20 years. Flamonville in France, one in Finland, the Georgia Vogtle plant and then Hinckley Point in the uk all cost many multiples of the plants that are being built in Russia, China and Pakistan. Now. There's lots of reasons for that. I've read all the studies on that. I personally don't believe that we can start cranking these things out in the same way that you build solar panels or lithium ion batteries to bring their cost down. So I think people are way too excited about the possibilities of nuclear power having some kind of renaissance that contributes meaningfully to data center demand. And in the outlook, we get into the weeds on this vault three, by the way, and Georgia already having operational problems and just came online. The US lacks a lot of uranium and is it. And has import reliance on certain kinds of uranium, which is creating problems for TerraPower. There are very limited opportunities for plant restarts. And way too much was made of the Palisades reopening and the announcement and as well the one that's taking place with Three Mile Island. You can only really restart plants that just recently shut down, meaning within the last couple of years because the decommissioning process hasn't started yet. If you start the decommissioning process, it's way too expensive to then reverse that and get that plant back online. So at maximum, I can think of maybe two or three other shuttered plants that would be eligible for restart. The next gen designs, everybody likes to talk about them. Sodium cooling, gas cooling, molten salt. According to the DOE's nuclear people, at least a decade away from commercialization in the US and then small modular reactors, very impressive pipeline. Six and a half gigawatts, 200 billion in orders. They're still lottery tickets. And the power commitments are not take or pay contracts. They're all contingent on final cost, as was the case with the new scale plants that were abandoned in Utah last year. So let's, let's, you know, take some reality pills on this nuclear renaissance. Take a look at this section. It gets into the details. We also have a section on Doge Quixote. I am. I am envisioning Vivek Ramaswamy and Elon Musk as Don Quixote and Sancho Panza from Don Quixote. The thing to remember is that one of the underlying themes of the model is the pragmatism and humility are required for them to complete their quest, and I would question whether Vivek or Elon qualify for each of those or either of them anyway via Condios Doge Quixote I think they'll obviously get some things done, but they're going to run into a number of different buzz saws and one of my top 10 predictions is they're not going to make it anywhere near some of the targets that they've mentioned. There are savings to be had from reversing some of Biden's recent executive actions, but those wouldn't count towards Doge targets on reducing current spending. That would just be reducing potential future spending that hasn't really even been penciled in yet. Non defense discretionary spending has already been cut. Budget control act of 2011. It's at its lowest level in decades. So therefore they're going to have to focus on entitlements. And the Doge billionaires are now finding out that that's a political third rail. Good luck with that. The sec, the Department of Labor, the Department of education and the EPA combined represent less than 2% of all federal workers. So fine, start firing them, but that's not going to get you very much. The vast majority of federal workers are, you know, the Postal Service and the Department of Defense. There will be efforts underway to expand the CMS is maybe expand weight loss coverage for weight loss drugs, and those are going to offset some of the Doge savings which takes place elsewhere. Trump has talked about impounding or redirecting congressionally approved and congressionally appropriated spending that's going to face judicial challenges. Trump There was an Impoundment Control act passed in 1974 in response to something Nixon did. A precedent can't, according to the Supreme Court and according to this legislation, can't just say, well, I'm going to take the money that was appropriated for the Department of Education and spend that on somebody else, which is what he's announced that he wants to do. Most defense spending is people in operations on the order of 70 to 80% rather than weapons procurements. And then with respect to weapons procurements, good luck. The number of federal contractors has fallen from 51 in the early 90s to 5. So it's going to be very difficult to cut those procurement costs with that much concentration in the defense contracting. And then we also get into some of the things on improper and fraudulent payments that the government makes. Sometimes accidentally you can try to reduce them, but it's going to cost a lot of money in terms of investing in systems and people to do that. So we get into the details there. It's interesting if you want to understand it. And I and good luck to all the billionaires that they've recruited onto the team along with Vivek and Elon to try and get this done. We have a section on China that looks at both the liquidities trap and the Thucydides trap, which is something we wrote about a couple of months ago. The bottom line is that China is experiencing some kind of liquidity trap, share some kind of characteristics with Japan in the early 1990s. As you can see here, a Bloomberg maintains an economic activity monitor. Exports, coal and electricity consumption, steel production, car sales, real estate investment, consumption of medicine, the kind of things that are harder for the Chinese government to paper over and obscure. And the momentum on this thing is fairly negative, which is why China announced that stimulus package. Now, the stimulus package was substantial, impressive. I believe there's more fiscal stimulus coming. Bridgewater did an interesting analysis a couple months ago that showed that the total impulse from monetary and fiscal stimulus would offset roughly half of the economic drag that's taking place in China right now. That's a good effort. And the domestic a share market kind of soared after the announcement and has retained its gains. Whereas the MSCI China Index, which is a broader index of Chinese exposed stocks, has since given up about half of the gains on the stimulus announcement. I'm not going to go through the details here. You can read the piece. I just think the days of 14 to 18 pes on MSCI China are a thing of the past and for geopolitical reasons they're going to be capped at about 12 12x, which doesn't leave a lot of room for a rally from here. So you can take a look at the piece. We go through the details of some of the tariff and espionage issues at the core of some of the conflict issues between the US and China. I'll just say that the increasing intensity of Chinese espionage spreading across almost every industrial sector in the US and other Western countries, it makes the idea of a rapprochement that I've read about highly unlikely. And the same goes for some of the naval blockade exercises that China has been conducting with regards to Taiwan. So you can read more about that, we have a section on Europe called Dr. Seuss Goes to Europe. It's just two pages with some Dr. Seuss style language and some charts. I just want to show you one of the charts here. We have charts and comparisons on labor productivity and energy prices and deindustrialization in Europe and problems with monetary policy being applied to countries that are too different compared to the US Low labor mobility, very poor ROA and ROE numbers in Europe other than in healthcare, and then very negative earnings revisions. The chart I really wanted to show you was this new one, which is the creation of new public companies in the 21st century, compared the US to Europe. This kind of tells you all you need to know about the outperformance of the US versus Europe over the last 20 years. It's kind of an amazing chart to see. I can't describe it verbally. You just gotta have to look at it. The CRYPTO PRESIDENCY I wrote a piece called the Maltese Filecoin a couple of years ago. It was February 2022. And I was skeptical of Bitcoin as a store of value and then even more skeptical on the transactions focused coins and the defi coins. And if you're not familiar with the jargon, you can look at the eye on the market on this section and it gets into the details here. But I was, I said I would take another look at Bitcoin if it fell. And it fell. It fell hard. It fell 65% after I wrote the piece. And my mistake for not looking at it again has since rallied pretty sharply. And a lot of the surveys of institutional investors are, are fairly positive on the prospects for increased digital ownership as it relates to the transactions focused coins and the defi coins. I don't believe it. I was right that about those coins. For three years, nothing much has happened in terms of actual utilization of either of those kinds of crypto coins. There's been this spectacular rally in a handful of that ripple in particular, but it looks highly speculative to me. And then specifically I've got this chart here looking at the volumes of utilization of ripple, Litecoin, Monero and Stellar. None of them have changed since two, two years ago. Right. And so if the value proposition of these coins is that people are going to use them more, you expect to see that happening and you don't. So for that, that means that this is a very technical and speculative rally. Same thing for Ethereum. The number of daily verified contracts in Ethereum being executed on Blockchain A are now unchanged versus what they were in early 2022. So to me what's really happening is that people are earning a sky high return on their political donations. Crypto packs received almost 250 million in donations, around half of all corporate donations made during the election. And Coinbase gave 75 million to a Super PAC called Share Fairshake. Their candidates won almost every race they got involved in. Look, they're playing the game and participating in the system in ways that they're allowed to do that. Not criticizing it. I'm just saying that this to me is a better explanation of the pop in crypto than the presumed proposition that their acceptance and utilization has been in changing. All that's really been changing is the politics. And you know, the GOP majority of the year of the House is pledging a pro crypto bill in the first hundred days. Trump has announced a crypto council and a crypto czar. The s the new SEC head will probably roll back some of the crypto accounting disclosure rules. So this is a shift in sentiment rather than a shift in utilization. And you can take a closer look. And then just to close out here and thank you all for listening. I started the top 10 list last year in honor of Byron Wein who had passed away. He did this every year for forever. I made a bunch of predictions last year. Six of them were right, three of them were kind of either too soon to sell or hard to say, and then one was wrong. I've made a new list for this year. I will tick through them very quickly and then sign off. At least three confirmed Trump cabinet members will be gone by the end of the year. Renewables will underperform traditional energy again in 2025 like they've done in the last three years. MSCI Japan will outperform China despite China's higher PE multiple. The discontinuation rates, which are approaching 50% of weight loss drugs are going to hurt some of the GLP stocks. Specifically Novo Nordisk, I think will end the year below consensus atlas price targets. Despite the order book referenced earlier, I don't think any small modular reactors in the United States will even begin construction in 2025. I think Doge cost cuts are going to be no more than 150 billion a year, excluding reversal of executive actions, compared to targets of 2 trillion hedge funds. I expect to continue to outperform stock bond benchmarks and we can explain what we mean by that, but they've been doing better than expected. Housing inflation, I think because of completions, both single family and multifamily will start to finally bring housing inflation down below 4%. The way that the Fed computes it, blue state out migration will continue. Over the last few years, 70% of all movers in the country in the US are moving from either blue to red or purple states. I think that's going to continue. And then lastly, I think there's a chance that the Trump administration launches a target military action against drug cartels in Mexico. So that's my top 10 list. Thank you for listening. Take a look at the Outlook. There's a lot in there that we can't get into in a podcast like this and it's been a privilege. Thank you very much. Bye.
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Podcast Announcer
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 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.