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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 afternoon everybody. This is Michael Sembalist with the June Eye on the Market podcast. I wanted to do something special this time in commemoration of the 250th anniversary of the Declaration of Independence. So I put together a long form piece called Semi Quinten. Let me get this right. Semi Quincententicals, the Semi quincentennial is the 250th anniversary of the United States. And the image that we created for this Eye on the Market is an Aquila Ceph, which is a name I made up, but it refers to this beast that you can see here that is a combination of a bald eagle and an octopus and it's a metaphor for the tight grip that the US on its 250th anniversary still has on global markets. And so in this issue and in this podcast we look at the details. I'm doing a webcast that will go through more details. This is going to be a more abbreviated version in this podcast of the materials and of course to get the whole shebang you got to look at the at the actual PDF itself. And I'm going to cover issues like the US reserve currency status, capital flows, this much anticipated but so far unprofitable. Sell America trade, corporate profitability and productivity at a time of AI investing in security and resilience, equity market concentration issues, energy independence and then the revival of the IPO market. And we also take a look at some of the medium term risks that I'm concerned about for investors, which is the increased unpredictability in the rule of law and government defunding and sidelining of scientific expertise. So again, this is an abbreviated version. Let's get into it. Let's start with reserve currency status. The usual suspects on this are the US has a large budget deficit. That's true, although note that China's, at least the way the IMF computes it, is even worse. Rising government debt. The US has a debt ratio that's basically doubled from 60 to 120% of GDP over the last 20 years. Again not that different from China. And then overall total economy wide debt, which is usually looked at as household, non financial, corporate and government debt together. Here the US has been kind of flat because what was happening was that for a while the government debt was offsetting declines in household and corporate debt and here China is much worse. And then the other thing that dollar doomsayers typically point to is the increase in U.S. sanctions applied to different entities and individuals. The idea being more and more sanctions would make people less interested in holding dollar denominated assets wherever they were because they could be seized. So despite all of this, apparently the dollar can do everything but read because the dollar has been remarkably stable. Ignoring all of this, these negative fundamentals. The dollar took a 10% hit when Trump was elected, but it's been pretty stable since then. And I'm not really surprised we have this reserve currency tracker. I would expect the dollar to come under pressure if any of these metrics or some combination of them started to decline. And what we look at is the dollar share of a bunch of things that are going on in the global economy, like the dollar share of cross border loans and the dollar share of international debt securities denominations and the dollar share of FX transaction volumes, FX reserve investments by central banks of exports, invoicing or of swift payments. And as you can see in our reserve currency tracker table that we're showing through the end of 2025, all of these metrics were pretty stable and none of them really experiencing much of way of substantial declines. So as long as the widgets driving the usage of the dollar as the world's reserve currency aren't really changing, I differ from some of the dollar doomsayers on this issue. And the dollar has gone down in terms of its share of global FX reserves by like 3%. But what's interesting is that hasn't been ground that has been gained by the yen, the pound, the Chinese currency or the Swiss franc. As a matter of fact, all of those numbers are lower than they were two, three years ago. What has gone up is this other category, which is a cats and dogs collection of Singapore dollar, Swedish Krona, Korean Won, Norway and other currencies where the IMF doesn't break out the individual numbers. Then what about this issue that, oh, the central banks have more and more and more of their FX reserves in gold. That's a price issue, not an allocation issue. As we wrote last year, if you hold market prices the same and you look at the actual gold holdings, gold allocations have gone down over the last 15 years or so. If we don't change allocations, but we just look at the price change, that's basically the entire thing. So what's happening is the central banks are getting a markup benefit on their existing holdings, but those allocations aren't really changing much in troy ounce terms. And China as the world's reserve currency is frankly an absurd concept. We write about it when you it has the highest money supplies, percentage of gdp, GDP in the world. If they ever decided to open the capital account, the amount of that, that giant sucking sound as Ross Perot used to mention that you would hear of renminbi rushing out of the country could clobber both their equity markets and their real estate markets. And we get into some research showing just how different China looks from a macroeconomic perspective than other pegged currencies and floating currencies like the Mexican peso, for example. China's system is basically totally inconsistent with the concept of being the world's reserve currency. Okay, so let's talk about capital flows. The US for sure is a debtor nation and needs a lot of money from abroad. The two ways you can look at that are the current account deficit and also the net international investment position. Both of those things are telling you that the US needs a lot of money. The good news, as far as we can tell, it's still rolling in and there's a lot of hand wringing about the falling foreign share of U.S. treasuries. And it's true that foreign holdings of Treasuries, excluding T bills have gone from like 45% to 25% just over the last decade or so. But that's because the debt's growing faster than foreign holdings. You look at the upper right here, foreign holdings of Treasuries and Tibbles are actually going up. They're just not going up as fast as the debt. And when we look at foreign holdings of corporate bonds and of equities, those are still rising. So we don't see any evidence of a buyer strike on U.S. assets. And as it relates to this kind of sell America trade, it's very anticipated and rarely profitable. So last year when, when Trump was elected, shortly afterwards, maybe two months later, there was this instance where the dollar went down on a given day by 5%. Equities under US equities underperformed the rest of the world. The treasury bond sold off the 10 year trade by 10 basis points. And this by the way, is over a 30 day period. And it happened for the first time since the since the 70s and early 1980s. And so there was a lot of hand wringing about this. I just didn't think that this was going to build on itself. And it hasn't. At the time right when this happened, I went on a Scott Galloway podcast, which I partially regret because before those podcasts begin, he goes on these bizarre R rated rants that are kind of better suited for his midlife therapy sessions that are Marcus discussion. But when we did get into the meat of the discussion, he was pushing pretty hard on the Sell America trade. And all I can tell you is ever since that podcast took place, treasury yields have Only gone up 10 basis points, US equities have outperformed the rest of the world, and the dollar's down by 1%. So so far, Sell America, I'm not seeing it. And the longer story here is that this chart on the PE discount to buy non US stocks compared to US Stocks has been the equivalent of a bug zapper for investors. And for the better part of 15 years, people kept diving in, diving in, diving in, buying non U.S. stocks over U.S. stocks. And it hasn't worked out well. And we have the full tally going all the way back to 1984. Depending upon when you invested, any long term investor would just be much, much better off. So let's use one example. If you start investing in 2012, US equities outperformed the rest of the world by almost 10% annually through the end of December 24th. Now there was a catch up in non US equities in 2025, but still using that same 2012 starting point, the US excess returns annually are 8% instead of 9 1/2 percent. So even with the catch up that took place in non US equities in 2025, for long term investors going back several decades and all the way through, recently, US equities have done much better. And while tech margins have exploded versus other sectors, in other words, tech margins have expanded a ton. They've gone from like 5% to 20 to 25% since the early 90s. The the the US market profitability advantage versus the rest of the world is not just a technology story. So again, this is one of my other favorite pages. We look here at the major sectors and at the minor sectors and we look at the us, Europe, Japan, China, and for the major sectors, the US basically has higher return on assets and higher return on equity across the board. And for most of the minor sectors, which is utilities, materials, real estate and energy, they also have higher ROA and roe. So this is not just a valuation story that's been driving the US outperformance, it's actual underlying profitability. So enough about that. Now there are signs. Look, there are plenty of signs of exuberance. I had an acid flashback recently when I was looking at some technicals on on the Philadelphia Semiconductor Index. The last time I saw the 200 day moving average chart look like this was sometime in the year 2000. Hedge fund exposures to semis and hardware is is flying off the page. Korean margin loans, which always gives me a nightmare when that goes up a lot and then just retail options trading in semiconductors skyrockets. There's plenty of investor exuberance right now, that's to be sure. I wanted to talk also in this piece about the issue of concentration because there's a lot of concern about concentration. And what, what do people mean by that? Well, they mean different things. The concentration that I'm not that worried about is the fact that the top 10 stocks in the United States now account for around 40%, 30 to 40% of the market cap and it was half that for most of the 1990s. So we now have a much more concentrated equity market. And by the way, the earnings of the top 10 companies are also very concentrated, about 35% of all earnings. And the U.S. is now 60% of global market cap, up from 30% at the end of the 1980s. Now first, amazingly, that 30 to 40% concentration of top 10 stocks, the U.S. has the third lowest number in the world. Only India and Japan are better. And we have a chart in here showing that every other equity market you pick, it, no matter how big or small, actually has greater market cap concentration of the top 10 stocks. Hard to believe, but true. The other concentrated issues that I'm more worried about have to do with things related to AI. One example is Nvidia has a very, very concentrated share of the accelerator market, which refers to the customized processors that are used for AI. But that share looks like it's shrinking and I'm not sure that investors are paying enough attention to this. And there was a research report from JP Morgan last week and buried inside of all discussion about hyperscale or debt financing was some research showing that the unit economics of AI are increasingly favoring companies like Google, Amazon, Microsoft and Meta using their own chips rather than Nvidia chips, and getting a 30 to 40% total cost of ownership production for doing it. And so that's why this chart here shows some projections of the overall accelerator market, which is referring to both GPUs and the ASICs, which are the all of the other views that that Nvidia's share of the Nvidia revenues are rising but a share of the total is falling. And I'm not sure that people are paying enough attention to this. The fact that Nvidia has 70% gross margins has certainly made it tempting for those other hyperscalers to develop their, their, you know, their own processors. And then there's the issue of the Frontier Labs. So the Frontier Lab revenues like Anthropic and OpenAI are going geometric at this point, that's clear. They are very profitable, reportedly between 40 to 45% gross margins. Unsurprisingly, they're not super labor intensive businesses. But the questions revolve around their operating margins, right? Net of capital spending, essentially, depreciation, things like that. And that part is less clear because these revenues that are growing can't grow unless they continue to acquire more and more computing resources to support all the modeling that people are doing and all of these agentic AI programs. And so there is a stratospheric revenue growth here. But I'm still grappling in the dark to understand the issues about their eventual operating margins, which we'll learn more about when and if they decide to go public. We do have some data showing just in the last year, like these are big numbers. 15 to 20 gigawatts of new compute resources for OpenAI and somewhere around 12 to 15 gigawatts for anthropic. And just to put some numbers on it, 1 gigawatt is the equivalent of a very large, you know, nuclear power plant, like the ones that were shut down in California or Indian Point in New York. You know, one gigawatt has more or less been the standard size of nuclear reactor for the last 30, 40 years. And when you look at the cloud revenue that we need, the cloud provider companies, you know, the big hyperscalers, around half of their entire revenue backlog is just OpenAI and at Traffic. And so the concentrated risks related to these Frontier labs is real and something we have to keep looking at, particularly since some now the token prices are going up, some enterprises may seek to avoid paying them by migrating to cheaper models. You know, whether they're cheaper US models or cheaper Chinese models. And let me just put some factoids in front of you. Brian Armstrong from Coinbase. I have mixed feelings about crypto, as you all know, but he tweeted the other day that 80% of workloads will be running with 99% cheaper models within a year. The founder of Lindy AI, which is a productivity assistant chatbot company, announced that they had moved their entire AI process from Claude to Deep Seek and will be saving millions of dollars and is also going to improve performance. And so what gets interesting is this chart that we have in Here from a company called Artificial Intelligence where they measure the cost of doing things and the effectiveness of the models that you're using. And there's this quadrant at the upper left of the chart for cheap models whose scores are kind of okay or just good enough, where you really have to ask yourself for an extra bit of performance, is it worth spending 20 times more? And there's one example here where we're looking at deep seq vs claudopus 4.8 where you're picking up a very marginal score improvement and paying 20 times more to do it. And so there's a lot of questions that this kind of thing raises as it relates to these open models and what they do. And then getting back to some of the economic stuff. For three of the last five quarters, tech, equipment and software has contributed more to GDP than the rest of the economy combined. Which is why I've said for over a year now, the Trump administration is extremely fortunate that this AI boom is happening on their watch because without it, the economic data would more accurately reflect some of the growth dampening aspects of some of their policies. And so this chart, just take a look at the chart here that looks at the GDP contribution from information processing equipment and software compared to everything else in the economy is pretty striking. Okay, so let me just keep going. Hyperscaler debt, everyone's concerned about it. We've written about it a lot. It's very manageable other than Oracle. And there's plenty of numbers in here to back that up. You could take a closer look. We get into productivity gains. The US has the highest productivity gains over the last 15 years or so within the G10. That's pretty consistent. So by the way, another supporting factor in terms of the US dollar remaining, the world's reserve currency, US productivity has actually picked up from pre Covid levels to post GPT levels. You have to kind of cut the COVID thing out of your productivity calculations for obvious reasons. We expect to get another productivity report at the end of June that continues to point in that direction. And then it's hard to talk about the US grip on global markets without getting into some of the issues related to China and Taiwan. So I know I'm running a little bit long. Just bear with me. China has been breaking into the top 10 in terms of the most innovative economies and export complexity, the capabilities of its frontier models compared to the U.S. narrowing the gap. And then, you know, the cost of the models that they're providing to the world. China, China. Innovation is, is moving pretty quickly and, and as we start to think about the US over the next decade, there's been an interesting convergence recently. The trade in semiconductors and integrated circuits is actually higher than oil trade. So while everybody is concerned about the Strait of Hormuz, as am I, I'm also concerned about the Taiwan Strait because at this point there looks to be more global GDP at risk from things that affect semiconductor trade than oil trade. And so, and then when you look at AI related imports in the US by far and away it's all about Taiwan. And, and a lot of you have heard me talk about this before, the US is now scrambling to rebuild what it once had, which was more domestic semiconductor fabrication. And after running through the numbers, looking at the TSMC projects in Arizona and some intel production in Arizona and Oregon and some projects that that are may happen for Samsung In Texas, the U.S. could, let's say, get to 30 to 35% semiconductor self sufficiency by 2030. But at the end of the day, for you know, when you're talking about these advanced node semiconductors, the US is still going to be highly reliant on Taiwan. And you know that gets into this issue that Taiwan is by far in my opinion the most blockadable country in the world. Forget about invadable. Blockadable is easy and CH and Taiwan imports 90% of its primary energy consumption as fossil fuels. So that puts them up there with Singapore and Cyprus and places like Morocco where they are just highly, highly, highly dependent on importation of energy. And China's military assets, if you look at where they're located, are mostly focused on one thing. So the vast majority of Chinese military assets are deployed near the Taiwan Strait. Either you know, whether that's in the eastern southern theater commands, when you're talking about surface vessels, submarines, Air Force, you name it. So that's something that we have to keep paying attention to. Now related to that issue is the the US is desperately trying to rebuild certain industries and there's a security and resilience initiative going on with inside JP Morgan that is focused on this. And so the US never really had much of an industrial policy, which is something that we've shown a chart on a lot in the past. Now the US is looking to catch up. And there are four or five main themes for investors to take advantage of this new industrial policy. Energy independence and resiliency, aerospace and defense, frontier and strategic technologies, advanced manufacturing and supply chains, and then to a lesser extent, farm and healthcare resiliency. The first four of those themes are doing quite well and have outperformed the equity markets last year and through today for all the obvious reasons, with the emphasis being put on repatriating a lot of these things and providing incentives for everything from shipbuilding to drones to aerospace, you name it. And the other thing that's interesting too is the new policies are putting a lot of emphasis on regular commercial contractors instead of the pure play defense contractors, in part because the pure play defense contractors are showing a lot of signs of supply chain stress in terms of their book to bill ratios, which is one way of looking at how much they're billing versus how much they're booking. And so there's a lot there's this new commercial first approach that's coming out of the National Defense Authorization act that is designed to really broaden out the number of companies that are going to be participating in this defense initiative. You can read more about it in the piece lots here. We have a lot of information on investment in robotics and drones, and it's going to take a lot of effort to reverse this image. This is a pretty tech. This is a pretty terrifying image from the MIT Technology Review. Most drone technology, when you look at the origin of it, most of it was the US with little bits from Japan, the UK and Europe. And then when you look at current country of manufacture, it's almost all China. And so that is going to take a lot of effort to reverse some of that. I want to close with a couple of things because this is important as well for investors. The rule of law issue gets talked about a lot. Some of the things the Trump administration has done, some of them are unpopular, a lot of them are unprecedented, but that doesn't make them unconstitutional. And we have a long list of things here that repealing Biden executive orders and duties of foreign imports and terminating federal employees not subject to certain protections, allowing states to change what the block grants get used for, suspending certain refugee admissions, withdrawing from the who. These things are not in our Constitution. And I think sometimes people are sloppy about the things that they describe as being a deterioration in the rule of law. We list a bunch of things that are, again, unpopular, unprecedented, but not unconstitutional. And also the congressional redistricting issue that's going on, that is not unconstitutional either. The US Constitution and most state constitutions do not contain bans on gerrymandering for political purposes. Now, you may not like it, and if you don't like it, you know your legislature would be more than prepared to pass laws against it if people vote for that. But there are no constitutional and few state constitutional bans on gerrymandering for political purposes. And that's why these gerrymandering things are taking place. The GOP may pick up anywhere from 12 to 16 seats for the midterms this year versus six for the Democrats. Some of that will probably reverse in 2028, when the Democratic states can catch up and figure out how to play the same game. But so I think, I think this is not a good example of deterioration in the rule of law. There are other examples one could use. And UCLA did a survey of federal judges, law professors and constitutional lawyers, and they do express a lot of issues. We have a chart in here that show a substantial deterioration in the rule of law since 2024. And they talk about substantial concerns related to executive branch power, compliance with court orders, politicized law enforcement, fear of reprisals. And then we have some specific information here on retaliation, compliance with the judiciary, legal representation and harassment, abandonment of core legal principles. If you want to find it, you can find it. You don't have to look very far. And there's also something called the Varieties of Democracy Project, hosted by the University of Gothenburg, that shows a pretty substantial decline in what they describe as legislative and government ability to question, investigate the executive branch. US has had the largest decline of all major countries in that index over the last couple of years. More on all this in the, on the webcast or in the piece itself. We also have a big piece in here on the federal section, in here on the federal government defunding of science. I don't want to go through it. There's, you know, you know what's going on. There are very, very, very large declines in grants for the National Science foundation and the National Institutes of Health, a massive cuts to agency staffing levels on anything related to science. There's an OMB proposal that would do some pretty bad things to the entire scientific process within the federal government. And then you have all the stuff that RFK is doing. You know, we have some charts here that go back to the Bronze age in 1200 BC in terms of life expectancy and the benefits of antiseptics, vaccines and antibiotics. I'm just going to leave you with this. Six surgeon generals appointed by Bush, Clinton, Obama, Trump himself, and Biden wrote an article recently called It's Our Duty to Warn the nation about RFK Jr. And they describe his profound, immediate and unprecedented threat to public health and how science and expertise are taking a backseat to ideology and misinformation. You can read more about it in the piece itself. We have some Stuff here on Energy. I want to close just with some IPO stuff because that's top of mind. I love this chart. It shows the creation of new public companies in the 21st century. And it was drawn from a Draghi report that's trying to boost European entrepreneurship. Good luck with that. And as you can see, in the 21st century, the US market has really been the leader in value creation with new public companies. China is actually a distant second, and then distant behind them is European Japan. There was a lot of hand wringing for many years about the decline in IPOs. And some people thought it was Dodd Frank and some people thought it was changing tax policy that allowed companies to stay private longer with more shareholders. The bottom line is then we had the SPAC boom. That was regrettable, but now with some of these big mega IPOs as a share of total market cap, we're getting close to some pretty high numbers, even going back to the late 1990s. And so we have a section in here on IPOs that's interesting. There are questions about whether or not mutual funds have enough cash to handle all this stuff because their cash balances are low. If you look from a big picture perspective though, I think there is because the gross buybacks, less equity issuance and shares from expiring lockups is still a positive number. It's a smaller positive number, so there's less money sloshing around than there used to be. But it's still a positive number. Again, that looks at buybacks less what you need to absorb new and secondary issuance and also for the expiring lockups. And remember, M and A may be another source of demand for these IPOs. M&A activity has been pretty resilient, up 50% this versus last year. And cash is around 70% of what gets paid. So there should be plenty of money to absorb some of these large IPOs. The bigger question is not how they get absorbed when they get issued, but how do they do after they get issued. And JP Morgan Equity Research did a report recently where they looked at the free float share timelines for the 10 largest IPOs since 2010. And the average now there was a very wide dispersion around it, but the average one floated around 40% of the shares. But you know, with before the end of the year, 80% of the shares were public. And, and for some of them they went from maybe 10 or 20% of the shares to 60 to 80% of the shares being public by the end of the year. So the question is less about how does the first I. How does it trade during the first week? Although that's of interest to people that participate in the syndicate and and are going to flip their shares for longer term investors, the question is how do they do after the first close heading into the lockup expiry? And that's particularly the case for a company like SpaceX. As a share of total market capitalization, for the whole equity market, it's a very small number up front. But then you've got the standard lockups expiring, the extended lockups expiring and then musk lockup expiring and you could have all of a sudden 3% of the entire equity market capitalization get released over the next year or so. And so when we look at what happens after the first IPO pop. First day IPO pop at the largest IPO since 2010 doesn't look so good. They're on average a 20% decline heading into the lockup expiry. And then we have some additional. So we can look at that actually by company by company. We do that in here and then. But just broadly speaking, when you look at the average IPO over the last 10 years and since 2023, you get like 5 to 10% declines heading into the lockup expiry and then improving a little thereafter. So for people that didn't participate in the original syndicate and you're trying to think when should I build a position? There are some clear signals from history that you should wait until further in, closer to the lockup period, in order to start acquiring this stuff. So that is the abbreviated oh dear, 30 minutes. That is the abbreviated version of the semi quincentennial piece. See the printed piece for all the details or listen to the webcast where I will not be speaking so quickly. Thank you for dialing in and I hope you guys are enjoying your summer. Goodbye.
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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 Semblast 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. These reviews 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.