The Year of Living Dangerously

Summary

Eye On The Market: “The Year of Living Dangerously” – Detailed Summary

Podcast Information:

• Title: Eye On The Market
• Host/Author: Michael Cembalest (Transcript indicates Michael Semblist)
• Description: Join Michael Cembalest as he explores a wide variety of investment topics, including the economy, policy, and markets.
• Episode: The Year of Living Dangerously
• Release Date: December 10, 2024

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Introduction & Episode Overview

In the December 2024 episode titled “The Year of Living Dangerously,” host Michael Semblist reflects on the tumultuous events that shaped the year and outlines key themes that influenced the markets. As the final podcast of the year, Semblist previews upcoming topics, including an outlook for 2025, Trumpism’s impact on the Federal Reserve and markets, advancements in AI, the resurgence of nuclear technology, updates on cryptocurrency, and a comprehensive review of last year's predictions versus actual outcomes.

Highlights of 2024: Key Events and Market Performance

Semblist begins by noting the notable bookends of 2024 involving Supreme Court Justice Neil Gorsuch. The year started with Gorsuch leading a pivotal policy debate on Chevron deference—the principle of deferring to government agencies in interpreting legislation—and concluded with his remarks about Peanut the Squirrel, an incident highlighting environmental policy tensions.

A key market highlight for 2024 was the S&P 500's remarkable performance, marking the second consecutive year with over 20% gains. Semblist emphasizes that such performance is rare, having only occurred four times since 1871, primarily during the late 1990s bull market. He remarks, “We’re on track for two consecutive 20% plus years for the S&P 500. That's only happened four times since 1871” ([03:45]).

The Six Ghosts: Symbolic Investment Insights

Using the metaphor of six ghosts, Semblist conveys critical investment lessons and warnings gleaned from the past year.

1. Ghost of Predictions: The Perils of Forecasting

The first ghost cautions against making investment predictions, highlighting the historically poor accuracy of forecasts. Semblist shares, “The Fed has had less than a 25% accuracy rate of professional forecasters since its inception in 2012” ([05:10]). He reviews his own predictions, noting successes in areas like the US dollar, Department of Justice antitrust cases, and Biden’s policies, while acknowledging misses such as electricity outages due to outdated grid infrastructure.

2. Ghost of MAG7 Stocks: The Importance of Key Large Caps

The second ghost warns about underweighting MAG7 stocks—Apple, Microsoft, Google, Amazon, Facebook, Tesla, and Netflix. Semblist concurs, stating, “Within the average large cap portfolio, it’s been very difficult to outperform the S&P unless you at least over-weight the MAG7 stocks” ([07:25]). He presents data showing that nearly all managers in the Morningstar universe struggled to surpass the benchmark without strategic weighting in these major tech giants.

3. Ghost of Private Credit: Risks in Pay-in-Kind Income

The third ghost highlights dangers in private credit, specifically the rise of Pay-in-Kind (PIK) income, which represents income that isn’t immediately cash-based. Semblist explains, “Private credit markets have tripled in size over the last five years and are now almost 70% of the entire banking sector’s commercial and industrial loan volumes” ([09:50]). He references a JP Morgan report showing increasing PIK income shares, signaling stress in the private credit space and urging investors to monitor the real cash coverage of dividends in Business Development Companies (BDCs).

4. Ghost of Controversial Topics: Navigating Sensitivity

The fifth ghost (as outlined in the transcript) warns against addressing potentially offensive topics in investment discussions. Semblist reveals a curated list of sensitive subjects he chose to omit from his analysis to avoid controversy, including geopolitical tensions, political endorsements, and social issues. He notes, “We’re at the highest rate of people being easily offended, or at least talking about it, since the early 1800s” ([12:15]). However, he provides links for interested listeners to explore these topics independently.

5. Ghost of Self-Care: Prioritizing Personal Well-being

The sixth ghost advises Semblist to take better care of his health. He shares a personal anecdote about undergoing a cardiac ablation procedure due to arrhythmia, underscoring the importance of self-care amidst a demanding career. Semblist recounts a challenging night in the hospital, emphasizing, “I hadn’t been taking care of myself as much as I should have” ([14:50]). This story serves as a reminder of the balance between professional responsibilities and personal health.

Personal Stories and Anecdotes

Semblist intertwines personal narratives to illustrate broader themes. He reflects on his meeting with his spouse, Rachel, in the early 1990s, highlighting the shift from traditional in-person connections to online interactions over the decades. This personal story underscores changes in societal behaviors and technological advancements.

He also delves into his experiences during the cardiac ablation procedure, sharing the emotional and physical challenges he faced. This vulnerability adds a human element to the podcast, making the discussion relatable and engaging.

Conclusion and Looking Forward

As the episode concludes, Semblist expresses gratitude for the year’s progress, particularly noting the anticipated soft economic landing that aligned with his predictions. He looks ahead to the “Eye on the Market Outlook” podcast scheduled for January 1st, promising insights into the New Year’s economic forecast.

Closing with a reflective tone, he shares a picture from the previous year’s Outlook cover featuring falling bears, symbolizing market volatility. Semblist reassures listeners, “I’m thankful for the fact that, at least so far, we’ve had the kind of soft economic landing that we had predicted a year ago” ([15:10]).

Notable Quotes

• On Market Performance: “We’re on track for two consecutive 20% plus years for the S&P 500. That's only happened four times since 1871” ([03:45]).
• On Predictions: “The Fed has had less than a 25% accuracy rate of professional forecasters since its inception in 2012” ([05:10]).
• On MAG7 Stocks: “Within the average large cap portfolio, it’s been very difficult to outperform the S&P unless you at least over-weight the MAG7 stocks” ([07:25]).
• On Private Credit Risks: “Private credit markets have tripled in size over the last five years and are now almost 70% of the entire banking sector’s commercial and industrial loan volumes” ([09:50]).
• On Sensitivity to Topics: “We’re at the highest rate of people being easily offended, or at least talking about it, since the early 1800s” ([12:15]).
• On Personal Health: “I hadn’t been taking care of myself as much as I should have” ([14:50]).
• On Economic Outlook: “I’m thankful for the fact that, at least so far, we’ve had the kind of soft economic landing that we had predicted a year ago” ([15:10]).

Final Thoughts

Michael Semblist's “The Year of Living Dangerously” offers a comprehensive review of 2024’s economic and market dynamics through the innovative lens of six metaphorical ghosts. By blending data-driven analysis with personal stories, Semblist provides listeners with a nuanced understanding of past trends and future expectations. This episode serves as both a reflection on a challenging year and a bridge to the insights anticipated in the New Year’s outlook.

For those who haven’t listened, this summary encapsulates the essence of the episode, highlighting key discussions on market performance, investment strategies, and personal well-being, all while maintaining an engaging and informative narrative.

Transcript

[Podcast Host]

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.

[Michael Semblist]

Good afternoon everybody. This is Michael sembalist with the December 2024 I am the Market podcast. This one's called the Year of Living Dangerously. It's our last podcast for the year. On January 1st. As always, we'll have our outlook for the New Year and we'll be covering it's called the Alchemists. We'll be covering Trumpism Part 2 and its impact on the Fed and the markets. Some issues around AI, the Next gen nuclear renaissance, Some issues around doge, an update on China and Europe, A revisitation of our crypto piece from February 22nd and what we got right, what we got wrong. Plenty of both. And then a top 10 list for this year and a scorecard on last year's list. So this was a strange year. The year began with Neil Gorsuch leading a policy debate about Chevron deference, in which deference is given to government agencies in terms of interpreting government legislation. As you can see here, over the last few years before the case was overturned, agencies were given deference around two thirds of the time. And then the year ended with Neil Gorsuch talking about Peanut the Squirrel at a Heritage foundation dinner. As you may know, Peanut the Squirrel was orphaned, adopted, lived for seven years, trained, seized, and then euthanized by the New York State Department of Environmental Conservation. So interesting. Neil Gorsuch bookends to 2024. Another interesting thing about 2024, where we're on track for two consecutive 20% plus years for the S&P 500. That's only happened four times since 1871, and only during the bull market of the late 90s did the good times continue. So some interesting things that we'll be discussing in the Eye on the market outlook on January 1st in terms of our outlook for the next year. In terms of this Eye on the market, I wanted instead to talk about the fact that I was recently visited by six ghosts and they wanted to talk to me about predictions, allocations, apparitions interventions, expurgations and ablations. And by the way, if plenty of people believe in ghosts, According to a YouGov survey, about 40% of Americans responded by saying they believe in ghosts, and 20% said they've actually had an actual encounter with a ghost. So there you go. Anyway, the first ghost that visited me warned me not to make predictions and pointing he this ghost pointed to the horrible track record of the Fed stop plot since its inception in 2012. That less than 25% accuracy rate of professional forecasters, which is an economics group since the late 1960s. At least 25% overestimation of stock prices by sell side analysts. You know there's a long history of difficult predictions, but it's too late. I already made a predictions list last year. Here's a rough schematic of how it turned out. Six right, three to be determined and one wrong. The ones I got right were on the dollar. Department of justice winning antitrust case, Biden withdrawing, little recovery in lidar stocks and self driving cars. Russian invasion drags on US regional bank stocks do well to be determined issues around private credit leverage loans, Argentine dollarization and an inhaled COVID vaccine. And what we got wrong was electricity outages related to outdated grid infrastructure. So anyway, that was the first ghost. The second ghost warned me not to be underweight the mag 7 stocks. And on that front within the average large cap portfolio. I agree. At least over the last 18 months it's been very difficult to outperform the S and P if you weren't at least neutral, if not overweight the mag seven stocks. We have a few couple of charts in the eye on the market this time that look at the average MAG7 overweight and then individual overweights to the individual MAG7 stocks. And the cluster of all the managers that we look at from the Morningstar universe indicate that it was almost impossible, not impossible, but very very difficult to outperform the benchmark unless you at least remarket weight some of these stocks. So no argument there. The other thing the ghost warned me about was the risk of investing in hedge funds, individual hedge funds. I would say yes, but this is an update of an analysis that we did last year and I think the results are kind of remarkable, which is we create 20 fund composites, like randomly constructed composites of 20 hedge funds drawn from the HFR Davis and then we look at their returns and volatilities over the last five years compared to a stock bond benchmark. And over 80% of the composites outperformed. And I think it's really interesting given all the negative things that you read about hedge funds, to see how that came out. So you know, again we, we update this chart each year and these numbers continue to look pretty good. And if you want to learn more about this analysis, we described it last year in the alternatives review. All right. The third ghost warned me about other Ghosts in private credit and specifically ghosts related to pay in kind income, which is income that's not really there, kind of like a ghost. So as you can see here, the private credit markets have tripled in size over the last five years and are now almost 70% of the entire banking sector. Commercial and industrial loan volumes. And every time more capital floods into a space underwriting standards decline. It's just a truism in the investments industry. There was a report recently from JP Morgan's Investment Banking Credit Research Group. I thought it was a very good report. And here you can see that the PC income of BDCs which are the primary way that people invest in private credit, the PIC income is a share of total investment income is going up, which means that the pay in kind income where borrowers aren't really paying you back interest, they're just adding the principal is rising even though we've been in pretty benign economic conditions. So this tells you about stress in the private credit space. And the other thing that I thought that they did that was really interesting was they looked at the PIK share of income, looking at it after subtracting cash expenses. So what's the real cash coverage of the dividend of the major BDCs? And here you can see as of the second quarter of this year there were some very high numbers on this page of anywhere from 15 to 35% pick share. So again, something to pay attention to if you're investing in private credit. And what I liked was a research paper I found which explained why banks are so anxious to lend to BDCs instead of lending to the underlying middle market companies that the BDCs are lending to. And here you can see the ROE return on equity for one of these loans goes from 18 to 46% from a bank's perspective as they shift the loan from the middle market company to the BDC itself. And that has to do with lending to a more diversified entity and lower expected losses and higher expected recoveries in the event of default. So anyway, I thought that was interesting. Then the fifth ghost came along and warned me not to write about certain things in the eye on the market. And the ghost warned me that in this day and age people are easily offended. And I was curious to see whether or not people are really more easily offended than they used to be. And there was an academic paper on this topic and what they did was they showed a Google Engram. A Google Engram is, is a, is a program that looks at a certain phrase as a percentage of all the phrases that have ever appeared in English language books, documents and research materials. And as you can see from this chart, we're at the highest rate of people being easily offended, or at least talking about it, since the early 1800s. So I put in the Eye on the Market a list of topics that I decided not to write about because they were potentially defensive. But I put in some links to information in case you're interested in reading about them. The topics include why Europe is incapable of defending itself, what's going on in Chicago's doom loop, the dismal rankings of US commercial ports and resistance to automation, Mexico as a failed state, Cathie Wood and ARC Investments, U.S. defense of Taiwan, the mistake of legalizing sports gambling, sneaks, sorry to people that own them, Israel and Gaza, and then Trump's nominee to run the FBI. So if you're interested in any of those topics, you can certainly read about them with the links that I put in the piece. And then the last ghost came to me and suggested that I take better care of myself and I'll explain why in a second. I want to start with this picture. This is a picture of Rachel and I back in the early 1990s when we met. And like most people in the early 1990s, we met at work. This is a really interesting paper from the Proceedings of the National Academy of Sciences that tracks how heterosexual couples have met over the last 70 years. And Rachel and I met at work. At the peak of people meeting at work, and at its peak in 1990, around 20% of people met at work. At the time. Most people met through friends, and if not there, they met at a bar or restaurant or maybe by family members. As you can see from the chart, all categories of coupling have declined relative to everything moving online. And one of the ways that I met Rachel was, you know, she was more senior than I was and a lot more well traveled and sophisticated. And so I, I, I, I wrote a program in Lotus 1, 2, 3 keystroke macros that did some basic trigonometry to create a surface plot. It was all I had going for me. Um, but miraculously it worked. And now a lot has changed since then. As you can see here. When I created that program, Lotus actually had a 70% market share of the spreadsheet market. And then, you know, within the decade, basically went to zero as Microsoft took over. In any case, Rachel comes from a long line of hardcore Chicago Democrats. And Chicago Democrats are pretty hardcore. Over the last two decades, the citizens of Cook county in Chicago, where Rachel's from have voted anywhere from 70 to 75% for Democratic candidates for president. And even at the University of Chicago, which people always tell me is a very free thinking, nonpartisan kind of place, I thought this was interesting. Between 2015 to 2023, 97% of University of Chicago faculty donations went to Democratic candidates in PACs, while 3% went to Republican candidates in PACs. So I think the University of Chicago's reputation for nonpartisanship needs to be severely questioned. Anyway, so anyway, as Rachel is a hardcore Democrat, I was not surprised that in November I kept hearing these strange noises from the other room. And I knew that every time I heard a gasp it was because another Trump nominee had been named. And I started thinking, every time I heard this gasp, it reminded me of the end of It's a Wonderful Life, where the little girl says, every time you hear a bell rings, a bell ring, an angel gets his wings. Except this time it wasn't an angel and it wasn't a bell. It was a truck nominee. Anyway, so I had to go in for a cardiac ablation the week before the election. I'd been having trouble with stairs. This year I hadn't been taking care of myself as much as I should have. And I knew that I was going to be on my own because Rachel was going to go that day to Philadelphia and the Pittsburgh and some other places in Pennsylvania to ring doorbells for Kamala Harris. So I knew I was on my own at the hospital for this ablation. And ablation procedures are interesting. They're. They use heat, typically heat or short bursts of energy to create scar tissue in your heart to prevent the arrhythmia that's affecting you. Medical research papers estimate the success rates at 60 to 90%. So far, so good for me. And the idea is that the bad impulses won't be able to pass through the ablated scar tissue that gets created. So anyway, the night after the procedure, I was put in a room and I was sharing with another person. And at about 1am this guy started screaming in a language I didn't understand. And it turns out I called the night nurse that he was sleep screaming. And he was mostly screaming about how angry he was at his wife. And so. And then she told me that I had nothing to worry about. But I was in the next bed, so I didn't get very much sleep. And I was really, I remember thinking about five in the morning, I was really looking forward to getting out of the hospital and getting back to work and starting my 37th year at JP Morgan, which is why I'm recording this podcast. So anyway, those are the six ghosts that visited me. I wanted to wish everybody a happy New Year and a happy holiday season. And I'll close with this picture of the falling bears from the Outlook cover last year. I'm thankful for the fact that, at least so far, we've had the kind of soft economic landing that we had predicted a year ago. Thanks for listening and keep an eye out for the Eye on the Market Outlook and the associated podcast, which will come out as usual on January 1st. Bye.

[Podcast Host]

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 and as 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.