Michael Cembalest

By now everyone, even CNBC, admits that the only reason stocks are where they are is due to the G-7 central banks. What many may not know, however, is how we got here, and where we will be at the end of this year. The answer, as provided by JPM Asset Management CIO Michael Cembalest in the chart below, is at the dot in the top right. This will represent the addition of $10 trillion in liquidity, or alternatively the conversion of the "planetary nebula" of central bank balance sheet expansion, in the past seven years. And considering that, as we explained yesterday, there is another $10-11 trillion in scarce "quality collateral" that has to be injected into the financial markets via central banks collateral transformations, the number in yet another 7 years will be at $20 trillion if not exponentially higher, or higher than where US GDP will be.

The $13 billion bailout in Cyprus is small (in 2011, France and Germany made $80 billion of loans and grants to developing countries) and as JPMorgan's CIO, Michael Cembalest, notes the situation is in many ways unique. However, he warns, the latest melodrama reinforces the inconsistent and chaotic nature of EU policy-making. Bondholders, equity investors, bank depositors and citizens of Europe are at risk of unpredictable outcomes as they play Eurozone Roulette. Here’s where they might land on any given spin...

Long-term growth conditions in Spain, Italy and France are as weak as they have been (other than during wartime) in over a century. The chart below tells the story. As JPMorgan's Michael Cembalest notes, while European sovereign debt spreads have rallied across the board, European bank lending to households and businesses is still declining, and the cost of small business loans in Italy and Spain is higher than both real and nominal growth. With ECB policy now clearly useless given Europe's fragmentation, and with Germany's forward expectations rolling over, it is hard to see how, absent wholesale devaluation and/or inflation (or as Cembalest notes destruction & rebuilding), Europe will recover from this.

Venezuela is a place of severe contradictions. It’s the only country we found that ranked in the top ten regarding improvement in the UN Human Development Index since 2006, and also ranked in the top ten regarding intentional homicides per capita. Usually, these two things do not go together. Similarly, income inequality has been reduced, but has been accompanied by very high inflation. Chavez’ redistribution policies contributed to a large decline in Venezuela’s Gini coefficient since 2002, now the lowest in the region (lower implies less income inequality). However, Venezuela has also experienced the highest inflation in the world over the last 5 years (excluding Zimbabwe, of course), which suggests that Venezuelans have in part been made more equal by having their incomes inflated away. Despite all the challenges, Venezuela’s economic model may well survive given how high oil prices are; but, what no one knows is how much hard currency the government needs to spend to maintain support from the Chavistas.

The people of Spain are prisoners of an economic adjustment that looks like something dreamed up by Torquemada.  A lot of the recent compensation decline had to do with public sector workers (who export nothing) and not private sector ones. Is this a sustainable way to regain competitiveness? Torquemada the Inquisitor would be impressed with the pain that Spain is inflicting on itself. The bad news for Spanish labor markets isn’t over: most measures of Spanish competitiveness show that only half the gap has been closed vs Germany. I don’t see how this can be sustained indefinitely, even with the rally in Spanish sovereign and bank spreads, and with looser fiscal policy sanctioned by the EU. Without a true fiscal transfer union in Europe, caveat emptor in its Periphery, unless prices for stocks, bank loans and real estate are sufficiently cheap.

Europe's dual problems of low growth and weak profit margins combined with this week's vote in Italy are likely to usher in another period of European underperformance, but as JPMorgan's Michael Cembalest notes, that is the least of it as Italy overtook Japan with the worst real GDP growth of all advanced economies since 1991. In fact, other than wartime, the last few years in Italy have been the worst for growth since Italian unification in 1861. But, before the rest of Europe gloats that 'they are not Italy, or Greece', he reminds us that the slowness of French GDP growth in recent years is the slowest in over 80 years. As he warns, all things considered, from an investment standpoint, caution continues to be warranted as problems appear to be taking their toll on EU profitability.

We have long-discussed the growing concerns of a rising level of social unrest in Europe. Our go-to chart has been youth unemployment - and it still reigns supreme as the scariest chart for European leaders (no matter what they publically claim). JPMorgan's Michael Cembalest shares our concern as he opines on the potential for a tear in the social fabric in Europe. While there may be increasing cracks in the social fabric, so far, concrete political manifestations have been limited. Could it be that the social fabric in Europe is stronger than many perceive it to be, and that 'Europeanization' has advanced a lot since 1992? Perhaps; but Michael is equally tempted to believe that Europeans simply recognize the financial and economic dangers of immediate dissolution, and remember the words of Benjamin Franklin: “We must all hang together, or most assuredly we shall all hang separately!”

If there was any debate whether the Fed's policies have helped the economy or just the market (and specifically the Bernanke-targeted Russell 2000), the following two charts will end any and all debate. As the following chart from the St Louis Fed shows, as of the just completed quarter, US GDP "growth" since the "recovery" is now the worst in US history, having just dipped below the heretofore lowest on record.

In many respects, 2012 was a year of waiting: waiting for a path forward on the European debt crisis; waiting for the results of a polarizing U.S. election; waiting for the Chinese leadership transition; waiting for a resolution to the U.S. fiscal cliff issues; waiting for the Middle East to find peace; waiting for a clear path to global growth; and therefore, waiting to invest additional assets in the markets (or not, as the case may be). In this 2013 Outlook, Michael Cembalest, JPMorgan Asset Management's Chairman of Market and Investment Strategy, provides a comprehensive summary of the global factors at play, with a tone of optimism grounded in realism. Perhaps just what we need after the surreality of the last two days.

Credit and equity markets (should they avoid a catalcysmic year-end slump back to reality) are heading for much better results that one might have expected. As JPMorgan's Michael Cembalest somewhat passive aggressively notes, this year looks to be a reward to those who stuck to normal investment allocations despite the macro issues in play, and despite low global economic growth. One way to visualize 2012: the red dot in the chart, which shows global GDP growth and equity market returns each year since 1970. There’s normally a connection between growth and equity returns, with the exception of the dots in the box, which are low-growth equity rallies. If we remove post-recession rallies and rallies based on significant interest-rate declines; what we are left with is the conclusion that 2012 is kind of unique: a low-growth year with double-digit global equity returns not based on a recession rebound or a bond market rally. The only other was 1998. Of course, a huge factor this year was the European rescue. What about 2013?

When Warren Buffett claimed that a lot of secretaries pay higher tax rates than the super-wealthy, JPMorgan's Michael Cembalest wanted to take a closer look, and sure enough Buffett’s assertion is only the case in a minority of situations (like his own). We would therefore not expect to see large revenue estimates from an analysis of the fiscal impact of the proposals in the Fair-Share Act of 2012, since there are not that many people that would be impacted by a minimum 30% effective tax rate. Sure enough, the incremental revenue raised by the Fair-Share Tax Act is around $8 billion per year. This is real money and may be sound public policy, but in the context of a $1 trillion budget deficit expected for FY2013, it’s a rounding error. To convey this zoologically, we show two animals whose volume is proportionally the same (125 to 1): a hippopotamus, and its symbiotic companion, the yellow-billed oxpecker. We would like to think that elected officials and political commentators would avoid grandstanding and not mislead anyone on the fiscal impact of their proposals, but right now, there are some people who need help distinguishing between birds and hippos.

Do not expect any changes to the trends of polarization and party non-conformists is the message from JPMorgan's CIO Michael Cembalest. As he explains moderates like Blue Dog Democrats and Rockefeller Republicans are now artifacts in the Natural History Museum, having given way to their more ideological offspring (through retirement or after having been beaten in primaries). If anything, Cembalest believes the House may become even more partisan after apparent losses by moderates in both parties. After a better than expected night for Democrats given Senate results, the fiscal cliff looms; With the status quo maintained, a divided government goes back to work to solve the Mutually Assured Fiscal Destruction problem. However, electoral results suggest the country is in no mood to address entitlement issues right now, will defer them to another day, and continue to shift towards a high-Federal debt economic model that bears some resemblance to Europe and Japan. In the 1950’s, the solution to 80% Federal debt was not taxation, austerity or inflation, but growth.

Scanning the world, France ranks at or near the top in government transfers to households, vacation times and labor market rigidity, and at or near the bottom in hours worked per week, labor force participation rates and retirement age as a % of life expectancy. As JPMorgan's Michael Cembalest notes, France is a workers's utopia - which is expensive to maintain - and sure enough four out of four of its main economic indicators are accelerating lower since Hollande's 'Deluge' began.

US reliance on oil imports as a share of consumption is gradually declining; but China's, however, is rising and is now higher than the US. As JPMorgan's Michael Cembalest notes, China now has the world's largest new car market and most extensive network of superhighways - which given the lack of a viable, affordable electric car - means fossil fuel consumption is expected to continue to rise. The trends that lead to this inexorable rise have critically important implications for the West in the ongoing containment of Iran's nuclear ambitions. Unfortunately for the West, the prospects for cooperation on sanctions appear dim as the following nine points (on China's relationship with Iran) should make clear.

UPDATE: Nigel Farage 'Must-See' rant on the' destruction of nation state democracy'

The need to convince any and all that will listen (and one's own self) that the Euro project must be preserved at all costs has never been so obviously politicized as the Nobel crony committee 'blessing' the European Union for bringing peace to a continent at war. While a laudable thing of itself, as JPMorgan's Michael Cembalest notes, by 1954, Germany had already become a stable, liberal, democratic society in one of the most amazing transformations in history given what preceded it ten years earlier. Whether the Marshall Plan helped this, it seems indisputable that conditions for a lasting peace in Europe were already in place by 1954. The notion that the Euro is needed to cement these gains appears to be more about the ambition of specific political movements in Europe/Brussels than anything else. The irony of the Nobel Peace Prize for Europe is that as shown below, it comes at a time of rising social stress, extremist politics, and a deterioration of trust in the very union that is supposed to be providing the social cement.