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FEMALE VOICE: 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.
MR. MICHAEL CEMBALEST: Good morning, this is late September Eye on the Market. This one’s called Arrested Development for reasons we will discuss. There are three topics I want to go through this time. One is on markets and the Citrix canary. The second topic is labor markets, the Fed, and if second chance policies for those people with criminal histories can expand the labor force. And then lastly, a brief COVID update.
So, on markets and Citrix and high yield and everything, I wrote in our Labor Day piece that we had expected the S&P to retest the June lows; now we’re there. Equity markets have been very slow to digest the path of policy rates, which continue to rise. It’s almost like people didn’t take Powell at his word, and Powell was extremely slow to recognize what was unfolding in front of him. Amazing that the Fed barely had forecast any rate increases a year ago, even though we had very tight labor markets and commodity prices were skyrocketing.
So you have the additional headwinds from Europe’s energy mess, China’s real estate collapse, its zero-COVID policy, et cetera. So more broadly, as we show in here, we’re emerging from this weird decade where the pricing on risky assets was very high relative to the pricing of cash and cash equivalents. And now that that gap is closing and renormalizing, that argues for lower valuations on a lot of different things. So we don’t think there’s a deep US recession coming, particularly given the strength of consumer balance sheets. But we think that better entry points on equities probably still lay head sometime between now and next spring, when the fund rate peaks.
Now on the Citrix deal, which a lot of you probably read about, the senior notes were originally underwritten a few months ago at 6.5. They got placed at 10, and the underwriters still reportedly held all of the second-lien Citrix notes, which had initial underwriting levels of 8.5, and nobody really knows where those would’ve been placed because they weren’t placed. And Citrix was reportedly one of the better deals in the pipeline. What comes next is Twitter and Nielsen, Tegna, Tenneco, all of which are lower rated and/or more cyclical than Citrix. So given while there’s been a lot of repricing in the equity market so far, the selloff in high yield and leveraged loan has been pretty modest. And Citrix, this Citrix deal and the next couple may be telling us something more about how much assets will reprice here.
We’ve got some charts in here on leading indicators for earnings, which are falling. They’re not dropping off a cliff, but obviously they’re declining as the economy gets weaker. And there is some evidence that positioning and sentiment are very bearish, and some valuations already price in a lot of bad news. And China banks are trading at less than half of book value. The P/E ratio on European equities is getting pretty close to the 2012 debt crisis lows and then all that kind of Metaverse, Fintech, hydrogen, SPAC nonsense stuff is down 50 to 80% from its peak. But right now, all eyes are on the Fed and a rapidly vanishing window for a soft landing. And that’s what we’re going to discuss next, as it relates to the Fed and the labor markets.
So a lot of clients are asking why in the world, with the Fed tightened into a weakening global economy. That’s a good question. But the risk of wage price spirals apparently worries them even more. The Fed’s under the gun here. The monthly job-fill rate has collapsed, right. That’s the percentage of open jobs that get filled each month. There’s a measure you can look at that looks at the ratio of employment plus job openings to the size of the labor force. So there’s a lot more jobs than there are workers right now. And that that number is close to the highest level we’ve seen in decades. People that switch jobs are earning a big premium relative to those who stay put. And then there’s a whole bunch of academic research coming out, citing labor markets as being responsible for the bulk of the increase in CPI. The latest NARO [phonetic] estimate from one of the other papers is 6%, which is one of the highest estimates we’ve seen in a long time.
And so it’s hard to increase the labor supply. Birth rates are stagnant, immigration is just beginning to pick up, and it’s difficult to lower all those retired people back into the workforce. I think two-and-a-half times the number of people retired over the last couple of years compared to prior pre-COVID trends. And so unless the labor supply picks up, the wage price spirals could become a risk for the Fed. And that’s why they may see themselves as being forced to crush the economy to get that labor supply number and labor inflation back to normal. And as we discussed last time, the labor force participation rate is already back to normal for 25 to 54-year-olds. It’s very depressed for those over 54.
So there’s a section in this piece, and I’m not going to go into too much detail ‘cause you kind of have to read it to see what we’re getting at, but there is a potential pool of underutilized labor in the form of people with criminal arrest records, a lot of whom are never convicted for serious crimes or incarcerated. And this is something that J.P. Morgan has done a lot of work on as a firm and with other members of the Business Coalition.
And in general, clean slate procedures refer to things that ease the paths to employment. It can be things like having your arrest records automatically expunged if you remain arrest-free for a certain period, something called ban the box approaches, which would require private employers to not ask about criminal records until after they’ve had the chance to interview or after they’ve been made a conditional offer of employment. The FDIC can do more to allow our banks to hire individuals with minor criminal offenses until recently that required written waivers.
I think more can be done in terms of preventing unpaid court debts from being able to clear your arrest record. In almost every jurisdiction, any outstanding fines and fees and things like that can be a barrier to having your record clear. And then in some states, they don’t allow for clearing of felony convictions at all, despite the number of years that you might be crime-free.
And to think about why this is important, and when I started looking at this, I didn’t think this was going to be this important and I found these numbers kind of shocking, one-third of all working-age adults in the US have a criminal record, which is again kind of shocking to me. And obviously that’s going to impair their ability to get a job, even though most of these people have not committed what you and I would consider to be a serious crime, and even after the rest of them who did commit serious crimes fulfill their justice system obligations.
And another study, and I spoke to someone from the Rand Institute who worked on this, almost two-thirds of all unemployed males who are currently unemployed today between the ages of 30 and 38 had been arrested at least once. And so again, it points to the fact that there could be, amongst this population of people that had been arrested, barriers to employment that are worth thinking about. And with respect to drug arrests, 70 to 80% of them historically have been for possession rather than manufacturing.
And then as you all probably know, the US has a higher, the highest rate of incarceration in the world, above places like Rwanda and Turkmenistan. So there’s a large pool of people here who could potentially benefit. And the US also has one of the lowest male labor force participation rates in the entire OECD. And again, that’s another sign that we’ve got people missing from the workforce, and some of these second chance policies have the potential to really help on this front.
The last topic for this week’s piece is a brief COVID update. I haven’t talked to you or written to you about COVID in a little while, and I wanted to just give an update on the bivalent vaccines, the inhalable vaccines, and preventable deaths. So as we all know, based on how transmissible omicron is, the vaccines are no longer very effective in terms of preventing infection and transmission. Those efficacy rates have dropped below 50%, and that’s in particular, after four to six months.
However, studies focused on people aged 50 and 60 and above, a cohort that I care a lot about, still show very large declines in mortality and hospitalization risk from a fourth shot compared to either two or three shots. So there’s a lot of research here showing the benefits in terms of mortality and hospitalization risk, even if it’s hard to prevent infection transmission.
The other thing that’s interesting is that a lot of the studies showing the risk of unvaccinated people versus vaccinated people ending up in the hospital or dying, is that a lot of the unvaccinated people have already been infected. So to the extent that those rates for unvaccinated people look bad, it now tells us that infection-induced immunity is not nearly as strong as immunity that’s acquired from vaccines.
So there are these new bivalent mRNA vaccines available. Bivalent simply means they’ve been engineered to work against two different strains, the original strain and omicron BA 4 and 5. There’s not a lot of hard data on efficacy yet for these new vaccines. The decision to move forward with them was based on the results of some prior vaccines and some lab data on this new vaccine from mice. So efficacy data should be rolling out in the weeks ahead.
But looking forward, what the world really needs, and we’ve all obviously been reading about this a lot, is something that does a better job on infection and transmission. And there is a new report from the New England Journal of Medicine indicating that that nasal mucosal antibodies are what may be needed to really block infection and transmission, ‘cause that’s where pathogens, airborne pathogens, are first introduced into the body.
A bunch of companies are working on this. Take for what it’s worth, China improved its first inhalable COVID vaccine, and I can understand why people would have concerns about the data there. But according to what they’ve reported, their trial show a better immune response from two injectable vaccines plus an inhalable booster, than from a regimen of three shots. They also claim the inhalable vaccine needs a lot less viral material to be affected.
And what I think is interesting and important is that India’s biotech approved its own inhalable vaccine, which it developed in very close conjunction with researchers at the Washington University of St Louis. So that has an imprimatur that I feel much better about. And I think in the future, the inhaled vaccines are going to be used in tandem with the injected ones. You still need the injected vaccines to produce antibodies in your bloodstream and internal organs in case the nasal vaccine defenses fail.
So that’s a brief COVID update. Thank you very much for listening. I’m very proud of Jamie’s testimony last week, particularly as it relates to energy topics. And for those of you that read the Eye on the Market annual energy paper, you will understand why. Thank you for listening, and I’ll talk to you next time, bye.
FEMALE VOICE: Michael Cembalest’s Eye on the Market offers a unique perspective on the economy, current events, markets and investment portfolios, and is a production of J.P. Morgan Asset and Wealth Management. Michael Cembalest 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 J.P. Morgan representative. If you’d 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 J.P. Morgan Institutional Investments Incorporated. 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.
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