J.P. Morgan Asset Management’s Michael Cembalest calls them “Alchemists” — the Trump White House nominees who are looking to dramatically alter the U.S. economy. The upshot, he predicts, will be a 10 to 15 percent correction in the stock market in 2025 “as the Alchemists apply their elixirs.”
“Policies and statements from Trump nominees (both cabinet-level and those not requiring Senate confirmation) indicate that the Alchemists aim to ‘break’ something, whether it’s globalization, the Federal bureaucracy, the IRS, the FBI, Medicare, US vaccine policy, lax US border policies, its “Deep State” opponents or something else,” said Cembalest, chairman of market and investment strategy for J.P. Morgan Asset Management.
“Whatever the goals, I take the Alchemists at their word: they are going to break something, I just don’t know what,” he said in his much-anticipated annual outlook. “Deregulation, deportations, tariffs, tax cuts, cost cutting, crypto, oil & gas, medical freedom and Agency purges: What could possibly go wrong?” (Mary Callahan Erdoes, CEO of J.P. Morgan Asset and Wealth Management, said in a letter to clients that “as always, this edition is full of deep thinking and controversial perspectives… and it is one of his best ever.”)
The impact on markets, which so far have largely reacted positively to the Trump plans, could be substantial. Cembalest noted that there’s “little room for error with valuations this high … since valuations are now driving markets just as much as earnings growth.”
The S&P 500 gained more than 20 percent during each of the past two years — something that has happened only ten times since 1871. The most recent period such lofty returns lasted for another two years was during the 1990s. Still, Cembalest is not entirely a pessimist: “U.S. equity markets should end the year higher than they began but be sure to have plenty of liquidity to take advantage of what might be a volatile year,” he said.
For one, Cembalest said that tariffs could be inflationary, as they were in 2018, and that border controls and deportations could reduce the labor supply, with the combination “driving consumer price inflation higher again.”
On the flip side, the question he posed is whether potential inflationary shocks of a tighter labor supply and tariffs could be offset “with a positive productivity shock from deregulation, which would be consistent with evidence that less regulation is correlated with higher productivity.”
Cembalest also raised the possibility that the efforts to cut government expenditures may not offset the tax cuts Trump hopes to pass.
Indeed, he mocked the efforts of Elon Musk and Vivek Ramaswamy to slash the bureaucracy through the newly created Department of Government Efficiency, or DOGE, calling it “DOGE Quixote.”
“Within federal workers, the largest employer is the Department of Defense (excluding active military) followed by the Postal Service and Veterans Affairs. As for agencies in DOGE crosshairs: the Environmental Protection Agency, the Securities and Exchange Commission, and the Department of Labor when combined account for less than 1 percent of federal workers, while the Department of Education accounts for just 0.14 percent, he said.
Meanwhile nondefense discretionary spending has been cut to its lowest level in decades and entitlements are a “political third rail,” while “attempts to eliminate agencies or their related functions, or to refuse to spend their appropriations, would generally be subject to substantial legal challenges,” he said.
Cembalest predicted that DOGE cost cuts will be $150 billion or less. That comes to only 2 percent of fiscal year 2024 federal government spending.
The ultimate barometer of the Trump plans will be the 10-year Treasury, according to Cembalest. “If the supply side benefits from deregulation and tax cuts overpower the inflationary impacts of tariffs, a shrinking labor supply and large budget deficits, the 10-year Treasury should remain in the range of 4.5 percent to 5.0 percent. But if the 10-year rises meaningfully above 5.0 percent and stays there, something will have gone very wrong,” he said.
“Investors are inclined to give the Alchemists the benefit of the doubt that this will all work out, and very tight supply conditions of U.S. equity markets argue in their favor,” he added. “But the Alchemists don’t have much room for error given the expensiveness of most U.S. financial markets.”
Cembalest has a good track record with his predictions, as laid out in his “Eye on the Market” commentary. He nailed six of his top ten predictions from 2024. President Biden’s withdrawal from the presidential race, a big antitrust case win for the Department of Justice and the Federal Trade Commission, a comeback for U.S. regional banks, and a continuation of the Russian invasion of Ukraine “with no ceasefire in 2024.”
However, he erred in his 2024 prediction that syndicated leveraged loan losses would rise above private credit losses for the first time. Instead, the rates are similar, at around 2 percent. Moreover, he noted that market data shows lower recoveries for private credit defaults than for leveraged loan defaults “which contradicts my (possibly mistaken) belief that covenant protections would result in the opposite outcome.”
This year, Cembalest is also predicting that hedge funds will outperform stock-market benchmarks, renewables will underperform, and Japan will outperform China. He also believes that at least three Senate-confirmed Trump-appointed members of his Cabinet and some agencies “will be gone by the end of the year.”
