JPMorgan’s Playbook for a 10-15% Correction (or Worse) — ft. Michael Cembalest

Key Takeaways

J.P. Morgan's portfolios are defensively positioned, with 30-40% allocated to cash and diversified assets.
The AI build-out significantly contributes to U.S. GDP growth, raising concerns about market fragility without it.
A 10-15% profit-taking market correction is anticipated for 2026, with a 40% drawdown considered a major risk.
Key risks for 2026 include power constraints, China's AI advancements, Taiwan's geopolitical status, and potential investor profit-taking from AI.
Investment strategy for large capital involves adjusting portfolio risk profiles towards more defensive positions.

Observations indicate a market sentiment where 'cash is trash' and stocks appear attractive, suggesting a potential shift.
Professor Aswath DeModeran presented a bearish outlook, suggesting overvaluation across the stock market and predicting a 40% correction in the MAG 10.
Michael Cembalest questioned academic predictions versus actual money managers, citing Berkshire Hathaway's cash stockpile as a better indicator of caution.
Cembalest expressed skepticism about a 40% correction in the MAG 7, noting corrections can be triggered by profit-taking.

75% of revenues, profits, and capital spending since November 2022 originate from 40 AI-related stocks.
Meta's announcement of spending 65-70% of revenues on R&D for AI is considered concerning.
Projected 2025 tech capital spending rivals the combined scale of historical infrastructure projects like the moon landing and Hoover Dam.
U.S. GDP growth would be only 1% without the tech AI build-out, which has effectively supported the public sector.

A past prediction of a 15-20% market correction within 50 days of the Trump inauguration is recalled.
A potential 10-15% profit-taking correction is expected in 2026.
A larger 40% drawdown is considered a more significant risk for asset allocators.
The conversation discusses underwriting discipline in private credit and data center financing, noting significant risk being taken by entities like Blue Owl.

Concern was raised about potential government intervention to support companies driving the AI boom.
J.P. Morgan CEO Jamie Dimon's strategy includes deals with MP Materials and Intel under industrial policy to rescue supply chains.
The MP Materials deal is defended as providing a price floor for critical minerals needed by the U.S. military.
Intervention in Intel is seen as a cash infusion for a company whose primary issue is not funding, with anticipated further administration intervention.

Amid fully valued markets, the recommendation is to adjust portfolio risk profiles from balanced to conservative or growth to balanced.
Healthcare is noted as historically cheap relative to itself and the market, offering better risk-reward.
Tech sector, even before the AI boom, demonstrated higher margins and capital efficiency compared to other market sectors.
The current equity risk premium of around 3.7% is compared to historical highs during the dot-com bubble.

Scott Galloway theorizes that AI adoption could lead to 10 million annual job disruptions or a halving of AI company valuations.
Current AI valuations are based on unproven incremental revenue assumptions, rather than just efficiency gains.
Michael Cembalest references studies showing rising unemployment for college graduates due to AI, contrasting with some industry narratives.
There is a noted scarcity of data on actual business revenue, profit, and productivity consequences of generative AI adoption by hyperscalers.

China is diversifying away from the U.S., with exports to the U.S. decreasing from 24% to 17%.
China may retaliate through a government-sponsored AI dumping strategy to gain geopolitical advantage.
Huawei is developing a chip cluster expected to match NVIDIA's performance, using more chips to compensate for lower individual power.
Taiwan's position is identified as a third major risk, with China's reduced reliance on Taiwanese chip output potentially escalating tensions.

The Federal Reserve faces a conflict between rising 'prices paid' and falling labor indicators in PMI surveys.
Historically, the Fed has not cut rates when prices paid are increasing, yet markets anticipate cuts by early next year.
Immigration policy is presented as a potentially greater inflationary risk than tariffs, as a tight labor market could lead to wage inflation.
The Supreme Court's potential ruling on tariffs could reduce effective tariff rates from 15% to 7%.

For regular investors dollar-cost averaging into the market, the advice is to accumulate cash ('dry powder') to capitalize on potential sell-offs.
Market corrections are often V-shaped, with rapid declines followed by swift recoveries, giving individual investors an advantage.
The 'bold case' for 2026 includes increased AI adoption leading to productivity gains and a Fed-vindicated inflation decrease.