Michael Cembalest’s 49-page 2025 outlook, The Alchemists,1 reads like an economic autopsy on policy experimentation. With a flair for dissecting the complex, Cembalest, Chairman of Market and Investment Strategy at J.P. Morgan Asset Management, sets a tone that’s both provocative and data-driven. This year's edition is unapologetically bold, presenting a wide-ranging exploration of deregulation, tariffs, energy policy, AI, and geopolitical traps. Here’s an elaborate take on the seven themes that define his report.
Economic Experimentation Through Tariffs and Tax Cuts
Cembalest paints a sobering picture of tariff-led economic experimentation, noting a reversion to a “1930s revenue mix.” As he explains, “a universal 10% tariff coupled with a 60% levy on China” could reduce global GDP by 1.2% while pushing inflation upward by 0.9%. Tariffs, once tools of protectionism, have morphed into instruments of economic warfare. Yet their consequences are far from neutral. Historical parallels to the 1920s’ and 1930s’ tariffs show diminished trade volumes and stagnated manufacturing employment.
Cembalest critiques the U.S. for wielding these measures with minimal foresight. The strategy of incentivizing foreign investment into the U.S. by deploying trade barriers could “undermine long-term competitiveness,” he warns. The risks are compounded when retaliatory measures, such as China's export bans on rare earths, destabilize global supply chains.
The Deregulation Conundrum
In one of the report’s standout sections, Cembalest argues that deregulation holds promise but is fraught with contradictions. While he cites “historical evidence correlating lower regulation with higher productivity,” he tempers optimism with realism: excessive deregulation risks eroding institutional stability. Examples include the energy sector, where the Biden administration’s subsidies for renewables met resistance from fossil fuel advocates. “The Alchemists appear keen to break something,” Cembalest writes, hinting at deregulation’s destabilizing potential.
AI: The Golden Goose and its Risks
Few sections encapsulate 2025’s economic zeitgeist like AI adoption. Describing AI as a “golden goose,” Cembalest underscores its transformative promise while cautioning against overreach. NVIDIA’s estimated 2026 revenue would rival 20th-century tech peaks, but the report questions whether hyperscalers like Google and Microsoft can sustain capital-intensive AI infrastructure.
“AI’s promise lies in efficiency gains,” he states, yet warns of financial fragility. Historical comparisons—Corning’s fiber optics after the dot-com collapse—offer a chilling reminder: overinvestment can haunt even the most promising sectors.
Energy Policy and Supply Constraints
On energy, Cembalest’s insights are unflinching. Despite high oil and gas production levels, “the inflationary consequences of energy mismanagement” linger. Renewable subsidies, while commendable, haven’t counterbalanced reliance on fossil fuels. The broader question is whether U.S. energy policy—anchored in deregulation and incremental production—can stabilize prices without exacerbating environmental concerns.
Geopolitics: Navigating the China Traps
China looms large in The Alchemists. Cembalest explores two traps: the liquidity trap—where China’s economic deceleration limits global spillovers—and the Thucydides trap, signaling potential U.S.-China military escalation. He emphasizes, “Trade deficits obscure the magnitude of in-country business conducted by U.S. firms in China,” a subtle critique of oversimplified narratives. Retaliatory trade policies—such as gallium and germanium export bans—reveal China’s leverage in critical supply chains.
Fiscal Policy: The Deficit Dilemma
Budgetary imbalance underpins Cembalest’s broader thesis on fiscal irresponsibility. With entitlement programs and interest payments forecasted to outpace federal revenues within a decade, the “deficit time bomb” ticks louder. Even the short-term relief of tax cuts could exacerbate systemic fragility. “The Alchemists’ fiscal agenda leaves little margin for error,” he concludes.
Equity Markets: Valuation at a Crossroads
Finally, Cembalest scrutinizes equity markets, where valuations teeter on unsustainable levels. He notes that the S&P 500 delivered two consecutive years of 20%+ returns, a phenomenon historically rare outside of the 1990s bull run. Yet 2025 could see a 10-15% correction. His takeaway? “Investors must balance liquidity with exposure to a market that offers little room for miscalculation.”
The core takeaway for investors is the importance of diversification amid heightened economic uncertainty. Cembalest emphasizes, “Traditional equity and fixed income allocations have faced their stiffest tests in recent years, compelling a reexamination of portfolio resilience.”
He underscores the importance of alternatives, noting that real assets and private markets have demonstrated superior risk-adjusted returns in turbulent periods. “Private equity, infrastructure, and real estate provide a ballast against inflationary pressures while offering uncorrelated returns,” he explains.
Cembalest also cautions against complacency in fixed income markets. While bonds have regained some allure following rate hikes, he warns, “The yield curve inversion remains a flashing recession signal, suggesting caution in overloading duration-heavy portfolios.”
Conclusion: A Cautionary Blueprint
The Alchemists is not just a report; it’s a cautionary tale. Cembalest’s analysis reveals an intricate web of opportunities and risks, where policy missteps could unravel fragile recoveries. His direct and incisive quotes add weight to each theme, ensuring readers grasp the stakes:
- “Tariffs are inflationary by design; their economic cost far outweighs their perceived benefit.”
- “Deregulation can unlock growth, but at the expense of systemic safeguards.”
- “AI adoption is not a guarantee of success; it’s an expensive gamble that could backfire.”
Investors, policymakers, and corporate leaders alike would do well to heed Cembalest’s insights—and tread carefully into 2025.
Copyright © AdvisorAnalyst, JP Morgan
