The short answer, I think, is that they’re sitting on their hands.

This is also unusual, in my experience.

We’ve had an immense run in the tech sector, both hardware and software, since early last year, which has left industries like domestic consumer staples in the dust. So one might reasonably expect that, at the very least, simply on a valuation basis, laggards would have their day in the sun–what jargon junkies might call a counter-trend rally. I thought this myself at around this time last year.

In particular, I thought that the administration’s effort to weaken the dollar might make companies with strong domestic brand names and distribution networks attractive acquisition targets for foreign firms seeking to expand their presence here. (This was Warren Buffett’s essential stock market insight, that intangible assets like brands and distribution infrastructure were worth their weight in gold. but appeared in company financials only as expenses.)

Neither has happened.

The reason for the first is pretty straightforward–shrinking the workforce, raising the price of imported raw materials and attacking the education system isn’t exactly a recipe for economic growth–nor is the lack of any opposition to the administration’s actions.

The second is less clear. ICE killings and imprisonments can’t be a plus. Nor can the amateur-hour (my view) conduct of the attack on Iran. But clearly potential buyers think the risk of acting now outweighs any potential reward.

As it turns out, I went back to school almost a decade ago in an MFA program for photo/video at SVA. The program, which has depended on foreign students (mostly from China) for over half its enrollment, is shutting down. The same is happening for iconic photography programs across the country. The reason is that foreigners are no longer coming here. I imagine the reason is some combination of fear of violence or imprisonment and the stigma of having an American degree.

There’s an interesting article in today’s Financial Times about US bank stocks. It’s about the banks’ private credit operations, but it also bears on the administration’s misguided (in my view) campaign to replace quarterly reporting with semi-annual reports.

Rightly or wrongly, I think of private credit as an expansion of the well-established practice of manufacturing companies factoring receivables.

Let’s say my company makes t-shirts. I buy cloth from a supplier who gives me 30 days to pay them. I make the shirts instantly and send them to a mass merchant who will only take them if I give it 90 days to pay me.

For one thing, this shows that I don’t have much market power. If the terms were reversed–the retailer pays me in 30 days and I only pay the contract manufacturer after 90–I’d be up to my ears in cash equal to 60 days worth of sales. But I’m in the opposite situation, with a perennial cash deficit.

How do I deal with this shortfall? Typically, I take out a short-term loan, using my receivables as collateral.

That kind of lending is basically what private credit does.

The blowup of auto parts supplier First Brands, which was in the negative working capital situation I described above, and which massively defaulted on its short-term loans, revealed to the investment world at large how gigantic the private credit market had become …and now risky it might turn out to be.

Given the opacity of the private credit market, and perhaps memories of the banking crisis of 2008 or the implosion of Long Term Capital ten years earlier, managements of the major commercial banks observed their PE ratios beginning to contract as investors began to worry about potential exposure to private credit.

The banks’ response has been to voluntarily increase disclosure, as a way of countering this PE erosion. According to the FT, this strategy is working.

I think this makes perfect sense. Less disclosure = higher risk = lower PE ratios in response.

But it’s also what I think can happen if the administration proceeds with plans to dilute disclosure requirements for all US-traded companies.

I’ve been dancing around the pension issue for public employees in various states, including my home state of New Jersey, for some time. I use California as a barometer because it’s a big state and has lots of public disclosure about its pension situation.

To my mind, state workers tend to get lowish salaries, but relatively high pension benefits. And they tend to have defined benefit (rather than defined contribution) pension plans, meaning that on retirement they get a clearly stated annual payment, usually a percentage of salary, for as long as they live.

My observation is that, ex the federal government, public pension plans tend to be underfunded. This is not the house-on-fire issue that a privately held company would be facing. That’s because the state government has the power to raise taxes to cover any shortfall. This, of course, would not be great for the reelection prospects for anyone who employed this measure.

There’s also the issue that the stock market–arguably the source of the best long-term returns–has a tendency to raise and fall with the national economy. The traditional formula has been that returns are linked to the presidential election cycle, with 2 1/2 years of up and 1 1/2 years of down (or at best sideways).

This means that there will be times when even a well-funded pension plan will look like it’s in trouble.

Hence the appeal of private equity, which promises both extra-high returns and, because the investment aren’t publicly traded, no reflection in pricing to the occasional bad moods of Mr. Market.

There is a tradeoff for this apparent stability, as there is for any financial endeavor. In this case, there are two: high fees, and pricing is done, in effect, by the purveyor of the investment services.

So a headline in this morning’s New York Times really caught my eye: Private Equity is Stuck with 33,575 Unsold Businesses.

Hard to know how widespread this issue is or how defined benefit plans will deal with it. To my mind, it argues for a higher future allocation of funds to public markets.

This is a stock guy’s perspective, and although I’ve been heavily involved in Asian stock markets in general, and Japan’s in particular, I’m not a fixed income expert.

Having written that, my understanding is this:

the simplest case

–the Japanese 10-year government bond yields 2.8%. The comparable US Treasury yields 4.6%. That’s a 160 basis point yearly difference. Why not, then, sell Treasuries, use the money to buy JGBs and enjoy the yield pickup? If we had all done this in early 2023, however, the spread would have been between 3.4% on Treasuries and less than 0.5% for JGBs.

In addition, the dollar value of the yen has fallen from about 115 to the dollar to almost 160–something like a 30% slide. Anyone who shorted JGBs three years or so ago has picked up 5%+ on the interest rate differential plus almost a third on the yen’s decline.

but why stay simple?

…that is, why not short the JGB and buy, say, stock in Nvidia? If you did that in early 2023, you’d have made 10x your money on the stock selection, while only needing to buy back yen worth 70% of your initial loan.

The US has recently enter the forex market along with the Japanese central bank to try to prop up a sagging yen. Interestingly, the Financial Times has written that the US has not sold dollars to buy yen but has used euros held by the Fed instead. Assuming, as I do, that the FT is correct (after all, it is owned by a powerful Japanese media conglomerate), I think this means that Washington fears that dollar-based entities, like hedge funds or private equity, have done enough of this that triggering an unwind could get ugly pretty quickly. Ugly here means large-scale selling of dollar-denominated instruments like Treasuries or publicly listed domestic equities and buying yen with the proceeds. This, of course, would not be in the same league as starting a war in Iran without doing a routine ammunition check, or ICE killing citizens, or shrinking the workforce through arrests and deportations. But starting a steep stock market decline would still be very visible, as well as another sign that Washington today isn’t chock full of the best and the brightest.

I’ve just updated my Keeping Score page for market results during July.

Overall, the Energy sector was up strongly, as Iran continues to outthink the Washington high command in the latter’s attempt to destroy Iran’s nuclear program and/or seize control over oil coming out of the Middle East.

On the other hand, the IT sector fell to the bottom of the pile, as its main constituents showed both sharp up and equally sharp down momentum during the month. July was also marked by the collapse of a highly leveraged investment fund, Situational Awareness. Focused on AI, SA was apparently unable to meet margin calls during last month’s ups and downs among IT sector names.