this is more random-ish thoughts than a coherent thesis, but. for what it’s worth…

bonds

–the current administration believes generally in the “trickle-down” economics of Ronald Reagan and Margaret Thatcher–that is, the idea that if the government puts more money in the hands of the ultra-wealthy, their extra spending will create a ripple effect that makes the entire population better off. So, the key piece of legislation for the administration is to extend the temporary individual tax cuts for the wealthy that were enacted during the first Trump term. Letting them expire would bring in about $350 billion a year to the federal government. That’s a lot, especially because…

government spending

…overall, Washington is spending about $2 trillion more each year than it takes in. It borrows the difference. At present, the central government has about $30 trillion in Treasury bonds outstanding, which is about the same as the GDP the country generates yearly. About a third of that is held by foreigners, including foreign central banks.

…GDP is growing at something less than 3%. Outstanding government debt is expanding at about twice that. At some point, probably not today, holders and potential buyers–especially foreigners–will begin to worry about whether they’re going to be paid back. So reducing deficit spending is a legitimate government concern.

Washington’s largest two sources of income by far are individual income taxes and payroll taxes (FICA). The biggest outlays are for Social Security, Medicare and Medicaid.

Balancing the budget without reducing spending would require something like doubling individual income taxes.

Hence, DOGE.

foreign holdings of Treasuries

Of the $30 trillion, about $8 trillion is held by foreigners, the largest amounts being $1.1 trillion in Japan, $760 billion in China (which is apparently selling) and $740 billion in the UK. Arguably–and also in fact, I think–foreign hands are weaker holders than domestic.

leveraged holders

I think this is a major worry. Think Archegos and Long Term Capital Management. In both cases, the firms were doing relatively straightforward arbitrage, but in highly illiquid markets and without any of their (many) their lenders able to assess the overall risk the firms were taking.

At least part of the bond market ructions this week seem to me to be based on fears of other similar implosions in the private equity sphere.

more on Monday

–One old-time, but still useful, definition is that the bear market ends when the last bull capitulates. I understand capitulation to mean shifting one’s holdings from stocks whose attraction is the possibility of large gains to ones whose charm is that they won’t go down much. Another way of looking at this is that the shift is from growth stocks which are bought because of the possibility for large future earnings gains to value stocks, whose attraction is that they are trading at substantial discounts to the assets already on the balance sheet.

Another aspect of this relates to financial leverage, meaning that there’s a whole class of professional investors who make much of their gains by borrowing large amounts of money–from domestic banks or abroad–to invest in ways they think will cover their interest costs and substantially more than that. In a down market, this equation reverses itself, with borrowers dismantling the debt/equity structures they have built. This process is in its early days, suggesting that for such speculators, more pain is still in front of them. This unwinding exerts downward pressure on the markets in general.

–Historically, the US stock market has been the most important leading indicator of domestic economic activity. It has tended to signal the ups and downs of GDP by about six months. My picture of why: new orders are coming into your firm for the first time in, say, a year. The personnel department lets line managers know they should be on the lookout for new workers to hire. Or, the CEO has a new spring in his step, whistles in the elevator (which he only does when sales are rising) and is booking a vacation for his/her family at Disney World or Universal Studios. This gets around relatively quickly–and people interested in the stock market begin to buy.

We’re nowhere near there yet, as I see it. In fact, we’re in the opposite position. We’ve had exceptionally good gains in 2023 and 2024. So we were arguably due for a breather. More important, the current administration seems to be hell bent on delivering a new version of the 1930s to the US.

setting the stage

It is about Trump …and it isn’t.

Trump’s greatest success–by far–is having been elected president of the US, twice. In the non-government world, his highest achievement, as I see it, is having played the role of a successful businessman on The Apprentice, a reality show. His record as an actual businessman is not as stellar. His most visible real estate venture is his casino venture in Atlantic City. The details aren’t pretty, especially for shareholders who lost everything in bankruptcy. As the New York Times put it:

“…even as his companies did poorly, Mr. Trump did well. He put up little of his own money, shifted personal debts to the casinos and collected millions of dollars in salary, bonuses and other payments. The burden of his failures fell on investors and others who had bet on his business acumen.”

During his first term, Trump’s policy of covid denial resulted in something like a half-million unnecessary deaths, according to Forbes. After he lost the subsequent election, he attempted, through a violent attack on the Capitol, to overthrow the legitimate government and reinstall himself as president. He also appears to be heavily economically reliant on Saudi Arabia (the Liv Tour and Jarrod’s management of $2 billion of Saudi money despite his lack investment experience (as noted by Saudi government investment professionals). Critics have pointed out his apparent devotion to Russia’s Putin.

On the other hand, in the face of all this Trump was still reelected as president last November. By its silence, Congress is ignoring his apparent cognitive decline, his plan to impose tariffs higher than those that caused the Great Depression of the 1930s, and the intentional cruelty of the administration’s treatment in deporting migrant workers.

Also, the Democrats were unable to nominate someone able to defeat what I view as a deeply flawed Republican candidate.

where to from here?

Ytd, MSCI EAFE, the standard for non-US, developed world stock markets, is down by about 2%

The S&P 500, in contrast, is down by about 14%. NASDAQ and the small-cap Russell 2000 (mostly US-centric companies, in contrast to the other two) are both down by around 20%.

The spread between EAFE and the R2000 expanded relatively steadily until about three weeks ago. During the swoon caused by Trump’s tariff threats, coupled with the apparent lack of thinking behind them and Trump’s apparent cognitive decline, all the indices have plunged. But the spread between EAFE and the R2000 remains at about 20 percentage points. In other words, the world economy is in a worse place with tariffs, but everyone is going to suffer relatively equally.

more tomorrow

trigger vs. cause

Sometimes it makes sense to distinguish between the event that triggers a selloff and the (more important) underlying causes that were lurking below the surface waiting for an inciting event to be unleashed.

In this case, the trigger is Trump’s announcements of widespread tariffs on imports. the kind of thing that caused the Great Depression of the 1930s. As I see it, the causes are:

–the least important, the fact that the US stock market had posted 20%+ gains for two years in a row

–the tariffs themselves

–the observation by notable economists that the structure of the tariffs corresponds to what a Chat GDP query would have suggested, rather than being the result of deep thought and knowledge of economics

–Trump’s erratic behavior after the announcement, which suggests substantial cognitive decline that is being covered up. Perhaps the most disturbing of all,

–the tacit approval of Republican congresspeople for measures that will most likely result in slower economic growth and accelerating inflation.

what to do

…better said, “What I’m doing.”

–I’m an aggressive investor, so I’m relatively comfortable having holdings that are substantially different from the structure of the S&P 500. I’m not doing anything to change that structure, but if I were I’d be moving closer to the index

–I’m shopping around. At times like this, everything goes down. Often, strong companies that have made large gains fall the most. So this is a chance to upgrade the portfolio by selling clunkers or somewhat iffy holdings to buy names that I really like but have thought were too expensive before the selloff began. I’ve also been making my portfolio more defensive for six months or so. I’m now trying to reverse that positioning a bit.

I’ve updated my Keeping Score page for these two sets of S&P 500 data. The most striking thing about the quarter, to my mind, is that it was the worst quarter of underperformance of the S&P vs the MSCI
EAFE (Europe, Australia and the Far East) index during the past 30+ years.