I’ve just updated my Keeping Score page for 2Q and ytd. Note the explosion upward in the IT and Communication Services sectors in Q2.

So far this year, the strategy of avoiding the stocks of companies dependent on the US market, while embracing tech and smaller growth companies in the US has worked shockingly well. I see no reason for change other than price.

I’ve also been thinking that Xi has embraced his inner Deng, just as Trump seems to have seized on his inner Xi–and that it may be time to back “socialism with Chinese characteristics,” assuming it has come back from the dead. This despite my worries about the accuracy of mainland financials and Xi’s (really stupid) destruction of Hong Kong as a source of reliable financial information. In this I’ve been, as they say, “early,” which typically means “wrong, but unwilling to fact facts yet.” Nevertheless, I think something’s there.

To my mind, a lot of securities analysis is about making up stories and then testing to see if they have any obvious explanatory value. So…

US GDP was $28.3 trillion in 2024. Imported stuff amounted to $3.4 trillion, or about 12% of GDP. GDP grew by 2.8% real in 2024 and–ex-tariffs–had been expected to do the same in 2025.

GDP growth

The internet tells me the workforce is about 168 million (pre-deportations by ICE, which intends to shave that figure by around one million per year). About one third of the people of working age in the US are either not working or not seeking work, so the number of people with actual jobs is more like 110 million. Ex immigrants, which make up about 20% of workers, the workforce is expanding by about 0.4% per annum as children born to citizens begin to work. That total is something under half a million.

So…

–if ICE is effective in deporting a million people a year, its activity appears to me to effectively shrink the number of workers in domestic industry by about 0.5% yearly

–this leaves productivity gains as the sole source of GDP growth. These come from better tools or better-educated employees. Given the administration attack on science teaching at the school level and its threats to major research universities (three prominent fascism researchers from Yale have already fled to Canada–plus more academics I’m unaware of?), I’d need long odds to bet on it either.

The conclusion I come to is that the government book-burning and its attack on Pride and intellectuals/ artists of all stripes is worse for the overall economy than tariffs.

tariffs

If we assume that everything that’s imported is subject to a 10% tariff, then total annual tariff collections will be initially about $340 billion (which amounts to about 5% of what the federal government spends yearly).

Who pays the tariff?

In the broadest terms, the parties to any tariff-generating transaction are: the foreign raw material supplier, the foreign maker/exporter, the domestic importer (who may also be a branch of the foreign maker), the domestic manufacturer of the final product (if the import is a component/ingredient), the retailer and the final domestic buyer.

In theory, and in practice, the parties with the most market power pay the least amount and the parties with the least market power pay the most. The Iron Law of Microeconomics is another way of putting this: the key determinant of price is the availability of substitutes.

Take cocoa, for example. Over the past few years, the price has quadrupled, due to unfavorable weather in the African countries where the beans are growth (yes, it’s a little more complicated, but I see no sense in laying out all the twists and turns). Early on, I noticed that one of my favorite candy bars went up in price by $.25. Then the packaging stayed the same size, but the bar inside had more nougat, less chocolate. Then they were hard to find. When they reappeared, the bar had shrunk. Then the price went up again. Then the nougat changed, too. Then I moved to gummy worms.

This is what I think will happen with many consumer products. Makers will depend on the brand name to carry them while the products become somewhat more expensive and items are made with cheaper materials. Smaller, older brands will likely disappear, because consumers won’t accept the new product/cost proposition. The stronger party will push more risk into the arms of the weaker–say, Amazon having foreign manufacturers pay the costs of carrying inventory and of absorbing returns. Companies with weak brand names, so-so products and poor distribution chains may well disappear.

This is arguably what the S&P 500 has been doing since the April 8 lows. So far in calendar 2025, that index is ahead by a bit less than 4%. But since 4/8, the rise has been about +20%. If we look at EAFE–the most commonly used index for developed world markets outside the US–which is ahead, in dollars, by about 16% ytd, its rise in dollars since the April lows is about the same +20%. A third of that return comes from the continuing weakness of the dollar, so a local currency chart may not seem as impressive.

All in all, the point I take is that although I don’t feel great about near-term prospects for the US economy as we await the negative impact of Trump tariffs on real growth and inflation, the upward bounce since April has been a significant positive statement.

What I worry about:

–the most obvious issue is tariffs. Microeconomic theory (and also reality, I think) says that the cost of this form of taxation will be shared among all parties in the distribution chain–foreign producers, importers, domestic sellers and domestic customers–according to their relative market power, with the weakest parties bearing the greatest burden.

Another micro truism (“the iron law of microeconomics” as my micro professor used to put it) is that what determines price is the availability of substitutes. In ordinary language, this means that people will deal with the tax on spending through some combination of trading down and doing without–i.e., postponing purchases. In theory, and, I think, also in practice, the tax will disproportionately hurt middle- and lower-income families. Hence, the big rally in dollar stores. Maybe I’ll keep my current Kia for another year, or trade down to a BYD electric vehicle–assuming Musk won’t be able to keep them out of the US. Disneyworld is probably out for a while…

Lots to figure out.

–the Trump administration. Arguably, politics typically makes no difference for stocks. This case may be somewhat different, though. It’s not just the weird posts on Truth Social that seem to be screaming out apparent cognitive decline. It’s also that much of the staff Trump has assembled appears to me to have been selected more as potential performers in a reality show than the best and brightest giving sage advice to the chief executive of the country. Of course, the gestapo-esque seizure and imprisonment of random workers by masked ICE operatives won’t exactly encourage tourism, or honor the idea that we’re the land of the free. And the resulting shrinkage of the workforce will retard GDP growth. Also, the attack on research universities isn’t exactly a winning move in a world where brainpower is more important than brawn.

–the dollar vs. the stock market. So far the bad news of the second Trump administration has been taken out in the sharp fall in the value of the US dollar rather than a decline in the major indices. Actually, from a Wall Street point of view, companies with costs in dollars and revenues in foreign currencies are substantial beneficiaries of the hot mess of the administration in Washington. The big question here, though, is whether the currency will remain the sole expression of government dysfunction or whether stocks will also begin to be stigmatized. My guess is that the latter will become more evident as tariffs begin to hit the domestic consumer.

This has nothing directly to do with the stock market, but…

…my first job as a newly commissioned second lieutenant in 1968 was as a platoon leader in the Fifth Mechanized Infantry at Fort Carson, in Colorado Springs. Luckily for me, an older (27?), Vietnam-veteran platoon sergeant took me under his wing. As we got to know one another, he told me that what made him proudest of being a soldier, and what kept him in military service, was that it was the only place he knew where he would be evaluated solely on his job performance, rather than on the color of his skin or how he led his personal life. That became the thing I was most proud of about the Army, too. (He also advised me to buy a rifle, shoot a deer and freeze it, so I’d have meat to eat. Yes, pay was awful, but I passed on that.)

Fast forward to now, with the Secretary of Defense being questioned by Sara Jacobs, Congresswoman from San Diego, on the firing of three career women military officers, all of whom were ranked on their fitness reports as among the top 5% of all officers of their grade and experience. Yes, there’s likely considerable “grade inflation” in reports like this (in my day, being in the second decile was a career killer. But the narratives written by their bosses made it clear that all three were superb officers. Mr. Hegseth agreed. Yet, Ms. Jacobs said, Hegesth was firing all three. Why? …because he (of all people) didn’t like the way they were choosing to lead their personal lives.

Another bad day for the land of the free, the home of the brave and the shining city on the hill.

EAFE, the most-used measure of the performance of developed world stock markets ex the US, is up so far this year by about 15% in $US ytd. The S&P, in contrast, is up by 2%. And the Russell 2000, which is a better measure of the pulse of the domestic economy (it’s mostly corporate earnings derived from US operations–vs. the S&P, which is maybe half- US/ half+ foreign), is down by close to 5%.

The euro, which is probably the best way to gauge the strength of the dollar, is up by close to 13% against the greenback since the inauguration. The yen has gained about 10%. Even the British pound, the sad sack of western Europe, is 10% higher now vs. the dollar than on inauguration day.

Put slightly differently, the lion’s share of the relative beating US stocks have taken since Trump took office has come from currency weakness. This fact makes the deep, bear market-ish, near-20% drop in the value of the US stock market vs. stocks in other countries (measured by EAFE) less visible to domestic investors–therefore, less painful–but no less bad.

How has this happened?

Ultimately, I think it’s that the rest of the world thinks the US is considerably less creditworthy than it was pre-Trump II. The debate, if any, is the line of reasoning that gets us to this result.

Two related rationales, both of which may contribute:

–#1. Trump is embracing the “trickle down” theory, advanced by Ronald Reagan, that income tax cuts for the ultra-wealthy (who are least likely to spend extra income) will somehow supercharge economic growth, increasing the overall government tax take. The idea may have had a useful rhetorical purpose back then, clearing the way for modernization of a woefully out-of-date domestic industrial base facing competition from much more modern plant and equipment that emerged in Europe and Asia out of the rubble of WWII (when I became a stock market analyst in 1978, for example, I learned that US Steel was still using furnaces from the nineteenth century). But it doesn’t make a lot of overall economic sense for today. And just offhand, it doesn’t appear to be working that well in the UK or Russia–or in the US of this century, for that matter.

In the US, Trump’s tax-cuts-for-the-wealthy strategy has revived worries that the amount of outstanding government debt will begin to spiral out of control, forcing an eventual Washington default on Treasuries. It’s hard to figure exactly when that might be. But it’s certainly becoming a worry for investors right now. It has to be an especially sore point for foreign holders of the long bond who have already lost, in local currency terms, two years of interest payments since mid-January. And we do know that foreign central banks have begun to shift their portfolios away from Treasuries and toward gold.

From my sideline view as an equity investor, my impression is that, ex foreign central banks, most of what we’re seeing now is bond investors hedging their currency risk. In my time as a professional equity investor it has always been domestic bond managers who have hit the “sell” button first, demanding higher yields to compensate for higher risk. So I think that’s the place to look for further financial deterioration. Presumably, if Congress okays the big beautiful bill, this will sooner or later be the next step. This isn’t just a bond problem. Higher yields means lower PEs for stocks.

–#2. shrinking the workforce through deportation, dumbing-down whoever’s left by cutting education funds and placing religious limits on what can be taught in schools, stand together as potent elements in the de facto drive to slow the rate of GDP growth–the first reducing the number of workers, the second/third lessening the chance of productivity gains through higher skill levels and/or clever alterations to current work processes.

Denying access of foreign students to US universities and the Third Reich-style terror tactic of masked operatives arbitrarily arresting people (including lawmakers and at least one judge) can only increase skepticism that we’re still the land of the free and the home of the brave. Not a great look for attracting or keeping great employees. My sense is that this brain drain is already in motion. Lower domestic earnings growth translates into lower PEs.

Is all the really bad stuff that’s flowing from Washington, tariffs and terror–apparently without much resistance from Congress, already factored into today’s prices? My sense is that it has not been.

How so? As far as I can see, it continues to be a successful equity strategy to avoid companies that take inputs from outside the US and use them to make products sold to domestic customers and to embrace the opposite–$US costs, foreign revenues. Smaller secular growth names are also having a field day, again because they’re not heavily reliant on the domestic economy.

For me, the key question is when to shift away from this strategy, a least temporarily, because the outperformance it has generated so far this year has been large enough that presumably a big chunk (all?) of what it will deliver this year has happened already. If I were an institution, I’d be starting the rotation process now. Personally, I haven’t. Certainly, the worst for US earnings won’t come until tariffs really begin to bite. We’re not close to that yet. But it’s a much trickier judgment to say that professional investors haven’t yet discounted most/all of the potential pain in today’s prices. Two thoughts on why this might nevertheless be correct: I think Wall Street is much more reliant today on quick-reacting trading bots than it has before; and analysts/strategists for the major firms may figure that there’s no percentage in making predictions that may cost them their jobs.