Overnight Israel mounted an air attack on Iran, targeting military commanders and nuclear research sites where Iran has apparently been trying to perfect a nuclear bomb.

It can be tempting to focus attention on the deep flaws of the leaders, Trump and Netanyahu, who authorized the apparently continuing attack, and what they perceive they will gain personally from it. But that’s hard to know motivations for sure and, as investors, probably not particularly key for figuring out stock market consequences.

What I see:

–Iran produces about 3 million barrels of oil daily, or about 3% of the world’s daily usage. News reports indicate that Iranian oilfields haven’t been targeted by Israel so far, however, and the reality is that the world is likely facing a continuing oversupply of crude, as it turns to other sources of power. Excess supply has been enough to have keep prices in a mild downtrend for the past three years. So today’s large 7% rise in oil, coupled with a similar increase yesterday, have only been enough to bring the quote to 5% below the comparable year-ago level. Still not great for new fracking projects, in my view.

–the $US has been in a nosedive since the inauguration, but is up by about 0.5% so far today against the euro and yen.

Yes, I think the slide that commenced in January has a lot to do with proposed administration tax/spending policies (the big beautiful bill) and it’s potentially severe negative consequences for the Federal deficit. But I think there’s also disappointment that the land of the free and the home of the brave is taking an anti-Robin Hood stance (taking from the poor to give to the rich). The performative cruelty of having armed and masked bands seizing residents and deporting them to foreign prisons without due process doesn’t help, either. The world has lived this rodeo before …and is beginning to fear a repeat performance is in the works.

–I’m interpreting the attack itself as a trigger rather than a cause.

I’ve been scratching my head trying to explain how the US stock market can be holding up as well as it has this year. The following is all I can come up with:

Most of the world’s negativity about the US has been expressed in the dollar’s sharp decline. Measuring performance in dollars makes it harder for Americans to see what’s actually going on. What I mean is:

—the US-centric Russell 2000 of smaller-cap, mostly US, sales is down by about -5% ytd. The S&P 500, a large proportion of whose business results come from international operations, is around +2%. NASDAQ, which also has a large international component, is a bit more than +1%. In sum, not great, but not a tragedy, either.

Look at EAFE, though. It’s +18% in $US. Put another way, the R2000 has lost a quarter of its relative value vs. foreign firms, in less than six months. An investor who thinks in terms of euro-denominated results, he’s something like +8%, ytd from holding EAFE –vs. a loss of 15% from holding the R2000. So for him, what we think of as “meh” turns into “oh, no!.”

a trip into my past

Back in the old days, when men were men and giants roamed the earth–that is, in 1968–I was commissioned a second lieutenant in the Army. My home branch was Military Intelligence. I received what was called a “regular” commission back then. I was to serve a three-year probation– the first two years in a combat arm (I chose infantry) and a third in MI. If I performed well, I would be guaranteed another 17 years of work and then a pension. (The government reneged on that promise to “regular officers” in the mid-1970s, but that’s another story. I’d chosen to leave the Army after my three-year commitment and was in graduate school.)

summer 1968

My first duty station was as a platoon leader in the Tenth Infantry regiment, which was part of the 5th Mechanized Infantry division, stationed at Fort Carson, outside Colorado Springs.

–among its other missions, the 5th had primary responsibility for riot control west of the Mississippi. Because of this, we continually practiced the coordination needed for large-scale riot control.

–in August, we were told we were going to be “pre-deployed” to the Great Lakes Naval Training Center outside Chicago just before the Democratic convention there to select the party’s presidential candidate started. The idea apparently was that this would reduce the number of anti-war activists who would demonstrate outside.

going to Chicago

Five aspects of our deployment stand out:

–our rifles came with us, but were secured in locked cases that only the highest command level had access to

–ammunition was stored separately, again in locked cases we had no access to

–we got frequent intelligence briefings, the most disturbing being reports that demonstrators were planning to blind law enforcement officials by throwing lye in their faces. As the convention began, we were informed that all the lye in downtown Chicago had been purchased over the preceding few days

–we each got a small card stating the rules of engagement. The essence was that if we harmed an American citizen in any way, we would be prosecuted and could expect no help from the Army. Yes, the high command was communicating that their careers were more important than our lives (not a good look). But the paramount idea was to make sure that an American soldier didn’t kill or harm another American.

–most of the soldiers in my company were Vietnam veterans who had gone directly from training into combat, and who were serving out the final months of their two-year service (some time later, the Army did the sensible thing and let returnees just go back to their families–but not then). Their overwhelming worry was that, having survived Vietnam, they would be disabled/killed by their fellow citizens.

Army and Marines in California today

Overall, the impression I get is that not much, if any, intelligent planning has gone into the decision to deploy Federal troops in California to support ICE. Maybe the idea is to legitimize ICE’s apparently intentional cruelty by mirroring to the deployment of Federal troops to force school integration in the South three-quarters of a century ago.

I find it a little scary to see pictures of the National Guard carrying firearms, apparently loaded. This sets up the situation where a soldier may be forced to choose between shooting a fellow American or losing a weapon and ammunition. Where’s the good possible outcome? Where’s the institutional memory?

It’s not clear to me, either, how much training or experience these Federalized troops have in riot control. Press reports I’ve read assert they have little/none, but I have no real knowledge. Hopefully, the press is wrong.

Also, Gavin Newsom seems to suggest that his conversation with Trump makes him think the president’s mind has gone down the same road as late first-term Biden’s. If so, who’s running the show?

Brad DeLong, a Berkeley economics professor who worked in the Treasury department during the Clinton administration, made a Substack post today about the $US.

individuals not governments

HIs point, made in part with support from research by Brad Setser, an economist with the Council on Foreign Relations, is this:

–most people think that demand for the dollar comes from its position as the world’s reserve currency–that is, from foreign governments seeking to bolster their reserves. This hasn’t been the case for more than a decade

–rather, the strength of the dollar comes from several strong beliefs on the part of foreign private investors: that dollar returns will be high, that their money will be safe, and–if bad comes to horrible–that they can shift residence to the US, and will want to do so.

implications

Their point is that, if this is correct, the Trump campaign using masked ICE operatives to detain and deport residents to foreign prisons, ignoring court orders to repatriate them, may have a much more profound negative effect on the dollar as foreign investors rethink their plans.

All in all, an ugly investment picture that my guess the Trump administration has not thought enough about, given the large increases in government debt its plans imply.

This possibility would be really bad for bonds, as potential buyers demand higher local currency returns to compensate for the currency risk they would be taking on, as well as the possibility there would be a considerably smaller number of potential buyers (meaning rates would be higher).

The overall effect on stocks would be less straightforward. Purely domestic firms would be clear losers. The fate of companies using foreign-currency denominated inputs to sell products to domestic customers would presumably be in the worst shape. In theory, the biggest winners would most likely be businesses using purely domestic inputs to sell to foreign clients. That’s where my money would be. The elephant in the room, however, is the possibility that ICE would kidnap part of any workforce, or simply that the secret police vibe it seems to want to project will create an atmosphere of terror that would make finding/retaining skilled workers here in the US very difficult.

what it is

“Equity” means ownership interest.

“Private” equity is a subset of equity that consists of the shares of stock of companies that are not traded on a public equity exchange like NYSE or NASDAQ. This blog, for example, is a product of LD Capital (not to be confused with the Singaporean crypto firm), the US-registered company, all of whose stock I own.

A key advantage, or at least, characteristic, of private equity is that companies aren’t subject to the rigorous legal disclosure requirements that publicly-traded companies are–like comprehensive information about business structure and earnings results through publicly-available audited financials, or prompt disclosure of material changes in the company, or limits on/disclosure of trading in the stock by company officials. To my mind, this makes them riskier.

For an outside observer like me, there are lots of flavors of private equity:

–there were the corporate raiders of the 1980s, whose positive social function (if any) was to force modernization of companies who were unable to compete against foreign competition with newer, rebuilt post-WWII, plant and equipment

–there are consolidators, stringing together mom-and-pop companies, either for resale or to combine into one corporate giant

–there are venture capitalists, hoping to grow promising startups onto behemoths.

What ties them all together is that they don’t fund themselves in the public equity market.

Starting in the 1980s, investors with very long investment horizons, and no immediate need for a considerable part of their assets, began to acquire states in privately-held companies. The most important of these was Yale, acting on the theories and advice of that university’s economics department. Eventually other universities, and then sponsors of defined benefit pension plans followed. The general idea was to obtain the superior returns that, in theory at least, come along as payment for accepting illiquidity.

For the early entrants at least, this approach has provided superior returns vs. investing in publicly-traded stocks and bonds.

tradeoffs, i.e., risks

The tradeoffs, of course, are two, I think:

–the lack of liquidity, and

–confidence in the completeness and accuracy of the financials, given that the big stick of the SEC is not in play.

sellers emerging?

Two (related?) factors are beginning to disturb the private equity market, as I see it:

–there’s talk of offering private equity investments to you and me, and in relatively small amounts, at least vs. typical PE clients. This suggests that the big-ticket pension plan and endowment market is saturated. Otherwise, why take on the added expense of selling to retail? Of course, it may also be that the big PE holders want to reduce their PE exposure–rather than just not buy any more–and this is the best way to do so. If so, same issue, but potentially bigger problem

–Trump’s attack on private universities, which are apparently beginning to take the sensible step of looking to offload less liquid assets in order to pay legal defense fees.

If there is a significant shift underway in the pension and endowment market, this is arguably good for the public markets, particularly for public equity. Hard to know at this point how big any uplift may eventually be.

As I’m writing this, NASDAQ is up by about 0.4% ytd. The S&P is ahead by 1.4%. This compares with Hong Kong’s Hang Seng at +17.21%, EAFE (the commonly used measure of non-US, developed world stock markets) at +17.5% in $US, and gold, normally a safe haven in rocky times (even though I think this is a lunatic idea, except in places where the official financial system is completely untrustworthy), is ahead by 29.3%.

In contrast, the Russell 2000, which I think is the best measure among the big indices for how the domestic US economy is doing, is down by -6.3%.

I’m thinking that the spread between EAFE and the Russell 2000, an opportunity loss to the holder of the latter of almost a quarter of his money in less than a half-year, is probably the right assessment of the damage to the domestic economy that the Trump administration has already set in motion. Is there something in there for the big hole in the budget from his proposed continuation of income tax cuts for the ultra-wealthy? I don’t know. In the days before trading bots ruled the world, I would have said “some, not all; less than half if I were forced to guess.” But now…???

And I don’t see much doom impending in my own active holdings.

So I decided to look a bit more closely at the structure of the US market, to see if there’s any clue as to what’s going through the stock market’s hive mind.

The S&P 500 is a top-heavy index. The biggest ten names (including two classes of GOOG counted separately) make up about 36% of the index. The top four make up about a quarter. Ytd, they have performed as follows:

NVDA 6.4% of the index +5.0%

MSFT 6.4% of the index +9.5%

AAPL 5.7% of the index -19.5%

AMZN 4.4% of the index -5.4%

META 3.4% of the index +14.3%

AVGO 2.3% of the index +9.5%

TSLA 2.2% of the index -14.4%

BRK.B 2.0% of the index +9.7%

GOOGs together 3.9% of the index -11.6%

If you own all the ytd winners, and only them, in equal amounts, you’re up by +8%. If you own all/only the losers in equal amounts, you’re down by about -12%. You’re in a much different stock market and a much different frame of mind.

There’s the same kind of story if we look at market sectors. Ytd, they break out as follows:

Industrials +8.0%

Utilities +7.9%

Staples +7.7%

Financials +5.2%

Communication services +3.8%

Materials +3.3%

Real estate +2.3%

S&P 500 +0.9%

IT -1.0%

Healthcare -3.8%

Energy -4.3%

Consumer discretionary -6.1%

I read the sectoral breakout as follows:

–the market is saying the economy is going to be relatively weak (most of the defensive groups are in the plus column) , and

–consumers are going to shift away from imports to things made in the US (i.e., the strength of Industrials, whose label is a bit deceiving, and whose members by and large compete with importers in making stuff for individual consumers). Not a sign of economic health, though, more one of choice being limited.

Again, if you’re up to your ears in Industrials, you’re probably very happy; if you’ve bet on a robust economy, not so much. Again, though, the spread between the first and last industry groups is very wide. So all of us are more likely than usual, I think, to either be wearing a dunce cap or patting ourselves on the back (although professionals typically regard it as the kiss of death to do the latter).