Why metaphors? Maybe that’s not the best word, but what I mean is that American investors, even professionals, tend to place huge weight on individual company analysis and stock selection. My experience with foreign PMs is just the opposite–all conceptual macroeconomic and political framework, coupled with inability to decipher individual company financial statements.

But why not do both?

These are the two high-level stories that I think have relevance for US portfolio construction today.

1. Japan in the 1950s vs. in the 1980s

World War II was economically devastating for Japan, with much of its industrial base and a large part of its workforce destroyed. Its recovery strategy was straightforward:

–keep the currency undervalued; rebuild domestic infrastructure with a focus on export-oriented manufacturing,

–keep strict control on wages and on the availability of foreign-sourced consumer goods, and

–constantly remind current workers that their economic suffering would make the country a better place for their children and grandchildren.

The result was a generation of economic privation, but the creation of a dominant export-oriented manufacturing powerhouse–and a blueprint for every emerging economy since then. By 1985, after a generation of sacrifice, Japan was so prosperous and economically powerful that the rest of the world forced a sharp revaluation of the yen, and the country entered the “high yen” era.

what’s key here

From a stock market point of view, the 1970s and early 1980s stars were export-oriented industrials, like Toyota or Sony. Their main attraction, other than the quality of their products, was that their costs were in yen and their revenues were in strong currencies like the dollar or the mark. Other rebuilding, domestic-oriented industries were protected from foreign competition through high tariff barriers.

As the yen revalued, however, all of these became relative losers to banks, property companies, importers–that is, firms that had either purely yen exposure or, even better, revenues in yen with costs in dollars or other weakening currencies.

This is the blueprint every successful emerging market since then has employed.

The current administration’s economic policy in the US reminds me a lot of 1950s Japan–depress the foreign exchange value of the dollar (in the US case, by trying to force the Fed to lower interest rates) and, through tariffs, raising the local economy cost of imports. Both of these lower the local standard of living while stimulating industry.

I have no idea what makes this tried and true up-from-poverty strategy a good idea for the US today–especially when action to stimulate local industry is coupled with efforts to reduce the working population, which pushes in the opposite direction. I don’t see, either, the patriotic call for self-sacrifice to make things better for the next generation. Very worrisome if Washington doesn’t know. In any event, this is what it’s doing.

The investment implications are clear:

the key to success is having foreign revenues and domestic costs. And even though the overall US stock market has been a distinct world laggard, owning export-oriented or import-competing businesses has been significantly better than owning stocks in foreign markets.

2. Hong Kong under Xi

Hong Kong has a colorful, if that’s the right word, history. Back in the Queen Victoria days, the British army invaded China to force it to buy British opium (from India)–a major source of foreign exchange for England. It also seized Hong Kong for dealers to use as a port of entry, ultimately forcing China to grant a 99-year lease on the surrounding area that terminated in 1997.

In 1982, Deng announced that the lease would not be renewed. In the negotiations that followed, China agreed that Hong Kong would remain a relatively autonomous ” Special Economic Region” until 2047, then revert to mainland control. The Deng years were ones of immense prosperity for China, as well as for Hong Kong–which became the headquarters/meeting place for domestic Chinese firms and foreign multi-nationals hoping to partner with them. It was an equity investor’s paradise, as well.

Deng’s successor Xi, a more old school Maoist, reacted violently to pro-democracy protests in the years just after his becoming head of the Chinese Communist Party in 2012. He ultimately tore up the Deng agreement, imposed much more draconian Chinese law, jailed protestors (sometimes after mainland court proceedings) and replaced elected officials with his minions. Kind of a repeat of Mao’s “reeducation’ efforts.

The result was an immense loss of stature for Hong Kong and its publicly traded companies, in the eyes of international investors–who, for the first time, had to worry about their own personal safety if they visited–as well as the economic and legal status of the company stock they might buy on the Hong Kong exchange.

what’s key here

In my view, none of this is as bad, from a reputational point of view, as ICE in Minnesota. On the other hand, I don’t think the negative effects on the S&P will be as severe as they were for the Hang Seng index. My guess is that the main result will be an intensification of the US costs/foreign revenue theme, with maybe an intensification of the idea that consumers will increasingly trade down as their economic circumstances weaken.

The Trump administration appears to me to have effectively erased the official jobs report previously produced by the Bureau of Labor Statistics, based on information provided to Washington by a network of companies around the country. I don’t know much (anything?) about the BLS’s data collection methods, but it appears that not every company put its A team on the task of providing timely and complete data. So the BLS had to extrapolate and revise as new data flowed in. The administration’s “fix,” however has apparently been silence.

There is a second source of jobs data, however. It comes from ADP, the private company that specializes in payroll and other corporate support services, which works in conjunction with Stanford’s Digital Economy Lab. For a very long time, ADP has offered its own statistical analysis of the job situation in the US, using in part an anonymized version of its massive customer information, and typically released a day or two before the official BLS figures.

It’s still up and running.

Its conclusion is that hiring remains weak. The line that jumped out to me in the latest ADP press release is: “Leading the slowdown was manufacturing, which has lost jobs every month since March 2024, professional and business services, and large employers.” (The italics are mine.)

This can’t possibly be a surprise. Hard to expect anything else from the twin blows to the economy of raising the price of imported raw materials and simultaneously shrinking the labor force.

I’ve seen a number of the-sky-is-falling articles about issues mutual funds, and index funds in particular, are having in meeting SEC-mandated diversification of holdings. The relevant section of the Investment Company Act of 1940 is:

[a]t least 75 per centum of the value of its total assets is represented by cash and
cash items (including receivables), Government securities, securities of other
investment companies, and other securities for purposes of this calculation limited in
respect of any one issuer to an amount not greater in value than 5 per centum of the
value of the total assets[4] of such management company and to not more than 10 per
centum of the outstanding voting securities of such issuer.

If you’re a fund that doesn’t meet these requirements–and, given the recent meteoric rise of Nvidia to become all by itself 7%+ of the value of the S&P 500, no S&P 500 index fund/ETF does–you can continue with business as usual, but you have to make a public declaration that you are no longer “diversified,” in the technical sense specified in the 1940 Act.

As a practical matter, the rules to call yourself “diversified” are:

–for 25% of the portfolio, there are no position size restrictions

–for the remaining 75%, the rules are all about purchases of a given security, not sales

–you cannot make a new purchase of a given security, if the purchase either raises the weighting of an already-existing position above 5% of the assets or establishes a new holding at a weight of 5%+

Three geeky points:

–if you establish a 3% position that doubles while everything else in the portfolio treads water, so it’s now 6% of the assets, you don’t have to sell. The rule only applies to new purchases that bring the weighting up. Same thing if everything else craters and this becomes, say, 10% of the portfolio (in my view, you’d be crazy not to rebalance, but this rule doesn’t force you to–and in the real world, unless you own the management company, you probably won’t be around any more to make portfolio decisions)

–if you want to buy more of this stock, that’s ok, provided you mentally place it in the 25% of the portfolio that the rule doesn’t apply to

–if you want to run a more concentrated portfolio than these rules permit, you simply announce that you no longer intend to run a diversified portfolio in the sense of the Investment Company Act of 1940.

As for S&P index funds, the main issue is the meteoric rise of Nvidia to become the largest weighting in the S&P, at 7%.

As of just after the open on Feb 3, the top weights in the S&P 500 are:

Nvidia 6.95%

Apple 6.26%

Microsoft 4.86%

Amazon 4.04%

Alphabet 6.57% (two classes of GOOG)

That’s 28.7%.

So at least one of these has got to fall outside the 25% box where it’s ok to have a position larger than 5%.

Two problems for an index fund:

–someone has to choose which stock to exclude and thereby underweight, which introduces an element of active management into a product whose main selling point is that it has no active management (the obvious candidate, I think, to move outside is Amazon, but that only reduces the weighting of the protected box to 24.8%–which doesn’t fix the problem, since even a slight gain in one of the others likely renews the breach of 25%.)

–one alternative is to close the fund to new money, since the SEC rule applies to purchases, but even then how does the fund reinvest dividends paid by the 5%+ stocks?

To step back for a minute, the rationale for index funds is the combination of their low cost + the inability of active, high-fee managers in general to do better than the index on a consistent basis.

The only out for index funds, I think, is what has happened–they have notified their holders that they are no longer going to describe themselves as diversified in the technical sense of the 1940 Act.

What I think commentators have missed is that what has changed is not the character of the indexers, it’s the character of the index. It may well be that the stock market world is now a riskier place. But it doesn’t change the peculiar, but well-established fact that index funds virtually always outperform higher-cost actively-managed products, even before considering the latter’s much higher costs.

I’ve just updated my stock market performance page for January results.

Last year’s relative losers have been having their typical early year bounce. IT service companies have been outdoing makers of IT infrastructure, in what I see as a relative valuation catchup. Both the US currency and US stocks continue to lose ground to the rest of the world, as they have since the inauguration–the first time in a quarter century this has been the case. The US consumer, understandably, continues to be a bad place to be.

…which may be a warning sign for the health of the domestic economy.

the rationale

As I’ve written maybe too many times already, I began my investment career at Value Line, where I got a job more or less by accident. Wall Street was raiding VL for seasoned securities analysts as it was recovering from the twin shocks of the deep recession of the early 1970s and the SEC banning the practice of (very high) fixed commissions for investment services. VL, in response, began to tap the expanding pool of would-be academics like me, unable to find university teaching work as the tide of Baby Boomers entering college began to recede.

I started with the odd mix of oils, oilfield services, semiconductors and public utilities. Soon, however, I was able to trade in utilities for casinos.

An important thing to note about VL is that although it wasn’t glamorous, (Gemini tells me) my reports were read by 100,000+ active individual investors. Many company chairmen and boards of directors looked at them as well. So my company contacts were at great pains ot make sure I had complete and accurate information.

I knew that US casino profits were split pretty evenly between gambling, on one hand, and hotels, restaurants, entertainment… on the other. Over time, it became clear that on the gambling side, operating profit growth is a straightforward function of the size of a given casino’s floor space and nominal GDP growth. Given constant space, you didn’t need to know how many table games, which kinds, the number of slot machines and their payouts… Yes, it might be fun to learn all that and build an elaborate profit model, which I tried to do –and that’s also how I learned you didn’t really need to. One key assumption, though–the casino management can’t be total idiots. They have to have enough skill to choose an appropriate market segment and to ensure the layout appeals to the casino’s target clientele.

the point

In its just-released report, The Nevada Gaming Commission indicates that gambling revenue on the Las Vegas strip over the past six months has only risen by 0.77% yoy. Statewide, the figure is +2.0%, which I read as saying locals feel better off than visitors. This statewide figure, though, shows current growth at only about half the rate of the prior two July-ending fiscal years.

Maybe there are other causes, like people spending too much time in the Sphere or at sports venues. Still, this is a pretty notable falloff.