I’ve gotten swept away by the holidays (happy all of them, by the way) over the past few days. So I haven’t had a chance to complete my ruminations about what 2025 has in store for us as investors. My basic idea, though, is that we’ve had two fabulous years in 2023-24 (admittedly after a ~20% decline in 2022), so some consolidation is in order. This typically means that individual stock selection will be more important than industry/sector selection and that there will be some reversion to the mean (i.e., previous outperformers correcting and former laggards catching up). As far as industries go, for the first time in my career, which began in 1978, I find electric utilities interesting. I’m also content not to have any oil/gas exposure.

The biggest wild card, in my view, is how President-elect Trump will act when he takes office. As I see it, he is deeply beholden to three mutually incompatible groups: white supremacist evangelicals, some of whom seek to trigger the second coming; tech billionaires like Peter Thiele and Elon Musk, who seek to enhance their business prospects; and the foreign governments that are supporting his middle east and other overseas real estate projects. It’s also possible that the Republicans are following the Democrats’ lead and disguising their leader’s steep cognitive decline.

So I find it hard to guess what he will actually do, once in office. His tariff plans will presumably protect Tesla from the competition it faces in other markets, but they–along with his plans to deport large numbers of non-citizen workers–are also most likely, I think, to tip the country into recession. The real question here is “how deep” rather than “whether.” More reasons no to deviate far from the structure of the S&P 500.

Substack

I subscribe to a number of Substack feeds. Recently, I’ve been getting solicitations from authors who claim to be working professional portfolio managers who are willing to sell their insights, and at least elements (if not all) of their portfolio construction, to Substack subscribers.

Three issues:

–is there any part of this that’s true?

–professional portfolio construction is usually a collaborative effort among securities analysts and portfolio managers, under the supervision of a chief investment officer. So the information on offer through Substack is most likely not the writer’s intellectual property to sell

–almost by definition, a professional money manager will have clients. Institutional clients will be paying, say, 1% or 2% of the assets under management as a fee for services; private clients may pay more. Why would anyone risk undermining that business by selling the firm’s intellectual property for a few bucks on Substack?

The stock market dropped sharply after the Fed’s interest rate announcement early yesterday afternoon. The Fed did, as expected, lower the Fed funds rate by 0.25%. But it also signaled that it will move cautiously in lowering short rates from here on out.

The main concern is, I think, lack of clarity about what the Trump economic program will turn out to be:

–Tariffs are one issue. Tariffs are a tax on imports. The tax is paid either by the seller, the buyer or both, according to the relative market power of each over the other. My go-to first guess for stuff like this is to use 50-50. If so, a 20% tariff on an imported good produces a 10% increase in its domestic price. So it’s inflationary.

–Income taxes are a second. Arguably, the one good thing Trump did during his first term was to lower corporate income taxes to a level where domestic firms were no longer strongly incentivized to recognize profits in lower tax-rate jurisdictions abroad. He also, however, lowered income tax rates for the wealthy as a supposed economic stimulus. Theory and experience both show that the higher one’s income the larger the percentage one saves rather than spends. So lowering taxes for the wealthy may get campaign donations but it’s the worst tax thing to do if you want to create economic stimulus.

The worry here is that if the government continues to need to issue bonds to fund its spending plans, at some point–no one knows exactly when–creditors will begin to worry that they won’t be paid back. If so, they’ll demand a higher return to offset the greater perceived risk. Worse if foreign lenders begin to also lose confidence in the currency.

Hence, the Fed’s lack of apparent enthusiasm, at least for now, for a promise of further interest rate cuts.

Among American equity portfolio managers, there are two basic approaches to the stock market. Of course, everyone tries to figure out what the future value of a given company’s stock will be. But

—growth investors do so by making forecasts of future profit growth. They look for companies where they think the consensus belief–manifested in the current share price–underestimates either what the strength of future earnings and/or the length of time a firm will produce surprisingly strong results.

—value investors, in contrast, look for companies whose assets they believe are undervalued by the market.

Put a different way, a growth investor know with a great amount of certainty when his calculations will be proved right or not (as results are announced publicly) and with less certainty what they will be. A good recent example is Nvidia.

For a value investor the reverse is true. If he’s done his homework he’s confident that the value of a company’s assets is far greater than the current share price, but he’s more in the dark about when an event will occur, like a change of management or a takeover bid, that will reveal the undervaluation and begin to remedy it. A good example of this is Robinhood.

Typically, the growth approach works best in up markets and the value approach in down markets. One of the quirks of today’s US stock market–and by extension the mutual fund/ETF market–is that professional investors are strongly incentivized by pension consultants to remain in “style boxes,” that is, to concentrate exclusively on one of the two approaches. And, as it turns out, the 21st century has been, so far, unusually cruel to value investors, many of whom have migrated to private equity or other forms of non-liquid investments.

To my mind, one consequence of this last development is that value situations can be extremely lucrative, as well as providing some degree of protection against a general market decline.

As regular readers will know, I’m a died in the wool growth investor. But I got my start and spent my first six years in a value shop, as well as a decade later on as the principal growth investor in what was a heavily value-oriented organization. So I do know something about value investing.

I’m also finding that over the past few months I’ve been increasingly responsive to value ideas. For what it’s worth, I’m reading this as my unconscious telling me to become more defensive.

Here’s the structure of the S&P 500 by sector from my last post:

Information Technology =31.3% of the index

Financials =13.9%

Consumer Discretionary =10.7%

Healthcare =10.6%

Communication Services =8.9%

Industrials =8.6%

Consumer Staples =5.7%

Energy =3.4%

Utilities =2.5%

Real Estate =2.2%

Materials =2.1%.

We can sort these broadly into two groups: defensive, meaning whose profits are not very sensitive to changes in the business cycle, and aggressive or cyclical, meaning profits will respond strongly to changes in economic conditions.

Defensives: = 20% of the S&P:

–Healthcare 10.6%

–Consumer staples 5.7%

–Utilities 2.5%

–Real estate (basically income-oriented REITs) 2.2%.

Aggressives:

type 1 = Traditional domestic business cycle beneficiaries = 38.7%

Financials 13.9%

Consumer discretionary 10.7%

Industrials 8.6%

Commodities = Energy +3.4%

Materials 2.1%

type 2 = Tech, mostly multinational = 40.2%

IT 31.3%

Communication services 8.9%.

The first thing that strikes me from this compilation is that it’s hard to become really defensive. If we define risk as deviation from the structure of the index, and if all one does is sector selection, a totally defensive stance would be an all-or-nothing bet on 20% of the index.

more tomorrow

a caveat to what follows

The 1990s were a devastating period for traditional value investors, many of whom lost their jobs at the end of that decade because of their chronic underperformance of broad equity benchmarks like the S&P 500. As typically happens with this sort of thing, the first several years of this century were marked by wild outperformance of value over growth. This allowed many of the just cashiered value investors to reestablish themselves as hedge fund/private equity gurus catering to pension funds desperate for any kind of magic bullet to prop up underfunded traditional pension plans. As far as I can tell, however, traditional Graham-and-Dodd value almost immediately reverted to its 1990s form …and has continued to underperform to this day.

relative performance as a tool to achieve absolute performance

As deep value investors understand all too well, it’s much easier to say that stock A is cheaper than stock B than it is to say that stock A is flat-out cheap. So most professionals I’ve worked with/for structure their portfolios with a close eye to the structure of the index, most often the S&P 500, that they are benchmarked against. Here’s what that index looks like today:

Information Technology 31.3% of the index

Financials 13.9%

Consumer Discretionary 10.7%

Health Care 10.6%

Communication Services 8.9%

Industrials 8.6%

Consumer Staples 5.7%

Energy 3.4%

Utilities 2.5%

Real Estate 2.2%

Materials 2.1%.

We can sort these broadly into defensive, meaning whose profits are not very sensitive to changes in the business cycle, and aggressive or cyclical, meaning profits will respond strongly to changes in economic conditions.

Defensives (18.8% of the index) and the easiest group to categorize, are:

Health Care 10.6%

Consumer staples 5.7%

Utilities 2.5%

Traditional cyclicals (40.9%)

Financials 13.9%

Consumer discretionary 10.7%

Industrials 8.6%

Energy 3.4%

Real estate 2.2%

Materials 2.1%

IT cyclicals (40.2%)

Information technology 31.3%

Communication services 8.9%.