One January in the mid-1980s I spoke up at the initial investment committee meeting said I thought that that year would be especially tough. Everyone laughed ,,,apparently because that’s what I said every January.

Nevertheless, I do think that next year will be especially challenging.

my general rules

Because of that, I think it’s important to go back to first principles, namely:

–almost all professional equity portfolio managers routinely underperform their benchmark indices, even before subtracting operating costs and management fees. So an index fund/ETF is probably the best option for all of us for most of our money. In my case, about 3/4 of my equity exposure is in Vanguard index products. Yes, Vanguard’s web infrastructure may be clunky, but I don’t see this as a big deal. And it’s really cheap. I manage the rest myself, because I think it’s fun

–for any money any of us actively manage, it’s important to study our own tendencies–what we typically do right and what we typically do wrong. The way I do this is through periodic post-mortems.

In my case, over twenty+ years as a pm I’ve generally outperformed in up markets and have counted myself lucky not to get beaten up too badly in down markets. About half my outperformance has come from industry/sector selection and half from overweights in individual stocks.

I know nothing about Healthcare or Staples and only a little about Financials. So it would take a lot of convincing for me to believe I’m not the dumb money in any of these. On the other hand, I think I know more than the average person about Energy, Materials and IT. Just about anyone can more or less wing it with Consumer discretionary. That leaves Industrials (really mostly suppliers to Consumer discretionary), Utilities and Real estate in no-mans land for me. Experience tells me the heart of my individual stock selection will be in IT and Consumer.

Taking a very wide perspective, what do I think next year will look like, from an economic perspective?

More tomorrow.

If we look back to the start of NVDA’s fabulous run of delivering extremely strong results and positive earnings surprises, it was clear from the outset that two factors were driving the gains:

–strong sales growth of the company’s cutting-edge AI chips, and

—operating leverage, the fact that the expenses of running the company’s research and sales efforts are rising at a much slower rate than sales. Over the past twelve months sales are up by 94% and expenses by 44%. The consequence of this is that profit growth has far exceeded that of sales.

It’s been evident to anyone who looks at the NVDA financials, however, that while sales are still expanding faster than costs, the rate at which they’re doing so has decelerated. In addition, the absolute gross margin, at 75%, is at eye-popping levels. Noticing this (how could anyone not?), TSMC has upped the price it charges to manufacture NVDA offerings.

This adds up to the likelihood that profit growth has lost the turbo boost operating leverage has been giving it and will depend solely on sales growth, at least for the near future, to make earnings gains.

All this was crystal clear on August 28th when NVDA reported 2Q25 earnings. The stock dropped by 20% in the ten days or so after the results were published. Arguably, though, the decline was triggered by the announcement that NVDA’s latest AI chip was having teething problems. In any event, the stock then roared ahead by 40% to a new all-time high just before the 3Q earnings announcement. It’s down slightly today as I’m writing this.

Where to from here?

I think that for the first time in a while, valuation will be based more heavily on current earnings rather than factoring in the possibility of large future positive earnings surprises. My sense is that, again for the first time in a while, the stock is fairly valued. I’m holding most of what I bought years ago, but I’m selling enough so that, for now, it will no longer be my largest position.

I own both stocks.

As I was writing yesterday, WMT stands out as the retailer best able to cope with the current economic environment.

I thought TGT was also putting its pandemic-related issues behind it. But no! The company reported earnings per share of $1.85 for 3Q24 this morning. This compares with analyst estimates of around $2.30. And the company said it expects to earn the same during the traditionally stronger holiday season quarter that we’re in now. That compares unfavorably with the $2.65 Wall Street had penciled in for the three months. To my mind, it’s the latter that explains the sharp negative reaction in opening trading.

In a nutshell, sales are flat and margins are being squeezed. The earnings call now under way will likely have more detail.

What I read this as saying about the general economy, comparing these results with WMT’s:

–although I lumped the two retailers into the same category in yesterday’s post, WMT is a bit more don-market than TGT. My guess is that WMT (maybe the overall economy has a role, as well) has been more than usually successful in persuading TGT customers who have traded down during the pandemic not to trade back up

–WMT sells a lot more food items than TGT, and food has been particularly strong

–TGT’s attempt to mimic Amazon’s online presence is less far along than WMT’s. Though online sales for TGT are strong, unit profits are lower than from in-store sales–maybe forever, but for now at least while TGT continues to build online and delivery infrastructure.

–also, TGT has much more exposure than WMT to California and the Northeast, as well as to city dwellers

–TGT’s inventory issues, which I had thought were in the rear view mirror, have emerged again. Hard to know what to make of this.

I’d like to hear more before I decide what to do with TGT. The general message, though, is that the overall economy seems to be more fragile than I’ve been thinking. WMT’s and Lowe’s’ recent statements that Trump tariffs will be bad for business–stating the obvious, but noteworthy that conservative managements would take the risk of offending the Trump-leaning part of the customer base–underline this.

I’ve always looked at publicly-traded retail companies as being an important bellwether of the overall US economy.

I sort firms into rough categories by who their typical customers are and how much things cost. From most expensive to least, they are:

–super luxury, which is basically invisible

–luxury goods

–specialty retail

–Costco

–clothing stores

–Target, Walmart

–fast fashion

–dollar stores

–sub-dollar-store, which is also in stealth mode as far as stock market presence is concerned.

It’s possible to segment each of these categories further, like dividing dollar stores into Dollar General, Dollar Tree and Ollie’s Bargain–each serving different segments of the dollar-store market, but that’s more detail than I’m usually interested in.

It’s also important to recognize that luxury goods companies typically charge much more for their wares outside the US than here, so even modest sales increases in places like China (where the opposite is the case right now) or the Middle East can move the needle a lot.

The basic idea is that consumers trade up and down in sync with the economic cycle. In bad times, the specialty retail customer trades down to Walmart, the Walmart customer to the dollar stores, and the dollar store customer to venues that aren’t publicly traded. …and vice versa.

So, where are we now?

The dollar stores are a mess. Walmart is booming. Target is finally putting its aggressive pandemic-era overstocking of consumer electronics, but is not growing as fast as Walmart. Luxury in general is struggling. (I don’t pay much attention to this segment any more. My impression, though, is that the collapse of the Chinese property market is the main culprit …and that so-so sales in the US and Europe are a much lesser issue.)

Overall, this is not a picture of economic strength. If we put Walmart to the side, it would appear that lower income domestic consumers are still struggling and that a reversal of the typical cyclical trading down has yet to begin.

What about Walmart (I bought shares starting early this year, when I realized that WMT offered camera stuff online that was much cheaper than anywhere else)? Three factors are involved, I think. In what I’m guessing is the order of importance, from most to least important, I think they are:

–management seems more interested in making market share gains than in defending the status quo

–it’s online business has become a more effective competitor to Amazon, although its recent discontinuing its Walmart credit card may well be a serious mistake

–it has been unusually successful in holding on to customers who would have begun to trade up in previous cycles

–political pressure from already-established merchants has limited Walmart’s presence in California, and late arrival in the Northeast has made finding prime locations relatively difficult. I don’t have a strong opinion, but being out of these two areas may have been a plus this year.

the stock

WMT is up by over +60% so far in 2022 vs. +24% for the S&P 500. For now, I’m content to hold what I have but don’t feel a strong need to buy more.

The fate of post-WWII China was determined when Mao defeated rival Chiang-Kai-shek, who fled with his army to take control of Taiwan. This established the Chines Communist Party (CCP) as the ruling force on the mainland.

A seminal Maoist idea was that the economy should not be led by private companies but rather controlled by state-owned enterprises run by high-ranking members of the CCP and following the dictates of central planners in Beijing. This created an unholy mess.

In 1978, the then head of the CCP, Deng Xiaoping, announced a new direction for the economy which he called “Socialism with Chinese Characteristics.” No more central planning. The economy would be led by private sector entrepreneurs, as the state-owned enterprises were gradually shrunk. Put another way, this was US-style capitalism. And the result was an explosion of growth.

This renaissance lasted more or less until Xi Jinping became the head of the CCP in 2012. Xi, apparently scandalized by the fact that considerable power had shifted away from the CCP to the private sector, launched the return to Maoism that continues today. Not surprisingly, a lot of oomph has gone out of the economy.

This is why I think the apparent wild enthusiasm for China on Wall Street continues to be misguided. It’s still dangerous to be an entrepreneur there, so why take the risk. Without this spark, however, China has revered to being a rapidly aging, slow-growing economy. In addition, the less healthy business environment + import restrictions are causing manufacturers of goods for foreign consumption to shot elsewhere in Asia.

There’s a second issue: the property market. Three reasons:

–People in China don’t trust the banks as places to store their wealth. More lucrative and safer to own property, where wealth will be less visible to the CCP and the chances therefore lower of being hauled in for interrogation or having the assets seized

–All mayors, governors and other civic officials are members of the CCP. Promotion comes from showing strong economic growth. One simple way of “manufacturing” growth is for a mayor to get a loan from the local bank, whose president will be a lower-ranking CCP official and so won’t look too closely at feasibility, and build something–an industrial park, say, or a gigantic residential suburb. The mayor will hope to be promoted and long gone before anyone finds out whether this was a good idea or not. Very often it’s not.

–the sale of residential apartments in China has an options market-like aspect to it. People typically stand in line to make a down payment on a flat that may be completed 18 months or so later. Buyers commit themselves to additional progress payments and a large final installment on taking possession. At least some intend to sooner or later sell their place in line at a profit to a third party. Developers also leverage themselves financially, partly to pay for construction expenses, partly in an effort to make a higher profit on the equity they’re committing to the project.

This is a little like the atmosphere in the US during the mortgage loan fiasco in the US in 2006-07. And, like the US two decades ago, the speculative bubble formed in China has also burst. A real–and huge–financial mess.

This is why I’ve been bemused at China bulls in the US encouraging global investors to dive right in. Yes, a huge rally since late September has brought the index into positive territory for the year, but…

A related issue: I was actively involved in the Hong Kong stock market for over two decades starting in 1983, when China was in the early stages of reopening to the West. The beauty of Hong Kong back then is that, like Taiwan, it too had been a destination for Shanghai residents fleeing Mao. Once Deng opened the door to better relations with other countries, the financiers in Hong Kong began to reestablish personal and business ties with friends and relatives on the mainland–and to list the higher quality corporate names in Hong Kong. The city soon became a wealth of knowledge about the good and the bad of the mainland–that was not available anywhere else. That all ended when Xi reneged on the agreement to a 50-year transition period, starting in 1997, for the return of Hong Kong to mainland rule, when he began to impose mainland legal/political control about a decade ago. That basically cut off the information flow–and created the risk that securities analysts could be jailed simply for writing sound fundamental analysis.