11/5/25 -
Additional
Notes:
In order for EPS to grow, a
company’s return on capital must exceed its cost of capital. Comparing the nine
months of 9/24 and 9/25, Verizon’s annualized cost of capital is about equal to
its return on adjusted assets. The company has been unable to grow its EPS.
Verizon annualized cost of capital is approximately 6%.
Verizon
Return on Capital Annualized
2024 2025
7.18%. 8.80%,
which was accomplished by unsustainable
rate
increases; corrections.
Although
this has resulted in adequate dividend coverage, earnings and therefore
dividends can’t grow in the long run. Verizon now has a new CEO, Dan Schulman,
who headed the company’s Board of Directors. Before that he was CEO of PayPal,
CEO of American Express’s enterprise growth subsidiary, and CEO of Virgin
Mobile. He says, “We will rapidly shift to a customer-first culture,
one that thrives on delighting our customers. These will not be incremental
changes. We will aggressively transform our culture, our cost structure, and
the financial profile of Verizon…”
__
The following regression and data indicates that there is a
substantial linear relationship between quarterly operating earnings per share
and S&P 500 levels. A sign of systematic behavior? The trouble is that
S&P 500 earnings in any particular period is
all over the place, and it is only recently that operating earnings have
increased fairly smoothly. It is likely that the
major cause of U.S. stock market fluctuation is operating income uncertainty,
as determined by Wall Street analysts. In contrast, we are focused on the
medium-long-term. This means more a focus on longer-term economic factors.
A.I. has
been responsible for smooth increases in an otherwise cyclical economy. A.I.
now accounts for 90% of all S&P capital expenditures and 75% of S&P
GDP growth.* A recent MIT
study indicates that personal adoption of A.I. has been very rapid, but
companies are finding out that A.I. doesn’t yet learn and can’t be easily
integrated into company workflows. We shall further address individual
investments in the future.
*
NYT,
10/26/25. Newspaper articles treat spending on A.I. as originating from S&P
companies. In fact, the highest spenders: Microsoft, Alphabet, Meta, and Amazon
are NASDAQ companies.
11/18/25
-
We have
effected a major change in our bond position. We have derisked the bond
position from ^VCIT to ^VGIT, which tracks the intermediate term U.S. treasury
bond at a lower interest rate of 3.81% and a reduced portfolio risk duration of
4.9 years. * The reason for our doing so is the apparent rapid infiltration of
private equity into the U.S. public markets. We reviewed the portfolio of ^VCIT
when we bought the ETF a while ago, it contained only a small position in an
unrated credit. Now a review of the portfolio contents on 10/31/25 reveals a
total private equity debt investment of 1.01%, including a 0.02% in a company
that has restricted equity investors from withdrawals in an investment. A 1%
position in private debt equity may not sound like much, but as Keynes wrote in
Cambridge 1938, “Another important rule is the avoidance of second-class safe
investments, none of which can go up and a few of which will surely to go down.
This is the main cause of the defeat of the average investor The ideal investment
portfolio is divided between the purchase of really secure future income (where
future appreciation or depreciation will depend on the (central bank) rate of
interest – as we also say) and equities which one believes will be capable of a
large improvement to offset the fairly numerous cases, which, with the
best skill in the world, will go wrong.” **
Proffered
investments will only get worse, as private equity eyes the public markets on
which to offload the deals they have done. Jeffrey Gundlach believes, “...(the)
market (is) awash in ‘garbage lending’ and unhealthy valuations….The DoubleLine Capital founder recommends a 20% cash
position to hedge against a market implosion...” *** We would stay away from private equity
and its newly discovered markets.
We will
discuss A.I. extensively in January.
* Taxable investors might want to ask tax
advisors
about how to handle the resulting capital
gains.
**J.M.
Keynes; “…Investment and Editorial”; p. 107.
***Bloomberg;
11/17/25.
1/1/26 –
Perhaps
the best place to start this discussion of A.I. is our 11/5/25 graph which shows what
are likely to be bubbles, including the “rational” bubble of the internet which
after a total loss in some companies, proved to have transformed society for
the better. Is A.I. a similar bubble, but even harder to understand? This time,
a few U.S. companies have poured billions of dollars into A.I. investments;
under the theory that if they build it, customers will come. Will these
investments eventually prove to be profitable?
Because
U.S. economic data is distorted by the hiring, and now firing, spree that the
largest companies went through after COVID, we turn towards Europe to assess
the short-term effect of A.I. The short term A.I. has a very deleterious effect
upon business services employment. One might generally think that largest
companies exist to enhance employment. In fact they,
and the CEOs job, primarily exist to enhance return on shareholder capital,
which means reducing the employee headcount expense when (advisable-possible).
Thus, as an 11/20/25 article by Bloomberg relates; in the developing
economy of Krakow, Poland, “Europe’s top location for global business
services…” The multinationals are reducing headcount due to A.I.: Heineken,
Shell, HSBC, UBS…a total of 32 companies by October,
2025.
In the
U.S. Adrian Woolridge, a columnist for Bloomberg, reports on 10/31/25,
“Employers are increasing using A.I. to standardize and measure workflows (and
to fire). There is, he relates, a choice: “to utilize A.I. as a ‘panopticon’ or
‘Put the power if A.I. into workers’ hands, and they will be able to do remarkable
things: improve the quality of their jobs by automating routine tasks but also
improve the quality of their organizations by collaborating with other
employees (to result in new markets).” It all depends on the CEO to determine
what he wants. In the future, likely both will be necessary.
An
article by the economists Mohamed El-Erian, formerly President of Queens
College at Oxford and CEO of the bond investor PIMCO (NYT, 11/20/25) says that
generative A.I. is in a “rational” bubble. Rational in that the technology will
result in the ultimate good for society; a bubble because many investors will
lose money. James Manyika and Michael Spence, of Google and formerly of the
Stanford Business School, respectively, (Foreign Affairs, 11-12/23)
write that generative A.I. has the potential to greatly enhance the
productivity of the United States. We wanted to see for ourselves what
generative A.I. could now do. We asked ChatGPT to create a product plan for a consumer packaged goods company, such as Procter &
Gamble. Here is what the program came up with:
·
The market is shifting from “big brands” to challenger
brands.” Consumers demand clean ingredients and sustainability. Social media
make it cheap for small brands to look huge. Big companies (like the drug
companies also) now buy innovation instead of building it.
·
A.I. can identify micro-trends earlier, scrape reviews and
social chatter to find unmet needs, Product development is now ten times
faster. Before R&D cycles were 12-24 months with dozens of physical
iterations. A.I. can simulate flavor profiles, shelf-life behavior, and
ingredient interactions. Predict regulatory issues and allergen risks.
·
At store level, A.I. can manage inventory, track
out-of-stocks in real time, create shelf layouts to maximize velocity, and
adjust pricing.
·
A.I. can create forecasts, not based on last year’s sales +
gut instincts, but by using 80+ variables and also
simulate disruptions. (But companies are created by “gut instincts.” We would
complement that with a thorough market analysis suggested by ChatGPT.) The
program then offers to create either a meeting slide deck or talking points.
To apply
generative A.I. well, one must be able to ask the right questions. The data
available must be FAIR to avoid garbage in and garbage out. One firm
practically describes A.I. as know your strength, “..and
use AI to sharpen your edge.” But a recent MIT survey indicates that only 5% of
companies have noted a general profit improvement. There is a real problem in
implementing A.I. in the larger firms, where top management wants to show it is
going all in on A.I., threatening the jobs of middle and beginning management.
A.I. has the potential to reduce employment (head-count)
in favor of capital (return on assets > cost of capital). The electricity
analogy, which opened up many new jobs, might not
apply to A.I., which has the potential to reduce all sorts of jobs.
Some
general points which may be interesting:
·
A.I. can make maximal use of existing data. But business
and markets also involve changes. What the changes are is more the province of
general political science rather than focused dy/dx
economics.
·
Data fed into A.I. is assumed to be FAIR, lacking bias –
assuming therefore to be objective. But bias, as a skilled marketing manager
once said, is inevitable. We believe, however, that some bias is inevitable,
and maybe even desirable. In total, however, there has to
be some balance, considering alternate points of view to retain a degree of
objectivity, More about this in another essay.
Here, as a 12/20/25
NYT illustrates, is the unfiltered output of A.I. of all relevant
documents (resulting from solutions to very large vector equations), to answer
the question: “Is (it) safe to feed a dog Honey Nut Cheerios.” ChatGPT
delivered a florid, nonsensical response (which read in part), ‘For more
inventive, yet more official and consistently fair, hound festivities, you
might consider high-fiber steam-hoofed, laced in line pick-offs
like dog’s head rattle…’ Anyone who has worked in preproduction A.I. can offer
similar examples.” What really matters for various versions of large language
models is human post-training, to “civilize” (to make humanly useful)
A.I. responses. Its human purposes, not machine purposes, that count. To the
extent that machine A.I. logic is presently not controllable by humans
is a source of great concern to many.
·
Consider a point of arcana, the origins
of the Baptistry in Florence, Italy. For the purposes of determining the
contours of the future economy, this is irrelevant. For the purposes of
Renaissance scholarship, this is important. As it turned out, it was Pope
Gregory VII. The author then ran ChatGPT, Claude, and Gemini to see if they
could discover a date discrepancy that resulted in this, “wholly new idea.” The
chatbots failed. The author concluded, “Discovery remains a human endeavor and
is propelled by the very human quality to see oddities that don’t fit patterns
and by examining them more deeply.” This is also how quantum mechanics first
developed. We would also add a curiosity to find out, “Why?”
The
Effect of A.I. on Climate Change
Is some
past relevant? What brought down the Bronze Age civilizations and trade routes
of Mycenean Greece, the Near East, and Egypt in 1177 B.C.; what caused the end
of the Roman Empire in the 5th century A.D.? It wasn’t one cause,
the Sea Peoples in the former and Elite Struggles in the latter. These were the
likely effects of greater ecological catastrophes: climate change, earthquakes
and pestilence (certainly in the latter case) that caused these civilizations
to collapse and the Dark Ages to ensue. In the present day, we believe that our
mastery of nature will ensure that we can live our lives normally. But due to
the larger natural processes involved, and certainly due to their unintended
side-effects, we are but a shrug of planet earth. The next generation would do
well to prepare for very great changes, which seem to be presently ignored, in
favor of the 1950s. Optimizing A.I. can help, but certainly not determine.
__
Portfolio Performance under Conditions of Volatility
10/24/25 10/27/25 12/05/25 12/31/25
S&P 500 6,791 6,728 6,870 6,846
Port YTD
Return* 16.87 14.03_? 18.20 19.40
Bond Return** 7.41 6.69 6.94. 7.30
S&P 500 16.68 19.92_? 18.22 17.88
50/50 12.05 13.31_? 12.58 12.59
Performance +4.82 +.72_? +5.62 +6.81
* Actual
12/31/24 S&P 500 = 5888; **Assume ^VCIT; _? Inaccurate data from an external
source.
10/27/25
illustrates that market swings are inevitable. But the performance of this
portfolio relative to the S&P 500 and a bond index is not strictly
relevant, because it is configured to produce (hedged) investible or spendable
income (cash flow) regardless of the market level. We track present portfolio
performance relative to the indices mainly out of curiosity.
A
4/4/24 Bloomberg
article by retirement economist
Allison Schrager discusses what we are talking about. Current Wall Street
practice is to maximize net worth rather than income, which one needs to live
on a day-to-day basis. Looking at income allows one to determine what will realistically
be required in the future; and how much has to be
saved, taking into account also inflation.
One
should also address the incentives involved. Our incentive is essentially buy side, we want to minimize investing and
trading expenses. The incentive of those tied to Wall Street, the sell side,
is to trade. It is impossible for those on the buy side to out-trade Wall
Street. It’s better to aim for the one to two year
mark, which is of lessened interest. Of course, one’s economic thesis has to be valid to produce long-term cash flow. This is why
we insist upon an 3% equity mark-up to the 10 year
federal bond rate, which sets the basis for what happens in the economy.
__
On
12/31/25, the S&P 500 closed at a level of 6,846, yielding a total return
of the index of 17.88% for the year. In contrast, our portfolio returned
19.40%, +6.81% above a 50/50 portfolio of S&P 500 stocks and bonds. The
long-term rate of return of the S&P 500 is presently unacceptable. As we stated
above, the performance of this portfolio relative to the indices is not
strictly relevant, because it is configured to produce (hedged) investible or
spendable income (cash flow) regardless of the market level.
The
next large portfolio change will involve a phased investment in the S&P
500, at appropriate levels. We will probably take into
account the projected contribution of A.I. to the economy, which will
result in a higher than normal S&P level. We have
shown in the following graph that the S&P 500 fails to follow the
convention of a 3% markup of the 10 year treasury rate
when the possibility of high growth beckons. We will wait for things to settle
down before committing to the S&P 500, which still has a long way to
fall.
We
show the new S&P 500 purchase points, with and without 30% A.I., for a
modified graph from our 5/23/25 entry. We use this graph because we also want
to show what the S&P 500 looked like immediately before A.I. In different
senses, Messrs. Shiller and Wall Street are both right, the former for the
longer-term market (to 2020) and the latter for the shorter-term market (when
something causing change is happening). You decide what kind of investor you
are, and therefore what analytics to apply. This is a site about long-term
investing; the present value analytics we use calculate long-term returns.
To
12/31/25
S&P
500 6846
With
30% A.I. 4264
Without
A.I. 3376
2/5/26 –
We can’t emphasize this enough. You must know what type
of investor you are. You are either a long-term investor, with a fairly settled temperament, choosing the present value
analytic tools that consider the entire course of the investment (28 years
plus), or you are short-term investor-trader, choosing the momentum driven
analytic tools that consider the course of your investment over the next year
or so. You really can’t be both, because the former will tell you to buy and
the latter will tell you to sell. Only on Wall Street, which makes a market,
can you do both. We think the mistake that Sir Issac Newton (1643-1727) and
today’s financial economists make is that they assume that there is a single
model that encompasses three types of market behavior. There isn’t. When not
much new is happening the market will act according to
the Shiller model. When something substantial is happening, the market will
tend to react according to a momentum model, such as “When the market crosses
the 50 day moving average…”
That’s fine. We have apparently described the stock
market, but we haven’t totally yet. There is a third case where something
substantial is happening, but the market doesn’t react for a long time. * From
the standpoint of stock market behavior, it is interesting to explore why this
is so. James Mackintosh is the former investment editor of the Financial Times
and now the senior market columnist for the Wall Street Journal. In a 1/19/26
WSJ article he wrote, “Here’s what should happen when you blow up the world
order and tax your closest allies, volatility and higher inflation with
pullbacks in corporate investment, (lower) stock prices and growth…In financial
theory (which we tend to assume), investors should be putting a probability on
the extreme outcome”
What in fact happened. “S&P 500 futures dropped a
little more than 1% overnight, similar to the fall in
European stocks, and gold rose less than 2%. These are hardly signs that
investors are prepping for disaster…There are four ways to justify this.”
·
First, investors may have grown inured to
trade crises.
·
Second, maybe this is the revival of the TACO
trade.
·
Third, perhaps investors can see the benefits
(of increased European defense spending).
·
…Fourth, it’s hard to imagine a new world
order, and its plausible that investors find it so
hard to price in this prospect that they just ignore it. Something like this
happened when Austrian Archduke Franz Ferdinand was assassinated in 1914.
Investors ignored it for almost a month, then when it became clear that war was
coming, they panicked-prompting a financial meltdown
in London, then the mainstay of global finance.
·
(our observation) And fifth, if you consider
the incentives of people to buy stock, and as a matter-of-fact
bank loans, investors and their City of London minders had to remain
optimistic as long as possible. (Mackintosh’s observation) “The problem for
investors is real. If they react to every event that could threaten the world
order, they would never take any risk. Get one of
these major turning points right and you make your fortune, but if you get all
the others wrong you lose big.” Most analysts will probably opt for the safe
route, figuring out next quarter’s earnings.
We think that the fifth point is crucial, for the market
is reacting early to the (eventual) positive good news of A.I. and totally
neglecting the negative fact of (certain) global warming. We will probably hold
10 percent in cash – to control the duration (risk) of our portfolio.
So what is
our strategy for 2026. We’re betting on the continued depreciation of the
dollar (due to adverse fundamentals), the consequent failure of inflation to
decrease to 2%, and the drop in the S&P 500 which is at near highs and
therefore providing low investment returns.
* The physical
sciences ultimately believe that there is a fundamental first principle that
rules the universe. In the social sciences, that is certainly not true; as the rule of law, for example, contests with
totalitarianism. But, and this is crucial, there has to be a distinction drawn between the market (where
there is more than one entity) and the person (investor) who had better act
with a degree of consistency. Thus, consider the level at which you are
speaking. In investing, we think that long-term ROI is the most important, in spite of short-term market behavior.
2/5/26 –
We didn’t expect the stock hedge between VZ and NEM, to
work perfectly, but it did – at least on 1/30/26. Maybe there was a strong
predicted negative correlation between Verizon’s Dan Schulman’s so far
successful efforts to turn the company around and President Trump’s appointment
of Kevin Warsh as the next Fed chair; we hope he will do the right thing at the
right time.
__
We couldn’t resist this short-term calculation. Our
portfolio will vastly outperform the benchmark 50/50 portfolio, if the
overvalued S&P drops further. We will further discuss A.I. in research,
footnote 10.
Portfolio
Performance under Conditions of S&P Volatility
02/5/26 02/10/26 03/05/26
S&P
500 6,798 6,942 6,831 -both Tehran and
Beirut
bombed-
Port
YTD Return 2.79 4.43 4.65
Bond
Return .40 .76 .87
S&P
500
-.60 1.52 -.01
50/50 -.10 1.14 .43
Performance + 2.89 +3.29 +4.22 -etc.-
We
were going to write about the Wall Street profit model. The much bigger issue
is that President Trump has attacked Iran, to wipe out its nuclear program, to
wipe out its Mideast terror, and to effect regime change. We anticipated
extreme outcomes from this Administration and have accordingly configured our
present portfolio (mainly) with money market cash, government bonds and a gold
miner. This is mainly due to our
training which was in political science, rather than in economics. Political
science can be about large changes, and economics is about small changes from
equilibrium. We’ll see who is right,
Trump or the previous Administrations. (We suspect it was the previous
Administrations.)
We
assumed in our portfolio that inflation would increase, profiting the price of
gold and the gold miners, in an energy intensive industry. We did not
anticipate that the Middle East would be busted up by the bombing of Iran by
the United States, and therefore the closing of the Straits of Hormuz to oil
tanker traffic. Since the price of oil will spike, the profitability of the
gold miners will be affected by, to use NEM 2025 figures, energy costs around
15% of the total and explosives an additional amount. NEM will bear slight
worrying; but since we already hold large amounts of cash, we have only
increased it by selling more NEM which is now around 6.8% of the portfolio.
We
do not, presently, anticipate additional portfolio sales because now almost all price changes
will be due to changes in the discount rate, as the Fed now has
to deal with additional inflation.
__
So
what’s happening in the Mideast; it’s the opposite of the social order that
enables businesses to flourish. A 3/4/26
NYT article says it well:
“Early
on a cool autumn morning in 2023, from a tunnel beneath the Gaza Strip, Yahya
Sinwar gave an order that sent thousands of Hamas fighters through the fence
separating the territory from Israel. That green light has reordered the Middle
East on scale comparable to the Arab Spring or the carving up of the Ottoman
Empire in the early 20th century – but not remotely in the ways
Sinwar had in mind. (As we remember, the prospect of peace between Israel and
Saudi Arabia caused Sinwar to launch the October 7th invasion in order for Hamas to remain “relevant.”)
…after
nearly two and a half years of bloodshed and upheaval the network he hoped would
ride to his rescue is in ruins. Iranian Supreme Leader Ali Khamenei was blown
up in a joint U.S.-Israeli airstrike on Saturday. The regime that bankrolled
and armed the Axis of Resistance for four decades is on the edge of
collapse-perhaps taking with it Hamas, Hezbollah and
the Houthis.
…What
none…can yet see is the shape of the thing being born. The old Middle East had
a logic, however brutal: Iran as a disrupter, America as a guarantor, Israel as
a contained power, the gulf states as the financiers of stability. What
replaces it will be decided in Trump’s whims…in Tehran’s succession struggle,
in Riyadh’s throne rooms, in Ankara’s presidential palace and in the rubble of
Gaza – where Sinwar’s great gamble ended not in liberation but in ash and
blood, and where the Middle East’s next chapter, unwritten and unpredictable,
has already begun.”