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.
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 add: value 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.
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.”
__
The
Iranian leadership has already chosen the son of the late Ayatollah as the next
secular and spiritual leader of Iran. (Unlike the Sunnis, the Shiites believe
in bloodline succession from the prophet Muhammed. *) If anything, he is even more radical than his
father. Bombing has killed his father, the leader of the country, his wife, his
daughter and son-in-law, daughter-in-law, and grandchild . This does not sound
like one who will be amenable to compromise.
How
does a radical Iran intend to survive in the Mideast?, by continuing to
disrupt. In the current Foreign Affairs magazine, University of Chicago
political scientist Robert Pape wrote, “ Why Escalation
Favors Iran.”
To make a long story short, look what happened in Vietnam.
The
above causes us to believe that the war could last a while, constricting
petroleum supplies. We sold some more NEM, down to the basic. The Obama
administration had hoped that at end of the nuclear accord in 2025, Iran might
have begun to evolve into a more normal society. We think the reverse has
occurred.
*
To add an inevitable complication: the late Ayatollah did not want his son to
succeed him; but the son was chosen because, among other things, he had the
support of the radical Iranian Revolutionary Guard.
__
We
hoped that deriving the present value of the S&P 500 would solve, once and
for all, the equity valuation problem. Instead, we ended up illustrating that
the equity markets are easily capable of overvaluation (and presumably
undervaluation).
The
S&P 500 likely trades at an equilibrium present value only when not much is
happening, or when the S&P cyclical earnings cancel out over long periods.
We tend to buy stock when the market reaches its present value or below, for
that enables a comparison of equity returns with bond returns. However, our
sale decision requires both overvaluation and judgement. The later should make Wall Street happy, but
their answer is usually to trot out permabulls or permabears. In any case, our
next challenge is to lock in the S&P 500 at around its then present value.
The benchmark performance of the portfolio will then be 50% corporate bonds and
50% S&P 500.
__
Our
portfolio value (on 3/19/26) is now almost (but not entirely) determined by how
general interest rates change. Since we are holding lots of cash, we have cash
buffers that can either be used to fund years of spending or (if appropriate)
years of cash flow accumulation.
The
time to buy stocks is when there is blood red ink running in Wall
Street. A left-brained statement would be, “U.S. equity returns should be available
at a decent markup to bond returns.”
4/9/26
-
In the Mideast, all sides seek revenge at perceived
“injustices”. Most obvious is the issue of Palestinian statehood, a problem
that both sides cannot resolve because there are so many “injustices” in
between. Now add to this, the new problem of Iran’s existence. The Iranian
government now wants, or more accurately has, control over the Strait of Hormuz
and therefore the world economy. The U.S., by only bombardment, has achieved
none of its major political goals: regime-change to get a more moderate government
and Iranian nuclear disarmament. What we have in the Mideast, now peppered with
problems, is another really big problem – a radical regime in effective
control of the world economy.
This is why we have invested in Occidental Petroleum, a
major U.S. based oil company. In spite of short-term fluctuations which could
have resulted in even lower acquisition prices, the Permian Basin based company
should benefit from higher international oil prices over the longer run.
According to the company, 82% of its energy reserves is in the United States.
The stock price x the number of shares approximates the present value of its
proven reserves and therefore the stock price approximates the current price of
oil/barrel.
From our experience and speaking also as one educated in
the more general political science: If you assume that humanity is bad, the
result will be inevitably bad. If you assume that humanity is good, the result
may be ultimately to the good. You get what you assume.
4/16/26 (a) –
This website has been about portfolio structure and also,
as events have turned out, about our own portfolio. Company accounting reflects
both the stock and the flow of transactions, the balance sheet and income
statements. In our website, and in our own portfolio, we have emphasized
long-term cash-flow. Our emphasis on the second implies a long-term view of our
portfolio that goes beyond trying to maximize short-term net worth, under the
assumption that the long-term is a succession of short-terms and that the
market is always correct in its evaluation of prospects.
We obviously assume that, in the short-term, the market
can be wrong. This is in accord with the market wisdom that there are times
when bad news is good news; and there are times when good news is bad news. The
average career in Wall Street is about seven years; and those who now mold
opinion may have experienced only positive markets (after 2008-2009). The
market has therefore valued the effect of A.I. on S&P earnings immediately,
and has now further assumed that the Iraq war has been settled, resulting in
business as usual. The jury, however, is still out as to who will ultimately
benefit from rapidly-advancing A.I. models and data. The Iranians through their
control of the Strait of Hormuz do seem to have a choke-hold on the world
economy. We do not think too optimistic Wall Street is correct in both cases
and prefer to structure our portfolio for actual cash flow (dividends and
interest).
add: We have attributed
market irrationality to an inappropriate market valuation of A.I. A 5/1/26 FT
article by Gillian Tett goes further. Quoting a psychologist,
“The symbolic language of market anthropomorphism…simplifies complexity and
offers a narrative framework for investors and the public to understand
chaos…What we perceive is not a ghost in the machine but a reflection of
ourselves – our fears, hopes and world views – projected on to a complex
system.” On the other hand, we believe the market, at times, is a rational
place; and one ought to invest one’s hard earned cash assuming rationality.
After citing four explanations of market irrationality, Tett writes, “Of
course, there is a fifth possible explanation of this rally too, which is often
muttered by regulators – namely this really is just a bubble that will
eventually pop. More specifically the new mantra about resilience might also be
interpreted as a pattern of complacency and ignorance; or, perhaps more
accurately as a dangerous consequence of a trifecta of the acronyms: Tina
(There is no alternative to stocks.), Fomo (Fear of missing out), and Taco (about
Trump)….So which of these five frames is correct? If we return to Graham’s
mantra that the stock market is a (short-term) “voting” and (long-term)
“weighing” machine, then it is possible that all five explanations will prove
true….but when analysts weigh the longer-term risks, there is likely to be a
future correction. Such is the nature of economic and market cycles.” QED
add: If we could just
comment on the difference between bank loan lending and equity investment. In
bank lending (when we were a credit officer), it is possible to be almost
perfect because there are fairly ample margins of safety to work with. We might
add that NY banks, at the time, were leveraged almost 20:1, so you had better
be ex ante perfect. At Chase Manhattan, we learned in a wholesale
environment how to be both fast and accurate. In contrast, it is not possible
to be almost perfect in equity investment. Equity is one notch lower on the
balance sheet, and thus subject to the vagaries of all sorts of things (as is
obvious). It is thus possible to be only approximately correct, a state
of affairs exacerbated by the uncertainties of how A.I. will ultimately
develop.
Our goal is to achieve a low maintenance portfolio that
will ultimately also include add: a properly priced S&P 500 index
fund. The traditional 60/40 or 50/50 portfolio that has well-reflected the
growth of the U.S. and international economies in the past may not serve
investors as well in the future, because of increased inflation. This is why we
have also added some provisions for inflation, which we may still adjust
slightly in the future. Ultimately, the real value of your portfolio depends
upon politics, the nature of administrations and the Fed Chair. We hope that
the American people will choose well.
4/16/26 (b) –
12/31/25 6/30/26 Calculation
S&P
500
6846 7499
With 30% A.I.
4264 4360 1.263 x the below
Without
A.I.
3376 * 3452 +38 S&P points/quarter
* This figure is
calculated from the last public dataset that S&P will make available, since
Howard Silverblatt is retiring from S&P. Our use of the data involves the
ten year average of S&P 500 operating earnings. Since the actual trading level
of the S&P 500 is far from its calculated equilibrium level, add:
the S&P 500 being highly susceptible to excursions, we can safely assume
equilibrium trend lines for the next couple of years.
4/27/26 –
The purpose of these postings is educational; we think
these postings are an opportunity to learn about the always fascinating market.
We have sold half our position in OXY at around $57.84.
In the short-term, the stock may further appreciate if the cost of WTI oil
increases beyond, say, $100/barrel. But in the medium term, the downside is
very large if the world falls into recession, due to the demand destruction of
too high-priced oil. The U.S. has been greatly disadvantaged, in all senses, by
the now open-ended Iranian war. Our stock portfolio is basically configured for
the medium-term of add: more than one year.
5/8/26 –
We hope to sell the other half of our position (1.80%) in
OXY. The stock is also an interesting case of market behavior. The value
of the stock is determined by the present value of its WTI petroleum reserves,
The near futures market prices for Brent crude is around $110/ barrel. But,
former Biden Mid East advisor Amos Hochstein says, “$110 of Brent oil is only
available on a Bloomberg terminal.” Real spot prices are around $145-$170.
Sooner or later the stock market price and the real market price will converge,
but not yet.
Should we have bought OXY? Still, maybe not. Here is a
quote from an oil trader:
“It’s so uncertain and the outcomes are so binary that
people just retreat from the (oil) market.” As it has turned out, the 5/7/26 Washington Post
reports a CIA estimate that Iran retains an estimated (sic) 70% of its
inventory of missiles.
Now that we are invested OXY, as things have turned out in
Iran, we are probably and, unfortunately, appropriately invested in more
Iranian strife. Danny Citrinowicz is the former head
of research and analysis for Iran in the Israeli Defense Forces’ intelligence
unit. In the April
29, 2026 Foreign Affairs, he points
out that Iran is not like Maduro’s Venezuela which was a brittle,
leader-centric system subject to easy change. (Iran was more like a
decentralized layer-cake with power was held in a more diffuse (Shiite) way.)
By assassinating the leader Khameni and the immediate family of the present
leader, the U.S. paved way for the ascendence of the radical Islamic
Revolutionary Guard.
In a nutshell, both sides feel that they have won in Hormuz;
and the U.S. side feels it has won because it always had. In the case of OXY,
its present value is only a very, very rough guide. Again, the decision an
investor has to make is what game he wants to play.
_
The price of an A.I. stock should be in accord with its
present value. But, as we have seen on 2/5/25, the price of A.I. is way in
excess of traditional economic measures. The market, it currently seems, values
A.I. as if there will never, ever be a general economic downturn.
This can’t be true. Research 11 will indicate, in a more
justified assumption, A.I. will have impact in the indefinite future. We assume
A.I. growth will be twice the economic rate and that the rest of economy, also
burdened by climate change but also benefiting from A.I., will grow at
traditional rates. We can then determine a reasonable value for the S&P 500
A.I. economy, which is around 4356. A.I. will be important, but at a lower
price than at present. The S&P is currently at 7393.
When it comes time
to buy the S&P 500, the best that we can hope for is to be approximately
correct. We will purchase the S&P 500 at around A.I. equilibrium, but are
also aware that “equilibrium” can be the average mathematical result of very
wide market excursions in both directions, as is obvious.
5/16/26 -
We will eventually sell our remaining holding in OXY.
Having done that, for us, portfolio management is just a matter of waiting for
the S&P 500 to reach a reasonable price and long-term return, presently
around 4356, and watching the paint dry until then (read our 4/16/26 (a) post
for the reason). A portfolio manager once said that he is a patient buyer and a
patient seller. This is good advice for the buy side.
In the meantime, we hope that you have found the market
fascinating, as we have, because it really is.
5/18/26 –
We have sold our remaining holding in OXY at 59.67.
Considering the downside of oil prices, we will not subject our investment to
the inconsistencies of U.S. Mideast policy. You don’t create a durable
international order by switching policies every few days; even deals depend
upon a stable infrastructure of shared values.
6/1/26 –
The S&P 500 closed at a record 7599.96 on this date.
We respect A.I., but…
On 6/5/25 we bought slightly more VZ at 45.20. The
financial market seems to be excised about possible competition to FIOS from
SpaceX’s satellites. Satellites are a high-cost internet niche market, not
applicable to densely populated urban areas.
6/27/26 –
We ought to comment upon the overvaluation of the S&P
500, which on a trend basis on our 4/15/26 posting, will exhibit a long-term
return of only 3.21% and on an A.I. basis will return 4.05%. A Silicon Valley
entrepreneur once commented that in the capitalistic system, where you are free
to succeed or fail, “many fall by the wayside.” This is, in fact, the opposite
of how we invest, for we prefer established companies, with more or less
predictable earnings and cash flows. Don’t all companies have audited financials?
Not in the start-up phase, as was re-emphasized to us by a Silicon Valley
manager.
In fact, the current market infatuation with A.I. is
founded on a different basis, as Gemini pointed out on 6/27/26. Momentum-driven
A.I. affords the user a “chunky” experience. In one simple example we saw,
Claude code for the Raspberry Pi 5 ran only on a Safari browser, and not
otherwise. Gemini notes, “You are experiencing the reality of a micro-level
user experience while the stock market is trading on the macro-level
structural landscape. Markets aren’t necessarily blind to the fact that
current agentic tools can be slow, expensive, and prone to breaking. Rather,
Wall Street prices assets based on a completely different set of incentives,
timelines, and structural realities. The gap between market enthusiasm and
“chunky” implementation comes down to several different factors. Directional
momentum driven markets (in this case), Infrastructure (as a moat), Asymmetric
upside (in case things work out, the effect of cracking the code of
intelligence will be riches) and Fear of Missing Out (FOMO).” The field of A.I.
is also a demonstration of human foibles.
How is generative A.I. actually useful?
Actually, it is. The 6/29/26 FT contains an article titled “How AI and an
astronomer’s laptop can bring new galaxies within reach.” AI can enhance the
scientific return of archival data sets. AI will also be used to discover new
objects in the new Vera Rubin 3bn pixel camera. On the whole astronomers are
using more specialized AI tools then the generative AI and large language
models from companies such as Anthropic and Open AI that have caught the public
imagination. Do you need a general purpose system to answer a specific question
in astronomy? In many cases not. Astronomers continue to develop and use
specialized tools for the research (add: business is the opposite,
where the programming tools of generative A.I. can be more integrated with the
four statistical models that, when properly used, allow for proper
generalization). In astronomy, generative AI will improve efficiency. For
example, “…it will help us to design user interfaces for our instruments, work
online with colleagues around the world and also carry out intricate work on
optical systems…”
As the 4/16/26
(b) posting illustrates, stock returns are presently horrendously
overpriced relative to bond returns. We would wait for a large market A.I.
drop before purchasing the S&P 500 at around the then calculated price.
_
Commenting on the large 9 % drop in Verizon due to its
exclusion from the Dow Jones Averages and continuing worries about SpaceX
competition: the fundamentals of the Verizon remain improved due to: cost
cutting, a bearable international telecom chargeoff,
a simplification in its consumer offerings. SpaceX satellites do not beat
fiber on speed, latency, reliability and cost. We ran some very general cost
numbers for SpaceX (Starlink) and Verizon. Satellites cost about three times
more per subscriber than does fiber, and are not applicable for high density
urban and suburban applications. add: The new Starlink v3 satellite
offers as much as 1Tbit download capacity, which allows the creation of many
more user cells to increase download speeds up to 10x. But the problem is that
the satellite connections do not penetrate concrete skyscrapers, thus the main
users of the service are transportation, rural, and (maybe increasingly)
suburban. The satellite business does not threaten the core business of
Verizon; but possibly limits its expansion, therefore management’s drive to
reduce costs.
7/5/26 – Larry
Fink, CEO of BlackRock, an investment company, said the solution to America’s
fiscal problems is real long-term economic growth at 3%, rather than 2%. Economic
reforms are necessary. He seemed to be less forthright about the ultimate
demand for A.I., saying that there are many supply chain issues that serve as
bottlenecks. Considering the above, A.I. betting and possible disillusion, the
presently generous valuation of A.I., the fact that a steady 2% growth of the
U.S. economy already includes the major effects of electrification, radio,
computers and the railroads (the saying at the time went: “The investors left,
but the railroads stayed.”) – what is the proper level of A.I. for long-term
investment? The best answer we can come up with now is, “we’ll see,” about this
present deal transaction.
7/11/26 -
To Excerpt This Site’s Legal Disclaimer:
Horizon is a value investor. We cannot know whether our investment
strategies are suitable for any investor’s unique financial circumstances.
Investors are encouraged to consult with their legal, accounting, or financial
advisors to formulate their appropriate exposures to the equity and bond
markets.
7/29/26 –
I should eventually add suitably priced S&P 500
index funds to my accounts. It is hoped that the projected returns, levels, and
the amounts of this fund will be suitable for me. Probably one account will
remain mainly for current income; and the other will be more for capital
appreciation over time.
We shall also comment upon what value investors seek.
Economists believe in perfect markets, and are opposed
to monopolies. In the U.S. economy (with the exception of
the regulated public utilities), there are very few monopolies. In capitalist
economies with free market entry, new competitors tend to compete away
excessive profits. In large capitalist economies, the most common state of
affairs is industry “oligopoly”, say three large competitors with some pricing
power. What value investor’s look for is some moat, a market position that
confers an ability to maintain or improve margins. Against this are the forces
of Schumpeter’s “creative destruction.”
GO TO EARLIER POSTINGS (suggested)