February seventeenth, two thousand twenty-five to February twentieth, two thousand twenty-five

I. Foundation 

resistance to change and hence greater dependability for the results shown in the past.

How much spending can Musk's DOGE actually cut?

In the current U.S. fiscal year, about 25% of government spending is discretionary spending; the remaining 75% is mandatory spending, including Medicare, Social Security, and interest payments on fiscal debt (Interest on Fiscal Debt).

In other words,the “Doge” team can truly control only 25% of discretionary spending.

If they are to fulfill Trump's promise not to cut any spending related to Social Security, that means only some portion of this 25% can be adjusted.

In addition, 12% of discretionary spending is defense spending. Given the current escalation in geopolitical tensions, the United States is unlikely to cut the defense budget and may even increase it further. That means, the only amount that can actually be cut is about 1 trillion dollars in non-defense discretionary spending (Non-Defense Discretionary Spending)

This also means that Elon Musk's initial pledge to cut 1 trillion dollars in spending is, in practice, unattainable. If they really leave mandatory spending untouched, there will be little left to cut.

Bloomberg's own model currently estimates that the final result will be cuts of about 4000 hundred million dollars per year.

Bessent once mentioned the Grace Commission, an investigative body established by Ronald Reagan in 1982 to study ways to improve government efficiency and reduce fiscal spending. The commission's final report (the Grace Report), expressed in today's dollars, recommended reducing fiscal spending by 1.3 trillion dollars over three years, or about 4000 hundred million dollars per year.

If Bessent can achieve this, it would actually count as a major success (his pledge was to cut “1 trillion dollars,” but he never explicitly said “1 trillion per year.”

A reduction of 4000 hundred million dollars is equivalent to 40% of non-defense discretionary spending. It could bring the federal debt-to-GDP ratio (Debt-to-GDP Ratio) down from the current baseline forecast of 130% to about 100%. In other words, compared with the baseline forecast, the debt-to-GDP ratio would fall by 30 percentage points.

2025.02.17

A better indicator for capturing China's macroeconomic changes

Compared with export and import data, high-frequency measurement of domestic economic activity is more difficult, particularly since the quarterly GDP estimate using the expenditure approach has not yet been released, and relevant consumption and investment data have gaps. For example, retail data cover only part of consumer spending, while fixed-asset investment data are reported in nominal terms and are defined differently from investment in the national accounts, among other things.

It is precisely these data gaps that lead investors in the market to question the growth figures reported officially.

To address this issue, GS developed a monthly GDP proxy indicator based on the composition of imports. The indicator is constructed as follows:Using China's input-output tables, it matches different categories of import data with consumption, investment, and export demand to infer the level of domestic economic activity.

Trade data are used because they are generally more reliable and transparent than official macroeconomic data such as GDP, since they are compiled not only by China Customs but can also be cross-checked against export data from trading partners.Cross-checking also makes it easier to detect data discrepancies.

At the same time, because Export data are updated frequently (released every month), making it possible to create monthly real GDP proxy indicators that are more frequent and timely than quarterly GDP。The monthly indicators constructed capture cyclical fluctuations more effectively than quarterly GDP, better reflecting short-term economic fluctuations and showing greater sensitivity, particularly at turning points in the economic cycle.

This tracking indicator shows, Domestic consumption and investment are far more volatile than official data suggest, while the periods of relative strength and weakness are broadly consistent with other alternative indicators constructed in the past. GS also validated this methodology, first by constructing similar import-based domestic demand trackers for other emerging market economies (such as Brazil, Mexico, and India). The results showed that these indicators captured historical consumption and investment growth cycles well, further validating the method. In addition, China’s monthly proxy for domestic demand growth is closely correlated with listed companies’ total revenue growth, further supporting the method’s soundness.

Figure: Investment in China is far more volatile than consumption

However, the tracking indicator constructed using this method also has certain limitations:

1/ The correlation between imports and domestic demand is imperfect:Some sectors have low import content, limiting the informational value of the inferred domestic demand. Some imports (such as commodities) may reflect marginal demand more reflect marginal demand, rather than average demand, making the estimates more volatile。

Figure: The ultimate sources of demand for imports vary significantly across sectors

2/ Overreliance on goods data and inadequate measurement of services: the method’s heavy reliance on goods-sector data does enable it to perform well in tracking emerging market demand(goods make up a large share of domestic demand), and to be relatively accurate for investment and consumption (investment is more goods-intensive than consumption).

But because services-sector data are limited, this method is less effective at capturing services consumption, for example, it performs poorly during periods of domestic demand fluctuations led by services demand (such as reopening after pandemic lockdowns), and may underestimate domestic demand growth when the composition of import demand changes (for example, China’s reduced reliance on imported intermediate goods in 2007-2017)

3/ Unable to distinguish final demand from inventory accumulation: imports may be used for final demand or may enter inventory, so this method cannot accurately distinguish between the two. This limitation is especially pronounced given China’s strategic stockpiling in recent years.

See further reading for details on the indicator’s construction:

Through the Looking Glass- Inferring China's Growth from its Import Mix

I’ve posted everything on Knowledge Planet; feel free to get it.

2025.02.17

II. Insights 

Our Viewpoints and ideas on market.

A not-so-optimistic 3-3-3 plan

The United States is currently at full employment, so GDP growth is mainly determined by two factors: labor force growth (Labor Force Growth) + productivity growth (Productivity Growth).

The United States is carrying out large-scale deportations of workers, which is effectively lowering labor force growth. Two structural factors also mean that the U.S. labor market will not grow in the coming years:

1/ Mass deportations of immigrants 2/ Acceleration of Baby Boomer retirements

This means that to achieve the planned 3% GDP growth, all growth must come from productivity..

However, even with good productivity growth, it may only reach 1.5% - 2%, meaning 3% economic growth cannot be achieved under the current policy framework.

Second, the deficit problem is also discouraging.

On the one hand, slower GDP growth will reduce tax revenue; on the other, Baby Boomer retirements will automatically increase benefit spending, such as Social Security and Medicare. For more on this, see 250217 How much spending can Musk’s DOGE actually cut?

The Trump administration has made clear that it will not cut Social Security or Medicare spending + low-interest debt issued over the past few years is about to be repriced, causing debt interest costs to rise sharply.At least for now, the “3-3-3” plan is still just a clever slogan, and the likelihood of actually implementing it is quite slim.

They will have to come up with other measures.

2025.02.17

Micro-driven factors will persist

Pair this note with 250218 excess HF vs. 60/40 Read them together.

In 2024, annual return dispersion for the S&P 500 widened to 70 percentage points, reaching its highest level outside a recession since 2007.whereas Higher return dispersion generally signals a more favorable environment for stock-picking. In 2024, return dispersion was above its historical average in 6 of the 11 sectors. The increase in return dispersion was driven by lower correlations among individual stocks and higher stock-level volatility.

Over the past 6 months, the average realized correlation of S&P 500 constituents was just 0.2, at the 6 percentile of data from the past 20 years. Options-implied volatility and correlation indicators both show that This high-return-dispersion market environment may persist.

Since the beginning of 2023, the market’s micro-driven characteristics have been markedly above the historical average.Over the past 6 months, among the returns of S&P 500 constituents, 74% came from company fundamentals rather than macro factors (macro factors), compared with an average of 58% over the past 20 years.

The micro-driven market environment is likely to continue in 2025, for three main reasons: first, the economic growth backdrop remains solid this year; second, the continued development and application of artificial intelligence will intensify differentiation among individual stocks; third, Policy uncertainty remains high, and discussions concerning trade, taxes, fiscal matters, and other policies may become catalysts for return dispersion.

Further reading:

250205 Reconsidering political noise and the ultimate performance of assets

241031 Micro performance outweighs macro politics in the U.S. equity market

2025.02.19

Ukraine reconstruction

This article provides some further explanation of the investment theme of Ukraine’s reconstruction:

The European building materials sector has outperformed the STOXX600 index by about 7% year to date in 2024, mainly benefiting from market expectations for a peace deal and Ukraine’s reconstruction. Overall, expectations are that 1/ local market demand in Ukraine may grow by 40%, benefiting both local companies and imported materials; 2/ the incremental demand will have a limited impact on the EU construction industry as a whole, with construction spending potentially rising by 0.5-1.0%; 3/ compared with other building materials, cement will be the main beneficiary category, although EU cement production is constrained by the reduction in CO₂ emissions allowances.

In terms of earnings impact, A decline in EU energy prices could be a key variable.

Energy costs currently account for about 40% of EBIT in Europe’s building materials industry.However, companies’ ability to pass cost changes on to customers depends on local supply and demand conditions. Since the EU energy crisis, most companies have maintained historically high price-cost spreads through price adjustments.At the individual-company level, HEI and ROCK are the two companies with the highest energy consumption and the greatest exposure to Eastern European markets

How much could Ukraine’s reconstruction boost demand for building materials?

Current foreign estimates suggest that Ukraine is expected to invest 100-200 hundred million dollars annually in reconstruction, which would mean domestic investment in Ukraine increasing by about 42%. For comparison, this increase is about 0.5-1.0% of current EU construction spending (EU-18, 2024 data). Compared with the World Bank’s estimate of 4860 hundred million dollars in reconstruction needs, this estimate is relatively conservative, mainly because Some damaged areas of Ukraine remain occupied, and some industries affected by the war may struggle to recover in the future.

In terms of building materials demand, the U.S. Agency for International Development (USAID) estimates that Ukraine’s reconstruction will require about 620 hundred million dollars’ worth of building materials. If spread over 10 years, this demand would represent an increase of 40% over Ukraine’s prewar average annual demand for building materials (160 hundred million dollars). However, supply chain bottlenecks (availability of materials, equipment, and labor) could be a constraint.

Which building materials will benefit the most? Cement will play a key role in Ukraine’s reconstruction because Cement is a core material for repairing buildings and infrastructure. As of 2024 1, damage to housing and infrastructure accounted for 37% and 23% of total losses, respectively.

Public data indicate that Ukraine’s cement demand could rise to 1400-1500 ten thousand tonnes per year during reconstruction, compared with current annual demand of about 900 ten thousand tonnes, an increase of 40%. The USAID estimate is based on data from 2022 11. As war damage accumulates (the Kyiv School of Economics reports that losses increased by 16% from 2022 11 to 2024 1), forecasts for future cement demand may be revised further upward.

Which companies are most affected?

Building materials are typically produced and consumed locally, and listed building materials companies have roughly 5%-20% exposure to Eastern European markets. According to USAID data, as of 2022 11, local Ukrainian producers can supply 90% of the building materials needed for reconstruction, the government estimates their total value at 628 hundred million dollars.

As for cement, Ukraine’s current cement capacity is 1800 ten thousand tonnes per year (about 50% of which is operated by CRH), theoretically enough to meet demand growth, although imports may still fill part of the gap. Notably, plants subject to the EU Emissions Trading System (EU ETS) may be less willing to export because of higher CO₂ costs.

From a supply chain perspective, Turkey is well positioned to export cement to Ukraine: it has ample capacity (1.53 hundred million tonnes), domestic consumption of 6900 ten thousand tonnes, export capacity of 3100 ten thousand tonnes per year (2021), and low production costs. In 2020, Ukraine had already imported about 100 ten thousand tonnes of cement from Turkey, accounting for 97%.If Ukraine increases cement imports from Turkey, U.S. cement prices could benefit, since Turkey is the largest source of U.S. cement imports.

What would be the impact of lower EU energy prices?

If a peace deal is reached in Ukraine, the building materials industry could benefit from lower EU energy prices. Building materials manufacturing is energy-intensive, with energy costs averaging 11% of sales (2023), and having a greater impact on EBIT (about 40%).

It should be emphasized that from fiscal year 2023 through the first half of 2024, despite lower energy prices, producer price indices (PPI) for most building materials (except EU flat glass) remained stable or increased.For cement, prices were previously supported at high levels by carbon costs, but cement margins are currently at historical highs. If CO₂ cost pressures ease, smaller producers or foreign importers may re-enter price competition.

In addition, the modest economic growth following a ceasefire in Ukraine (Eurozone GDP growth of 0.2-0.5%) would benefit cyclical building materials stocks。

2025.02.20

III. Market Pulse 

Our latest Comments on the economic and market environment

Excess return: HF vs. 60/40

The higher interest rates and greater market volatility of the post-COVID era differ substantially from previous cycles, and this situation is likely to persist for a long time..

The period from 2015 to 2019 marked the second half of the “secular stagnation/new normal” era (the federal funds rate averaged about 1% over these five years).During this period, a basic 60/40 stock-and-bond portfolio generated an average annualized return of +6.1%.

Over the same period, hedge funds returned +4.8% on an annualized basis.

Next, consider the five years from 2020 to 2024:

The average return of the 60/40 portfolio fell to +5.5%.

By contrast, the average return of hedge funds rose to +9.3%.

The 60/40 portfolio’s return fell from 6.1% to 5.5%, while hedge fund returns rose from 4.8% to 9.3%.

Further reading: The Current State of the Hedge Fund Industry and the Outlook for 2025

I’ve put all the materials on Knowledge Planet; feel free to get them.

2025.02.18

Note: All content in this article is for reference only and does not constitute investment advice or serve as a basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as a basis for their decisions.