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1) The SMCI Debacle
 SMCI has been one of the darlings of the AI boom over the last few years. But earlier this week they announced some, um, accounting “irregularities”. Not great. Now, I don’t know the specifics of the troubles there, but one thing I highlighted earlier this year was the strange addition of SMCI to the S&P 500 in March. SMCI was added despite having qualified for the index for just a few months. I (somewhat) jokingly wrote that the S&P Committee was making a highly subjective and “active” decision there.It’s not a huge issue for such a diverse index, but for nerds like myself, it really highlights the active nature of indexing. Despite having a largely systematic process there is an inherently discretionary aspect to which they add and remove certain firms. One criteria that is absent from the systematic process is the time horizon over which a firm must qualify for certain criteria. SMCI was strange because it would not have qualified for the S&P 500 in December of 2023, but then a few months later it did qualify and was injected into the S&P 500 almost immediately. I’ve often alluded to the idea that the S&P 500 is like a momentum fund in that it adds and subtracts firms as they grow and shrink. But the interesting thing about a proper momentum factor is that it adheres to a relatively systematic inclusion process where new additions to the strategy would need to exhibit momentum over 12 months. SMCI met no such criteria and only qualified for the index for a few months. And so here we are with a stock that was haphazardly added to the index that is now down 70% from when it was added just 8 months ago.Does it matter? Not really. The S&P 500 is such a diverse fund that nitpicking over things like this isn’t meaningful, but it is an interesting thought process when considering the systematic or active nature of how index funds work. 

2) Heterodox Economics and Bad Accounting
 Speaking of bad accounting – there was an interview floating around Twitter with MMT advocate Stephanie Kelton arguing that the national debt isn’t worrisome. Stephanie always makes some excellent points and regular readers here know that she’s right about a lot of things including:– The national debt doesn’t get paid back like household debt – The national debt isn’t inherently worrisome, just as no debt is inherently good nor bad. But Kelton and the MMT people are notorious for sloppy accounting and this is a great example of taking a salient point and going too far in the other direction. In the interview, Kelton argues that the national debt is part of national “wealth”. Oh boy.Let’s think about this as though the govt just prints money rather than bonds. If the govt rolled out a wheelbarrow of $100 bills and handed them out would you claim that the recipients of those Dollars are now “wealthier”? You might think so from the perspective of the people who received those Dollars. But in the aggregate, the US economy is not necessarily wealthier at all. In fact, it’s very likely that those Dollars just create inflation and actually make us poorer in real aggregated balance sheet terms. And that’s the slippery trick being played here. Kelton is acting as though the government’s liabilities are no one’s liabilities. It is as if our government is some sort of Martian entity. In reality, we are all very much liable for government debt in real terms.It’s like looking at corporate debt issuance and saying “Corporate debt is non-corporate debt so we should think of corporate debt as non-corporate wealth”. This is obviously wrong since the corporations are owned by the people in the non-corporate sector. If corporate debt dilutes corporate value then we’re worse off in aggregate, not better off. And the same basic thing is true at the government level. You might not be born with a national debt balance on your balance sheet, but you are very much liable for helping fund the viability of the government’s balance sheet, and to the extent that govt debt is harmful it will dilute your wealth via inflation. Asset creation always creates corresponding liabilities. Balance sheets balance. Wealth is the residual of assets minus liabilities and you can’t just print wealth into existence. What matters is how we use the printed assets/liabilities and whether they’re used to create wealth. But don’t be mistaken – printing the national debt is definitely not printing wealth any more so than corporate bond issuance should be described as “wealth creation”. 

3) Margins, CAPE and the Future 
 I was in NYC this past week attending the Astoria Portfolio Advisors conference and an interesting topic came up between two smart panelists, Adam Parker of Triumvirate and Ken Suzuki of Richard Bernstein Advisors. Ken was discussing CAPE and corporate margins and during the Q&A I asked Ken what would make margins fall or whether we’re underestimating the potential that margins (and CAPE) could go much higher. Ken argued that margins could shrink for several reasons including:

Adam Parker did not like this answer. Adam was much more optimistic and argued that CAPE and margins could move higher as AI and corporate efficiencies increase. What a great debate. I don’t know who is right. I don’t think an era of high inflation is head of us. And I also don’t think labor will suddenly start to hurt capital significantly. But I am also not sure how much AI will really accrue to margins. I probably lean a little in the Parker camp, but if I had to guess I’d probably argue that both of these positions are overstated.More By This Author:Nvidia, Rising Rates And Recession Risk We Need To Have A Talk About “Bond Vigilantes” Weekend Reading – Booms And Brats