This note is about how to play the investment game given what's happening now.

Imagine that you’re playing a game like bridge, poker, backgammon, or chess and have to make your move, and you have a computer that works with you to assess the circumstances and suggest a move. That’s what playing the investment game is like for me. Whether or not you have a computer to help or not, I believe that you should:

I have been playing the investing game for a long time and my goal at this stage is to pass along how I’d play it—and beyond that to create a platform that all sorts of people can use to explore playing the investing game anyway they want to play it to learn, see how they would have done, and to do it well. I believe that there are right and wrong ways to deal with the hand that one has been dealt, so, when encountering XYZ configuration of circumstances, you should ask yourself, “How should I bet given that configuration of circumstances?” and be able to come up with good answers.

I now want to pass along what the existing characteristics of the market look like to me and what I think should be done (and I am actually doing) in light of them.

What are the most important circumstances today and how should one place one's bets in light of them?

It appears to me, and probably to most everyone else, that we are now in a market environment in which a very limited number of companies in a sector characterized by remarkable new technologies (mostly AI) are dominating the market action. These companies constitute a high percentage of the market cap and are having a huge effect on the markets and economy. As with all such times, there is a great deal of excitement, uncertainty, and volatility concentrated in the new technology sector, which are being passed through to the stock markets around the world. So, the swings and uncertainties around this sector matter a lot.

There are also other big uncertainties related to other big, important drivers, which are what I call the five big forces: 1) what's going on with debt and money, 2) what's going on with political and social issues that can have big effects on taxes (and other politically-driven influences on markets), 3) what's going on with geopolitical influences on the markets (such as the wars), 4) what's going on with acts of nature, and 5) what's going on with new technologies. I plug those circumstances into my investment system which thinks about how to place my bets in light of them while I simultaneously do my own thinking about what to bet on.

When thinking about how to place ones bets given these circumstances, the most important question to ask and answer is do you want to: a) bet on the new technology even more than is imbedded in the broader stock index (e.g., the S+P 500) by overweighting this new sector or a few companies that you think are the best ones in that sector,  b) keep your exposures at about index weights, or c) diversify away from that concentration?

While just about everyone wants to buy the best investments and strives hard to do that, and there is this new technology that appears to be changing just about everything. History shows that most everyone has failed by putting a high percentage of their chips on the few stocks of the leading companies producing that technology at this stage in the cycle. That is for logical reasons that have always played out in the past. While this new AI technology is unique, there have been many new unique technologies that were analogous to look to as a guide. One should look at them and, if one chooses to ignore them, have good explanations for why this time is different.

All the past cases of great new technologies have played out in the same ways for the same logical reasons. High risks with great uncertainties are intrinsic to these new technology companies. When we look at how they performed in the past under this configuration we see that even the best revolutionary new technology companies that prospered in the long run (e.g., Microsoft and Apple) got annihilated at similar times along the way, and that, at the time the new technology companies came along (rather than in retrospect), it wasn’t easy to say which ones would succeed and which would fail, like IBM. If you look at all those cases, you can see that it is in the nature of remarkable new technology companies to have highly uncertain futures. For example, they either over-invest or under-invest. That’s because they will certainly lose if they don’t invest well enough to win, and they can’t possibly know what’s going to happen precisely enough to know whether they’re over-investing. Over-investing or under-investing is costly.

Also, they can’t possibly accurately anticipate all the changes in all the things—including the exogenous ones like the tightening of money, wars, and big changes in taxes—that are going to affect them. So, they all go through big up and down waves that first excite and then scare the hell out of and shake out the weak investors, which leads to exaggerated market swings. Further, just as these new technologies and new technology companies were disruptors to those before them, most of them are eventually disrupted by newer technologies and newer technology companies in ways that are impossible to consider, so we should consider the risk that the same thing could happen to these new technologies and technology companies. The implications of quantum computing are some of the known knowns that one might consider. What about the ones that haven’t yet been imagined?

And what about the risks coming from competitors? For example, China is producing and distributing AI technologies, and Chinese policy makers have a whole different view of economics and AI. We are in a new technology war that leaders believe that they must win. Their view of AI and its effects on the economy and people’s well-being lead them to make it available free or inexpensively because the technology has such a productivity benefit and can raise living standards for the whole. As they see it, profits are less import than the holistic benefit that comes from many people using these new technologies. I would think they are going to compete in international markets like they do with cars, solar panels, batteries, and many other products.

This configuration of circumstances looks a lot like that in many cases throughout history that provide lessons. I can’t help but think about when the British outcompeted the Dutch in shipbuilding and other important industries at the end of the Dutch Empire and the beginning of the British Empire. Also, there is a geopolitical war going on related to Taiwan that should lead us to at least consider the possibility that China could prevent chips from getting out of Taiwan as a tool for geopolitical warfare. And there are other risks for AI stocks like the rising risk of wealth taxes and other taxes that would require those who are holding a lot of their wealth in these stocks to have to sell them, or the risk that rising anti-AI sentiments could lead to constraints on companies’ advancements.

I can give you more things to worry about, and I can give you an equally long list of great opportunities that AI will produce that I want to bet on. I’m not saying how these risks will play out or that one shouldn't bet on AI companies. I am just saying that it is indisputable that there is a lot of concentrated risk in the market and that one should know how to play circumstances like these. From my study of all analogous cases and for logical reasons, I am confident that the risks are high and that the bestway to play such a configuration of circumstances is to:

As you probably know my mantra is diversify and my “holy grail of investing” is to *strive to have 15 good uncorrelated investments that are risk balanced. Or said another way: