SITALWeek #199
Stuff I thought about last week 6-30-19
Greetings – Google and Facebook are paradoxically asking for more government regulation as a way to potentially cement their market dominance; one sector in the tech market is giving me flashbacks from the year 2000; the big opportunity to bundle all the video streaming apps; musings on entropy, ants, and investing; “ESG” investing is just a trendy label...how to sincerely invest with impact; and, a whole lot more this week. As always, grab me on Twitter with any feedback.
Click here to SIGN UP for SITALWeek’s Sunday EMAIL (please note some ad blocking software may disrupt the signup form; if you have any issues or questions please email sitalweek@nzscapital.com)
Stuff about Innovation and Technology
Harvard researchers have built a tiny drone: the RoboBee X-Wing, as it's known, is the first self-powered, untethered bug-like flying robot. Well, actually a rather large bug at around 3” across. And, it only flies for half a second with twice the photons it would receive from the sun; however, even with all those qualifications, it’s a sign of where the tech is going. Video is here.
Eviation’s “Alice” plane can fly 650 miles at 500 miles/hr, and it’s electric! It has five motors and about 9x the battery capacity of a Tesla. The company received its first order at the Paris Air Show from Massachusetts-based Cape Air. Planes account for about 2-3% of all global emissions (but, given the altitude of those emissions, the relative impact could be much greater).
Africa is seeing significant growth in AI research as IBM, Google, and others open facilities across the continent. African research groups and universities have also ramped up machine learning programs. Tapping local talent and knowledge could be a powerful accelerant for applying AI to address humanitarian challenges like hunger, healthcare, and poverty.
Renewables surpassed coal for the first time in US power generation. Unfortunately, this was in part due to maintenance at the Spring coal plant, and coal will slot back into the 2nd largest source of power behind natural gas this summer. However, the trend is encouraging.
This week in disturbing surveillance news:
Schools are using microphones to detect escalating violent behavior or conversations, but it doesn’t really work.
Big global casino companies in Macao are using AI, RFID chips, and facial recognition to identify risk aversion vs. risk seeking behavior.
The Pentagon has a laser that can identify you 200 meters away if it knows your cardiac signature. You might wonder how they would build a database of cardiac signatures until you glance down at your Apple Watch! Importantly, the tech can at least identify patterns it has seen before, even if it does not know a specific target’s heart information.
Zillow has updated their Zestimate algorithms thanks to the “Zillow Prize” competition for ideas. The new algorithm, informed by image recognition, is within 2% accuracy for 50% of home sales.
FedEx is vying for “face-palm” of the year as they cut overnight rates in order to fill planes after they dropped air volume from Amazon. Speaking of logistics, I was thinking about the back of a UPS truck in a residential neighborhood and how filled it is with Amazon boxes. UPS does well in business-to-business shipments, but I have to wonder what happens to margins as those Amazon boxes drop off the residential routes and onto Amazon-owned delivery vehicles. UPS and FedEx can keep flexing their duopoly by raising prices on all of their non-Amazon customers...at least until Amazon opens up their logistics business to anyone that wants to use it, then that residential delivery duopoly melts quickly for UPS and FedEx!
Platform or Publisher?
The heart of the regulatory/free speech/extreme content issue at Facebook and YouTube is whether the companies are tech platforms or publishers. If they are publishers, like The New York Times, they are responsible for what is said and must follow strict rules around speech, libel, and truth. Recently, YouTube’s CEO Susan Wojcicki and Zuckerberg have declared wholeheartedly they simply do not have the technology to moderate the amount of content coming onto the sites. Scifi writer Cory Doctorow had fun with this concept in a NYT “Op-Eds From the Future” series piece where he explores what would happen if the governments around the world did start treating Facebook and Google as publishers. Effectively, Doctorow predicts this would cement their monopolies because the money and tech required to actually implement moderation would assure that no startup could ever raise the funds to compete. I think it’s safe to say that Google and Facebook are currently spending in excess of $10B each annually on equipment and people to post and moderate user-generated content on their sites. And, both companies assure us that is not enough; perhaps no amount of money is enough to stay ahead of bad content. Zuckerberg said this week yet again that he can’t fix this, only governments can as he declared the problem “above Facebook’s pay grade” (he really needs some more self-aware PR folks!). Two weeks ago, I mentioned Amazon’s CTO Werner Vogels joining the chorus of calling for governments to regulate tech products in the case of facial recognition. Earlier this month, the CEO of Amazon Web Services Andy Jassy floated a (bloody) strawman argument when he said that knife makers weren’t responsible for “surreptitious” use of their products, so Amazon should be responsible if facial recognition is abused. I believe I understand all the complexity here, but when I put myself in the position of a CEO running a company that has no control over it’s product, I have to ask: “should I change my product so that I have control over it?” Peter Kafka asked that very question to YouTube’s CEO with respect to limiting who can upload content. Her response was that they feel it’s better not to restrict any voices. Of course, if they did restrict who uploads, they would be quickly branded and regulated as a publisher instead of a platform. I get that this is complex, but I really wish the tech leaders would take even some small responsibility for their products and services. However, based on the fact that “more government control” has become their mantra, I think we can only conclude that Facebook, Amazon, and Google actually want increased government regulation because it would allow them to keep their platforms intact (rather than suffer government-mandated fragmentation), and because Cory Doctorow is correct: regulation will assure they become even stronger monopolies.
The question of Facebook’s social networking monopoly will be moot if China’s TikTok app keeps up its meteoric rise.
Cloud software revenue recently hit a $100B run rate according to Synergy Research, with Microsoft, Salesforce, and Adobe accounting for 40% of the total (I think the Microsoft number is somewhat overstated by the analyst). Obviously, the future is bright for SaaS companies as the enterprise transition continues; however, objectively, the valuations in this sector of the tech market are at levels I’ve personally never seen. The closest valuation bubble for companies with real underlying businesses (so, excluding the dotcom bubble) that I’ve seen was when I covered the optical components and communications semiconductor industry in the year 2000. Back then, we still used the quaint metric of price/earnings instead of price/sales (however, I am completely fine with using p/s for SaaS companies given the ratio of lifetime value of customers to the cost to acquire those customers). That said, the starting point matters, and despite my absolute love of SaaS companies for the long term, when companies are trading at over 15x forward revenues (in some cases over 20x) that’s a really hard place from which to compound value.
When Netflix stopped selling subscriptions through Apple’s app store, opting instead to take direct credit cards, it did not impact Netflix’s business, but Apple lost the revenue share. This outcome disturbs the notion of an Apple app store monopoly and shows how easy it is for Apple to lose services revenues. However, how many companies have the brand, scale, and tech to maintain direct relationships with customers?
In other Netflix news, content head Ted Sarandos seemed to reinforce the value of content, and the fact that content will be exclusive to many different streaming services. The result he says? Consumers are likely to subscribe to several platforms. I tend to agree, but it also comes down to value and pricing vs. alternatives in terms of total cost and convenience. In 2020, if you have Netflix, Hulu, Disney+, WarnerMedia, NBC Universal, and CBS All Access in the US, you might be paying $60-70. That’s easily approaching some cable bundles, and it doesn’t include much of the sports or other live content. Additionally, it’s already a nightmare to remember what show is on what app and deal with the different user interface quirks for each. If you look at the trend of bundled Pay TV viewing in the US from Matthew Ball/REDEF, everyone under age 34 watches more than 50% less today vs. 2010, and the 34-49 age group is in freefall, already down 30%. The situation seems ripe for a new “bundler” to step in and bring all the content back together for this group of under-50 year olds. It’s unlikely that every writer, actor, and director in the world wants to work for just one company, so we should still see the centers of power persist in content creation: Netflix, Disney, CBS/Viacom, NBC Universal, and WarnerMedia along with a longer tail of smaller and independent studios. And yet, the “Balkanized” state of the industry is unlikely to allow for an aggregator to step in. That means we should continue to see the strongest content bundles with the biggest, most global, subscriber bases slowly take share in both streaming subscriptions and original productions, which would heavily favor Netflix and Disney.
Here’s an informative, long read on RISC-V open-source processors. The following quote from the article is really the crux of everything happening in semis right now – because of the power road block, general-purpose chips are no longer cutting it, and a heterogeneous computing explosion will be very good for the chip industry: “With the diminishing of Moore’s Law, the only way to improve performance is with customization, which leads to the development of more chip variants.” And SiFive’s CEO said this week that mobile chips based on RISC-V are now 2 years away, with Qualcomm leading the charge, and server chips are only five years away. In other processor news, the head of CPUs at ARM jumped to Apple, presumably to move Macbooks off of Intel in the future. The range of outcomes for ARM and Intel are widening dramatically.
Mainframe and legacy database companies like IBM and Oracle have historically had a good business in China. Recently, however, China is seeing the rise of open-source, home-grown technology, like PingCAP, make inroads. PingCAP has ambitions to compete with Amazon’s Aurora database, and the company claims to be “the most actively developed open source NewSQL database on GitHub.”
Miscellaneous Stuff
CNN comments on Nick Cave and his Red Hand Letters email newsletter: “Like a lot of artists, his spirituality is idiosyncratic and undogmatic. He believes humans are hard-wired for transcendence, which can be accessed through creativity and imagination.” (The Red Right Hand has been my ringtone for eight years and counting.)
Our favorite economist Eric Beinhocker argues that the climate debate needs to shift from an economic, cost/benefit analysis to a question of morality. In order to focus the problem and create a moral imperative, Beinhocker calls for global “carbon abolition” laws, stating that humans need to abolish carbon emissions by 2050 – that means net-zero carbon (e.g., capturing any emissions that are still necessary). I’d argue that a combination of economic and moral reasoning would be even stronger.
Entropy is a measure of disorder: around the start Universe (at least the part that’s visible to us) ~14B years ago, matter and energy were very organized – i.e., there existed an extremely low entropy state. When you have information (a.k.a. order) entropy is very low. As information (or matter and energy) become disordered, entropy grows over time. Life, as it turns out, is uniquely suited to taking ordered, high-information matter/energy and turning it into disordered, low-information states; indeed, this seems to be the vector of the Universe and life’s role in it. For example, take sunlight, plants, and animals: sunlight is highly ordered electromagnetic rays that help plants grow through photosynthesis; then animals eat those plants (and sometimes animals eat the animals that eat those plants); and then animals (e.g., humans), turn that energy into all sorts of interesting things, ultimately scattering that neat, organized solar energy into myriad disorder around the planet and surrounding space. I came across an interesting example of ants and entropy recently on Sean Carroll’s Preposterous Universe podcast (Episode 51): one ant crawling across your porch is low entropy, but a thousand ants swarming a sandwich that fell on the patio is high entropy. This might seem intuitive, but if you look at why it’s true, the answer ends up being a bit of a paradox. If you have one ant, you could have a lot of information on that ant, so if you have 1,000 ants, then you could have 1000x times the information, and that’s more order, and less entropy, right? Not quite: the operative word here is could – data on the ants haven’t been collected and organized, or rendered into “useful” information yet. Indeed, how would you collect and maintain real-time information on 1,000 ants? The energy cost of tracking every possible known bit of information about each ant would be too high (in fact, you would use a lot of solar- or fossil-fuel-based energy to compute and track all that information, which would take ordered energy and create a lot of entropy, or disordered energy!). So, the reality of a swarm of 1,000 ants on your sandwich is low information, and high entropy, or high disorder. Now, because humans are prone to tell stories and draw analogies, even when they don’t necessarily apply, my brain immediately wanted to understand this idea of ants and entropy as it relates to investing. Much of what society has done is try to create temporary order despite the long-arching trend toward disorder of the Universe. We build buildings, cities, communities and companies – we take organized energy and order it into all sorts of literal and figurative structures. But, it’s only a temporary, local increase in order, and, in the long run, the information value is lost and entropy rises. I think about this idea of “energy in” and “energy out” a lot with respect to investing: the best investments – whether for your portfolio, your company, or your home life – are going to involve the least amount of information, or more directly, the least amount of prediction. The trend toward more disorder means that predicting the future is very hard, if not impossible, so if you can invest such that almost any scenario can happen, and you will still win, then you’re making the right decision. You can only fight entropy for so long. Ants have created a unique strategy when it comes to survival: only about half of the colony is ever out eating your sandwich, so, odds are, a catastrophic event will spare one half or the other. This is how ants fight entropy, and there are a lot of lessons built into that strategy. (We talked more about ants and investing on page 11 of Complexity Investing.)
Dimethyltryptamine is a neurotransmitter responsible for psychedelic experiences in the brain. A recent study on rats showed that neurons can make DMT in similar quantities as other monoamine neurotransmitters like dopamine, serotonin, and noradrenaline. (There is speculation that DMT is involved in dreaming.)
Stuff about Geopolitics, Economics, and the Finance Industry
Over the last decade, as technology stocks outperformed, it became increasingly obvious that the tech sector was creating a new digital economy in every other sector. As a result, we saw just about every portfolio manager around the world declare they were tech- and innovation-focused (except for the value managers, who are still hoping the 1900s come back – hang in there!). And, following the 2016 elections in the US and UK, it became obvious to everyone paying even the smallest amount of attention that there were broader societal issues around inequality. Recently, it’s been hard to ignore the potential risks of environmental damage. These last two combined with the techification of the economy have created a situation where just about every portfolio manager is now declaring themselves an ESG (environmental, social, governance), innovation-focused investor. I hope that’s true, because we certainly agree these are the trends that are here to stay. The tech sector will continue to transform every product and service into a platform in the Information Age, leaving most existing companies behind to melt into irrelevance. And, those companies focused on environmental, social, and governance issues are much more likely to grow their share of the world’s profits than others. (We expanded on this topic in detail in our NZS whitepaper.) However, we don’t feel there is any such thing as an “ESG portfolio” or a “innovation portfolio”; rather, these concepts should be implicit in all investing strategies. It’s easy to put a label on anything – it’s just marketing that guarantees nothing. We are more interested in the integrity of the underlying methodology and principles that guide investing. As such, we advocate investing in the long-term growth and innovation at companies that take into account a broader definition of fiduciary duty that includes, not just investors, but employees, customers, society as a whole, and the global environment. We see the most potential in companies who seek to maximize non-zero-sum (NZS), or win-win outcomes; however, such entities are not always easy to identify or predict given the disruption and innovation that exist in the complex adaptive system that is the world’s economy. A company or investor declaring itself “ESG compliant” may apply all or very little of this philosophy. Instead, these concepts must be built deeply and organically into the process an investment team uses, otherwise it’s just a label.
I had an excellent conversation this week with a consultant tasked with recommending portfolio managers to institutional investors like pensions. As is always the case when I try to explain our investment process to someone for the first time, I gain a new depth of understanding of our philosophy through teaching someone else. One thing that stood out to me from the conversation was the following: once you have a disciplined process for finding companies and building a portfolio (like we outline in Complexity Investing), we believe there are two sources of outperformance in the stock market: cognitive bias and compounding. The brain has uniquely evolved to make it very hard for humans to identify their own behavioral biases, and, equally, the brain’s unique, evolutionary wiring has made it near impossible to understand the impact of duration of growth, or compounding. The way to overcome these two sources of alpha is through a team that speaks the language of compounding and can respectfully challenge each other on potential mistakes of cognitive bias (common bias mistakes are explored in chapter 6 of Complexity Investing). Overcoming these two shortcomings of our bundle of neurons is really hard, sometimes nearly impossible, but that’s what is both special and very fun about our process. And, I’d be remiss if I didn’t connect this paragraph with the prior one in terms of compounding and ESG: companies that run their business with a broad fiduciary duty that encompasses the planet and everyone on it are more likely to compound growth for a much longer period of time – the stock market will serially underprice this duration in stocks over the short term.
Is 80% of the stock market now passive or quantitative-model driven? We know at least 50% of the market is passive, and another 10-15% is traded with minimal daily human adjustment through quantitative models. This raises some existential questions about how price levels are set for individual securities, and it also implies that automated investing could go much higher from here given the market still appears to be functioning fine today. I assume the remaining shrinking roster of active managers are actually now amplified signals in the quant models, which rely on information embedded in active trades amongst other factors. Further, the swings caused by quant funds signal passive investors who might take money in and out of index funds. So, this should create a very fun ride over the next few years where you would actually be much better off relying on a long-term focused active manager!
Morningstar will change fund ratings in October to take into account more accurate fees. Top ratings will now also only apply to funds that can beat both their peers and their benchmark. And, the company will be assigning fewer high ratings to funds in categories where “there’s less payoff to active investing,” which could accelerate flows away from those active funds toward passives.
US State Pensions Plans are underfunded by $1.28T according to this FT article.
Putin says in an FT interview that liberalism is obsolete. The great thing about liberalism, which tends to favor freedom, something human brains have evolved to favor as well, is that the idea itself can adapt and evolve. The same cannot be said with a straight face about communism.
Disclaimers:
The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”). This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. I often I try to make jokes, and they aren’t very funny – sorry.
I may include links to third-party websites as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by NZS Capital, LLC (“NZS”). If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which NZS Capital has no control. In no event will NZS be responsible for any information or content within the linked sites or your use of the linked sites.
Nothing in this newsletter should be construed as investment advice. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. There is no guarantee that the information supplied is accurate, complete, or timely. Past performance is not a guarantee of future results.
Investing involves risk, including the possible loss of principal and fluctuation of value. Nothing contained in this newsletter is an offer to sell or solicit any investment services or securities. Initial Public Offerings (IPOs) are highly speculative investments and may be subject to lower liquidity and greater volatility. Special risks associated with IPOs include limited operating history, unseasoned trading, high turnover and non-repeatable performance.