SITALWeek #352

Welcome to Stuff I Thought About Last Week, a personal collection of topics on tech, innovation, science, the digital economic transition, the finance industry, Vecna, and whatever else made me think last week.

Click HERE to SIGN UP for SITALWeek’s Sunday Email.

In today’s post: the negative feedback loops of analog problems will slow digital progression for many industries; the energy costs of AI; graphyne; will mobile gaming also fall victim to our ever-shrinking attention spans? inflationary Vecnas and Demogorgons and how economists' certainty of inflation should give us great comfort; interest rates have powered PE, VC, debt, and public markets for over a decade, but some asset classes are more at risk to higher rate shocks than others; and, much more below...

Stuff about Innovation and Technology
Mobile Gaming Jeopardy?
One of the consumer behavioral shifts I’ve been writing about lately is how short-form video, such as TikTok and YouTube Shorts, is taking significant share from other media. Coupled with economic weakness and inflation, short-form might even be causing subscribers to drop streaming video and music services, at least temporarily. News last week that mobile gaming platforms Unity and Niantic are laying off employees might be a signal that casual, phone-based gaming will also fall victim to economic headwinds and shifting consumer behavior. While currently totaling over 60% of app store sales, mobile gaming could be an area of relative weakness in the near future, especially given its dependence on advertising in the wake of Apple’s privacy changes. Or, are game mechanics so addictive that they will prove recession- and TikTok-proof? The WSJ reports on the rise of hypercasual games, which people play for very brief periods of time, and the psychological hooks used in the battle between developers for user attention and dollars.

AI’s Electrons
While having Dall-E mini create image mishmashes for me last week (see #349 and #341 for more on AI transformer models and how they might displace traditional software), I was wondering who was paying for the server time, and, more importantly, the electricity required to generate the stupid images? IEEE has a story on new techniques to measure the energy usage for training AI models, along with ways to potentially reduce their carbon footprint. As AI models are increasingly deployed around the clock to run neural networks, process data, respond to queries, etc., their potential benefit will hopefully more than offset the rising energy footprint of using them. The NOAA has a pair of new 12.1-petaflop supercomputers named Dogwood and Cactus. As I joked a while back, the energy required to run the increasingly sophisticated weather models might be contributing to climate change. 

Digital’s Analog Shackles
A couple of weeks ago, I wrote about Amazon’s forecasting errors, with the company even fretting during the pandemic that they might run out of employees in 2024. I’ve been thinking more about that (albeit theoretical) concern as it broadly relates to the pace of the analog-to-digital economic transition. Some industries that are based more on bits (like payments) can transition faster, but most sectors are faced with the challenge of wrangling a host of analog inputs and bottlenecks. Amazon, if it were to run out of employees before it could replace labor with robotic automation, would be an example of a digital power law running headlong into an analog wall. Looking at battery forecasts for EVs (the US will need 500,000 metric tons of lithium by 2034, a market dominated by China), you can imagine a similar digital power law thwarted by the real, analog world. In #326, I discussed this challenge in a bit more detail:
What’s surprising about Amazon and Tesla’s blistering growth is how atypical it is for non-software companies to achieve. Amazon and Tesla leverage plenty of software, but, by and large, they deal with messy, complicated, real world things – objects, people, commodities, extremely complex manufacturing/physics, etc. We expect this type of accelerating progress more from a purely software business, such as Google’s search engine. To achieve this type of growth in sectors that require the interface of the analog and digital worlds is remarkable. 
I talk a lot about the transition from analog to digital – from the Industrial, to the Information, to the AI age. Amazon and Tesla are at the leading edge of this transition, and we hypothesize that we will see digital leaders emerge in other sectors/industries. However, the rollover isn’t inevitable by any means, especially for non-data-centric businesses. And even some data-centric sectors – like finance and healthcare – remain mired in the analog world. As we wrote in Pace Layers, regulation can be an impediment to change. Indeed, regulators have been long-time party crashers for finance and healthcare, yet have been late to the party for media, retail, and autonomous driving, leaving Amazon and Tesla to grow unfettered. Maybe that is part of the explanation for their success. We are seeing some fairly large digital finance businesses built, but it’s a wide open question as to whether they will survive the regulatory gambit.
If the underlying process (not just the interface) of a business is rooted in the Industrial Age, then the transition is more complex – as Zillow can attest. Their recent strategy shift was due (at least in large part) to the messy nature of trying to herd contractors into fixing up a house while simultaneously dealing with a complex financial market, interest rate risks, macro factors, and more. Energy is another messy, analog industry that’s struggling with massive logistical hurdles in storage, grid improvements, etc. in its bid to go digital. And yet, Amazon and Tesla have successfully dealt with some equally impressive analog hurdles, so what sets them apart? Vertical integration? Lack of regulation? Was the role of luck, timing, or some other unknown factor much more important than we might think? Does it come down to the personality of the lead entrepreneur – does breaking out of analog shackles require a higher risk-seeking propensity as well as creative genius? Will we wait decades for the next digital Einstein to emerge in finance, healthcare, or energy? Are Amazon and Tesla anomalies, destined to take over (and possibly evacuate) the planet in Buy n Large fashion? Or, is it just a matter of time before we see more transformational companies and leaders pulling the analog world into the digital future?
The safest bet is that the digital transition will take decades as negative feedback loops of the real world grind back on the positive feedback loops of innovation. It’s possible progress over the next twenty years will be slower than for the last twenty as the world faces constraints in labor and other resources. There will be a divergence in speed of innovation: if it’s a matter of bits only – like we are seeing with changing consumer media preferences for short-form video – shifts will accelerate faster and faster; but, when you are interfacing wholly or in part with the analog world, the further into the transition the slower it may go. If you're running/assessing a business that is navigating the transition to digital, I think the key is to identify areas where you can successfully push harder with automation – software, hardware, and data – and analog pinch points where you can find ways to relieve pressure from negative feedback loops of the real-world’s slowly moving cogs. In many cases, it will just take time – a lot of it.

Graphyne, not Graphene
Graphene has long been sought as a potential semiconductor substrate. However, difficulty in processing the naturally conductive material to make it semiconductive has pushed out expectations. Bulk graphyne, on the other hand, is a natural semiconductor, but it has been difficult to synthesize in large quantities. Now, researchers at the University of Colorado Boulder think they have a new way to make bulk graphyne. As IEEE explains: “Graphite, diamond, fullerenes, and graphene are all carbon allotropes, and their diverse properties arise from the combination and arrangement of multiple types of bonds between their carbon atoms. So while the 3D cubic lattice of carbon atoms in diamond make it exceptionally hard, graphene’s single layer of carbon atoms in a hexagonal lattice make it extremely conductive. Graphyne is similar to graphene in that it’s an atom-thick sheet of carbon atoms. But instead of a hexagonal lattice, it can take on different structures of spaced-apart rings connected via triple bonds between carbon atoms. The material’s unique conducting, semiconducting, and optical properties could make it even more exciting for electronic applications than graphene. Graphyne's intrinsic electron mobility could, in theory, be 50 percent higher than graphene.”

Miscellaneous Stuff

Ryder, Pitt in Profile
I am a sucker for profiles of aging Hollywood stars as they enter a different era of their career. Last week, I enjoyed reading these profiles on Winona Ryder and Brad Pitt.

Stuff about Geopolitics, Economics, and the Finance Industry
Rates Put Pensions on Thin Ice
The WSJ reports on the increasing use of leverage by pensions to try and make up for years of underperformance to maintain funding for future beneficiaries. And, risk isn’t limited to leverage, as pensions have also heavily increased their investments in private equity, whose returns fare better in low and declining rate environments. VC is another asset class that saw increasing allocations from pensions and other institutional investors that is now going through a valuation adjustment, much like the public markets, with a 23% drop in new investments from Q1 to Q2 this year and some high profile deals like Klarna rumored to be raising money at an 85% lower valuation than last year. Most pensions, endowments, and other large investors hold a mixture of bonds, public equities, private equity, VC, and real estate. Chasing returns in less liquid assets was boosted by low and declining interest rates. Odds are that we will see a normalized rate environment again sooner than the market thinks (see below), but the shock to the economy from higher rates may reveal the shine on these less liquid assets is not quite as bright relative to good old liquid, public equities. Of course, public equities have benefited from low rates as well, with around half of public companies’ margin expansion having come from low rates since 2010, according to a recent research report from Empirical Research.

When Economists All Predict Inflation...
We opened our 2014 paper Complexity Investing by explaining that no one can predict the future, and we showed that economists are some of the worst forecasting offenders. Economists and policy setters have no special knowledge, and often they know less than anyone reading this newsletter. For example, Federal Reserve Chair Powell believes that inflation is an enigmatic force that defies logic. As with Vecna in Stranger Things, he claims to know where it came from or what we can do about it, but he is certain it will multiply in a runaway fashion, destroying life on earth as we know it. At least that's how I interpret statements he and other central bankers have made over the last few weeks. Surely, recent inflation couldn't be the result of fiscal and monetary policy errors that he endorsed! Of course not! Instead, it must be a mythical beast that magically sprang into being, and Powell must tame it into submission. In a discomforting admission last week, Powell said: “We now understand better how little we understand about inflation.” Really? Then by all means jack up rates with no understanding of the consequences. Here is another wild prediction of Powell’s with little basis: there will be a reversal of globalization. I’ve covered this topic many times, but, in brief: globalization is a one-way street. There is no evidence that material deglobalization is happening, or even could happen, given the population and resource constraints in developed countries. It’s a narrow prediction that’s likely to have only marginal impact over a very long time. Assuming deglobalization is an inflationary certainty, like Powell seems to believe, could cause central banks to keep rates higher for longer, only to discover in hindsight the damage caused. (There is some irony here that higher rates will make it harder for US and European companies to borrow to rebuild lost infrastructure replicated by emerging markets, thwarting deglobalization.) We don’t need to bet on continued globalization to think inflation will return to steadier, lower levels once pandemic stimulus and supply issues are normalized. Global trade peaked in 2008 and has been declining since 2011. So, it would seem, globalization may not have been the disinflationary force central bankers think it was over the last decade. Speaking at the European Central Bankers forum, Powell and European Central Bank President Christine Lagarde kept referencing powerful "forces", as if inflation is a enigmatic evil. Like the Demogorgan or Vecna, these evil forces of inflation, they seem to believe, will beget more evil inflation in a runaway spiral (which can happen in third-world countries that borrow in foreign currencies, but that kind of flywheel scenario has no precedent in a developed country with a reserve currency). Or, maybe, they just don't want to admit their own role in opening the portal to the Upside Down. Given that economists cannot predict their way out of a paper bag, the one thing to take comfort in today is that the central bankers and economists all see higher inflation as permanent and inevitable. It is therefore destined to abate.

There are surely sources of inflation beyond anyone’s control or prediction capability, like the war in Ukraine. There is also a tug of war between shrinking births and aging populations (see the final section of #328 for more), which will create many cross currents of inflation and deflation over the coming decades – e.g., older people consume less in general (but far more healthcare), more younger folks are needed for labor supply, but lower child births will lead to less demand long term (and, ultimately the end of the human race). There will be times when the labor force is out of balance and driving inflation, and also times when declining consumption will be deflationary. Additionally, global warming and its impact on food supplies and energy demand will need to be met with heavy technology investments and innovation. However, there is no reason to believe that the largely technologically-driven deflationary run of the last several decades has been anything but temporarily derailed by two years of fiscal and monetary policy mistakes. Market economies (when governments don't messily try to intervene) are self-healing; a recession, rising unemployment, resolving supply chain issues, etc. will eventually return us to the deflationary road paved by innovation. And, we should be thankful for economic self-correction, because, if the economy doesn’t self-heal in time to stop Powell’s fantasy cures, we could suffer potentially irreversible damage. No one should be naïve about inflation – there are certainly some paths where it stays high before innovation, time, and human ingenuity stamp it out, but we also want to make sure we don’t bank on theoretical futures that are just guesses. Regardless of high inflation or a return to low inflation, the important thing to focus on as investors and business leaders is to solve problems for your customers and constituents by creating the most non-zero-sum outcomes possible. If you generate more value for others than you take for yourself, then you will fare better no matter what the economic future brings.

✌️-Brad

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is an informal gathering of topics I’ve recently read and thought about. I will sometimes state things in the newsletter that contradict my own views in order to provoke debate. 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. 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, LLC has no control. In no event will NZS Capital, LLC 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.