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We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general.

Here are the articles for the week ending 06 February 2022:

1. Oral History Interview: Morris Chang – SEMI, The Computer History Museum and Morris Chang

Q: The idea really wasn’t very well received in the industry at that time.

MC: No. It was very poorly received. Well, people just dismissed it, you know, “What the hell is Taiwan doing? What the hell is Morris Chang doing?” They really didn’t think that it was going to go anywhere. There was no market because there was very little fabless industry, almost none. No fabless industry. So who are you going to sell these wafers to? Who are you going to manufacture the wafers for? Of course, the obvious answer was the companies that already existed at that time, the Intels, and TIs, Motorolas, and so on. Now, those companies knew that they would let you manufacture their wafers only when they didn’t have the capacity, or when they didn’t want to manufacture the stuff themselves anymore. Now, when they didn’t have the capacity, and asked you to do the manufacturing, then as soon as they got the capacity, they would stop orders to you, so it couldn’t be a stable market. And when they didn’t want to make the wafers anymore, well, the chance was that it was losing money for them. The product was losing money for them. And so what do you want to do? Do you want to take over the loss, you know? And so that wouldn’t be a very good market either.

So the conclusion at that time, the conventional conclusion was that there was no market. Maybe this idea, this pure-play foundry idea, exploited the only strength you have, which is manufacturing, but there’s no market for it. That’s why it was so poorly thought of. What very few people saw, and I can’t tell you that I saw the rise of the fabless industry, I only hoped for it. But I probably had better reasons to hope for it than people at Intel, and TI, and Motorola, etc because I was now standing outside. When I was at TI and General Instrument, I saw a lot of IC designers wanting to leave and set up their own business, but the only thing, or the biggest thing that stopped them from leaving those companies was that they couldn’t raise enough money to form their own company. Because at that time, it was thought that every company needed manufacturing, needed wafer manufacturing, and that was the most capital intensive part of a semiconductor company, of an IC company. And I saw all those people wanting to leave, but being stopped by the lack of ability to raise a lot of money to build a wafer fab. So I thought that maybe TSMC, a pure-play foundry, could remedy that. And as a result of us being able to remedy that then those designers would successfully form their own companies, and they will become our customers, and they will constitute a stable and growing market for us…

…Q: Was there ever a time when it looked like TSMC, or the dedicated foundry idea would not work?

MC: Oh, yeah, I mean the first few years were not easy, but look, the investors had already put in so much money, and we never had any thought of failing. And in fact, we only had two loss years in all our history. We had a loss year in 1987, the first year that we started, and we again had a loss year in 1990. I mean the first few years were pretty tough, but from ’91 on, we just grew without looking back. The year 2000, that was a tough year for a lot of people. Yes, it was a tough year for us too, but we were profitable, 2000, 2001. We have not lost any money, and we don’t intend to lose any money from 1991 on.

Q: In your view, why has the Taiwan foundry industry been successful?

MC: Well, when you say, “Why has our foundry industry been so successful?,” I have to change that. Actually as of two years ago, some analyst made a calculation…TSMC, up to that point, accumulatory, had made 110 percent of the total pure-play foundry industries’ profit. That means our profit exceeded all other people’s losses by 10 percent. Yes, I guess that’s what it meant. So when you say, “Why is the foundry industry so successful…,” maybe you should change your question to, “Why has TSMC been so successful?”  

2. Bored Ape Yacht Club Artist Says Compensation ‘Definitely Not Ideal’ – Matthew Gault

The people behind the BAYC collection, Yuga Labs, have made millions. But someone had to design the now-iconic apes. Every grin and hat and disinterested eye was lovingly crafted by artists before it was fed into an algorithm. In a new interview at Rolling Stone, BAYC lead artist Seneca shared a conflicted experience working in the NFT space.

Seneca is an artist specializing in disturbing and dreamlike imagery. She was the lead designer of the BAYC collection and did many of the initial sketches. She didn’t draw every hat, shirt, and ape herself, but she’s responsible for much of the overall design. “Not a ton of people know that I did these drawings, which is terrible for an artist,” she told Rolling Stone.

Yuga Labs did pay Seneca for her work, and though she wouldn’t disclose the details of the transaction, she said it “was definitely not ideal.”

She’s still hyped on crypto, web3, and NFTs, but she said she learned some valuable lessons working on BAYC. She told Rolling Stone that artists should ask for royalties and understand NFTs and smart contracts before taking on a project like BAYC.

3. Gavin Baker – The Cyclone Under the Surface – Patrick O’Shaughnessy and Gavin Baker

[00:09:15] Patrick: If we had talked, I don’t know, 9, 10, 11 months ago, the setup arguably would not have been nearly as good. Who knows what we would have said then. Maybe we would have thought multiples would have just continued to expand. But today, undoubtedly, like you said, they’re at or below their 2018 levels. The businesses are better. So it stands to reason sort of that there’s more interesting opportunity set in those set in those three major sub-sectors of semis, software and internet. I want to come back to those in a minute. Before we do that, I’d love to level set with the things in the market or the economy or the world that you’re most carefully interested in and watching relative to the last time we talked, when obviously it was sort of all COVID. But the world has changed a lot since then. We’re sort of settled into COVID, inflation has become a dominant theme. What are the themes that, outside of just individual companies, have your interest most, that you think most matter for general market returns from this point forward?

[00:10:05] Gavin: I think for me, inflation is the only thing that matters. And I think there’s a lot of focus on the fed. To me, the fed is a little bit of a side show. I’ve lived through a lot of fed tightening cycles. There’s a lot of great work that’s been done on how equities do. Generally stocks are up, actually I think in every tightening cycle dating back something like 25 years, stocks are up 12 months after the first rate hike. By the way, the reason they’re up is they generally sell off into the first rate hike because the market is anticipatory. And everybody sees these studies, things happen faster, the market is becoming even more anticipatory over time. So I think the Fed is a little bit of a sideshow, from my perspective, and what’s different about this Fed tightening cycle is you just had the highest CPI print in 40 years. And I do think in terms of mistakes I made, I really under-reacted to Powell’s appointment. I’m not somebody who’s mindlessly bullish on growth. I’d say I was very cautious of high multiple growth stocks for probably the summer of 2020 to April, May of 2021. Wrote this big piece on Medium explaining why I was getting more positive. That was way too early. But a lot of those stocks, even back in May, their multiples that already corrected 50, 60%-plus. We digested a pretty big move in the 10 year. Powell was reappointed, clearly with a mandate to crush inflation. The market got that right. I mean, it was right away. The data Powell was appointed, that was a sea change in the market that has persisted through today. And I think just what’s different is that 7% CPI number. And if you think about what drives the market, just like stocks, it just comes down to earnings and multiples. And liquidity drives the multiples and GDP growth drives earnings growth.

The fed, because inflation is at 7%, I think that’s why this selloff has been so severe. Just because this is different than anything any professional, I mean, maybe there’s some people. I guess Warren Buffett was investing in 1982, okay. Maybe there are a couple of people who were professional investors in active investors in 1982, but not many. So as a bottoms-up investor, you do kind of have to be macro-aware. And I think there’s two parts to inflation. The first one is supply chain driven, the shortage of goods everybody’s read about. Ships stacked up the port, we can’t get enough semiconductors to make cars. I am so relaxed about that. It is very rare for me to have a view on something like that. I just think we now have hundreds of years of history and capitalism is amazing at solving problems. It is so good. And we have seen a massive supply response. This is a statistic, I actually just ran this this morning. Amazon has spent more money on capex, and this is just illustrative, it’s not a comment on Amazon. It’s a comment on the supply response. They have spent more money on capex in the last two years than they did in the preceding 20 years.

[00:13:06] Patrick: Insane.

[00:13:07] Gavin: Think about that. From 1999 to they spent 62 billion on capex. They’re going to spend 87 billion in 2020 and 2021.

[00:13:16] Patrick: That is crazy.

[00:13:18] Gavin: That’s unimaginable. And no, I did not go through and nerdily adjust every year for capitalized leases. And maybe it makes it more striking, maybe it makes it less striking, but either way it’s crazy. Taiwan City, their 2022 capex is going to be many multiples of 2018. 2021 and 2022, they’ll spend more than they did in the preceding five years. So there is a massive supply response coming. We know that the economy is slow. We know it from credit card data, retail sales, which a couple of reports here have 16% for the year. They’re flat in November, down two in December. And then the Atlanta Fed does this thing they called the GDP now. And that was ten in November, five in December. So the economy is slowing rapidly. So you’ve got this massive supply response, an economy rapidly slowing before the fed begins to take away the punch bowl. I think you’re about to have a truly massive shift in consumer spending away from goods towards services. If you trend out and look at real personal expenditures, goods spending is roughly 500 billion above the pre-COVID trend line. Services spending is 500 billion below the trend line. And that shift, Omicron is probably the end of COVID, to me as a factor for investing for daily life. So I do think the economy will finally normalize. So when you have this supply response, meaning a slowing economy and a shift away from goods towards services, then I just think all of that inflation goes away.

Goldman did this analysis. Auto is accounted for half of the overshoot in core inflation, used auto prices. They were kind of flat for forever and then they went up 50% in 18 months. All that goes away. Maybe it doesn’t, want to be appropriately humble, but I think highly likely that all that is going to go away. If it doesn’t go away, wow, okay, I’m going to be horribly, horribly wrong. And I do think this post-World War II period is an interesting analog for this. You had a 20% CPI basically, because there was huge boom, factories, really good at making takes and fighter jets and not good at making anything else. There was a supply response and CPI went right back down. And so I think for that component, that is for sure going to normalize. And I think the other thing is wage inflation. And this is something where there are things happening in the economy that have literally never happened before. Like the ratio, there’s more unemployed people looking for work than there are job openings. Now there’s more job openings than there are people looking for work. The ratio of job openings to unemployed hit an all time high. Something happened that’s never happened before. I think it’s important to think about it with an open mind and it’s like, okay, why has this happened?

Well point number one, we had massive stimulus since the New Deal. And on top of that, we had a debt jubilee. And I don’t think we really fully understand how powerful that debt jubilee was. We basically said, “You don’t have to pay rent.” Student loan forgiveness, eviction moratoriums, all this stuff. You had all of that. You had people, lot of people over the age of 62 left the workforce. And I think part of that is people probably took these voluntary buyouts that companies, I’m sure they wish they had not given in the spring of 2020, that I do think you have give people credit for being rational. I think the idea of getting COVID is much scarier if you’re over 60 than if you’re under 40. Sad to say I’m over 40. So you had a lot of people retire. And then I also think you had a lot of people who, because of remote learning, a lot of two income households went to one income households. All of that is normalizing. The debt jubilee is over, stimulus is fading, consumer savings are beginning to draw down. I do think after Omicron, kids are going to be able to sustainably go back to school. So a lot of that stuff is fading, but really, really who knows. And if wage inflation is here to stay, I think it means very bad things for the market. It’s just that simple. I think on balance, it’s probably not here to stay. These forces of globalization, they’re too powerful. I’m not sure that the idler movement is here to stay. It’s one thing to be an idler while you have a debt jubilee and, and a lot of savings. It’s another thing when you burn all of that down.

But I just think it’s important to be humble. Anytime you’re talking about forecasting the future, you want to be humble. People have been trying to do it for thousands of years unsuccessfully. And at the end of the day, that is what fundamentally investing is. You are forecasting the future. You have a differential opinion on the future, full stop. People don’t like to admit that, but that is what it is. As hard as that is to do for individual companies, it’s way harder to do for entire economy, which is the world’s most complex chaotic system, high sensitivity to initial conditions, unpredictable interactions. Everything I’m saying, I want to caveat with that. I don’t know if I’ve given you my two examples before, Patrick, and feel free to stop me if I have, but I always think about the Federal Reserve, they employ more PhD economists than anyone. They have more information on the economy than anyone, like way more information than anyone. They have vast amounts of computing power, and they have no ability to forecast the economy out more than six months. And so A, I’m way less smart. B, I have way less information, certainly have less computing power. So there was a letter written, an op-ed written in the Wall Street Journal somewhere in between 2010 and 12. And I think a majority of the world’s PhD economists signed it. Every famous macro-investor you can think of signed it, but it basically said, “Hey Ben Bernanke, you have no idea what you’re doing. This quantitative easing is going to cause massive inflation. It’s going to ruin America. You’re going to bring about hyperinflation. It’s going to be the ruin of America.” They were dead wrong, horribly wrong…

…[00:25:39] Patrick: I’d love to dive in a little bit, just underneath that big trend, you mentioned the three sub-sectors of semis, software, internet. Maybe we could also talk about a fourth category, which is the big five or the big 10 technology companies that are conglomerates at this point. Maybe we’ll start with semis. I’ve talked to you about this in the past, I’m just totally fascinated by the semiconductor industry. I know this is where you cut your teeth a lot, followed it since its beginning and since the start of your career. A lot of people had never heard of Taiwan Semiconductor two years ago. And I think a lot more people have now, for a variety of reasons, not just the shortages and the importance of supply chain, but also the geopolitical stuff. Walk us through your take on semis today and what’s evolved and what matters in that subsector in tech, since it’s such a key one?

[00:26:21] Gavin: Let’s step back and look at the last 15 years of semis. The industry has completely consolidated to where you almost have these monopolies – monopolies or duopolies in every subsector of semis. You either have a monopoly, duopoly, or in the worst case, an oligopoly of three. And in even their suppliers to capital equipment companies, they’re all either monopolies to duopolies. So the industry has massively consolidated over the last 15 to 20 years in a way that maybe should have never been allowed to happen. Although the fact is that a lot of these markets, for a lot of reasons, mostly because the network effects around software code and then economies of scale, they do tend toward being a monopoly, a monopoly or duopoly. So in basebands, there’s a duopoly. CPUs, there’s a duopoly. GPUs, there’s a duopoly, now it’s an oligopoly because intel is entering that industry. Memory, it’s oligopoly for for both NAND and DRAM, analog almost part by part, it’s generally a duopoly, same thing for FPGAs. So it’s a very consolidated, concentrated industry. And you have had demand, I think structurally shift up. And this has always been a secular growth industry, it’s always grown, I call between 1.5 to low twos, multiple of GDP, global GDP. So it’s always been a secular growth industry, but that multiplier’s shifted up. And the reason it’s shifted up is broadly speaking because of artificial intelligence. Human beings, when they write software code, they make a big effort to minimize their, at least good programmers do, use of resources like compute and memory. You used to have to have a budget you had to work with before the dates of cloud computing, only so much memory and only so much storage. The way of cloud computing has thrown that all out the window. And AI is just the inverse. The way you make AI better is you train it on more data. That’s it.

It’s really just that simple. And there’s just a really good rule of thumb, and Microsoft wrote about this in a research paper 10 years ago, or maybe not, 12 years ago, the quality of a given AI algorithm doubles with every 10X increase in the amount of data you used to train that algorithm. And Mark Edrison wrote this op-ed, whatever it was, 10 years ago about how software is eating the world, now AI is eating software. And that just means that the world is getting much, much more compute and semiconductor intensive. And then on top of that, you have all these, at the end of the day, cars are a massive, massive consumer market. And as those become EVs the next AVS, the semiconductor content for car is really exploding. And you put those two things together, the world is just becoming a lot more semiconductor intensive. The bummer, and I would say I’m probably as cautious as I’ve been on semiconductors in a long time right now, it’s still a cyclical industry. If you look at the history in the industry in the eighties and nineties, you have these capacity cycles and they’re driven by the fact that, God I can’t remember his last name, but he was hilarious, TJ, he ran Cypress Semiconductor, he famously said real men own fabs, because there was this trend of going fab-less. But it used to be, in the eighties and nineties, if you ran out of capacity, well, the only thing you could do was build a new fab. And everybody would tend to run out of capacity at the same time, so all these fabs would come them on at the same time. And so you could think of demand as being the smooth, underlying, true demand, the relatively smooth line, and then capacity comes on in the stair step path.

So you would have these vicious cycles, and companies were always going out of business, but then the world moved to fab-less with few exceptions. Today, Intel, Samsung, Taiwan Semi, they’re the are only companies in the world that can make leading edge logic. There’s only three companies that can make leading edge DRAM, maybe four for NAND. And so they got much better about aggregating capacity smoothly. And as a result of that, the cycles you’ve seen last 20 years are just inventory cycles. And the reason for that is the fundamental equation that covers semis is customer inventories must equal lead times. Because if they don’t, and you’re purchasing manager, you get fired. Okay? And so whatever lead times are, that is what customer inventories are. And that leads to this crazy positive feedback loop where if lead times are going up, inventories are building, which causes lead times to go up, which causes inventories to build further. And then as soon as something changes, all that unwinds. And then lead times are going down, you’re burning inventories. So if you’re a semiconductor company, you’re never seeing true in demand. You’re either seeing above market demand because lead times are going out and inventories are building, or below market demand, or below true in demand. And so you’ve had these inventory cycles really consistently for the last 20 years.

What you have right now is, I think a massive inventory cycle. And everything we talked about, the economy slowing even before the fed hikes hit, PCEs shifting away from goods towards experiences. I think demand for semis is almost inevitably going to decelerate a little and that’s going to lead to an unwind of this inventory cycle. And then all the capacity that’s being brought on probably makes it worse. But then I think, you get to the other side of that, and you’re left with that industry that used to grow at 2X nominal GDP to one that probably now is a 3X nominal GDP grower. And you still have that super consolidated supply structure. You’re now having people saying semiconductor companies should be valuing software companies. And no, they shouldn’t. You have a bunch of people. Every fund I know that’s under 50 billion is frantically looking for a semiconductor analyst, where somebody’s really good at semis, have a lot of tourist to the sector. And it’s just when these companies miss, they miss big. Just going back to the fourth quarter of 2018, you can see some really, really, really big misses. So I would say relatively cautious on semis.

4. 14th Five-Year Digital Economy Development Plan – Lillian Li

“It’s the Chinese government’s wishful blueprint. It’s a guidance document that’s put together through rounds of discussions and buy-ins from provincial, municipal and state levels. Still, if any startup or large corporations release the OKRs, there’s no guarantee they will all happen. The history of Chinese Five Year Plans (FYP) is littered with their failures as much as their successes…

…Key takeaways

• The anti-monopoly and other regulations ensuring fair competition will continue throughout 2021 to 2025 –  it seems like there’s significant intent to bring in rules of law to this domain in order to remove systemic risk. More rules around data safety and fair competition seem inevitable given the tone of this document. 

Implications:

• More comprehensive laws and regulations are coming that will specify the limits of platforms and promote consumer and worker welfare.
• The exact methodology for how consumer welfare and fair competition will be guided is still being defined, leaving a certain margin of error for interpretation.
• Fintech will be seen as finance by another name and will be regulated as such.
• Given the indicators around transaction growth and e-commerce, I also do not think the government wants to see platforms completely destroyed. Who’s going to deliver the growth if everyone’s stagnating? 
• Timing will be the tricky part and I have no insight here.  

Key takeaways

• Platform players specifically are asked to step up and become de facto institutions – Tech giants are being asked not what their country can do for them but what they can do for their country. In the guidance plan, the tech players are asked to help with sharing data for future data exchanges and to open their technology stack to help SMEs and other industries digitalise.

Implications: 

• I don’t think platforms will be nationalised, though their functions could become somewhat grey. They are faced with a carrot and stick situation. For instance, they could be asked to help Chinese industries digitalise through DingTalk, Tencent middleware, PDD agricultural investment fund and Meituan’s new retail functions, and not to double down on their current consumer platforms, as there are implications for consumer welfare encroachment.
• I’m sanguine about this, as I think all Chinese consumer tech platforms are being offered a chance to have a second leg as a B2B company. They have the government’s support if they go forward with it. Put another way; they also have a cornered resource since China will not be asking AWS, Google or Salesforce to help with China’s digital transformation anytime soon.

Key takeaways 

• Software and manufacturing cloud is front and centre of policy. It receives strong tailwinds and platforms have a role to play – What gets measured gets done, and in the indicators for the Digital Economy Five-Year Plan, the size of the software and IT service industry is being asked to grow by at least 72% 2025.

Implications:

• The focus for manufacturing industries seems to be the digitalisation of the supply chain I expect many startup players in this space to accelerate through funding and government support in the coming years. More on this in the State of Chinese Cloud part I
• Agricultural tech is also seen as a top priority given the frequency it gets mentioned (seven times in the document), it is still a 13.8 trillion RMB ($2.1 trillion) that employs 25% of the Chinese workforce.
• Open-source software gets several shoutouts as a way to harness decentralised software manpower. This has also followed what I’ve observed in the VC community, opensource in China has been having a hot year in 2021. Now with government backing, expect Chinese open-source to go mainstream in the coming years. I’ll be posting more frequently on this topic too.

5. Fluke – Morgan Housel

Forecasting is hard. And not because people aren’t smart, but because trivial accidents can be influential in ways that are impossible to foresee…

…One night in college – I remember it was late, maybe midnight – I was reading a blog post about hedge fund manager Eddie Lampert. It was written by a guy named Sham Gad, who I had never heard of. I can’t remember where I found his blog; maybe I was searching for information on Lampert, who I admired.

Sham wrote that Lampert went to Harvard. I knew that was wrong – he actually went to Yale. Obviously it doesn’t matter, who cares? But using my student email address (which I rarely used but turned out to be important) I emailed Sham to let him know he was wrong. I never do stuff like that, then or now. The common denominator of the internet is misinformation. I have no idea why I thought it was necessary.

Sham’s a nice guy. He responded and said thanks, he’ll fix it.

A few minutes later he sent another email: “Hey I see from your email address that you go to USC. I’ll be in Los Angeles tomorrow. I’ve never been before, what’s the best way to get from LAX to downtown?”

It was a weird thing to ask a stranger who just trolled your blog. But it’s a reasonable question. If you’re familiar with LA you know there is no good answer. It’s the least transportation-friendly city in the world.

I don’t know why, but without thinking I responded: “It’s hard. I can pick you up. Let me know when you get in.”

He said great. I’ll see you tomorrow.

I’m a private guy. I’ve never done anything like this. At this point my relationship with Sham consisted of 10 cumulative sentences. I didn’t know if he was 17 or 87 years old. But the next day I was driving to LAX to get him.

We stopped at Chipotle on the way back. While eating he said, “I haven’t booked a hotel yet. Is there one nearby you can drop me off at?”

Adding to the list of things you shouldn’t say to a stranger, I said, “You can crash on my couch.”

“Wow, thanks,” he said.

I texted my girlfriend and said, “I met a guy named Sham online. I just picked him up at the airport and he’s sleeping on our couch tonight.”

“Excuse me?” she said.

I know, I’m sorry. I don’t know why I agreed to this…

…The next summer I was interning at a private equity firm. One day – and I remember this occurring within the same hour – two life-changing things happened.

Global credit markets started exploding in 2007, the preamble to the financial crisis. The firm I was at wasn’t in great shape. They told me there wouldn’t be a full-time spot for me after I graduated. I’d have to leave the next month.

That hurt. I needed to find a job as the economy was melting down.

I also needed to finish a project I was working on, researching logistics companies for the private equity firm. That included gathering information on a tiny public company called FreightCar America.

I went to Yahoo Finance. I didn’t find much, but just before clicking away I saw one lonely article in the FreightCar America news feed.

It was a Motley Fool article written by … Sham Gad. (It’s here).

Hey, I know that guy!

I emailed Sham for the first time in a year and told him how cool it was that he was writing for a publication.

We chatted for a bit. I told him I was looking for a new job. Anything. I was desperate.

“The Motley Fool is hiring writers,” he said. “I can put in a good word.” He owed me a favor, after all.

And that was that. I became a Motley Fool writer and stayed for ten years.

I’ve been a writer my whole career. It was never planned, never dreamed, never foreseen. It only happened because Sham got Eddie Lampert’s alma mater wrong and I needed a job at the very moment he wrote a blog post about a company I was researching at a job I was about to be laid off at.

6. Our Take on the Data Deluge, and What’s Next – Dharmesh Thakker, Chiraag Deora and Jason Mendel

Today, our company Collibra*, which focuses on data intelligence—particularly around areas like compliance—also hit a corporate milestone when it announced its latest $250 million financing. It all underscores just how detailed and granular the data market has become, and how much market value is up for grabs as companies both 1) increasingly seek out better data to make more-informed decisions, and 2) use data to improve customers’ experiences.

So what’s driving this data deluge? And how long can it continue? Our research and discussions with hundreds of companies over the last five or more years have highlighted six key factors driving the creation and growth of data and business-intelligence (BI) companies. They’ve also given us insights around how the market may shift in the coming years, so we’re sharing some predictions here too.

Literally, zettabytes of data

The first factor driving the growth of new, data-focused technology is simply the unbelievable volume of data being produced today—data that needs to go somewhere to be useful. Data is being produced from all around us whenever we interact with mobile applications, shop online or even through customer support interactions. If technology is being used, data is being created. Research firm IDC predicts that the global datasphere will grow to 143 zettabytes (for context, each zettabyte is 1 trillion gigabytes) by 2024—a 26% increase from the 45 zettabytes of data that were around in 2019.

It’s obvious, but important we say it anyway. The shift to the cloud is real!

We are still very early in the public-cloud adoption journey, as the majority of data still resides in legacy, on-premise data centers. By 2025, IDC estimates that approximately 46% of the world’s stored data will reside in public-cloud environments. This is a direct driver of the massive increase in data, and new data technologies, as the cost of compute and storage in the public cloud is much lower–there are no upfront capital-expenditure requirements, and access to data is often governed by reasonable, pay-as-you-go or consumption-based pricing. In addition, the automation that comes with the cloud allows companies to free up system engineers from worrying about customizing on-premise systems, and instead focus on other data-management priorities. The migration to cloud promotes flexibility, scalability, and cost efficiency in a way not previously possible with on-premise deployments.

Consumers need information, and they need it now.

Old-style, batch data sets historically have been used for many analytics needs; in this method, data is gathered over time prior to being analyzed. There are and will continue to be great use-cases for batch analytics, including managing payroll or customer billing. But with the advent of mobile computing and the Internet of Things, among other trends, there has been a pressing, new need for analyzing data in real time. Use cases here include fraud detection, tracking real-time ETAs on ridesharing applications, managing the temperature of your home as the day progresses, and many more. Per IDC, the market for real- time or continuous analytics is expected to grow to $4.4 billion by 2024. Aside from enabling a different set of applications, real-time analytics contributes heavily to the growth of data given the constant need for up-to-date data.

7. Why 7% Inflation Today Is Far Different Than in 1982 – Greg Ip

Consumer price inflation in December, at 7%, was last this high in the summer of 1982. That’s about all the two periods have in common.

Today, the inflation rate is on the rise. Back then, it was falling. It had peaked at 14.8% in 1980, while Jimmy Carter was still president and the Iranian revolution had pushed up oil prices. Core inflation that year reached 13.6%.

Upon becoming Federal Reserve chairman in 1979, Paul Volcker set out to crush inflation with tight monetary policy. In combination with credit controls, that effort pushed the U.S. into a brief recession in 1980. Then, as the Fed’s benchmark interest rate reached 19% in 1981, a much deeper recession began. By the summer of 1982, inflation and interest rates were both falling sharply. Four decades of generally low-single-digit inflation would follow.

“We have had dramatic success in getting the inflation rate down,” one Fed official observed that August. But Mr. Volcker had other problems to contend with: His high interest rates had pushed Mexico into default, touching off the Latin American debt crisis, and unemployment would climb to a post-World War II high of 10.8% that fall.

Unemployment took out that record in the early months of the Covid-19 pandemic in 2020. Since then, it has been falling rapidly as the economy roars back thanks to vaccines, fewer restrictions on mobility and ample fiscal and monetary stimulus. In December, unemployment sank to 3.9%, closing in on the 50-year low of 3.5% set just before the pandemic.

Monetary policy then and now couldn’t be more different. Back in 1982, the Fed was still targeting the money supply, causing interest rates to fluctuate unpredictably. Today, it largely ignores the money supply, which expanded dramatically as the Fed bought bonds to hold down long-term interest rates. Its main policy target, the federal-funds rate, is close to zero.

Rather than 1982, two previous episodes when inflation reached 7% might hold more useful lessons for today. The first was in 1946. The end of the war had unleashed pent-up demand for consumer goods, and price controls had lapsed. Inflation reached nearly 20% in 1947 before falling all the way back. Today, consumption patterns have similarly been distorted and supply chains disrupted by the pandemic.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.  Of all the companies mentioned, we currently have a vested interest in Amazon, Meituan, and Tencent. Holdings are subject to change at any time.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general.

Here are the articles for the week ending 30 January 2022:

1. How Inflation Swindles The Equity Investor – Warren Buffett

There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn’t going to be a big winner. You hardly need a Ph.D. in economics to figure that one out.

It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their value in real terms, let the politicians print money as they might.

And why didn’t it turn out that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds.

I know that this belief will seem eccentric to many investors. They will immediately observe that the return on a bond (the coupon) is fixed, while the return on an equity investment (the company’s earnings) can vary substantially from one year to another. True enough. But anyone who examines the aggregate returns that have been earned by companies during the postwar years will discover something extraordinary: the returns on equity have in fact not varied much at all.

2. Complexity Investing & Semiconductors (with NZS Capital) – Ben Gilbert, David Rosenthal, Brinton Johns and Jon Bathgate

David: I’d heard a little bit about complexity theory and the Santa Fe Institute, which I want to get into. I think Bill Gurley talks about this fairly frequently and Michael Madison, and that’s how I kind of originally got turned onto it. Tell us a little bit more about what is it? Because it’s not at all about investing. It’s about the world.

Brinton: That’s right. In fact, I think it was Bill Gurley that recommended Complexity to Brad. Complex adaptive systems are all around us. That’s what governs the world. That’s how the world works. We don’t know how the future is going to unfold because the system is interacting together and it creates what’s called emergent behavior.

Emergent behavior makes predicting useless in most cases, and we can have guidelines, and heuristics and those are all helpful. As far as exact outcomes and what’s going to happen in the future, those are a lot more difficult.

Santa Fe Institute started with a group of scientists from the Los Alamos National Labs. They came together—they were mostly physicists—and they started talking to economists. It was sort of hard sciences and soft sciences, and the physicists were like, hey, economists, guys. You guys seem really smart, but your theories don’t work. All your math doesn’t work. So what’s up with that? With our math, it’s extremely precise. In fact, when the math is off just a little bit, Einstein’s like oh, your math is off. Pluto should really be here and come up with a Theory of Relativity.

David: It’s like we literally made the atomic bomb, it works.

Brinton: Yeah, it works. So they started coming together around this idea of complexity. What is complexity? How do we define complexity? Where does it sit? Because we are living in this complex, adaptive system, how do we think about the future? How do we think about life? How do we think about going forward?

For us, this sparked an interest in biological systems and we found this sort of biology vein much more interesting than the traditional economics vein, and much more applicable to investing than the traditional economics vein…

…We just learned so much. I remember sitting outside of this cafe in Palo Alto with Brad and we have just sort of been at this course with Deborah Gordon, this lady that teaches at Stanford, here to study ants. I thought, man, this concept of resilience is really fascinating. It’s really more about resilience than it is about predicting the future and it’s about adaptability.

Biology doesn’t really care that much about the future. They care about adapting to this wide range of futures. Bees don’t really care if it’s going to snow tomorrow, they can adapt to snow. They’ve learned how to do that over millions of years. What if we looked at companies like that?

Of course, we kept reading, we kept writing. This is probably 2011–2012, and in 2013 we published this long paper that you reference, which is super geeky, but it’s got a lot of pictures because that’s the way we think.

David: You’ve got the Back to the Future DeLorean in there.

Brinton: It’s got the DeLorean. What more could you want? We were really hoping for a DeLorean for the office. That’s our dream office furniture.

Ben: On the note of ants, this is probably the first and best example of an extreme version of resilience in an organization. Can you share the insight you had there?

Brinton: Yeah. We attended this class by Deborah Gordon and she has been studying this group of ants for 30 years in New Mexico. They obsess over this group of ants. They know what every ant is doing at all times. What they found was really fascinating.

They found that about half of the ants of the colony weren’t doing anything. They were just sort of sitting around and then they had half the hands doing these defined jobs. That’s very counterintuitive. We think of ants as sort of the ultimate productivity machines. Then it turns out ants aren’t optimized around productivity. They’re optimized around longevity. They’re optimized around resilience, around living as long as possible, let’s say it that way.

That was really insightful for us. We thought, man, all these companies are optimized around productivity and Wall Street only makes it worse because we’re obsessed over quarterly earnings. What if companies were really optimized around this long-term thinking? Of course, we see that with lots of companies, most of them tend to be run by founders, because founders have a lot of skin in the game, they think long-term, but there are CEOs that think that way also.

We know that the average tenure of a CEO in a SP 500 is less than five years. They’re not optimized like ants are. They’re trying to get a lot of returns really quickly. But companies that take this long-term view are so much more interesting.

David: When I read that, in your paper, the thing that hit me over the head, I was like, oh, this is Warren and Charlie’s laziness bordering on sloth.

Brinton: That’s exactly it.

David: The goal is not productivity. The goal is long-term steady returns and resilience.

Brinton: I think Warren and Charlie got this very early and there’s a lot of science behind that math, but they don’t need that. They’re so good with folksy wisdom.

3. Zoom CEO Eric Yuan on trusting your gut, learning from failure, and leaving behind an enduring legacy – Byron Deeter

When Eric joined Webex as a founding engineer, he witnessed the transformation of this first generation video and collaboration product into a major player that was acquired by Cisco in 2007. He’d also worked his way up to VP of Engineering. But by 2011, Eric was no longer happy.

“Every time I talked to a Webex customer, I was embarrassed,” he says. “I did not see a single happy customer.” Eric realized there was no way to fix all the modern problems plaguing customers by tweaking legacy Webex software. He was convinced that the only way to win back disenchanted customers was to build a new solution from the ground up.

But when he presented his ideas to his coworkers, they were not sold on cannibalizing their existing product. They also doubted whether Eric’s proposal was even possible. In the face of this tremendous pressure from naysayers to abandon his ideas, Eric trusted his gut. He decided to tender his resignation and start his own company.

Buoyed by a strong instinct that he could build something superior, Eric began creating the product we now know as Zoom. The first iteration took him only one year. “I like Nike’s mantra,” says Eric. “Just do it. A lot of my friends told me, ‘Eric, please don’t do it.’ But if it’s your dream, you need to ignore them.”…

…Eric stresses the value of building trusting relationships with customers. He prizes this above all else, even if it means leaving money on the table. “Quite often our sales team would tell me, ‘Eric, we’ve got to increase the price. Customers told us we can,’” he says.

But Eric would repeatedly refuse. He remained steadfast in his conviction that some things are worth more than money. “Our philosophy is to always keep adding more value, while keeping the same price,” he says. “Because down the road, the customer will realize ‘Wow, I paid $14.99, but the product just keeps getting better and better.’”

“If you’re a founder, don’t always think about always increasing the price,” Eric advises. He believes it’s myopic to think that short-term cash in the bank is worth more than deep usage engagement, which creates momentum that will build over time.

4. The Tech Monopolies Go Vertical – Fabricated Knowledge (Doug)

The phrase “Owe the bank 500 dollars, that is your problem. Owe the bank 500 million – that is the bank’s problem.” is something that comes to mind for some of the tech monopolies right now. There is a shifting relationship between the largest software companies in the world and their suppliers, and as the leading software companies have become ever-larger portions of the compute pie, it’s kind of become the problem of the tech companies, and not the semiconductor companies that service them to push forward the natural limits of hardware. Software ate the world so completely that now the large tech companies have to deal with the actual hardware that underlies their stack. Especially as some companies like Intel have fallen behind…

…I believe that in a few years, most of the large tech companies will have a much tighter level of integration and we will likely see much less “commoditized” platforms. Yes, they might run on partially open stacks (think open networking roadmap and Facebook) but their differentiation is going to be not only software but also hardware. We are going back to the old patterns of integration of both Software and Hardware.

The unit economics of this is profound, partially because if a company doesn’t pursue this, they will have to pay the exponential cost of AI compute at face value, but also potential competitors will have to face a new barrier to entry. The profit deserts around their moats, as mentioned in the first @modestproposal1 Invest like the Best podcast, will climb even higher. They will be able to sell products below their competitors while making a profit..

…This is a barrier to entry that few companies can really climb over anymore, with 500 million in R&D only possible by a few companies (270 according to a screener I used) and many of the companies with R&D budgets larger than 500m is large tech companies themselves. It is no surprise they are going custom, as now this is a very capital intense way to create a gulf between them and the rest. For example, something I wanted to note is that every single company mentioned so far spends more on absolute R&D than Intel! Samsung, a company that is out of the scope of this discussion rounds out the list of the companies that spend more than Intel on R&D worldwide. This is likely not a coincidence! Semiconductors are becoming more capital intense as we hit the wall of physics, and by being at that leading edge the new technology monopolies will get to operate in that world alone.

Just imagine now that you are an entrant, trying to sell IaaS, maybe like Digital Ocean (huge fan). If Intel and AMD chips are all that you can use, you better pray and hope their roadmaps are strong, because now that your competitors are able to create and expand their own roadmaps faster than the large semiconductor platforms, you may be forced to eventually buy from them or just be at a structural gross margin disadvantage. You could offer identical services but make worse profits, just on the basis that you don’t make your own chips. If they lower prices, you could even lose money! You cannot compete…

…Software ate the world and hardware has been struggling to keep up recently. Now the largest software companies are slowly becoming hardware companies and pursuing an integrated strategy that only can be achieved at the largest scale possible and with barriers of entry that are quickly expanding in addition to their well-known network or aggregation effects. The walls are slowly rising, the moats slowly widening, and as we are on the cusp of a new hardware renaissance, the decisions the hyperscalers make now are going to have a long-lasting competitive shadow. Stay tuned.

5. It’s Never a Market Crash Problem – Safal Niveshak

It’s almost always an –

• I don’t know who I am problem
• I don’t know how much pain
• I am willing to take problem
• I don’t have the patience to give my stocks time to grow problem
• I bought on the tip of that popular social media influencer and did not do my homework problem
• I did not diversify well problem
• I bought the stock just because it dipped problem

6. Tyler Cowen is the best curator of talent in the world – Tony Kulesa

I am a biotech investor. I know a lot of top biotech investors. I’ve also spent close to a decade at two of the best life science academic institutions in the world.

Tyler’s understanding of biotech is that of a very broad economist. Yet, he is often beating me and many of the people and institutions that I know.

Tyler has identified talent either earlier than or missed by top undergraduate programs, the best biotech startups, and the best biotech investors, all without any insider knowledge of biotech. In comparison, Forbes 30U30, MIT Tech Review TR35, or Stat Wunderkind, and other industry awards that highlight talent are lagging indicators of success. It’s hard to find an awardee of these programs that was not already widely recognized for their achievements among insiders in their field. The winners of Emergent Ventures are truly emergent.

I have now met >5 Emergent Venture winners that work in life sciences. The average age of this group is ~20 years old.

One has attracted international recognition for his new non-profit founded this year. Tyler funded him ~2.5 years ago when his most notable public accomplishment was amassing 300 twitter followers.

Another winner has now started a company backed by top tier investors – professional talent hunters – but he received his first funding from Tyler a year prior, when he was still experimenting with what to build.

Others had been rejected by undergrad programs at Harvard, MIT, and Stanford, but their research talents have become recognized by the best academic life scientists and top biotech startups…

…It isn’t just a matter of more elite selection. In fact, Emergent Ventures has a higher acceptance rate than elite colleges. In May 2020, Tyler reported in an interview with Tim Ferriss that the award rate is ~10%. For comparison, the 2021 acceptance rates of Harvard, Princeton, and Yale were 5%, 6%, and 7%. It also isn’t a wider pool. At that time, he had only ~800 total applications since 2018.

Tyler’s success at discovering and enabling the most talented people before anyone else notices them boils down to four components:

1. Distribution: Tyler promotes the opportunity in such a way that the talent level of the application pool is extraordinarily high and the people who apply are uniquely earnest.
2. Application: Emergent Ventures’ application is laser focused on the quality of the applicant’s ideas, and boils out the noise of credentials, references, and test scores.
3. Selection: Tyler has relentlessly trained his taste for decades, the way a world class athlete trains for the olympics.
4. Inspiration: Tyler personally encourages winners to be bolder, creating an ambition flywheel as they in turn inspire future applicants.

7. Some Things I Remind Myself During Market Corrections – Ben Carlson

Time horizon is all that matters during a correction. This may sound like a humblebrag of sorts but market corrections don’t really bother me all that much anymore. The sight of my holdings falling in price day after day doesn’t bother me for the simple fact that I’ve already resigned myself to this fate.

You see I don’t put money into risk assets that I’m going to need for spending purposes in the next 5 years or so. It’s all long-term capital.

And given this money is going to be invested for the long-term, I already know in advance I’m going to have to endure corrections, bear markets and crashes from time to time.

I know my balance will get vaporized on occasion, I just don’t know when those occasions will be.

The money that I know will be spent in the short-term doesn’t go into risk assets.

An understanding of your time horizon saves you from becoming a forced seller.

It’s best to sell when you want to not when you have to. I’m guessing a lot of the selling in recent days has come from margin calls from investors who bought stocks using leverage. You don’t see massive moves of 10-15% in individual names like we’ve seen without some forced selling.

Buy and hold can be painful when stocks are falling but ‘buy on leverage and get a margin call when your stocks just got killed’ is a far worse fate.

Buy and hold requires you to do both when stocks are falling. It’s much easier to both buy and hold when stuff is going up.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.  Of all the companies mentioned, we currently have a vested interest in Zoom. Holdings are subject to change at any time.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general.

Here are the articles for the week ending 23 January 2022:

1. Interview: Ryan Petersen, founder and CEO of Flexport – Noah Smith and Ryan Petersen

N.S.: The supply chain crunch has been the biggest economic story in the world for about a year now, causing inflation and throwing the Biden administration’s plans into disarray. What sparked the supply chain crunch? How much of a factor was increased demand for physical goods due to the pandemic? Were shifting trade patterns at all to blame? Basically, why now?

R.P.: The supply chain crunch was started by increasing demand for goods, as consumers stopped spending on services. Americans in particular had more money in their pockets because they weren’t going on trips, spending at restaurants and bars, or attending concerts. Instead as city after city started enforcing lockdowns and restrictions, people started spending a lot more goods and not services. You’ve got to get your dopamine somewhere. So what we saw was an unprecedented increase in imports from China—as much as 20% more containers entering the United States than were leaving our ports since the start of the pandemic. It turns out, our infrastructure is just not made to scale this fast, and by infrastructure what we mean is the entire ecosystem: The number of container ships in the world, the number of containers available, the throughput of our ports, the availability of trucks and truck drivers, the availability of chassis (the trailers that haul containers around), the entire system is overwhelmed and clogged. We simply don’t have enough of these essential supply chain elements, or resilient systems that are agile enough to shift the supply of these assets to where they’re needed.

While the pandemic drove this shift in demand from services to goods, it also changed where consumers were buying goods (increasingly online), the types of goods they were buying, and where those goods were flowing to and from. One thing to note is that e-commerce logistics networks are fundamentally different in their geographical and physical space than that of traditional retail. They’re more complicated because you are edge caching your inventory to be closest to your users instead of positioning everything in a distribution center in a single hub. You now have to position your warehouses all over the United States, making it exponentially more complicated. So the more people bought things online, the more these systems were overloaded.

Then there was the impact of cascading second orders that are inherently unpredictable. For example, as imports increased as much as 20%, exports actually decreased because the United States economy was slow to reopen. In fact exports are still down. If you look at the journey of a shipping container, it runs in a loop: The same container that brings in imports later helps transport exports out of the U.S. So if there are fewer exports going out, that means companies are consciously choosing to ship empty containers back to Asia or else they will run into shortages at the origin ports. At one point over the last year, as an industry, we were 500,000 shipping containers short in Asia. These shortages led to increases in prices. If you wanted to get a container you had to pay a real premium to get access. In some cases renting a container for one journey was more expensive than the price to buy one. In January 2019, rates on the Trans Pacific Eastbound route (TPEB), and Far East Westbound (FEWB) were around $3000. In December 2021, rates remained elevated in the $12,000 – $15,000 range. At one point this year, TPEB rates were as high as $24,000.

Consumers are just buying more stuff than ever and our infrastructure, frankly, isn’t ready for it. It’s getting held back by dilapidated port infrastructure, by congestion, non-automated ports, and bad rail connections to the ports. We’re just recognizing the pain of 20 years of not investing in our infrastructure. And we’re feeling all that pain in one year right now. It’s increasingly difficult for truckers to pick up or drop off containers at ports and warehouses, leading to today’s congested ports, lots, and railyards. So boats can’t get in, we don’t have enough containers, a lot of the empty containers are stuck on the chassis, we don’t have enough chassis because we don’t have enough warehouse space, and we don’t have any space in the warehouses because we can’t move the goods out fast enough.

Until we can focus on what actually clears the ports, rail yards and warehouses, and goods can begin to move at a pace that aligns more closely with the growth in consumer demand, there’s nowhere for the containers to go, and the number of ships waiting to unload will continue to grow…

...N.S.: Was the global economy simply over-engineered? Did we optimize supply chains for efficiency at the cost of resilience, like a machine with tolerance gaps that are too small? And if so, should we recalibrate going forward, to leave more slack in the system in case of future crises?

R.P.: In my opinion, what’s caused all the supply chain bottlenecks is modern finance’s obsession with Return on Equity (ROE). To show great ROE, almost every CEO stripped their company of all but the bare minimum of assets. “Just-in-time” everything with no excess capacity, no strategic reserves, no cash on the balance sheet and minimal investment in R&D. We stripped the shock absorbers out of the economy in pursuit of better short-term metrics. Large businesses are supposed to be more stable and resilient than small ones, and an economy built around giant corporations like America’s should be more resilient to shocks. However, the obsession with ROE means that no company was prepared for the inevitable hundred-year storms. Now as we’re facing a hundred-year storm of demand, our infrastructure simply can’t keep up.

Most global logistics companies have no excess capacity, there are no reserves of chassis, no extra shipping containers, no extra yard space, no extra warehouse capacity. Brands have no extra inventory and manufacturers don’t keep any extra components or raw materials on hand.

And let’s not forget the human aspect of the workforce that makes this all happen. A lot of companies in the industry haven’t invested in taking care of their people, especially during market downturns, so now they can’t staff up quickly to meet surging demand.

When the floods inevitably hit, the survivors will be those who invest in excess capacity, in strategic reserves of key capital assets, in employee trust that let them attract and retain talent. Running lean systems may seem beneficial, until the whole system fails like it did this year. We’ve removed the shock absorbers from the economy and it’s time we add them back.  

2. Standard Oil Part I – Ben Gilbert and David Rosenthal

We dive into original American capitalist mega winner, Standard Oil, and its legendary founder John D. Rockefeller…

…David: Yeah. Rockefeller though just got this vision where he’s like, oh man, the more profit I make, the more capital I can put into this, the more oil I can hold, and the more I can produce. When the price crashes, I’ll just keep buying. He buys the dip over and over again. Because his operations are so much more efficient and so much more profitable, he can afford to pay more than anybody else. He can afford to hold this stuff longer. He’s really thinking long-term in a way that none of his other competitors are.

Ben: When we say he’s tweaking stuff and he’s so much more profitable, he is both horizontally and vertically integrating. Let’s talk about vertically integrating first. He’s doing things like realizing, jeez, we’re hiring a lot of plumbers to come in and lay this pipe every time we do a build-out. They do things like hire their own plumber, hire their own blacksmiths, and decide actually, we should do this ourselves. That way, we can save all this money on piping instead of buying it from a third-party contractor.

Later down the road, he even plants a forest. He buys up a forest so that they can cut down the trees themselves to build the barrels out of.

David: To make their own barrels. Oh my gosh, this is so great.

Ben: They save all this money rather than buying barrels from somebody else. Then, of course, they can innovate on the barrel-making process. He figures out, oh, if we treat the wood in the forest, then it’s lighter and cheaper to ship back to the refinery so we save all this money on transportation. That’s the vertical integration side of things, which would be crazy enough, but he’s figuring out that wait, we do this process. How can we use the whole buffalo? What can we sell the gasoline for? I think they invented Vaseline.

David: Yes. I think they buy the company that invents Vaseline. Petroleum jelly, which is one of the byproducts, they commercialize it.

Rockefeller found his calling here. This is divine passion. There’s just one problem which is the partner, Clark. Clark is not so into how much capital Rockefeller is tying up in the business here. He’s like, hey, we’re merchant traders. The point is profits, and then we keep the profits.

Rockefeller is like, no, reinvesting it in R&D, CapEx, and inventory. Rockefeller starts going around to all the banks and all the financers in Cleveland and lining up. He’s not even using just the profits from their operations. He’s getting more external financing to finance growth here.

Ben: When I say both vertically and horizontally integrating, in the horizontal sense, he is obsessed with trying to figure out how to be the sole supplier of oil to the world. As soon as he figures out that there are economies of scale here, he’s like, okay, cool. How do we start the flywheel, get as much capital as possible, build out as much production as possible, and start having agreements with whoever’s got rights to the land as possible so we can start vending to the world?

David: Yeah, and own this super strategic chokepoint of refining in cities. Clark is spooked by all this. Chernow has this amazing quote that he finds from Rockefeller. I don’t know where he found this. I should look up in the notes at the end of Titan. This is so good. Rockefeller apparently wrote or said this at some point. “Clark was an old grandmother and was scared to death because we owed money to the banks.” It’s so great. 

Rockefeller engineers a coup. Some of Clark’s brothers are also partners in the business at this point in time. They get into all these arguments. John baits them one day into threatening that they should just dissolve the partnership. John’s like, okay, great, let’s dissolve the partnership.

Ben: Because he knows that if he goes to them and says, look, first of all, I don’t think you are risk-tolerant enough, and second of all, I don’t think you’re upstanding so I want out. He knows that he loses leverage by doing that. That’s why he baits them into doing their normal thing of getting all up in a fit and saying we’re going to back out.

David: Totally. Rockefeller immediately goes to the local paper and places a notice that the partnership is dissolving and that there’s going to be an auction for the assets of the partnership including the oil refineries. It sets up this showdown where the Clark brothers and Rockefeller bid against each other for each other’s 50% stake in the business.

Ben: Which is, by the way, a great way to do it. If you’ve got a partnership that’s blowing up, all right, whoever wants to pay more to buy the other person out is the person that should get to own the whole thing. The idea of a bidding war between the two of them to figure out how to value the business makes total sense.

David: Between the two principals. Rockefeller though, remember, he’s been going and getting the relationships with all the banks and financiers, he lines up financing in advance of the auction. He’s got basically unlimited resources, although the price ends up stressing him out. He buys Clark’s 50% of the oil business for $72,500. In exchange, Rockefeller gives Clark his 50% share of the produce trading.

Ben: Which by the way, he probably buys him out for $3–$4 million, something like that, in 2021 dollars.

David: A good chunk of change. That 50%, that $72,500 or however you want to think about it, is 50% of Standard Oil right there.

Rockefeller would say later, “It was the day that determined my career.” Probably bigger than job day. “I felt the bigness of it, but I was as calm as I am talking to you now.” This is what we’re going to see. This man has literally solid ice running through his veins. It’s crazy.

This was a big price. It was more than Rockefeller wanted to pay, but this happens in February of 1865. Back to what’s going on in America, two months later, General Lee surrenders to Grant, and the Civil War is over. With the Civil War over, what’s less important? Commodity, produce trading. What is all of a sudden a hell of a lot more important? Oil, industry, urbanization, everything.

Ben: Because all these soldiers are coming back and getting jobs in factories, you have an industrial boom here. It’s interesting how Rockefeller is obsessed with I’m not a speculator. I’m not one of these people rushing to prospect various plots of land in Western Pennsylvania. It’s funny that it’s, I would say, a picks-and-shovels play. I guess the point to make here is he’s doing the predictable, reliable, stable, very strategic part of the value chain. He’s not out prospecting land.

David: To just doubly underscore strategic, did Rockefeller know the war was going to end in two months? Probably. Sherman’s probably marching to the sea at this point.

Chernow writes, “The war had stimulated growth in the use of kerosene by cutting off the supply of southern turpentine, which had yielded a rival illuminant called camphene. The war had also disrupted the whaling industry, and led to a doubling of whale oil prices. Moving into the vacuum, kerosene emerged as an economic staple and was primed for a furious postwar boom. This burning fluid extended the day in cities and removed much of the lonely darkness from rural life.”

Soon, John D. Rockefeller would reign as the undisputed king of that world. He’s now got the oil operations, the refining business all to himself. December of 1865, the war’s over, all this is going on, and he opens a second refinery in Cleveland next to the Excelsior Works with a new name that he chooses, he wants to let everybody know that his oil, his kerosene, his business, and his operations are going to be bigger than anyone else. It’s going to be the best quality and it is going to reign from sea to sea. What does he call the new operation?

Ben: Standard Oil.

3. Bitcoin Failed in El Salvador. The President Says the Answer Is More Bitcoin – David Gerard

More than 91 percent of Salvadorans want dollars, not bitcoins. The official Chivo payment system was unreliable at launch in September—the kiss of death for a new system. Users joined for the $30 signup bonus, spent it or cashed it out, then didn’t use Chivo again. The system completely failed to check new users’ photos, relying solely on their national identity card number and date of birth; massive identity fraud to steal signup bonuses ensued. Bitcoin’s ridiculously volatile price was appreciated only by aspiring day traders. Large street protests against compulsory Bitcoin implementation continued through October. The government stopped promoting Chivo on radio, TV, and social media. Chivo buses and vans were seen with plastic taped over the company’s logo.

Bukele’s financial problems remain. El Salvador can’t print its own dollars, so Bukele urgently needs to fund his heavy deficit spending. The International Monetary Fund has not lent the country the $1 billion Bukele asked for, and has indicated its strong concerns about the Bitcoin scheme.

So Bukele, known for a populism that is half aspiring dictator, half Elon Musk, once more announced national policy from the stage: At the Latin American Bitcoin and Blockchain Conference on Nov. 20, Bukele came onstage to an animation of beaming down from a flying saucer and outlined his plans for Bitcoin City: a new charter city to be built from scratch, centered on bitcoin mining—and powered by a volcano.

Bitcoin City would be paid for with the issuance of $1 billion in “volcano bonds,” starting in mid-2022. The 10-year volcano bonds would pay 6.5 percent annual interest. $500 million of the bond revenue would be used to buy bitcoins. The bitcoins would be locked up for five years, then sold to recover the $500 million purchase price; any profit on the sale would be paid out as an additional dividend. Holding $100,000 in volcano bonds for five years would qualify investors for Salvadoran citizenship.

4. TIP406: Finding Hidden Treasure w/ Thomas Braziel – Trey Lockerbie and Thomas Braziel

Trey Lockerbie (35:25):

You mentioned your investors expecting you to knock the cover off the ball sometimes. There is this unbelievable example or this investment that you did that I think encapsulates a lot of what we just talked about on this episode, and that was your Mt. Gox investment. So start at the top of this example. I know you’re going to try and spin it in a very humble way, but this is just such an incredible investment. Give us the lay of the land here with this, what you saw and how it’s panning out.

Thomas Braziel (35:54):

You know, I would just say that so much of your life in business, your personal life, and in investing is going to be serendipitous in the sense that I really believe so much of it as preparation meeting opportunity. I happen to be in the right place at the right time. I happen to know a lot about bankruptcy. I happen to know how to buy claims. And I just so happen to something I thought, “Well, wow, this is ridiculously asymmetric. If this works, yeah, this could really work, and I’ll get this ridiculously magnified return on probably the most volatile and interesting asset of our time.” So Mt. Gox was interesting. I mean, I tripped upon Mt. Gox reading the FT, and I saw the administration. It was probably year into the administration and there was an article in the FT. And I had known what Bitcoin was, but I didn’t think anything of it. I mean, I’m living, as we all do, I’m living in my own bubble.

Thomas Braziel (36:50):

And that’s the hard part about investing is this time period where you need to have your ears up and your antennas out and you’re looking, scoping out, trying to find opportunities. But then when you find something that might be interesting, you have to choose and choose wisely as best you can on where you’re going to spend your time. So for this, I saw the docket, I thought, “Wow, Japanese insolvency cryptocurrency claims. Wow. That’s amazing. That is really crazy. I wonder how you buy these.” It was out of curiosity. I wonder how you actually paper buying this kind of thing. And I thought, “Wouldn’t it be cool to buy one just to see if I could do it?” It was like someone saying like, “Wouldn’t it be cool to build a cabinet, see if I could just do it?” And there’s something like that. Someone.

Thomas Braziel (37:35):

So I did. So I went out there in the market, and it’s easy to read about the case. It was all in English and in Japanese, it was in dual languages, just because there were so many foreign creditors that they do everything in English and Japanese. So this is 2016, Bitcoin was probably at $300. I remember I bought some Bitcoin on Zappo and maybe on Coinbase as well, just to be like, “Hey, if I’m going to buy these claims, I should probably know what Bitcoin really is. People talk about it.” I bought one claim and I thought, “Oh, that’s really cool.”

Trey Lockerbie (38:08):

Where did you buy the claim? How did you find someone to sell you a claim?

Thomas Braziel (38:11):

So this is true in American cases, it’s not always true in foreign cases, and it just happened to be that a list of creditors, of approved creditors was… It is available if you’re a creditor in the court, but someone had actually leaked the approved creditor list, and I remember, hopefully this was pre-GDPR, but we had gotten ahold of the list and it’s all public there. I mean, I think there was even links probably to a newspaper where they had the list posted or at least in their servers or whatnot. But there was a list of approved creditors floating around. So I started fishing around and I figured, “Okay, I’ll start with the funny names because those will be easier to Google and find somebody that matches it, because John Smith’s going to be pretty hard to find. But your last name is Lockerbie, is that how you say it?

Trey Lockerbie (38:58):

Lockerbie, yeah.

Thomas Braziel (38:59):

That’s pretty, Trey Lockerbie, I might Google Trey Lockerbie and I’d look for a guy who was maybe into computer science.,Maybe he was into crypto, if he had it as an interest on LinkedIn or on Twitter, something, and maybe he’s the right age, maybe he’s below 35 and is into computer science or is somehow into cryptography and whatnot. So I started doing that and I basically found a few claims, bought them, and I didn’t think… At the time crypto was at 300, we bought the claims for a look through price of about $100 in Bitcoin. So it was an OK trade. It was like, “That’s an okay trade.”

Thomas Braziel (39:36):

This happens a lot of times in the life cycle with trades. It’s like a company you know a lot about. I don’t know, maybe if you follow Disney really close or something and you’re like, “This is an inflection point.” The real inflection point in the trade was 2018, I think when Bitcoin went to over 20,000, but it kind of pulled back, and the trustee was sold some crypto to basically raise a fiat. And we were able to buy the claim, where we were buying the crypto for free. And let me explain how. If you added up the cash in the estate and you added up the crypto, or you just added up the cash, leave the crypto for a second, and you divided by the outstanding claims, you were going to get about 450 to 480 dollars per claim, per BTC, per Bitcoin.

Thomas Braziel (40:23):

And we were able to buy them anywhere between 300 to 400 dollars. So we always knew we were going to get the 450 to 480 back in cash. And on top of the cash was Bitcoin. And I pitched this trade all over town in New York, trying to get a hedge fund to put in capital and let’s do it. And they were… People were like, “Hey, this is not that scalable, this is crypto. We’ll never get it past…” The common objection, too small, not scalable, it’s crypto. I’ll never get it past my investment committee. Or, “Oh, I get it. You’re getting free optionality, but what is Bitcoin even worth? I mean, let’s be real.” And I was like, “Yeah, I don’t know. I think it’s a real possibility it could be worth something, and it hasn’t died yet.”

Thomas Braziel (41:06):

Even at the trade I was putting it on, assuming Bitcoin stayed where it was, it was somewhere between the 8 and 10 X return. And that was in Bitcoin, I think was at about 10 grand. So we’re getting the Bitcoin for free. So our downside extremely limited. I mean, in my mind, practically zero, other than legal risk and cost of collection and IRR risk, and optionality and convexity was incredibly high. So I loaded the boat. I mean, my hedge fund at the time, we were actually winding it down, so we didn’t add any in the hedge fund, but I was able to get a family office on board, and since my hedge fund was winding down, we were making distributions. I mean, this is crazy and I would never recommend someone do this. I put all my personal money in it.

Thomas Braziel (41:49):

So I did that knowing that it was a little aggressive and maybe I did it out of spite for my hedge fund closing, but no, not really. I really thought it was an amazing trade. I remember I actually had a… The claims that we bought in the whole setup, I remember sitting at dinner here in London, where I am now, and one of my investors was coming through. And I remember sitting at dinner with him, trying to explain to him how great this was. And his just… And he is a nice guy and he’s very smart but just can’t be bothered to look at the spreadsheet that… I’m such a young, somewhat naive person just thinking that this guy at dinner, when we’re having drinks and dinner, wants to see my spreadsheet that I printed out where I lay out the convexity and how great this is and all this stuff.

Thomas Braziel (42:36):

And he’s like, “This is great. Yeah, whatever, whatever. Great, great, great.” And he just doesn’t… He did not care. Maybe I wasn’t very good at pitching it, but anyway. So I got a family office on board. We bought a few million dollars worth. I put all my money into it. And I’m going to say the rest is history, because we’ve been buying claims over the years, but now we buy claims, of course we’re not making 40 X, we’re buying the Bitcoin for about half price and maybe 60 cents on the dollar. So we buy them for a large crypto hedge fund that believes in crypto. And I have to say, I’ve spent a lot of time in crypto now because of this, and I’m a bit of a believer.

5. Is the Fed Responsible for an 800% Gain in the Stock Market? – Ben Carlson

In a recent post I shared how the U.S. stock market is now up more than 800% since the lows of the financial crisis.

Right on schedule my Twitter replies and inbox were full of people bemoaning the fact that this entire bull market is an artifact the Federal Reserve policies…

…But what about Japan and Europe? Their central banks have also taken on trillions of dollars of assets on their balance sheets…

…The S&P 500 is outperforming stocks in each of these developed countries by more than 200% in total over the past decade. These countries have been providing similar levels of monetary stimulus over this time and their interest rates have been even lower than ours.

While the 10 year U.S. treasury bond currently yields around 1.7%, yields in Japan (0.1%) and Germany (-0.1%) are much lower. Why aren’t stocks exploding higher in those countries?

Interest rates certainly have an impact on how people allocate their capital but low interest rates alone don’t explain everything that happens in financial markets.

6. How Shein beat Amazon at its own game — and reinvented fast fashion – Louise Matsakis, Meaghan Tobin, and Wency Chen

Over the past decade, thousands of Chinese clothing manufacturers have begun selling directly to international consumers online, bypassing retailers that traditionally sourced their products from the country. Equipped with English-language social media profiles, Amazon seller accounts, and access to nimble garment supply chains, they’ve fueled the acceleration of trends and flooded closets everywhere with a wave of impossibly cheap clothes.

Rest of World spent the last six months investigating this new ecosystem, speaking with manufacturers, collecting social media and product data, making test buys, and interviewing shoppers and industry experts in both China and the U.S. Our reporting reveals how Chinese apparel makers have evolved to cater to the desires of internet-native consumers — and transformed their consumption habits in the process. Capitalizing on this shift are companies like Shein: the most successful, well-known, and well-funded online retailer of its kind.

Shein is now one of the world’s largest fashion companies, but little is known about its origins. 

It was founded in 2012 under the name SheInside, and reportedly began by selling wedding dresses abroad from its first headquarters in the Chinese city of Nanjing. (A spokesperson for Shein denied it ever sold wedding dresses, but declined to specify other details about its history.) The company says its founder, Chris Xu, was born in China, though a since-deleted press release described him as from the U.S.

Shein eventually expanded to offer apparel for women, men, and children, as well as everything from home goods to pet supplies, but its core business remains selling clothes targeted at women in their teens and 20s — a generation who grew up exploring their personal style on platforms like Instagram and Pinterest. 

Its clothes aren’t intended for Chinese customers, but are destined for export. In May, the company became the most popular shopping app in the U.S. on both Android and iOS, and, the same month, topped the iOS rankings in over 50 other countries. It’s the second most popular fashion website worldwide.

By 2020, Shein’s sales had risen to $10 billion, a 250% jump from the year before, according to Bloomberg. In June, the company accounted for 28% of all fast fashion sales in the U.S. — almost as much as both H&M and Zara combined. The same month, a report circulated that Shein was worth over $47 billion, making it one of the tech industry’s most valuable private startups. (Shein declined to say whether the sales or valuation figures were accurate.)…

…Through its manufacturing partners on the ground in China, Shein churns out and tests thousands of different items simultaneously. Between July and December of 2021, it added anywhere between 2,000 and 10,000 SKUs — stock keeping units, or individual styles — to its app each day, according to data collected by Rest of World. The company confirmed it starts by ordering a small batch of each garment, often a few dozen pieces, and then waits to see how buyers respond. If the cropped sweater vest is a hit, Shein orders more. It calls the system a “large-scale automated test and re-order (LATR) model.”…

…The secret is Shein’s internal software, which connects its entire business from design to delivery. “Everything is optimized with big data,” Lin said. Each of Shein’s suppliers gets their own account on the platform, which spits out information about what styles are selling well and can also quickly identify which might become future hits. “You can see the current sales, and then it will tell you to stock up more if you sell well and what you need to do if you don’t sell well. It’s all there.”

The software contains simple design specifications that help manufacturers execute new orders quickly. “A big brand might need a very high-end designer, or a designer with top technology, and even then may only be able to produce 20 or 30 styles a month,” said Lin. “But Shein does not have high design requirements. It is possible that a typical university student could get started designing quickly, and the output could be high.”…

…To convince suppliers to join its system, Shein had to meet only a very basic bar: paying them on time. Receiving timely payments is a huge problem for factories in China, said Malmsten. “They’ve built a lot of loyalty from their suppliers, so they can have more urgency on their orders,” she said. The result is that over 70% of products on Shein’s website were listed less than three months ago, Malmsten found, compared to 53% at Zara and 40% at H&M. “Shein just kind of blew Zara out of the water,” she said.

7. Casualties of Your Own Success – Morgan Housel

Two scientists, Aaron Clauset of the Santa Fe Institute and Doug Erwin of the Museum of Natural History, explained why in a paper that is dense but summed up in a wonderful sentence: “The tendency for evolution to create larger species is counterbalanced by the tendency of extinction to kill” off larger species.

Body size in biology is like leverage in investing: It accentuates the gains but amplifies the losses. It works well for a while and then backfires spectacularly at the point where the benefits are nice but the losses are lethal.

Take injury. Big animals are fragile. An ant can fall from an elevation 15,000 times its height and walk away unharmed. A rat will break bones falling from an elevation 50 times its height. A human will die from a fall at 10 times its height. An elephant falling from twice its height splashes like a water balloon.

Big animals also require lots of land per capita, which is brutal when land is scarce from farming or natural disaster. They can need more food per unit of body mass than small animals, which is the end game in a famine. They can’t hide easily. They move slow. They reproduce slow. Their top-of-the-food chain status means they usually don’t need to adapt, which is an unfortunate trait when adapting is required.

The most dominant creatures tend to be huge, but the most enduring tend to be smaller. T-Rex < cockroach < bacteria.

Size is nature’s leverage. Sought after for its benefits straight up to the point that it ferociously turns against you.

Same thing applies to companies and investments.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.  Of all the companies mentioned, we currently have a vested interest in Amazon. Holdings are subject to change at any time.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general.

Here are the articles for the week ending 16 January 2022:

1. My first impressions of web3 – Moxie Marlinspike (a.k.a Matthew Rosenfeld)

To get a feeling for the web3 world, I made a dApp called Autonomous Art that lets anyone mint a token for an NFT by making a visual contribution to it. The cost of making a visual contribution increases over time, and the funds a contributor pays to mint are distributed to all previous artists (visualizing this financial structure would resemble something similar to a pyramid shape). At the time of this writing, over $38k USD has gone into creating this collective art piece.

I also made a dApp called First Derivative that allows you to create, discover, and exchange NFT derivatives which track an underlying NFT, similar to financial derivatives which track an underlying asset 😉.

Both gave me a feeling for how the space works. To be clear, there is nothing particularly “distributed” about the apps themselves: they’re just normal react websites. The “distributedness” refers to where the state and the logic/permissions for updating the state lives: on the blockchain instead of in a “centralized” database.

One thing that has always felt strange to me about the cryptocurrency world is the lack of attention to the client/server interface. When people talk about blockchains, they talk about distributed trust, leaderless consensus, and all the mechanics of how that works, but often gloss over the reality that clients ultimately can’t participate in those mechanics. All the network diagrams are of servers, the trust model is between servers, everything is about servers. Blockchains are designed to be a network of peers, but not designed such that it’s really possible for your mobile device or your browser to be one of those peers.

With the shift to mobile, we now live firmly in a world of clients and servers – with the former completely unable to act as the latter – and those questions seem more important to me than ever. Meanwhile, ethereum actually refers to servers as “clients,” so there’s not even a word for an actual untrusted client/server interface that will have to exist somewhere, and no acknowledgement that if successful there will ultimately be billions (!) more clients than servers.

For example, whether it’s running on mobile or the web, a dApp like Autonomous Art or First Derivative needs to interact with the blockchain somehow – in order to modify or render state (the collectively produced work of art, the edit history for it, the NFT derivatives, etc). That’s not really possible to do from the client, though, since the blockchain can’t live on your mobile device (or in your desktop browser realistically). So the only alternative is to interact with the blockchain via a node that’s running remotely on a server somewhere.

A server! But, as we know, people don’t want to run their own servers. As it happens, companies have emerged that sell API access to an ethereum node they run as a service, along with providing analytics, enhanced APIs they’ve built on top of the default ethereum APIs, and access to historical transactions. Which sounds… familiar. At this point, there are basically two companies. Almost all dApps use either Infura or Alchemy in order to interact with the blockchain. In fact, even when you connect a wallet like MetaMask to a dApp, and the dApp interacts with the blockchain via your wallet, MetaMask is just making calls to Infura!

These client APIs are not using anything to verify blockchain state or the authenticity of responses. The results aren’t even signed. An app like Autonomous Art says “hey what’s the output of this view function on this smart contract,” Alchemy or Infura responds with a JSON blob that says “this is the output,” and the app renders it.

This was surprising to me. So much work, energy, and time has gone into creating a trustless distributed consensus mechanism, but virtually all clients that wish to access it do so by simply trusting the outputs from these two companies without any further verification. It also doesn’t seem like the best privacy situation. Imagine if every time you interacted with a website in Chrome, your request first went to Google before being routed to the destination and back. That’s the situation with ethereum today. All write traffic is obviously already public on the blockchain, but these companies also have visibility into almost all read requests from almost all users in almost all dApps.

Partisans of the blockchain might say that it’s okay if these types of centralized platforms emerge, because the state itself is available on the blockchain, so if these platforms misbehave clients can simply move elsewhere. However, I would suggest that this is a very simplistic view of the dynamics that make platforms what they are…

…Given the history of why web1 became web2, what seems strange to me about web3 is that technologies like ethereum have been built with many of the same implicit trappings as web1. To make these technologies usable, the space is consolidating around… platforms. Again. People who will run servers for you, and iterate on the new functionality that emerges. Infura, OpenSea, Coinbase, Etherscan.

Likewise, the web3 protocols are slow to evolve. When building First Derivative, it would have been great to price minting derivatives as a percentage of the underlying’s value. That data isn’t on chain, but it’s in an API that OpenSea will give you. People are excited about NFT royalties for the way that they can benefit creators, but royalties aren’t specified in ERC-721, and it’s too late to change it, so OpenSea has its own way of configuring royalties that exists in web2 space. Iterating quickly on centralized platforms is already outpacing the distributed protocols and consolidating control into platforms…

…“It’s early days still” is the most common refrain I see from people in the web3 space when discussing matters like these. In some ways, cryptocurrency’s failure to scale beyond relatively nascent engineering is what makes it possible to consider the days “early,” since objectively it has already been a decade or more.

However, even if this is just the beginning (and it very well might be!), I’m not sure we should consider that any consolation. I think the opposite might be true; it seems like we should take notice that from the very beginning, these technologies immediately tended towards centralization through platforms in order for them to be realized, that this has ~zero negatively felt effect on the velocity of the ecosystem, and that most participants don’t even know or care it’s happening. This might suggest that decentralization itself is not actually of immediate practical or pressing importance to the majority of people downstream, that the only amount of decentralization people want is the minimum amount required for something to exist, and that if not very consciously accounted for, these forces will push us further from rather than closer to the ideal outcome as the days become less early.

2. Unpacking the Web3 Sausage – Dror Poleg

The vision for web3 is admirable. But Moxie set out to understand how the decentralized sausage is made in practice. He was not impressed.

Moxie’s first concern was that Web3 is not as decentralized as it claims. In this case, access to the basic infrastructure of web3 (the Ethereum blockchain) ends up being routed through a couple of popular API providers. So, even though the blockchain itself is decentralized, most apps that depend on it still go through bottlenecks that are centralized and operated by private, for-profit entities.

To use an analogy, consider a person who buys a piece of gold and stores it in a keyed vault, under a mountain, maintained by a Swiss bank. When the person logs into the bank’s app to check his gold balance, the app doesn’t send a person into the vault to check how much gold is there or whether someone tampered with the vault’s key. Instead, it simply shows data from a third-party database that records the inflow and outflow of gold bars from the whole mountain. So, the customer gets the latest information, but it does not get direct, indisputably true information.

The imaginary bank does this because it’s much easier to maintain a central database of all deposits and remittances from the mountain rather than send someone in person each time a client logs into the app. Ethereum-based apps use API providers for the same reason: it’s easier and simpler for them to do so rather than verify every query on the blockchain itself.

This choice of expedience over decentralization is bad in some use cases and harmless in others. The issue Moxie raised is known, and Ethereum developers have spoken and written about them publicly and are working on ways to mitigate them. And I have also written about how each wave of decentralization creates a concurrent wave of centralization…

…Moxie created an NFT on OpenSea. He intentionally programmed the listing to look different on different platforms (by loading a different image depending on the IP of the requesting site). Initially, he could see the NFT in his crypto wallet, which meant his ownership of it was documented on the Ethereum blockchain. However, a few days later, OpenSea decided to remove his NFT from their marketplace, claiming Moxie violated their terms of services (due to the code that changes what users see).

Technically, the fact that OpenSea decided to remove the NFT from their marketplace should not matter. Moxie still owned it, and this ownership was recorded independently of OpenSea, on the blockchain itself. But when Moxie checked his crypto wallet app, he noticed the NFT had disappeared. How could this be?

Moxie dug deeper and found out that the wallet app he was using (Metamask) did not really show what was in his account on the Ethereum blockchain. Instead, his wallet app relied on an API — the OpenSea API! — to check which NFTs were associated with which blockchain account. And since Moxie’s NFT was removed from OpenSea, the API showed it no longer existed.

This felt like Web 2.0 all over again. A powerful platform managed to confiscate/delete a user’s data and assets from his account without his consent.

But there’s an essential distinction between what happened to Moxie and what happens when a Web 2.0 platform decides to delete a user’s file or listing…

…Moxie dove into how Web3 apps interact with one another and discovered a few key limitations. The most alarming among them was the disappearance of his hard-earned digital goods from his crypto wallet.

But even though Moxie’s NFT did not appear in his wallet app, it still existed, and Moxie was still its owner. The failure to see the NFT was a problem with the wallet app’s architecture and the API it relied on.

The wallet app relied on an API instead of verifying information directly on the blockchain, and the API provider did not include NFTs that were not listed on OpenSea.

If Moxie had used a different app that checks the status of his NFT directly on the blockchain, he could have seen that the NFT is still there. Indeed, you can see that NFT on Rarible, an OpenSea competitor. To return to our earlier analogy, the gold bar is still inside the vault, inside the mountain, even though the bank’s app doesn’t show it.

Of course, the fact that popular wallet apps don’t display stuff in people’s accounts even though that stuff is still there is a problem. But the good news is that even though OpenSea removed Moxie’s NFT, that NFT “survived” and remains in his posession.

3. Mark Smith – Finch Therapeutics: Empowering Immune Systems – Patrick O’Shaughnessy and Mark Smith

[00:02:55] Patrick: Mark, we’re going to talk about an especially interesting topic today, one that I’ve definitely read a bit about, but I’m somewhat of a rookie on. And so you can educate the audience alongside me. And that topic is the microbiome. It’s one of the areas of health and wellbeing that is a very recent phenomenon in the public consciousness and certainly in medical research. It would be good for you to begin by giving us an overview of what this thing is, this word “microbiome,” what it represents. And then I’d like to get into your own origin story and why you’ve devoted this part of your career to this idea.

[00:03:28] Mark: First off, Patrick, thanks for having me here. Excited to share the story of the microbiome and the hidden majority of microbes that live inside all of us. There are about as many microbial cells as there are human cells inside all of us, and they’re fundamental to everything that we do, from the way we digest food and extract energy from it, synthesis of important vitamins, regulation of our immune system. Even how we think and feel can be manipulated by these bacteria that live on and inside of us. It’s almost like a new organ system that we’re just now learning to understand. And the reason that it’s taken us such a long time to really understand the importance of this community is that a lot of these bacteria are actually really hard to grow in the lab. So it’s only when we started to use the methods of high throughput genomic sequencing, that we first used to sequence the human genome, we started to shine that flashlight onto the microbiome over the last 10 years, that we realized there’s actually this enormous diversity of microbial organisms that lives inside all of us and has been really important to our health. You can think about it like a rainforest that lives inside of each one of us and is responsible for keeping us healthy in a lot of ways. As we think about the evolution of this space, this first chapter, which is understanding what’s there. And now we’re at a really exciting point. We’re able to actually go in and manipulate the microbiome, so we can make changes, make edits, add subtractions, and do that in a targeted, rational way in order to try to improve health outcomes for patients.

[00:04:57] Patrick: Give us an overview of where these things are. It’s non-human cells living inside human bodies. You said it’s almost equal in terms of allocation of cells, human versus not. That’s pretty crazy. Where do these things mostly exist? Is there a useful taxonomy or categorization system that might help us understand, for the rest of the conversation, the types of these things, what they’re doing, why they’re related to our health, why they’re there in the place?

[00:05:22] Mark: They’re everywhere. In fact, inside of every one of your cells, there’s this thing called mitochondria. That’s what helps us get energy from food. It’s actually a bacteria that’s just lived with us for such a long time that got embedded into all of our cells. In addition to those, though, the bulk of the microbes that we’re talking about, thinking about here, those that are not part of our human cells and the primary place that they reside is in our gut. And the reason for that is, while microbes are pretty much ubiquitous throughout our bodies, our gut is actually specifically designed to grow bacteria. We’ve spent the last 10 years trying to get really good at growing bacteria. Despite tens of millions of dollars of investment, we think we’re pretty good at solving this problem. We’re orders of magnitude less efficient than you are right now at growing these bacteria inside of your gut. And that’s because we’ve evolved this system specifically to ferment bacteria, and we can go into a little bit more around why we’ve evolved that capability and what it does for us, and why think it’s an important target for developing medicines. But just in terms of a framework to think about these going forward for the rest of the conversation, I usually think about these commensals, that are bacteria that are either neutral to our health or helping us out, and then their pathogens. If you study a medical textbook, you just hear about all the pathogens, all the bad bacteria, but they’re actually the minority. In most of us, most of the time, are dominated bacteria that are a really important part of who we are and our identities…

…[00:10:45] Patrick: What would happen if inside of a human, the entire stock of bacteria was nuked and gone? What would happen to that person?

[00:10:53] Mark: Your immune system would freak out. We actually have examples where we’ve done this, gnotobiotic or germ free animals. We grow them up in incubators, surgically remove them from their moms, prevent any microbes from getting into them when you feed them throughout their lives. They live shorter lives. They’re profoundly unhealthy, and they have dysfunctional immune systems. If we’re the landlord renting out space to bacteria, we want to really firmly control where they are, because if they suddenly got into our bloodstream, they’d make us really sick and we could die from that. Like a nuclear reactor, you want to carefully contain it and prevent it. It can be awesome when it’s going in the right spot, but it’d be really harmful if that leaked out and got into places where it’s not supposed to be. We have this immune system that takes a very significant percentage of our total energy balance. And it’s not dysfunctional that we have this chronic lifelong infection. It’s actually one of the main purposes of it is to shape and control that system. It’s almost like a dead man switch, back in the Cold War. “If you don’t get a signal we’re alive every two minutes, send out nukes” or something like that. How your immune system is regulated, you constantly need to get a signal from your microbiome that they’re paying the rent. And there are these metabolites that they use, energy currency that they pay us in. And if you don’t get that, your body starts to mount this immune response.

And one of the things that’s really interesting is, while antibiotics don’t nuke your entire microbiome and eliminate all the bacteria, they diminish it pretty significantly. We’ve been on this massive uncontrolled experiment over the last 70 years, since we started developing antibiotics. And what happens when you just give a bunch of people antibiotics and really decimate this microbiome, what does that do to their health? And right now we use about 42 billion doses of antibiotics every year, around the world. And what we’ve learned is they have a really big impact on our microbiome, unsurprisingly. That’s what they’re designed to do. We found that there are a lot of diseases that basically didn’t exist a hundred years ago that are now some of the big scourges of humanity. Chronic autoimmune and inflammatory diseases that seem to be linked both in time and place to changes in our relationship with our microbiome. We believe that by restoring the functionality of this interface between these organisms that we’ve co-evolved with since before we were human, in our immune system, by restoring that relationship, you get at the underlying cause of a lot of these autoimmune and inflammatory diseases. Right now, the way we treat those diseases, some of the best selling drugs in the world try to shut down the immune response. And that has a lot of negative consequences and doesn’t necessarily address the underlying cause of that inflammation, which is disrupted communication between our microbiome, this organ system inside of us, and our immune system…

…[00:31:39] Patrick: If the Finch Therapeutic story has got chapter headers from inception through now, what have been those major chapters? So if there’s this blunt force instrument of fecal transplant, C. diff is one disease killing 30,000 people, what are the other addressable conditions that we’re confident in some sort of therapy here working to mitigate or eliminate? I did a conversation on tumor treating fields in cancer, which is this other interesting new modality for treating a big class of problems and has to be tuned for brain versus lung versus whatever other cancer. So what’s the equivalent here? What do you think the biggest, chunkiest problems to be solved are? And then we’ll go into those chapter headers for Finch Therapeutics to business.

[00:32:19] Mark: We see a very large opportunity here. Again, we think this is fundamental to human biology. We think that your immune system is regulated by your microbiome. Your immune system touches almost every disease and that’s the common thread. The nested opportunities that we see laid out ahead of us are C. diff, where we have a phase three program ongoing right now. There’s a lot of evidence that this can be highly effective there. The next wave of opportunities that we see are in conditions where there’s a GI component, maybe multiple opportunities to benefit. So ulcerative colitis, Crohn’s disease. Autism, actually, interestingly enough, there’s a meaningful GI component. About a third of kids with autism have severe GI symptoms. And we’ve seen benefits both on the GI symptoms as well as behavioral endpoints. Those are a wave of indications that we’re really excited to develop. It gets broader than that. So you start thinking about your point around applications in oncology. There’s some really interesting data that’s come out over the last year. Some of the most interesting new therapies that have been developed over the last few years are these things called checkpoint therapies, that unleash your immune system to attack cancer. We’re actually all developing cancers almost every day. And our immune system mostly clears them before they become problematic. And if you can help to empower your immune system to drive that assault, you can fight cancers. Checkpoint therapies for tens of billions of dollars a year in sales. It turns out that your life expectancy on checkpoint therapy is half as long if you have antibiotics within six months of starting checkpoint therapy. If you take a microbiome from a responder into a non-responder, you can drive a more than twofold increase over the expected response rate complementing what we’ve seen as the setback that you get from disrupting your microbiome.

That speaks to the potential breadth here, where seemingly unrelated indications all have this common thread. And it’s an area that we’ve spent a lot of time focused on. To summarize the broad chapters in developing this technology, for us, the first step was just show this works somewhere, show that we can put all the pieces together to develop an effective therapy. We can manufacture it, we can do it in a consistent way, can deliver it to the right location, all that stuff. The obvious first choice for us was going to C. diff. We had a lot of experience treating those patients and serving that community. C. diff is the first step. For us, this long journey to go from zero to one, and then to go from one to many has actually been a lot faster for us because we’ve been building plans for how we would attack all these other diseases once we’ve proven to the world that this works somewhere. We saw C. diff as creating a floor value in the company where we know it works there. We know we can serve patients and have a reliable revenue stream. And we can use that as a foundation to take some really big swings into these large, potentially transformational opportunities and get to our long term view, which is, “This is going to be a really important new class of therapies over the next 10 years.” My personal mission is to accelerate that reality as much as possible and bring that forward now, so that patients don’t have to wait. When I think about my wife’s cousin having to do this on his own, that is not okay. That’s unacceptable answer to me. There are tons of other patients like that that are out there, just waiting for these therapies to be developed. And every day that we delay that, we’re doing a disservice to that group.

[00:35:27] Patrick: Talk me through the end game. Let’s say you’re successful. You’re able to have a solution that’s much more frictionless than the current, sounds like really arduous problem solving for C. diff or something similar. What does that look like? Are we taking a pill that’s been engineered for us? Are we doing something different? What does the end game look like and what’s the timeline look like?

[00:35:47] Mark: The end game here is that we can sequence your microbiome, identify deficiencies, and then come in and deliver this. Say, the following 10 groups of bacteria, we’re going to deliver those to you. You’re going to take these five pills and that’s going to restore your health and not only treat the specific disease you have today, but potentially prevent other diseases. We’ve made a lot of progress over the last hundred years in terms of living long. We don’t necessarily live well. People end up with these chronic diseases throughout their lives that make their lives really unpleasant with tools like antibiotics. Those are some of the things that drove the longevity and those are life changing and amazing therapies. And I want to be able to use some of those agents that modulate our immune system, that change our microbiome and can save people’s lives, without impacting the quality of those lives. That’s an important long term objective. In terms of what the timeline is, this is happening now. There are already … at OpenBiome are the first step in my journey, we treated over 60,000 patients, built a network of about 1300 hospitals and clinics that we were serving. That is very much a practical reality for patients today. The next step is, we’re running a phase three clinical trial right now at Finch to develop an approved therapy that can scale and serve many more patients. If things go well, this will be available in the next couple of years for patients. These aren’t applications that are decades away. This is already reality for many patients today and has quickly become standard of care. Now we’re scaling that up and bringing it to new indications where we also believe that we can have a differentiated impact. And the way that we do that at Finch is unique to this therapeutic area.

Classically, drug development is all about risk management. And we fundamentally think about ourselves as risk managers. It costs about a billion dollars to develop a new drug, this incredibly capital intensive exercise. And anything you can do to reduce risk early on in that process has a dramatic impact on the expected value of this kind of product. Normally, when you start development of a drug, you maybe have a 5 to 10% probative success when you treat your first patient, that it’s going to actually get approved. You lose roughly a third of candidates just because of safety when you treat the first 10, 20 patients. Before we start any program, a firm underwriting criteria for us to support an investment in new program is we need to have clinical data that already shows that a composition works. And it’s this incredible privilege to basically start with the answer before you underwrite new investments. We start off with all this microbiotic transplant data. At Finch, we built the company around this concept of human first discovery, essentially reverse translation from what’s happening in the clinic, where there are more than 300 ongoing clinical trials exploring all these new applications. When I talked to you about ulcerative colitis and Crohn’s disease and oncology, that’s not speculation, like, “Hey, maybe this could work here and we’ve got some animal model that suggests it.” Those are completed clinical studies that have read out data, where clinical investors went in, modulated someone’s microbiome and saw that that radically changed their clinical outcome.

We think that’s an exceptional place to start from and to launch a drug development enterprise from. There’s this long co-evolved history of engagement between microbes and humans. It’s the absence of those microbes that’s dangerous, not the presence of them. There’s this expectation and empirical reality that these are generally well tolerated when run in well controlled clinical studies. There are all of these ongoing clinical studies with microbiotic transplantation which gives us that shotgun approach. And then we can mine all that data to figure out why did that work? What made that work? And then use that to develop the next gen products that we’re advancing at Finch. One of the things that’s really interesting is, we don’t just say, “This strain of bacteria matters.” We can say, “This specific strain from this sample put 10 patients into remission. That’s the strain I want to put in my drug.” We can actually cryo-revive these things. We have a massive biorepository with more than 10,000 samples that have been in patients, and we understand what the outcomes are. And we can go back and say, “This strain is a strain that I want to put into my drug. Now I’m going to grow it up and do that going forward.” So it’s that combination of all of these elements of the clinical data, some of the samples and the algorithms to make sense of it that have enabled us to use this strategy of reverse translation from what’s already working in the clinic today.

4. Are we witnessing the dawn of post-theory science? – Laura Spinney

Isaac Newton apocryphally discovered his second law – the one about gravity – after an apple fell on his head. Much experimentation and data analysis later, he realised there was a fundamental relationship between force, mass and acceleration. He formulated a theory to describe that relationship – one that could be expressed as an equation, F=ma – and used it to predict the behaviour of objects other than apples. His predictions turned out to be right (if not always precise enough for those who came later).

Contrast how science is increasingly done today. Facebook’s machine learning tools predict your preferences better than any psychologist. AlphaFold, a program built by DeepMind, has produced the most accurate predictions yet of protein structures based on the amino acids they contain. Both are completely silent on why they work: why you prefer this or that information; why this sequence generates that structure.

You can’t lift a curtain and peer into the mechanism. They offer up no explanation, no set of rules for converting this into that – no theory, in a word. They just work and do so well…

…Somewhere between Newton and Mark Zuckerberg, theory took a back seat. In 2008, Chris Anderson, the then editor-in-chief of Wired magazine, predicted its demise. So much data had accumulated, he argued, and computers were already so much better than us at finding relationships within it, that our theories were being exposed for what they were – oversimplifications of reality. Soon, the old scientific method – hypothesise, predict, test – would be relegated to the dustbin of history. We’d stop looking for the causes of things and be satisfied with correlations.

With the benefit of hindsight, we can say that what Anderson saw is true (he wasn’t alone). The complexity that this wealth of data has revealed to us cannot be captured by theory as traditionally understood. “We have leapfrogged over our ability to even write the theories that are going to be useful for description,” says computational neuroscientist Peter Dayan, director of the Max Planck Institute for Biological Cybernetics in Tübingen, Germany. “We don’t even know what they would look like.”

5. Fundsmith 2021 Annual Letter – Terry Smith

In investment, as in life, you cannot have your cake and eat it, so it is difficult if not impossible to find companies which are resilient in a downturn but which also benefit fully from the subsequent recovery. Of course, you could try to trade out of the former and into the latter at an appropriate time but it is not what we seek to do as the vast majority of the returns which our Fund generates come from the ability of the companies we own to invest their retained earnings at a high rate of return because they own businesses with good returns and growth opportunities. In our view it would be a mistake to sell some of these good businesses in order to invest temporarily in companies which are much worse but which have greater recovery potential… 

…Our portfolio consists of companies that are fundamentally a lot better than the average of those in either index and are valued higher than the average S&P 500 company and much higher than the average FTSE 100 company. However, it is wise to bear in mind that despite the rather sloppy shorthand used by many commentators, highly rated does not equate to expensive any more than lowly rated equates to cheap.

The bar chart below may help to illustrate this point. It shows the ‘Justified P/Es’ of a number of stocks of the kind we invest in. What it shows is the Price/Earnings ratio (P/E) you could have paid for these stocks in 1973 and achieved a 7% compound annual growth rate (CAGR) over the next 46 years (to 2019), versus the 6.2% CAGR the MSCI World Index (USD) returned over the same period. In other words, you could have paid these prices for the stocks and beaten the index — something the perfect markets theorists would maintain you can’t do…

…You could have paid a P/E of 281x for L’Oréal, 174x for BrownForman, 100x for PepsiCo, 44x for Procter & Gamble and a mere 31x for Unilever.

I am not suggesting we will pay those multiples but it puts the sloppy shorthand of high P/Es equating to expensive stocks into perspective…

…Turning to the themes which dominated 2021, you may have heard a lot talked about the so-called ‘rotation’ from quality stocks of the sort we seek to own to so-called value stocks, which in many cases is simply taken as equating to lowly rated companies. Somewhat related to this there was periodic excitement over so-called reopening stocks which could be expected to benefit as and when we emerge from the pandemic — airlines and the hospitality industry, for example.

There are multiple problems with an approach which involves pursuing an investment in these stocks. Timing is obviously an issue. Another is that their share prices may already over anticipate the benefits of the so-called reopening. As Jim Chanos, the renowned short seller, observed ‘The worst thing that can happen to reopening stocks is that we reopen.’ It is often better to travel hopefully than to arrive.

In our view, the biggest problem with any investment in low quality businesses is that on the whole the return characteristics of businesses persist. Good sectors and businesses remain good and poor return businesses also have persistently poor returns as the charts below show:…

6. What A World – Morgan Housel

Franklin Roosevelt looked around the room and chuckled when his presidential library opened in 1941. A reporter asked why he was so cheerful. “I’m thinking of all the historians who will come here thinking they’ll find the answers to their questions,” he said.

Everything we know about history is limited to what’s been written down, shared publicly, or spoken into a camera. The stuff that’s been kept secret, in someone’s head, taken to the grave, must be – I don’t know – 1,000 times as large and more interesting…

…Gabby Gingras was born unable to feel pain. She has a full sense of touch. But a rare genetic condition left her completely unable to sense physical pain.

You might think this is a superpower, or an incredible gift. But her life is dreadful. The inability to feel pain left Gabby unable to distinguish right from wrong in the physical world. One profile summarized a fraction of it:

As Gabby’s baby teeth came in, she mutilated the inside of her mouth. Gabby was unaware of the damage she was causing because she didn’t feel the pain that would tell her to stop. Her parents watch helplessly.

“She would chew her fingers bloody, she would chew on her tongue like it was bubble gum,” Steve Gingras, Gabby’s father, explained. “She ended up in the hospital for 10 days because her tongue was so swelled up she couldn’t drink.”

Pain also keeps babies from putting their fingers in their eyes. Without pain to stop her, Gabby scratched her eyes so badly doctors temporarily sewed them shut. Today she is legally blind because of self-inflicted childhood injuries.

Pain is miserable. Life without pain is a disaster…

…John Maynard Keynes once purchased a trove of Issac Newton’s original papers at auction. Many had never been seen before, having been stashed away at Cambridge for centuries.

Newton is probably the smartest human to ever live. But Keynes was astonished to find that much of the work was devoted to alchemy, sorcery, and trying to find a potion for eternal life.

Keynes wrote:

I have glanced through a great quantity of this at least 100,000 words, I should say. It is utterly impossible to deny that it is wholly magical and wholly devoid of scientific value; and also impossible not to admit that Newton devoted years of work to it.

I wonder: Was Newton a genius in spite of being addicted to magic, or was being curious about things that seemed impossible part of what made him so successful?…

…Part of the Armistice that ended World War I forced the dismantling of Germany’s military. Six million rifles, 38 million projectiles, half a billion rounds of ammunition, 17 million grenades, 16,000 airplanes, 450 ships, and millions of tons of other war equipment were destroyed or stripped from Germany’s possession.

But 20 years later, Germany had the most sophisticated army in the world. It had the fastest tanks. The strongest air force. The most powerful artillery. The most sophisticated communication equipment, and the first missiles.

A catastrophic irony is that this advancement took place not in spite of, but because of, its disarmament.

George Marshall, U.S. Army Chief of Staff, noted:

After the [first] World War practically everything was taken away from Germany. So when it rearmed, it was necessary to produce a complete set of materiel for the troops. As a result, Germany has an army equipped with the most modern weapons that could be turned out. That is a situation that has never occurred before in the history of the world.

There’s a set of advantages that come from being endowed with resources. There’s another set of advantages that come from starting from scratch. The latter can be sneakingly powerful.

7. Twitter thread on evaluating people – Dan Rose

In 2006 I was meeting with Jeff Bezos to discuss acquiring Audible when he described their founder Don Katz as “a missionary, not a mercenary.” I later learned Jeff got this framing from John Doerr, and it struck me as a good distinction when evaluating people…

…Most great founders are missionaries. Starting a company requires a level of commitment that lends itself to missionary zeal. Of course some founders are primarily motivated by money, but mercenary founders tend not to build lasting companies, opting instead for a quicker exit.

Missionary founders also care about making money, but they are primarily motivated by a higher calling. The mission of the company means something to them in their bones. They truly believe in serving their customers, improving people’s lives, putting a “dent in the universe.”

I remember my new hire orientation at Amazon in 1999. They shared a letter from a customer living in a rural village in Eastern Europe who was grateful to have access to books. We left with stickers that read “Work hard. Have fun. Make history.” I remember thinking, Let’s Go!

Chris Cox delivered a new hire orientation speech at Facebook religiously every Monday talking about the evolution of communications from the printing press to the internet and social media. Cox’s missionary speech left everyone in the room with that same feeling, Let’s Go!

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.  Of all the companies mentioned, we currently have a vested interest in Amazon and Facebook. Holdings are subject to change at any time.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general.

Here are the articles for the week ending 09 January 2022:

1. We may finally be able to test one of Stephen Hawking’s most far-out ideas – Paul Sutter

In the 1970s, Hawking proposed that dark matter, the invisible substance that makes up most matter in the cosmos, may be made of black holes formed in the earliest moments of the Big Bang. 

Now, three astronomers have developed a theory that explains not only the existence of dark matter, but also the appearance of the largest black holes in the universe…

…Dark matter makes up over 80% of all the matter in the universe, but it doesn’t directly interact with light in any way.  It just floats around being massive, affecting the gravity within galaxies.

It’s tempting to think that black holes might be responsible for this elusive stuff. After all, black holes are famously dark, so filling  a galaxy with black holes could theoretically explain all the observations of dark matter.

Unfortunately, in the modern universe, black holes form only after massive stars die, then collapse under the weight of their own gravity. So making black holes requires many stars — which requires a bunch of normal matter.Scientists know how much normal matter is in the universe from calculations of the early universe, where the first hydrogen and helium formed. And there simply isn’t enough normal matter to make all the dark matter astronomers have observed.

That’s where Hawking came in. In 1971, he suggested that black holes formed in the chaotic environment of the earliest moments of the Big Bang. There, pockets of matter could spontaneously reach the densities needed to make black holes, flooding the cosmos with them well before the first stars twinkled. Hawking suggested that these “primordial” black holes might be responsible for dark matter. While the idea was interesting, most  astrophysicists focused instead on finding a new subatomic particle to explain dark matter.

What’s more, models of primordial black hole formation ran into observational issues. If too many formed in the early universe, they changed the picture of the leftover radiation from the early universe, known as the  cosmic microwave background (CMB). That meant the theory only worked when the number and size of ancient black holes were fairly limited, or it would conflict with measurements of the CMB. .

The idea was revived in 2015 when the Laser Interferometer Gravitational-Wave Observatory found its first pair of colliding black holes. The two black holes were much larger than expected, and one way to explain their large mass was to say they formed in the early universe, not in the hearts of dying stars.   

2. Orlando Bravo – The Art of Software Buyouts – Patrick O’Shaughnessy and Orlando Bravo

[00:09:54] Patrick: Would you take us all the way back to the very first deal? I think Prophet 21 was the name of the firm that you did in the software world. I want to start there, because obviously, this has become an absolute dominant trend in the world of investing, of businesses, et cetera. But back then, when you did your first one 22 years ago, it was a very different situation. I think the evolution from then to now is really important for people to understand. Talk us through the unique dynamics of that deal, how you came to it, how you got the idea, how it was financed. I know that was very different back then. I would love to hear the story of the first technology software deal that you did.

[00:10:30] Orlando: Prophet 21 was a deal that our team originated because we had an investment team at the time after the dot-com bubble burst in 2000. We were looking to do something different than all of private equity, really. We were searching for it. Carl Thoma, my mentor, was open-minded enough to allow us to do that. The theme that we had at the time was you can buy software maintenance streams… remember, it was all on-premise two years ago… you can buy software maintenance streams less expensively than almost any other form of recurring revenue in different industries, media, radio, which was popular then, transaction processing, and that quality of that revenue is even more sticky than those categories. Now, the challenge was that that universe, which is a challenge today, by the way, but the challenge then, having us not done that before, was that these companies were unprofitable, especially coming out of that bust that happened in the year 2000. We had to say, theoretically, with 90% gross margins, these businesses can be high cashflow generative, and therefore good candidates for a fundamental control-type investing.

In doing our work, we came across Prophet 21. The company was for sale. We were able to succeed, actually, without much competition. That was interesting. It was one of those unusual deals where there was not that much competition, even though there were players starting in the software industry back then that were very good and had similar ideas as we had. It was interesting, because that company had never made money before. Now, it wasn’t losing all kinds of money. It was close to break-even, so management did care about that. That wasn’t a completely irrelevant concept to them. Secondly, the company had never done a lateral acquisition and the company had inconsistent performance. We bought the business and part of the reason was the price looked great at around two times maintenance revenue, one times two. Imagine, remember those days.

[00:12:37] Patrick: Charming.

[00:12:39] Orlando: Exactly, those were the days. We decided through meeting the person that became chairman of our operating committee, that the best approach was to back existing management for all the reasons that I mentioned before that existing management has. They really wanted to win, but have them work with our operating partner in terms of improving that company. Of course, three years later, you end up with a success story, a five margin, good growth, six software acquisitions, and it was a great investment. That experience really made us very passionate about the possibility of working with existing management that deeply cares about that business, that doesn’t move from company to company, that lives in that environment. They provided software for small and mid-market distributors, so they knew all the distribution customers, they knew the culture, they knew how they talk, how they trade, how you have to discount it. They know that world and were good at it. If you can marry that with an operational approach… as my partner would always say, “Everybody needs somebody to learn from”… if you can marry that with what we would bring, you would not only have the possibility of great success, but also it was a good approach to doing business. It felt really good. Then we did a second deal, and the same thing happened with existing management, and then a third one and so on and so forth, so we quickly developed this as our mission.

[00:14:02] Patrick: I’d love to zoom out and talk about the software industry, maybe even the enterprise SaaS-specific sector of it, where you’ve done a lot of your work and some of the weird features of it. You mentioned some of these businesses have 90% gross margins. Everyone herald’s software as like the best business model ever, but I think the average public market business, or maybe even the private market ones, they lose a lot of money still. Obviously, there’re reasons for that, but I’d love you to just walk through what seems like a huge dissonance between the average SaaS company and the type of company that you’re trying to run and manage.

[00:14:34] Orlando: There is no difference in the business model between that average and what we’re looking to do. In essence, when you see us buy control of the business, we are underwriting our plan, not what is going on in that company. In many cases, we’re buying break-even businesses or businesses that may be losing money. That’s not the way it’s going to be run in partnership with management going forward, because the model would break and you couldn’t support some debt into that transaction, which is highly creative. The challenge is for the market inefficiency here is that public investors who are extremely smart, creative, highly-educated, and great, for some reason they believe that “investing in growth” is the same and goes hand-in-hand with losing money and having a negative margin. Those two concepts are completely different. They many times have nothing to do with one another, and many times high profitability leads to higher growth because what high profits means, really, is that first you have operating management that innovates correctly, that runs those different functional areas in a way that is operationally sound. They measure all their activities. They look at inputs versus outputs. They readjust to what is working. Being highly profitable also means that you have a good enough product and you’re charging a price for that product that allows you to produce that profitability, where for example, the yearly increase in the value of that product merits a price increase that is higher than your labor inflation, a key point today in this inflationary world. If you do that really, really well and you provide so much value to your customers that you capture some of that in your price, and every day you become better at your operations because you learn from the past and you’re actually measuring this, it means that you have more money to invest in tactical growth, which is sales and marketing or distribution and more money to invest in strategic growth, which is product development, R&D and new initiatives.

See, when you’re highly profitable and you’re growing very fast, it also means that management is making the right investment decisions in growth. You’re an investor. You see all kinds of different sales channels. Well, if you lose money and you can lose money, sure, you’ll try it all. You’ll try direct sales, channel sales, inside sales, web sales, marketing. You can try all kinds of marketing plays. When you’re really profitable, it means you’re doing the right ones that fit your product and your business and what your customers need. The same thing is in R&D. You could have 20 R&D initiatives, and if one works and you grow really fast, that’s great. But how about the other 19? I can get really passionate about this. The other fallacy that I see with investors in this space is saying, “Well, this company’s growing really fast now. It’s 200 million in ARR, which is plenty of scale by the way to run it profitably, and I’m going to model what management told me, which was a 30% operating margin in year four. I understand why they’re losing a lot of money now is they’re growing at 50%.” But see, the operating world doesn’t work that way. That company in year four is not all of a sudden going to change how they plan, how they think about initiatives, how they tell their direct reports what’s important and what’s not. It just doesn’t work that way. They’ll never get there. You’ve got to start now to get there.

[00:18:23] Patrick: What do you think most explains… I think I have these numbers roughly right… the average SaaS company, maybe in the category has a slightly negative EBITDA margin, losing money on an EBITDA basis? I think probably your portfolio is closer to 35 or 40% EBITDA margin today. That’s a huge gap. What are the major explanations that make up that 40%? I mean, you’ve started to talk around some of the attitude differences, but literally, where do you think that change in margin most comes from versus the average SaaS company out there that’s loss-making?

[00:18:54] Orlando: I think that comes from investors really incenting management teams, just on top line. We work in a free market, capitalist, incentive-based system. If you’re running a company and your investors tell you, “I don’t care about the bottom line at all. Go grow revenues as quickly as you can,” that’s the directive from the shareholders and that’s what’s most likely going to happen. Now, those investors, at what point in time did they become indoctrinated with this business model? We could have a philosophical discussion about that.

[00:19:29] Patrick: Yeah. I’d love to hear.

[00:19:30] Orlando: Right. Is it that early-on VCs, teach these companies that way in order for them to, of course, grow in winning their markets? That’s the great thing to do, but also by doing that, do these companies need to raise more money and therefore there’s more room for investors to get the equity and then so on and so forth? It’s very interesting. One of the things that’s just so important to say is we believe in both high growth and high margin, and they’re not mutually exclusive. One actually drives the other, because when you also get growth, you should drop to the bottom line a higher margin than your existing margin in your business. In software where you have the marginal cost of your product is nearly zero, you do have to provide support, and of course, you have to pay for the distribution.

3. 10 Lessons from 2021 – Michael Batnick

Investors don’t necessarily get better with experience because markets are adaptive, unlike most of our learning environments. I won’t ever touch a stove again on purpose because I know it’s hot. I won’t go in a cold shower because I know it’s cold. But “I won’t ever buy stocks again when the CAPE ratio is above 25 because I remember 1999” is not the same thing.

To quote myself, “The greatest lesson we can learn from history is that those who learn too much from it are doomed to draw parallels where none exist.”

Skeptics sounds smart. Optimists make money. As I said at the top of this post, my reflections and lessons of this year are a time capsule of the current environment. An environment that might change as soon as I hit publish. Sure doom and gloomers will look like soothsayers from time to time, but I don’t know anybody who got rich fading the human spirit. Don’t short capitalism.

It’s easy to be a knee-jerk skeptic. In fact, that will probably serve an investor well. Shiny objects can be dangerous. But a healthier attitude, especially in a bull market, is to be knee-jerk curious. “Metaverse? What’s that? Sounds dumb, but maybe it’s worth investigating.”…

…Avoid extremes. Never go all in or all out. Both lead to extreme thinking, which leads to extremely bad outcomes. It’s one thing to say, “crap, I guess I can’t handle a portfolio of 80% stocks, I’ll dial it back to 60%.” It’s a whole other thing to say, “crap, I can’t handle the volatility. I’m gonna go to cash until things settle down.” One person is going to survive the ups and the downs and the other person isn’t.

4. DAOs, DACs, DAs and More: An Incomplete Terminology Guide – Vitalik Buterin

Here, we get into what is perhaps the holy grail, the thing that has the murkiest definition of all: decentralized autonomous organizations, and their corporate subclass, decentralized autonomous corporations (or, more recently, “companies”). The ideal of a decentralized autonomous organization is easy to describe: it is an entity that lives on the internet and exists autonomously, but also heavily relies on hiring individuals to perform certain tasks that the automaton itself cannot do.

Given the above, the important part of the definition is actually to focus on what a DAO is not, and what is not a DAO and is instead either a DO, a DA or an automated agent/AI. First of all, let’s consider DAs. The main difference between a DA and a DAO is that a DAO has internal capital; that is, a DAO contains some kind of internal property that is valuable in some way, and it has the ability to use that property as a mechanism for rewarding certain activities. BitTorrent has no internal property, and Bitcloud/Maidsafe-like systems have reputation but that reputation is not a saleable asset. Bitcoin and Namecoin, on the other hand, do. However, plain old DOs also have internal capital, as do autonomous agents.

Second, we can look at DOs. The obvious difference between a DO and a DAO, and the one inherent in the language, is the word “autonomous”; that is, in a DO the humans are the ones making the decisions, and a DAO is something that, in some fashion, makes decisions for itself. This is a surprisingly tricky distinction to define because, as dictatorships are always keen to point out, there is really no difference between a certain set of actors making decisions directly and that set of actors controlling all of the information through which decisions are made. In Bitcoin, a 51% attack between a small number of mining pools can make the blockchain reverse transactions, and in a hypothetical decentralized autonomous corporation the providers of the data inputs can all collude to make the DAC think that sending all of its money to1FxkfJQLJTXpW6QmxGT6oF43ZH959ns8Cq constitutes paying for a million nodes’ worth of computing power for ten years. However, there is obviously a meaningful distinction between the two, and so we do need to define it.

My own effort at defining the difference is as follows. DOs and DAOs are both vulnerable to collusion attacks, where (in the best case) a majority or (in worse cases) a significant percentage of a certain type of members collude to specifically direct the D*O’s activity. However, the difference is this: in a DAO collusion attacks are treated as a bug, whereas in a DO they are a feature. In a democracy, for example, the whole point is that a plurality of members choose what they like best and that solution gets executed; in Bitcoin’s on the other hand, the “default” behavior that happens when everyone acts according to individual interest without any desire for a specific outcome is the intent, and a 51% attack to favor a specific blockchain is an aberration. This appeal to social consensus is similar to the definition of a government: if a local gang starts charging a property tax to all shopowners, it may even get away with it in certain parts of the world, but no significant portion of the population will treat it as legitimate, whereas if a government starts doing the same the public response will be tilted in the other direction.

5. In the Middle of Transition: 2022 Semiconductor Outlook – Doug (Fabricated Knowledge)

The semiconductor market for years has been characterized by booms and busts… Historically, the boom-bust cycles are primarily driven by supply.

The core reason for this is that capacity additions are extremely lumpy and adding new capacity via a fab came with huge fixed costs, and then very low variable costs, especially in sub-sectors like memory. The incentives were obvious. If you had a new fab, you could use your marginal cost advantage to offer a cheaper product and, in the process, blow up the total profit pool. In many ways, this was the story of the ~80s-90s memory market…

…But of course, things changed. Moore’s law slowed down and the rising cost of making semiconductors from both the fabrication and design perspective has forced consolidation and more rational industry competition. Why blow up the profit pool of your entire industry when the magnitude of costs is reaching tens of billions of dollars? Why not add capacity in a more disciplined manner given that you know what your competitors are doing? This is exactly what’s happening in memory, the most hyper-cyclical part of the industry. Most of the more mature semiconductor segments have already started to focus on their own product fiefdoms. With little competition head to head and only at the margins. Consolidation also helped quite a bit.

Another large driver as software eating the world and semiconductors being used in more and larger parts of the economy. Our cars and our homes took more semiconductors, and of course, our phones became much more integral parts of our lives. We went from essentially one market in the 1990s (PCs) to multiple end markets today…

…The important thing is that each of these cycles are happening independently. For example, phones are starting to slow down in volume as the average life of a phone increases, while automotive companies are just starting to ramp EV and ADAS content in their cars.

This is a simple expression of the law of large numbers. If semiconductors have a positive growth relationship it would mean that the bigger the number of different markets that are not correlated, the closer the aggregate results will approach the underlying trend. Each new diversifier will lower the volatility of just a single market’s results. I think that’s happening today.

So back to the path of cyclical to secular growth and what it would look like. Especially for a cyclical industry, each time there’s a year of sustained strong results there’s an expectation of a reversal to the mean. As bullish as I am, I don’t have the guts to say, “growth only, no down years.” That kind of statement is insane to make if you’re in the business of having reasonable accurate projections given the historical base rate.

But right now, we have clear indications of new demand streams from AI, new industries, and the broader slowing of Moore’s law. We also have more disciplined and consolidated supply, and despite the crazy capacity additions that have already taken place, the industry continues to grow. Semiconductors seem to have swapped from a supply-driven industry to a demand-driven industry since the pandemic. That, to me, is the big key of what the cyclical-to-secular market would look like. Additionally, semiconductors actually grew through a recession, which is pretty telling for the secular argument.

If there were ever a scenario of an historically cyclical and supply-driven market shifting into a secularly growing, demand-driven market, we’re living in it. Students of history know that each year there should be a supply-driven correction at some point, but each year the balance of supply and demand looks to be in demand’s favor. So, while we think that the continued and consistent supply additions will eventually turn the market, demand continues to outweigh supply additions.

If this sounds familiar, it’s because it’s pretty much the regime we’ve been living under since 2020. The chip shortage was originally expected to abate or turn around by the end of 2021 and that looks like it won’t happen. Now it’s expected to end in 2023, but it’s not like there hasn’t been a huge capacity addition since last year. The supply-demand crossover always seems to be just one year away. What’s happening? Why haven’t the recent capacity additions relieved the supply-chain crisis? An exchange that I thought was pretty enlightening was this conversation on the Q3 2021 ASML earnings call, answering an analyst’s question:

“Yes, Sandeep. I mean you’ve been around a long time and you asked the million-dollar question. So — and the real answer is we don’t know. We have some indications and some ideas. And yes, you are absolutely right, the wafer out capacity today is a big — is a lot larger than it was in Q4 2020. That’s true. And still, we see these shortages. Now I spoke to a very large customer and basically asked the same question.

And I actually said, Peter, we don’t know either. Because somehow we haven’t been able to connect all the dots that actually are the underlying drivers for this demand.”

This sounds like an anecdote in favor of the shift towards a demand-driven market. Each year, massive supply is added, yet demand continues to simply outweigh it. That would be what the “secular growth” case would look like for me, and in some ways we’re in the perfect expression of that transition. We’re in the middle of it.

6. Does Not Compute – Morgan Housel

Investor Jim Grant once said:

To suppose that the value of a common stock is determined purely by a corporation’s earnings discounted by the relevant interest rates and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin and believed Orson Welles when he told them over the radio that the Martians had landed.

That’s always been the case. And it will always be the case.

One way to think about this is that there are always two sides to every investment: The number and the story. Every investment price, every market valuation, is just a number from today multiplied by a story about tomorrow.

The numbers are easy to measure, easy to track, easy to formulate. They’re getting easier as almost everyone has cheap access to information.

But the stories are often bizarre reflections of people’s hopes, dreams, fears, insecurities, and tribal affiliations. And they’re getting more bizarre as social media amplifies the most emotionally appealing views.

A few recent examples of how powerful this can be:

Lehman Brothers was in great shape on September 10th, 2008. Its Tier 1 capital ratio – a measure of a bank’s ability to endure loss – was 11.7%. That was higher than the previous quarter. Higher than Goldman Sachs. Higher than Bank of America. It was more capital than Lehman had in 2007, when the banking industry was about as strong as it had ever been.

Seventy-two hours later it was bankrupt.

The only thing that changed during those three days was investors’ faith in the company. One day they believed in the company. The next they didn’t and stopped buying the debt that funded Lehman’s balance sheet.

That faith is the only thing that mattered. But it was the one thing that was hard to quantify, hard to model, hard to predict, and didn’t compute in a traditional valuation model.

GameStop was the opposite. The statistics showed it was on the edge of bankruptcy in 2020. Then it became a cultural obsession on reddit, the stock surged, the company raised a ton of money, and now it’s worth $11 billion.

7. TIP410: The Changing World Order w/ Ray Dalio – William Green and Ray Dalio

William Green (00:11:23):

You make some slightly chilling predictions about the US without being definitive because, obviously, these are probabilistic bets. For example, I think at one point you say, “I think that the odds of the US devolving into a civil war type dynamic within the next 10 years are around 30%.” You say that’s related to the high risk of internal conflict, the kind of politic polarization and anger that we’re seeing in the country. You also talk about the rivalry with China and say that the probability of a big war in the next 10 years is 35%. I was both struck by the way that you think the importance of thinking probabilistically, which is something that’s always struck me when I interview great investors, whether it’s Joel Greenblatt or Howard Marks, this sense that nothing is black and white. It’s always betting on probabilities, which clearly is something that you’ve been a master of over the decades.

William Green (00:12:17):

But also I was very struck by actually the seriousness of those claims. I wondered if you could talk about that gravity because you say, for example, that the US really is in danger of tipping over one way or the other. It’s that you say it’s, “The world’s leading power is on the brink and could tip one way or the other.” Can you give us a sense, digging into firstly the debt issue and the printing of money, why this is such a precarious position to be in? Because I’m no economist and I sort of need the idiot’s guide to why this is such a treacherous financial situation to be in.

Ray Dalio (00:12:53):

Maybe I can describe the typical cycle and then pull it out. I won’t go through all of the 18 measures, if that’s okay. I think it’ll create the template. There are internal orders and there are external orders, and what I mean by an order is a system of operating. Usually, internal orders are written by constitutions and external orders are written by treaties and so on, and they follow a war typically. Let’s say World War II. There’s a war. After the war, there are winners and losers. The winners get together and they determine the order, the system. For example, the system in 1944 they determined the Bretton Woods monetary system with the dollar at the center and gold at the center. It was an American world order because the United States had 80% of the world’s gold, it accounted for half the world’s economy and it had the monopoly on nuclear weapons, which was dominant.

Ray Dalio (00:14:06):

So the United States was dominant in all ways and the center of it, the reason United Nations is in New York and the IMF and the World Bank are in Washington because we began the American world order dominated that way. That’s an example. But if you go back to other cases, the Treaty of Versailles was the prior world order. In order words, a war and then a resolution of that war and then new rules as to who did what. If you keep going back, you will see that there are those world orders that just go back, the Peace of Westphalia in something like 1668 or something. Each system then creates a new system and a new world order, and then that happens also internal orders like, let’s say, revolution.

Ray Dalio (00:14:57):

The Chinese domestic order began in 1949. They had a civil war and then they started their domestic order in 1949. There’s a cycle, and the way the cycle works typically is after the war there’s a peace. The peace comes because there’s a dominant power that no one wants to fight, and also everybody’s so sick of war and then so you usually have a period of peace, often quite an extended period of peace. And there’s the consolidation of power by the new leader and then the development of a system that allows development because you wiped out a lot of the old. You wiped out the old debts, you wiped out many of the old things, but you’re in the process of wiping them out and new start. Then that begins the arc of the period of peace and prosperity and productivity.

Ray Dalio (00:15:53):

For example, the Second Industrial Revolution was that kind of period, the post World War II period was that kind of a period in which there’s competition, things working hard and there’s a rise in living standards. Those rise in living standard, particularly work well in a capitalist economy. Capitalism was really, that I mean markets, stock market and so on, was invented by the Dutch. It’s a way of creating buying power to enable, let’s say, entrepreneurs to be able to do well but it distributes wealth indifferently so that it creates a larger wealth gap. Over a period of time, it creates a larger opportunity gap because there’s a tendency of those who gained well to be in a favored position.

Ray Dalio (00:16:47):

For example, their children can get education that poor children can’t get or they might have more influence and so on, and so you get larger gaps and those gaps also can represent opportunity gaps and so on. There’s a tendency also toward debt and capital market valuations to keep rising, so debt rises in relation to income because debt is buying power but there’s… If you pay it back in hard dollars or hard whatever the currency is, then that’s a problem. So you see it rise. All of these cycles, you see debt rise relative to income and that’s because it’s better to have spending power like we had this last cycle, send out the checks and send out the money. You’re sending out buying power. That is so much easier to do and favorable to do than to restrict it and to contain it. That’s what raises debt relative to income and raises that so that you produce a debt cycle.

Ray Dalio (00:17:55):

Go back to Old Testament and they’ll about the 50 year cycle and the Year of Jubilee and so on. But these cycles have gone on for a long time, and so these wealth gaps grow, level sort of indebtedness grow. Also what happens is the competitiveness as they get richer, the competitiveness declines because… It declines first because people, as they get richer they become more expensive in the world, they want to work less hard and also they gather more competition. Let’s say, for example, the Dutch built ships that were the best to go around the world and collect riches, but the British learned from that and hired Dutch ship builders to build ships or inexpensively and better ships by learning from them. So others become more competitive.

Ray Dalio (00:18:52):

Also, when they do very well at the top they typically become dominant in world trade. The Dutch accounted for 25% of world trade. As a result, they bring their currency and the currency that’s then commonly used around the world becomes a world currency, which we call a reserve currency. When they have that currency, then that becomes also something that people want to save it so those in other countries will want to buy that currency, which means lend and so that they will lend to countries, which tends to make them get more into debt. It’s a great privilege, they call it the exorbitant privilege, to be able to borrow money because you the reserve currency, but it does get you deeper into debt in your own currency. That sows the seeds again for problems.

Ray Dalio (00:19:48):

There’s a political system that also operates with this kind of cycle, which is the political system rewards spending and it doesn’t penalize debt. Nobody pays attention to how much debt you get into, they pay attention to what they receive. When they get more stimulation, that produces it so there’s a tendency to have that which raises the living standard over the short run but also produces the indebtedness for the long run. So that when you get, let’s say, in the top of that cycle you can see living standards are really at their highest, they’re very high. You start to see the complexion of the finances deteriorate, you see the competitiveness deteriorate and so on. People also behave differently.

Ray Dalio (00:20:38):

There is an age cycle. Those who went through the war and went through the Depression have a different psychology than those who are now the next generation, so as this passes on so then you have newer generation operating that, they know really to enjoy life more, devote attention to other things and so on. So competitiveness starts to decrease while the indebtedness… But it’s a very good feeling position to be in, but that sows the seeds. Then when you have excessive levels of indebtedness… When you have the gaps and the excessive level of indebtedness and you have the bad finances… Because when you have that borrowing, the debt, then it’s bad for the owners of the debt. Right now you have very negative real interest rates, in other words inflation adjusted interest rates so it doesn’t make any sense to hold the debt, those assets. Then you see the movement to other things and so on.

Ray Dalio (00:21:42):

Then when you have the large wealth gaps that enters into it at the same time as you have internal conflict and external conflict. When that gets… The cycle’s described in detail in the book, but you start to see political polarity and the rise of populism of the left and populism of the right becomes extreme and progressively more extreme. As a result, you no longer can be in the middle. In other words they say, “Pick a side and fight.” And the media and the politics work together to enrage people and to make them more inclined to fight. Of course, that generation didn’t go through war. Because they didn’t go through war, they’re more inclined to fight and everybody is cheering the fighter who will fight for their side.

Ray Dalio (00:22:33):

In history, it shows that when the causes that people are behind are more important to them than the system, the system is in jeopardy, which is the case now. That progresses and you have either an internal conflict, you have a financial problem [inaudible 00:22:50]. Now other things matter. You asked about the cycle because there are other things like education and civility. A long leading economic indicator is the quality of education, but education is not just understanding history and memorizing or knowing how to do math and such things, it’s also education in civility, how people behave with each other, the idea of all of those. As there’s better education, there’s better productivity that follows.

Ray Dalio (00:23:21):

There are a number of measures that I include in there. For example, infrastructure investing, how you’re improving your infrastructure, there’s measures of the military strength. When they go internationally, they need a stronger military to protect their supply lines and all of that. All of those… There’s 18 different measures that you can see, and you can see what the numbers were and are of those types of things to make up the arc, but the arc is basically along those lines until you get to the irreconcilable differences, whether they’re internal or external, and you get to the financial problems. That’s why I’m saying… I think just by the measures that’s where we are. If we take the very simple financial, is the amount of money that somebody’s earning greater than the amount that they’re spending? Are their assets better than their liabilities?

Ray Dalio (00:24:19):

That’s true for individuals, companies and countries because that country’s an aggregate of those. You can look at the financial condition. When you get to the printing of money stage, you are very late in the cycle. That’s a concerning thing. You have that financial piece together with the internal conflict or, let’s say, internal order and disorder piece. There’s a chapter on internal order and disorder, explains the cycle. Then there’s the external order and disorder, but it’s made up of a number of those other things like education, quality of leadership and so on.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.  Of all the companies mentioned, we currently have a vested interest in ASML. Holdings are subject to change at any time.