What We’re Reading (Week Ending 05 February 2023) - 05 Feb 2023
Reading helps us learn about the world and it is a really important aspect of investing. The legendary Charlie Munger even goes so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 05 February 2023):
1. Carl Kawaja – Dealing with Regime Change – Patrick O’Shaughnessy and Carl Kawaja
Patrick: [00:25:52] I’d love to talk a bit more about Apple because, one of the things that I’ve learned about myself in the last seven years is in public markets, I’m sort of a PureQuant. I found in my research and my own ability that a lot of where I think outperformance can come from, for me, is really more in things like multiple change and misevaluation, I’ll call it, versus some thesis about the fundamentals of a business over 5 to 10 years.
The reason I’ve gravitated more towards direct investing in the private markets is I’ve realized I just love products. Really, what I love to understand and think about is products. It really makes me think about Apple because, when you’ve been involved in all these companies that I’ll mention here in one way, shape or form, so I’m just fascinated to hear how you think about product cycles.
Because in many ways Apple’s success story, I don’t know if it’s apocryphal or not, but apparently Tim Cook and a few of his executives went to Buffett and said, “Look, like here’s our plan for capital allocation. We’re going to return excess capital to shareholders through dividends and buybacks.”
And that was a major contributing factor to his buying Apple. Versus a Meta on the other side of the spectrum where it’s like, no, no, no, we’re going to roll this and bet the farm on this whole new platform that’s very different and maybe control the next big interface platform or something.
And then in between, you’ve got Amazon, which you know really well with this amazing second act in AWS. And it’s very confusing to me how an investor like you might approach a second act or a new big bet or a new bet-the-farm moment for a company like these three that we just mentioned.
Because in many ways, it seems like Apple is just like we’ll keep doing R&D, but like we’ve got these unbelievable products. We’re going to keep making them better. We’re going to return tons of capital and the returns have been otherworldly as a result. And that seems very Buffett-esque. And like you said, he’s telling us what to do, like, why don’t we all just do that?
How do you think about all of this? I don’t have like a cleanly formed question in all of that. But I think you see my point that I just love these product cycles, and I’m curious how you approach one or think about one.
Carl: [00:27:50] Like you, I love good products. I’m a bit of a sucker for it. So if a company has a product that is exceptional, it makes me very interested. You and I were chatting casually before we started on the podcast a bit about the GLP-1 class of drugs that Lilly and Novo Nordisk can have and Pfizer is working on one.
And if you speak to someone who is on Wegovy, it’s just astounding the health benefits that they’re having and how quickly they’re losing weight. When they see something like that, it really makes my ears perk up. Like, oh my God, I love this thing. That’s a good base to start with.
I feel like Buffett was correct and determined in his own way that the iPhone is just really totally and utterly awesome, and you become very bonded to it. And I know that they’re expensive. But if you said to me, instead of having the iPhone, you have to use this phone that Patrick O’Shaughnessy invented, that works pretty well also, that would be a very sad day for me.
I would pay a lot of money to stay on the iPhone. And actually, like everyone else, we have a bunch of family chats in my family. And one of my siblings stubbornly refuses to use an iPhone and uses an Android. But you don’t see the videos as well. My family videos, if someone’s on the chain who’s not in the iPhone chain.
And my father — I’m shaming my relative, but my father kicked my brother off of the family text chain because he was on Android, that he didn’t have an iPhone, that’s a powerful product. And you’re right, I think Buffett’s genius was that they’ve got a great product, and they’re going to focus 100% on that, and that’s great.
So what makes what Meta is doing problematic or potentially problematic? Mark Zuckerberg may end up being right. I think we have to be open to that. And in fact, I love his vision of the future, and I love that TV show this fall happened to be on Amazon Prime, The Peripheral based on the William Gibson book, which is the metaverse in a way, with large.
And if that ends up being right, then that is going to be brilliantly right. The thing that I find slightly problematic about Meta and where I draw contrast with AWS and Amazon is I often find that good brilliant new ideas and new products start out small and then catch on like wildfire.
And when the fire is burning, throw more wood on it. As opposed to things where you gather a huge ton of wood and try to start the fire. And I’m a little worried, and I know Mark Zuckerberg with his absolute brilliance, which is widely acknowledged, may be right. And he thinks a lot of scale needs to be thrown at it.
But I worry that good things start small and run from there. And if you’re investing $8 billion to $10 billion a year and something to get it started and you do that for five years, it might even just prima facie be a sign that it’s a bad idea.
Patrick: [00:31:10] Have you ever heard of that book, The Systems Bible? I reference it all the time. I love it.
Carl: [00:31:15] Yes, I know. I ordered it. I haven’t read it yet.
Patrick: [00:31:17] The lesson in there that stands out is that every successful complex system evolves from a simple system to start. You can’t airdrop in a complex system, like it just does not work. It will not hold. And that’s another way of saying the same thing you’re saying, I think, about Meta. Whereas AWS was an organic outgrowth in 2005 or ’06 or whatever of the retail infrastructure, basically.
Carl: [00:31:40] To be humble for both of us, though, about the fact that we may be wrong, I do have one good counterfactual, I think, which is Reliance Enterprises, the Indian conglomerate. Years ago, they thought that organized retail has the potential to do really well in India.
And they were going to invest in it, and they were going to open hundreds, eventually thousands of new stores. But they had a concept for selling goods in India where, for example, they would package rice and sell rice in packages rather than in a big bin where you self-serve into a package and stuff like that.
And a lot of Indian retail is not organized chain retail. And they said, “Well, we’re going to open hundreds of stores. We have this very innovative idea.” I said, “I don’t know if I’ve ever heard of a retailer who opened 100 stores and then like 300 more and was successful.”
Like pretty much every retailer started with like one Walmart and then three Walmarts or one Dollar General and two Dollar Generals. And I was like honestly internally, I simply said, this is a really dumb idea. This will never succeed. Boy, has it been successful. They kind of were right.
They had a different vision for retail. It was grounded in insight and data. Of course, they took a while to optimize it. But it really looks like it’s working. So some things maybe you do have to do at scale. It’s higher risk, and it’s probably higher reward too…
…In terms of someone else I’ve learned from and in terms of our theme of being open-minded, I think I told you and you’ve read the book subsequently, but I was really impressed. One of the favorite things that I’ve read and maybe it will make it on to your Investor’s Field Guide reading list is this book called Don’t Sleep, There Are Snakes by a linguist and anthropologist named Daniel Everett.
He went to the Amazon as a Christian missionary to basically translate this language that a tribe in the Amazon speaks called the Piraha, a pretty remote tribe. And he discovered some very interesting things about the language that are a source of controversy in the linguistic world.
But essentially, he proved that the language doesn’t have any numbers beyond two. So it’s one, two and then few or many, but that’s about it. And they don’t have a past or a future tense. They only speak in a present tense. They don’t have words for colors, really.
And their system of orientation is exocentric as opposed to endocentric. So they don’t have a word for left hand or right hand. And I was actually having dinner last night with some friends who were saying like, oh, I always get confused with my left hand or my right hand.
And I’m like, well, you’re like this tribe in the Amazon who doesn’t orient themselves based on their left hand or right hand, but relative to their external environment. So they live near the river. And if they’re on the west side of the river, their left hand is upriver.
And if they’re on the east side, their right hand is upriver. And it’s either the upriver or the downriver hand. And the concept that your hand has a position in space in and out itself doesn’t really make sense to them. Like why would you orient yourself that way?
But actually, when you start to think about it, it kind of does make sense to orient yourself that way. But they have these very different ways of thinking, and I’d recommend that book to folks, Don’t Sleep, There Are Snakes by Daniel Everett and recommend studying him.
Because he sort of found a group of people who think about the world in a very different way. And any time that I can get insight into that, I think it’s helpful to me and helpful to me as a person. I mean another thing they do is they live very much in the present.
And I feel like for many of us, we spend so much time living in the future in a bad way, because we’re anticipating future stress or future work. And my wife likes to say that I never go on a vacation with our family without spending half the vacation planning the next vacation.
And she says, “Why can’t you just enjoy the vacation we’re on right now rather than spend half of your time on the phone trying to get reservations at the hotel for the vacation next year?” And that is a failing, and that’s something that the Piraha don’t do. Their language doesn’t even…
Patrick: [00:55:38] Allow it.
Carl: [00:55:39] Yes. It doesn’t incorporate those concepts because it doesn’t make sense to them.
Patrick: [00:55:44] I just finished the book last night. One of the things that’s so striking about it is the trade-offs. So on the one hand, he remarks through the book how incredibly happy they are. Just by like simple objective measures, how much they smile and laugh and the lack of stress, all these measures that you would associate with the happy people.
And that one, two and many thing, it’s just so fascinating to think about the implications of it. If the rest of your life, you could only say one, two and many. Once you get to many, you’re at many and you kind of stop. And that’s reflected in the trade-off of there has been no progress. One of the things they said is they’ll only make baskets out of this very degradable material and the baskets last like a couple of days and it degrades and it’s gone.
And like they could make a basket out of like tree bark or something that lasted a long time, but they’re just like don’t think, do and don’t care because of this orientation. And it’s so strange that, to me, the trade-off could be between contentment and happiness. And like, well, call it, technological progress, which very much lives in the future. I don’t know what the hell to make of that, other than it’s like very, very interesting. And it sure sounds like the life of the Piraha was pretty good, for the most part.
Carl: [00:56:52] And I do think there’s something we can take from it. Like we make durable baskets to store things so that we can use them later. And yes, that’s nice, not to be hungry later. But in a way, it’s like stressful to be worrying about later.
And sometimes, it’s nice to begin each day when you go out and look for food. And there’s that story you remember from the book where they talk about the dugout canoes. They canoe in these very shallow, flat-bottomed canoes that work well in a variety of environments but aren’t good for catching a lot of fish, because you just can’t store a lot of fish in a very shallow canoe.
And so Daniel Everett embarks in a process with the help of another tribe of teaching them how to make deep canoes. And they learned how to make deep canoes and they perfect it, and they make a very good, deep canoe.
And then I think they give it to Dan. And he says, “Why aren’t you psyched about this? Now you can make these really deep canoes and just fill them full of fish.” And they’re like why would we do that? Is there any reason on earth why we would do that? And I know you love Emerson and you love that Self-Reliance essay. There’s a relationship between the Piraha and Emerson a little bit.
2. BOJ’s Unplanned War on Japan’s Zombie Companies – Rei Saito
However, raising interest rates is much harder for the BOJ than its western counterparts. On December 2, 2022, Hitoshi Asada, a council member asked, “If the interest rate rises by as much as 1%, how much will the BOJ’s holdings of bonds lose on valuation?” In response, Deputy Governor Masayoshi Amemiya responded, “Around 28.6 trillion yen ($221 billion) in valuation losses.”
This is money that the BOJ, nor the Japanese government have, which will result in them having to borrow from foreign entities at increasingly high interest rates.
The BOJ is well-aware of this predicament, but might have no choice. The Japanese consumer price index rose 3.7% in November compared to the same month last year. This is the highest level in about 41 years and will only be exacerbated with the current 0% interest rate. Couple this with the sinking attractiveness of Japanese 10-year bonds and doing nothing could lead to a disaster.
However, there is an issue that scares the BOJ even more…
BOJ Interest Rate hike is a potential catastrophe for Zombie companies
Simply put, zombie companies are businesses whose sole purpose is to survive, often through subsidized loans from the government, and they contribute nothing to society except stable employment.
As the zombie companies stagger on, unable to make a profit, they are unable to invest in their own workforce. The employees of these zombie companies are left to wither, without the training and development they need to evolve and thrive in the job market. Instead, they often become trapped as “Zombie employees”, doomed to spend the entirety of their working lives in these dying companies, unable to escape and find new opportunities.
Currently, only about 35% of companies in Japan pay corporate tax. That means that the remaining 65% don’t pay a dime in corporate taxes, and hence are free-riding on Japan’s infrastructure and zero-interest environment while not contributing at all!
So, if the BOJ is serious about the future of this country, they need to raise interest rates.
The scary thing is how easy it would be to weed-out these zombie companies: There are reports that a measly 0.25% interest rate hike would bankrupt over one fifth of all zombie companies. That’s a lot of unemployed people the BOJ and the Japanese government would have to answer for.
3. Mark Nelson – Nuclear Power: Change the Memes, Change the Future (EP.144) – Jim O’Shaughnessy and Mark Nelson
Jim O’Shaughnessy:
You had a great quote, which I’m going to let you elaborate on, but is, I think, really, what’s his name? Scott Adams, the guy who does Dilbert. Would call this a linguistic kill shot. Because what you say is Chernobyl, the molecules, versus Chernobyl, the memes, is very, very different. The molecules killed several dozen people. The memes are killing millions and are still at it. Please elaborate.
Mark Nelson:
Sure. The memes being the ideas. And Richard Dawkins famous coining of this phrase, meme is a spreadable idea. Which we can expand, often spreadable phrases or images. That move between people and can take on a life of their own versus the molecules which are needing to be born by the wind. Which are bound by the laws of physics, which help determine the rate of decay or the danger of that molecule when it gets into a body, if it gets into a body. So, at Chernobyl, you had a plant where there was a catastrophic explosion that vented a burning reactor core into the world, and there were several
dozen deaths from that accident. Several from the trauma of the impact, people who would’ve died whether it was just a steam explosion with no radioactive molecules at all. There are people who died of exposure to acute quantities of radiation from the material in the core.
Mark Nelson:
There are a few folks on a helicopter, including the pilot, that got tangled up during key critical stages of the cleanup operation, which is why I include those who died in the helicopter accident. And then finally, there were several dozen victims of a very particular set of diseases that came from exposure to one of the isotopes, that does the most amount of damage in a short period of time in the days, or even first week or two, after a nuclear accident like Chernobyl. But then the plant kept operating, it kept operating for 14 years. The plant made more electricity the year after the blast than it did of the blast. Made more the year after that, made more the year after that. It kept setting plant efficiency records. And when it was finally shut down in year 2000, workers were quite upset that the best jobs available were being taken.
Mark Nelson:
And those who had some emotional connection to the plant were saying, why would you shut down this one? This type of reactor’s in operation around Eastern Europe and European Russia, and you were not shutting down those. Why would we shut down ours, which has had the most number of safety upgrades based on our learning experience from the disaster? So Jim, right there, I’ve had smart, young, physics educated, anti-nuclear people convert to being pro-nuclear on the spot when I replaced the Chernobyl meme with Chernobyl kept operating and was shut down by European Union cash payouts’ meme. That alone is an example of the difference between, because why? When I say Chernobyl kept operating, I’m not explaining to you the isotope story. I’m not justifying the safety or not of the improvements that they made to the reactor so it wouldn’t blow up in the future.
Mark Nelson:
And when I say and the workers wanted it to keep operating, we fundamentally know they had the most amount of skin in the game in terms of those most likely to be impacted if another one of them blew up. So, you’re going directly for, I guess, thank you for calling that a linguistic kill shot, but you’re stating an easily verifiable fact. And go on Google and see what’s the production record for Chernobyl nuclear plant. You see it cuts off after year 2000, right? You can see that bodies we trust to keep us safe from nuclear, like IAEA, International Atomic Energy Agency, verify that it kept operating. Whatever you think you knew about the worst nuclear disaster in the history of mankind, if it didn’t even stop the plant from operating and the plant operated better after one of them blew up? That destabilizes some of the most deeply held beliefs that people can have about nuclear energy…
…Mark Nelson:
I talk to people all around the world, all over the world and talking about Ukraine, about Zaporizhzhia Nuclear Plant, the largest nuclear plant in Europe, occupied by force with gun and tank fire and rocket fire led to an outburst of fear but no meltdown. It could have. In fact, if this happened and there was no Fukushima Daiichi, there’s a chance that the confusion and chaos and lack of backup that was… All changes that got better with the response to Fukushima Daiichi triggered an immune response by the industry that strengthened every single nuclear plant around the world, world. Without that, we may have lost a reactor or two. Come up. They had a giant plant that needs to be connected to the grid, get chopped off the grid because of shelling and damage and war. And yet, what happens in that plant daily, despite being a crisis just does not get people’s attention it would’ve a year ago. So it’s giving people calibration we’ve never had before because nuclear was so safe that the events weren’t frequent enough to develop an intuition about how dangerous they were.
4. Kishida vows unprecedented scope of steps to lift the birthrate – Takahashi Narasaki
Prime Minister Fumio Kishida on Jan. 23 pledged to tackle the alarming decline in the birthrate through measures that far exceed the scope of those taken by previous governments…
…The declining birthrate has long been a thorn in such programs. And it may be worsening.
The estimated number of newborns in 2022 was fewer than 800,000, a figure that came eight years earlier than the government’s projection.
“We are now only a few weak moments away from reaching a point on whether we can sustain social functions,” Kishida said. “We need to reverse the sliding birthrate.”
He said the government must immediately draw up policy measures for families with small children based on three pillars, including financial support, such as child allowances.
Kishida said a framework for doubling budgets for supporting families raising children will be created by June, when the government maps out its basic policy.
Turning to the “new capitalism” that he advocates, Kishida stressed that wage increases must be achieved.
“If companies that generate profits fully distribute the fruits of the profits to employees, higher personal consumption and further economic growth will result,” he said. “The key to this virtuous growth cycle is pay increases.”
Kishida also said he will push for reform of the labor market to build a structure that can sustain such pay hikes.
“The first necessary step is to increase wages to a level higher than the (recent) rate of inflation,” he said.
Kishida urged companies to transition from traditional seniority-based pay hike systems to ones that better reflect job evaluations to skill levels of workers. Such a shift, he said, would fuel growth.
The prime minister vowed to present a model of how to introduce such merit-based pay systems for Japanese companies by June.
5. What’s the Modern Data Stack? – Technically
Data teams exist, more or less, to build knowledge at your company. It’s their job to figure out what’s going on with the business, what might happen next, and how that information can help teams like Product, Marketing, and Sales make more money and such. So when we talk about a data stack, it just means what tools these teams use to get their jobs done.
There are a million ways to cut the data stack, but generally it will fit into a few categories:
- Something to pull in data from where it’s generated
- A place to store your data
- Something to transform your data with
- Something to visualize and analyze your data with
Yes, it turns out there’s a lot of logistics involved with “simple questions” like can you pull last month’s revenue for me?..
…The modern data stack basically just applied cloud philosophy to the data stack. Instead of large, highly configurable, on premise software, companies started using cloud-based, easy to get started with, more opinionated software. Tools in the modern data stack are:
- Cloud first – your data sits on someone else’s servers in the cloud; no need to manage your own, deal with upgrades, etc.
- Simple – products are designed to get started with quickly and require minimal configuration; you should be able to get something working in a single sitting
It’s worth noting that the old data stack didn’t suck because anyone wanted it to: technology has just progressed, a lot.
6. Why America Should Ban Crypto – Charlie Munger
In the U.S. in recent years, privately owned companies have issued thousands of new cryptocurrencies, large and small. These have later become publicly traded without any governmental pre-approval of disclosures.
In some cases, a big block of cryptocurrency has been sold to a promoter for almost nothing, after which the public buys in at much higher prices without fully understanding the pre-dilution in favor of the promoter.
All this wild and wooly capitalism is much like that described in a remark often attributed to Mark Twain, who was thought to have said that “a mine is a hole in the ground with a liar on top.”
Such wretched excess has gone on because there is a gap in regulation. A cryptocurrency is not a currency, not a commodity, and not a security. Instead, it’s a gambling contract with a nearly 100% edge for the house, entered into in a country where gambling contracts are traditionally regulated only by states that compete in laxity. Obviously the U.S. should now enact a new federal law that prevents this from happening.
7. Should You Protect Your Portfolio Against a Possible U.S. Debt Default? – Ben Carlson
The debt ceiling debate makes politicians feel important. They use it as a negotiating ploy to pass or block other legislation. It’s leverage.
Could we see some crazy politician take things too far at some point and force a default? It wouldn’t surprise me but that seems like a short-term problem that would be remedied fairly quickly once they see the problems it would cause. Politicians want to get re-elected and wrecking the U.S. economy is not a great strategy for that.
But even if you knew how badly a politician could screw this up someday it still might not help you position your portfolio correctly. Back in the summer of 2011, Standard & Poor’s downgraded the U.S. credit rating. It felt like a big deal at the time…
…How about the stock market? Things did get weird in the stock market in the short-term. The Monday after the downgrade was announced the S&P 500 crashed more than 6%. That’s a big down day. The next day it was up almost 5%. The day after that it was down more than 4%. And just for good measure the market ripped 5% the very next day. So we had down 6%, up 5%, down 4% and up 5% back-to-back-to-back-to-back. It was a volatile time for sure.
However, even including that down 6% day, the S&P 500 was up almost 20% a year later…
…$31 trillion is kind of a lot of debt. I’m not as worried about that debt as others. Let’s look at the interest we pay on that debt as a percentage of GDP:
It’s rising but is still much lower than the outlays in the 1980s and 1990s for interest expense. We can still afford to pay our debts even though rates and the amount of liabilities have risen.
The debt was lower back then but rates were higher and GDP was obviously much lower as well. The latest GDP number came in at more than $26 trillion. And that’s not an accumulated figure like the debt. This year the economy will likely produce a number that’s even bigger than that.
I know the debt number is scary but just know people have been worrying about government spending for a long time. As long as the economy continues to grow, federal debt will grow as well as the pie expands.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. We currently have a vested interest in Alphabet (parent of Google), Amazon, Apple, and Meta Platforms (parent of Facebook). Holdings are subject to change at any time.
