What We’re Reading (Week Ending 04 August 2024) - 04 Aug 2024
Reading helps us learn about the world and it is a really important aspect of investing. The late Charlie Munger even went 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 04 August 2024):
1. No More EU Fines for Big Tech – John Loeber
The EU takes an aggressive stance toward American Big Tech. Citing concerns about privacy and monopolization, it has enacted countless regulations, and fined Google and Meta for billions of dollars. In the last six months, EU regulators have kicked this motion into overdrive:
- They adopted the Digital Markets Act (DMA), which they used to immediately open investigations into Apple, Google, and Meta.
- They adopted the AI Act to constrain AI applications.
- They slapped Apple with a $2B fine.
- In July alone, they opened antitrust proceedings against Nvidia, antitrust investigations into Google, and threatened to fine Twitter over seemingly-trivial Blue Checks.
The posture is clear: the EU is not satisfied with the bloodletting-to-date and is raising its demands from Big Tech. The AI Act and DMA both may assess penalties as a percentage of global turnover, and are so broad in scope that European regulators are emboldened to pursue tech giants for practically limitless amounts of money…
…The EU’s framework goes so far as to assess fines on a percentage of global turnover:
- GDPR: up to 4% of global turnover (top-line revenue);
- AI Act: up to 7% of global turnover;
- DMA: up to 20% of global turnover;
These just keep getting more expensive! The idea of issuing fines based on global revenue for local violations of law is a brazen stretch of legal convention:
- Penalties must be commensurate with damages;
- Courts may assert their authority only over subjects in their jurisdiction.
The legal convention would be for the EU to assess fines based on EU revenues, not global revenues. Permitting fines based on global revenue would set disastrous precedent: if the EU can set fines based on global revenue, why can’t any other country? Any other big market with a little bit of leverage could try to extract a slice of the pie. Why shouldn’t India, which has ~500M Meta users, start fining Meta for 10% of its global revenue? Why shouldn’t Brazil do the same? Or Nigeria? And why should they keep their fines to Big Tech? Why don’t they fine Exxon Mobil for a percentage of global revenue?
Permitting this scope would set terrible precedent, and it has no legal legitimacy. Not only must Big Tech refuse to comply, but the US must reject it as a matter of national interest and international order…
…The EU might account only for 7% of Apple’s global revenue. 7% is still a big market, but Apple is by no means dependent on it. Especially considering the exceptionally high level of operational headache in complying with European requirements, if it comes to be Apple’s view that the fines-as-percentage-of-global-revenue cannot be avoided, then it may be rational to pull out…
…The EU doesn’t have true local alternatives. If it pursues Nvidia on Antitrust grounds: does it really want Nvidia GPUs to be replaced by, say, Huawei GPUs? Does it want Facebook to be replaced by VK? If EU regulators are motivated by concerns over unaccountable, outside influences, I might suggest that American Big Tech is still their best option…
…Never forget: these Big Tech products are, for the most part, cloud services. They can simply be turned off remotely, from one minute to the next. Hypothetically, if Big Tech were to coordinate, play true hardball, and shut off EU-facing products, the EU economy would grind to a halt overnight. Imagine the fallout from hundreds of millions of people suddenly not having email anymore. Without AWS, GCP, Azure, etc. things simply wouldn’t work. We live in a digital world; the dependencies are everywhere. It’d be like when OPEC constrained oil supply in the 70s, except percolating much more deeply and instantaneously throughout economies.
Of course, it’s very unlikely for Big Tech to withdraw from the EU entirely. That would be drastic. The reality is subtler, and we’re seeing it play out right now: Meta is not making its multimodal Llama models available in the EU. Apple isn’t going to bring Apple Intelligence to the EU. These are important, state-of-the-art products. If you believe at all that AI is promising or important, then EU businesses and consumers will suffer from not having access to them…
…Maybe multimodal Llama AI is not important for EU consumers today. But what if the best radiology AI assistant gets built on Llama AI — and EU patients can’t have access? Or an EU business needs the best-in-class AI to remain globally competitive? What if Apple Intelligence can automatically call an ambulance for you if you have a heart attack — but not in the EU?…
…The EU must compete or cooperate. Either one is fine. But it would be ill-advised to continue the current regime of low-grade economic harassment of its nominal allies by syphoning off fines and imposing obnoxious requirements.
2. 4 Key Lessons Learnt in Legacy Planning – Christopher Tan
In the plans that clients want us to put in place for them, one of the common requests is to put in place structures to prevent their children from squandering their inheritance. This is not just limited to young beneficiaries but beneficiaries who can be as old as in their 50s!
The lack of trust is largely due to many of these children not needing to work for the good life that they have been enjoying from a young age…
…But it is not that parents do not know this. No sensible parent starts off their parenting journey with the intention of spoiling their children to such an extreme. It usually begins in a small way, unintentionally, incrementally, and by the time they realise what they might have done, it is too late.
When we give our children too many good things in life, especially when they are still young, we deny them the opportunity to learn the importance of delayed gratification and we do not allow them to foster resilience and independence, which can cause them to have a self-entitlement mentality…
…When I first started my firm in 2001, this new “baby” began to consume me and took time away from my wife and two young children.
Well-meaning friends warned me not to chase wealth at the expense of my family. “But I am not even trying to be richer. I am just trying to survive!” I retorted. Finally, it came to a point in my life where I did not have a relationship with my family.
Thankfully, I realised it early enough to turn around. Otherwise, I would have lost my family…
…In all my work with my clients, I have realised that behind every legacy and estate plan, there is a message of love. Unfortunately, this is lost in the legal documents and structures that are put in place.
I have always encouraged my clients to share their gifting plans with their beneficiaries. Share not just the “what and how” of the plan but also share the “why”.
But as Asians, some of us may not be so willing to communicate our emotions so openly, especially before our passing. In this case, one can consider using the Letter of Wishes (LOW).
The LOW is a non-legally binding document by the settlor to guide the protectors and trustees on how they wish their assets to be managed. But instead of writing it like an instruction manual, write it like a love letter to your loved ones.
3. Nike: An Epic Saga of Value Destruction – Massimo Giunco
A month ago. June 28th, 2024. Nike Q2 24 financial results. 25bn of market cap lost in a day (70 in 9 months). 130 million shares exchanged in the stock market (13 times the avg number of daily transactions). The lowest share price since 2018, – 32% since the beginning of 2024.
It wasn’t a Wall Street session. It was the judgement day for Nike.
The story started on January 13th, 2020, when John Donahue became CEO of Nike, replacing Mark Parker. Together with Heidi O’Neill, who became President of Consumer, Product and Brand, he began immediately to plan the transformation of the company.
A few months later, after hist first tour around the Nike world, the CEO announced – via email – his decisions (using the formula “dear Nike colleagues, this is what you asked for…”):
1) Nike will eliminate categories from the organization (brand, product development and sales)
2) Nike will become a DTC led company, ending the wholesale leadership.
3) Nike will change its marketing model, centralizing it and making it data driven and digitally led…
…Clearly, one important support came from the brand investments. The marketing org. dramatically changed its demand creation model and pumped – over the years – billions of dollars into performance marketing/programmatic adv to buy (and the word “buy” is the proper one, otherwise I would have used “earn”) a fast-growing traffic to the ecommerce platform (we will talk about that later).
After a few quarters of good results (as I said, inflated by the long tail of the pandemic and the slow resurrection of the B&M business), things started to take unexpected directions. Among them:
a) Nike – that had been a wholesale business company since ever, working on a well- established “futures” system – did not have a clear knowledge and discipline to manage the shift operationally. Magically (well, not so magically), inventory started to blow up, as all the data driven predictions (the “flywheel” …) were simply inconclusive and the supply chain broke up. As announced by the quarterly earnings releases, the inventory level on May 31st, 2021, was 6.5bn $. On May 31st, 2022, it was 8.5bn $. On November 30th, 2022, it reached 10bn $. Nike didn’t know anymore what to produce, when to produce, where to ship. Action plans to solve the over-inventory issues planted the seed of margin erosion, as Nike started to discount more and more on its own channels – especially Nike.com (we will talk later about it)…
…The CEO of Nike doesn’t come from the industry. So, probably he underestimated consumer behavior and the logic behind the marketplace mechanisms of the sport sneakers and apparel distribution. Or wasn’t aware of them. At the end, he is a poorly advised “data driven guy”, whatever it means. It is more difficult to understand why the President of the Consumer, Product and Brand, a veteran of the industry, one of the creators of the Women’s category in Nike, a professional with an immense knowledge of the company and the business, approved and endorsed all of this. Maybe, excess of confidence. Or pure and simple miscalculations… hard to know…
…What happened in 2020? Well, the brand team shifted from brand marketing to digital marketing and from brand enhancing to sales activation. All in. Because of that, the CMO of that time made a few epic moves:
a) shift from CREATE DEMAND to SERVE AND RETAIN DEMAND, that meant that most of the investment were directed to those who were already Nike consumers (or “members”).
b) massive growth of programmatic adv investment (as of 2021, to drive traffic to Nike.com, Nike started investing in programmatic adv and performance marketing the double or more of the share of resources usually invested in the other brand activities). For sure, the former CMO was ignoring the growing academic literature around the inefficiencies of investment in performance marketing/programmatic advertising, due to frauds, rising costs of mediators and declining consumer response to those activities. Things that were suggesting other large B2C companies – like Unilever and P&G – to reduce those kind of DC investments in the same exact period… Because of that, Nike invested a material amount of dollars (billions) into something that was less effective but easier to be measured vs something that was more effective but less easy to be measured. In conclusion: an impressive waste of money.
c) elevation of Brand Design and demotion of Brand Communication. Basically, style over breakthrough creativity. To feed the digital marketing ecosystem, one of the historic functions of the marketing team (brand communications) was “de facto” absorbed and marginalized by the brand design team, which took the leadership in marketing content production (together with the mar-tech “scientists”). Nike didn’t need brand creativity anymore, just a polished and never stopping supply chain of branded stuff…
…Obviously, the former CMO had decided to ignore “How Brands Grow” by Byron Sharp, Professor of Marketing Science, Director of the Ehrenberg-Bass Institute, University of South Australia. Otherwise, he would have known that: 1) if you focus on existing consumers, you won’t grow. Eventually, your business will shrink (as it is “surprisingly” happening right now). 2) Loyalty is not a growth driver. 3) Loyalty is a function of penetration. If you grow market penetration and market share, you grow loyalty (and usually revenues). 4) If you try to grow only loyalty (and LTV) of existing consumers (spending an enormous amount of money and time to get something that is very difficult and expensive to achieve), you don’t grow penetration and market share (and therefore revenues). As simple as that…
He made “Nike.com” the center of everything and diverted focus and dollars to it. Due to all of that, Nike hasn’t made a history making brand campaign since 2018, as the Brand organization had to become a huge sales activation machine. An example? The infamous “editorial strategy” – you can see the effects of it if you visit its archive, the Nike channel on YouTube or any Nike account on Instagram – generated a regurgitation of thousands of micro-useless-insignificant contents, costly and mostly ineffective, all produced to feed the bulimic digital ecosystem, aimed to drive traffic to a platform that converts a tiny (and when I say tiny, I mean really tiny…) fraction of consumers who arrive there and disappoints (or ignores) all the others.
4. Getting bubbly – Owen A. Lamont
Is the U.S. stock market currently in an AI-fueled bubble? That’s the question I asked back in March, and my answer was “No, not even close.” Since then, new data has come in, and my answer has changed. As of July 2024, I still think we’re not in a bubble, but now we are getting close.
Here are my previously discussed Four Horsemen:
- First Horseman, Overvaluation: Are current prices at unreasonably high levels according to historical norms and expert opinion?
- Second Horseman, Bubble beliefs: Do an unusually large number of market participants say that prices are too high, but likely to rise further?
- Third Horseman, Issuance: Over the past year, have we seen an unusually high level of equity issuance by existing firms and new firms (IPOs), and unusually low levels of repurchases?
- Fourth Horseman, Inflows: Do we see an unusually large number of new participants entering the market?
What I said before was, “As of March 2024, we may perhaps hear the distant hoofbeats of the First Horseman (overvaluation), who has not traveled far since he last visited us, but there is no sign yet of the other three.”
What’s changed is the Second Horseman, who is now trotting into view. But there’s still no sign of the other two horsemen; for the aggregate U.S. stock market, we see neither issuance nor inflows…
… The table shows that, as has been widely reported, CAPE is very high today and has only been higher around prior bubbles in 2021 and 1999. The market ain’t cheap.
The only point I want to make is that the 2021 bubble was different from 1999/2000 in one key respect: interest rates. In 1999, both nominal and real rates were high and the excess CAPE yield was negative, implying that there was an obvious alternative to investing in overpriced stocks. In 2021, in contrast, both nominal and real rates were very low and the excess CAPE yield was positive, so that one could argue that stocks were fairly priced relative to bonds.
Today looks closer to 1999 than to 2021: a stock market that looks high relative to bond markets. So in that sense, today’s market looks more bubbly than 2021, though less bubbly than 1999…
…Talking to academic economists in mid-July 2024, I got a 1998ish vibe. When I asked them if they thought the market is overvalued, they almost all said yes, sometimes adding “of course” or “definitely” and mentioning megacap tech stocks. I don’t think the overvaluation sentiment among finance professors is as strong and uniform as it was in 1999, but it is far stronger than it was in 2021.
I’m guessing the gap between public and private utterances mostly reflects the slow pace of academic research. There were many economists studying stock market overvaluation in 1999 because the market had been overvalued for years. In contrast, today we see mostly visceral reactions to high prices as opposed to formal analysis…
…I previously showed a table with survey data from Yale’s U.S. Stock Market Confidence Indices,[5] and I said that in order for the Second Horseman to be present:
“I need 65% or more respondents agreeing that “Stock prices in the United States, when compared with measures of true fundamental value or sensible investment value, are too high.”
Below, I show an updated table where I have just added a new row for July 2024. We are not quite at my proposed threshold of 65%, but we‘ve reached 61%, mighty close. With 61% of individual investors saying the market is overvalued but 75% saying that the market is going up, it appears that bubble beliefs are emerging…
…Other evidence suggests bubble beliefs emerging within specific segments of the market. For example, a recent survey found that 84% of retail investors expected the tech sector to outperform in the second half of 2024, but 61% said AI-related stocks were overvalued.
5. Does the Stock Market Care Who the President Is? – Ben Carlson
I took a look back at every president since Herbert Hoover to see how bad stock market losses have been for each four-year term in office…
…Every president saw severe corrections or bear markets on their watch. The average loss over all four-year terms was 30 percent. The average loss under a Republican administration was 37 percent while the average loss under the Democrats was 24 percent. But these differences don’t really tell you much about the two parties. The stock market does not care about Republicans or Democrats.
For example, if you look at the stock market performance under both Republicans and Democrats going back to 1853, two full presidential terms before Lincoln took office, the performance is fairly similar. Total returns under Democrats were 1,340 percent, the total returns under Republicans were 1,270 percent.
Presidents have far less control over the markets than most people would have you believe. There are no magical levers they can pull to force stocks to rise or fall. Policy decisions often affect the economy with a lag. And the economy and stock market are rarely operating in lock-step.
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), Apple, and Meta Platforms. Holdings are subject to change at any time.
