What We’re Reading (Week Ending 13 February 2022) - 13 Feb 2022
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 13 February 2022):
1. The Reason Putin Would Risk War – Anne Applebaum
But of all the questions that repeatedly arise about a possible Russian invasion of Ukraine, the one that gets the least satisfactory answers is this one: Why?
Why would Russia’s president, Vladimir Putin, attack a neighboring country that has not provoked him? Why would he risk the blood of his own soldiers? Why would he risk sanctions, and perhaps an economic crisis, as a result? And if he is not really willing to risk these things, then why is he playing this elaborate game?…
…But although Putin missed the euphoria of the ’80s, he certainly took full part in the orgy of greed that gripped Russia in the ’90s. Having weathered the trauma of the Berlin Wall, Putin returned to the Soviet Union and joined his former colleagues in a massive looting of the Soviet state. With the assistance of Russian organized crime as well as the amoral international offshore-money-laundering industry, some of the former Soviet nomenklatura stole assets, took the money out of the country, hid it abroad, and then brought the cash back and used it to buy more assets. Wealth accumulated; a power struggle followed. Some of the original oligarchs landed in prison or exile. Eventually Putin wound up as the top billionaire among all the other billionaires—or at least the one who controls the secret police.
This position makes Putin simultaneously very strong and very weak, a paradox that many Americans and Europeans find hard to understand. He is strong, of course, because he controls so many levers of Russia’s society and economy. Try to imagine an American president who controlled not only the executive branch—including the FBI, CIA, and NSA—but also Congress and the judiciary; The New York Times, The Wall Street Journal, The Dallas Morning News, and all of the other newspapers; and all major businesses, including Exxon, Apple, Google, and General Motors.
Putin’s control comes without legal limits. He and the people around him operate without checks and balances, without ethics rules, without transparency of any kind. They determine who can be a candidate in elections, and who is allowed to speak in public. They can make decisions from one day to the next—sending troops to the Ukrainian border, for example—after consulting no one and taking no advice. When Putin contemplates an invasion, he does not have to consider the interest of Russian businesses or consumers who might suffer from economic sanctions. He doesn’t have to take into account the families of Russian soldiers who might die in a conflict that they don’t want. They have no choice, and no voice.
And yet at the same time, Putin’s position is extremely precarious. Despite all of that power and all of that money, despite total control over the information space and total domination of the political space, Putin must know, at some level, that he is an illegitimate leader. He has never won a fair election, and he has never campaigned in a contest that he could lose. He knows that the political system he helped create is profoundly unfair, that his regime not only runs the country but owns it, making economic and foreign-policy decisions that are designed to benefit the companies from which he and his inner circle personally profit. He knows that the institutions of the state exist not to serve the Russian people, but to steal from them. He knows that this system works very well for a few rich people, but very badly for everyone else. He knows, in other words, that one day, prodemocracy activists of the kind he saw in Dresden might come for him too.
2. Classic 06: Elon Musk – Stig Brodersen and Preston Pysh
Preston Pysh 14:41
One of the key points that I felt was really important to highlight his childhood was his desire to read. They talked about in the book how he had pretty much gone to the local public library and almost had read every single book inside of that library. They described hs characteristic, “If you saw Elon Musk at any given point in time, he probably had a book in his hand, and he was reading it.” And I think that that’s really important for people to understand and to know that a guy like Elon Musk doesn’t become as intelligent as he is. And we’ll get into some of this stuff later on in the discussion here.
15:15
But the one takeaway that I had is this guy is brilliant. He is absolutely a wicked smart dude. And I attribute most of that to the fact that he is a total learning machine. And that’s such a common thread that we’ve found with all these billionaires that we study. They are total learning machines. They are learning something every single day. They’re learning something new. They’re studying things that might not even seem like they’re correlated. And we definitely got that at a very extreme level with Elon Musk, and I find that to be extremely important for people to understand…
...Preston Pysh 24:58
It was around 200 million, I want to say. From the sale of PayPal off to eBay, based on the equity that he owned, he had a very large chunk of money at this point. He moves to Los Angeles, and he really wants to get into the space industry. And he has this idea to start his own space company. There’s some time in between here where he’s living in LA and really trying to figure out what is it that he really wants to do in space. And he’s in these different Mars societies. And he’s donating money to these research stations and things like that.
But in the end, he decides that he wants to start his own space rocket company and really go into the private space industry. Now, where I think the story was really awesome in the book. He talks about how he wants to go over to Russia and buy some of their rockets to start his own space company. So he goes over to Russia and he just has a really bad visit with them. And they really didn’t take him seriously because he’s like 29 years old. He’s still in his 20s at this point. He goes over to Russia and he’s like, “Yeah, I want to buy some of your rockets.” And they look at him like he’s absolutely crazy and weren’t really playing ball really with him.
26:15
So on the flight back, he went over there with some of his close friends that he was wanting to start this space business with… And on the way back, he pulls out his laptop computer and has like all the components listed for basically building his own rocket. And he looks at his friends and he says, “We don’t need to buy this rocket from Russia. Let’s just do our own. Let’s just make our own.” And I think his buddies were looking at him like, “This guy’s going off the deep end.” He’s in these Mars society wanting to the initial thought was let’s put a plant on Mars. So we can say that we put life on Mars. And just this discussion in the book was absolutely fascinating. I think anybody who would read this part would really get a kick out of it.
But anyway, Elon was not in the least bit deterred by how crazy it might be to start his own rocket company and create his own space company from the ground up. I mean, literally, from the ground up and not be buying any of the components from anybody. He’s just like, “We’ll make it all and we’ll just do it.”
Stig Brodersen 27:20
I think it was just so much fun because what people don’t realize that if they listen to the book is that he has a very detailed plan of how to colonize Mars, like, “This year, there should be so many inhabitants. And this year, we should fly this out to Mars.” And if this came from anyone else than Elon Musk, I don’t know… The FBI will probably arrest that guy because he thought he was crazy. He is one that would harm other people. I don’t know. He just sounds so crazy.
But the interesting thing is that all of these things and we were talking about Tesla, and later on, but all these things that he said that would happen, actually happened. I mean, I can see why people would think he would be crazy with his plans about building a rocket because no one does that. Usually, you have countries doing this and it would take decades for countries to do it. But he just flies out to Russia with a friend of his to buy rockets. And when they said no, he just built his own. And he just seems so unrealistic that’s even possible.
Preston Pysh 28:23
You know, the thing I didn’t know before reading this book is I just thought the mission of SpaceX was really to pump all these private satellites into space and be profitable and bid on government work and stuff like that. But that wasn’t it. The mission of SpaceX is to colonize Mars. And I mean, they say that in a very straight face manner. Like that’s the thing that I think is so crazy. When I read that in the book, and I heard that for the first time, I was pretty much flabbergasted like, “Oh, that that was probably not right.” And then it keeps coming back up and keeps coming up. And I’m telling you, folks, the mission of SpaceX is to colonize Mars and to put human beings in colonies on Mars. That’s what Elon is wanting to do.
In fact, that mission statement is so strong for him, that he will not take the company public until that mission is pretty much assured. He will not take the company public. So that’s just totally… I find that to be total insanity. Okay, I really do I find that to be totally nuts because I just don’t think that you would find too many people in this world that would want to do that. Maybe I’m wrong. Maybe I’m out in the left field, but I don’t think you’d find too many people that would want to do that. Let alone would have the money to pay to go do that and live in those conditions. I just think that’d be really dismal. But what are your thoughts on that? Is he out to launch?
3. NZS Capital Part II: What’s Going on in Today’s Markets? (Plus more Semiconductors!) – Ben Gilbert, David Rosenthal, Brad Slingerland, and Jon Bathgate
David: Speaking of, we were talking before the episode, the reason we wanted to do this with you guys is from the first episode we did with NZS, your whole way of using complexity theory to think about investing in companies and markets is fascinating. I love it. So many of our listeners loved it and we thought because it’s so different from everything else we’ve heard. Let’s talk to you guys about what is going on right now here in late January 2022 as markets are different than they were a month ago.
Ben: Let me tee up with what David means by right now. We’re recording this at 9:00 AM Pacific on January 27. Right now, the S&P year to date is down about 9.5%, probably rebounded a little bit this morning, and the NASDAQ, which everyone knows is more tech-focused, down about 15%. Quite a start to 2022 after a hell of a run in 2020 and 2021.
By the time you hear this, who knows because it seems like every cycle in every part of the business has gotten shorter and shorter, but that is where we are today. Brad, maybe let’s start with you. This is an enormous question so you can choose to answer however you’d like, but what is going on and how did we get here?
Brad: I want to go all the way back a million years in time, but we probably couldn’t.
David: This is Acquired.
Brad: Around the evolution of human psychology. Just to not go quite back that far. I mean, obviously, we had the pandemic started, we’re coming up on two years on that. There was this initial fear that Jon references, I think everybody probably remembers, it does feel like a lifetime ago. Then this just unleashing of incredible coordinated global economic stimulus, both fiscal and monetary in form of low rates here in the US, literally checks being sent to people.
There is this period of uncertainty in 2020 that just exploded into this period of spending in 2021. You look at consumer spending 2021 over 2019 and it’s like probably 18% more I think is the recent Commerce Department data for the US. That’s […] 2020 but versus pre-pandemic levels, there’s just all this money. The way we’re spending it, where we’ve spent it as consumers has been in different places. Instead of going on vacation, we’ve been fixing up our houses, so it’s caused all this sort of acute demand for a lot of things and then not demand for these other things.
The economy just can’t turn. We are so global. We’ve been on the sort of 30-year globalization trend where the supply chain is getting more spread out, and in a lot of ways more fragile and you just can’t get your hands on things. This huge burst in demand last year caused this big pickup in inflation. I think one of the latest numbers is 6% or 7%, and some of it is transitory, some of it is maybe a little bit structural and we can come back to that.
Now the governments are saying, okay, well, we gave everybody way too much money. We gave way too much stimulus out there in the economy, and we’re going to reel it back in. The main tool they have to do that is to raise interest rates. They’ve signaled raising interest rates—depending on how you want to read the tea leaves—maybe four times.
Ben: When they’re raising interest rates, I think I haven’t seen, obviously they’ve been taking on more and more on their balance sheet every month. They’ve been buying hundreds of billions of dollars in assets and I think that’s tapering. Have they ever announced any plan to start shrinking the balance sheet of the Fed along with these interest rate raises?
Brad: I think that ultimately, the Fed would like to stop the experiment of running a massive balance sheet. Suddenly, there are a lot of questions on certainty around how that plays out. You end up with this scenario where no rates are going up and then there’s this tension in the stock market between people who think this is appropriate, inflation is the root of all evil, it’s structural, and it’s here to last and we’ve got to just kill it.
The people who think well, actually, the economy’s quite fragile. We’re still in a pandemic, people are still sick. There’s a lot of things going on. If we all of a sudden just hoover all of the money back out as quickly as possible, then that’s probably as bad as what the situation was, to begin with. The market always wants to find some level of homeostasis.
One of the things we learned from complex adaptive systems is to really think biologically rather than computationally, which is the way a lot of market participants think. If we think about homeostasis, here in our body, we’re trying to constantly maintain our temperature right around 98.6 degrees, we’re trying to make sure we’re not hungry, and then we get enough sleep at night. All these things that our bodies regulate often without us knowing.
The market’s also trying to do this. It’s trying to come to a consensus on what do we think interest rates are going to be a year from now, 5 years from now, or 10 years from now? What do we think inflation is going to be? What do we think profit margins are going to be? What do we think is going to happen in emerging market growth versus developed market growth?
Most of the time, you can never reach equilibrium or homeostasis in a complex adaptive system. You can in a biological closed system like a human body, but most of the time, it’s constantly being perturbed. This idea of disequilibrium is the equilibrium is a concept from Brian Arthur, who sort of wrote a lot of the great texts, complexity economics, and wrote the original paper on compounding and network effects.
David: Increasing returns, right?
Brad: Sorry, increasing returns not network effects. The market, in particular right now, is struggling to find this homeostasis point, these extreme bouts of volatility up and down. The one thing the market needs to come to some sort of agreement on is what is the discount rate? What are interest rates? What should people use as their hurdle rate for the next 1, 3, 5, 10 years? Right now, there are two camps that are disagreeing on it. I think this creates tension, this sort of bouncing back and forth between these two equilibriums in the market.
That started in March of 2021, actually. It was the first time rates started to go up, growth stock started to come down. You can just see this sort of anti-correlation over the last 10 months now of rates going up, growth stocks coming down, and then we’re in this extreme phase right now.
It’s interesting if you look back, I’ve been through a few rate hike cycles in the market over the last 24 years now, I guess. There does tend to be this initial difficulty in finding an equilibrium fear over high growth, high multiple stocks, stocks that may not have current earnings, but people are banking on earnings in the future.
Then what happens is people tend to gravitate back towards the growth assets because they are the assets that are going to create the most value long term. We’re in this initial period of finding equilibrium or something as close to equilibrium as we can get, and then I would expect this to be no different from prior cycles where unless there’s something structural that we’re not aware of yet, people would be gravitating back towards growth assets.
Ben: As another way to put that—just to make sure I’m understanding it—for these companies without earnings but have high growth that got tremendous multiple expansion by public market investors over the last several years, that was the first place where investors got scared and were selling and created all this downward compression on the multiples so these prices dropped like crazy if this high growth, currently unprofitable, or currently not cash generating tech companies.
Those get sort of whacked the hardest first, but you’re saying ultimately if that’s where the growth is in terms of the companies that will become large and profitable in the future, then that’s a place also where there’s flight back there after the exhale of, okay, we’re safe.
Brad: Yeah, that tends to be what happens. One of the things we learned from complex adaptive systems is we can’t predict the future. I’m always sort of on thin ice when I say this happened in the past and so it might happen in the future. I don’t see any particular reason why at the right equilibrium point, these growth assets aren’t, again, more attractive.
Everybody should have their own sort of way of managing a portfolio of investments, whether it’s in public markets, real estate, or whatever you do. What we do is we balance two types of investments we call resilience and optionality and we’re able to shift back and forth. In times of volatility like today, we like to say, and I’m quoting Brinton here but we don’t see volatility as risk, we view it as an opportunity.
Come back to whatever the basics of your own investment strategy are, it’s a very personal thing for everybody and say, what are the two different types of businesses that I own and where should I be shifting the portfolio today? For us that would be, as the market is volatile, moving out are more resilient growth businesses into our more optional growth businesses.
4. Joy & Competitiveness & Culture – Ravi Gupta
Talking about culture is easy. Living it is hard. But I think at least part of the reason it’s so hard to live is because people often don’t take the time to rigorously define it.
Before we get to some thoughts about how you might go about defining your culture, we should talk about why culture is important.3
Earlier in my career, I thought young people talked about strategy and execution being important and old people talked about culture being important. I actually think they are both true. It’s just a timing difference. The thing that matters right now is the strategy and the execution. The thing that matters in the long term is the people who are setting that strategy and driving that execution. In my mind, the culture determines who self-selects to be those people over the long-term. So if you care about the people who will make the strategy and execution decisions in the moment beyond right now, you should care about culture.
I think of culture as the unwritten contract with your team. Here’s what matters to us. Here’s what will endure even if everything else changes. You should only put things in it that you will honor no matter what. With that in mind, I think it makes sense to only have one or two of these things.
5. How Do You Solve A Problem Like Inflation? – Stephanie Kelton
The second chapter of my book, The Deficit Myth, is titled ‘Think of Inflation.’ From the very beginning, MMT has rejected the conventional approach to fiscal sustainability. While mainstream economists were warning of a looming debt crisis here in America, MMT economists were explaining that the relevant constraint facing currency-issuing governments (like the US, the UK, or Japan) is inflation, not bond vigilantes or insolvency.1
It’s been a long time since the world’s major economies had to wrestle with the problem of high inflation. For most of the last decade—and longer in Japan’s case—central banks have been struggling to push inflation higher not lower.
Now that inflation is here—and running well above target in the US, the UK, Canada, across the Euro Area, and beyond—a fiery debate has erupted over what sent prices soaring and what should be done to rein them back in.
Some blame monetary policy—i.e. the Federal Reserve—for stoking the fire by holding interest rates too low for too long and for ‘pumping too much liquidity’ into the system via the Fed’s massive bond-buying program. Others mainly fault Congress and the White House—i.e. fiscal policy—for sending out too many checks to too many people for too many months, sparking an “excess aggregate demand” problem. Occasionally, someone will even assert that the run-up in inflation is the natural consequence of having embarked on an “MMT experiment,” by which they usually mean the combination of quantitative easing (QE) and massive deficit spending.
On one level, I think it’s fair to say that policymakers did experiment with MMT. But I’m not talking about about QE, which was never championed by MMT economists. What I mean is that the fiscal response to the pandemic differed in important ways from what was done in the wake of the Great Recession, when people like Larry Summers and Jason Furman were helping to shape the Obama administration’s (inadequate) economic policy. Back then, both men pushed hard for deficit reduction, with Furman touting a White House budget that would “show that we can live within our means” by bringing “spending down to the lowest share of the economy since Eisenhower was president.” He delivered those remarks in February 2011, when the unemployment rate (U3) stood at 9 percent and headline inflation (CPI-U) was running at just 2.1 percent.
But this time around, it looked like Congress—Democrats and Republicans—had grown more comfortable with the idea of allowing fiscal deficits to cushion the downturn and sustain the economic recovery. And it was the robust fiscal response that came out of the late-Trump/early-Biden administrations that reflected a shift toward a more enlightened understanding of our monetary system and the spending capacities of the federal government—i.e. MMT. Instead of cowering in fear of debt and deficits, as it did during the Obama years, Congress went big. Not once, not twice, but repeatedly, committing some $5 trillion in fiscal support in the first year of the pandemic alone…
…Alongside the debate over what caused the current bout of high inflation is a debate about how to resolve the problem. A number of people have asked me for the MMT solution. There isn’t one. Let me explain.
Before the pandemic, when inflation was consistently running below 2 percent, I was often asked what MMT would tell us to do if inflation ever became a problem. I have probably answered that question a hundred times, and I always try to separate my response into two parts.
The first part of the answer reminds people that the goal is to fend off inflation before it becomes a problem—i.e. the MMT framework aims to promote price stability. The second part of the answer addresses the question of how to deal with inflation after prices begin to accelerate.
Here are my favorite pre-emptive measures. First, instead of relying on a pool of unemployed workers (NAIRU) to keep inflation in check, MMT relies on a buffer stock of employed workers—and a wage anchor—to promote price stability. This has always been the first line of defense against inflation in the MMT framework. The idea is to create a new automatic stabilizer that triggers a powerful counter-cyclical response to changing economic conditions.4 Instead of allowing millions of people to fall into unemployment each time the economy falters, workers could transition into a public service job that replaces some or all of their lost income. The program enhances price stability by maintaining a supply of employable labor from which employers can hire (at a small premium) as conditions improve. The program facilitates bigger deficits (or smaller surpluses) when the economy softens and smaller deficits (or larger surpluses) as demand strengthens.5
The other way to fend off inflationary pressures before they emerge is to change the way Congress currently evaluates proposed legislation. Instead of asking the Congressional Budget Office (CBO) to assess the budgetary impacts of a proposed legislation, lawmakers should seek to identify—and mitigate— any inflationary pressures before voting to authorize the spending (or tax cuts). As MMT economist Scott Fullwiler put it, this is about replacing the budget constraint with an inflation constraint.
6. Twitter thread on counter-intuitive investing truths – Max Koh
I’ve received a ton of crappy investing advice over the years. And I see even more here on Twitter. What I’m about to say will piss off some people. Don’t read if you’re easily agitated. Still here? Then grab a whiskey and here’s 25 investing “truths” that just ain’t so:
1. Picking individual stocks isn’t for everyone. 90% of people lack the temperament to be good investors. If seeing your net worth get eroded by 30% or more scares you… Then this is not the game you’re built for. It’ll cause you more pain than joy. And you won’t last long
2. Diversification isn’t for idiots. People who diversify are those who acknowledge that they don’t know what the future holds. It’s healthy to have self doubt. The real idiot is the one who goes all in purely because you spent months deep diving the business.
3. Concentration isn’t an action. It’s an outcome. Concentration is mostly a result of letting your winners run. It’s an outcome that comes from great performance. It’s NOT something you do from day 1 based purely on your own blind faith (or ignorance)…
…9. A company can be a better buy at $200 instead of $20. When companies are much smaller, they’re less proven. But as they execute and their revenues grow, their market cap grows too. So a company can be a safer bet when it’s bigger. It’s all about the execution…
…12. Management is the most important moat of all. In the end, almost everything can and will be copied. What endures will be the culture and quality of people running the ship. That is much harder to replicate. Speaking of management… Find great leaders and teams who impress you with their character and values. You often find positive surprises when you invest in good quality managers. They also help you sleep better at night when your stock drops 50%.
13. Management is important, but execution is king. The quality of the people matters. But make sure the numbers align with the narrative. For great companies with great leaders, you should see a consistent trend in their key metrics. (continued…) Other than some hiccups along the way… The overall direction of the business and metrics should be moving up. Otherwise, something is amiss. I get suspicious if the management says a lot but numbers are taking a long time to show. Execution is everything…
…17. Everyone talks about product-market fit. Nobody talks about investor-portfolio fit. Even if you own the best companies, you could still lose $$. Because your portfolio may not be constructed in a way that suits your unique personality. (continued…) To endure drawdowns and hold through… Your portfolio must fit your specific risk profile and time horizon. And you only learn whether your portfolio is suitable for you during corrections. The market is an expensive place to find out who you really are.
7. The Attention Span. “Racehorses and Psychopaths.” – Tom Morgan
Cognitive biases are not a particularly interesting topic to me. Just learning about biases doesn’t seem to change people’s behavior much. But I was fascinated by an excellent recent review of Julia Galef’s new book The Scout Mindset (below). Scott Siskind writes:
“Of the fifty-odd biases discovered by Kahneman, Tversky, and their successors, forty-nine are cute quirks, and one is destroying civilization. This last one is confirmation bias – our tendency to interpret evidence as confirming our pre-existing beliefs instead of changing our minds.”
Why is confirmation bias “destroying civilization?” I think it’s super helpful to step back for a second and examine this idea through the universal framework of map and territory. Consciousness exists on a spectrum from pure abstraction (map) to pure engagement (territory).
Galef’s Scout Mindset sets out to remove information to provide a clearer view of the territory. Soldier Mindset just adds more confirmations to make the map more elaborate, regardless of its accuracy.
The really, really dark side here is that the stronger an abstraction, often an outright lie, the more motivating it can be for tribal behavior. The soldier metaphor is doubly-appropriate. Taken to its most horrifying extreme, war and genocide is facilitated by abstraction. Beyond direct kinship bonds, we have developed common coordinating fictions like nationalities. We went from being able to mobilize a tribe of hundreds, to nations of millions. How many people do you personally think you’d be able to convince to risk their life for you? As the author of Sapiens, Yuval Noah Harari, puts it: “you could never convince a monkey to give you a banana by promising him limitless bananas after death in monkey heaven.” A motivating abstraction has to take over at the cognitive limits of empathy, beyond who you can really know and love personally. And yet we can compete and kill more easily by stripping universal humanity from our enemies by turning them into an out-group.
The single passage I have thought of most as I ponder the cultural events of the last two years, and last two thousand years, is from Karen Stenner:
“All the available evidence indicates that exposure to difference, talking about difference, and applauding difference – the hallmarks of liberal democracy – are the surest ways to aggravate those who are innately intolerant, and to guarantee the increased expression of their predispositions in manifestly intolerant attitudes and behaviours. Paradoxically, then, it would seem that we can best limit intolerance of difference by parading, talking about, and applauding our sameness.”
Social movements that create more in-groups are less likely to succeed than ones that emphasize our universal humanity. There’s a remarkable study where participants were shown a video of a hand being stabbed, while their empathic response was measured by fMRI. They found that the empathic response was larger when participants viewed a painful event occurring to a hand labeled with their own in-group, rather than a hand labeled with a different out-group. All it took was a single word emphasizing difference to change how people felt about others experiencing pain.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. Of all the companies mentioned, we currently have a vested interest in PayPal and Tesla. Holdings are subject to change at any time.
