Over the last few weeks we’ve had a particularly insightful series of meetings with business operators, investors, venture capitalists and strategists.
Here are some of the most interesting and relevant themes that have emerged from those discussions.
What’s going on?
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“Heard about the guy who fell off a skyscraper? On his way down past each floor, he kept saying to reassure himself: So far so good... so far so good... so far so good. How you fall doesn't matter. It's how you land.”
-Hubert Koundé, La Haine.
Source: Getty Images
When markets are falling, we all tend to focus on how much downside might be left and what kind of state we’ll be in when we get there. In order to get a better sense for that answer, it’s worth examining what the world might look like when we land.
My favorite recent investing podcast was an interview with Scottish strategist Russell Napier on Hidden Forces. With monetary policy having been the only game in town for years, Napier believes that central banks are now increasingly irrelevant. Generally speaking, developed-world politicians now have direct control of the money supply. This is not a power they will relinquish easily. Continued “emergency” interventions will be justified by the rolling crises we’re witnessing daily. This means state-directed investment in heavy industry, infrastructure, defense, and labor-intensive sectors. In contrast, financial engineering and profit-maximizing strategies like buybacks and outsourcing will become increasingly politically demonized. Napier believes investors haven’t seen this kind of environment for at least thirty years.
With the supply chain crisis so radically exacerbated by the Ukraine war, deglobalization has become the consensus theme. Like a great many others, Napier observes that it’s been gradually underway for over a decade, but will now significantly accelerate. It may not be possible to unscramble the globalization omelet entirely, but European countries have been talking increasingly aggressively about independence and fragmentation. However, in Tom Pence's superb recent interview with Harvard economist Megan Greene, she noted that she’s not yet seeing it in the data. Moreover, how much fiscal stimulus is “one-time” is a huge debate. Greene has noted that America is currently experiencing the second largest fiscal drag in history, as we move further away from last year’s gargantuan stimulus.
The primary argument for fiscal stimulus being more enduring is that it’s much more politically acceptable than it used to be. The overwhelming theme of The KCP Group’s annual Blackberry conference last month was the fracture of traditional institutions. One of the best things I’ve read in the last few years was an exceptional interview with former CIA analyst Martin Gurri. Watching the unfolding information tsunami, Gurri anticipated the current social unrest because average citizens now had unprecedented transparency into the political world. This suggests that politicians will now have to be much more visibly responsive to their electorates.
“The story-tellers- public officials, the media, scientists: the elites- live in an entirely different information universe from the rest of us. They behave as if we were still in the 20th century, and information is still their monopoly, which they dispense as they see fit and which we will accept on authority… The public, which swims comfortably in the digital sea, knows far more than elites trapped in obsolete structures. The public knows when the elites fail to deliver their promised “solutions.””
Clocktower Chief Strategist Marko Papic gave a powerhouse presentation at Blackberry last month. He outlined his “constraints theory” of geopolitics. In short, politicians may talk about all manner of things, but when it comes to action, they care most about the preferences of their median voters. Like Napier, Marko’s view is that we’ve ushered in a new era; where voters care far less about balanced budgets and far more about inequality and fiscal stimulus.
What does more fiscal stimulus mean for the markets in the long term? Stepping back even more broadly, I was stunned by Vaclav Smil’s recent book, How the World Really Works (insights here). Essentially, he argues we’ve consistently failed to grasp the scale and energy intensity of the modern physical world. The urgent question that it raised for me is how we can get emerging market growth, developed world fiscal stimulus, and decarbonization all at the same time.
“Replicating the post-1990 Chinese experience in those [low income] countries would amount to a 15-fold increase of steel output, a more than 10-fold boost for cement production, a more than doubling of ammonia synthesis, and a more than 30-fold increase of plastic syntheses.”
With many commodities already in short supply and with prices at record highs, it’s nearly impossible to see how this doesn’t make the inflation crisis considerably worse. The single consistent theme I’m seeing everywhere, and something The KCP Group is positioned for, is that energy capex has to recover from unsustainably low levels.
But despite the overdue re-focusing on the physical world, it’s something of a false dichotomy to argue that anything digital is insubstantial.
The dominant trend of the last couple of years in markets has been decentralization. At the peak of the bubble this was exemplified by the rallying cry of “WAGMI” (We’re all going to make it). The monopolies and wage deflation of Web 2.0 was going to give way to the memes of production being returned to individual workers via the Web3 revolution. But the receding tide has exposed the predictable ponzis and paper-thin business models. A market overwhelmingly based on digital intangibles has simply never encountered this kind of inflationary environment. But, as the speculation layer has evaporated, many of the crypto experts we speak to have retained faith in the technology layer. At Blackberry, blockchain investor Emil Woods of Liberty City maintained his belief that over half the world’s $600 trillion worth of assets could be tokenized by 2035. The foundation in digital assets is more likely to be found in the tech layer than in the speculation layer masquerading as a safe asset. The same should be true of public equity investments.
Last week I attended the magical Capital Camp in Missouri. It’s an eclectic mix of universally curious operators and investors. The plural of anecdote is not data, but there was a consistent theme across most conversations I had with public markets investors. Essentially it’s that there’s much more quality and differentiation hidden within the meaninglessly broad definition of “tech companies.” The SAAS model is considerably more robust and cash generative than it has been in any previous cycle. As we wrote recently, The KCP Group’s Tom Pence has been defensively positioned but thinks we’re approaching a valuation floor.
I recently learned the term “first lien” software from an interview with tech CIO Gavin Baker. These are services that are so mission-critical you pay their bills before the first lien on your debt. A conversation with tech investor Ram Parameswaran of Octahedron Capital broadly suggested much more nuance to assessing the potential trajectory of the Silicon Valley fallout. He would watch missed numbers at outsourcing companies, slowdown in payroll processors, and then a reduction in office space for indications of headcount cuts. This would likely be followed by non-mission-critical software, where consolidation into single platforms would be likely, then consumption-based software; because companies cut non-critical workloads, and finally, per-seat software.
Another fabulous conversation at Capital Camp led to a recommendation of an absolutely brutal assessment of America’s cultural and financial trajectory in the eyes of the Chinese leadership. Essentially they are looking on in horror as Western liberalism exacerbates the kind of societal fractures in their own society that Gurri anticipated so well. I was amazed to see it was written by N.S. Lyons, an anonymous writer whose work I’ve found unusually insightful. The bottom line echoes the best China commentator I’ve found, Gavekal’s Dan Wang. Essentially, the Chinese are pivoting hard away from Silicon Valley and Wall Street's business models toward real world industries like semiconductors and steel. This also fits with Marko Papic’s assessment that the key constraint for Chinese leaders is keeping their emerging middle-class happy by addressing obvious inequalities.
Conclusion: The Reality War.
More generally, Lyons has framed our current era as a “Reality War” between “physicals” and “virtuals.” Monetary policy overwhelmingly boosted the fortunes of the virtuals, the recent increasing reliance by the U.S. on fiscal policies may yet redress that balance. Virtual-world politicians will be forced to pay more attention to physical-world voters. Whether it’s hydraulic fracturing or cybersecurity, knowing where an investment sits on this spectrum is going to become critically important.
However this plays out, and wherever we land, we’re here to talk to on any topic at any time. All these thoughts merely represent a snapshot of views from some of the most insightful people we have discovered. I love questions or comments.