Happy Saturday morning! If you missed Thursday’s expert call on sustainable investing with the remarkable Megan Starr, Head of Global Impact at Carlyle, let me know. I also wrote our first white paper on the topic, which is available at the following link (click the picture).
“Stoats Kill Moats”
[5 minute read]
"Well, in our country," said Alice, still panting a little, "you'd generally get to somewhere else—if you run very fast for a long time, as we've been doing."
"A slow sort of country!" said the Queen. "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"
- Alice Through the Looking Glass, by Lewis Carroll.
A stoat. Adorable but deadly. Source: Getty Images.
In 2013, my wife and I spent 3 days hiking through the majestic landscapes of New Zealand. It’s probably my favourite trip ever. Throughout the entire time, we didn’t hear a single note of birdsong. I asked our baritone guide, Bard, why. He said the Europeans had introduced rabbits. With no natural predators, the rabbit population exploded. So the Europeans introduced stoats to kill the rabbits. With no natural predators, the stoats killed all the birds. Sigh.
New Zealand, 2013. Stoats not pictured. Birds not available.
Unlike Australia, where it seems like nature is relentlessly trying to kill you at all times, New Zealand’s mild climate and relative isolation led to a very benign evolutionary environment. Then, all of a sudden, it was connected to the rest of the world.
This is what has just happened in the global economy. Digital networks allow for completely unfettered and almost instantaneous movement of capital. That means that companies and people are suddenly competing globally. An important realization is that when something is connected to a network, it often moves from a normal distribution to a power-law distribution. In simple terms, this means that 80% of outcomes are due to 20% of causes. Instead of thousands of species of birds, you end up with stoats. This is what it looks like graphically (in the case of European companies pre-and-post globalization):
Source: Assessing Competitiveness: How Firm-Level Data Can Help, Carlo Altomonte, Giorgio Barba Navaretti, Filippo di Mauro, and Gianmarco Ottaviano
One of the most famous examples of this is what happened to global incomes between 1980 and 2016. This is known as “The Elephant Curve” or “The Most Important Chart in the World.”
Source: Alvaredo, Chancel, Piketty, Saez, Zucman, 2018 World Inequality Report, World Inequality Lab
As capital dispersed all over the world, the U.S. and Western Europe stagnated, Emerging Markets rose into the middle class, and the top 1% exploded. As I wrote a few weeks ago, it’s my view that the reaction against this kind of concentration of wealth is behind much of the “decentralization bubble.” This is being further facilitated and exacerbated by the likes of blockchain and greater digital market access.
There are all sorts of other weird power-law results of broader global networks. For example, Patel and Kortina found that digital dating now has higher inequality than 95% of the world’s national economies. Based purely on “likes,” the bottom 80% of men are competing for the bottom 22% of women, and the top 78% of women are competing for the top 20% of men. Their conclusion, supported by the work of Erik Hurst, was that many males have responded to such poor perceived odds by retreating into digital entertainment options that have become exponentially more engaging.
Many companies are faring little better. A McKinsey study found that the average lifespan of companies listed on the S&P 500 was 61 years in 1958, now it’s less than 18 years. They believe that 75% of the companies currently listed on the index will be gone by 2027.
An absolutely superb study from J.P. Morgan (JPM) found that, using a universe of Russell 3000 companies since 1980, roughly 40% of all stocks suffered a 70%+ decline from their peak value and never recovered. Moreover, the return on the median stock since its inception vs. an investment in the Russell 3000 Index was -54%. Two-thirds of all stocks underperformed vs. the Russell 3000 Index, and for 40% of all stocks, their absolute returns were negative.
In further support of the power-law theory, just 7% of JPM’s universe generated lifetime returns more than 2 standard deviations over the mean.
While this obviously screams “technological disruption”; tech as a sector also produced the third fewest extreme winners. Picking winners within tech is even harder than average. Bain found that, of the 15 largest companies in tech in 1999, only 4 were on the list 20 years later. Consumer discretionary, tech, and financials were responsible for most of the removals from JPM’s sample universe.
Recall from a few weeks ago that market returns can also cluster in the tails. Fidelity found that, between 1980 and 2020, the cost of missing only the best 50 days in the market was a staggering 93% of performance.
The conclusion is fairly obvious: if you are not 100% confident you can identify the ever-smaller number of winners (or even the right timing): start diversified. It has literally never been more important. As JPM concludes, “perhaps the most important epiphany we gained from the study: that exogenous forces may overwhelm the things we can control.”
Other Interesting Reading This Week:
- Read. What is your favorite deep, elegant, or beautiful explanation? By Stewart Brand in Edge (4 minute read).
- Why Read. Super brief and highly relevant to today’s topic; evolution and the local environment. This is Stewart Brand’s answer to the cool Edge series of asking one question a year to interesting people. This is maybe the shortest article I’ve thought the most about.
- “Fitness landscapes express so much so economically. There's no better way, for example, to show the different modes of evolution of a remote oceanic island and a continental jungle. The jungle is dense and "rugged" with steep peaks and valleys, isolating countless species on their tiny peaks of high specialization. The island, with its few species, is like a rolling landscape of gentle hills with species casually wandering over them, evolving into a whole array of Darwin's finches, say. The island creatures and plants "lazily" become defenseless against invaders from the mainland.”
- “You realize that for each species, its landscape consists almost entirely of other species, all of them busy evolving right back. That's co-evolution. We are all each other's fitness landscapes.”
- Read: Labor Supply and the Attention Tax by Patel and Kortina. (27 minute read)
- Why Read. Referenced above. It’s an interesting argument that labour force participation for young men has dropped so significantly because the quality of digital entertainment has risen so dramatically. Meanwhile, the marginal benefits of making money to signal wealth has decreased as the dating market has digitized and seems more competitive. It’s going to be absolutely fascinating to see how the pandemic and stimulus alter this dynamic.
- “Media companies are aggregating human attention and selling it at a discount- far below minimum wage- to advertisers in a massive arbitrage on human capital”
Have a great weekend!
Director of Communications and Content
The Knall/Cohen/Pence Group
Work (317) 571-4525
Cell (917) 656-2742
Diversification does not ensure a profit or protect against loss.
Past performance is not indicative of future results.
Indices are unmanaged and are not available for direct investment.
The Standard & Poor’s 500 Index is a capitalization-weighted index that is generally considered representative of the U.S. large capitalization market.
The Russell 3000 Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization, which represents approximately 98% of the investable U.S. equity market. The average market capitalization is approximately $4 billion, and the median market capitalization is approximately $700 million.