Stuff I thought about last week 2-17-19
Greetings - topics this week include making decisions in the multiverse, why the entropy causes the Universe to favor the development of life, Amazon’s transportation ambitions, and more...
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Decision making in the multiverse - this a bit of a digression, regular “Stuff” follows after the dashed line below if you want to skip this! Have you ever been so sure of an outcome only to find out later you couldn’t have been more wrong!? Have you invested time and energy weighting probabilities and convincing yourself you had some ability to see the outcome for an important life decision? However, inevitably, if you are honest with yourself, you likely end up more wrong than right. That’s life in a complex adaptive system - a universe ruled by chaos and fitness functions where small perturbations can cause hugely different outcomes in the future. Perhaps the best remedy is a large dose of humility and an attempt to live without making decisions based on specific predictions of the future. This approach is at the heart of our framework for investing, as detailed in our paper Complexity Investing. Recently, I’ve been leaning on my degree in astrophysics to create the “multiverse decision making exercise” whereby I think about points of commonality and divergence between our universe and other, parallel universes (e.g., for a given decision, was I right in this universe because I was lucky, or because of an underlying commonality likely shared by many parallel universes?) For example: we had a long-term and large investment in a great semiconductor intellectual property licensing company called ARM Semiconductor in the fund I used to co-manage (these data are publically available). As you’d expect of any world-class investment firm, we knew that business inside-out, and had a very specific view of how the world would play out in their favor. Softbank acquired ARM (prior to the Softbank Vision Fund, but subsequently, the Vision Fund absorbed part of Softbank’s position in ARM as Masa’s grand vision of the IoT), and we no longer had the option of owning it in the mutual fund. But, in a parallel universe in Everett’s many worlds interpretation of quantum mechanics, there is a universe where ARM wasn’t sold to Softbank and I am faced with their current reality as a shareholder. Let’s take a look at that current reality: subsequent to the Softbank acquisition, the smartphone market, which drove a large portion of ARM’s revenues, has softened dramatically. Further, there have been unseen changes in competition from open-sourced processors that could significantly undermine a large portion of ARM’s business model. ARM was a classic fit into our investing framework - a network effect platform that provided significantly more value to their customers than they took in profits for themselves. They are a company built on innovation, long term thinking, and partnering with their customers. I loved ARM as an investment, and it served the portfolio well for many years; however, I was wrong about their future earnings potential, despite being sure I was right. Let me also be clear I might now be wrong that ARM is in trouble - it’s a great organization with great people, and they are investing heavily against these challenges. Here is another example - as I was working on “decision making in the multiverse,” Brinton offered up Tyler Technologies, which provides software for state and local agencies like court systems. In how many versions of the universe similar to ours is there a complicated legal system - I’d guess a whole lot of them - so, by betting on a company that helps resolve a complicated legal system through software, you are making the (seemingly sensible) assumption that a complicated legal system is a reasonably stable and enduring characteristic. I am reminded of Bezos frequent saying that he has believed in three things since day one: customers will want more selection, lower prices, and more convenience. These fundamental truths are likely to be found in any one of the universes in the multiverse.
Last week, I mentioned the idea of a pre-mortem analysis on stock decisions - on any given trade (adjusting for time frames) there is a 100% chance that either the buyer or sell is wrong - is it you or the other side of the trade? Are you sure? So, this brings us back to a bedrock of our investing philosophy - the fewer predictions you have to make about the future growth of a company, the bigger the position you should make that stock in a portfolio. If your view of a company relies on fundamental truths being true across the multiverse, you probably have a relatively safer investment. However, if your view of the future growth of a company resembles more of a parlay bet requiring one specific thing to be true followed by another followed by another, etc. you might want to own that stock as a small position in a portfolio. In other words, whereas most investors base position size on conviction around their view of a specific future playing out, we would suggest inversely linking position size (or bet) to the number of predictions you have to make (e.g., the fewer the predictions, the better odds your investment will do well across the multiverse). Further, this concept maps directly over to any decision you might be making, whether in running a company, life, or investing: the fewer specific predictions you have to make, the more likely an outcome is going to exist across multiple future paths (and the more specific things that need to happen for your decision to be successful, the less likely you will find that to be a high-probability outcome). Overweight the low prediction decisions, but don’t stop making those high prediction decisions - instead, just don’t bet the farm on those specific parlay bets that might create a lot of Optionality in the future. Successful investing is all about assigning high weights to Resilient outcome and low weights to Optionality outcomes.
Stuff about Innovation and Technology
India continues to take China-like control of its Internet after handcuffing Amazon and Walmart, as they are increasingly scrutinizing messaging platforms such as Facebook’s Whatsapp. India would like access to all messages, including encrypted ones. Many Internet users are increasingly opting for encrypted tools, and Facebook has indicated plans to unify and encrypt all of their messaging platforms as well. It’s going to create a huge standoff between every government, both West and East, against the US-based tech giants.
Frozen 2 is landing in Q4 of this year - a little help for Disney as they go through an investment year in their shift to streaming and direct consumer relationships - 22M views of the trailer in the first couple of days!
Kevin Kelly writes on the mirrorworld - the melding of the analog and digital spaces. If you’ve spent much time in augmented reality glasses like Magic Leap, you’ll know that the distinction between real and virtual quickly dissolves - the brain doesn’t really care if something has solid matter or if it’s just simulated with photons and sound waves. Kevin writes:
“From the earliest stirrings of the internet, the digital world was seen as a disembodied cyberspace—an intangible realm separated from the physical world, and so unlike material existence that this electronic space could claim its own rules. In many respects, the virtual and the physical worlds have indeed run in parallel, never meeting. In the virtual there was a sense of infinite liberty, unleashed by disconnecting from physical form: free of friction, gravity, momentum, and all the Newtonian constraints holding us back. Who wouldn’t want to escape into cyberspace to become the best (or worst) version of themself?
The mirrorworld bends that trajectory upon itself. Rather than continue two separate realms, this new platform melds the two so that digital bits are embedded into materials made of atoms. You interact in the virtual by interacting in the physical, moving your muscles, stubbing your toes. Information about that famous water fountain in a Roman plaza can be found at that fountain in Rome. To troubleshoot a 180-foot wind turbine, we troubleshoot its digital ghost. Pick up a towel in your bathroom and it becomes a magical cape. We will come to depend on the fact that every object contains its corresponding bits, almost as if every atom has its ghost, and every ghost its shell.”
Amazon invests in Rivian’s big fundraising - the electric truck platform maker could be a simple technology investment by Amazon, or it might play deeply into Amazon’s future logistics and delivery plans. Or, more broadly, as Amazon builds a consumer demand generation funnel for all sorts of goods and services, logistics is at the heart of it. A few companies are building multi-sided logistics networks for moving people and/or objects, including Lyft, Uber, and Google. Amazon is likely to want to be an important challenger in that huge sector of moving an object from point A to point B - whether that object be their package, someone else’s package, a meal, a person....
The cost of operating in global warming? PG&E says an order from a Federal judge as they go through bankruptcy to eliminate risk of fire from its electrical equipment could cost up to $150 billion!? Maybe there is reason to be an inflation hawk after all.
On the topic of semiconductors, AI and gaming behemoth NVIDIA reported their previously pre-announced weak quarter this week, but also called for a bottom in demand and inventory correction similar to what others reported in the semi industry recently. NVIDIA is a unique combination of chip technology and a software platform with CUDA. With respect to the huge demand for AI and the temporary inventory drawdown the CEO said this, which I believe was the semiconductor quote of the week: "The computing needs of Earth is not certainly being satisfied with what we shipped last quarter."
The Netherlands has a wonderfully high rate of bicycle use, which is also presenting increased complications for autonomous vehicle technology - maybe the goal should be more bikes and fewer autonomous vehicles in areas where cycling makes more sense! “More than a quarter of all trips made by Dutch residents are by bike. Of all trips of a distance of up to five miles, a third are made by bicycle, with the rate only dropping to 15% for trips up to 10 miles in length.”
After Alibaba failed to pass US regulatory approval to acquire Moneygram, they are focusing on acquiring UK-based WorldFirst to expand their global payments footprint. Increasing acceptance of Alipay in the US and Europe is similar to the global dominance built by Mastercard and Visa as US travelers went abroad. However, this time around, fears of data sovereignty and national security may increase hurdles for the Chinese payments giants.
A comment on the ChannelAdvisor earnings call this week caught my attention with respect to slowing ecommerce growth, perhaps because large ecommerce platform market share is becoming somewhat saturated in the US. Some of this has been company specific to ChannelAdvisor, but it’s hard to ignore that much of Amazon’s revenue and profit growth is now from advertising, AWS, and other services (online retail grew low-to-mid teens % y/y for Amazon throughout 2018, down from high teens to low 20%’s growth in 2017, and this growth rate might be even slower in the US). Might this slowdown be a small positive for brick and mortar retailers, if indeed we are seeing some stability between the online and offline shopping transition? From the earnings call: “The other headwind we saw in the fourth quarter specifically was a deceleration of Marketplace GMV on both eBay and Amazon in North America, especially in December, which are our #2 and #1 GMV channels, respectively, and which is consistent with reported results from both of these companies, and affected our variable revenue growth rate. Taking into account eBay's growth outlook and the reality that Amazon already represents roughly half of the U.S. e-commerce, we assume that GMV growth rates on both channels in the U.S. is likely to be lower going forward and are incorporating that into our outlook as well.”
The “developer” loophole for distributing unregulated apps on iOS and Android is a major flaw that is still being exposed and needs to be fixed - this is the issue that lead to Apple punishing Google and Apple recently.
Training AI models on the corpus of 600,000 Enron emails - if we are teaching algorithms morality from Enron emails, I think I know where we might have gone wrong...
The universe favors life because complex systems like living entities are the most efficient at creating entropy - the spreading out of energy in the universe. Long time readers of SITALWeek might remember my enthusiasm for the work of Jeremy England as well as several connected concepts that the Santa Fe Institute has been working on. This article is an excellent overview of the state of the research, which points to the highly likely conclusion that life is inevitable anytime you have a concentration of energy, like a sun, and a place for that energy to concentrate, like a planet. Further, we can imagine how this fundamental law might map over to humans and the complex systems we create like companies, governments, and societies: “The series of phase transitions that led to life consisted of multiple jumps to more complex (and therefore stable) arrangements, in particular those system configurations that were better at relieving free energy build up through greater dissipation. Like England, Smith and Morowitz—who sadly passed away just before the publication of his opus—describe a natural selection process whereby those phases that best stabilize the system are the ones that endure.” These phase transitions to more stable arrangements effectively form what we call Resilience in our Complexity Investing framework. I absolutely love this following line from the article - if it’s true and you can truly understand it, then it is just about everything that matters: “The second law of thermodynamics does not just generate disorder; it is also a motor for complexity, because complex adaptive systems efficiently dissipate free energy, thereby increasing the universe’s entropy.”
The Most Radical and Rebellious Choice You Can Make Is to Be Optimistic - this is a great point by the director Guillermo Del Toro, and reminds me that cynics always sound smart, but in a world that is ever improving, they are almost never right, and certainly they represent the opposite of artful progress.
Over 20M people have done online genetic tests in the US: “The unilateral change in policy—which users weren’t alerted to—is troubling because it means that our DNA, just like our posts on social media or our location data, is at the mercy of user agreements none of us have any control over or even bother to read. And that may be the biggest lesson of taking a DNA test.”
I imagine everyone, especially my Colorado readers, know this story already, but it’s so incredible I have to include it here - the man who successfully fought off a mountain lion attack while running - he thinks by forgoing his headphones that day he got a critical time advantage as the animal prepared to attack - a little reminder to pay attention to the real world!
Stuff about Geopolitics, Economics, and the Finance Industry
Taiwan control continues to be the key issue in a potential future West vs East conflict - last week an Air New Zealand flight to Shanghai had to turn around over a misplaced reference to Taiwan in some paperwork.
Recent headlines over Chinese reach into students at Western universities as well as a related data breach exposing China’s tracking of Muslims and the estimated million they have put in re-education and internment camps are even more disturbing in the broader context of the use of AI and monitoring to control behavior. And, if you really want to lose some sleep, combine the AI facial recognition and GPS tracking with swarms of killer drones and you get a modern genocide pretty quickly.
Bloomberg estimates the top 10 hedge fund managers made $7.7B in 2018.
So far US entrepreneurs continue to take money from Saudi Arabia (Vision Fund) and China (largely Tencent and Alibaba), but not without controversy. The recent fundraising by Reddit, a site long banned in China, included money from Tencent. Why would Tencent antagonize Chinese leaders by investing in a site that promotes the truth that China wants to keep suppressed? This example of users protesting a company’s investors joins the recent examples of employees protesting their employers actions at the big tech platforms. Even in a company like Reddit which built on freedom and transparency, it seems like leaders are still deaf to their responsibilities in an age of increased transparency - something we covered in our recent NZS paper here.
Nothing in this newsletter should be construed as investment advice. I may own long or short positions in stocks discussed in this newsletter. This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. I may change my opinions without updating them in the newsletter. Lastly, often I try to make jokes, and they aren’t very funny - sorry.
I was the portfolio manager of the Janus Henderson Global Technology products (ticker: JAGTX) from May 2011 to November 2018. Prior to that I held various roles as an analyst and portfolio manager at Janus Henderson Investors for most of the period starting as a summer intern in 1998 up until the end of 2018. I graduated from Williams College in 2000 with BAs in Economics and Astrophysics. A complete resume can be found at www.linkedin.com/in/bradsling
Investment framework co-authored with Brinton Johns “Complexity Investing” can be found here: http://www.evolusophy.com/complexityinvesting/
If you have any articles of interest, comments or questions please send them by responding to this email. I will generally try to read and respond to your comments or questions, but may not always be able to in a timely manner, for which I apologize in advance.