Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, adaptability, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

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In today’s post:  the coronavirus will be part dotcom crash, part 9/11, part financial crisis, part pandemic, and the first global emergency in the social-network-dominated Information Age – my thoughts on which industries might be impacted and the importance of staying focused on long-term adaptability; also this week: virus-fighting robots; the KISS method for avoiding facial recognition; new team members at NZS Capital; and, more below...

Stuff about Innovation and Technology
NZS Welcomes Jon Bathgate, Joe Furmanski, Jim Goff, and Minesh Patel
NZS Capital is excited to announce several new team members this week. Jon Bathgate and Joe Furmanksi join Brinton and myself on our investment team. We worked with both of these world-class investors at Janus Henderson in Denver for over a decade. We also welcome Jim Goff, former Director of Research at Janus Henderson, as a Senior Advisor to NZS Capital. We are thrilled to have guidance from someone of Jim’s experience and character as we build our enduring investment culture over the coming decades. We also officially welcome Minesh Patel, Chief Corporate Strategy Officer at Jupiter Asset Management, to the board of NZS Capital. 

Viral Pandemic in a Complex Adaptive System 🦠
Before I go into thoughts about coronavirus, I want to first and foremost recognize the humanitarian crisis and thank every frontline worker around the world for their ongoing efforts to help everyone who has been/will be affected by the viral spread and shutdowns. 🙏

Julius Caesar was assassinated in Rome on this day, March 15th, in 44 B.C. Known as the Ides of March, March 15th has become a sign of ominous events since Shakespeare immortalized the expression in ‘The Tragedy of Julius Caesar’ Act I, Sc. 2:
Soothsayer: Beware the ides of March.
Caesar: He is a dreamer; let us leave him: pass.
However, with the global, coordinated effort to slow the coronavirus pandemic, we can both take the threat very seriously and be optimistic about the future. It will always pay to be skeptical short term, but optimistic long term. Cynicism (i.e., assuming the worst), might pay off in the ultra-short term, but it never pays over time. For long-term investors, volatility is opportunity, not risk.

The coronavirus is becoming a significant disequilibrium shock to the economy. In a complex adaptive system like our global economy, these shocks have potential to create punctuated equilibria, widening both the near- and long-term range of outcomes. This is the 3rd significant economic shock in my 22 years of professional investing, and there are clear parallels today to both the dotcom crash (including the compounding impact of 9/11, which happened shortly after) and the 2008-2009 global financial crisis. The coronavirus will be part dotcom crash, part 9/11, part financial crisis and part pandemic. When you combine the elements and layer in the added complexity of society living through its first, very real and serious shock in the Information Age and the post-truth era, it’s best to think long term and focus on adaptability.

The terrorist attacks of September 11, 2001 redoubled the dotcom crash’s economic impact, putting many startup industries out of business. Ultimately, a lot of great ideas disappeared, only to become bigger, more interesting, and more transformative years later with the advent of smartphones, apps, and mobile Internet. Seven years later, the great financial crisis exposed the extreme use of leverage and systemic risk across the banking system. We have infinitely more liquidity in the system today than in 2009, and that money is looking for a home, so the problems won’t be quite as halting. Both recessions exposed excesses, bad behavior, and questionable business models. And, they both ultimately accelerated the digital transition of the global economy. I suspect the coronavirus’ impact will be similar: it will expose marginal businesses, punish risky leverage, and cause a wave of creative destruction and behavioral shifts, giving a huge boost to innovation and the Information Age economic revolution. 

But, I need to make one crucial point: this is a complex event in a complex adaptive system. Everyone, including me, is completely guessing about what could happen. Perhaps, if fiscal and monetary stimulus bridge us through the negative consequences, nothing happens. Shocks to the system significantly broaden the range of possible outcomes. Predictions are useless, especially if they contain narrow guesses about the future, even if those guesses seem informed. I am optimistic, now more so than ever, about the future. But, it’s still worth thinking about the expanded range of outcomes, so below are some thought exercises about changes that could happen or accelerate for various sectors of the economy.

Sharing, Gig Economy, and Direct to Consumer: Dotcom Bust 2.0?
One obvious fallout from coronavirus could be an accelerated bankruptcy trend for physical retailers that were already on the edge of survival, and an increased adoption of ecommerce and local retail (e.g., Walmart) delivery. With Apple now closing all stores globally (except China where, optimistically, all stores are now back open) for two weeks, there is a huge loss in foot traffic for many mall-based stores that people walk by on their way to get AirPods. 

In the dotcom crash, we saw a lot of great ideas go away because they were too young to have gained sufficient traction, and the recession put the final nail in their coffin. But, we later saw a lot of those ideas reimagined and reborn with the advent of smartphones and mobile Internet. Today, we have a lot of sharing economy (AirBnB, Lyft, etc.), gig economy (DoorDash, UberEats, etc.), and new direct-to-consumer brands (Casper, etc.) that have reached customer scale, and in some cases meaningful network effects; but, largely, they are yet-to-be-established business models. 

If travel and social interaction are slow to return after coronavirus, or if there is significant viral flareup this coming winter, we will likely see a much bigger shift in behavior and a lot more creative destruction in the economy. This scenario will likely favor the bigger, profitable, and (in many cases) vertically-integrated platforms, such as Amazon. In the food business, if a lot of restaurants don’t survive the next year, then we will see an accelerated reimagining of the restaurant, delivery, and food supply chains. This too will likely favor larger, vertically-integrated platforms with ghost kitchens, subscriptions, delivery routes, etc. (so far those winners aren’t emerging, but Amazon and Walmart could be well positioned). I suspect many of the gig-economy workers might ultimately transition to full-time employees (with benefits and sick leave!) of these larger, surviving platforms in retail and food.

We may also see power law trends pushing consumer behavior to two ends of the spectrum, away from the current marketplace middle. Take AirBnB for example. The sharing economy travel site was seeing slower growth, and a lack of profits before the coronavirus hit. If there is an extended negative impact to home/room renting as a result of coronavirus, consumers may lean toward hotels and professional vacation home rentals on the one end (which can all easily be found on Expedia and Booking sites), and if necessary, couch surfing on the other end, and the latter probably wouldn't support AirBnB’s $30B valuation. That would leave AirBnB stuck in the middle without profits or easy access to public capital markets. This idea of a shift to “professional” sharing economy workers from “gig” workers could happen in ridesharing as well. The current iteration of Lyft and Uber may fizzle, only to see a reimagining years down the road. To be clear, I am NOT predicting any of this, I am just laying out a framework for thinking about what may or may not happen – the point being that there is no reason we should expect automatic mean reversion on the sharing- or gig-economy businesses.

Media Industry Impact
Effects in the media world are also being felt. Obviously all sporting events, live and broadcast, are on pause; meanwhile, the Phoenix Suns will play out the rest of their season in Take Two’s NBA 2K video game, in what could be emblematic of an accelerated growth in esports and video game spectating. I fully expect live sports to come roaring back in popularity when the leagues are up and running again. Coronavirus has also stopped production on most TV and movie sets globally. While it’s about the least important problem facing the world right now, for the coterie of new, streaming apps that just launched (or will launch soon), it will leave a large air pocket of new, original content in their competitive lineups. 

This content shortage will likely favor the streaming apps of incumbent studios with deep libraries to draw from at launch; but, they will all need to get fresh content ASAP to fend off churn. Disney announced that Frozen 2 will come to Disney+ today, three months early, to help parents “during these challenging times”. The interesting event here is that this collapses the DVD window (the time between renting a new movie and when it hits cable or streaming), and could signal a significant change going forward. Will the theatrical, rental, DVD, and pay-TV windows all disappear as a result of coronavirus?

Cloud Shift Accelerates Despite Speedbumps
The big, coronavirus-induced increase in video conferencing, work-from-home, distance learning, video streaming, and online gaming could put a heavy strain on cloud computing. Telecom Italia reported a 70% increase in traffic – driven in no small part by kids playing Fortnite. The market for cloud servers to run all these workloads was 1M units in Q419, according to this Next Platform article on the state of the server market. Looking through the impacts of the 2018 cloud overbuild and the 2019 trade wars, it’s reasonable to assume 20%+ cloud server revenue growth. That supports 40-50% server unit growth (with price declines being the difference), which in turn (given price/performance increases) implies around 80-100% traffic growth. 

If all of this virus-driven demand causes an increase in overall traffic of 50-100% in short order, we could see significant strain at peak times. To be sure, there are mitigating factors – clouds typically operate at a fraction of peak demand, there is some balancing that can be done across time zones, and some workloads are time dependent (e.g., enterprise apps during the day and Netflix at night). I’d speculate (somewhere between an educated guess and just pulling numbers out of nowhere), that Amazon might typically install ~2000+ servers a day (or a ~million a year) to meet annual traffic growth. A traffic surge of 100% within a few weeks would roughly 10x that server install number. While China is already back online (iPhone- and computer-maker Foxconn’s founder Terry Guo said things are back much stronger than expected already), not all components can be rushed to production and tested quickly enough. Intel has been a bit behind AMD lately; but, everyone making chips for data centers, including NVIDIA and the foundry TSMC, should be in hot demand now and into the future.

If this perfect cloud storm happens, AWS, Azure, and Google might need to begin limiting or favoring some apps, such as banking software over Fortnite. While this underscores a limitation of the cloud to some degree, it also clearly reinforces the value of the cloud over time, and could create the potential for premium availability pricing tiers and capacity redundancy commitments. We are going to need vastly more compute power in the future; (I have a far-out theory that autonomous vehicles, with their extensive and under-utilized compute capacity, will become connected data centers on wheels). Then, we have the network bottleneck, which highlights the value of fixed-broadband providers, which carry the vast bulk of Internet traffic vs. wireless. This week, AT&T removed overage caps to help people work from home. If usage stays high, the idea that 5G could replace a wired network any time soon seems less likely. And, as more people work from home successfully (I started in 2008), they will finally realize they only need about three productive hours a day to do most jobs that currently clock in at 40-50 hours/week in the office! 😂

The growth and demands of the cloud might also be great timing for ARM to finally take off in the data center. At a partner conference in August 2015, ARM targeted to get to 25% server share in 2020; but, instead, that number today rounds out to zero. But, times are changing – Anandtech’s test of the new Amazon Graviton2 ARM server chip shows a huge leg up in cost/performance vs. Intel and AMD: “In terms of value, the Graviton2 seemingly ends up with top grades and puts the competition to shame...If you’re an EC2 customer today, and unless you’re tied to x86 for whatever reason, you’d be stupid not to switch over to Graviton2 instances once they become available, as the cost savings will be significant.” The chip was designed in house by Amazon’s fast-growing chip division, Annapurna. In addition to Amazon’s Graviton2, there’s a new ARM-based chip from Ampere Computing, a company that has several Intel veterans and backing from Oracle and ARM-owner Softbank.

What other areas of IT are highlighted by the shift to the cloud and remote work as a result of the coronavirus? Identity protection and zero-trust, or perimeter-less, security come to mind – companies like Okta, SailPoint, CyberArk, etc., and of course any software that is enabling remote collaboration and customer service – Zendesk, Atlassian, DocuSign, and a host of others. Of course, Zoom video conferencing stands to benefit; here is an interview with Zoom founder in Forbes on his decision to give free access to K-12 schools (and, I bet Logitech is making cameras as fast as they can!). The Washington Post reports on the burden of federal employees working from home. Many government systems (state and federal) are extremely old and require on-premises access; so, the pandemic could dramatically accelerate the shift of government IT spending for cloud conversion. Vendors like Tyler Technologies would continue to benefit from state and local agencies going to the cloud.

When you step back, it appears the coronavirus will be fuel added to the already-raging cloud transition for enterprises. This move could, in turn, create increased vulnerabilities for the legacy IT hardware and software companies, many of whom have taken on a lot of debt to pay dividends and buy back shares over the last decade. These businesses may ultimately be like the retailers and restaurants, churning away at a faster pace, fighting time as customer behavior shifts.

Coronavirus Closing Thoughts
Let’s identify some common threads woven through these various scenarios and thought exercises. The coronavirus has significantly widened the possible range of outcomes, which could include 1) causing a recession that smothers emerging consumer (Uber/Lyft, AirBnB, food delivery middlemen) and legacy businesses (IT, retailers) from multiple angles; 2) providing oxygen to fuel accelerated consumer and enterprise behavior shifts (cloud computing, vertical food supply chain); or 3) some combination of the two, or 4) no significant changes if government stimulus saves the day. Fiscal and monetary stimulus combined with human behavior are complicated and difficult-to-anticipate factors. The value propositions and economic models (both short term and long term) of all of these businesses – and the severity and duration of the lingering effects of coronavirus – will dictate the outcome. When analyzing businesses, I’d pay special attention to management quality, adaptability, and the degree of NZS (or win-win, which can provide critical insulation from competition and drive network effects, provided there’s sufficient path to profitability) that these companies are creating for all of their constituents – not just their customers, but their employees, contractors, suppliers (all sides of the network effect), and investors. 

It’s possible the coronavirus will create echoes of the dotcom crash – great ideas (like today’s ride sharing and ghost kitchens) that were simply too early, or hadn’t quite become economically viable, may disappear, only to be reimagined 10 years from now. It’s also possible that we will see echoes of the financial crisis – excess leverage and risky behavior accelerating the digital economic transition from the losers to the winners. Younger, adaptable companies that tend to already run in the cloud with an eye toward meeting customer needs are likely to shine compared to the older businesses still depending on disappearing 1900’s competitive “moats”. Mean reversion, pattern recognition, and traditionally-defined margin of safety, etc. are mythical concepts for us at NZS Capital. Instead, we try to make broad and safe predictions where possible, and this advice holds here. We discussed this concept in more detail in our paper Redefining Margin of Safety.

There is every reason to stay optimistic while also being vigilant and focused on stopping the virus as quickly as possible. The good news for the economy is that all this sequestering might feed right into my theory on the pending baby boom from the 30-something demographic sneaker wave! 😜 

Germicidal Robots
Danish company UVD Robotics makes hospital-bots that can enter an area and “shred the DNA and RNA of any microorganism” with UVC light. The $80-90k robots clean a room in 10-15 minutes. Related, here is an interview with the founder of Chinese industrial drone company MMC. MMC drones have been used in the coronavirus outbreak in China to broadcast messages, monitor hotspots, and even spray disinfectant. The company sees a need for all governments to have a diverse set of skilled drones for the variety of low frequency, but high importance, events that take place.

The ‘Gene Simmons Method’ of Fooling Facial Recognition
Makeup applied in geometric shapes easily fools facial recognition software.

Big Tech Back in Government’s Good Graces
As I listened to Trump, speaking from the Whitehouse Lawn on Friday, publicly thank Google for their efforts to contain the coronavirus by putting 1700 people to work building a viral testing website (turns out the website was only theoretical, according to Alphabet subsidiary Verily), I can’t help but reflect on how quickly the anti-tech-platform rhetoric has slipped from the political vernacular. With the lefter-leaning presidential candidates dropping out, a seeming lack of public support for anti-tech regulation, and the distraction of the coronavirus, it seems like the extreme threat of breaking up the big tech platforms (or imposing heavy taxes) may be dropping in probability. Remember Bernie Sanders’ “Stop BEZOS Act” of 2018? Times have changed, at least for everyone except Facebook, which seems to be missing from Trump’s four-company, “Trillion-Dollar MAGA Club” of Microsoft-Apple-Google-Amazon.

Google Enters the Streaming Hardware Market
Google is (finally) releasing an Android TV box (aka Chromecast with a remote control, according to 9to5Google). It’s not clear why anyone needs yet another inexpensive adapter to stream video apps on the TV, but it again highlights the fragility of the standalone Roku platform. Roku’s competitors for streaming video hardware are Amazon, which leverages video in their Prime ecosystem, Apple, which leverages video as part of the iPhone ecosystem, and now Google, which leverages video as part of their giant Android, YouTube, and advertising ecosystem.

Miscellaneous Stuff
Silver Lining: Environmental Reprieve
Decreased economic activity in China due to coronavirus dropped carbon emissions by 25% compared to the same period last year. With similar effects likely pending across the world, the Earth will get a small buffer against spiraling global warming this year. 

Virus Infects Humans and the Social Collective
Tweet From Lex Fridman: “Coronavirus does not only infect individual human organisms, it infects the organism of collective human intelligence which emerges and evolves over the billions of social network interactions per day. It spreads through coughing, sneezing, and communication of ideas on Twitter.”

Stuff about Geopolitics, Economics, and the Finance Industry
US Housing Market Aided by Rate Drop
Redfin reports that the 100bps drop y/y in the 30-year fixed mortgage to 3.2% in the US allows the average homebuyer to buy a 10% more expensive house. So, despite the record-low inventory of homes for sale, there is an increase in the affordability of those houses that are for sale from 68.6% to 70.5% in just the last week. Redfin also reported that the housing market overall was hanging in there, but that the drop in the market could cause buyers to lose part of their down payments – it’s a fluid situation short term that is likely to change this week.

Vanguard’s Investors Smarter than the Average Bear
According to an interview on CNBC Friday, only 1.5% of Vanguard’s clients traded on Monday’s selloff, and 77% of their households shifted into equities, not bonds. Vanguard’s head of portfolio construction in the Vanguard Investment Strategy Group, Fran Kinniry, sees both their clients as well as other retail investors becoming countercyclical reblancers, buying stocks when they are down. If true, that would fix an enormous problem that has plagued investing for years – selling at the bottom and buying at the top.

Asset Management in a Pandemic
How will the coronavirus-induced market correction impact the asset management industry? The bear market likely keeps the power law going, whereby big managers merge and get bigger and a large number of truly active boutiques thrive. Depending on how things play out, it might impact the passive vs. active debate. I certainly hope active managers can differentiate themselves vs. the market on the way down and on the way back up. Also, perhaps leverage will expose underlying vulnerabilities in a few over-levered private equity strategies, which could make public equities more attractive for institutional investors again (the most contrarian investment for institutions coming into 2020 seemed like active public equities!). Unfortunately, with the lack of liquidity in private investments, institutions cannot shift those dollars on a dime into public markets; but, liquid fixed income might be a good source of capital here to play the eventual recovery. And, fresh capital looking for distressed private assets could do well here, but don't bank on mean reversion across the system.

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Disclaimers:

The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  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 often I try to make jokes, and they aren’t very funny – sorry. 

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Nothing in this newsletter should be construed as investment advice. The information contained herein is only as current as of the date indicated and may be superseded by subsequent market events or for other reasons. There is no guarantee that the information supplied is accurate, complete, or timely. Past performance is not a guarantee of future results. 

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