Welcome to Stuff I Thought About Last Week, a personal collection of topics on tech, innovation, science, the digital economic transition, the finance industry, the Casimir effect, and whatever else made me think last week.

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In today’s post: machine vision sees green (avocados); how to price technology that only exists because of its customers' data; your gullible brain; warp bubbles and the Casimir effect; VC funding in 2021...oh my; regional unemployment; WFH impact on housing crunch; founder-led premium problems; market commentary; and much more below.

Stuff about Innovation and Technology
TaaS
John Deere is considering selling its new, fully-autonomous, AI-controlled smart tractor to farmers as a subscription service. The new tractor debuted at last week’s Consumer Electronics Show and has six camera systems as well as learnings from years of sensor data collected by John Deere, akin to how Tesla amasses and utilizes data from its owners, who are then charged $12,000 and rising to use the self-driving module their “free” data powers. The tractors will gather, analyze, and adapt to real-time data, such as soil conditions. This raises the question of how to value an autonomous solution that is powered by the customers paying for the autonomous solution. The highest non-zero-sum outcome would be a low priced service that acknowledges it is nothing without its contributors. The zero-sum price option would be value-based by determining what money the service saves the user and maximizing how much they are willing to pay. What if autonomous is worth more to some users than others? One type of customer might be willing to pay $100,000 for Tesla's self-driving service and even more for the autonomous tractor features. Pricing at that level would keep the vast majority of users, who are contributing the data to make the service work in the first place, from ever being able to use it.

Tongue to Text to AI
Engineers are working on a smart retainer that learns your tongue movements in order to translate what you are saying into text. The prototype, which still requires a wire (future designs could be wireless), has an accuracy of 97% for letters and 93% for words. While the smart retainer likely has applications for people with motor diseases like Parkinson’s, I also expect there will be a greater effort focused on using sensors for lip reading, facial gestures, and eye tracking as AR glasses come to market, which could have much broader implications. We may want to start getting used to the reality that our lips will be read, our expressions analyzed, and our actions predicted without our permission in the near future.

Guacamole Vision
The CEO of Chipotle discusses the burrito chain’s use of technology with the Washington Post, including their use of machine vision to track more closely how much guacamole is used hourly and daily so as to not be short or waste any. Chipotle has been on the leading edge of the digital restaurant transition, which is creating many winners and losers.

Miscellaneous Stuff
Our Friendly Neurological Con Artist
I am a nut for demonstrations of the fallibility of our brain’s prediction engine. We have this innate feeling that we can trust our brain, which couldn’t be further from the truth (see last week’s Algorithmic Threat to Illusion of Free Will). This short YouTube video is a nice example of how disconcertingly unreliable the brain’s prediction engine is.

Tribute to Super Bob
I am always fascinated by people who can create and maintain a character for their entire life without ever winking to the audience that the character is a joke. This HBO Max documentary on the late Bob Einstein, who many of us knew first as Super Dave, is a nice exploration of this special kind of devotion. Einstein also played surrogate Larry Middleman on Arrested Development with the classic meta line: “Wink. Did you say ‘wink’ or did you wink?”

Warp Bubble Realized
If you are a Star Trek: TNG fan, you might remember the classic episode “Remember Me”, where Dr. Beverly Crusher is accidentally caught in a static warp bubble created by her son Wesley. A warp bubble is part of space that is contracted in the front and expanded in the back, and it creates the potential for faster-than-light travel – without time dilation – for anyone/thing within the bubble. As such, travel via warp bubble eliminates the devastating consequences of time moving at different relative speeds, as occurs with “ordinary” faster-than-light travel, a concept the movie Interstellar so dramatically explores. The energy required to create a theoretical warp bubble has seemed unachievable. However, by tweaking the physical model a bit and using something called the Casimir effect, it appears possible to create tiny, real warp bubbles. Casimir cavities are negative-pressure, quantum vacuums that could potentially pave the way for tech breakthroughs in such things as batteries and communications. The Casimir effect has potential applications in other types of micro devices as well.

Stuff about Geopolitics, Economics, and the Finance Industry
What Goes Up Must Come Down
Crunchbase reported a 92% y/y increase in VC funding in 2021 to $643B. Despite the pandemic, 2020 was also up 4% from 2019. The doubling of VC over the last couple of years comes on fewer deals in 2021 than 2019, with deal size (and in most cases much higher valuations) accounting for the rise in overall VC investments. The absurd rush to fund anything and everything at bananas valuations should offend the senses. Perhaps the most offensive stat is the $196B increase in late-stage rounds to $413B as, in many cases, investors raced to markup existing portfolio holdings as fast as they could get their hands on excess cash sloshing around the financial system thanks to pandemic stimuli. This unprecedented level of VC investments creates capital calls that are likely forcing many institutions to divert capital away from public equities or other asset classes. When many of these deals eventually get marked down in value, watch out below!

Regional Unemployment; Pontiff’s 2c on Cats and Kids
As employment continues to shuffle and struggle in the US, a record one million restaurant and leisure workers quit in November 2021. There is a media narrative that many younger job market participants have been sitting out of the workforce to trade crypto and meme stocks. I am a little skeptical that’s more than anecdotal, but, before the recent 30%+ decline, Bitcoin also peaked in November. Something I just learned recently is how unemployment varies widely by US state, with Utah and Nebraska at less than 2%, while New York, Nevada, and California are at 6%. I wonder how much unemployment has to do with migration from Middle America to the coasts and growth states? When you look at this chart of data from October, you can see much lower unemployment across the middle of the US. It makes unemployment look more like an issue of having the right people in the right places. Utah had an unemployment rate of 1% in October! If you have a population that is aging faster in some states, but not enough young people are entering the workforce as nurses, etc., we may start to see wage inflation vary widely by region as well. Maybe some states will follow Poland and create localized incentives for people to have more kids (of course you still have to make those kids stay put when they grow up!). In related news, the Pope, who also is facing a Catholic Church membership crisis, thinks that younger people getting cats and dogs instead of having kids are being selfish (which is rather ironic since he himself chose not to have kids).

WFH Contributing to Housing Crunch?
Something that’s been puzzling me lately is how to reconcile the household formation slump with the record demand for homes and apartments. Vacancies are at a multi-decade low of just 2.8% for apartments and 5.8% for single-family homes (PDF). Household formation is an especially complex formula involving marriages, births, divorces, roommates, multigenerational living, life expectancies, immigration, and more. Slowing household formation indicates more people are living together (and fewer immigrants are coming into the country), so how can vacancies keep dropping? It seems like some combination of lagging new construction, older generations remaining in their houses longer (vs. entering COVID-prone nursing homes), and households occupying multiple dwellings (e.g., for work-from-home purposes) could account for reduced rental inventory. It’s hard to pin down these latter two stats, but anecdotally it seems like WFH is a meaningful impact on supply without a net increase in new households.

Founder Mentality Pre-Baked into Valuation?
Founder-led companies have historically outperformed non-founder-led companies, often dramatically. In the investing world, conventional wisdom lately suggests that the owner-operator mentality will produce better long-term results. Long-duration growth can be achieved either with a founder in the lead or with a CEO and management team that act like owners and focus on the long term. We find all too often what we call ‘rent-a-management’ teams that swoop in and out looking for a quick gain and don’t particularly care what they leave behind. So, it was with interest that we looked at a recent report from HBR showing founder-led companies have been underperforming. It appears that several big founder-led companies that have gone public in recent years started out at a premium valuation, and, as a result, have not done as well as the market in some cases. This could also be due to founders keeping their companies private longer, i.e., beyond the high-growth window when more significant investment gains were to be had. If founder-led companies overall are carrying a large premium in valuation, then, essentially, that advantage has been arbitraged away, or perhaps even turned into a disadvantage for investors in those stocks. It’s something to keep an eye on. Our approach is always to favor management teams with owner-operator mentalities because they tend to care more and are willing to focus on long-term adaptability and win-win in their businesses; but, we also need to be mindful of valuations that favor a good expected return over time.

Seeking Homeostasis
The following market commentary is excerpted from our 2021 Annual Letter, which will post on the NZS Capital website later this week.

All biological systems exist in an ongoing effort to achieve homeostasis – a perfect level of nourishment and comfort for the organism to optimally survive and procreate. The stock market, like the global economy, is analogous to a living organism in that it is constantly seeking homeostasis, i.e., some sort of balance between supply and demand that manifests as the price of a stock and of the overall valuation of the market. Living organisms and the stock market are also both complex adaptive systems, and that means that disequilibrium is generally the equilibrium state. In other words, we are always shuffling one way or another to try and achieve homeostasis, drifting through – but never maintaining – that ideal state.

In the body, we balance things like calories, sleep, temperature, mental wellbeing, satisfaction, etc. The financial markets are trying to balance interest rates, inflation, geopolitical forces, shocks to the system (oil supply, pandemics, wars, etc.), and the range of possible future states of the world along with the range of outcomes for each individual stock. In a complex system rife with chaos and emergent outcomes, maintaining equilibrium for any meaningful duration of time is of course an unachievable goal.

The human body is concerned with maintaining temperature, food, and water within a narrow band, because those parameters are so critical to survival and the minimization of physical disequilibrium. For the markets, the key element is probably a consensus around interest rates, because everyone in the markets has some sort of hurdle they need to meet in order to take on the risk of investing money rather than sitting on it or making other investment choices. For individual stocks, homeostasis revolves around valuations.

When the market has wide divergence in opinions on things like long-term interest rates, or when there are a lot of shocks to the system, its struggle to find homeostasis tends to become more dramatic. In other words, the typical disequilibrium operates in a wide band as price levels are more volatile than when the market can agree on a tighter range of future scenarios for variables like interest rates. This is an overly elaborate way of saying that more unknowns create more volatility, but the key point I want to make is that thinking biologically can give you more context for how markets behave over time.

Humans need a full stomach, a warm fire, and a good night's sleep that isn't plagued by worries over the future. To feel equally sated, the markets need stable leadership, calm geopolitics, and a consensus view of future inflation and interest rates. But, predicting the future of any type of complex system is a fool’s game. So, we humans have learned to stock the pantry, have alternative heat sources on hand, and shelter funds for a rainy day. The markets, in contrast, have a more subsistent existence, digesting news minute-to-minute while never fully satisfied with achieving any level of consensus. Whereas adult humans can understand when they are hungry or tired, markets are more like a crying infant, unable to fully communicate what would calm them down.

When the future is unknowable, the best basic strategy is to own assets that require you to make as few predictions as possible for achieving a desired outcome. That means owning assets that imply a return rate above your hurdle rate without having to know with precision how the world will unfold. That's a challenge if you cannot pin down interest rates to a relatively narrow band, especially when the variables going into inflation are difficult to forecast. That conundrum seems to be what the markets are grappling with today, but it could be a million other things as well. It is complex, after all.

Fortunately, we can return to a few basic first principles that we believe hold true long term: 1) the future is always better than the past; 2) technology is an overarching deflationary force; 3) one person's debt is another person's asset, which impacts the direction of interest rates; 4) humans are innovative and rise to the challenge; and 5) given enough time, optimism always wins over pessimism and cynicism.

✌️-Brad

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC.  This newsletter is an informal gathering of topics I’ve recently read and thought about. I will sometimes state things in the newsletter that contradict my own views in order to provoke debate. 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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