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

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In today’s post: green energy without storage poses a problem; the missed opportunity for official digital IDs; gaming is in the spotlight, but M&A is not always straightforward; the odd shift to sentiment from rational language; beverage makers have unrealistic recycling goals; globalization of supply chains unexpectedly increases; how to approach down stock markets: you're not as dumb as you feel; and much more below.

Stuff about Innovation and Technology
Win for Wind, Bummer for Bats
Berkshire Hathaway’s MidAmerican Energy Wind Prime project would add another 2042 megawatts of wind power in Iowa with a goal of achieving “wind self-sufficiency”, if approved. Iowa derived 41% of its power from wind in 2019, and this new investment would be enough to power an additional 600,000 homes. I assume the lofty self-sufficiency goal is on a “net” basis, with MidAmerica shuffling electrons out to other states when they aren’t needed in Iowa and pumping fossil fuel in when the wind isn’t blowing. That much reliance on one source of power seems like an extreme fragility for the state. If we were to have an extended period of atmospheric doldrums combined with other factors, like a cold winter and fuel shortage/price inflation, Iowa residents could be in a cold pickle. It would be great to see green energy projects accompanied by massive battery plants or other means of storing energy to achieve real self-sufficiency. One group unhappy with the news is the hoary bat, given that turbines are responsible for around a half million bat deaths a year. Bats are important for many reasons in the ecosystem, most endearingly as mosquito predators.

IRS’ Facial ID Security in 3rd-Party Hands
The IRS will begin requiring (or at least making it onerous to avoid) facial identification for filing and accessing taxes starting this summer. The system, run by ID.me, has users upload a government ID and then take a selfie with their computer or phone, and the company’s facial recognition software determines whether or not the images match. It seems like it would be far simpler and more secure to have a standard security app that could digitally validate ID without sending sensitive data to a third party. Instead, the government is stitching together a complex process utilizing a company that started out with ambitions to be a ‘Groupon for military personnel’ and then pivoted to ID services for military vets. The founder of ID.me, which counts Google as an investor, is known for hyperbolic claims and vacuous jargon, according to Bloomberg, and is trying to “control the identity layer of the internet” despite having a product that is plagued by problems and a disturbing lack of transparency. In one example, only 40% of people requesting unemployment benefits in California were able to get the ID.me service to work. Apparently, you’re out of luck if you look noticeably different from your DMV/Passport photo, have recently moved and not updated your address with the DMV, have an older phone, or poor internet connectivity, among other variables. This is one of the problems with placing too much confidence in technology before it’s ready – everyone loses except the people selling that technology. While the new system could help fend off refund fraud (filing for a tax refund using another person’s identity), a problem that’s incurred losses in the tens of billions of dollars, it introduces a host of new technological bugs and security concerns. Digital identity should be designed and controlled by a government entity, and it should work with the excellent built-in tools in iOS and Android. However, with a large swath of the US public increasingly fearful of the federal government treading on their rights, such an app might be a tough sell. Perhaps, however, at least some states will try to create a privacy-focused digital ID that leverages smartphones.

CCP’s Olympic Surveillance
The app required for all Olympians and coaches attending the Beijing Olympics contains several security vulnerabilities allowing communication to be monitored, a list of words commonly censored in China, and the ability to report politically sensitive information.

Tricky Business of Gaming Acquisition
Microsoft announced its intention to acquire game-maker Activision for $75B last week. Microsoft has been building a house of game publishers to bolster its Xbox Game Pass subscription service, which now stands at 25M subscribers. Activision appears to have been a sold asset rather than a bought one as the company was looking for a way out of mounting internal culture problems. Buying game publishers is tricky because the creative talent and engineers are the core of the games, and if they have already left (see: Microsoft Accretes Gaming Content) or will leave, you can lose the heart of the game – and the gamers. Big games are communities cultivated over many years, and players are likely to walk if their expectations aren’t met, especially with the ever-rising bombardment of media and game options. Talent loss is a concern in any big acquisition, but it seems especially pertinent in creative ventures. Some gamer interest is also beginning to shift to nascent VR systems, like Meta’s Oculus. Sony stock at one point dropped nearly $20B in value on the news of the Activision deal over concerns Microsoft is building a monopoly position in console gaming distribution that will advantage it over Sony. I am a bit skeptical of that narrative, but, if true, then clearly the deal should be stopped. Other notable players interested in owning more gaming content are Netflix and Amazon (prior discussion); but, for whatever reason, they were apparently absent when it came time to bid for Activision. In other gaming news, Take-Two is looking to acquire Zynga. As I’ve written in the past, console- and PC-based gaming enjoyed strong growth at the start of the pandemic, but then leveled off while mobile gaming continued to surge. This mobile growth is perhaps part of the logic behind the deal; however, past attempts at buying mobile studios to help shift console/PC games to phones have largely failed given the different development platforms and culture clashes between teams. Last week, I discussed the explosion of content in competition for our increasingly saturated attention and time. If we look at the $10B+ incremental spending by Hollywood on movies this year, much of that is inflation due to the scarcity of creative talent. In terms of hours of consumption, gaming content is cheaper to produce than many Hollywood productions, i.e., consumers might play a game for many dozens of hours vs. watching a show or movie just once. And, games allow for incremental purchases while playing. The two industries are also blurring together now that tools like Unreal’s gaming engine are used to make movies. You can see an eventual future where the interactivity of all media goes up, creating a very different type of storytelling and world building for which the Hollywood studios are ill-equipped.

Miscellaneous Stuff

Rise of “Fact-Free” Language
Researchers analyzed books, newspapers, and other texts to show that, beginning in 1850, rational-leaning language rose at the expense of sentiment-heavy language, a trend that began reversing in 1980. The trend was spotted across English and Spanish fiction and non-fiction texts, including the New York Times archives. The rise of rational language seems somewhat explainable: “Inferring the drivers of this stark pattern necessarily remains speculative, as language is affected by many overlapping social and cultural changes. Nonetheless, it is tempting to reflect on a few potential mechanisms. One possibility when it comes to the trends from 1850 to 1980 is that the rapid developments in science and technology and their socioeconomic benefits drove a rise in status of the scientific approach, which gradually permeated culture, society, and its institutions ranging from the education to politics. As argued early on by Max Weber, this may have led to a process of ‘disenchantment’ as the role of spiritualism dwindled in modernized, bureaucratic, and secularized societies.” However, the reversal in 1980 seems harder to explain. The time marks the rise of the PC-era followed by the Internet, ecommerce, and social media. If anything, science and technology have been more ubiquitous in popular culture in the last four decades than ever before. One explanation is that language itself became more casual around that time, although that too seems to require an explanation. There was a marked acceleration in sentiment-related over rational language in 2007, around the time of the global financial crisis. The authors admit to sources of bias in the text passages analyzed, but the trend seems powerful enough that it’s worth looking at and speculating about.

Recycling Rekindled
The rally to increase renewable content of beverage packaging has hit a few stumbles lately thanks to price increases for both recycled PET and aluminum, according to the FT. As beverage makers push to improve their environmental scores, recycled PET prices have doubled in Europe and soared in the US. Recycled PET is now more expensive than new PET despite the rise in fossil fuel costs that more greatly impact the latter. This is a far cry from a few years ago when China stopped accepting shipments of recycled PET and it seemed to be of no value. Meanwhile, aluminum prices have increased for a variety of reasons (e.g., higher energy costs) ratcheting prices for the significantly more environmentally friendly PET alternative. However, containers are a tiny percentage of the cost of a beverage (i.e., peanuts compared to the logistics, shipping, and energy costs of producing and delivering beverages to store shelves; high-production cans are under 10 cents each), so this expense can be absorbed. Significant increases in recycling infrastructure are still needed for the industry to meet its green goals.

Value of Transgressive Humor
A beautiful essay on Bob Saget and the importance of his lesser-known transgressive comedy by Penn Jillette appeared in the NYT: “What Bob Saget practiced was emotional stage diving. He would fall face-first into the audience’s arms. If the audience didn’t trust him enough to catch him with their laughs, it would be worse than smashing onto a concrete floor. The Beat poet Allen Ginsberg understood that this kind of gamble was intrinsic to great art. He is said to have said, ‘The poet always stands naked before the world.’ I think there’s more to it. The artist must bravely say, ‘I am going to show the world who I am, and I trust that someone will understand.’ Real art, beautiful art, is always a scary act of trust. We look to art to see another person’s heart. That human connection is all that matters. For me, it is a reason to live.” I wrote more on the value of comedy in Laughter is the Best Medicine.

Stuff about Geopolitics, Economics, and the Finance Industry
High-Priced Venture Capital Comes with Risks
The NYT discusses the frothy market for venture capital, a topic I covered a couple of weeks ago (see What Goes Up Must Come Down). “It’s so crazy that hot start-ups no longer have to pitch investors for money. The investors are the ones pitching them.” There are a lot of funny lines in the article, but what’s not funny is how many entrepreneurs are unwittingly hampering their company’s future success by raising too much money at too high a valuation. Abundance can make even great management teams sloppy – creating impossible hurdles and expectations and the hiring many employees at valuations they may never see again in their tenure with the company. These perpetually-underwater employees will have little motivation to stick around and help fight when the going gets tough. Further, the investors piling into new venture funds participating in these sky-high funding rounds are also setting themselves up for a reckoning. Of course, for any type of portfolio, it comes down to balancing exposure to different types of risk, and private assets play an important part in diversification, but, at some point, it stops being investing and starts becoming gambling.

Indomitable Globalization
Early in the pandemic, there was speculation that the burgeoning awareness of supply chain fragility and the West’s reliance on China would lead to a slow reversal in globalization. As shipping woes dragged on, the problematic logistics of having manufacturing far removed from demand seemed like it could fuel a deglobalization trend. However, China’s exports were up 30% in 2021 to $3.36T, causing their trade surplus to eclipse 2020’s record and land at $676B. Globalization of supply chains was a key disinflationary force over the last several decades, and a reversal would potentially be inflationary. Despite marked supply-chain related inflation today (driven by logistic costs, energy, and raw material pricing), there is no evidence of changes coming to the status quo of manufacturing abroad. The significant, stimulus-fueled upswing in US consumption last year no doubt influenced the jump in export demand, and companies are still reassessing their supply chains after two years of triage. The idea that, in general, an inventory buffer will be built back into supply chains seems logical regardless of whether deglobalization happens. Maintaining reliance on China raises the stakes for a potential military conflict, which can be both good and bad. The higher the stakes, the less likely ware is to happen, but if war does start, the consequences will be even greater.

Investing Platitudes for a Down Market
To the extent it’s useful to the investors who read this newsletter, here are a few things we keep in mind when the market pulls back as it’s done in recent months. 1) You aren’t as smart as you feel when stocks are going up, and you aren’t as dumb as you feel when stocks are going down (especially keep that in mind during up markets!). As hard as it is to relinquish emotion and acknowledge luck, both good and bad, it’s important to have humility on the way up and confidence on the way down. 2) Don’t forget to pay attention to portfolio math: when one part of your portfolio is down far more than another part, its fractional contribution to the overall portfolio has shrunk. So, when those down stocks go back up, they can contribute less to performance given their now smaller weights. In order to return to – or improve upon – your standing prior to the pullback, you need to buy more of the stocks that you like (based on your personal investment strategy/criteria). For us, that means balancing the right mix of Resilient and Optionality stocks, as we detail in our whitepaper Complexity Investing. I like to look at the reasons for why the market is down (or why people think the market is down), and then ask: are these reasons widening, narrowing, or keeping the range of outcomes the same for a given stock? If the reasons are real and caused the long-term range of outcomes to actually widen, then the stock should have gone down. The question then becomes: has it gone down enough to account for the wider range of outcomes? 3) Volatility is opportunity, not risk. It would be great to wait until all the jellyfish (i.e., short term market worries like rising rates) have moved on before we get back in the water; but, at some point, you have to dip your toe back in and then take the plunge. There are always sharks (i.e., unexpected shocks to the system like a pandemic) in the water even in good times, it’s a risk you have to live with and mitigate with good portfolio construction. 4) Do whatever you can to slow down time vs. the market/other investors. We talk about this concept in Redefining Margin of Safety: anything you can do to create space between yourself and the noise, think long term, and incorporate adaptability and mindfulness will pay off eventually. 5) Lastly, looking at the big picture, things always get better over time. Cynics can be right in the short term, but Optimists are always right in the long run. As Mark Twain once said: “I've had a lot of worries in my life, most of which never happened.”

For Demographic Gourmands Only
For all the readers tired of me talking about the population growth slowdown and demographics, now is a good time to log off. Gone? Ok. Now that it’s just us demographic nuts left, I’ll share some findings from a projected US population model I built last week. I decided to run the numbers myself because all the official models out there (formulated by governments and think tanks) seemed wildly off target to me. Population models are pretty simple, at least in theory: 1) start with the current population delineated by year of birth (i.e., current age); 2) apply a birth rate based on the prior year’s population of child-bearing-aged women; 3) apply the death rate from a current actuarial table to every age level; 4) make an assumption for net immigration and distribute that population across the historical ages of past immigrants. The birth rate dipped in the US during the pandemic, and of course it’s been on a steady decline for some time. I made what might prove to be an optimistic assumption that the birth rate going forward would return to 2019 levels. I also assumed immigration would settle around 300,000 per year. That’s up from last year, but down a lot from the 0.5-1M+ of prior years. At the moment, there are bipartisan efforts to dissuade immigration, and, with rising nationalism trends, it’s hard to forecast a rebound, but I certainly hope we have one. Assuming stable death rates from here on out, these inputs give me 338M US citizens in 2030 (vs. a current population of 332M). This figure is significantly below the Census Bureau's official forecast of 355M (last updated in 2017 when Obama-era immigration had been running much higher: PDF). In order to get to 355M by 2030, we would need immigration to jump to 1.7M people a year, which is hard to imagine from where we sit today. Lofty government forecasts have serious ramifications because they overestimate the number of people able to fund social security, pay taxes, and shoulder the ever-rising pile of sovereign debt.

Another trend that stands out in my population model is the steady decline of working-age adults in the US. Driven by the lack of immigrants, the increased death rate for middle-aged workers from the opioid crisis, and lower births some twenty years ago, folks aged 20 to 64 look to be slightly down over the next decade. On the flipside, the diminished working age population puts the spotlight on folks over 65, who will grow at 1.68% per year through 2030. Traditionally, retirees spend and consume far less than the working-age population, so an aging population tends to be a headwind for consumption growth. However, Boomers have accumulated significant wealth in markets and home equity, thanks to decades of accommodative stimulus and rate policies, so perhaps they will drive more consumption in retirement than expected. None of these projections is revolutionary, it’s simply the continued outcome of what’s been happening for several decades: declining birth rates in developed countries. The incremental change is the slowdown in immigration and the risk of reaching a breaking point on labor availability, which could be inflationary for many years until technology and automation advance to offset it.

Of perhaps greater note, if you roll my model forward with the same assumptions, the US population begins to decline in 2035, and, by 2050, there are several million fewer people in the US than there are today. This is a far cry from various models out there which optimistically show 50-70M more people in the US than we have today by 2050. There seems to be a massive disconnect between the general expectation and the reality of where we are headed. If the US aimed to keep the population flat through 2050, we would need to attract an average of 100,000 more immigrants per year than 2021’s level, and simultaneously keep the birth rate from falling while stabilizing life expectancies. While I have only run this model for the US, if anyone does a similar analysis for other countries or regions let me know what estimates you come up with – I imagine we will find similar trends across most developed countries as well as China, which also faces a significant aging population problem.

✌️-Brad

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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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