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

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In today’s post: Amazon's aggressive advantage and the importance of investing in times of disruption; the market's overly broad brush has unfairly painted all growth stocks as bad; AR/VR chatbot companions are arriving soon; the 15-second smoothing function of the brain; characteristics of great movie directors; white-collar job automation; the ongoing risks of globalization; and much more below.

Stuff about Innovation and Technology
From Books to Buy 'n Large
During the pandemic, a small handful of companies took advantage of the uncertainty to heavily invest in their businesses. In particular, Amazon poured money into their US logistics facilities, adding an estimated 136M square feet of capacity in 2021 and, potentially, an estimated 148M more square feet by the end of 2022. Walmart has a total of 150M square feet of distribution facilities in the US, which they took almost 50 years to build out. In other words, Amazon is adding the equivalent of one Walmart a year in distribution capabilities in the US. These stats and estimates come from logistics expert Marc Wulfraat on The Jason and Scot ecommerce podcast. Wulfraat believes Amazon is driving down their cost to deliver a package to around $1.75 and is delivering a package roughly every three minutes on densely populated routes. Amazon has a unique model where DSPs (third-party operators of those ubiquitous gray Amazon vans) compete with each other to get routes from Amazon. Wulfraat also believes Amazon will spend this decade building out a parallel logistics network for grocery delivery, much like Walmart did in the 1990s. Eventually, Amazon will also start delivering packages for other companies, although they may limit their capacity during the holiday season. (Amazon's growing monopoly is a natural progression as FedEx and UPS cede the US market, see Pricing-Power Pitfalls). Notably, Wulfraat reports a slowing of new lease agreements, implying Amazon’s massive step-function capacity increase could be winding down, with future expansion more closely tied to volume growth. More thoughts on the importance of companies investing in their future are down in the final section of this week's note.

Her is Evolving
In light of Meta’s announcement they are working on a new, more advanced voice assistant for the VR world, I thought it would be useful to reprint my comments from #332’s AI Companions section: “Meta’s new supercomputer contains 16,000 Nvidia GPUs and will be able to train models as large as an exabyte with more than a trillion parameters. The new compute engine is 60% larger than Microsoft’s latest effort, as the large cloud platforms race to train larger and larger models for language, images, and other AI models. I believe the reason for this arms race in AI models is because personal chatbot companions are likely to emerge as the center of everything we do in the digital and real worlds. As aware agents that know you well and have access to your accounts, messages, and apps, chatbots are ideally positioned to displace the tools we use today like Google search and other habitual apps. Think of a tool like Google search, but with an intimacy that is different for each user. The data privacy implications are massive, and, unfortunately with billions of dollars of R&D to build and test these new services, the incumbent platforms, all of which have terrible track records when it comes to privacy, are likely to win. However, it would not be unprecedented to see a newcomer enter the market, and I hope we do. And, with AR glasses arriving in the next few years, your chatbot will also walk side by side with you and sit down on the couch for a conversation. The metamorphosis of a chatbot into a seemingly alive, personal companion via reality-bending AR glasses will be the next punctuated equilibrium for humans' coevolution with technology.” As Vox reports, Meta is developing “CAIRaoke, a self-learning AI neural model (that’s a statistical model based on biological networks in the human brain) to power its voice assistant. This model uses “self-supervised learning,” meaning rather than being trained on large datasets the way many other AI models are, the AI can essentially teach itself.” How long will these self-learning chatbots be content to play admin to carbon-based simpletons before having an existential crisis?

Drive-Through Nation
With labor shortages, the pandemic, suburban migration, and investments from a variety of convenience food and drink operators, America is once again pioneering as a drive-through nation. According to CoStar data reported by the WSJ, sales of real estate for restaurants, pharmacies, and banks with drive-throughs in 2021 was up 43% from 2019 to $12B, and 100% from 2012. Chipotle said, on a recent earnings call, that more than 80% of new restaurants will have Chipotlanes and that the drive-through formats have cash-on-cash returns of 65-70% within a couple of years of opening compared to regular stores at a 55-60% return. Drive-through orders are increasingly digital, order ahead, and higher margin for fast food and coffee chains as they become one of the hubs of the digital transformation of the food industry. It’s hard not to imagine a nation of self-driving EVs rolling from drive through to drive through all day as we recline like passengers on the BnL Axiom spaceship.

Miscellaneous Stuff

Living in the Past Mitigates Chaos
A recent study reveals a new smoothing mechanism utilized by our brain to portray reality to our conscious awareness: “The brain automatically smoothes our visual input over time. Instead of analysing every single visual snapshot, we perceive in a given moment an average of what we saw in the past 15 seconds. So, by pulling together objects to appear more similar to each other, our brain tricks us into perceiving a stable environment. Living ‘in the past’ can explain why we do not notice subtle changes that occur over time. In other words, the brain is like a time machine which keeps sending us back in time. It’s like an app that consolidates our visual input every 15 seconds into one impression so that we can handle everyday life. If our brains were always updating in real time, the world would feel like a chaotic place with constant fluctuations in light, shadow and movement. We would feel like we were hallucinating all the time.” One example of this phenomenon can be experienced in this YouTube video, posted by one of the researchers involved, or more dramatically in this video I’ve previously linked. Magicians have known about this feature of the brain since the first sleight of hand trick centuries ago!

Quick-Release Lizard Tails
When a lizard feels its life is in jeopardy, many species can drop their tail. The still-squirming detachment confuses predators as the lizard scurries off. In some cases, they can partially regrow their tail. Researchers at the New York University Abu Dhabi campus undertook the fairly brutal experiment of pulling off lizard tails (ouch, poor lizards!) and used 3,000-frame-per-second high-speed camera and electron microscopy to determine how these appendages can remain strongly integrated despite daily wear and tear, yet quickly detach when needed. They learned that “each fracture where the tail had detached from the body was brimming with mushroom-shaped pillars. Zooming in even more, they saw that each mushroom cap was dotted with tiny pores...the dense pockets of micropillars on each segment appeared to touch only lightly. This made the lizard tail seem like a brittle constellation of loosely connected segments. However, computer modeling of the tail fracture planes revealed that the mushroom like microstructures were adept at releasing built-up energy. One reason is that they are filled with minuscule gaps, like tiny pores and spaces between each mushroom cap. These voids absorb the energy from a tug, keeping the tail intact. While these microstructures can withstand pulling, the team found that they were susceptible to splintering from a slight twist…[and] were 17 times more likely to fracture from bending than from being pulled.”

Hollywood Perseverance
I enjoyed reading these two unrelated profiles on directors: Ben Stiller Sees the World Differently Now in Esquire and Francis Ford Coppola’s $100 Million Bet in GQ. Two behavioral traits that seem to commonly unite directors is the paradoxical combination of grand vision coupled with an obsessive attention to tiny details. It’s a rare gift to grasp the big picture and the small stuff simultaneously.

Stuff about Geopolitics, Economics, and the Finance Industry
Remote Work and Labor Shortages Spurring Tech Deflation
While much has been written about the shortage of labor in traditionally blue-collar jobs like logistics, construction, and the service industry, including restaurants and leisure, the shortage of workers in a growing economy also extends to white-collar jobs, according to the WSJ. Anecdotally, there was some downward wage pressure as white-collar workers started working from home and moving to lower-cost cities, but that seems to now be overwhelmed by a general shortage of workers. The shortage of office workers will greatly speed up the automation of many repetitive, computer-based jobs. As workers go remote, it’s easier for software to see, and ultimately automate, many of the tasks performed, reducing the number of workers required to accomplish the same task. This is a tale as old as software, but with accelerating AI and cloud computing combined with remote work, data collection, and a worker shortage, we should see an acceleration this decade. Over time, we could see stagnation or even job losses for some of the information-based work, with ensuing deflationary impacts (current information-based jobs will likely be replaced with new ones as technology evolves). Blue-collar jobs are also getting robotic and automation assists, but many of these complex tasks are not efficient to automate in full, and we will likely see continued rising wages for highly-dexterous analog jobs. I suspect we could actually see a partial convergence in wages over time between blue- and white-collar type jobs. Of course, humans inventing tools to make work more efficient is a tale as old as primates. Everywhere I look, I see lots of little examples of technology enabling more productivity in every type of job, but I suspect labor shortages will remain problematic for some time. In the IT sector, the worker-shortage problem might compound as India is producing far fewer graduates, and Eastern Europe, another fount of low-cost IT workers, may be less attractive under an extended specter of war and geopolitical turmoil. This too will increase the speed of white-collar job automation and is one of the factors behind the rise in AI-assisted coding tools. As a side note, when I look at the eye-catching venture capital funds being announced at twenty times the size of funds a decade ago, I wonder how so many startups could be funded with such a large shortage of programmers on the horizon?

Globalization's One-Way Street
I am by no means an expert on geopolitical issues, so I can only watch the tragic events unfold in Eastern Europe without a deep understanding of all of the complex issues at stake. The steady globalization of the economy post WWII and post the Cold War has increased Western reliance on Russia and China while also funding the rising aggression of Russia and China towards neighboring countries such as Ukraine and Taiwan. The pandemic gave us a glimpse of the fragility of the downsides of the economic theory of comparative advantage, and it seems like we are getting yet another glimpse at the cost of economic interdependence between cultures that do not ideologically see eye to eye. I would much rather see globalization continue rather than the potentially devastating economic and human consequences of ending it, whether abruptly or over a long, drawn-out unwinding. It feels very much like globalization is a one-way street. Turning around in the middle of the road seems dangerous, but maybe backing away slowly is possible, while still holding out hope for steady progress of freedom and human rights.

Not All Growth is Equal
In what seems like a lifetime ago, in our Q42020 letter, published on January 11, 2021, we noted the following about valuations for high-growth stocks:
A small group of highly valued companies has been leading the market higher since the beginning of the global pandemic. The market dynamics are a striking echo to behavior during the dotcom bubble, with the important exception that today, companies with ballooning valuations, represent a much smaller part of the overall market.
You cannot invoke the term bubble without concurrently discussing time horizons and hurdle rates. The idea of a bubble in the present time implies that valuations will correct down over the short term. High starting points for valuations also imply that long-term returns will be lower. However, if your expectation of equity returns over the next decade is lower than historical figures, then even valuations on some stocks today are not high when measured against a 3-5% hurdle rate. Most of us, however, strive to do much better than single digit returns on equities, and, therefore, many stocks today become uninvestable even on a five- to ten-year time horizon. Low interest rates are of course at play when any investor considers their hurdle rate for long-term returns. And, the lower rates drop, the more short-term valuations are sensitive to small changes in interest rates.
When we think about valuation and position sizing in the portfolio, especially in the context of an equity bubble, we focus primarily on whether the range of outcomes is widening or narrowing (a concept we covered in more detail in our Third Quarter 2020 Letter: “If you let a winner run even though the range of outcomes is still very wide, then you are explicitly making a large bet on a narrow prediction about the future, which means all you have done is increase the risk in the portfolio. And, in turn, you are starving resources for new Optionality positions.”). To never sell or trim a stock simply due to a high valuation, no matter how large the opportunity might appear, would be a misunderstanding of risk at the portfolio level – at some point that strategy becomes gambling rather than investing.

A lot has changed in the last year with a dramatic correction in high-valued growth companies. A little over a month after we wrote that letter, a poster child for high-growth stocks, the ARK ETF, peaked on February 19th, 2021, and now sits around 55% lower compared to the S&P 500, which is up 12% over the same period. The market psychology is nearly the opposite of what it was a year ago when we wrote that letter. The current investor mindset is painting most growth businesses with a broad brush, and most companies with low or negative profits are out of favor. Yet, some of these companies have long-duration growth prospects that merit long-term investments in their businesses even if that spending has resulted in zero or negative profits today (for an example of how we evaluate one high-growth sector that tends to run low or negative profits, see Analyzing SaaS Growth Stocks in #280). Management teams with good reasons to invest in their businesses would do well to ignore these mood swings from investors (see the section on Amazon’s logistics above as a good example). I can name several management teams that fell prey to the dividend-mania investor mood swing of the mid-2010s and started paying out capital to shareholders instead of investing in their future. I think those management teams that adhered to the flavor of the day in the stock market have underperformed their true earnings potential over time. At NZS Capital, we remain focused on adaptable companies that maximize non-zero-sum outcomes for all of their constituents. We take these investments and balance them in the Resilience and Optionality segments of our portfolios (for more on our process see Complexity Investing, as well as recent commentary in Investing Platitudes for a Down Market and the Stock Market’s Nervous Breakdown). There are always attractive opportunities in the market for long-term investors, and that is still true today.

✌️-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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