Cover Your A$$, Ultimate Bargaining Chip, Silicon Valley's Shakedown
December 3, 2020
“Decide whether or not the goal is worth the risks involved. If it is, stop worrying.”
- Amelia Earhart
“Remembering that I’ll be dead soon is the most important tool I’ve ever encountered to help me make the big choices in life.”
- Steve Jobs
“It is not true that people stop pursuing dreams because they grow old; they grow old because they stop pursuing dreams.”
- Gabriel Garcia Marquez
A. Cover Your A$$
What is the dominant guiding principle of western societies today? At the risk of sounding crass, let me suggest that it is the “cover your ass” or CYA principle.
This principle has always been fairly prominent in democracies. But now it has gone into hyper-drive and is now an important driving force even in financial markets.
John Kenneth Galbraith’s said:
“It is far, far safer to be wrong with the majority than to be right alone”.
This CYA behaviour can be seen in the political response to COVID or fiscal and monetary policy. Every one is doing and saying the same thing, because no one wants to stand out.
I enjoyed Gavekal’s recent piece titled: “The Guiding Principle Of Our Time”, it dived into this CYA theme and the place where they think CYA is most extreme: Indexing.
Quoting the piece:
We have also argued that indexing is the new in-vogue form of socialism. Capital is not allocated according to its marginal return—the foundation on which capitalism rests.
Instead, capital is allocated according to the size of companies. Just as in the days of the old Soviet Union or Maoist China, the bigger you are, the more capital you get. It is hard to think of a stupider way to allocate one of the key resources on which future growth relies.
So why is indexing so popular? Simple: it is the ultimate CYA strategy. As Charlie Munger likes to say: “Show me the incentives, and I will show you the outcome.” In a world where every money manager is told his or her target is to achieve a performance close to that of the index, it is hardly surprising that ever-more money ends up getting indexed (see Indexation = Parasitism). As a consequence, over the years the dispersion of results among money managers has become smaller and smaller.
One of the side effects they believe of Indexation, which is just a momentum strategy = buy more of the winners, leads to more volatility.
Take the past few years as an example: since January 2018, the S&P 500 equal-weighted index has suffered six corrections of -10% or greater, including one -20% drop and one -40% drop. In contrast, in the preceding two years—January 2016 to January 2018—the S&P 500 did not see a single -10% drop, while the July 2016 to January 2018 period didn’t even see a -5% drop.
Clearly, something in the environment has changed.
Quoting the piece again:
More indexing makes sense from a CYA perspective, but ends up delivering lower returns and higher volatility all round. If capital is allocated only according to marginal variations in the price of an asset, then the more the asset’s price rises, the more capital money managers will allocate to that asset. And the more an asset’s price falls, the less capital is allocated to it. Such momentum-based investing inevitably creates an explosive-implosive system, which swings wildly from booms to busts and back again. And in the process, capital gets misallocated on a grand scale.
In the 20th century, the goal of every socialist experiment was for everybody to earn the same salary.
In the 21st century, it seems that the goal of indexing is for everybody to earn the same return.
As we now know, fixing everyone’s return on labor at the same price was a disaster. People stopped working, and economic growth plummeted. Fast forward to today, and why should we expect a different outcome if the end-goal of our investment strategy is to ensure that everyone gets the same return, not on the their labor but on their capital?
Should we be surprised if the growth rates of our economies continue to slip? Why should we expect a positive growth outcome from an epic misallocation of capital?
In A Study Of History, Arnold Toynbee reviewed the rise and fall of the world’s major civilizations. He showed that throughout history, when any civilization was confronted with a challenge, one of two things could occur.
The elite could step up and tackle the problem, allowing the civilization to continue to thrive. Alternatively, the elite could fail to deal with the problem - read: CYA.
In this case, as the problem grew, their failure led to one of three outcomes.
1) A change of elite
2) A revolution
3) A civilizational collapse
If as a society, CYA is your guiding principle, the problems you chose to tackle will be those where there is little controversy within the elite about the required solutions. By definition these won’t be the big and important problems, but the trivial obvious ones.
This means risks in the system and to the systems will grow while we are busy looking elsewhere.
Where are biggest the risk hiding today and what are you doing about?
If you want to dive deeper here, Louis Gave discussed these ideas with Mike Green on this podcast.
B. The Ultimate Bargaining Chip
Semiconductors are at the heart of innovation and geopolitics. They provide the bedrock of AI/ML innovation while also setting the stage for the conflict between China and US.
The team from NZS Capital were on the Knowledge Project podcast discussing semiconductors, their key role in society and the future’s dependency on them.
Here’s a link to their impressive white paper.
C. A Few Things Worth Checking Out:
1. Chamath Palihapitiya, of Social Capital, joined Azeem Azhar to explore the dysfunctional relationship between capital and companies, why SPACs (special purpose acquisition companies) are such a necessary innovation, and why he’s pivoted his own firm to focus on hard, important issues like climate change and health.
2. One of my favourite people Dan McMurtrie of Tyro Partners was on the Business Brew podcast discussing how a true hedge fund manager thinks. This one is deep and will make you a better investor.
3. Bitcoin Is Winning the Covid-19 Monetary Revolution by Niall Ferguson
4. Apple’s Most Downloaded Apps of 2020 (thanks David G)
5. Yuval Noah Harari, NYT - When the World Seems Like One Big Conspiracy. Conspiracy theories have been around for thousands of years, coming in all shapes and sizes. They all possess a common and alluring structure: behind the myriad events, we try to make sense of lurks a single sinister group that controls almost everything while simultaneously concealing this control (the Jews, the Freemasons, etc.). Global cabal theories appeal because they offer a single, straightforward explanation to countless complicated processes. To their believers, they give the comforting feeling that they do understand everything. The reality of the world is of course much more complicated than conspiracy theorists would have us believe.