People and companies typically don’t change unless or until they’re forced to. Christensen’s Innovator’s Dilemma points out how companies often fail to grab new markets because they both fear disrupting their core business and vastly underestimate the opportunity. An amazing amount of innovation gets left on the table when companies follow the status quo. Google invented the transformer model in 2017 that paved the path for OpenAI and eventually ChatGPT. While ChatGPT is not considered revolutionary within the top of the AI field, it’s interesting that someone at Google didn’t release a consumer facing version before OpenAI.
The founder of Zoom, Eric Yuan, left his position as a VP at Cisco working on Webex in 2011 after unsuccessfully pitching product improvements to management. Today Zoom does $3B in annual revenue with 50% market share to Webex’s 11%.
Given the latest wave of tech layoffs, this is a really exciting time to find talented people and start something new. There are 100k+ newly unemployed and highly sophisticated engineers, employees and managers who have had their paths disrupted. It’s also probably a wake up call to incumbents to not rest on their laurels.
There are a number of public company innovators who are just part of the way through their growth opportunity. Given that capital markets are in a period austerity, markets do not have patience for companies that are cash crunched or not profitable. Some innovators are fortunate to have mature product lines with nice profit margins. They are faring better than others but defending a current market is not enough. Just one example, John Deere, the tractor company, founded in 1837 is now in the satellite and geo-spacial business for connected agriculture and has been working on self driving tractors. The status quo would have left John Deere in the dust a long time ago. Companies need to consistently invest in innovation because innovation is a long term investment and not just a short term cost.
Inflation and Rates
Next week will bring the first rate hike of 2023, another .25% to increase the rate from 4.5% to 4.75%. The 3-month treasury is paying one of the highest rates on the yield curve at 4.675% today. By next week we could see the Fed Funds rate higher than the rest of the curve, signaling that it’s time for rates to start falling.
The Truflation indicator, which attempts to calculate a more real-time reading of inflation than the official CPI releases, is down to 5.35% y/y, down 55% from its peak. The last official CPI print was 6.5% y/y inflation. Given the lags in inflation reporting, I’d guess that CPI is closer to 5% today. We won’t know until February 14th when the next data is released.
Another important factor in the mix are critical commodities, which are down from panic levels to general historical norms. Natural gas, which is not my area of expertise, is down from $9.8 in August to $3 today. You may remember a panic over the summer regarding natural gas prices over the winter season. Lumber is down -60% from last year’s March highs. International shipping rates are down -81%(!) from 18 months ago. It takes time for prices to filter through to end consumers. Regardless of the “transitory inflation” debate, clearly at least part of inflation is transitory. We’re simply not going to see $1300 lumber and $10000 international shipping without another Covid-like global catastrophe. At least that is behind us. If anything, the biggest drag on the stock market today is an overall pessimism on general economic conditions and conservative positioning. It’s a short term bearish, long term bullish scenario that I think many investors are willing to look past.
Warren Buffett on staying invested
Warren is a big believer in staying invested through the ups and downs. What does that look like in practice? He always holds cash in Berkshire Hathaway. In the 2000’s he held 20% on average in cash, sometimes as high as 35%. In the 2010’s that average dropped to 15%, but the nominal value was dramatically higher, averaging $45B in cash for the decade.
There are some assets that he just buys and holds. He’s owned the same 151m shares of American Express for over 20 years. He doubled his CocaCola position from 200m shares to 400m shares in 2012 and hasn’t touched it since. He has various quotes on this theme, but essentially he says, “only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” Another is, “Our favorite holding period is forever.”
If you see what he’s done with Apple, you can see how he’s built the position up to 40% of the total portfolio over time. He started buying in 2016, growing the position from 1% to 10% over 12 months and increasing methodically over time. More recently he bought small amounts in Q1 and Q2 of 2022.
When the story changes, he sells. Berkshire held Wells Fargo for more than 20 years before finally selling the last position in Q1 2022.
In recent years, he’s owned companies that value investors would traditionally scoff at. The data cloud company Snowflake which had an over 100x p/sales multiple in 2021 is a good example. So is NuBank, a Brazilian fintech neobank. Both were originally venture investments that went public. Warren overwhelmingly favors US companies, but that hasn’t prevented him from investing selectively in international markets.
Finally, over his career, he’s seen two 50% drawdowns in the overall portfolio. Rare, but it does happen. Generally speaking, you should never be fully out of the market. Raising cash at certain times, selling positions when the market changes and keeping certain positions as permanent fixtures in the portfolio are classic Warren Buffett habits.
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