Weekend Reading #39

Photo by Sergi Ferrete on Unsplash

This is the thirty-ninth weekly edition of our newsletter, Weekend Reading, sent out on Saturday 26th October 2019. To receive a copy each week directly into your inbox, sign up here.

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What we're doing.

Reading is important. In business and in life, those who read, thrive. 

We get through quite a bit of material, but if we’re honest with ourselves, we don’t read enough. We've always done most of our reading on our commutes or at home while prioritising office time for “action and engagement”. But we want to read more. Simply wanting it isn’t going to change anything – we need to prioritise and integrate more reading time as part of our process – a daily ritual that fuels our imaginations, expertise and ultimately, our ability to generate returns for investors. 

So, starting this week, everyone at Three Body Capital is setting aside 1 hour every day to read – in the office, or out and about in our favourite new coffee shop, 40 Zero (where we recently tried our first CBD-infused cocktail, but that’s another story). The only condition is that everyone shares what they have read and what they have learned, so we can benefit as a group.

Speaking of which, we were STUNNED by the positive response to our blog post on Edelweiss. Yet more evidence of the strength of that business, with so many engaged employees and shareholders weighing in via email and social media to defend our thesis and the honour of their company.

We also spent time this week working on marketing materials for our soon to be launched fund. This will be a showcase for process over ideas, enabling us to combat counter-productive biases in our thinking and behaviour in order to manage complexity and generate consistent absolute returns. We believe this is a critical differentiator in the multi-asset hedge fund sector and we’re looking forward to sharing more with investors once the fund is up and running. 

What we're reading.

As you might imagine, it’s been a big reading week!

This long-form piece from Jean Fan on the unlikely crossover between contemporary China and the American Dream was a joy to read and crystallised a lot of what we’ve seen and heard about China and its developmental trajectory. Fan writes:

“China is changing in a deep and visceral way, and it is changing fast , in a way that is almost incomprehensible without seeing it in person. In contrast to America’s stagnation, China’s culture, self-concept, and morale are being transformed at a rapid pace—mostly for the better.”

With this in mind, we’re organising a field trip to China for early next year to gain a deeper understanding of the pace of change and its ongoing impact on capital markets. We’re keen to catch up with old friends and make some new ones, so please do get in touch if you would like to meet up and share ideas. 

We referenced Marc Benioff’s New York Times op-ed in our blog post. As chairman and co-CEO of Salesforce he's benefited from capitalism more than most, so it might surprise you to learn that he thinks “Capitalism, as we know it, is dead.” He goes on to suggest practical ways to change the system as it stands, including legislating around workers’ rights, reforming corporate taxation, beefing up data privacy and acknowledging the crucial role of corporations in fighting climate change. But when the advice comes from a billionaire who reaped huge rewards from the system, it doesn't have much oomph.  

We have mentioned tokenomics as a possible way to drive bottom up change by optimising around network value for stakeholders rather than shareholder returns and we continue to evolve our Theory of Nachas framework. Please have a read – we want feedback and criticism!

This is a critical piece of the puzzle, and we believe it is too early for mainstream business leaders and policymakers to see the big picture in the crypto landscape. In years to come, we might just find that the true value of decentralised computing is not the technology it has spawned, but the ideas. 

Finally, this week we continued on with Tim Urban’s Waitbutwhy masterpiece “The Story Of Us”. This epic series has really resonated with us and helped us to formalise and articulate how we feel about investing and entrepreneurship in general. 8 parts have now been released, and each one is better and better. Identifying not only our biases but understanding why they occur helps us to develop an investment process from scratch that counteracts the emotional, egotistical neanderthal ensconced in the deepest reaches of our minds. The number of “AHA” moments is truly mind boggling. It is deep and engrossing and well worth making the significant investment in time to read (we recommend reading more than once).

One last bit we added in last minute which is too good not to pass on is Matthew Ball’s piece on how Hollywood has botched its natural advantage in the gaming industry. We are big fans of the gaming industry as we have written before and this piece is just beautifully written and contains real fee insights from a media expert. His insights in particular on Netflix in some other pieces really add value. 

What we're listening to.

We're regulars of The Knowledge Project podcast. And this episode couldn’t have come at a better time for us, as we ramp up our efforts to launch the Three Body Fund.

Those who take the time to sit down and digest its contents will benefit from the wisdom of psychologist and Nobel laureate Daniel Kahneman, whom we have mentioned before.  He is one of our all time favourites and in this episode shines more light on the biases that cripple our decision-making, hamstring negotiations, and dampen our thinking. He also suggests some potential remedies to fight against these natural biases we all have. Most exciting of all is that he spoke of a new book about the impact of noise on decision making. We look forward to reading it when it ultimately launches!

What we're watching.

We've been watching HBO/Sky’s new epic miniseries on Catherine the Great featuring Dame Helen Mirren as the legendary Russian Empress. This is the incredible true story about a German-born teenage princess forced to marry a pitiful Russian heir. She taught herself Russian and embraced the Russian Orthodox Church on the way to becoming Russia’s most powerful ever woman (and indeed the only other leader to have “The Great” appended to her name beside Peter).

The series focuses on Catherine's relationship with lover and de facto co-ruler Grigoriy Potemkin and their joint strategic genius at running the Russian Empire. Interestingly, still remaining today from this relationship are the letters they exchanged which show the intricacies of their romantic as well as strategic exchanges – right there, unbiased, for anyone to read. 

We highly recommend watching this, and we're sure that those who do will enjoy an immensely entertaining history lesson.

What we’re writing

What leftist politics could mean for US equities.

Most of our readers will know that the most recent incarnation of Chinese economic development has been self-termed as “Capitalism with Chinese characteristics”. If one looks all the way back to when the CCP took official power on October 1st 1949, Mao himself called for “Socialism with Chinese characteristics”. So our title today was originally very provocatively called “Socialism with American characteristics”, mainly because it was too good to resist. In reality, however, the current landscape in America is suggesting simply a possible move left of centre, but certainly further than we have seen for some time at least.

Our original idea was to write a very focused piece on what would happen if the United States had a more “socialist” leaning government than we’ve seen in a very long time, if not ever, and examine the sequence of events that could lead up to it.

But then we fell down a rabbit hole and began talking about the merits of democracy vs socialism vs communism. We spoke about China and the US and everywhere in between. As we have team members from all over the world in our business the views were very widespread and the debate very heated! Eugene grew up in one-party-state, Singapore. Lupo grew up in a welfare country (Denmark) as well as a divided (literally) Germany. David C and David K grew up both in pre and post apartheid South Africa and Emad, Ed R and Ed P grew up in 80s–90s Britain.  

It became quite clear that this was a topic we simply couldn't (nor wanted to) squeeze into one note about the implications of more leftward policies on asset prices in the US. So we’ve elected to keep the scope of this one a bit more focused and save the big one for a later note.  

“Crazy” Bernie Sanders and “Pocahontas” Elizabeth Warren (and the rest) are plastered all over the news as we approach the 2020 US election. Their derogatory nicknames were coined by none other than President Trump himself, perhaps a sign that he sees them as a genuine threat to his grip on The White House – as he should.  

We don't claim to know what will happen in the 2020 US election, but we do know that this race is only the beginning of the real popularity contest that’s been raging under the surface of American society. Looking deeper at some of the Democrat candidates, we see a common thread emerging. It began in earnest already in 2016 (and seeded long before) and it could loom large in 2024 and beyond, perhaps even in 2020. 

A long dormant political movement. 
 
With the Cold War long forgotten, America’s younger generations are becoming increasingly enamoured with a long dormant political movement. The Left is here to rescue America from itself, and the leader-in-waiting (she’s a bit young still apparently – until she isn't) of this new movement is Alexandria Ocasio-Cortez or “Eva Perón”, as President Trump has sardonically anointed her. Just this week, Ms. Ocasio-Cortez took to Twitter to comment on her trip to Denmark:

“Spending the day in Denmark after C40, enjoying this social democracy that treats healthcare & education as rights, zero-carbon as priority & infrastructure as a key public good.”

Denmark is consistently voted as one of the world’s happiest countries (along with the rest of Scandinavia) and is a great success story, so it’s no wonder Ms Ocasio-Cortez admires this nation. However, to be honest, whether Denmark is a social democracy is seriously debatable. We are not experts on Denmark but we stumbled across this thought-provoking piece by Jefferey Dorfman from last year which argues that Denmark is a mostly free market capitalist state which simply has high taxes in exchange for high entitlements from the state and is not in fact a social democracy.

Either way, according to a poll from Gallup conducted in 2018, young Americans (those aged 18 to 29) are souring on capitalism. Less than 45% view capitalism positively, a 12-point decline in young adults’ positive views of capitalism since 2016 and a marked shift since 2010, when 68% viewed it positively. Meanwhile, 51% of young people are positive about socialism, a number that’s held constant since 2010. 

For a country that’s built itself and its culture upon the concept of the American Dream, this is astonishing. Or is it?

The other side of the world.

There is much emotion when we talk about which economic system is best but there can be no arguing whatever the incumbent economic system is that the key economic question needing to be addressed is: does it lead to the economic emancipation of its people?

It was Deng Xiaoping who famously once said, “It doesn't matter whether a cat is black or white, as long as it catches mice.” Even a strict early disciple of the Chinese Communist Party was open to other forms of policy if they worked. If we apply this to the US democracy today that question is far less clear to many than it used to be. It can't be denied any longer that the capitalist system that made America great has left swathes of the population behind.  

It’s fascinating to speculate and play with all the permutations and implications of what this could mean. The most critical point about this thought experiment is not which economic approach is right and which is wrong, but more importantly it is that the people whose lives are shaped under them are the ones qualified to judge. That is what democracy is all about, for good or bad.

A 2017 Ipsos survey on “What Worries the World" showed that the proportion of people in America who believe their country is heading in the right direction was 42% in 2017, 41% in 2018 and 42% in 2019. That means nearly 60% of respondents in the USA believe the country is heading in the wrong direction.

This aligns with what we are seeing in popular discourse. It comes at a time when US society is promoting (amongst other things) the issues of income inequality and climate change and is punctuated by things like the remarkable (and inexplicable to many older Americans) rise of young stars like Billie Eilish and climate change activist, Greta Thunberg (although she is Swedish). This suggests that a new generation of voters may indeed prioritise very different things to the Baby Boomers and Generation X incumbents who have dominated the political landscape as we have known it for some time. 

It also appears that it is increasingly difficult for the generational gap to be filled. This is surely one of the reasons for the divide we see opening up in politics, which is possibly exacerbated by the echo chamber of social media. Indeed, there is a school of thought that believes if it weren’t for Cambridge Analytica, there wouldn’t have been a Trump presidency (or Brexit). We leave the social media discussion for another time, but if you are interested in this angle then watch The Great Hack on Netflix.

A thought experiment.

Our objective here is not to determine which economic system is better but rather to understand what is happening in our own quest to discover the answers. We're writing this more as a pure thought experiment than anything else, given some trends we have been observing and discussing as a team.

In 2002, John Judis and Ruy Teixeira wrote a book called “The Emerging Democratic Majority”, predicting Armageddon for the Republic Party based on demographic data. Of course, we know this to be premature, but the generational data continues to portend long-term problems for Republicans. Indeed, the New York Times has reported that in 2018, voters under 30 supported Democratic House candidates over Republican ones by an astounding 67% to 32%. And a 2018 Pew survey found that 59% of millennial voters identify as Democrats or lean Democratic, while only 32 percent identify as Republicans or lean Republican. Perhaps more significant than political party affiliation is the data on ideology, with 57% of millennials calling themselves consistently liberal or mostly liberal. Only 12% call themselves consistently conservative or mostly conservative. That's quite a chasm that has opened.

The point here isn’t whether America will turn towards a more left-leaning economic system. It's that this is one of many paths that the road ahead can take, and if this scenario unfolds it would likely have substantial implications for US equity prices in particular. This is not because more left-leaning economic policies are a bad idea, or a good one but rather because what financial markets (or more accurately, people who participate in financial markets) hate with unbiased consistency is uncertainty and change.

What can happen, and why?

We’re the first to admit we have no idea what the outcome will be, so we simply prepare for a series of possible outcomes, of which this is one. So what can happen, and why?

Let’s start with our assertion that what makes markets move are its participants. In the US, most participants have been brought up on a diet of free market capitalism = good, socialism = bad. President Trump knows this and it’s possibly why he has been so aggressive with equating Venezuela’s full-blown socialist disaster to the Democrats’ plans for the US economy (never mind providing AOC with his nickname for her).

But imagine what most Americans would do with their stocks if a proper left-leaning candidate came close to being in power. Imagine one thought process:

“Taxes could go up, protectionism could rise further, big tech could get broken up, big oil could come under more pressure and large banks could get regulated even further. Private equity is under greater scrutiny too. This could affect the entire market capitalisation of US indices.”

It's laudable to reduce inequality and of course, it’s something that every society should aim for, but the stock market is very unequal. The wealth sits with the wealthy. They have A LOT to lose. This grouping also just so happens to be the very same grouping that is very much against this new, left-leaning economic angle. They are calling for a change to capitalism to include a more balanced mandate, but they’re certainly not calling for Leftist policies! The latest voice calling for change is Marc Benioff, founder of Salesforce, who published his thoughts in this op-ed. 

Another possible thought process could be to look back at the effects of President Franklin D. Roosevelt’s New Deal from 1933 to 1938 on stock prices. The Dow Jones Index rallied aggressively of course for most of this period, but in fairness it was just after the crash of 1929, so the base from which the rally came was extremely low. It's probably not appropriate to use this as a barometer for what to expect now.

The bull case can be made that more inclusive policies and infrastructure programs will lead to better and more balanced growth in the future and this may well be the case over the medium term. However, we think it more likely that markets would be frightened by the implications of higher taxes and more intense regulation as well as possibly yet higher budget deficits.

The role of decentralised finance. 

Bitcoin to the rescue? Just kidding. Kind of... Our paper for a new paradigm based on utility which we think is more suited to the “stakeholder rather than shareholder” world we are heading towards, is available here. In our view, Binance, the world’s largest digital asset exchange, is the pioneer and leader of this movement, with Binance Coin optimising for the network value of its utility portending the possibility of all sorts of upheaval for traditionally structured companies.

Our contention on the question of where the economic policies are going is that we need to be aware of how close this shift in US voter base could be. Let’s look at some data to help us assess this.

The two charts below show the share of the American voter base by generation. Both show the same thing – that by the 2024 election the share of millennial and later generation voters will approach the share of earlier generations in aggregate. 

Source: U.S. Census Bureau, States Of Change, Center For American Progress, American Enterprise Institute, Brookings Institution.

This demographic shift is inevitable, but there are simply too many variables right now to predict precisely when and how this plays out, never mind whether younger generations will vote further left of centre at all. The point we make here is that it is possible a more left leaning candidate takes power, and when markets get wind of it becoming a reality, we cannot preclude severe volatility given where we have come from and who the holders of capital are. For this reason it is critical to monitor this narrative as it develops. Have a look at Epsilon Theory’s fantastic 2020 election narrative monitor which does a great job of this already.

As we said at the start, this was just a fun thought experiment. We actually ended up dramatically toning down this piece as we started heading off in all sorts of unintended directions. Bottom line is we monitor with great interest as investors and great fascination as students of history what is unfolding in America. The last decade has seen the biggest bull market of most of our careers and who knows what will bring it to a close (we will probably only work it out afterwards). We certainly are not going to preempt it. Our approach here is always to tread carefully and be aware of the risks, so that we live to fight another day in the colosseum that is global markets.