The Marine Biologist

Ah, the summer of 2003. A simpler time for the world. Before technology morphed the way we live. Back to a time when people still engaged in face-to-face conversations. When steroids in baseball dominated the national discussion. To the days before I had young children and still slept...

I was just a 17-year-old goofy, curious and mildly athletic kid who thought it would be a fun and adventurous idea to spend my summer in Costa Rica studying ecology and marine biology on a high school sponsored science program. Adventurous it was.

You see, in the course of exploring Costa Rican rainforests, observing the local wildlife and - the highlight - working with giant, nesting leatherback turtles in a remote and pristine Pacific coastal enclave, I encountered the most peculiar of surprises. That being my near brush with death. But, on the plus side, I have quite the amusing story to tell. So, please, allow me to take this unusual detour before discussing the current state of global affairs for investors.

July 2003. Alajuela Province, Costa Rica. Cavernas de Venado. A few weeks into my Costa Rica trip while spelunking through the narrow corridors of a bat cave, I scraped my right elbow. Nothing too serious - certainly not enough to impede an afternoon's adventure. However, sometime shortly after suffering this regrettable graze, I had the misfortune of coming into contact with the urine - yes, urine as in the pee - of a diseased bat. "It was a million to one shot, doc. Million to one."

Unfortunately, my summer pretending to be an ecologist and marine biologist ended about as well as George Costanza’s brief foray into the world of aquatic life. Instead of coming home with a good tan, I came home delipidated and disheveled to the point where the passengers seated in my plane row all moved prior to takeoff. Turns out, I had come down with a good old-fashioned case of leptospirosis.

Typically seen in animals, like dogs, who come into contact with diseased rodent urine, leptospirosis occasionally infects people. A rare occurrence in the US (about 100-150 cases annually), but slightly more common in the tropics.

Though never a walk in the park, the disease need not pose a serious health risk. But in the 10% of cases like mine that are "severe," the fatality rate climbs to as high as 40%. The longer you wait to treat it, the worse your prognosis. So, in hindsight, I didn’t really do myself any favors by trying to tough out the symptoms for a few days, making it through some arduous hiking with a 103 degree fever and the chills.

Then one morning I just couldn’t get up. Couldn’t move. I was completely disoriented and delirious. All I can recall is lying in bed staring at a small green lizard resting on the corner of my wall and thinking it was going to eat me... That evening - out of concern for my health and probably the school district's potential liability - my teachers arranged for transportation to the local hospital.

When I arrived, the fun was only starting. After conducting some tests, noting the yellow hue of my skin and figuring out my organs weren't properly functioning, the doctors ruled out malaria and diagnosed me with leptospirosis.

To add an extra wrinkle, as a child, some allergy analysis determined I may have been allergic to penicillin. Coincidentally, that's how you deal with a severe bout of lepto. Just load up with a bunch of penicillin IV bags until the symptoms subside.

So I tried telling the doctors in my broken Spanish that I might "tengo alergias" to penicillin. From what I recall, they decided to do a test injection and then wait to see if I went into anaphylactic shock. It was an exciting experiment, and after a few minutes of suspense the doctors concluded I was in the clear. So they hooked me up with an IV and wheeled me down to the only (semi) private room in the hospital.

It being a small hospital, in a remote part of the country, my room also happened to be the location of the facility's only toilet. So my broken memories of the ensuing days are just drifting in and out of drug induced hallucinations with random people coming into my room to relieve themselves every 30 minutes. I will also note, for the record, that proper ventilation was an architectural oversight.

Days later when my fever finally broke, I got on the first flight back to the States where, upon landing, my parents took me straight to an infectious disease specialist. The doctors I saw here had never treated a case of leptospirosis and were sort of clueless as to the best course of action. They handled my case like a novelty - a chance for them to learn something unique. Bragging rights at a cocktail party.

Long story short, they had no clue what they were doing. After beginning to regain my stamina, they tapered my medication and I experienced a vicious relapse. Basically a month's long fever with extreme night sweats, leaving me barely able to move and 30 pounds lighter. You win some, you lose some...

Clearly, I would have been far better off staying in the toilet room for another week and fully recovering. While the doctors in Costa Rica may have been short on some of modern medicine's amenities (frankly, almost all of them), they were long on experience. So I guess the lesson here is that having all the tools to get the job done doesn't really do much good if you don't know how to do the job in the first place.

Also... BATS! Have to hand it to them. One hell of a species.

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Now, why I am leading in with this? One, I still find it all fairly humorous. And two, I am going to weave this story back into my investment analysis.

But, first, one more purposeful digression: I'd like to briefly discuss the main science lesson that's still stuck with me from this trip, which brings us to the concept of symbiosis.

Formally, symbiosis is a type of close and long-term biological relationship between different species. In many instances (such as parasitism), such relationships are only advantageous to one party. But ecologists commonly refer to symbiosis when discussing mutually advantageous relationships. This happens when two or more species co-evolve to benefit each other.

A classic mutual symbiotic relationship I learned about and observed firsthand involves the Acacia Tree and Acacia Ant. As the invigorating video below highlights, the ants defend the tree from predatory species while the tree secretes a nectar that feeds them. A true partnership.

In the abstract, I understood symbiosis as the defining feature of entire ecosystems. At the most basic level, an ecosystem is simply the interaction of organisms within some geographic boundary. A healthy ecosystem is one in which the various species that live within it exist in a state of loosely defined "balance," with no one species dominating to the detriment of all others. Technically, this doesn't necessitate mutually symbiotic relationships, but in the abstract a healthy ecosystem does require beneficial interactions (from a systemic perspective) across a variety of species that have co-evolved to co-exist.

For example, an old-growth Costa Rican rainforest teaming with wildlife is a healthy ecosystem. Most of the Alaskan national parks, where I've spent a great deal of time camping, are healthy ecosystems (my wife's picture below). Conversely, the Florida Everglades, where the recent introduction of the invasive and now pervasive Burmese Python which has decimated native species, is regrettably an ecosystem in decline.

Much like the natural world, the global geopolitical, economic and investing ecosystem to which we've grown accustomed the past few decades is predicated on symbiotic relationships across a variety of parties that have resulted in something resembling a state of balance. Or at least that was the case. Countries, businesses and investors co-evolved to create a healthy environment in which (generally) nations respected international norms, trade flowed freely and investors deployed capital to productive uses.

This system wasn't perfect and there are plenty of examples of imbalances and disparities, but for the most part it served most people around the world quite well. In recent history, we've fought less with each other, produced and purchased stuff more cheaply, driven accelerating technological innovation and grown healthier and wealthier. Diplomatic, trade and economic norms established after the second world war and cemented after the fall of the Soviet Union benefitted most of humanity. Let's look at a few charts to help tell the story.

1) After WW2, "Great Powers" got out of the direct confrontation business.

2) Deaths in state-based conflicts have markedly declined - particularly so once the US ascended to hegemonic status.

3) After barely growing in the 19th Century, global trade accelerated in the latter half of the 20th, into the 21st.

4) The incorporation of emerging economies into global trade (especially China), pushed the value of trade to GDP to 60% before leveling off.

5) While real wage gains for many in the West stagnated, globally humanity has grown wealthier as we fight less and trade more.

6) Geopolitical and economic stability have been good for global investors.

One additional point on investing: the decline in global geopolitical uncertainty, coupled with the free flow of trade and availability of capital also benefitted valuations. Last August, I examined what might account for higher earnings multiples relative to historic data in a piece titled: Valuation, Rates, Risk and History. While not trying to justify elevated valuations I offered up that: The more accurately investors can predict an outcome, the less risk that outcome entails, and, in market terms, the more comfortable investors should be willing to wager on it happening.

The key question for investors now is whether the world is on the precipice of an era of greater geopolitical uncertainty and economic friction. In which outcomes become harder to predict. And whether our global state of "ecological balance" predicated on mutually beneficial symbiotic relationships is on the verge of breaking down.

I'll cut to the chase. Most current signs are pointing to yes. Now, that doesn't necessarily spell disaster, but we're no longer operating in an environment in which the rising tide lifts all boats (see here and here for more on that). Without question, the last thirty years of global peace, economic integration and policy conformity/certainty, provided ideal conditions for the consistent rise in asset prices. Yes, I know the starting point had low valuations and high interest rates, so the bar was set lower for future returns. But low valuations can always stay low and high interest rates can remain high. The global ecosystem also matters.

As I explored in my last month's letter and in October's note on global conflict, the hard truth is this recent period of general peace, stability and shared prosperity may have been a historical blip. Perhaps, the function of a brief Pax Americana that is now giving way to a fragmented global order.

No need to get into a deep geopolitical discussion here, but suffice to say that many countries across the globe have different visions for their internal politics, economic development and national security than the classic liberal, democratic order led by the US. And they are pushing back.

To rehash, global norms regarding international diplomacy, trade and capital flows have benefited a lot of people and investors. With the backdrop of peace and cooperation, the world economy became optimized for efficiencies. Abundant capital flowed to the most productive uses in the most productive places. With free markets and the free-ish movement of people, businesses became globalized and supply chains could rely on just-in-time inventories.

However, if a substantial part of the world pursues different diplomatic and economic models, that may lead to a major rupture. The ideal of "globalization" already was taking a hit post-Covid. Now, with Russia's invasion of Ukraine, the scrutiny has intensified.

If international stability, the availability of global capital and ever-more optimized supply chains contributed to stable prices and lower interest rates, then heightened geopolitical tensions, the curtailment of capital flows and building out redundancies will likely result in the opposite for some time. This will not only filter into profit margins (lower), but in all likelihood into interest rates as well (higher).

Borrowing from Gavekal Research, the prevailing economic environment of the last 30 years was marked by stable prices and economic growth: a "disinflationary boom." But the types of assets investors might want to own in a world prioritizing economic efficiency are likely different compared to a world structured per geopolitical considerations.

Such strategic priorities lend themselves to trading blocs amongst allies, regardless of whether that creates economic frictions and redundancies (it inevitably does). I think it's safe to bet that should a new world order emerge, the trajectory of prices will be up. What's not yet clear is whether higher prices will coincide with an economic boom or bust.

My wager would be for an eventual boom given all the capital spending required to beef up regional infrastructure. Yet, a bust could occur if consumer and business demand collapses under the weight of higher prices and supply shortages. (For an analysis of how to position for a potential inflationary boom, see my note from last September: History 101.)

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Now, how did we transition seemingly so rapidly from a global ecosystem in an apparent state of harmony to one in potential collapse? As Hemingway would say, "gradually, then suddenly." Fractures were apparent prior to Covid disruptions, but the death knell coincided with the introduction of an invasive species. One who discarded beneficial symbiotic relationships for the pursuit of sheer dominance. This brings us to Vladimir Putin and my initial story about leptospirosis.

What Putin is to the Russian presidency, George Costanza and myself are to the field of marine biology. A total impostor. A man who has projected toughness to mask fundamental weakness. Whose gambles have been confused with boldness. Who misrepresents the great culture he claims to safeguard. And whose deluded visions and pure luck many until recently mistook for strategic competence.

In blunt, bordering on crude terms, Covid was the open wound that a diseased Vladimir Putin pissed on, sending the global balance into severe shock. Causing untold death, despair and destruction for no purpose at all other than the perverse pursuit of a nationalistic fantasy.

Not the kind of language you're probably expecting in an investment analysis. But, I told you, I'd tie everything together.

* * * * *

It's impossible to ignore the terrible humanitarian aspects of the crisis in Ukraine. I will not pretend to offer up any meaningful analysis on the subject, but only wish for this war and the pointless suffering to end with Russia's retreat as soon as possible.

For those living in the US and broader "West," we are beyond fortunate to have the comparatively meaningless luxury of considering the unfolding global order and investment landscape. So, now what?

A few predictions building off the above and some of my prior work (see links at the end):

• In a regime of deglobalization, prices (and interest rates) may rise for some time until supply chains (including those for key commodities) become more localized or re-routed amongst allied trading partners. The economic orthodoxy of free markets will evolve to better account for geostrategic considerations. Economic uncertainty will increase, as will market volatility.
• A more capital intensive world will be a world of lower returns on capital. Further, geopolitical considerations may lead to more emphasis on returns to society relative to returns on investment. This, combined with rising capital intensity, may result in downward pressure on corporate profit margins.

• Fiscal policy will supplant monetary policy as the key liquidity mechanism in markets. However, achieving strategic imperatives through increased fiscal spending will require a tighter monetary framework to control inflation.
• Investors will demand higher rates of return to compensate for rising financial and geopolitical risk premia. This means valuation multiples could compress and that the world of long-duration risk (whether in fixed income or emerging growth firms) could remain under pressure.
• Investment skill and discernment will likely replace momentum as the driver of performance, particularly within the growth subset of markets where selling has been indiscriminate of late.
• Capital abundance and cheap financing will give way to capital preservation. As funding cools and financing terms become more demanding, firms that have raised (or seek to raise) billions premised on expanding total addressable markets or scalable intellectual property will need to prove the viability of their business models.
• As a corollary, cheap financing for the past decade has subsidized services and products that are otherwise uneconomic. In a world where the cost of capital is rising, investors will start caring more about realizing returns. Soon, we will see who truly has pricing power. Not all will. As returns disappoint, the meteoric growth of private market investing is likely to plateau (see below). Will we will be talking about "democratizing" private equity and venture capital in several years?

• Finally, let's discuss the topics of resiliency and adaptation. If growth was the idealized investment criterion of the past era, resiliency is likely to become the quality that investors prize most in the future.
• Simply put, a resilient business is one that provides critical products or services, for which demand is close to inelastic, and that has operating leverage built into the business. There aren't many firms like this and when you encounter one at an attractive valuation, you should consider investing.
• Every ecosystem eventually adapts to change. Even when change comes suddenly. Ours will be no different, but investors must evolve with the times.

Quoting from Book of Ecclesiastes now: "The thing that hath been, it is that which shall be; and that which is done is that which shall be done: and there is no new thing under the sun."

At the end of the day, the key to successful investing remains the same as it has always been: buying well-managed companies at reasonable valuations that can reliably make money producing or doing things consumers need. The central questions to grapple with are: what's needed most in our changing world order and what are reasonable valuations?

I don't necessarily have actionable ideas today for you. However, over the last two years I have been laying the grounds for a changing investment framework and think it's worth referring to prior pieces for in-depth analysis on strategy and positioning (see the links below).

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This was a long, perhaps somewhat meandering and definitely "different" type of communiqué, but I hope it was of some value (or at the very least, entertainment).

As always, please feel free to reach out to discuss markets or how we may be able to work together in managing investments.

- Stuart

Links to Recent Thoughts on the Investment, Economic and Geopolitical Landscape

The World as It Is: A philosophic take on our current moment in history, with brief thoughts on what it mean for investors (Feb 2022)

Navigating the Low Tide: Part 2 of 2 presentation on how tightening liquidity and increasing economic uncertainty may favor different types of investments relative to those that outperformed over the prior decade (Dec 2021).

Restless Dreams in Macroland: Part 1 of 2 presentation on how tightening liquidity and increasing economic uncertainty may favor different types of investments relative to those that outperformed over the prior decade (Nov 2021).

ESG and the Road to Serfdom: A thorough review of how well-intended, but poorly conceived ESG investment and policy choices undermine capital markets, capitalism itself and global stability (Oct 2021).

History 201: An examination of the root causes of conflict, prospects of heightened global instability and investment implications (Oct 2021).

History 101: An examination of the causes of natural resource shortages and overview of the investment case for the commodities complex (Sept 2021).

The S&P 5(00):A review of trends leading to the top-heavy nature of the S&P 500 and what might cause momentum to shift, favoring stocks outside the large-cap tech category (July 2021).

Thinking Long Term: Introduction to a contrarian framework for analyzing new investment ideas borrowing in part from the Gartner Hype Cycle (Oct 2020).

The Problem with Hindsight: A reminder for investors that extrapolating past trends, though analytically convenient, may pose unappreciated risks to future performance (Sept 2020).