The Great Unwind: Capital Cycles, Concentration Risk, and What Comes Next

 Sign up to The Lead-Lag Report on Substack and get 30% off the annual subscription today by visiting http://theleadlag.report/leadlaglive.

Transcript

Going Live And Setting The Frame

SPEAKER_00 0:02

Okay, folks. Give me a second, as always. Uh let me make sure that we are streaming live on all the various platforms. Uh bringing the live back to Lead Lag Live here is uh what's happening with uh my friend Mr. Kaiwoo. Uh it's been already a very busy day for me. I've got like nonstop uh webinars and podcasts. But the good thing is that uh Kai is just a joy to listen to. Uh he actually was on a uh recent interview with Phil Rosen, uh, who I did an interview with too, and that uh was a nice studio, and I saw some uh some great uh great clips from that. So if you haven't seen that from Phil Rosen, I'll try and link to it. Phil's a good guy to know in this industry. Uh if you're watching this live on YouTube, on X uh or LinkedIn, do me a favor, like, repost, do all that good stuff. Again, we are live. If you have any questions, we can actually see it. Uh, it'll pop up here on the platform that we're on. So it isn't gonna be engaging, so don't hesitate to ask questions live. Uh, this will be a good conversation though, because uh Kai's been very much on top of the uh theme of the moment, which is AI uh infrastructure and maybe now the adoption phase, which I happen to think we are at and has massive, massive implications. As somebody who's a massive perplexity user, I can talk from experience when it comes to that. So uh with all that said, my name is Michael Guy. I'm the publisher of the Lead Lag Report, founder of Lead Lag Media. Here is Mr. Kai Wu of Sparkline. Uh Kai, maybe a quick intro as far as you and your firm, and then let's get into your latest investment letter.

AI Agents And The Adoption Shift

SPEAKER_01 1:18

Sure. Yeah. So um I'm Kai, I'm the founder and chief investment officer of Sparkline Capital. We um run a suite of ETFs, um, which you can you can look up that implement intangible value. The idea is to take the value investing concept and and add to it um intangible modes such as human capital, brand equity, intellectual property, and network effects. And in the process, of course, of doing the research and and building these strategies, I've done a lot of work in in AI, um, which you know I think is the topic of today's discussion. So I'm excited to get into it.

SPEAKER_00 1:53

Okay, so uh you have a letter that you put out. Uh you made the point that this whole phase has been all about infrastructure, right? The build-out of AI, and that now we're maybe entering the adoption phase. And that has all kinds of implications on portfolio construction, what's you know, worked and what could work in the future. Uh, first of all, let's get into this adoption phase for a moment. I keep seeing these posts on X by, you know, I think one of the co-founders of Google, or somebody says says something along the lines of uh uh enjoyed the final last year of uh meaningful work, right, with some kind of post like that. And I gotta tell you, like I personally I've been um skeptical of the agentic AI, let's call it movement until I started implementing it myself uh in lead lag media. And I can tell you that I've probably automated 70 to 80% of my business now with agentic AI. And I myself also believe uh with that will probably come a massive surge in unemployment as people catch on to how powerful these tools are. Um that's the adoption phase. Let's talk about um the implications of this adoption phase of AI going from prompt response to actually doing things and what that means for portfolios.

From Infrastructure Boom To Past Cycles

SPEAKER_01 2:57

Yeah, Michael, I agree with you with regards to the power of AI um agents and AI coding tools. Um I heard it said pretty well uh recently that you know there is a Chat GPT moment in November 2022. Um, you know, and then there's kind of this lull in which you know people digested kind of the implications of AI chatbots. But really, the more impactful moment was, I guess you could call it the Claude Code or the Codex moment um, you know, late last year, when you know the confluence of better harnesses around um, you know, the the AI models and better models, you know, basically opened up the prospect of these autonomous agents able to do meaningful work, right? So Claude Co-work and uh Codex are you know pretty incredible products. And I've also noticed you know a complete change. We can talk about it too, in the way I conduct my my day-to-day work um, you know, utilizing these US tools. So 100% on board with um with that argument that we are you know set to have some disruption with regards to how how business has done it in uh you know in in the economy, and that of course will have implications on on companies. Now, from a portfolio standpoint, I think the the biggest thing that's happened over the past you know few years has been you know basically over a trillion dollars going into AI infrastructure. And that's you know, the not just OpenAI and um you know and and and Google, but you know, the the build out of the data centers, then the power and the land, all the kind of like physical stuff that needs to be put in place in order to run AI. Um and that's of course led to an outperformance by the stocks associated with these, these, um, with the build-out, these investment um recipients. Now, the the thing is that if you go back through history and look at how similar events had played out, um, you know, of course, every event in history is singular, but you know, history does rhyme. You can look at, say, the dot com uh boom when we saw a huge build out in fiber optic cables to power, of course, the internet. The telecom companies, the stocks did really well for a period of time throughout the 90s to the late 90s. And then at some point there was a shift and these stocks collapsed, right? Um, you know, many of these companies, the global crossings of the world, are no longer around. The telecom index was down over 90%. Um, and and from that, of course, that did not spell the end of the internet. We use the internet every day today. Um, and in fact, the technology was, you know, as transformative as the tech bulls of the time said. But what ended up happening was that the leadership shifted from those guys to um the the next generation, what I call it, the adopters, the users of technology. Um so you know, Meta, Google, Netflix, these sorts of firms were able to leverage um the infrastructure built by the telecoms and they were ultimately the winners, right? So who were the winners of the internet era? They were, it was ultimately the users of technology as opposed to the builders. And the same thing happened in like the railroad boom a hundred years ago. Hundreds of railroads were uh companies were set up to build to lay rail. Most of them went bankrupt. Um, but of course, the rail still exists, and we as consumers and the businesses that ship goods um from coast to coast benefit tremendously from their creation. So I guess the question is, you know, where are we in the AI cycle? Right, if this plays out similar to how past cycles have, there is a transition point at which, you know, in the in the beginning you see um outperformance by by infrastructure stocks and you know a lot of investment in the physical um under you know layer. And then, you know, over time you start to see diffusion of technology and the usage of technology, both by consumers and enterprise users, industrial companies, pharmaceutical companies for drug discovery, all these sorts of use cases that should in theory give them an uplift. And those perhaps could be the long-term winners. So I think that that's the big question is you know, where are we in that cycle? Are we approaching this tipping point where things could could be quite different moving forward?

SPEAKER_00 6:45

Yeah, and and to that point, I just I use AI to build this out as we're talking here. Uh look at the uh 2026 CapEx, uh, my company has part of the AI build out. You can see Amazon, Alphabet, Meta, Microsoft, Oracle. Like this is the pretty much the SP.

SPEAKER_01 6:57

That's right. So so that that's the big thing, which is you know, a lot of investors they you know own SP 500 and they say, hey, look, I'm a passive investor, I'm like super diversified, super cautious, super safe. Well, it turns out that you know, I think 46% is a precise number, but about half your half of the SP is in AI infrastructure related stocks. So that's the you know, Google, Amazon, Meta, that's also Oracle and some other names like that, NVIDIA, Broadcom. All right, so that's that's that's the the question here, which is you know, whether you like it or not, you as an investor, to the extent you have money in cap-weighted indices, are likely very exposed to how this situation plays out.

SPEAKER_00 7:37

So is the simplest answer the right one, which is well, just you know, if that's the case, just remove those names and invest in everything else, or do we do we enter a phase where we need more thoughtful stock picking and filters as far as how the construction should be?

SPEAKER_01 7:50

Yeah, so that's that's a really good question. Um, you know, my I I have a strong view on this, and and it it's this that look, you could try to do the opposite and say, look, I'm gonna basically avoid all the AI stocks and instead kind of hide in uh you know value stocks, international stocks, small caps, companies that are as far away from AI as as possible. But I feel like you kind of risk then being like the Luddites, right? Where you kind of you resist this technology and and get look, if AI completely flops, um, then that could work out. But I think, you know, Michael, you and I in the beginning of this call, like just kind of way we frame it, is we do think AI is going to be an exponential technology. So then the question is if you want to be long AI, but don't necessarily want to be exposed to the specific layer of the stack, right? The the massive capex um and you know um concentration associated with the Mag 7 and these infrastructure stocks, what's the way you thread that needle? How do you kind of you know find a middle ground and a balanced approach to being you know exposed positively to AI without a lot of these risks? And and that's where this I kind of lay out a framework, a taxonomy, where I say, look, there's three categories of companies. There are AI infrastructure, there is then early adopters, and then laggards. So think about the classic diffusion model. Um, you know, this is the idea of those S curves where you have the innovators and infrastructure stocks in the left, and then you know, as the diffusion happens, the early adopters, and then finally the laggards. What you can what you find if you look at historical data is actually there's an opportunity for companies that are a bit more open-minded towards the use of AI to gain market share and kind of be the winners in the disruption. Right. So in disruptive periods, what you often find is a greater dispersion and outcomes and a new set of winners and losers who are able to either leverage or you know fall behind with regards to a technology. Um, you know, I think there are there are ways to kind of identify companies that are positioning to take advantage of certain technologies. And historically, if you look at, you know, again, the internet, cloud computing, um, you know, streaming, things like that, it is the case that the companies that are um you know more forward-thinking with regards to the new paradigm shift tend to outperform. So that's the early adopter group. And that that is a group that I think if you look at the valuations, are trading basically in line with laggards. So, in other words, the market is giving a significant valuation boost to AI infrastructure companies like NVIDIA because um you know they are such an obvious play on AI. But you know, when it comes to the users of AI, they're making no differentiation between companies that are um, you know, investing heavily or positioning for um to use the technology as opposed to those that are just completely um kind of head in the sand trying to avoid it. And I think that's where the opportunity lies.

SPEAKER_00 10:34

I think also maybe um there's a degree of confusion as to identifying which companies will benefit from AI versus which companies will be replaced by AI. Like the SAS pocalypts, right? It's about replacing these software service companies. Uh, not all of them are gonna be replaced, but I actually think a lot of them will be replaced, right? But um, it's hard for I think the crowd of investors to really make that this that distinction, which may be why the laggards are having the same sort of you know valuations, because it's just still not how to value it, right? Because that's the big unknown.

SaaSpocalypse And What Keeps Software Safe

SPEAKER_01 11:04

That that that's right. I think the SaaSpocalypse, so we've seen over the past um you know, three to six months, huge sell-off in software stocks, um, you know, down 50%, basically across the board, um, you know, indiscriminate selling of the category on the the back of this concern that perhaps if we can use AI to vibe code um software, the value of software goes to zero. Now, I personally think that that view is somewhat overblown. Um, you have to remember that you know a lot of these companies are you know selling to big enterprises. Um, you know, you're not gonna blow out of your CRM overnight and and vibe code your own if you're a you know uh company that employs you know 30,000 people. Um, you know, the the modes for these companies are not always software, right? Like even before AI, there are plenty of kind of silicon value startups that could create um uh user interfaces and and technology that look better than you know what some of the big, big, big boys you know do. The reason people buy these sources these sort of um software is to kind of outsource the risk um you know to a third a third party, to have someone to maintain it. Um and for the brand value and for the and there's you know high switching costs, and there's you know, all the the most of these software companies are not necessarily just the code. It's you know the brand, the human capital, et cetera. Um to the extent it is just the code, those companies are certainly in trouble. So I think that's kind of the way to think about it, right? If you look at all the different um software companies out there, look for ones where the code was never the moat. Those guys are probably gonna be fine. And then versus the ones where their only advantage was they could produce nice code, they might be in trouble. I think the other lens is, you know, to what extent do they service enterprise versus small businesses? The folks who service like the huge Fortune 500 companies are going to be fine. The switching costs are too high to get rid of them. Those that that kind of service a long tail, you know, folks like yourself and me, Michael, like, yeah, we're probably most likely to say, you know what, like, why am I paying thousands of dollars? I can just do this myself. Um, so I think that's another lens that could be used to help sort through um this opportunity.

SPEAKER_00 13:02

I also think as a friend of mine recently said that um to your point about the enterprise uh working with these other companies, they still want somebody to sue.

unknown 13:11

Right.

SPEAKER_00 13:11

So it's like if you're using a vendor and the vendor is blowing things up and you're a massive Fortune 500 company, you can't sue uh uh Open AI, you can't sue you know Claude, right? Or or or Anthropic, rather. So um that oddly enough, the uh the ability to sue is maybe a vote. Uh right.

SPEAKER_01 13:27

I mean, that that's all professional services too, right? Right McKinsey, BCG, Accenture, um, you know, lawyers, doctors, like they, you know, one of their one of their motes is that they, you know, they're we need a liability shield. We need something to yell at when things go south, and you can't yell at an AI model.

SPEAKER_00 13:43

Yeah, well, I'm sure a lot of people do, uh, because it's illusion.

SPEAKER_01 13:45

You can, but then when there are our overlords, they'll get back at us, right?

Capital Cycles And Mag 7 Overinvestment

SPEAKER_00 13:49

Exactly, exactly. Right. That's uh that's companies for the next podcast. By the way, folks, we're gonna try and do this as a series. There's a whole bunch of interesting things we're gonna be talking about uh as we do these podcasts. So, you know, feel free to ask questions if we want to make this engaging again for the series. Um, okay, you got an October 2025 paper where you did an interesting study looked at um uh looking at stocks that have or companies that invest uh heavily in their asset base. And it turns out that those companies tend to underperform, and obviously there's been a big investment on the Mac 7 side. So let's talk about um the asset heavy versus asset light side of the Mac 7. Um and say I put a post out maybe a few months ago. I said, it must be odd to be working at Microsoft building out the very tool that's gonna cause you to get fired uh as a coder, AI, right? So I guess the question is like, are these Mac 7 companies almost sowing the seeds of their own destruction? I mean, in terms of their people, their employees, because they're building out things that will replace the people that are building them?

SPEAKER_01 14:45

Yeah, I mean, there's there's a couple questions in there. Um, I guess just first to answer your point about the underperformance, um, you know, the the idea of investment cycles and the idea of the capital cycles are really powerful idea. And I think it it's not discussed enough, um, both in the kind of academic literature, but also just amongst investors, which is this idea that you know the supply side matters too. Just because there's an opportunity, it doesn't mean that it will be a profitable thing if everyone at the same time overinvests and there's an overcapacity. This is what happened in the dot-com bubble, this is what happened in the railroad boom. Um, and I think it's happening today, right? So individually, it may make sense for any any company like a Mag 7 to be investing heavily into AI data centers, right? Because they want to capture the market. But here's the thing is that if everyone does it at the same time, you end up in this kind of like uh uh bad equilibrium from a game theory standpoint, where now there's potentially overinvestment into capacity, at which point, this is again what happened in the dot-com boom. A lot of the fiber optic cable was not used, it was dark fiber. And as a result, um, the prices collapsed, um, which would be, I guess, again, good for the early adopters, good for consumers of the technology, but not necessarily good for the builders. And I think that that's sort of what's happening, right? Which is again, go back to the game theory, the competitive dynamics of these Mag 7. Entering AI, before AI, they were in an amazing place. It was basically like an old agopoly. They said, hey, here's all the different markets. There's services, there's like um, you know, search, there is shopping, social media. Why don't we all just like carve those things up and everyone can have their little fiefdom? And then we just we just print money, which is basically what happened. Then when AI came around, it shifted the dynamics such that now they're viewing um, you know, AI as kind of this existential threat where there's only now one market, right? AI is shopping, it is search, it is everything. And these companies basically feel compelled um rationally to compete, because if they don't, then then they're just ceding the market to Sam Altman or somebody else. So they're all going all in on AI. The thing is that they all go all in on AI, it leads to a suboptimal outcome. Um, and I think that's kind of the way that this is starting to play out, um, you know, which is which is concerning. So there's a bit of an irony to all of this, right? Which is that these are the companies building AI, yet are they they are potentially sowing the seeds of their own destruction or their own demise. And again, I don't want to be like too dramatic. I don't think these companies are going bankrupt, but like, you know, from a business quality standpoint, you know, the massive CapEx, you know, going in, you know, we see we see Meta spending over a third of their um you know revenue on CapEx is certainly deteriorating the quality of their businesses. You got to remember the reason why these the Mag 7 are the Mag 7, why they're magnificent, is because they just were able to um create so much free cash flow over the past decade on the back of very little capital investment. These are you know the kind of canonical perfect asset-light businesses, Google search, these sorts of things. You don't have to put much money in and they print. Um now the problem is that they're going into what's basically a utility business model now, where they have to invest heavily just to kind of like, you know, keep um um things without from going obsolete, right? The depreciation um that will start kicking in once these data centers go live is is pretty massive, right? So they're basically now in this treadmill where they're always going to have to be investing just to kind of you know replace these chips that depreciate very quickly. Is that a good business to be in? I mean it's fine, but it's not nearly as good as Google Search.

SPEAKER_00 17:59

You think these um we've gotten to a point where these mag 7 companies are almost too big to fail at all?

SPEAKER_01 18:06

Yeah, I mean, I don't again, I don't think that they're going down. I mean, again, their free cash flows are position is less good than it used to be, right? So they used to have a a lot of free cash flow. Now they're kind of just like um it's basically been all eroded away. Um but yeah, I don't see them failing. They're not they're not leveraging any by any means, you know, Meta's being pretty smart, trying to do some stuff off balance sheet um where they're not 100% um, you know, liable if things go south. So I don't think that even if AI, you know, and I don't think that you or I either either of us believe this, but if AI ended up being a huge bust and it ended up just being kind of like the metaverse or whatever a couple of years ago, I don't think that these companies would, I mean, they would just write off the loss and it's they take a hit and they move on.

SPEAKER_00 18:47

The other part of this is, of course, uh they may not be too big to fail, but they're too entrenched to fail, right? Which is this kind of circular financing thing which you've flagged, which you know, you see people talking about on X, but I feel like we should touch on that because again, from an investment portfolio perspective, um, that seems like a weird vulnerability.

SPEAKER_01 19:04

Yeah, so the circular financing thing is is interesting. This is something that came up, you know, it was a big issue during the dot-com boom, um, where certain companies would would kind of uh finance other companies to go buy their products, right? And and and there's a whole like intertangled web now of companies that include OpenAI, Microsoft, Oracle, Core Weave, all these businesses where you know either they're investing in each other's businesses as shareholders or they're lend lending. And it's a whole, it's kind of a mess. And you know, like I think the the reason this is irrelevant is you know, the the common retort to anyone who's bearish on Mag 7 is, well, look, these guys are cash printing machines with a beautiful with a kind of perfect sterling balance sheets, they shouldn't, they're not exposed at all. But the problem is that that not everyone's like that, right? They're open AI is is certainly not in a, they're very financially constrained, let me put it that way. Um, as is Oracle, as is Core Weave. And to the extent that these companies are now increasingly entangled with each other, it does create some contagion risk that if there's an issue at, say, at OpenAI, that that could affect Microsoft and a few other companies, creating kind of a cascading um, you know, issue. And again, I don't want to like spread too much fear. I don't, I don't think that's going to happen. But I but I do think that the the position of these companies, these large companies, is less good than you know, their than just uh their 10K might suggest.

SPEAKER_00 20:57

All right, let's uh let's flip the conversation a little bit to what's going on today. Um, because with the war, with oil, um everything seemingly correlating the same way, like 2022 all over again, uh there's a lot of concerns about um stagflation. Now uh we don't know how AI integrates uh into stagflationary dynamics, but I'm curious if you have any thoughts on let's say we're in this broader cycle where we're gonna just be like the 70s. Um what does that mean for investment portfolios? What does that mean for the AI uh infrastructure SP 500? And what does that mean for stock picking in general?

Intangible Value And Tariff Resilience

SPEAKER_01 21:34

Well, I don't personally think that we will end up in a stackflationary 1970s-like environment. I mean, if we did, I know what I can tell you what you should do, right? You should go buy commodity equities, go buy commodities. Um, I don't think that's where we'll end up, but again, it's it's hard to predict because a lot of this centers around the Middle East and you know, um the US policy there, um, which is kind of inherently unpredictable. Um, I mean, if you look at the um, you know, the the futures curves for oil and and and and things, it does um kind of price in a normalization um over the next several months. I mean, there are, you know, domestically, Trump has a lot of um a lot at stake. Um, Madure elections are coming up, and you know, it's not popular to be involved in a in a war in the Middle East. Um, but again, like I'm not like a geopolitical expert, it's hard, hard to say. Um, I think the other thing that we have going for us is that is is AI, right? AI is is going to be a deflationary technology. I mean, all technologies are deflationary. Look at the cost of you know, flat screen TVs over time. Time or or whatever, right? These chips get better and better. Um, AI gets better and better. It's already gotten a lot better, as we discussed initially in the beginning of this talk. Um, so yeah, I mean, I think AI will be a deflationary force that will help um, you know, save on labor costs and and other things that can help perhaps push against um issues if they do arise with regards to kind of the the energy um situation.

SPEAKER_00 22:59

And of course, we're obviously not out of the terror uh dynamic by a long shot. Um now you you mentioned that kind of your framework around portfolio constructions around intangible values. Um let's let's get into that a little bit in terms of the current environment, maybe how you know a focus on intangible value from an investment stock picking perspective uh might just result in a very different return stream going forward, how it might act as a hedge against some other dynamics like tariffs, because I think this is where what you have to offer in the marketplace with your funds uh is is important to talk about.

Sparkline ETFs ITAN And DTAN

SPEAKER_01 23:29

Yeah, so look, so basically there's two types of assets that allow companies to generate returns. There are tangible assets like factories and and um you know real estate, things like that. And then there is intangible assets. That's like intellectual property, patents, um, um, like um brand brands or or human capital, things like that. And and these assets kind of like transcend borders, right? Um and so to the extent that, you know, so in April we saw a huge, a huge trade shock around Liberation Day, you know, all these tariffs came up, and then there were reciprocal tariffs, other countries put tariffs on us. And basically what what's happening is we're seeing kind of a uh a devolution of this kind of free trade um globalized world into one that's maybe more regional, right? Maybe it's more trade blocks um in instead. And I think again, I think it goes beyond Trump. I think even if Trump were to lose election and um and the Republicans will lose election, Trump you know, turns out, and we have a new new administration. I think the issues that he raised are just structural issues, right? The way that you know China has taken advantage of certain aspects of free trade. And um, you know, I think that that's here to stay, this idea of a more like um like mercantile um approach towards uh towards trade. Now, here's the interesting thing, which is around the time of Liberation Day, what happened was a lot of investors started to get panicked about um, you know, the the exposure of their companies to other to trade and started hiding in what I call domestic stocks. So these are companies that are like, you know, a utility, let's say, that doesn't really rely on trade with any other country. At the time, I thought that was concerning and I did some research. And what I found was if you imagine there's two types of companies, there's domestic companies and then multinational companies, um, they're either exports or export exporters, importers, or or both. It turns out that basically all the returns of the stock market over the past several decades has been driven by these multinational companies. In other words, globalization is good for capitalism. Why? I mean, there's so many reasons why. You can, you know, you get cheaper labor costs, you can access bigger markets. There's a selection bias. You know, all things equal. If you are a, you know, a really um well-run company, you want to play in the big leagues and compete against companies in China and in Europe. If you're less of an A player, you kind of hide in your local market. And so these are the stocks that you want. This is kind of what I call capitalism's golden goose, these multinational stocks. Um, but the problem is that they are, you know, of course, exposed to the kind of um whipsawing effects of you know, tariffs up, tariffs down, trade up, trade down. Again, highly unpredictable um situation. Um, and and that's where you know another dimension is quite interesting, which is you know the intangible versus not tangible or um intangible component. So, you know, obviously to the extent you're trying to ship goods back and forth over a border, yeah, customs will stop you and it will slap a tariff on you. Um, but they can't do that to intangible assets. Intangible assets, by definition, there are they kind of transcend borders. And so what I found is that come is that you know I focus on owning companies that are both multinational, but also are more intangible in nature. Um they tend to be less um exposed to you know the whims of um you know kind of trade policy.

SPEAKER_00 26:41

And you've got uh two specific funds on that. So maybe touch on uh what those funds are.

Why International Lagged Intangibles Matter

SPEAKER_01 26:46

Yeah, so I have two ETFs. Um the original one is called ITAN, it's a Sparkline Intangible Value ETF that owns um US large and mid-cap stocks um that are undervalued on our models relative to these four intangible pillars, which are intellectual property, brand equity, human capital, network effects. Um it's a value fund, right? We're always looking for the most undervalued uh um stocks. But what I like to say is it's it's it's value for the modern era. The portfolio composition is very different from a traditional value fund, which might own more banks or industrials, and instead tends to own companies that say have, you know, through IP, you know, or maybe in the pharmaceutical or healthcare industry, or perhaps in technology or communications. Um much more modern sector exposure, um, but still paying attention to valuation. So it's not a not like a traditional growth fund, which will just kind of buy things and then you know have a hard time figuring out when it needs to be sold. And then we have a second fund called DTAN, which is the um international version of ITAN. Um this is the exact same process, but it invests in a starting universe of non-US developed market stocks. So that's like Japan, Europe, um, you know, Australia, Canada. Um, and so it's kind of the sister fund to ITAN in in the US.

SPEAKER_00 28:05

We know that um uh most investors uh are massively underallocated to international. And it's beyond just home bias. It's like it makes sense. International is not performed, so you know why should money chase what has not done well? Um from a forward-looking perspective, uh, what are your thoughts? Do you think we're in a cycle where international does persistently? And that's the key word, persistently outperform the US.

Where To Read More And Closing

SPEAKER_01 28:30

Yeah, look, I mean, I think you have to step back and ask the question of why has the international stocks underperformed? And so I did this analysis, and you know, a lot of people say that that US stocks outperform because their valuations have gone up. I actually don't think that's the case. I think what's happened is it's more that's a second-order effect. I think the thing that really happened was that the fundamental growth of US stocks has been robust the past 15 years, whereas the fundamental growth of non-US stocks has been pretty tepid, right? In kind of inflation adjusted US dollar terms, basically zero real earnings per share growth for non-US stocks, which is pretty pitiful. And as a result, you know, the investors have rationally said, well, if this, if they haven't, if they've been dead money for 10 years, they'll be dead money for the next 10 years. And that's what has led to the valuations. So in my mind, the valuations are kind of a second-order effect. And the the primary driver is uh is the question of fundamental growth or growth growth in earnings per share. Now, I studied this and I looked at uh the question of why is this the case? And you know, my lens that I developed is this idea of intangible investment, right? What companies are investing in intangible assets through RD, through sales and marketing, through human capital development. Um, and you can look at this both at the company level, but also at the country level. And so I did this interesting analysis. Think of a scatter plot, or look at all the different countries um, you know, throughout the world and then rank them on their starting level of intangible investment, say 10 years ago. And then um on the y-axis, I looked at how much was our subsequent um earnings growth. And it's just like really strong correlation, like a really strong relationship here where you know companies that invest countries that invested more in intangibles, they ended up having more growth, like the US. And those that invested less had less growth. And lo and behold, you know, the average European or non-US country has just been underinvesting in the um in intangible assets, which are of course what drive um earnings growth in the modern economy. So that led me to think, well, all right, so maybe the index is not like the best place to look, right? We all know, say, the EFA index is about is about 150% of the non-US index is um industrials and banks, or banks, you know, or one third industrials with a second, um, you know, which are not necessarily the most exciting companies uh or sectors, but not the most dynamic. Um so I said, you know, what would happen if we instead of looking at just the index, we were to decompose it into different components on this lens of intangible investment. Like if you're with me and you say intangible investment is kind of what drives growth, why don't we just buy the intangible intensive companies within the index? Right. And that that was kind of the research that led to you know what I'm doing on the strategy side. And yeah, it turns out that that portfolio looks a lot more like the US companies, right? So the thing is that it's not, you know, the way I always say it's it's not a US versus non-US thing. It's a intangible economy versus non-intangible economy thing. Like that's the dimension on on which everything has split. Um, and it just so happens that more US companies have levered themselves to the intangible economy and fewer European and Japanese ones have. But that doesn't mean that everyone's in that category. Of course, like, you know, um ASML, TSMC, there are companies that are very integral to what's gone on with AI, for example, um, outside the US. Um, and and um, you know, it I I think so I think it it it I think the key is that if you're willing to be active and you're willing to, you know, not just buy the cap-related indices and instead kind of skew towards you know where you see quality, where you see value, um you can do just fine outside outside the uh US.

SPEAKER_00 31:52

A lot of good uh topics covered here. We're gonna do another uh uh series of these podcasts because a lot of stuff I want to talk about with Kai here, uh given his unique uh way of looking at markets. Um for those who want to uh get access to your investment letter and maybe just learn more about the funds, where would you point them to?

SPEAKER_01 32:07

Yeah, just just go to my website, sparklinecapital.com. Um I have there posted um you know all my past research papers, many of which um we discussed today. You also have the option to sign up to the newsletter for free. Um and if you want to look at the funds, there's a separate link off that page to the ETF website.

SPEAKER_00 32:26

Appreciate those that uh watch this. So this will be an edited podcast on the lead lag live. And yes, it is live, folks. So I hope you enjoyed it. Uh make sure you follow Kai on X. Follow me as well if you don't already. I you might be annoyed by some of my posts, but I promise you you'll at least get some entertainment out of it. Uh Kai's is much more thoughtful than I am in the post. So uh thank everybody for joining, and I'll see you all in the next uh episode. Thanks, Kai, appreciate it. Thank you. All right, cheers, everybody. Okay, give it a second.