What our five years of blather regarding advantage flywheels is all about.*
From Yahoo Finance, July 8:
It pays to be big. And it's a good time to be on team growth.
A key insight from recent years — from the pandemic crisis through the "Liberation Day" turmoil — is that the most well-capitalized and growth-oriented names are outperforming their counterparts.
Investors who tend to favor small-cap and value stocks, because of their time horizon, risk appetite, or other preferences, might point to earlier periods of trading to show the merits of their strategy.
Last year notably featured glimmers of a small-cap revival.
A broadening of the stock market rally, optimistic economic forecasts, and expectations of Fed rate cuts bolstered the case for the double-A and triple-A tickers that don't always get the major league limelight.
But the call for small caps turned out to be short-lived, ill-suited for the trade conflicts of 2025 and the wait-and-see posturing of the central bank.
In fact, the performance gap between US large and small caps has widened considerably over the last two-and-a-half years, according to a new analysis by DataTrek co-founder Nicholas Colas, who wrote in a recent note to clients that the duration of the relative outperformance suggests it's structural rather than cyclical.
"Relative return data suggests that there is a 'new normal' at play in US stock markets, one where large caps and Growth have the upper hand versus small caps and Value," he wrote. "Moreover, enough time has passed that these differences look durable rather than being temporary anomalies."
Big Tech's steadfast march to higher valuations has played a major role in the stock market's lopsided behavior.
But the growth of the Magnificent Seven is only part of the story....***...While a broadening rally hasn't unfolded in the way small-cap proponents had hoped, the spoils of AI excitement have flowed to many other players aside from the mega-rich tech platforms. As my colleague Josh Schafer has reported in this newsletter, AI chip and data center trades not named Nvidia (NVDA) have posted some of the highest gains in the S&P 500 (^GSPC). Investments in AI energy and cloud tickers have payed off too....
This is a corollary of the basic framework for understanding businesses and investing that we've been pitching for the last six or seven years.
If interested see:
Why Do the Biggest Companies Keep Getting Bigger? It’s How They Spend on Tech"
...Much more important than the direct monetization of big data is the strategic advantage it can bestow over time.
In a winner-take-all economy, as in a horse race, small differences in superiority are rewarded all out of proportion to the actual advantage. A top thoroughbred may only be a couple fifths of a second faster than the field but those two lengths over the course of a season can mean triple the earnings for #1 vs. #2.
In commerce the results can be even more dramatic because rather than the 60%/20%/10% purse structure of the racetrack the winning vendor will often get 100% of a customer's business.....
In Nvidia's World, If You (and your company) Don't Have Money You Will Not Be Able To Compete (NVDA)Competitive Advantage and Feedback Loops
How to Think About Companies: 'Advantage Flywheels'
A very handy conceptual framework first posted after the start of the U.S. lockdowns, April 2020. Schools were closed so it seemed natural to link to a superb mini-MBA module.
Eat your heat out HBR....****....As artificial intelligence comes more and more to the fore, the advantages accruing to those companies that can afford to make use of their data and custom train the machines will act as advantage flywheels that shift the distribution of profits from the normal Pareto: 80% of the loot goes to the top 20% of businesses to perhaps as much as 95% of all the profits going to the top 5% of businesses.I didn't really mean the "eat your heart out HBR" line.
Here's the Harvard Business Review on this very point:
HBR—From Pareto To Hyper-Pareto: "AI Is Going to Change the 80/20 Rule"Flywheel Effect: Why Positive Feedback Loops are a Meta-Competitive Advantage
"America's Biggest Firms' Moat Is Becoming Impregnable" (TSLA; NVDA; GOOG)
The announcement at the end of August that Tesla was going live with their supercomputer — Elon Got Himself A Supercomputer: "Tesla's $300 Million AI Cluster Is Going Live Today" (TSLA)—reminded me of this piece at ZeroHedge, last month. We'll be back with more on Morgan Stanley's Tesla note later today but for now the TL;dr is "To the victor go the spoils" or "The rich get richer" or "Those who can afford a supercomputer will get closer to discovering the profitability (if any) of AI than those who can't afford a supercomputer."
The advantage flywheels keep spinning and reinforcing each other to the point that the Pareto distribution of profits - 20% of companies reap 80% of the profits - is becoming Super-Pareto where 5% of the companies reap 95% of the profits and is approaching Hyper-Pareto at maybe 2% of companies reaping 98% of profits.
It all comes down to having the resources to keep up.
I watched Mr. Huang give the keynote and it's all a bit much to digest before firing out comments that would make any sense at all so here are some of today's headlines to give a taste of what the intro paragraph is based on.
These are Nvidia's press releases via GlobeNewswire....
This.
This is such an important concept to grasp. It's the advantage flywheels, the rich get richer, winner-take-all reality of business in 2024....
The Hyper-Pareto Distribution Of Profits Is Happening Right Now (plus an anniversary)
It's not some cutesy management* fad or pop insight like "Business secrets of Genghis Khan."To the rich go the profits and internalizing that fact makes the rest of this portfolio construction/fund management/investing stuff easier to conceptualize and execute.
And AI is accelerating the already extant dynamic....
*Although people had been observing and discussing "rich get richer" and "winner-take-all" dynamics for over a century, one of our favorite pointers toward the current situation did come out of a business school. We've been hammering on this for so long that I start to bore myself. Here's a recapitulation from last year, linking to an article that was published seven years ago today:
HBR—From Pareto To Hyper-Pareto: "AI Is Going to Change the 80/20 Rule"
A prescient article from the Harvard Business Review, February 28, 2017:....
*****
Just to reiterate, every incremental advantage that a company can afford does not affect income production in isolation. They accrete in sometimes unforeseeable combinations:
AI: Tesla Installing Second Dojo Supercomputer In New York Gigafactory (TSLA; NVDA)
AI: "Inside Tesla’s Innovative And Homegrown 'Dojo' AI Supercomputer" (TSLA)
It really is a big deal that a company can afford to spend over a billion dollars to build their own supercomputer and it really is a big deal that the same company has all the training data from the billions of miles of real-world driving and it really is a great example of the concept of advantage flywheels and hyper-pareto distribution of rewards, i.e. the rich get richer.
Whether it is going to open-up the $10 trillion addressable market and add the $500 billion of market cap that Morgan Stanley foresees is still an open question....
....As artificial intelligence comes more and more to the fore, the advantages accruing to those companies that can afford to make use of their data and custom train the machines will act as advantage flywheels that shift the distribution of profits from the normal Pareto: 80% of the loot goes to the top 20% of businesses to perhaps as much as 95% of all the profits going to the top 5% of businesses.
I didn't really mean the "eat your heart out HBR" line.Here's the Harvard Business Review on this very point:
HBR—From Pareto To Hyper-Pareto: "AI Is Going to Change the 80/20 Rule"
And many more. If interested use the 'search blog' box, upper left.
