Chatphishing, veracity and “two years of chaos and a reset”

Danny Crichton:
So, we have the new tagline, is Securities is a global community of engineers, scientists, and capitalists who are empowered by Lux Capital to construct and defend the future of humanity's prosperity. Hello and welcome to Securities, a podcast and newsletter devoted to science, technology, finance, and the human condition. I'm your host, Danny Crichton. And joining me today is Lux Capital's Josh Wolfe. Josh, welcome to the program.

Josh Wolfe:
Danny, great to be with you, as I am almost every day.

Danny Crichton:
And you were able to sit down in your chair after multiple basketball games. I hear your musculoskeletal system is more upright than sitting down these days.

Josh Wolfe:
The hamstrings, there's a mechanical system between the muscles and the bones. And they don't want to work together.

Danny Crichton:
Well, welcome to the program. And we are talking about a very important document in our world, which is the end of year quarterly letter. Yes, both a reverse and rewind of 2022, but also looking forward into 2023. And I just want to talk about a couple of things, because I think the global macro picture, some of the stuff we're seeing on the frontiers of science technology. So, I'm going to actually start at the end. You concluded the letter with a line that said, there are plenty of famous investors and thinkers to listen to for where the world is headed and where one might wisely allocate capital. The teacher better than Warren Buffet or Howard Marks, whoever, may well be Xi Jinping, the Chinese president. Why did you say that?

Josh Wolfe:
When you look back over the past seven years, there was this evident pattern, which was all of the capital in the U.S. which saw the greatest growth and the greatest returns went into SaaS and growth companies. And those SaaS companies were primarily focused on things in software, ranging from social media to fintech, to logistics, to mobile, to banking. And when you zoom out and you look at China over the past seven years, it's clear that Xi Jinping, beginning about 7, 8, 9, 10 years ago, said, "Everything in this sector, we will allow to grow and prosper." And in fact, you had Tiger and you had foreign investors coming in and standing up groups like JD and Alibaba, and ultimately Alipay was going to spin off an IPO.

And what ended up happening is all of those companies became the champions inside of China. And almost every founder or CEO running those companies got to about $10 billion. And to be precise, I think it was $9.9 billion, any further upon which they were basically decapitated. And you would see these situations where they were going to spend time with their family or you would see Jack Ma. But as a former Intel chief in former CCIA, a head in Asia had shared with us that you will see Jack outside of the country. You might see his family outside of the country. You won't see Jack and his family outside of the country.

And so, it was just very clear that there was a motive in the permissiveness that Xi Jinping gave to these sectors. And it happened to be parallel and correlate with global growth around these sectors. And venture capitalists and growth investors made a fortune over the past decade doing this. But if you look at what has happened over the past few years, and with great surprise in some sectors like edtech or fintech, where Xi Jinping has basically said, "This is done, this common prosperity era. Thank you for capitalizing these sectors. Thank you for producing these tools, whether they are AI tools or e-commerce or web or logistics. Thank you for providing tools that the state can further use for surveillance and coercion."

But now the things that are going to matter are going to be different. And those things are going to be semiconductors, biotech, aerospace, defense, satellites, the hard tech and deep tech sectors. And so, if you follow that, as you might have followed seven or 10 years ago and made a fortune basically doing what Xi Jinping told you to do, I believe that, over the next decade, the most winning sectors are going to be these hard tech sectors globally because you're going to have to compete with China and parallel systems that Chinese competing over the rest of the globe for market share.

Danny Crichton:
Well, you've seen the VIPKid, a huge ed tech company in China that went bust and a bunch of others. And I think the pattern here is you're seeing a massive shift of capital allocation, both at the state level and state-directed enterprises, as well as in the startup community, where, as you're pointing out, you're going from the social sciences, these services we need in everyday human life, finance, education, etc., into the hard sciences, these longer-term projections. And it's not so much that Chinese money is going to show up here. It's not going to trigger itself that this Chinese capital is emerging in America to fund these companies. It's the competition between the two. It's going to trigger more U.S. investment here. It's going to force the U.S. government to invest, as we've already seen with the CHIPS Act, with the Inflation Reduction Act, which we've not seen that sort of investment from the government in decades.

Josh Wolfe:
Yeah. In fact, of course, China is notorious for its five-year plans. And they have had a clear shift from made in China to invented in China. And the thrust of pulling back engineers and scientists to build back in China is something that is very profound. Now, interestingly, at the same time and in recent years, you're seeing an outflood of really talented rich people who are trying to keep their money. So, they're going to Singapore. They were going to Hong Kong. Now, they're leaving Hong Kong, as that becomes closer to China. They're coming to the U.S. They're buying real estate in New York, marquee and prized properties. Their kids are going to Stanford.

There's this signal from this monarchy magisterial might that comes from Xi Jinping that says, "This is what we are going to allow to get capitalized and build up. This is where the money's going. This is where we want to celebrate and encourage talent." And in fact, when you think about what cultures get, they get what they celebrate. And Xi Jinping has been celebrating with media, basically an admonition from the government of a Netflix-like show that celebrates this protagonist that was this former intel engineer who comes back to China and builds up the semiconductor industry. We are sitting here and we're celebrating the Kardashians and Kanye, or at least their rise and their fall, and they are celebrating the next great entrepreneurs. And I think that that is a cue for us.

Danny Crichton:
Or folks at the Oscars getting slapped, and then their follow-on standup comedies as part of a dialogue of culture. But one of the themes that you have in the LP quarterly letter is this concept of open cultures versus closed cultures. And specifically, you say open cultures with free speech and systems of error correction via conjecture and criticism allow themselves to update their priors. And we call this progress. Do you think that the U.S. has the best open system? Is it in the right place? Is there good parts, bad parts? [inaudible 00:06:14] as the old quote goes, democracy's the best system, the worst system compared to all others.

Josh Wolfe:
I do think we do. I think that we have to be constantly reminded every generation of the virtues of free speech. There's a lot of people out there that I think are utter idiots. There are a lot of people that I wish would just be quiet of it. I actually think, and I don't like Trump, I don't like anything he says, I think he should be on Twitter. I think that people should be allowed to hear him. And I think that, in the arena of ideas, his idea should be out there. And idiots can follow it or believers can follow it and you could beat him down. This goes back even to some of the stuff around censorship and cancel culture. 10, 15 years ago, I can't remember the exact date when you had Lee Bollinger at Columbia who had actually invited Ahmadinejad from Iran to come and speak at the school. There were protests from the American Jewish community, from Israel, from people that were anti the despot that was Ahmadinejad.

And he said, "No, no, we're going to put them on stage. And I'm going to destroy bad ideas that are beaten by better ideas." And that was the right way. That would probably be met with total cancellation today. But I think that systems that invite bad ideas and let them get destroyed. So, I do think that you want systems that are open. You want systems where people can have conjecture, where that conjecture can be vigorously criticized and people can change their mind. And that's what should happen in the marketplaces of science, of stocks, of political ideas. In science, people have conjectures, they have ideas. You want to have free speech. Yu want to have ridiculous, absurd ideas, no matter what their source is. And then you want peer review motivated by the animus of the pursuit of ambition and squashing somebody else's rise as an alpha male or female.

And that is how you get scientific progress. In markets, you want things that trends towards truth. And we have promoters and hucksters and people that are able to get stocks up. And that can last for a long time until the fundamentals are actually analyzed. And any rigorous return to people that can read 10 Qs and 10 Ks and look at financial statements and say, "Wait a second, this is a terrible business." And eventually, people might agree with that, but the persistence of all kinds of things that are irrational will always have false beliefs that get adherence and believers. But I do think that the best systems are ones that are open. They're subject to criticism. They're subject to absurd ideas. They invite them. And that's how we get progress.

Danny Crichton:
I'm thinking about the Bed Bath & Beyond and what may be better called Bed Bath & Bankruptcy. But one of the questions, so we had a great episode last year with Danny Kahneman, Annie Duke, Michael Mosson talking about decision-making, pre-mortems, a whole bunch of different topics. And one of the most striking and definitive statements that Danny made was this concept of no one ever changes their mind. Yes. And so, isn't there a little bit of, we want these open cultures, we want good debate, we want Oxford style, but then no one ultimately, theoretically, at least according to Danny's point of view, ever changes their mind or their way of framing different issues. That once you've made your decision, if you've not made a decision, you're open to different interpretations. Once you've committed to some action plan, you never get out of that all. Do you think that that gets corrected in all these systems?

Josh Wolfe:
There might be a slight nuance to what would be interpreted as Kahneman's nihilism, the futility of objective facts that can act or imprint upon us to change our hardened views. I actually think that one of the things that he associates with that is the idea that the reason that we believe the things we believe is not why we think we believe those things. In other words, the reasons we would give for why you hold a position might be grounded in all this rigorous logic that we think. But in fact, it's because the three of you are my best friends and you have influenced me and I want to be part of this tribe. And so, I might come up with other ideas and you can get into whether this is left brain, brain stuff, and the storytelling aspect versus the rational, fundamental analytical self. But the reasons that we say we believe something are often just not the real reasons. It's often very much the social primate social proof, the peer pressure being part of a tribe, identity politics and not wanting to skew from the party line.

Danny Crichton:
One of the points that you're making with the open cultures is this concept of reconsideration, that there are these intrinsic notions of technology of society that need to be reconsidered today. And you gave a couple of different examples. What were some of those?

Josh Wolfe:
Well, anytime you have a dogmatic system, so something that basically says you cannot question this, by definition, you can't change. It's fixed. And so, hardened Iranian clerics. In contrast to that, if you look at actually the Japanese and the Amish, it's actually quite interesting. The Amish are very protective of their culture, but they're not as one might caricature them totally against technology. They actually like to really investigate it. And they have almost a small experimental group that looks at, what are the implications of this if we introduce it and use it?

And so, they're slow to adopt it, but they adopt it. The Japanese, and again, I'm caricaturing here in a broad brushstroke, will actually value the simultaneous preservation of the old culture with the modernization and introduction of new tools that's adapted. And so, it's much more of a living organic preservation of a culture that's evolving. The Amish is a little bit more, "Hey, we're not totally against everything, but we got to be really careful as we adopt it." It's more of a precautionary principle thing. Whereas, you have other hardened, mostly religious societies that are against, in a very dogmatic way, updating their priors. Because to update a prior is to somehow point to the vulnerability of that prior belief, that it's not with the authority of a deity or some other religious authorities. And that's a very vulnerable thing, because once you allow one thing to be questioned, then suddenly you allow the entire canon to be questioned. And that's a position of vulnerability.

And one of the examples we gave in our own country in the United States here was the gas stove. This was great controversy. In part, this is a simple technological thing. I do believe that we will look back, and I don't know if it's in a generation or two, it will take time, and we will say, "I can't believe that we actually had fire in our homes and we had pipes that were pushing natural gas, taking these fossil fuels so that we could spark electricity and produce fire so that we could heat things. It's almost barbaric and caveman-like."

And the idea that you now have electric stoves or inductive stoves, we readily embrace the virtues of getting rid of the ice, the internal combustion engine for an electric car and being able to have propulsion in a way that doesn't burn fossil fuels. But suddenly, the idea of having a gas stove replaced by an induction stove became this religious political ideology. The same emotion that it evoked was the don't-tread-on-me crowd. You're not taking my guns. You're not taking my gas stoves. This is mine.

And so, that itself goes back to condiment of the loss aversion phenomenon and people not wanting to actually lose something that they believe that they have, something that could be taken away from you, and the possessiveness of that. But this sparked, pun intended, a firestorm online, the idea that the country might actually invoke at some point a ban on gas stoves inside of homes leading to a widespread introduction of induction or electric stoves. And people went crazy.

Danny Crichton:
Well, I have to say a couple points. One is I do have an air pollution monitor at my house. And one of the amazing things that I learned, just by having this installed, is when I turn on a gas stove, called traditional natural gas-powered stove, the scale at which you go from clean New York air, which New York outside of the streets is actually quite nice, from an AQI perspective, and you jump to New Delhi in about four minutes, small apartment.

Josh Wolfe:
Inside your apartment?

Danny Crichton:
Inside the apartment, the pollution is going from 30s to 500. You can see the PPMs and the PPVs for the VOC chemicals just skyrocket. And we have graphs from the device. And it is just a line straight up into space, because all of those fumes flow into the house. And like most New York apartments, there's no actual external ventilation. And so, all those gas particles are just literally floating the house for hours. And because it's a newer building, which was designed to be green and we're supposed to be healthy, now, it's an unhealthy building for the people actually inside it because there's no airflow. Because in order to limit the amount of damage for HVAC and AC, there's no flow from the outside. So, it'll actually stay for 10, 12 hours inside the home.

And so, one of the interesting things I took from that was, when I first heard that we were going to be mandated to have electric stoves, I was like, "God, a very, no, don't tread on me. I like my fire. I want to turn it on and I want to see a flame, that blue glow.

Josh Wolfe:
Danny is going to be the Charlton Heston gas stove, "not my cold dead hands.""

Danny Crichton:
12 burners.

Danny Crichton:
And then you do the work and you actually go into this. And what I learned from the whole process is there is a classic technology adoption curve, which is, and you can get into induction, you have this image of 1980s dorm room style stoves that are ancient history. The modern induction stoves, yes, do require a little bit of change of techniques of cooking, etc. But the amazing thing is they're actually so much better. They actually can boil water so much faster. They're so much more efficient. You can use pots much longer because there's no damage to the enamel or whatever the actual case. They're actually better at almost every factor, with one exception, which is Asian food, which is if you want use a wok, the wok is a huge gap. That's fine. Most of us do not have a wok in the house. It's interesting, the wok is actually a obsession. I'm not somebody that cooks, so talk about the pot calling the kettle black. I don't even know what the difference between a pot and kettle are. I know how to order sushi and pizza.

Josh Wolfe:
Sam D'Amico, who's the founder of one of our Lux family companies, Impulse Labs, is obsessed with wok cooking. But he is the guy that is creating what is the first product introduction, which is this inductive stove. But his secret plan is, is there a way to get high-battery storage appliances throughout the home so that you can trickle charge throughout the day and then flash release or discharge as you need to be able to boil water very quickly or do all kinds of things that you might not otherwise have been able to done with natural heating elements. And I think that, over time, he's going to win.

Danny Crichton:
Well, and look, he's done obviously demonstrations here, but it's one of the most amazing things is when you go from the seven to 10 minutes it takes to boil a pot of water for your pasta. The pasta takes 10 minutes to cook, but it actually takes 10 minutes to set up the boil. Watching it actually go to boil in 75 seconds, scintillating. It just goes instantly. You start watching the bubbles and you're like, "Holy, you actually save so much time." And that's the experience that makes it so hard. Now, the question is, do people already prejudge entire class of technology before they even tried it?

Josh Wolfe:
Yes.

Danny Crichton:
And that to me is fearful. Let me pivot the conversation to another topic. You have this frame about the investments that we're making and the thesis going into 2023. The SaaS world has declined over the last couple of years. Many of our friends in the industry are suffering from, you have a great term for this, the highs of highs and the lows of lows, as the multiples of a compress in SaaS. But over here in the hard sciences, you have these three-partite frameworks, this open space, latent space, or inner space getting that out of order. Tell us a little bit about that and why that theme matters so much in 2023.

Josh Wolfe:
Well, as with everything we do here, we try to put some narrative framework around it so that it sticks internally, and then we share that with a little bit of externally with the order.

Danny Crichton:
I screw up.

Josh Wolfe:
No, no. But that's right, it's inner space, it's outer space, and it's latent space. Inner space is biology and biotech. And there really is just an absolute flood of brilliant biologists, brilliant computer scientists, many of them meeting for the first time. I have seen more people in AI and ML more interested in, how do we do protein and drug discovery, protein design, drug discovery? How do we do generative biology, which is a really exciting area? Way more than they're concerned about the next chatbot or the next generative photo or image or even video design where we also have assets and portfolio companies that are doing that.

So, the intersection of computer science and biology, I think, is just a fertile area, lots to be discovered. And there's all kinds of amazing things where we learn things in biology that then inform computer science models, which then inform biology further. My favorite example of this most recently is the idea that the architecture of neural nets, which originally came from kahal and the hierarchical structure of neural nets, inspired the computer design for these nodes of how you wait and do back propagation or convolutional neural nets, which unleashed all the fury that we see today.

That then ended up inspiring at least one researcher, Erik Hoel, who I think very highly of as both a writer and a scientist. He's done a lot of work on theories of consciousness. To look at some of these models, how they're being trained in AI, and he said, "Wait a second. If you train very narrowly on something like a dog and then you show it a chocolate chip muffin, well, it might mistake the chocolate chip muffin for a dog."

So, if you introduce noise into the system, which is one of the key tactics that researchers use, you improve the predictability of the system. Now, that's very not intuitive. Introduce noise into a system to actually make it better? Well, it turns out that inspired a hypothesis that he had, which was the overfitting brain hypothesis explaining why we might dream, the idea that you're training on something every day, you're receiving stimuli, you store that stimuli in memory. If you just had rote memorization of those things, when you encountered something the next day that was slightly different, you would be less adaptive than the person who, maybe, introduced noise into their dream and had some weird variation of that, making them more prepared.

So, it's a very interesting hypothesis, but more interesting is how something in biology inspires something in computer science, which then inspires something in biology. And we're seeing a lot of that. And so, everything from people doing 3D modeling to doing 3D modeling of proteins, figuring out binding sites and looking at mechanisms of action inside of cells, I just think that computer science and biology, which we call broadly, this idea of inner space is really powerful. So, that's number one.

Number two is outer space. And outer space for us is aerospace and defense. It is the declining cost to launch per kilogram. It's people that are designing things that might be manufactured out in space that has a high cost per kilogram that would justify making it there and bringing it back. It's earth's surveillance, observation, communication, and all of the geopolitics that is associated with that. We are going to see real-life Star Wars. And they will start relatively benign. "Oh, I've got to move this weather site, this weather satellite. Oh, sorry, we had to make sure that we blow up this other space asset so that there wasn't debris." And there's going to be a lot of conflict in space.

And then the third one after inner space and outer space is latent space, which is, again, AI that we're talking about, and AI far beyond the Chat GPT-3 and a half or 4 models that are coming. It's really looking at new conceptions as you go back, even from the early days of neural nets to today, what are the next generations? We did a little bit of talk about this in preview with Gary Marcus in a recent episode, but that's an area that's just very exciting and how it touches every industry that you can imagine.

Danny Crichton:
Well, both Gary Marcus, and then last week on a previous episode, we had Grace Bert here talking about some of the stuff with AI, the AI Film Festival. And I know you go to a lot of the film festivals. The ability that we have today to generate original techniques here. And Grace and I talked about the difference between special effects and AI. And it really feels like we're going from an evolutionary to a revolutionary improvement. We're not just getting little bit better effects that we've seen over the last 30, 40 years, from Star Wars all the way into Marvel. But now, you and me can actually go into the studio, and Chris, our producer here on Equity... almost said Equity. Wrong podcast, Chris.

Josh Wolfe:
Equity is a form of security, ergo, security, modus tollens.

Danny Crichton:
But Chris just got a license to Runway and is playing with it. And it's just like your ability to just produce something immediately out of nothing is incredible. And you and I were just talking about your fears about AI bots and the internet. We can talk a little bit of that.

Josh Wolfe:
Let's start with the premise, which is all of these technologies, as they progress, democratize, meaning something that was once very expensive and only in the hands of a very few suddenly becomes very cheap and widely accessible in the hands of nearly everybody. And so, Hollywood effects studios, you had to be a Weta or a George Lucas or a James Cameron and you had the ability to commandeer a 50 or $100-million budget and you would have the best designers in technology and the cutting-edge stuff, and you'd take the guys and put them in the green room and you put them in the black suits with the white dots and you'd do the tracking and all this crazy technology, all of that is becoming obsolete. You can, on your laptop today, do special effects that Avatar was doing 20 years ago. Was that the first Avatar? And Terminator before that. Yes. The morphing that you saw in those early Michael Jackson videos and then in the Abyss and then in Terminator, all of that today is child's play.

And so, the rotoscoping techniques that used to be extremely expensive are now virtually simplistic at the touch of a button from a browser in something like Runway ML. So, all of that is democratizing the ability to produce content. If you extend that further and you think about all the different modalities of producing content, text, image, video, voice, pretty much anything that is an output today, it is all becoming democratized. And there's many competing programs that are allowing you to do this.

So, let's look at a natural progression. We always like to spot here at Lux the directional arrows of progress. And I'm just going to give you some anecdotal ones. You can find other adjacent ones. You go back a few years, Google introduced, for those that were using Gmail, simple auto replies, things that were the statistically or most probabilistic responses, given the context of the email without fully reading all of the content of a good reply. You write me a note, "Looking forward to seeing you on Tuesday." It gives me three choices, "Okay. Great. Looking forward to it." I picked the third one, "Looking forward to it." It's a little bit more human. And some percentage of your emails today can be very quickly dismissed with these auto replies.

Now, fast-forward to today, you are on the cusp of Microsoft releasing something called copilot, which is a different thing, not just for co-generation, but introducing Chat GPT into a variety of Microsoft products. What are the vast majority of enterprise people use Microsoft for? Not just obviously to conduct daily work, but marketers and salespeople.

So, it's easy to imagine that we will be flooded not by the Nigerian princes for whom we might wistfully wish we were once receiving emails again from, but just troves of marketers who are now suddenly way more productive and efficient. Their ability to send out, not just hundreds or thousands of emails using a CSV, meaning an Excel spreadsheet equivalent, with lots of people's names and contact that's uploaded into a CRM, a customer relationship management tool, like a Salesforce or something in Microsoft. But now they can send it to tens of thousands of people. And people might reply or delete, or they can follow up. And all of that can be basically actuated and activated automatically.

So, we're going to get a lot more spam, but we won't be able to tell it's spam because it might seem like it's a very customized personalized message. It might be taking stuff from my Twitter feed and be like, "Hey, saw your thing. Really liked your comment on this. I also blah, blah, blah," and all that could be fake. So, over time, you start with these auto reply messages from Gmail. You go into enterprise, basically blasts of what I coined the neologism this week, I call chatphishing. I looked online. There was no mention of chatphish, so it may be the first coinage of it. But the idea that these things are basically going to be phishing for people and trying to wheel them in. Well, the next thing you see these early incarnations, whether it was the Steve Jobs podcast with Joe Rogan, which wasn't a real one, you could tell it was tinny, it was low quality. There was another one recently of a video of Leonardo DiCaprio that was giving a speech at the UN. There were five or six different voices that were put into him. They had Bill Gates. You had Elon Musk, Steve Jones. It became more believable. And it was quite impressive.

Now, if you segment that by demographics, if you're an old person that receives a call, and we already have indications that this is happening, those robocallers are not the classical pause, "Hello, hello?" And then it's like, if you're calling about your insurance, people are going to be exploited by these systems. So, where does that lead? You start with these auto-generated emails. You go to widespread marketing spam and chatphishing. You get voice calls, where you might actually even be conversing with the other person on the other end, thinking it's an actual human. And it's believable enough and conversational enough that it passes the equivalent of a relatively low-hanging fruit Turing test.

You might even be able to program some of these things for enterprises to have some parameters in which they can negotiate some simple things of, "We'll take up to this price or below this price," and let it actually negotiate on your behalf. And it probably will effectively. I see that happening within a few years, where bots are negotiating with people, and then ultimately bots are negotiating with bots.

The logical extension of that, to me, is two things, thinking about abundance, think about scarcity. If all of that stuff is abundant, go back 20 years, with the democratization of text and blogs and ultimately Twitter and Facebook posts and all this stuff, the thing that became abundant was the information on the internet. What became scarce was the ability to find the thing ergo search. Now, whether that was Google or Look Smart or AltaVista or Yahoo, I don't know. Who the winner was in hindsight, obviously, we know it was Google. But you knew that search was going to be the scarce and therefore valuable thing. Today, with the abundance, not just of information, but misinformation and fake things, what becomes scarce is veracity, is truth.

So, it leads me to two things. The first is a natural reaction akin to the fast-food movement, which is a counter movement, which was the slow-food movement. What will I want if I'm being flooded by voicemails that I can't tell are real humans? By texts that I can't tell they're real humans? By Slack posts, by Twitter replies, by emails? If all of the sources of input I'm getting I can't tell are real humans, what am I going to want? Real humans. And so, I'm going to pine for in-person communication like this. I'm going to be able to look at you in the eye and know that I'm actually talking to you, your vulnerabilities, that you're not lying to me, that you don't have a bot at your hand. And so, that's number one. But that's relatively benign. That's a natural reaction to what seems inevitable.

The second part of this, which I was scripting season four of the sci-fi episode here, is again, looking back to history. Ned Ludd, the apocryphal Ned Ludd, it's not clear whether he actually existed or not, but if he did, he was the guy that was going and attacking the looms, these manufacturing mechanical machines that were threatening society that would basically debris the precursors to computers. And ergo, the term Luddites. I think that there will be a group of Luddites who are basically reactionaries akin to 12 monkey violent extremists, the movie 12 Monkeys or Extinction Rebellion, people that feel like something must be done. And they won't listen to us, these capitalists, so we've got to burn it all down. And what do they do? They go and they attack the looms of the LLMs, the large language models. And those are the data centers.
So, Facebook is talking about all the GPUs and all the crazy tens or hundreds of millions of dollars they're putting into these systems. Those become targets, if their location is known. So, that would be the scary phenomenon that I see, that people have such an aversion. Not only do they want human interaction that these anti-technology, anti-capitalist people that actually attack the looms of LLMs.

Danny Crichton:
And that leads into the last subject here, which is the global macro situation. So, obviously, scary times in the Chat GPT, people are going after data centers or going through the LLM movement. I believe that that actually aligns up with an economic recession as well in England, which was not so much on the growth side. People are fine. Generally, when things are growing, people are making more money, people are making more prosperous. But when things go wrong, suddenly these machines that are more productive are taking work away, suddenly become in the crosshairs of all these different folks. And so, you had a couple of comments on the global macro situation going in through 2022 and into early 2023, which is mostly that there was strife in the market, that we expect market conditions to be very volatile with wild chaotic swings. What do you see going forward in the next couple months?

Josh Wolfe:
Well, when you take all kinds of different markets, so let's take the equity markets, equity markets to me, and we've talked a little bit about this in the past, feel like they are Q3 of 2000, range bound, high volatility, meaning that they're not going really high or really low, but in this tightly bound range, but probably declining. And I think that they probably have another 30% down to go. Part of that is, who is the marginal buyer that's coming in? Why is somebody coming in? Well, you're not going to have any more, in my view, of these Cathie Woods and other people that are just thematically waving their hand in the air and being like, disruption and technology and future. So, that goes away. Then, you have people that are basically saying all of these companies, whether they went public through SPACs and there's no fundamentals, or they raise money and they shouldn't be, these guys either go out of business, they get starved, they get sued, but you see a real decline in the number of really crappy companies.

That, then, creates the space, as it did in 2002 or thereabouts, going back as an analogy, 21 years, for long short stock pickers, people that basically were able to identify great companies that would compound and stand out, be the babies that could be saved from the bathwater that were being otherwise drowned. And then great short sellers. And so, people that could pick terminal zeros and fads and frauds and technological obsolescence say these companies have no shot of surviving. And they won't have this phenomenon where you get these crazy short squeezes because you have the meme stocks and the excess capital that's sloshing around the system, because it isn't anymore or as much anymore.

And so, 2002 to 2007, you had the rise of all these now household names of David Einhorn and Dan Loeb and Bill Ackman. And I think we will have the next generation of those people and hopefully a few more women in there. The likes of my wife, Lauren Taylor Wolfe, who's an activist investor, and a brilliant one. And there will be many others who are great compounding long investors and short investors, and we just don't know their names yet.
So, that's on the equity side. But I'm overall constructively bearish that there will be a big shakeout and that the winners will be the ones that can consolidate market position using their stock price or their cash to buy up their competitors and their customers and so on. Bond markets are very interesting, obviously, heavily dependent upon the Fed and inflation and most importantly expectations of what the Fed does and what inflation does.

But the one thing that people have paid a little bit less attention to, macro people are all over it, but most of the everyday people do not is Japan. If Japan were to repatriate assets, and they own high single-digit percentages of equities and global bonds, that would be a sucking sound of securities, securities, not equities, securities, out of the system. So, that would mean you have a spike in yields on the bond side, selling out of treasuries. You would have a decline further and again, maybe 20, 30% on equities. And it would be driven by Japan's own attempt historically to inflate or reflate their economy and then repatriating some of their assets.

So, a lot of smart global macro people have been looking at that. That's not a secret in that space, but it's something that I think is not widely appreciated. But I think that these next two years, you're going to see a handful of companies that end up IPOing. People will look at those as false signals and say, "These guys just went out. That's the comp for us."

Not going to happen. Only a handful of companies are going to get out. You're going to see a lot of companies that were able to raise money over the past two years, kick the can, and then realize their fates in the next year or two when they realize so many people. We've talked about dry powder and wet powder. So many people do not have dry powder. That powder is already spoken for their existing companies. They've got to preserve it. They've got to prop up their marks, because they don't want to take write-downs. They're trying to raise another fund. All the human agency things that are in conflict with actually good, going back to what we talked about, conjecture and criticism and rational allocation. And so, I think it's going to be two years of chaos, and then a reset.

Danny Crichton:
I'm going to finish up here. The thematic component we did for the letter was this from strife to strife. So, obviously, a lot of strife going on in the markets, a lot of strife on the geopolitical side. We got balloons flying over America, similar to the opening scene of a new hope. I think that's the Star Wars instead of a corvette, just a balloon slowly spiraling over the skies. We have this theme from strifes to strifes. There's tons of strife going on. Why do you think strife is an important theme for 2023 and onwards?

Josh Wolfe:
Well, the strife is the conflict. It's the conflict between people realizing their fates. It's the conflict between people running out of money. It's the conflict between LPs and GPs, between equity owners and boards, between shareholders and management. It's just that the conflict that is inevitable when you lose a rising tide, and suddenly people are swimming for the rafts and the lifeboats and they're fighting for each other because it's zero sum. And that just happens in cycles. It's nothing new. It happens every time there's a bust. It's going to happen now.

But what comes from that, and I always say people ask, is it better for innovation when you have high rates or low rates? And my answer is, it doesn't matter, because when you have low rates, everything gets funded. Failure rates are higher. Only a few things end up sticking in the end. You throw everything against the wall. When rates are high, the cost of capital is high, fewer things get funded, only the most essential and more scrutinizing investors that are really doing selection and picking. And the result is that fewer things, but more high-quality things, get funded.

But in the first case, the detritus, all the stuff that fails becomes the fodder combinator for the next wave. So, the strife almost speaks to the human spirit because that will never change. There will be people that will feel despondent. There will be people that feel dejected. There will be people that go bankrupt. But the striving from that are the people that when they're beaten down, when they fall in the gutter, they look at this and they say, "I'm getting back up, and I'm starting something new. Or I'm taking those assets and I'm going to repurpose them."

And you're starting to see the capital market signals for that. You're seeing the private equity players start to come in and look at taking companies private. You're seeing activists come in and call for better capital allocation. So, it's all, if you are looking at this as a biological ecosystem, whether it's the cockroaches or the insects that are coming and the vultures to feed on the carrion, that's striving. It never stops. The old groups might die, but the new groups come. They pick up those assets, they carry on, they carry on, and they live.

Danny Crichton:
Well, you end the letter with a quote from Will and Ariel Durant from a classic book, the Lessons of History. And the quote is, competition is not only the life of trade, it is the trade of life. Peaceful when food abounds, violent when the mouths outrun the food. Animals eat one another without qualm. Civilized men consume one another by due process of law. And so, competition becomes the fodder and the key for striving going forward. And I think that's an amazing way to end. Josh, thank you so much for joining us.

Josh Wolfe:
It was great to cooperate with you on this one. Thank you so much.