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Daydream Believers: Read This Before You Invest In AI



AI is going from red hot to white hot. Is that hot enough to burn investors?

Pitchbook notes that venture capital investment in generative AI like ChatGPT is up 425% since 2020, from $500 million to more than $2.1 billion.

The global VC industry is on track to have ¼ of its roughly $350 billion in total assets plunked into AI.

Roughly 40% of companies are either using AI or exploring using AI.

A Crunchbase query shows that the world has 27,505 AI companies, even if not all are pure-play.

ChatGPT is already the fastest-growing app of all time, surpassing 100,000,000 users in two months.

Whether you’re a private market or a public market investor, artificial intelligence seems like an obvious good investment (and perhaps a good investor: the AI Powered ETF (AEIQ) which uses AI to choose its investments, doubled the S&P 500’s returns in January).

But is it really?

Is biotech overvalued?

Biotech gives us clues. Like AI, biotech has a tremendous long-term bull case: The world’s population is getting older and wealthier, and spending a greater share of that wealth on healthcare technology – which, incidentally, keeps getting better. And better healthcare is like indoor plumbing: once you have it, you’re not giving it up.

Since its 2006 inception, the S&P Biotech Index has roughly tripled the S&P 500’s return.

Biotech represents a breakthrough, or string of breakthroughs, for humanity. That’s the good side of the megatrend coin, and the one that gets disproportionate focus from investors.

The darker side is that economics is a recursive social science, meaning that a great trend – in the sense of adding value to the world – can become a lousy investment in aggregate if too many people jump on. Most companies that participate in megatrends end up failing, and most investors do just so-so.

More excitement. Lower standards. Crappier projects. Dumber money.

Is AI as overvalued as biotech?

For instance, biotech turned hot in 2021 thanks to a cocktail of low interest rates (which inflate the present values of cash flows expected far into the future), a giddy “everything bubble” market and, arguably, a COVID-savior halo.

With enough demand, supply will appear – and keep appearing: Per IBISWorld, the number of biotechs has grown at 7% per year since 2018, yet the industry’s market size has grown at 2.6% per year.

This is despite the fact that oversupply is particularly dumb in biotech because of a logistical regulatory “ceiling” of sorts: As my friend, biotech analyst Leon Tang, is fond of pointing out, more than 3,000 biotechs are hoping theirs will be one of roughly 50 new drugs approved by the US Food and Drug Administration each year.

This is slightly less pathetic than the 1-in-60 chance it appears to be, because not every biotech company is vying for an approval every year. But it’s still pathetic that the market wasn’t paying attention to these odds.

If 3,000 people show up to an event that seats 50 (or even several hundred), most will be left standing outside.

AI bubble: seems inevitable

Fundamentals can get (temporarily) bulldozed by the greater fool effect. It’s silly, but let’s not hate it, because the greater fool’s alter ego – irrational avoidance – creates underpricings.

Fortunately, in the long haul, prices of things revert to the value those things add to the economy.

They should. Markets that don’t revert well to economic fundamentals (and instead remain permanently “drunk” with speculation, insider trading, sudden or arbitrary policy changes, etc.) fail at adding value to their societies – which, from a society’s perspective, is supposed to be the benefit of markets.

So, from a market rationality perspective, biotech’s bubble-ish rise is bad, and its reversion is good, even if the me-too investors didn’t feel that way.

More excitement. Lower standards. Crappier projects. Dumber money.

Investors in the bubble can relate. Yes, some eventual big winners emerged from the tech bubble’s ashes (Amazon AMZN AMZN at one point declined 95% before later rising 58,000%). But in an aggregate sense, the bubble was just a big version of the biotech bubble: one of the greatest investing frenzies the world has ever seen – yet just about a wash for investors.

It was likely worse than a wash for individual investors. Academic evidence from Brad Barber and Terrance Odean shows that individual investors tend to buy at the top, and Dalbar Research found that individual investors tend to underperform a market index (by buying at the top).

Can I still make money with AI?

The counterargument – whether it’s AI, biotech, tech, or tulips – goes something like this: Maybe hot trends and their resultant bubbles aren’t great for investors in aggregate, but new industries tend to be winner-take-all-ish – a few winners and scores of losers – so I’ll just identify the ultimate winners and buy them.

This can work. And if it does work, it will make you extremely rich. There’s a “but” and there’s a “but” to the “but.”

You can guess the first “but:” the odds are against you.

  • Few things changed the world – and the US in particular – as much as the automobile. But more than 3,000 US car makers have come and gone. Sure, some losers were bought by winners, but on balance, if you bought any particular participant, you likely lost money.
  • Many people know the story of the American Gold Rush of the mid-1800s: the average California miner made $10-15 per day (probably a generous figure if we consider everyone who tried). The real money was in selling supplies to the people attempting to strike it rich*.
  • Although the extent of the Dutch Tulip Mania of the 1600s is doubted by some academics, whoever paid the price of a mansion for a one bulb probably regretted it.

*One could argue that this is the cause of bubbles in the first place, or at least an exacerbator: Instead of picks and shovels, modern enablers are selling the aspiring (if indiscriminate) investors inferior, overpriced versions of the “winners” they hope to buy.

Don’t let me be a wet blanket. If you are truly skilled at identifying the future winners, by all means you should do this. It’s an enormous relative advantage (for instance, there’s evidence that only about 10% of individual investors are actually good stockpickers).

What will AI’s dud-to-winner ratio be?

If you’re not sure but want to play anyway – and this is the “but” to this “but” – we need to talk about histograms.

If you’ve bought a pack of Pokemon cards (or baseball or football cards – or run a VC fund), you understand that most cards in the pack are going to be duds. In fact, many packs are all duds or near-duds. Therefore, anyone aspiring to invest by buying Pokemon packs – probably a dumb thing to do, but this is theoretical – would need to consider two histogram-y questions:

  1. How many packs will I have to buy before getting one or more winners?
  1. Will the aggregate winning-ness of my winners offset the aggregate dud-ness of my duds?… i.e., will my winners pay for my losers?

It’s a bit unfair to equate Pokemon card pack investing to VC investing, because randomly buying Pokemon packs requires no skill*, whereas VCs at least try to apply skill to separate wheat from chaff.

*Index investing, by contrast, is a bit closer to Pokemon pack investing, although most index investing isn’t an attempt to net runaway winners per se.

I’m generally skeptical of VC returns data – shop around and you’ll see “averages” ranging from stock market-ish returns to 57% per year – but VC is like the Pokemon pack effect on steroids: Correlation Ventures found that 65% of VC investments lose money, and that just 4% return 10x or more. (And 0.4% return 50x or more.) In fact, Institutional Investor magazine pointed out that a VC fund would need to hold more than 500 investments to capture one of these mega-winners.

The upside of buying all those Pokemon packs? Look at the white rotated square in the middle: It’s higher (although note that these are pre-fee numbers, and VC funds may charge 2-and-20 fees that get negotiated up or down depending on the hotness of both VC and the particular VC fund at the moment). Plus, the dispersion of returns is a lot tighter than I’d have expected, too.

How to win the AI war

We’ve discussed

  • A gold rush where the real money was made on people showing up for the gold rush.
  • A tech bubble where values were propped up by people showing up for the tech bubble.
  • A biotech bubble that happened because people put more money into biotech stocks, and not because biotech added more value to the world.
  • A planet that got motorized – while most of the companies trying to help (and their investors) failed.

Still, my intention isn’t as negative as may seem. I’m really trying to establish that:

  1. Investors often assume that a hot new thing that moves humanity forward will automatically be a great investment, but so many investors assume this that the hot new thing may end up a disappointing investment in aggregate.
  2. Mega-winners from megatrends indeed create fortunes for a few people and a few investors, but mega-winners are usually surrounded by hundreds, or thousands, of also-rans.
  3. It’s possible to diversify by investing in a fund, but there’s a high chance the fund’s returns are also watered down by the also-rans.
  4. As the market realizes that it owns a lot of also-rans instead of actual mega-winners, prices come down.

Everything I’m saying is a sweeping generalization. Almost recklessly vague. Funds can do very well by investing in hot things. So can individual investors. It happens frequently. And if you invest in AI, my wish is that it happens for you.

My goal is not to dissuade you from investing in AI. AI will change the world. Precedence Research predicts its market size will grow from $120 billion now to $1.6 billion by 2030. AI will birth AI millionaires and AI billionaires.

But if history is a guide, it will leave a lot of dead companies and burned investors in its path.


The Calculus Behind The ESG Battle Between The White House And Capitol Hill



When President Biden used his first veto (less than 60 days after his party no longer controlled both houses of Congress), the media reported on the event with much fanfare. That it had to do with a very narrow subject didn’t matter. But was all the chest pumping justified? Could it be that the issue was already moot even before Congress passed the joint resolution that inspired the veto?

On Wednesday, March 1, 2023, the Senate voted 50-46 to overturn the Department of Labor’s new Fiduciary Rule. This new Rule was to replace a similar Rule promulgated by the DOL under the Trump administration. At issue was the application of ESG criteria by ERISA fiduciaries to retirement plan investments.

What does ESG stand for?

“ESG stands for environmental, social, and governance,” says Andrew Poreda, VP and ESG senior research analyst at Sage Advisory Services in Austin, Texas. “ESG factors are non-financial (yet important) factors that are critical to the success of a corporation or entity.”

The concept isn’t entirely new. A similar philosophy called “Socially Responsible Investing” (“SRI”) emerged as a favorite among activists in the 1980s. It primarily targeted institutional investments in South Africa.

Going further back, religious organizations have practiced this form of exclusionary investing for quite some time. For example, it’s not unusual to see portfolios for church groups prohibit investments in “sin” stocks (alcohol, tobacco, and gambling) or stocks in the defense industry.


Why is ESG important?

If ESG is just an SRI rose by another name, why has it suddenly become the center of such controversy? In short, it’s because it’s a little hard to define, and when it’s defined, it seems to run contrary to fiduciary practices.

Lawrence (Larry) Starr, of Cornerstone Retirement, Inc./Qualified Plan Consultants in West Springfield, Massachusetts, says, “There is no way to mandate something that is so poorly defined and differs widely in application from company to company and from investor to investor.”

As one of those investors, however, it’s critical you understand how other investors view ESG for the same reason it’s important for value investors to understand how growth investors think and vice versa.

“ESG is data that can provide a more complete picture of how a company operates beyond financial analysis alone,” says Bud Sturmak, the head of impact investing and a partner at Perigon Wealth Management in New York City. “ESG analysis helps to better understand a company’s overall stability, its opportunity to create shareholder value, and its exposure to critical business risks. ESG data can help inform sound investment decisions and allow you to tailor your portfolio to reflect your personal values.”

What is the main focus of ESG?

Starr says the primary reason ESG exists is “to provide ‘socially conscious’ investors with guidance as to a company’s attention to these (not well-defined) subjects.”

Again, if you look at things from the point of view of proponents, ESG, no matter how ill-defined up close, has a sincere intention when looking at it from the 30,000-foot level.

“The main purpose of ESG investing is to reward good corporate citizenship and encourage companies to act responsibly by allocating capital to companies that share the investor’s values,” says Rob Reilly, a member of the finance faculty at the Providence College School of Business and an investment consultant at North Atlantic Investment Partners in Boston. “Environmental criteria consider how a company deals with environmental risks and natural resource management, including corporate policies addressing climate change. Social criteria evaluate how a company manages relationships with customers, suppliers, employees, and the communities where they operate. Governance deals with a company’s leadership, board of director diversity, internal controls, executive pay, audits, and shareholder rights.”

This broad objective can have multiple tactics. How do these varying approaches impact the definition of ESG?

“This depends on one’s perspective,” says Matthew Eickman, national retirement practice leader at Qualified Plan Advisors in Omaha. “At a binary level, it’s either to invest in companies in an effort to support or advance social and environmental agendas, or it’s to invest in companies whose commitment to environmental, social, and/or governance issues situates the companies to perform well in the future.”

This confusion can lead some to question the real aim of ESG.

“It is a Machiavellian and subversive attempt by ESG woke proponents to seize and control how boards of directors in America run their company on ESG goals rather than profit and loss goals,” says Terry Morgan, President of OK401k in Oklahoma City.

What did the President and Congress hope to achieve by their actions?

Given the passion ESG generates on both sides, is it any surprise that it has become a political hot potato? And when something becomes a political hot potato, you need to guard against hyperbole.

“First, it should be noted that there is a disconnect between what the bill does and what some politicians are claiming it does,” says Poreda. “The intent of Congress’s joint resolution appears to be aimed at preventing retirement plans from investing in strategies that are aimed at pushing political and ideological agenda (e.g., ESG strategies are seen as being aligned with climate activism and ‘woke’ agendas).”

Indeed, it could be that both proponents and opponents of ESG may not have read the fine print of either the Trump or Biden Rules.

In a post published in the Harvard Law School Forum, Max M. Schanzenbach (Northwestern Pritzker School of Law), and Robert H. Sitkoff (Harvard Law School) wrote, “Much of the confusion that the 2022 Biden Rule endorses ESG investing, and that the 2020 Trump Rule opposed it, traces to the original proposals for those rules. The Biden Proposal favored ESG factors by deeming them ‘often’ required by fiduciary duty. The Trump Proposal disfavored ESG factors by subjecting them to enhanced fiduciary scrutiny. However, following the notice-and-comment period, the Department significantly revised those proposals before finalization. Neither final rule singled out ESG investing for favored or disfavored treatment. The final Trump Rule did not use the term ‘ESG.’ The regulatory text of the final Biden Rule refers once to ESG investing, but only to state that ESG factors ‘may’ be ‘relevant to a risk and return analysis,’ depending ‘on the individual facts and circumstances.’ This statement is true for all investment factors, ESG or otherwise.”

Certainly, political leaders possess the legal literacy to discern this similarity. Why, then, did we have all the fireworks surrounding the Joint Resolution?

“Unfortunately, this issue has become politicized and certain politicians believed these factors were being taken into account to achieve political rather than financial goals,” says Robert Lowe, a partner (through his professional corporation) of Mitchell Silberberg & Knupp LLP in Los Angeles.

Clearly, there is no consensus on the meaning of ESG. Perhaps, given there are multiple ideas concerning the definition of “ESG,” it’s only natural that the reasons behind the various maneuverings might also be divergent.

“Different supporters of the vetoed proposal had different intents,” says Albert Feuer of the Law Offices of Albert Feuer in Forest Hills, New York. “Many supporters believe risk return analysis should be subordinated to ESG factors that are not called ESG factors, such as investing in United States fossil fuel ventures to preserve jobs in those ventures even if they have poor risk-return profiles. These same supporters criticize ESG advocates of the divestment fossil fuel investments, which the regulation prohibits absent a showing that these investments will be replaced by those with a better risk-return profile. Other supporters have little confidence in financial analysts and free markets. They believe ESG factors are inherently bad and thus fiduciaries should be prohibited from considering them absent compelling evidence that in a particular situation, such factors would improve the risk-return profile of an investment.”

Marcia S. Wagner, Esq., president/founder of The Wagner Law Group in Boston, Massachusetts, in a interview, said that President Biden faced pressure from his own party. Starr agrees. He says Biden had no choice but “to bow to his far-left constituency, especially since he just approved major drilling for oil in Alaska. This gives him a countervailing argument to show he hasn’t abandoned his ‘progressive’ policies completely.”

In the end, you could have easily predicted the actions by all actors in the dance between the joint resolution and the veto.

“This was a foregone conclusion,” says Eickman. “Biden knew he couldn’t appear weak on this, even if he may not view the DOL regulation as having nearly the impact as Congress had suggested with its votes.”

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Deutsche Bank Should Disclose Its Current Liquidity Levels To Investors



Investors’ fear about the financial health of banks globally was palpable today. As they swarm bank after bank, Deutsche Bank was next on their list. They pummeled Deutsche Bank’s stocks and bonds. And the price for protection against a Deutsche Bank’s bond default rose significantly as evidenced in the credit derivatives market.

Nothing new, in particular, came out about Deutsche Bank today. It is not as if market participants only discovered today that Deutsche Bank has a long history of weak risk controls and a list of scandals rivaling Credit Suisse. Every time that there have been scandals about Deutsche Bank’s poor risk management, the stock falls, but eventually investors seem to just shrug their shoulders and move on. Yet, when you look at the stock over a much longer period of time, investors have been showing their discontent with the beleaguered bank for over a decade. Deutsche Bank has never recovered from its high on April 1, 2007. In fact, the stock has fallen almost 95% since then.

Liquidity Risk Is Key

What investors should be monitoring for all banks is how liquid they are, that, is whether they can pay all their obligations when they come due. It is difficult, if not impossible to know, how liquid Deutsche Bank is right now. Banks are only required to disclose financial and risk information on a quarterly basis. By the time, market participants get this information, it is already old.


According to Deutsche Bank’s Basel III Pillar III Risk Disclosures, as of the end of December 2022, Deutsche Bank’s Liquidity Coverage Ratio was 135%, higher than the minimum requirement of 100%. The figure tells us that at that end of 2022, Deutsche Bank had enough high-quality liquid assets such as cash, money market instruments, and unencumbered investment grade bonds, to cover net cash outflows in periods of stress. That figure has declined by 7% from 2018 when it was at 145%.

In the U.S., as a stand-alone entity, Deutsche Bank’s Liquidity Coverage Ratio at the end of December 2022 was 141%. Banks are not required to disclose this ratio more frequently, so no one outside of Deutsche Bank knows what the LCR is today.

Unlike Silicon Valley Bank, Deutsche Bank has a diversity of funding sources such as retail and corporate deposits from different geographies, short-term and medium-term credit lines, as well as access to wholesale funding. Stable sources of funding are always important, especially right now.

In comparison to its globally systemically important bank (G-SIBs) peers in Europe at the end of 2022, however, Deutsche Bank did not have as high a percent of liquid assets as a percent of total assets. It appears to be less liquid than Barclays, UBS, Société Générale, Credit Suisse, or HSBC HBA . Deutsche Bank’s LCR and Net Stable Funding Ratio, a measure of funding stability for a twelve-month period, are also both lower than most European banks in that peer group.

As of today, the global rating agencies had Deutsche Bank in the A – BBB+ range which is considered investment grade, and the outlook is stable or positive. The very nature of processes that have to be abided by ratings analysts means that market participants always move faster to exhibit what they think of any company.

What Deutsche Bank should be doing right now is disclosing granular information about its current liquidity levels, sources of funding, and capital ratios. That certainly would give market participants a good idea of how the bank stands. No one had banking chaos on their bingo card at the end of 2022. So why should we be relying on financial information from then? In this environment, opacity only unnerves market participants even more.

Other Articles By This Author

Deutsche Bank’s Death By A Thousand Cuts Is Not Over

Global Rating Agencies Do Not Sound Optimistic About Deutsche Bank’s Restructuring Plan

Deutsche Bank’s Impending Auf Wiedersehen Will Hurt Americans

Does Greed Drive Deutsche Bank And Other Banks Not To File Suspicious Activity Reports?

Deutsche Bank Needs Serious Laundering

Deutsche and Other Scandal-Plagued Banks Should Learn From Novartis, Tenneco, And Volkswagen

Possible Trump Deutsche Bank Fraud Raises Serious Questions

Measure U.S. Banks Credit Exposure to Deutsche Bank Now

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It’s Time For Some Serious Railroad Regulation



There are times that news coverage seems like an ongoing recreation of the Adam Sandler and Drew Barrymore movie 50 First Dates. Bad things happen and are then forgotten. Something happens again and rarely is it treated like an ongoing story. The public, other than those directly involved, also forgets and doesn’t press for closer coverage.

A current example is the railroad industry. Take the disastrous accident in East Palestine, Ohio that happened on just before 9p.m. on February 3, 2023. About 50 out of 149 cars derailed, according to ABC News. Out of the cars that went off the rails, 11 carried hazardous waste, including vinyl chloride, ethyl acrylate, and isobutylene. The last two are highly toxic and potentially carcinogenic.

Then came the mandatory evacuation, first within a one-mile radius, then two. Officials conducted a controlled burn of the substances, which turned into a heavy cloud. Eventually, the officials said that air and water samples were deemed safe. Except, the EPA found the chemicals in streams near the derailment site.

Later, large amounts of aquatic life would be found dead, even though officials had kept saying that everything was fine. Thousands of cubic yards of contaminated soil and millions of gallons of liquid waste have been collected. The State of Ohio has filed a lawsuit against Norfolk Southern NSC .

Back on February 21, U.S. Transportation Secretary Pete Buttigieg sent a letter to the rail line. One part of the multi-page paper: “Major derailments in the past have been followed by calls for reform – and by vigorous resistance by your industry to increased safety measures. This must change.”


Yes, it must. But while an extreme issue, this isn’t the only rail accident that takes place in a year. In fact, there are literally thousands of varying degrees. Here’s a chart from the Department of Transportation:

In the latest year for which there is available data, 2021, 8,096 accidents occurred. Again, that could mean anything. But it does include 747 total fatalities and 4,647 injuries. Of those, 11 deaths and 2,577 injuries were of employees. Outside of grade crossings, where most of the troubles occur, there were 1,626 train accidents.

Total incidents in 2020 were 7,785. In 2019, 9,747; 9,682 in 2018; and 9,497 in 2017.

Shifting from such dangers and outcomes for a moment, think back to the impending rail strike in the fall of 2022. Many of the union workers were, and probably still are, deeply angry. Money was an issue, but the big holdup had been around attendance, sick time and scheduling. People get badly hurt working on rail lines and they need time to recover and get medical help. But rail companies, including BNSF Railway Company, owned by Berkshire Hathaway BRK.B with carefully avuncular Warren Buffett, don’t want to spend money on more staff.

No good crying poor. For perspective, the median value for all industries is 7.9%. The heights the railroad industry reaches are the fifth highest of any industry, only exceeded by money center banks (the really big ones), non-bank financial services, regional banks, and entertainment software. Look at “pre-tax, pre-stock compensation operating margin” numbers—before paying taxes or large stock grants. From that view, tobacco is at the top at 44.7%. And second highest? Railroads with their 42.4%.

If you look at the data only from the Bureau of Transportation Statistics, employee injuries and fatalities have been falling since at least 2000.

In large part because the companies keep cutting back staff. In October 2000, there were 220,200 railroad transportation workers. By October 2022, the number was 142,300. Over the same period, the number of hauled containers and trailers went from 782,694 to 1,129,125, up 40%.

They could easily afford more workers. Better technology. Additional safety measures. And still make carloads of cash. But they don’t and clearly won’t.

The executive branch has to step in. So does Congress. When last they did, though, it was to side with the owners because of concern that a strike would shake supply chain logistics. Railroads transportation account for about 28% of freight transportation in the U.S., according to the Federal Railroad Administration.

However, there’s another factor as well. As an analysis shows, the rail industry spend $653.5 million on government lobbying over the last 10 years, “with the biggest splurges occurring between 2008 and 2012 where the industry lobbied an act aiming to enforce antitrust laws on the freight railroad industry.” The lobbying expenses in 2022 were only $24.6 million, the lowest annual amount, adjusted for inflation, in more than two decades. (Check the link to see the article for many more details.)

Profits and spending on political leverage—money is the key and people, whether employees or citizens who are in the wrong place at the wrong time, are eventually sacrificial.

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