Guild Investment Management, Executive Summary, Apr. 6, 2017

Executive Summary

 

1.  Elon Musk wants to connect your brain to the internet, so you can beat artificial intelligence at its own game.  As if Elon Musk didn’t have enough on his plate already — three major businesses and five children — he announced the creation of a new company, Neuralink, devoted to the development of brain-computer interfaces.  For months, Musk has been cryptically tweeting about “neural lace,” which it turns out is his concept of an additional digital layer surgically implanted in humans to give them cognitive super-powers — and hopefully make them able to defeat the intelligent robots Musk fears will make humans obsolete.  His anxiety may be the stuff of science fiction, but the technology he’s talking about is developing rapidly and will soon be able to provide novel treatments for a host of currently devastating neurological disorders.  

2.  South Korea shrugs off scandal and fear, and steams ahead.  South Korea’s current political drama has seen the Prime Minister impeached and arrested in a scandal involving a corrupt cult-leader some have likened to Rasputin.  At the same time, the country is facing a diplomatic showdown with China, who is threatening sanctions if South Korea goes ahead with a U.S. anti-missile system to defend itself against a nuclear attack from the North.  In spite of all this, the South Korean currency and stock market have posted healthy gains so far in 2017.  The tailwind of global reflation and improving economic growth may simply be more powerful than the political worries.  The South Korean stock market is cheap compared to its own history and compared to many regional peers, and earnings estimates are rising.  We like South Korea as a way to play an inflection in global growth.

3.  Market summary.  Analysts expect the strongest first-quarter earnings in over five years, with technology and financials leading due to strong growth trends and lessening regulatory costs; energy and materials may do well as a result of benefitting from easy comparisons to last year.  We expect the U.S. dollar to gradually return to an appreciating mode as the U.S. economy gradually moves forward.  U.S. stocks remain in an uptrend.  Technology, finance, and industrials remain our favorite investment areas.  Special situations in the consumer sector, such as building-materials retailers, continue to look attractive.  European equities remain attractively priced.  European stocks should move steadily ahead over the longer term.

In Asia, we recommend that investors look at Korea — technology and industrial manufacturing are our favorite sectors.  We also like India, which is benefitting from the reforms of Prime Minister Narendra Modi.  Modi has boosted the popularity of his party by attacking tax evasion by the rich, and is now working to make the tax code more supportive of commerce and new business formation.  The achievements of India over the last seven years in reducing corruption, modernizing the payments system, and reducing tax evasion are revolutionary, and they will set the stage for a more prosperous and fair nation.

Gold continues to move gradually higher.  We expect continued steady appreciation as long as the U.S. dollar does not move up too rapidly.  Slow and steady appreciation of the U.S. dollar will not hurt gold, but a rapid rise in the dollar could upset all commodity prices.

 

Elon Musk On Our New Robot Overlords:  If You Can’t Beat ‘Em, Join ‘Em

Elon Musk is a larger-than-life titan of industry — the modern equivalent of Gilded Age figures such as Carnegie, Vanderbilt, and Rockefeller.  The style may have changed, but the essence is the same: bold innovators and visionaries who identify epochal technological and social trends and position their enterprises to ride the wave.  While the barons of the Gilded Age were known for industries typical of the first industrial age (e.g., railroads) or the second industrial age (e.g., electrification), entrepreneurs like Elon Musk (and Steve Jobs, and Bill Gates) are known for third industrial revolution technologies — artificial intelligence, the internet, and the other converging components of 21st-century disruption.  But what’s common between the two eras is technology and the embrace of its mass distribution and application as the driver of business success.

That’s why it was so surprising to hear Musk’s skepticism about artificial intelligence back in 2014, in a now-famous interview where he stated:

“I think we should be very careful about artificial intelligence.  If I were to guess what our biggest existential threat is, it’s probably that.  So we need to be very careful with the artificial intelligence…  With artificial intelligence we are summoning the demon.  In all those stories where there’s the guy with the pentagram and the holy water, it’s like, yeah, he’s sure he can control the demon.  Didn’t work out.

A tech titan expressing such reserve about one of the key technological developments of the era?  It was almost as jarring as it would have been to hear Jay Gould meditating on how traditional rural American life would be disrupted and ultimately destroyed by railroads.

In later interviews, Musk has elaborated on his point.  He believes that the development of intelligent machines and networks is inexorable and inevitable, and that these machines will be so superior to human beings in the speed and capacity of their “thinking” that they will reduce us to the status of being their “pets” — at best.  He views this “human obsolescence” as a problem and a danger.

Therefore, the creator of PayPal [NASDAQ:  PYPL], Tesla [NASDAQ:  TSLA], SolarCity [NASDAQ:  SCTY], and commercial spaceflight outfit SpaceX has added a new startup to his roster: a company registered in California called Neuralink.  

Musk has been teasing his Twitter [NASDAQ:  TWTR] followers with talk about something called “neural lace” — a term coined by science-fiction author Iain Banks to describe an interface between humans and computers.  In a recent interview, Musk got more explicit.  He noted that the human brain has two basic “layers”: the limbic system, which is the locus of primal autonomic, instinctive, and emotional function; and the cortex, which is the locus of “higher” mental function, reasoning, logic, speech, and so on.  He wants to add a third layer, a digital layer, to augment human brain function so that it can compete in speed and power with artificial intelligence.  And the additional layer would be implanted surgically and permanently.  That’s “neural lace.”

Science, or Science Fiction?

Far-fetched?  (Not that the far-fetched would faze Musk, who has been doing things that critics initially called impossible for years.)  To find out, we looked at some of the recent scientific literature, including a review of the field of neural implants published in Nature earlier this year (“Neural recording and modulation technologies,” Nature Reviews Materials, 2017), and a description of one innovative technique for introducing nanoscale electronic components into neural structures in a minimally invasive way (“Syringe-injectable electronics,” Nature Nanotechnology, 2015).  

The bottom line is that the technology is not as outlandish as you’d think.  The main problems have to do with materials.  Until recently, the only way to connect electronic components to the brain was through highly invasive and cumbersome devices that essentially cover the head with electrodes.  The connections to brain tissue tended to create glial scarring, which interferes with the ability to read neural function or send signals.  The focus now is on innovative materials, such as advanced polymer substrates that don’t cause a rejection response by the body’s immune system, and on nanoscale technologies.  New flexible micron-scale meshes are essentially “neurophilic” — intermeshed with neural structures on a cellular level, accepted by the body and not disturbing its normal function.  New technologies are also being developed for powering these devices, and for wireless communication, so that no permane nt breach of the blood-brain barrier is required.

In reviewing the literature, we noted that the basic concerns of investigators are not on Musk’s grand, existential scale of robotic threats to human supremacy.  Rather, they’re fundamentally concerned with the treatment of neurological disorders, including Parkinson’s and Alzheimer’s, and the repair of trauma to the brain and nervous system.  

With advances in materials technology in particular, the future for the development of neural interfaces for therapeutic purposes is bright.  The precision of analytics and of neural stimulation, repair, or prosthesis promised by these new devices is qualitatively different from the clumsy methods pursued so far.  Alzheimer’s remains one of the most pressing unmet needs in chronic illness, with many researchers believing that drug therapies have reached a dead end, in part because of inadequate understanding of how the disease functions.  The development of “neural lace” may provide that understanding — and may also provide effective treatment through neuromodulation.  “Neural lace” has the potential to revolutionize the treatment of currently untreatable brain conditions and spinal cord injuries.

          Musk’s Future

Whether Musk is right about the dangers of artificial intelligence or not, we’re glad that he’s thinking about the problem, because we believe that a byproduct of his concern will be the development of technologies that improve human lives.  Indeed, when we look at the “solution” he envisions for avoiding the rule of super-intelligent robots, we’re not sure that this solution — making us all into cyborgs — is without its own existential dangers.  As we wrote early last year when discussing the economic impacts of artificial intelligence:

“There will always be a need for humans; computers will never render us obsolete.  Within any discipline, profession, or entrepreneurial activity, there will be aspects of the work where brute-force calculation processes are most significant, and where the assistance of mechanical thinking will enable humans to work more quickly and effectively.  But there will also be aspects of the work where human flexibility, intuition, and non-rational insight are critical — and these capabilities are likely, in the end, to be decisive.”

With all that said, however, investors would be foolish to overlook the technology Musk wants to develop — because even if it isn’t needed to defeat some future robot overlords, it will provide excellent opportunities for investors.

Investment implications:  As with any emergent technology, the time frame for these technologies to become operative is unknown but it may take many years. Nanoscale neural interfaces will present opportunities to both speculative and more conservative investors.  Speculative investors should begin by familiarizing themselves with the current scientific literature and making a list of prominent scientists in the field, and then finding companies that those scientists have founded or whose boards they sit on.  

The very long-term conservative investor might want to begin to look at the stocks of chemical companies, particularly those who develop advanced polymers (companies such as Eastman Chemical [NYSE:  EMN], Celanese [NYSE:  CE], Chemours [NYSE: CC], Dow [NYSE:  DOW], or BASF [Germany: BAS]; the stocks of technologically innovative medical device companies (companies such as Becton Dickinson [NYSE:  BDX], Thermo Fisher [NYSE:  TMO], Edwards Lifesciences [NYSE:  EW], Boston Scientific [NYSE:  BSX], or Medtronic [NYSE:  MDT]; and the stocks of technology companies with life sciences emphasis (companies such as Alphabet [NASDAQ:  GOOG] through its Calico division).  We are not recommending any of these today, but over the long term some of the above may become participants in this new trend.

 

 

South Korea Steams Ahead


As the global reflation trade has proceeded since last year, South Korea’s stock market has performed strongly, up more than 14% year-to-date in U.S. dollar terms as of this writing (about half that return was due to the appreciation of the Korean won against the U.S. dollar).

Source:  Bloomberg

We’ve made the case over the past months that the post-election rally in the United States ultimately had more to do with improving economic fundamentals, the end of the U.S. “corporate profits recession,” and relief at the conclusion of a closely fought election — and less to do with optimism about new policy directions from a new presidential administration.  Still, political turbulence in the U.S. has been challenging.  It hasn’t quashed the fresh optimism of markets, consumers, and businesspeople, but it hasn’t been constructive.  

If we think we’ve had political turbulence in the U.S., though, South Korea makes our situation look like a cakewalk.  Their Prime Minister, Park Gyun-hye, was impeached and arrested in a bizarre corruption scandal that allegedly saw money funneled to the administration from big corporate conglomerates, or “chaebols” — through a cult leader’s daughter who some observers have likened to Rasputin.  The process was accompanied by mass demonstrations against Park’s administration attended by millions of South Koreans.

At the same time, tensions have been rising with China over the deployment of a THAAD anti-missile system by the U.S.  With years of provocation from the North and little effective pressure put on the Hermit Kingdom by their Chinese patrons, the existential threat felt by the South finally gave them no choice but to implement some defense against a nuclear strike.  And of course, China is threatening sanctions on a broad swath of South Korean companies.

Yet the Korean market remains basically unfazed.  Perhaps the same dynamic is at work here as in the U.S. — the political and geopolitical turbulence is a side-show, and the real story is about reflation, profits, and valuations.

Some points for consideration:

(1)  The threat of Chinese sanctions is likely more bark than bite.  The South Korean industries most exposed to Chinese sanctions will be travel and personal care.  These industries are relatively insignificant parts of the Korean market (contributing about 2% of earnings).

(2)  South Korea, as a manufacturing economy, is one of the best-positioned Asian markets to benefit from an ongoing reflation trade and uptick in global economic growth — especially because the economy is weighted so heavily towards technology.  

(3)  Even after this year’s good performance, the KOSPI is trading at a significant discount (a full standard deviation) to its ten-year average valuation of 9.8 times forward 12-month earnings, and at a similar discount to regional peers.  In part, this is because of ongoing upward earnings revisions — a trend that’s more robust in South Korea than in many other of the region’s economies.

We like South Korea and view it favorably as a good way to play the global reflation trade.

Investment implications:  Retail investors can easily gain exposure to South Korea through a variety of exchange-traded funds.  Although there are currency-hedged South Korean ETFs, we think the Korean won could appreciate further and would not hedge it at this time.
Market Summary

          The U.S. Market

Analysts expect the strongest first-quarter earnings in over five years, with technology and financials leading due to strong growth trends and lessening regulatory costs; energy and materials may do well as a result of benefitting from easy comparisons to last year.  We expect the U.S. dollar to gradually return to an appreciating mode as the U.S. economy gradually moves forward.  U.S. stocks remain in an uptrend.  Technology, finance, and industrials remain our favorite investment areas.  Special situations in the consumer sector, such as building-materials retailers, continue to look attractive.

We remain convinced that the Trump administration will continue to try to stop drug price gouging, and pressure drug manufacturers to keep prices down.  Pharmaceutical wholesalers and pharmacy benefit managers could be heavily scrutinized.

          Europe

European equities remain attractively priced, as we explained in these pages last week.  We do not expect chaos as a result of the French election.  European stocks should move steadily ahead over the longer term.  The big longer-term risk remains the poor financial condition of European banks and the unwillingness of the governments of Europe to make them raise capital.  Investors could consider owning European stock ETFs; remember to hedge the currency if you are a U.S. holder.

          Asia

Our two favorite countries for investment are India and Korea.  The situation in Korea is described above.  We recommend that investors look at Korea — technology and industrial manufacturing are our favorite  sectors.

India is benefitting from the popularity of Prime Minister Modi, who has recently worked to stop tax evasion by the rich.  This made his party popular and allowed him to gain a stronger foothold in parliament.  He is now attempting to reform the tax code, which is currently destructive to new business formation and all types of commerce, and very hard to administer.

India is growing very rapidly (official GDP growth of 6.5%); interest rates and inflation are falling as he dismantles social welfare schemes which are subject to corruption and abuse, and substitutes a more modern electronic welfare distribution arrangement.

The achievements of India over the last seven years in bringing bank accounts to hundreds of millions, using technology to allow government transfer payments to be sent without theft and corruption, and slowing tax evasion and fraud are revolutionary, and they will set the stage for a more prosperous and fair nation.

Prime Minister Modi is a friend of growth and modernization, as we have seen from his industrial initiatives which are, among others: to improve India’s infrastructure, improve the liquidity of the banking system, and create a strong manufacturing base.  Indian stocks are reasonably valued, and we expect them to appreciate over the next several years as Modi’s initiatives are implemented.

          Gold

Gold continues to move gradually higher.  It has stabilized around the $1,250 level and its next technical target is the $1,270/ounce range.  We expect continued steady appreciation as long as the U.S. dollar does not move up too rapidly.  Slow and steady appreciation of the U.S. dollar will not hurt gold, but a rapid rise in the dollar could upset all commodity prices.

Thanks for listening; we welcome your calls and questions.
Tim Shirata
Executive Vice President
Guild Investment Management, Inc.

12400 Wilshire Blvd. Suite 1080
Los Angeles, CA 90025
Tel: (310) 826-8600 Fax: (310)826-8611
email: tshirata@guildinvestment.com
http://www.guildinvestment.com

 

 

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