Gavin Baker - The Cyclone Under the Surface - [Invest Like the Best, EP. 260]

Episode Summary

Executive Summary: Patrick O'Shaughnessy and Gavin Baker discuss the post-COVID growth stock crash, inflation, semis, software, internet, metaverse, and private-market dynamics. Baker argues inflation is the key macro variable, sees software and select mid-cap tech as attractive after multiple compression, is cautious on semis, and thinks public markets will continue to set the tone for private valuations.

Main Topics: Growth stock drawdown and market dispersion (Priority: 5/5): Baker says broad tech/growth stocks have crashed beneath the surface despite index highs. Inflation as the dominant macro variable (Priority: 5/5): He argues inflation, especially wages, will determine earnings, multiples, and market direction. Semiconductor cycle and structural demand (Priority: 4/5): Semis are more consolidated and structurally important, but Baker sees a near-term inventory unwind. Software vs. internet fundamentals (Priority: 5/5): Software looks stronger and more resilient than internet names, which face a COVID hangover. Metaverse and platform ownership (Priority: 3/5): Baker sees gaming, mobile OSs, and major platforms as early forms of the metaverse race. Private markets and venture re-architecture (Priority: 4/5): Illiquidity premiums and public-market leadership shape private valuations and venture strategy.

Key Arguments: 2021 was brutal for growth managers because returns were concentrated in a few mega-cap winners. Multiples in tech have largely round-tripped to 2018 levels, but businesses are better today. Inflation matters most because it drives liquidity, margins, and ultimately equity valuations. Supply-chain inflation should normalize as capital spending surges and goods demand cools. Wage inflation would be more dangerous since it compresses ROIC and relative equity returns. Software is preferred over internet because it is less GDP-sensitive and more cash-generative. Semis are structurally stronger long term, but the current setup still looks cyclical and risky. Public markets lead private-market repricing; venture valuations lag but eventually follow. Crossover-style investors gain advantage by seeing companies early and owning them through IPO.

Data Points: NASDAQ concentration: Google, Microsoft, NVIDIA, Tesla - Baker says these names dominated index returns and were the right portfolio positions. Growth stock drawdown: 40% to 65% off all-time highs - Estimated decline for average tech or consumer growth stock below $100B market cap. 10-year Treasury: 3% - Level cited for 2018 when software multiples were at similar levels. CPI: 7% - Baker says this level changes the market regime and explains severe selloff. Amazon capex (1999-2019): $62 billion - Used to illustrate the scale of recent supply response. Amazon capex (2020-2021): $87 billion - Illustrates how much supply response has accelerated recently. Retail sales: Up 16% for the year; flat in November, down 2 in December - Evidence that the economy is slowing rapidly. Atlanta Fed GDPNow: 10 in November, 5 in December - Used to show weakening growth momentum. Real PCE goods vs services: Goods spending $500 billion above trend; services $500 billion below trend - Supports Baker's thesis that spending is rotating back to normal. Job openings vs unemployed: More job openings than people looking for work - Baker highlights an unprecedented labor-market condition. Job openings/unemployed ratio: All-time high - Evidence of unusual wage pressure. Semiconductor industry growth: 1.5x to low 2x global GDP historically - Baker's estimate of the sector's long-run secular growth rate. Semiconductor industry growth outlook: ~3x nominal GDP - Baker thinks AI and EVs may lift the structural growth rate. Private fund size example: $20 billion - Cited as evidence of massive dry powder in private markets. Public-market tech focus: Two or three or 4% free cash flow yield looking out to 2023 - Used to distinguish cash-generating winners from cash-burning names. Capex from Taiwan Semi: 2022 capex many multiples of 2019 - Shows the scale of semiconductor supply response.

Pivotal Quotes: "Inflation is the only thing that matters." — Gavin Baker: His central macro thesis on what will drive markets next. "Capitalism is amazing at solving problems." — Gavin Baker: His view that supply-chain inflation will self-correct through investment and innovation. "If wage inflation is here to stay, I think it means very bad things for the market." — Gavin Baker: Why persistent wage pressure would be especially harmful for equities.

Implications: Investors should separate temporary supply shocks from persistent wage pressure, and watch public-market repricing as the key signal for both tech and private assets.