(Rationally) Investing in Technological Revolutions, Human Capital, and Asset Allocation (EP.125)

Episode Summary

Executive Summary: In this episode, hosts Benjamin Felix and Cameron Passmore discuss the rational pricing of technological revolutions, challenging the notion of market bubbles. They explore two models from Luboš Pástor that explain high stock prices through uncertainty about growth rates and changing discount rates. The episode also covers human capital's impact on financial planning, including asset allocation and life insurance decisions, and reviews Ashley Willens' book on reclaiming time for happiness. The bad advice segment debunks the idea that passive investing destabilizes markets.

Main Topics: Book of the Week: Time Smart by Ashley Willens (Priority: 4/5): Review of the book focusing on shifting focus from money to time to increase happiness. Key points include valuing time, savoring experiences, and outsourcing disliked tasks. Rational Pricing of Technological Revolutions (Priority: 5/5): Deep dive into Luboš Pástor's papers explaining that high stock prices during tech booms can be rational, not irrational bubbles, due to uncertainty about growth rates (Jensen's inequality) and changes in discount rates as new technologies become integrated into the economy. Human Capital and Financial Planning (Priority: 4/5): Discussion on how human capital (present value of future income) interacts with financial capital to influence asset allocation, life insurance needs, and risk-taking. Younger investors with safe labor income can take more stock risk. Life Insurance and Asset Allocation Joint Decision (Priority: 3/5): Exploration of how life insurance needs and portfolio allocation should be determined together, considering the correlation between human capital and risky assets, discount rates, and risk aversion. IPO Waves and Rational Pricing (Priority: 3/5): Analysis of how IPO waves are driven by time-varying market conditions: lower expected returns, higher expected profitability, and increased uncertainty about future growth rates. This rational model aligns with empirical evidence. Bad Advice of the Week: Passive Investing Destabilizes Markets (Priority: 3/5): Critique of an article claiming passive investing is removing market guardrails and increasing instability. Ben and Cameron argue that passive investors are price takers, not price setters, and active managers still dominate trading. News Roundup (Priority: 2/5): Coverage of Moderna and Pfizer vaccine efficacy, Ant Group IPO stall, MicroStrategy investing $425 million in Bitcoin, quiet marijuana stocks, and top five ETFs by assets.

Key Arguments: Higher uncertainty about average profitability leads to higher stock prices (Jensen's inequality in Gordon growth model). This was rational, not irrational, during the dot-com era. As new technologies become adopted by the old economy, their risk transitions from idiosyncratic to systematic, raising discount rates and lowering prices, explaining booms and busts without irrationality. IPO waves are endogenous, driven by declines in expected market returns, increases in expected aggregate profitability, and increases in prior uncertainty. This explains poor post-IPO returns. Human capital should be considered jointly with financial capital in asset allocation and insurance decisions. Higher correlation between human capital and stocks reduces optimal stock allocation and life insurance needs. Young investors have high human capital relative to financial capital, allowing them to take more stock market risk (and potentially use leverage) because they can adjust labor supply or savings. Passive investing does not destabilize markets because passive investors are price takers; active managers still set prices. The shift to passive may actually increase opportunities for skilled active managers.

Data Points: Moderna vaccine efficacy: over 94% - Initial trials announced on the day of recording. Pfizer vaccine efficacy: 90% - Announced the prior week. Happiness value increase from shifting mindset from money to time: $2,200 - Per year, per Ashley Willens' research. Happiness value of eight more vacation days per year: $4,000 - Increase in annual happiness. Happiness value from savoring meals (vs. planning): $1,800 - Annual satisfaction increase. Happiness value from outsourcing most disliked tasks: $12,800 - Annual happiness increase. MicroStrategy's Bitcoin investment: $425 million - Half of excess cash invested in Bitcoin; stock jumped 9% then 23% on subsequent announcements. Top 5 ETFs combined share of all ETF assets: ~25% - SPY, IVV, VTI, VOO, QQQ have ~$1 trillion combined AUM. NASDAQ beta doubling period: 1997 to 2002 - Used as proxy for new economy in Pástor's model. Small cap value valuation discount: 60% - Discount to its average post-WWII valuation. Rational Reminder community users: 618 - As of the recording date.

Pivotal Quotes: "The number of firms going public changes over time in response to time variation in market conditions. So in economic speak, they're saying that IPO timing is endogenous. It happens based on conditions within the economy." — Benjamin Felix: Explaining the rational model for IPO waves from Pástor and Veronisi. "What would I be nervous about? If I had $500 million in cash, that would make me nervous because I would think it would go to zero in purchasing power over five years. What's my choice? I think Bitcoin is better than gold as a store of value." — Michael Saylor (quoted by Cameron Passmore): MicroStrategy CEO justifying large Bitcoin investment. "The magnitude of that doesn't really matter. It's more the point that you can increase your happiness just by making this simple shift." — Cameron Passmore: Describing the key lesson from 'Time Smart' about shifting mindset from money to time.

Implications: For investors, understanding that high prices during tech revolutions can be rationally explained reduces the urge to call bubbles and make timing bets. Financial planning should integrate human capital with asset allocation and insurance decisions. The persistence of value and small-cap underperformance does not signal passive-driven instability; active managers still dominate price-setting.