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This week's number one. We are number one in this week's New York Times bestseller rank for miscellaneous. Miscellaneous. Seriously, what the fuck? Welcome to proPg markets. Today we're discussing first quarter earnings season with Aswath Demodaran, professor of finance at NYU Stern School of Business. But first, here with the news is PUBG, media analyst and also not miscellaneous. Very focused, mister Ed Elson. Ed, you are speaking to the number one author of the category Miscellaneous. Is that literally the weakest flex in the world?

Yeah, but you're number two in business, so that's. I don't know. I think you've done pretty well for yourself.

Number two.

Who's number one?

The same guy it is every week. It's James clear Atomic Abbott.

That bitch. Yeah, I knew who it was. I just want to describe, literally, is that. That's like. I don't know. That's really. That's like getting a hand job from your cousin at Thanksgiving. I mean, it's okay. It feels okay.

It feels okay.

But it's like, miscellaneous. Miscellaneous. God, my agent and my publisher. Like, you're number one.

The email said.

I'm like, oh, God, I opened it up and miscellaneous.

I'm like, it doesn't matter. You are now a number one New York Times bestseller. And that's what you're gonna tell people?

Yeah. Don't be so fucking mature. It's miscellaneous. Anyways, I'd get to the headlines.

Well, before we get to the headlines, I just want to announce that Profg Markets is moving to its own dedicated feed, which is exciting. We'll be releasing two episodes per week on Mondays and Thursdays starting on May 20. But the new proFG markets feed is live right now. So go subscribe to Profg markets. Type it in wherever you get your podcasts.

Yes. We want you to spend more time on your phones, so we're doubling up, and we are going to spend more time doing deep dives around sectors and companies we are committed to, to your financial security in an entertaining and illuminating way, and also finding a career and, you know, somewhat of a life for little ed. For little Eddie Elson. This is really all about him, you know? This is okay. He's learned how to play baseball. We've enrolled him in soccer just to see. Just cause he feels good about himself. He feels good about himself. So people need to go subscribe to our new feed. Is that right?

Yeah, we have a new feed. It's called Prof. G markets. It's separate from the Prof. G pod, so you gotta type it in. Subscribe if you want to get the twice a week content.

Love it. Love it. All right, get to the headlines. You. You self promoting ho. Go ahead, Ed.

Let's start with our weekly review of market vitals. The S and P 500 rose. The dollar was volatile. Bitcoin fell, and the yield on ten year treasuries dropped. Shifting to the headlines, the Federal Reserve held interest rates steady, citing a lack of further progress toward easing the rate of inflation. Economic data has challenged the case for cutting rates, but Jerome Powell maintained that the Fed is far from putting rate hikes back on the table. Prices at California fast food restaurants are up as much as 10% since September. Wendy's, Chipotle, and Chick fil A are just some of the restaurants that raised menu prices following the state's decision to increase the minimum wage for fast food workers. Venture capital firm general Catalyst is close to raising almost $6 billion to invest in tech startups. The firm will distribute the money across many sectors, including space, fintech, and climate. In the US, Europe, and India. The Biden administration is moving to reclassify marijuana as a less dangerous drug. It's proposed to move the drug from schedule one classification to schedule three, meaning it has an accepted medical use and would be subject to fewer restrictions and more favorable tax treatment.

Cannabis stocks soared on that announcement. And finally, we saw a slew of big tech earnings. Last week, Apple announced its largest ever share buyback of $110 billion, and shares rose 3%. Amazon, Google, and Microsoft all reported double digit revenue growth, mostly driven by huge sales in their cloud services businesses. Those stocks also rose across the board. Scott, your thoughts?

Well, in terms of interest rates, it is a bit of a surprise. Expectations have shifted dramatically. Interest rate futures are now expecting one rate cut in 24. The market had priced in five or six. But I also think the market's coming to the conclusion that maybe interest rates that are what you would call modest. I mean, historically, it would be unfair to say interest rates are high, or you might even say they're kind of mid to low based on if you go. It depends how you frame how far back you go. And there's this really interesting theory that the amount of money that is invested in short term instruments is greater than the debt owed on consumer loans. So it's actually been stimulative to the economy that it hasn't dampened the economy, that people are getting more money from the interest on their short term instruments, and as a result, it more than covers the additional debt they have or the increase in interest rates. And that has been stimulated the economy. And so it feels like, okay, the punch bowl isn't back, but I don't need punch. The economy is sort of shrugging off the fact that it doesn't look like we're going to have rate cuts.

Fast food, restaurant prices. There's no free lunch here. Raising minimum wage has had an impact on food prices. I would argue it's worth it. There's a price to be paid when the inputs go up in terms of price, whether it's the price of food or the price of labor, they can either pass it on to consumers and hope that consumers don't go elsewhere, and obviously that's inflationary or expensive for consumers, or the company can just absorb the hit itself and that reduces their margins and their share price goes down. I think this is on a balanced scorecard. Absolutely was the right thing to do. Young people and people without kind of the opportunity to get the certification you need to be in the information economy, need to make a living wage. Also, I think we get a free gift with purchase here, and that is, I think fast food should be more expensive. I think it's unhealthy. I think it's resulted in what is the COVID pandemic times two every year? And that is we have a absolutely out of control obesity epidemic in this country. So yeah, I'm all for it.

You mentioned two consequences from raising the minimum wage. One is you pass it on to the consumer, which means higher prices, you absorb it, you just take a hit on your bottom line. I would add a third one, which is you just lay people off. And we're already seeing that in California. Pizza Hut laid off 1200 delivery drivers. We've seen layoffs at other fast food chains in California. Which raises an important general economic principle, which is when you increase the minimum wage, you make labor more expensive and companies eliminate jobs. I know you've been an advocate for increased minimum wage for a long time. How do you think about this trade off?

Anytime there's a change or a shift in the economy, there's going to be winners and losers. I'm not sure I buy into your initial premise that you end up with workers being laid off. And it's bad for low wage workers because for every dollar additional dollar you give a low wage worker, about $1.21 is added to the overall economy. Because the multiplier effect is greater when you put more money in the pockets of low and middle income workers because they spend it all. And where you've seen studies in California and Washington state around the effects of increases in minimum wage, that's the myth in the scare tactic that, oh, all these small businesses will go out of business and actually these people won't be able to find jobs and it'll be worse for them. I think that's bullshit. Employment has never been stronger. And there'll be some limited instances of a burger bot making burgers or a shift to automation, fine. But if a taco truck or a fast food company can't stay in business because it can't afford to pay its people a living wage, then that business should go out of business. And if people are in an industry where it's sub wage, then we need to figure out a way to retrain them.

But the reality is these companies are hugely profitable, most of them, and they're absorbing the dollar 20 increase in dollar 20 minimum wage. And then David takes that additional money and he goes out and he buys more shit, which leads to a growth in the economy and more jobs. I think it's a scare tactic among shareholders and the entrenched who want to maintain their margins. I really sounding so Bernie Sanders. I just don't buy it. People making a living wage or putting in place regulation such that people are living in poverty, working 40 hours a week. It's hard for me to imagine that the world's wealthiest economy can't figure that out. And anyone telling you that their business can't make it or they're going to have to fire people, that really is a misdirect at this point. Let's talk about General Catalyst. Full disclosure, general Catalyst is invested in, I think, everything I've done for the last ten years, them and Andreessen Horowitz raised six and 7.2 billion respectively. This is more of the same. There's just a concentration of power. I mean, not only is it a small number of firms that get all the deal flow, it's a small number of partners at a small number of firms that get all the deal flow.

And the fear is that these funds get so big that a key criteria in where they invest is where they can shove a ton of capital. So it used to be VC firms kind of raised two to 300 million, made ten to 15 investments, initial investment, 3 million, then maybe the company's doing well, they put $10 million, maybe they put up to 15 or 20,000,020 to 15 to 20 investments. Now they need to find things where at some point they can maybe shovel 100 or 200 million into the company. And I think that changes the dynamic. And you just know what's going to happen here. They're going to invest in cloud and AI, because those companies, a, offer huge upside and b, are just voracious monsters in terms of their appetite for capital. But this is kind of the same thing and it's a little bit scary. And that is that. Not even the big, but the giants are becoming megalodons.

Well, just some data to put it in perspective. First quarter of this year, US VC firms combined raised $9 billion, and now we've just seen two firms in basically two weeks raised 13 billion. So I think that sort of demonstrates your point. The other side of this is that the VC industry has just generally been bad over the past couple of years. I mean, total VC funding last year was down 60% from the previous year. I think it was a third of total funding in 2021. But we've just seen two huge races from two massive names. My question to you would be, do you think this could be the moment that kind of jump starts the broader VC industry? Do you think we'll start to see some more headlines on big fundraisers from other firms in America?

Yeah. The tier ones of the world. The insights, there'll be small niche firms like an activant or Lux Capital, that are very focused, that'll be able to raise money, and then there'll be just these megalodons, because they're able to diversify, they have great partnerships, they have really well run firms with great leadership. Montana general Catalyst is this adult who's very well respected. They'll either be niche and highly focused and differentiated, or they're just going to be giant, basically asset allocators that diversify. For you, where I see the opportunity among venture capital firms right now is not where you would expect. One, it's obviously shoveling money into AI, but two, it's follow on rounds in good companies where valuations have come way down. What do I mean by that? Series B, C and D in a SaaS company that's doing really well, it was valued at 2030 times revenues two years ago. They need more capital. The company's doing really well, but the markets have recalibrated and you can invest at five to ten times. So I think where the real opportunity is, and I know this is true at a lot of big vc firms, is follow on rounds, taking advantage of their pro rata rights.

Meaning if they own 20% of the company, any subsequent round, they have opportunity to put up to 20% of the capital for the next round. I think where these firms have a lot of advantage is a firm like general Catalyst probably has 300, I don't know, it might be 500. As far as I know, portfolio companies and the ones that are doing really well, their valuations have come down. So this is the opportunity to go in and get more of that firm for a lot less. I think the opportunity, the huge upside is picking the right AI company. But on a risk adjusted basis, the biggest opportunity for that capital right now is to take advantage of their pro rata rights and invest in subsequent rounds at a much lower valuation.

Thoughts on marijuana going schedule three.

Well, you know, I don't know much about marijuana, Ed. I. So, look, I think this is a good thing. Let me be clear. And I get a lot of, I got a lot of calls from mothers saying that I shouldn't endorse or shouldn't romanticize drinking or THC. Let me put it this way. This is my public service announcement. If you're in high school or college, don't be that guy that smokes pot every day or that gal. It just, it's not a good rap. It's not good for you. Anyways, having said that, I do think if you're like me and you love to get high. If you're a better version of yourself, a little fucked up, which the dog is, then I am trying to substitute THC and edibles for alcohol. I've been listening to too much Andrew Huberman and Peter Atta who have literally declared war on alcohol. They make it sound like if you open a bottle of wine, you're going to have a stroke. So I'm trying to take down the alcohol. I do edibles once or twice a week. I could immediately turn this into about me. I don't understand why this in any way would be considered something more dangerous, quote unquote, more illegal, if you will, than alcohol.

So I think this makes a lot of sense.

The industry has been a shitty industry because there are. It's the definition of overinvested. Every baby boomer in their fifties and sixties who as a Democrat likes the idea of investing in marijuana, and so the field is overinvested. It's overregulated, it's state by state. So it's incredibly hard to scale. It's hard even to get a bank. So there's theft risk because you can only take cash.

I think it's a good point that it's been a terrible investment, at least if you're in it long term, because all these stocks hit their highs around 2018 2019, when the boom was really starting. And the stocks have soared on this announcement. Like there's this company, Tilray, which jumped 40%, canopy growth, which jumped 80%, and then the advisor shares, cannabis ETF, jumped around 25%, but they're still not anywhere close to what they were, to what they were trading at in 2018 2019. I was going to ask. It sounds like the answer is no. Are you invested in any weed companies?

I'm not. I just. I think it's a shitty business. I think it's overinvested and a regulatory nightmare. I'll give you an example. Up until now, pot businesses pay an effective tax rate of more than 70% because, get this, they aren't permitted to deduct expenses except for the cost of production. So Williams Sonoma, if a store does a million dollars, if a Williams Sonoma store does a million bucks and it's rent and it's cost of its employees to, you know, give you. Give you hot apple cider that was cured by apples raised in a farm in Tibet, or whatever it is, they do say it's got 900,000 and the store does a million. It's 100,000 in profit. Marijuana store, you can't deduct the cost of retail and employees. So you pay taxes on a million dollars. So overnight it's unprofitable. These companies have the odds just stacked against them. And it's too bad because marijuana could be, I mean, they're getting good tax revenue here, but they're essentially cutting off their nose to spite their face. The industry can't grow.

Yeah, but to be clear, I mean, this news, the reason the markets love this so much is because marijuana is now exempt from that provision in the IR's code, which said that if you're selling a schedule one or a schedule two drug, you can't deduct the business expenses. So that's what all those jumps in the stock, that's the reason those happened. And then finally, big tech earnings. We'll discuss it in detail with Aswath. But before we have him on any reactions to Amazon, Microsoft, and Google's earnings.

There'S only a few companies that can make the staggering investments in compute required in AI. I used to think they were getting to nosebleed territory and they were overvalued. Now I'm beginning to think, and this is dangerous, just throw in the towel and invest in these companies because I don't see they feel unassailable at this moment, which is famous last words, champagne and cocaine cut in. Ching. As we record this, Apple reported fiscal second quarter earnings. It's increasingly its quarterly dividend, and it's going to repurchase an additional $110 billion of stock. So basically, it's buying Boeing or at and t in the form of a share buyback. So this company continues to just. Wow.

We'll be right back after the break for our Q one review with Professor Aswath Demoderen.

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We'Re back with profit markets, first quarter earnings season is in full swing. That means it's time for our coursely review with Professor Aswath Demoderan, the Kirschner family chair in finance education and professor of finance at NYU Stearns School of Business. Aswath thank you very much for joining us again.

Thank you for having me.

So let's start with big tech. We saw earnings from Google, Microsoft and Amazon last week. All of them saw double digit revenue growth, largely due to this massive demand in their cloud businesses. I mean, I'd love to just start with your initial reaction to those earnings, Google, Microsoft and Amazon.

A couple of weeks ago I was in Brazil and I did a session on AI and whether AI is a revolutionary change, how it's rippling through investing. And one of the things I talked about is we often focus on the big winners in AI by looking at AI products in video, obviously, AI chips and Adobe products. But I think AI brings with it demand for other stuff. Ultimately AI. Now chat, GPT might have brought it to our public consciousness, but it's a convergence of two big forces that have been exploding over the last 15 years. One is the collection of data, not just numerical and financial data, but data about your behavior and my behavior that the big tech companies have accumulated over time, which has to be stored somewhere. And the other is incredibly, almost insane. Computing power brought to play. So when we talk about AI, we're really talking about big data plus computing power on steroids. And there will be the beneficiaries of those companies that make money on those two things, Nvidia and the computing power side. And the big data, for better or worse, is in the hands of the it's not just the cloud that you store it in, but the companies that have exclusivity to that data.

So I've always believed that in the AI space, Google and Amazon are going to start with an advantage, because no two companies have as much exclusive data as those two companies have. And since AI requires that data for its power, you're going to start with an advantage. You saw that not just an extended use of the cloud, the cloud and the service and the revenues that come from it, but you still start to see it in more explicit benefits that emerge from AI products that come out of these companies that use their data. To me it's not a surprise, because if AI is playing out as big as it is, you should see those effects show up at those companies.

I think the other thing that would reflect this is just the sheer amount of spending that we're seeing on AI, basically just AI. Capex obviously Meta announced it'll increase spending on AI and the stock despite some pretty remarkable earnings. It actually fell on that news. We discussed that last week. But then also we're seeing this with Google, Amazon and Microsoft. So just some data I'd like to point to regarding cloud infrastructure capital expenditures. So that's data centers, power plants, GPU's, et cetera. Last quarter, Google spent $12 billion on the cloud. Amazon and Microsoft spent $14 billion each. That's roughly triple what they were spending around two years ago. So it definitely feels as if every tech company is just doubling down on AI.

And Microsoft has it from both the cloud business as well as being this partnership with OpenAI that's become one of the great investments they could have ever made. But I think that, I'll be quite honest, the big story for me over the last few weeks is not the earnings season, but the fact that two companies in the mix that you talked about announced that they were going to start paying dividends, both meta and Google. That to me is revealing because it tells me what they think about where they are in the lifecycle. As you know, I have this fixation about the corporate life cycle, and announcing that you're going to pay dividends is like announcing you're going to wear khakis, which basically means, hey, I'm not, you know, ripped jeans kind of, you know.

Where are my dockers?

Yeah, I'm growing up. I'm going to get a job. So in a sense, there is this admission, at least internally, that this is, you know, the glory days of just easy. I mean, so the cloud business might give them a boom right now, but this is, I mean, they're recognizing they're very different companies than what they thought they were. I mean, it's amazing, especially with Facebook and those initial periods of metaverse, you could still see the arrogance of, we're a growth company, we can go to the metaverse, we can do all kinds of stuff. And I've got to give Mark Zuckerberg credit. He's in a sense grown up quickly, partly because he got punished by the market so intensely. But I think that is to me a big story because it tells me that these companies are laying the foundation. Because when you pay dividends, what you do is you change your investor base. You're calling in people into your investor base who traditionally might have stayed away from you, more value oriented investors, and they might bring a lower price, but they also bring in more stability. These are not the people who are saying, what have you done for me lately?

When are you going to deliver 20% growth? And that's why it's a big story, because I think they're preparing an investor base for a more sobering decade going forward. In spite of all the bubbling of AI right now, looking forward, I think they see more competition, less growth, and I think that paying of dividends signals that that's what they're seeing.

Just a quick follow up specific to dividends. Amazon is the only one you mentioned there that did not issue a dividend. But the rest of tech has. Google, Microsoft, Nvidia, Apple. Amazon's done more than $50 billion in free cash flow in the past twelve months. Do you think they'll issue a dividend anytime soon?

They're the odd man left out. I mean, I think it's a question of, I think what the price does and how the market reacts to it. And I think they might be. It might make sense for them to remember these dividends are not big dividends. They're almost like first rounds in a much longer fight. So I think if Amazon wants to get a more mature, and I'm going to use the word with quotes around it, investor base, this might not be a bad idea because I don't think you want the kinds of investors who invest in GameStop and AMC buying your stock because they might push your stock up 30% quickly, but they can also push your stock down 30% for no good reason at all. So I think that there is a significant portion of our investor base which has gotten used to this playing investing as a game. They're playing the same way they do casino tables. And if I'm a company, I want those investors away from my company, not in my company.

So, aswath, it's interesting what you said about you sort of couched the announcement to issue a dividend, not as a negative thing, but almost a signal of sobriety. Or the days ahead might not all be champagne and cocaine. Something I learned from you, though, is that it reflects maturity to recognize you're no longer a teenager, and that if your core business is so strong and it's spinning off so much cash that it's unlikely you could start a new business or make an acquisition that could offer the same cash flows as your current business, that it's a fairly efficient way to return capital to shareholders, is that. I mean, to me, I saw this as a good sign. Do you have any evidence or research that shows the performance of companies pre and post when they launch a dividend?

In fact, when you see companies initiate dividends, it's often, and you look at earnings growth before and after. Earnings growth peaks about two quarters before dividends get initiated. And after that, what you see is earnings growth get much lower. So I think, in a sense, dividend initiation is really signal of, hey, guys, we got used to 20% growth in our earnings. We're a different company now. And we want you to recognize that going in, it's a sign of maturity to recognize that going for a higher price now and pushing up expectations that you cannot deliver is actually a bad thing. And I think these companies have come to that recognition. And I think that dividend payment might be the start of that process of kind of reorienting people's thinking about what the future will hold.

I didn't think I'd be able to recommend these stocks after their huge run up. And then when I see that their cloud business, which they have made, just staggering, I think we read or saw that across the big seven or the magnificent seven, they've invested something like $32 billion just in infrastructure around AI, you have the hottest growth segment of the world, AI, which every company wants to explore, build their own llms, but they can't build it themselves, so they need to rent it from a cloud based provider. In order to be a cloud based provider that can make the requisite investments. To attract these types of clients, you have to make multi $10 billion investments. So it's sequestered to just a smaller and smaller number of firms. One, it strikes me that the champagne or the nitro and glycerin of cloud and AI built on top of cloud, means that the entire world's growth expenditure, corporate world growth expenditure, is going to be funneled into literally a small handful of firms, which is, one, great for those shareholders. But two begs the question, is this yet another speedballing of concentration of power where we should start thinking about antitrust?

I mean, who's going to be able to compete with these guys?

It's been one of my worries with AI. I think this winner take all phenomena we've been seeing build up over the last two, three decades, which I think you pointed to when you first looked at the tech companies, AI, I think, is going to make it even more winner take all. I'm sure in the Clayton Christensen argument about disruption 30 years ago that it always comes from outsiders, and that's the way it worked out with.com and with AI, I don't think that's going to apply. And here's why. You need two big things for AI. You need processing power in immense amounts and control of data. So it's going to be very difficult for a newcomer to even venture into the space because you're going to get squashed. This is one of those things where the biggest tech companies might actually start off with such an incredible advantage over everybody else that they're going to be. It's going to be tough to catch up with them. So the mag seven might have an extended run, or the fangam, if you prefer to call it, might have an extended run, because AI actually makes the strong even stronger, just like COVID made the strong even stronger.

This seems to be another phase of the strong will gain strength. There might be a newcomer who creeps in. But the interesting thing about the Mac seven is when one of the companies underperforms Apple, for instance, somebody else steps in and fills the gap. So it's almost like you hold all seven or all ten or whatever. You make the number that the collective group finds a way to outperform the market, because if there's a loser, that the winner often is another company in the same group. It's not some outsider that's coming in. So I worry that 20 years from now, you're going to look at the S and P 500 and you're going to find even or any index, you're going to find even more concentration at the top than you did, which creates social and economic questions that will get bigger over time. If you think antitrust is, and Lena Khan might think they're big, that question is only going to get bigger five years from now, ten years from now, and it might become even more difficult to confront as these companies get bigger.

Along those lines of, I mean, there's concentration, sort of seven companies within the S and P or within the Nasdaq. One of the things I've been focused on a lot, and some of this I gleaned from you, is just the power of diversification. The number one question I get is, is it too late to buy Nvidia? And I always say, I don't know. But if you buy an index fund, $0.33 on the dollar are going to to the magnificent seven because they're weight adjusted. And if the other 493 companies have their day in the sun, you got $0.67 in those. What I haven't done, or I haven't done much of, is I haven't diversified geographically. And it strikes me that if you think about AI, I think we're 97% of the revenue and 140% of the profits within, not only within the US, but within a seven mile drive of SFO International. Do you tell people. I know you tell them to diversify, but do you think it's a bad idea to be pretty much all in on american markets?

I'll tell you the biggest problem we have. I mean, I was in Latin America last week and I was in Brazil or two weeks ago and I took the top 20 companies in the US and I put the ages of those companies right next to the companies. And a lot of the companies are 1520 years old. Facebook, if you think about it, is not that old. And then I took the top 20 companies in Latin America and I put them up and they ancient. And I did the same thing with Europe. Ancient companies. You do that. I mean, the US in a sense, is the outlier in this in terms of young companies not just breaking through but making it to the top. I think the more the EU acts, the more convinced I am that Europe will never be a player in AI because in the interest of protecting consumers, they've actually created a system where if you have a young, smart person who's got this incredible AI idea in Europe, he's going to get on a plane, fly to Silicon Valley. And it's not just that. If you look at the total global market gap, the US has actually increased its share of that global market cap significantly.

And with China falling, you actually are getting an even larger segment of global market cap coming to the US. So even if you held a global index fund, you're going to end up being overinvested in us stocks because us equities are just taking an increasing slice of global equities. But I don't even think of these companies as us equities anymore. I mean, they might have, through the accident of history, become incorporated in the US, but these are global giants. They happen to be us companies. So when you buy the S and P 500, you're buying global companies that happen to be US based. I think of my portfolio primarily now as global companies. And to the extent that global companies, the fact that most of them are US based, I think reflects the way the rest of the world seems to be allowing or not allowing companies to catch up with the 21st century. I think with us companies, you're seeing that explosion of young companies take off. That's a plus of what's happened in the US. The minus is when you have these young companies explode, you're going to create. I wouldn't be surprised if within my lifetime, and probably sooner rather than later, you get the first trillionaire, it's only a matter of time before it happens.

So I think you're going to see all those side effects as well. Greater in terms of income, wider disparities in income, and we have to be prepared for the consequences just on that.

Idea of the concentration of power. Something Scott and I have been talking about recently is this idea of interlocking board directors. Basically, you have a board director on one company and then they're also at the same time a director of a competitor, or they have some sort of financial interest in a competitor. And my feeling is that this is pervasive in AI, just as the examples we've looked at. Microsoft is involved in OpenAI, but also mistral and also inflection. Reid Hoffman is the co founder of inflection, but he's also on the board of Microsoft. Brett Taylor's the chairman of OpenAI. He's also on the board of Salesforce, which is invested in anthropic mistral. It's basically, they probably all drink at.

The same bar and they stay at the same hotels, right? I mean, there's a very incestuous component to this, but I think that we get the corporate governance we deserve. I mean, in 2004, when Google went public and they said, we're going to have two classes of shares, one with ten times the voting rights, they were breaking from the pack because for a century in the US, we were moving away from that model because the New York Stock Exchange said, if you want to be listed on the exchange, you cannot have two classes of shares. When Google announced they're going to have two classes of shares, I expected institutional investors to rise up and revolt and say, this is not something that's acceptable, but that's not what we saw. We saw institutional investors, that's okay because you guys are well run and well, man. It's almost like they were saying a benign dictatorship is okay because they're benign dictators. Facebook is a dictatorship. I don't even know whether it's benign or malignant, depending on what you think about Mark Zuckerberg. But we allowed Mark Zuckerberg to have the kind of power that he did because as investors, we look the other way.

Now, I remember in 2019, at the peak of Facebook's issues, money manager complained to me that Mark Zuckerberg, I mean, he held a big stake in Facebook. He said, Mark Zuckerberg is not listening to me. And I said buying shares in Facebook and complaining that Mark Zuckerberg is not listening to this, like getting married to a Kardashian and saying, you know, cameras keep following you all over the place. What exactly did you expect when you married into a reality show's family? Investors, in a sense, have looked the other way with tech companies in terms of corporate governance. And what you're talking about is a slice of that issue. Corporate governance is dead at tech companies. If there's going to be change here, it's not going to come from the board of directors pushing for it. It's going to come from outside. And it's going to come almost entirely from the price dropping enough that they care. The reason Mark Zuckerberg woke up after that metaverse fiasco is because the stock price dropped so much. So I think if you it's unfortunate because we talked the talk about corporate governance. We started measuring corporate governance 20 years ago at scores.

But we've actually let corporate governance become worse because we spend more time talking about it than following through with actions.

We'll be right back.

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We're back with profitry markets, just a pivot to entertainment and the content world. I'd love to get your general reactions to this paramount drama.

The lunatics are running the asylum is my reaction. Right? I mean, this is exactly why you don't bind to benign dictatorships. Right?

Well, sorry. Before you comment, let me just set the stage for our listeners, which is, you know, paramount. They've been fielding offers from several buyers, including Skydance Media, which we've discussed, Apollo. And then a little over a week ago, we learned that their longtime CEO, Bob Backish, is now leaving the company. And he's been in this, it appears, a spat with the controlling shareholder Sherry Redstone, who controls it through her company, national amusements. Just wanted to set that stage. Aswath, go ahead. Thank you.

I mean, I think we need to go back to the original sin, which was when Sumner Redstone was given these voting shares. The reaction was, he is such an insanely good manager, so what harm is there in giving him controlling power in perpetuity? And at that time I remember thinking, but he's a human being. He's going to get older, and he did, and he got dementia. And the voting rights still stayed with them. They passed on to. So what we're seeing is the residue of decisions made in the eighties and the nineties. So what if Zakuberg turns, becomes, I mean, he will get to be 80, 85. What if he gets dementia? Who's going to be running Facebook? This is a problem we set ourselves up to repeat on all these big tech companies with voting shares, with different shares, with different voting rights. Sherri Redstone is, let's face it, she is eccentric. That's the right word. And she might not listen to reason, but she has controlling power. So we know the entertainment business, we need to consolidate that. This business is in disruption. You can't do the things you used to. And there are only three players outside of Netflix.

It's Disney, Warner Brothers and Paramount. And the question is, where will they go? Because everybody else is going to be a side player. What I saw happen with Sherry stepping in and push in a, you know, essentially putting a stop to this process is, you know, you're devising a pathway to drive Paramount into essentially ruin. If you don't do something, there's not a whole lot you're going to be able to do as Paramount shareholders because of something you did 25 or 30 years ago. And I want this almost to be etched into people's memories the next time some company comes along with voting and non voting shares.

Yeah, but they never remember, we need.

To make a Netflix movie about Paramount in the years after and say, hey, watch this movie over and over again in case you're tempted to do it, because it's just, you know, it's funny at one level, but I think about all the jobs and the content you're putting at risk. It's a tragedy in the making that was born out of corporate governance fiasco.

At some point, do you think about running into the fire? I mean, Warner Brothers Discovery is now sub $8 a share. It's got a market cap of $19.5 billion. Now, granted, its enterprise value because of the debt is much greater than that. I think it's got about 40 billion in debt. But at some point, with a company like Paramount or Warner Brothers, when they begin trading as if they were going out of business, isn't there real upside potential there when these things get left for debt?

I'm amazed that. I mean, maybe it's a governance issue that an apple. I mean, because Apple could buy this with petty cash, right, any of these companies. And if you think about buying content for entertainment, you're effectively getting an entire library with each of these companies that you can find better ways of using than each of these companies are. So we talk about winners getting bigger. This is going to be the next phase is I have a feeling that a lot of the existing entertainment companies are going to become parts of the big tech companies. And, you know, you mix it up with all the other things that come with these companies, it's kind of a terrifying thought. But you're getting your news from Apple, your entertainment from Apple. I mean, it's a, it's, it's, it's. I think it's only a matter of time. I think the only reason the big tech companies are avoiding it is do you really want to buy Paramount and have to deal with Cherry Redstone? I think unless you find a way to separate her from the company, no tech company will touch Paramount. So it's almost as if the presence of some of these existing people in the company makes them toxic enough that nobody wants to touch them.

But you're right, at the right price, somebody's going to be tempted. And it's a morbid thought, but time sometimes takes care of some of these problems. So I'd keep a good watch on Sherry Redstone's health because that might be the dividing line of what happens to Paramount.

We've been talking about pretty high profile companies. Are there any sectors or companies that you're looking at where you think they've been kind of overlooked and you see something interesting in the markets, either overvalued or undervalued.

I've been tracked. I mean, as you know, I track markets on a monthly basis, looking at the equity risk premium. And April, when I did the update April 1, it was peak momentum for markets. Everything looked amazing. If you remember, the story was inflation has been conquered, Fed is going to cut rates. The economy is back and four weeks late. It's amazing how much the mood has shifted on big questions. All of a sudden there's this worry about, is the inflation as strong as the economy, as strong as we thought it was? Maybe. I mean, I've read a few stories. Maybe inflation will never drop below 3%. Fed rates. I would, wouldn't be surprised if you saw the Fed raise rates rather than cut rates during the course of the year if inflation doesn't come down. But it tells you how much markets driven by mood and momentum. And I think this month will be a make or break month because the mood continues to shift down. We'll be heading into the summer in a bad mood, with momentum kind of against us, and you put on top of it a presidential election and political instability, we could be looking at a pretty bad year by the time we're done.

And it's across sectors and there's an adjustment, you're going to see it cut across. So for the moment, that's what I'm keeping my honest momentum factor. There isn't a sector that I can point to. That sector is obviously undervalued right now because collectively, I think everything's been pushed up so much that you look at beverages, you look at technology, everything is trading at a much higher multiple of everything than it did a year ago, two years ago. But I think you're just one big correction away from things starting to pop onto your data saying that's been pushed down too much. I mean, I think the entertainment space is an obvious space where I can't buy Disney because my son works at Disney, so I don't want to create issues with them because that's one reason I don't value Disney or write about Disney, though I have lots of thoughts about Disney because I use it in my class. But to me, Warner looks interesting because it doesn't have the sherry redstone effect that I would get with Paramount. And I think the content, I mean, ultimately, I don't care if you're an entertainment giant without the content, what exactly are you going to stream?

So I think the content is interesting enough and ultimately, I think somebody's got to be in charge of the content. Disney and Warner are still better at creating content than Netflix is. Netflix throws a lot more money, but it creates a lot of crap along the way. So I think that to me, there will be more businesses like that show up on my radar. Now Im interested in PayPal as a company. Im amazed at how much the mood has shifted against from PayPal being this high flying financial service company to its boring and nothing's happening. I have companies that I have on my list that I haven't bought yet that I want to wait through May and see what happens, because I'm just one downturn in the market away from saying those companies look good. I would say the same thing to the person who says, can I ever buy Nvidia? My reaction is in the last 15 years, Nvidia has been cheap at least five times on an intrinsic value basis. It's not been all upswing. I mean, the reason I bought Nvidia in 2018 is people were beating it up saying this is the end for Nvidia, there will be a time on every one of these companies where it's the right time to buy.

It might not be right now, but patience has its own rewards.

Just in terms of asset allocation, I've never owned bonds and I have a lot of friends who manage credit funds and theyve said to me lately, Scott, why are you in equities? Do you think the markets could be really volatile? Do you think the markets could go down substantially? And the answer is sure, I can see it. And they said that, look, I can get you with reasonable certainty, ten to 12% a year in the credit markets right now. I can find you high quality debt in great companies and get you double digit returns and nothings guaranteed, but the number youre getting, the return youre getting on fairly low risk assets has surged. Why wouldn't you reallocate or rethink your portfolio strategy and allocate more to credit? What are your thoughts in general?

You're right. Fixed income clearly is. For a decade it was equities on nothing. You earn nothing on t bills, nothing on bonds, even AAA rated bonds. You were earning two, 3%. I think that we have more choices now and I think we need to look at those choices. I don't think you can make, to be quite honest. The ten to 12% with no risk comes from the fact that when, when lenders and bondholders look at risk, it's always backward looking. There's been no default in the last decade. Based on that, it looks pretty safe. But we know that at least in bond markets, default risk is highly correlated, which means that if there's trouble, there's a tipping point where all your bonds get into trouble at the same time because of some macro event. 2008 was a classic event. Bonds that look safe all of a sudden start to blow up on you. But I do think you can make solid returns. I tiptoe into this because I've not been a big fixed income person, but I'm much more conscious about sweeping my money into t bills where I make 5.5% a year. That's a lot of money to leave on the table if you have it in cash.

Would I lock in bonds? The reason I worry about bonds is the same things that would bring equity markets down are the things that will bring bonds down even more. For instance, if you think inflation is your big worry that it might explode, it's going to bring equities down, but it's going to be far worse for bonds because you have no pricing power to increase your coupon your coupon is stuck. So the ten to 12% is assuming that you effectively are going to stay in this debt and that you collect the interest payments with no default. But the price of debt, especially if it's long term debt, is a function of what's happening to inflation. And interest rates saw in 2022, stocks were down 20% because inflation went up, but bonds had a return of -22% it was the worst year for the bond market in a century. Inflation is deadly for stocks, but it's even more deadly for bonds. So it depends on what do you think your worry is for markets? My worry, more than the economy, is inflation, because in my experience, inflation is incredibly stubborn. You think you've conquered it, but it finds a way back.

And I think, as we've seen in the last three years, you think you've got it nailed, but then it comes back because it seems to seep in through other channels. And if inflation is my worry, I'm just as exposed, perhaps more so, if I put my money in long term fixed income as I am in equities.

You also recently wrote this piece on risk in your blog, musings on markets, which I thought was great. And you brought up this distinction between incremental risk and catastrophic risk. The former is risk to sales and earnings. The latter is something that can kill a company.

I don't want to waste your time, but I want to give you a little bit of background to how I wrote that paper. It started with an email I got from somebody in Iceland reading, who read my blog. He said, look, I'm an appraiser in Iceland, and one of my jobs is to appraise the value of this company called a business called Blue Lagoon. Blue Lagoon is this legendary icelandic spa, and it's been around a long time. It's great margins, great profits, but it's facing an existential threat, which is the volcanoes that have become active in Iceland. The lava is flowing in the direction of the blue lagoon. He said, how do I incorporate that risk into my value for the company? It's too late to buy insurance, obviously, because the answer is, go buy insurance. Build in the cost. So it started me thinking about, how do we deal with catastrophic risk in investing in valuation. So I was walking my dog on the beach, which is where I do much of my thinking. And I was thinking about this, and I said, before I point fingers at other people not dealing with catastrophic risk, I just walked out of my house, which is two blocks from the Pacific Ocean and sits on an earthquake fault.

And I paid $2.5 million for this house. Did I bring in catastrophic risk into the valuation of this house? I mean, I'm one tsunami away or one earthquake away from the house becoming rubble. And my earthquake insurance is very limited. It's not going to rebuild the house. And a tsunami, I don't even have tsunami insurance, so I don't even know what would happen if that happened. I said, I'm not building it. And I think this is part of a broader theme with catastrophic risk. In investing. You know what? We deny it. We act like it's not there, and I think there's a reason for it. I use this example of an apocalyptic movie, Mad Max beyond Thunderdome. I said, go watch the movies. Check to see how many times people in that movie check what their portfolio is doing. Nobody does, right. It's survival, survival, survival. So I think in a strange way, as investors, as business is, we shut off catastrophic risk. We pay $500 million for a building in downtown Manhattan, even if we believe that climate change is going to put Manhattan underwater, because our view is, what's the point of even bringing it in?

It's not. I mean, at that point, my portfolio won't matter anyway. Life is going to come to a standstill. I'm either going to live or not live. And I think that's part of a broader issue in business and investing. We tend to ignore catastrophic risk entirely. In fact, I think there might be lessons there for the climate change folks, which is if you preach catastrophe and you ask people to behave better, it's not going to happen. It's like telling people that they have 60 days to live and say, can you live more healthily? Eat. If I have 60 days to live, what difference does it make? So if you want people to behave better, maybe less catastrophe forecasting and more, there is hope, and you can change things. But I think it's part of. I mean, I think we're starting to grapple with the question of catastrophic risk and how to bring it in, but we're just. It was just very early in the process, and we're not very good at dealing with it.

Aswath de Modern is a professor of finance at the Stern School of Business. Aswath, as always, we really appreciate your time.

Thank you, Scott.

This episode was produced by Claire Miller and engineered by Benjamin Spencer. Our associate producers are Jennifer Sanchez and Alison Weiss. Our executive producers are Jason Stavers and Catherine Dillon. Mia Silverio is our research lead, and Drew Burrows is our technical director. Thank you for listening to professor gmarkets from the Vox Media podcast network. Join us on Wednesday for office hours, and we'll be back with a fresh take on markets every Monday.

If you enjoyed our discussion with Aswath, go check out our conversation from last week with Josh Wolf, the co founder of Lux Capital, to hear what hes most bearish and bullish on and which of the magnificent seven hes most excited about.