The Coming Revolution


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07.07.21
Thomas Donnelly


As we wrap up a long July 4th weekend, I’ve been thinking about the fact that the Declaration of Independence came not at the end of the American Revolution but the start of it. It was an ideological argument, stating unequivocally that the world was changing and that we — The United States — would be on the right side of that change. The American Revolution inspired the French Revolution, all while the First Industrial Revolution took hold in Britain. Nearly 250 years and several rounds of profound societal changes later, we are now on the cusp of what has already been dubbed the Fourth Industrial Revolution. Taken, autonomous technologies are expected to be just as or even more disruptive to society as the steam engine, electricity, and the integrated circuit have been through the previous three Industrial Revolutions. What does this have to do with your finances? Let’s get into it.

Disruption On The Horizon


“Disruption” is a word that gets thrown around a lot vis-à-vis stock investing, with many people assuming it just means that a newcomer has displaced an incumbent market leader — Netflix vs. Blockbuster being a common example here. But when you look under the hood, so to speak, what is really going on is that the incumbent’s products and/or services have actually been made obsolete by some innovation.

I will not get into the organizational psychology of it, but there are understandable reasons why incumbents tend to be less innovative, and in some cases, even resist change. And as we have seen with the accelerating innovation in recent decades (and just in recent years, in fact), the “turn-over” in the stock market has increased. For example, in 1965, the average tenure of companies on the S&P 500 was 33 years. By 1990, it was just 20 years. It is now forecast to shrink to 14 years by 2026. Fully half of the companies in the S&P 500 today expect to be replaced within just ten years. That’s disruption. And we see evidence of this so-called “creative destruction” starting with record numbers of Initial Public Offerings (i.e., new companies going public) over recent quarters.

Right now, there is a persuasive case to be made that the widespread application of machine learning, artificial intelligence, and other autonomous technologies are poised to make as significant an impact on society in the coming years as new technologies like the automobile did a century ago. Consider for a moment that “driving a vehicle” in some form or another is currently the top job in most U.S. states and how disruptive it will be when the need for human drivers becomes obsolete. Think of how far-reaching the economic impact of just autonomous vehicles will be.

The Right Side of Change


When we talk about autonomous vehicles, one company stands out leaps and bounds ahead of the rest. It is a great example for our discussion: Tesla.

Last week, Tesla announced that they produced a record-breaking 206 thousand vehicles and sold 201 thousand in Q2; an annualized production rate of nearly 850k vehicles, and 70% more than the total (and at the time, record-setting) number of vehicles they produced and sold in 2020. Those numbers become even more impressive when considering that Tesla is currently only operating one of their production facilities at full capacity. Tesla is effectively executing well beyond all expectations and doing so with three hands tied behind its back. Their new Shanghai facility is still ramping production, while the Austin and Berlin facilities are on track to come online at the end of this year. These new production facilities expect to launch Tesla’s new battery platform, which was announced last year. This is projected to drive down costs further and increase performance dramatically, allowing Tesla to produce the highly anticipated $25k mass-market vehicle electric vehicle.

While the legacy/incumbent automakers are finally beginning to push into the electric vehicle market a full 10 years after Tesla pioneered it, our view is that they have been doing so in a way that strengthens Tesla’s competitive advantage. For example, the legacy automakers have outsourced their non-core competencies like technology and battery production, whereas Tesla has pursued an aggressively vertically integrated strategy in these areas, controlling most of their supply chain from the raw materials like lithium to designing their custom chips. Ultimately this strategy, assuming it is executed successfully, could allow Tesla to produce higher-quality vehicles at lower costs than the competition.

And importantly for Tesla, the vehicle itself is not even the endgame. Using a razor/razorblade metaphor, Tesla’s future profit centers are all in in-vehicle services, including autonomous driving and autonomous ride-hailing as its killer app. Tesla aims to make its future profits not just by selling electric vehicles to consumers but by replacing consumer electric vehicles with autonomous driving electric vehicles — think of something like robot Uber rides — thereby making owning a car completely obsolete for the majority of people.

Specifically, regarding autonomous driving, there is no one else even remotely close to cracking this complex AI puzzle. So, assuming Tesla is the first, we believe this could be a winner-takes-most market. Disruptive change is coming, and we believe it is coming faster than most people can imagine.

Positioning Yourself


It should be said that Tesla and the auto industry is just one example of the disruptive revolution we see coming. Indeed, we see similar disruption stories playing out in legacy banking, dirty energy, old-school real estate, and on and on. And if we are on the cusp of the sort of changes over the next decade, then being on the right side of it (or not) could make (or break) one’s ability to achieve financial independence.
That said, investing in innovation and disruption are not for the faint of heart. Performance could be highly differentiated from average market indices, including periods of under-performance and the potential for much higher long-term returns. My approach to investing is ultimately a long-term project — and short-term reactions to market events may be counter-productive and harmful to successful investing and goals for portfolio outperformance.

Please reach out if you want to discuss your situation.

Cheers,
Thomas


Thomas Donnelly is a Financial Advisor of Santa Monica, Calif-based Gerber Kawasaki Inc., an SEC-registered investment firm with approximately $1.8 billion in assets under management as of 02/22/21. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which course of action may be appropriate for you, consult your financial advisor. No strategy assures success or protects against loss. Readers shouldn't buy any investment without doing their research to determine if the investments are suitable for their situation. “All investments involve risk and one should consult a financial advisor before making any investments. Past performance is not indicative of future results.”