Gavin Baker - The Cyclone Under the Surface

Principles & Lessons:

• Public markets have seen a hidden “crash” despite index highs. Gavin points out that “the average tech or consumer oriented growth stock that’s below a $100 billion in market cap is probably somewhere between 40 and 65% off its all time high.” He contrasts this “carnage underneath the surface” with the strong overall performance of a few massive technology companies, describing how “the market’s at or near all-time highs,” yet many growth-oriented funds have felt real pain because they lacked the biggest winners like “Google, Microsoft, Nvidia, Tesla.”
• Inflation now dominates market thinking, overshadowing typical rate-cycle worries. Reflecting on “the highest CPI print in 40 years,” Gavin stresses that “the Fed is a little bit of a side show,” because “the only thing that matters is inflation.” He points to how wage inflation in particular could compress companies’ return on capital, referencing Warren Buffett’s 1970s work on how inflation “inflates your asset base and depresses your ROE or ROIC.” Gavin adds that if wage inflation stays persistent, “all those calculations go out the window,” increasing risk for equities.
• Supply chain issues look solvable, but wage inflation remains unpredictable. While addressing the shortage-driven inflation in goods, Gavin points to “massive supply response” examples like, “Amazon has spent more money on capex in the last two years than they did in the preceding 20 years,” and TSMC’s multiyear capex surge. He labels that side of inflation “very likely to normalize” as the economy shifts “away from goods towards services.” Yet he is cautious with wage inflation, explaining “nobody fully understands how powerful that debt jubilee was,” and emphasizing that continued wage pressure can have bigger consequences for the entire market.
• Semiconductors remain consolidated but still face cyclical inventory risks. Gavin notes that semis have consolidated into “monopolies or duopolies in every subsector,” and demand is structurally boosted by AI, 5G, and EVs. However, he highlights that semis are still cyclical because “customer inventories must equal lead times” and “that leads to this crazy positive feedback loop,” which can end abruptly once “something changes.” He cautions that a slowdown in consumer demand plus rising capacity “probably makes it worse,” yet the long-term structural growth of semis at “3X nominal GDP” stays intact after the cycle.
• Software shows resilience but demands a focus on free cash flow. Gavin explains that, unlike certain internet companies facing a “COVID hangover,” software does not have the same risk of demand normalization. “Software is the consumer staple of tech,” he says, but urges distinguishing between those “with a 2 or 3% free cash flow yield” and others still burning cash. He admits, “I was wrong” on how big software’s pandemic pull-forward would be, yet remains bullish on “infrastructure” software that can thrive atop leading clouds, seeing a durable transition to cloud services and stable growth.
• Internet businesses diverge more by business model than by broad label. Gavin divides internet stocks into e-commerce, advertising, and subscription, describing how “e-commerce and advertising are way more GDP sensitive than software.” He warns that some internet platforms now “have real, legitimate fundamental weakness,” while subscription-based models can keep steadier revenues. He also points out that at scale, many internet giants effectively earn “levered royalties on global GDP,” but that does not shield them from short-term slowdowns if they depend on consumer goods spending or digital ads.
• Private markets trade on an ‘illiquidity premium,’ but public valuations still set the ceiling. Gavin details that “the entire system wants less frequent marks,” so private capital has become the favored “high Sharpe ratio” place for many allocators. However, “if public market weakness or strength persists for six to nine months, private valuations will cool off” accordingly. He sees the venture ecosystem restructuring into four major participants—angels, seed-to-B specialists, big multistage investors, and some niche operational growth firms—while cautioning that they all eventually “have to become liquid” and face reality when “public multiples are the ultimate truth.”
• Cultivating rationality about mistakes is crucial, especially in public investing. Reflecting on the psychological differences between private and public markets, Gavin says that in public markets “you’re going to be wrong all the time,” and the real key is being able to “be rational when you’re wrong.” He contrasts this with private investing, where “you don’t mark to market every day and you don’t feel like an idiot every time the market disagrees.” To remain open-minded, he returns to books like “A Wizard of Earthsea,” which warns that “ego is at the root of most failures,” thereby reminding him to stay humble amid market volatility.

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