Modest Proposal is one of the most thoughtful investors in financial markets. We cover the historical context behind today's market dynamics, the state of active management versus index investing, and why there's no shortage of exciting opportunities despite high valuations.
Principles & Lessons:
1) Surging demand often meets inelastic supply, creating temporary surplus that markets overcapitalize. Modest illustrated this dynamic with 2000s commodities, where “China… went from consuming a very small amount of global traded commodities to a very large amount,” causing a price surge. He further noted that “capitalism did its job: people went around the world and built mines,” eventually bringing prices back down. He sees recent parallels with COVID-era demand and overcapacity in areas like freight and beverage cans, cautioning that markets “put multiples on…temporary surplus,” yet new capacity often erodes that surplus.
2) Technology hype can obscure whether surging demand is economically sustainable. In semiconductors, for instance, Modest highlighted that “TSMC can’t make chips fast enough” for AI, but one must still ask: “Where is the economic activity coming to support the type of spend that is being undertaken?” He draws on the dot-com example, where heavy fiber-optic investment eventually found justification, but only after much capital was sunk. In his words, “It’s not surprising if near-term spending outruns near-term revenue.”
3) Frontier AI models might retain strong lead—unless open source fast follows enough to level performance. Modest hears claims from “folks inside OpenAI [saying] AGI is here within three to five years,” implying large labs could keep a big performance edge. But he also sees “the investment community concluding that LLM models…will be relatively undifferentiated,” so open source might become “good enough.” In one scenario, “enormous surplus accrues to the big frontier labs;” in the other, “the application layer sees enormous upside” from commoditized models.
4) Large U.S. tech incumbents remain formidable, leaving active managers with a tough benchmark. He pointed to Apple, Microsoft, Google, and others, noting, “these are some of the most incredible businesses ever and they’re still performing.” He reminded that “if you’re a software investor, you have to ask, if my opportunity cost is Microsoft at mid-teens growth, what am I doing here?” The moral is that simply continuing to hold these giants often outperforms more complex strategies.
5) COVID distorted many industries by inflating demand and spurring capital overshoot. As Modest put it, “we’re two years later, and in trucking, we still haven’t worked through the overcapacity,” after supply was added to move everyone’s lockdown shopping. Similarly, beverage can makers massively expanded capacity amid “10% a year demand,” only to see “demand revert” after pandemic behavior ended. He sees “a huge cyclical hangover” in freight, energy, and distribution networks.
6) Rapid capital flow into private markets may reflect return smoothing more than superior opportunities. Modest questioned the “institutional impetus” behind large endowments pouring 30–40% into illiquid private funds, suspecting that “the reasons now…are far more about volatility avoidance” than about “highly attractive risk/reward.” He mentioned public benchmarks like QQQ easily compounding 5x MOIC over a decade, observing that “not many fund families have multiple 5x MOIC funds,” so illusions of outperformance can be shaped by illiquidity and slow marks.
7) Commodity pricing can correct for overinvestment, yet short-term markets reward the surplus. Modest cited mid-2000s metals and current supply chain expansions: “The willingness of markets to continually put multiples on temporary surplus… is a constant source of confusion.” Nonetheless, he acknowledged “if you tried to skip that mania, we might never get needed mines or capacity.” In other words, booms attract capital to fix shortages, which then overshoot, resulting in eventual busts.
8) Macro and capital cycles create “tensions” that often drive the best investing opportunities. He pointed to interest rates, housing mismatches (existing vs. new homes), overcapacity in freight, and “capital cycles with big up/down moves” as places to look for inflection points. His framework is: “Look for that tension—like a huge mismatch or ‘controversy’—likely to be resolved near-term.” He added, “The best invests are often buying in the trough of the capital cycle,” but acknowledges “timing is tough,” as proven by the persistent freight downturn.
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Transcript