Remember the past to understand the future

It’s just another good reminder that in the short term, the market and the economy aren’t in sync.

I mean, by nearly all measures the economy is one of the worst we’ve experienced in many years outside of the COVID shutdown. High taxes, inflation, and interest rates are slowly strangling the middle and working classes.

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If you’re asset rich and debt free, life is good, though. Higher interest rates mean returns on risk-free cash are around 5%.

Why would you buy Commonwealth Bank on a prospective yield of around 3%?

Wait…

Everyone is buying Commonwealth Bank on a prospective yield of around 3% (or 4.3% grossed up for franking credits)!

The stock closed at a three-month high yesterday. It’s up 15% from its early October lows.

Who is buying it?

My guess is that a lot of money is coming out of the property sector and going into the market, with large caps like CBA being major beneficiaries.

Whether this continues to push the market to new all-time highs, I have no idea. But I do know that in the background, a low-growth economy caps earnings growth, and therefore long-term stock market returns will likely be poor from these elevated levels.

For a given level of earnings, the price you pay determines your future return. Given earnings growth remains weak (especially for domestically focused businesses like the banks), investors continue to pay a price that will likely deliver a poor long-term return.

Not that anyone does the maths these days. It’s all based on emotion. Should I get in, or get out? Is AI in a boom or a bust?

As I mentioned on Monday, the AI trade probably moved too far to the bust side in recent weeks. Now we could be in the early stages of moving back to the ‘AI’s booming’ mentality.

I’ve been thinking a lot about the longer-term implications of AI lately.

Many people a lot smarter than me say this is one of the most revolutionary technologies in history.

That’s a big call. But even if it’s on par with the steam engine, which kicked off the Industrial Revolution, it will have profound implications for society in the decades to come.

The Industrial Revolution was essentially an energy revolution. Thomas Newcomen built the first practical steam engine in 1712. Mine owners used it to pump water out of mines, including coal mines that had to go deeper to satisfy increasing demand, as wood became too expensive.

James Watt greatly improved the Newcomen engine in the 1760s, making it much more efficient.

Watt’s bigger long-term impact came in the 1780s, when he adapted the engine to produce rotary motion. That made it usable for driving mills and factory machinery, not just pumps, and it’s a big part of why his name became attached to the steam engine and the Industrial Revolution in general.

In the decades that followed, alongside steam, a wave of new machinery transformed employment. The biggest impact was on textile artisans.

This was the era of the famous (or infamous) Luddites (1811–16). They were skilled textile workers from the Midlands, Yorkshire, and Lancashire. They weren’t against technology as such. They were protesting machines and practices that cut wages, deskilled their trades and flooded the market with cheaper goods.

The power loom spread from the 1820s, and handloom weavers’ earnings collapsed over the following decades. This hit hundreds of thousands of workers. Many kept weaving at starvation rates rather than enter the mills.

As industrial factories sprang up, women and children made up most of their workforce. They could earn better wages (albeit with much worse conditions) than they could on the farm, given the reduction in income from weaving etc.

The early stages of the Industrial Revolution had a profound impact on the labour market.

You’re going to see a similar impact with the AI revolution.

The key insight here is that the Industrial Revolution didn’t come for the low-skilled labourer; it came for the skilled artisan.

In the same way, the AI revolution will come for the knowledge worker. My guess is that it will happen slowly at first, then come in a surge.

Throw in the rise of robots and you can see how the labour market is going to be fundamentally different in the years to come.

For the investor, the question to ask is where the benefits of this revolution will flow. Will companies like Anthropic (which is set to become public in the next few weeks) be all-dominant?

Or will the benefits disperse widely?

Does the labour market crash before new AI jobs come about? And if so, what does that do for consumption, which accounts for around two-thirds of GDP in developed economies?

Does this disruption give added impetus to socialism, as disaffected youth do what they have always done and blame ‘the system’?

The early stages of the Industrial Revolution (1800–1840) saw output per worker rise but real wages stagnate. Capital took the gains. It’s no coincidence that Engels’ The Condition of the Working Class in England came out in 1845 and Marx’s Communist Manifesto in 1848, just as social revolutions were underway in Europe.

As I mentioned at the start, the Industrial Revolution was at its core an energy revolution. Moving from a wood-based to a coal-based economy was revolutionary for productivity.

It’s just that capital took the initial gains. Labour gains and vast improvements in living standards came later.

What’s in store this time around?

Productivity gains are set to come at the expense of labour (loss of the basic ‘knowledge worker’), with question marks over whether lower energy costs will play a part. Indeed, AI is energy hungry.

Capital looks set to take the gains again in the early phase of the AI revolution.

Maybe the best option is to just buy shares in the upcoming Anthropic IPO as a hedge against losing your job?

And, of course, we’ll still have the ghosts of Marx and Engels to contend with.

May you live in interesting times!

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