AI Is Today’s Tractor

Not investment advice.

All eyes are on the war. War is terrible, the outcomes unpredictable.

The most likely moves are oil, gold and the Swiss franc up, probably the yen too. The reaction of stocks and bonds is less certain. In 1991, stocks rallied. So far, bitcoin has moved down but then up modestly perhaps following Israeli reports that the senior Iranian leadership suffered losses.

The war is unfolding against the backdrop of major, disruptive technological change.

AI is today’s tractor.

In 1900, when the majority of the global population worked on farms, the tractor was a terrifying innovation. Opponents even founded The Horse Association of America to resist the shift. In the process of freeing a population from arduous labor, mechanization overturned an economic, social and political order that had existed for centuries.

Once the order is disrupted, two things follow—enormous wealth creation and, as wealth shifts, political instability. In the last month you can see the AI shift violently rippling through all the vectors that impact us—income, borrowing, and saving and, as that happens, the political reverberation.

AI’s Impact on Income
Growth is driven by spending, and spending is fueled by income and borrowing; both are currently being disrupted. Last week’s data point: Jack Dorsey, the founder of Twitter, and now CEO of Block, fired 50% of his workforce in one day. Large cuts at Amazon, UPS and others have also been announced. Dorsey said that AI, paired with “smaller and flatter teams,” are enabling a new way of working. This will bring wealth to those that keep a job and the opposite to those that lose it.

While Block may have been overstaffed relative to its peers, the broader analytical question remains—will AI boost profits (by cutting costs) faster than it reduces income (by letting people go)? Said differently, can a company grow EBITDA per employee using AI? If the answer is yes, profit margins will grow. If it’s “no,” top line growth will falter due to weak demand. This might explain why labor turnover has ground to a halt. One lawyer told me AI has transformed her practice. “We aren’t hiring junior lawyers any more,” she said, because the functions they used to do can now be done far faster and more accurately by AI.

AI’s Impact on Borrowing
Interest rates for most borrowers are falling as inflation cools, with ten-year U.S. bond yields dropping below 4%. War with Iran will accelerate that. There are many forces driving down inflation, but technology is certainly one of them. However, interest rates for companies being disrupted by AI are rising as their cash flows deteriorate and credit quality worsens.

Investors have narrowed their focus to Business Development Companies (BDCs), a lending vehicle designed by Congress to support small and medium-sized businesses. While the global corporate bond market is over $40 trillion, the BDC market is small (around $450 billion). Firms at the epicenter of this shift face risks when investors pull capital from illiquid credit markets, causing borrowing costs to spike—a secondary form of disruption. Blue Owl, the firm at the epicenter of this, has seen its stock fall 60% because their investors can pull money while their assets, many of them loans to tech companies, are illiquid.

AI’s Impact on Saving
Asset prices are generally up since ChatGPT was unveiled. But investors are also punishing companies tethered to legacy processes—such as traditional HR, word processing, and insurance brokerage—fearing they cannot pivot as quickly as Block. But it’s messy. Microsoft (which owns a significant stake in OpenAI) sees its price-to-earnings ratio (shown below) compressed due to “disruption fears,” even though MSFT owns a big chunk of OpenAI.

AI’s Impact on Politics
Regarding politics and geopolitics, AI is exacerbating existing tensions, fueling surveillance states or intensifying partisan friction. The US shift in domestic politics is unsettling enough that record numbers of citizens are seeking more stable jurisdictions, as the WSJ pointed out last week. This mimics the pattern of capital flows, dollar down.

Like with the tractor, the most likely outcome is a period of lower inflation and solid profits, but also significant and sometimes terrifying employment and geopolitical disruption. Creative destruction lives on. I particularly favor liquid assets because it allows me to adjust my views and jurisdictions as the facts shift, as opposed to be locked into long-term illiquid commitments.

And as we all watch what unfolds in the Middle East, the loss of human life deeply pains me.

This document is strictly confidential and is intended for authorized recipients of “A Letter from Paul” (the “Letter”) only. It includes personal opinions that are current as of the date of this Letter and does not represent the official positions of Kate Capital LLC (“Kate Capital”). This letter is presented for discussion purposes only and is not intended as investment advice, an offer, or solicitation with respect to the purchase or sale of any security. Any unauthorized copying, disclosure, or distribution of the material in this presentation is strictly forbidden without the express written consent of Paul Podolsky or Kate Capital LLC.

If an investment idea is discussed in the Letter, there is no guarantee that the investment objective will be achieved. Past performance is not indicative of future results, which may vary. Actual results may differ materially from those expressed or implied. Unless otherwise noted, the valuation of the specific investment opportunity contained within this presentation is based upon information and data available as of the date these materials were prepared.

An investment with Kate Capital is speculative and involves significant risks, including the potential loss of all or a substantial portion of invested capital, the potential use of leverage, and the lack of liquidity of an investment. Recipients should not assume that securities or any companies identified in this presentation, or otherwise related to the information in this presentation, are, have been or will be, investments held by accounts managed by Kate Capital or that investments in any such securities have been or will be profitable. Please refer to the Private Placement Memorandum, and Kate Capital’s Form ADV, available at www.advisorinfo.sec.gov, for important information about an investment with Kate Capital.

Any companies identified herein in which Kate Capital is invested do not represent all of the investments made or recommended for any account managed by Kate Capital. Certain information presented herein has been supplied by third parties, including management or agents of the underlying portfolio company. While Kate Capital believes such information to be accurate, it has relied upon such third parties to provide accurate information and has not independently verified such information.

The graphs, charts, and other visual aids are provided for informational purposes only. None of these graphs, charts, or visual aids can of themselves be used to make investment decisions. No representation is made that these will assist any person in making investment decisions and no graph, chart or other visual aid can capture all factors and variables required in making such decisions.