Grurray

April Showers

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Yesterday, the GDP figures were released for the first quarter of the year, and they showed that the economy is flatlining. We grew at only a pitiful 0.5%. Much of it was caused by a huge decline in business investment, which saw the biggest monthly drop since the recession.

This is mostly blamed on the troubles in the oil and gas industry, but output in other areas of the economy also showed weakness. Factory orders dropped and have remained flat the past several months. Car sales plummeted 2.1% last month, their biggest drop in a year. With gas prices low this is the one thing we should see rising. The car industry stumbling means there may be some other underlying problems.

The conventional wisdom, on the other hand, views this as just a blip. The winter season in the post-recession era has usually been the weakest time of year only to be followed by a rebound into the rest of the year. The exception was 2012 where the high hopes at the start gave way to the rising probability of an Obama reelection. The economic shock spread during the year, and the traditional holiday hangover came a little early in the wake of the electoral wreckage. This year, with the jobs market expected to stay strong and the Fed signaling it will put the brakes on further interest rate increases, the economy is seen bouncing back as the rough waters give way to the calm port.

It may very well turn out that way for all I know. My crystal ball has been a little foggy lately, so I wouldn’t venture a guess either way. However, there may be some other causes for concern further down the road. This week the McKinsey Institute just issued a research report on the stock market, ominously titled, Diminishing returns: Why investors may need to lower their expectations. In it they provide a detailed analysis of why the next 30 years will see lower stock market returns than the previous few decades.

Now admittedly, most analysts’ forecast for the next 30 days can usually be attributed to luck. A forecast for the next 30 years probably isn’t something you want to bet the whole farm on. A small corner of the barn maybe, but I would save the rest of the homestead to see how things actually unfold.

The report lays out in detail why the oversized returns between 1985 and 2015 were possible, and the reasons they say are because of four factors: low interest rates, low inflation, high productivity from technological advances, and favorable demographics from emerging markets entering the global economy. Nothing controversial there. The first three elements increased profit margins, and the last one provided cash influxes, which kept interest rates low, which in turn increased the others. Virtuous cycle wash, rinse, repeat. They also include some calculations, but the self-evidence is apparent enough.

The wrench in the works is going to be the fact that those elements won’t have the effect that they once had. Interest rates are already rock bottom, and in some cases even below that. Squeezing more out of low yields is going to be tougher and tougher. In 1980 inflation was 13% and interest rates were 20%. Now they’re currently at 1.6% and 0.5% respectively. There’s nowhere to go but up. Sideways is always a possibility, but we’re still in the same boat. That won’t drive future growth either like it once did.

Demographic growth may still hold up. There’s still a whole lot of world out there with the potential to drive a modern global economy. The question is will they be capable of replicating what we saw in the recent past with hundreds of millions of Chinese rising out of the Maoist ashes and into the middle class? Any new emerging markets will have a lot more work to do. The report points out that the countries with the largest economies have seen slowing population growth, and that will continue to decelerate

In Western Europe, aging is more striking than in the United States. In France, for example, the share of the working-age population is expected to decline from 63 percent to 58 percent over the next 20 years. In Germany, the fertility rate has exceeded replacement rate in only seven of the past 50 years. Employment has already peaked in Germany, and its labor pool could shrink by up to one-third by 2064. Until the 2015 influx of refugees from Syria, Iraq, and elsewhere, the German population was expected to shrink by as much as 0.3 percent per year over the next 20 years.

Germany has decided to address their demographic collapse by welcoming in an unproductive culture. Either way they haven’t much left to contribute in preventing the forecasted shortfall.

McKinsey does hold out hope for some technological breakthroughs which could pick up the slack in productivity. Whatever it may be, they say it will need to have a bigger impact than the previous computer and internet revolutions because of the other headwinds. The best scenario would be in some combination with fast growing emerging market or industry. The problem with that happening is now that taxes and regulation are increasing, companies involved in fast growing sectors will tend to want to stay private, so equity returns will be elusive for only a select few.

Interestingly, one sector highlighted that will benefit from higher interest rates is insurance companies. The era of low to zero interest rates has made it difficult for them to make any money on annuities. Their annuities pay out guaranteed yields to customers, but ZIRP and NIRP keep profits low. Fixed income annuities in which insurers bear most of the risk will benefit from higher yields.

However, variable annuities where the customers share the risk have more exposure to equities, so they would be vulnerable to the lower growth/lower returns environment. Providers of variable annuities along with other asset managers will need to adjust their investment strategies:

To confront this, asset managers may have to rethink their investment offerings. One option would be for them to include more alternative assets such as infrastructure and hedge funds in the portfolios they manage. Such alternative assets already account for about 15 percent of assets under management globally today.

To chase returns, investors will be forced into riskier assets, possibly with dubious intentions, i.e. government boondoggles otherwise known as shovel ready infrastructure projects. We may already be seeing something like this with the imminent government takeover of financial advisors

The Department of Labor dealt a bit of a surprise blow to fixed indexed annuities in the final iteration of its rule, issued Wednesday, by lumping the annuities into a more complex and costly regulatory regime than they have presently, representing an about-face from the department’s original proposal.

Just like Obamacare pushes out the small to medium firms that can provide much needed innovation in order to capture the market, the new DOL fiduciary rules will push out small to medium sized advisors to replace them with automated puppets that will be programed to herd investors into investing in government programs.

There’s a good reason the Obama Administration is currently fighting so hard to keep these rules. It’s a template for taking over other industries. And with that it’s another impediment to productivity growth and innovation which reinforces the grim forecast of diminishing returns by McKinsey.

When will we win?

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From some recent readings on the Vietnam War

A bitter little story made the rounds during the closing days of the Vietnam war:
 
When the Nixon Administration took over in 1969 all the data on North Vietnam and on the United States was fed into a Pentagon computer population, gross national product, manufacturing capability, number of tanks, ships, and aircraft, size of the armed forces, and the like.
 
The computer was then asked When will we win?
 
It took only a moment to give the answer: ‘You won in 1964!’

Without Churchill, India’s Famine Would Have Been Worse

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There’s been quite a bit of clamor going on the past week about Winston Churchill. First Marc Andreessen made a rather poorly received joke about Indian anti-colonialism on Twitter a few days ago. Then, in last night’s Democratic debate, Bernie Sanders referenced Churchill as a foreign leader to be emulated.

I’m an avid follower of Andreeson. He tossed out a flippant comment, probably without giving it much thought, and inadvertently got caught in the middle of a hornet’s nest. I’m certainly no fan of Bernie Sanders’ socialist proposals, but I do appreciate his point of view. He made a good point about Winston Churchill. It’s something unfortunately not shared by others in his party.

In response to these two events, the left wing camp has been working overtime to consign the legacy of Churchill to history’s dustbin, and one of their preferred vehicles has been the Bengal famine of 1943. The hipster-Jacobins at Vox.com have written a piece documenting Churchill’s supposed war crimes including his alleged complicity in the famine. They’re all based on rumor, heresay, quotes taken out of context, and statements by political and personal rivals. If you feel like diving into the pseudo-journalistic dumpster you can go search for it, but I’m not going to give it any more attention than it deserves, which is very little.

What I will provide is the Churchill Centre’s rebuttal.

When the War Cabinet became fully aware of the extent of the famine, on 24 September 1943, it agreed to send 200,000 tons of grain to India by the end of the year. Far from seeking to starve India, Churchill and his cabinet sought every way to alleviate the suffering without undermining the war effort. The war—not starving Indians or beating them into submission—remained the principal concern.

The greatest irony of all is that it was Churchill who appointed, in October 1943, the viceroy who would halt the famine in its tracks: General Archibald Wavell immediately commandeered the army to move rice and grain from areas where it was plentiful to where it was not, and begged Churchill to send what help he could. On 14 February 1944 Churchill called an emergency meeting of the War Cabinet to see if a way to send more aid could be found that would not wreck plans for the coming Normandy invasion. “I will certainly help you all I can,” Churchill telegraphed Wavell on the 14th, “but you must not ask the impossible.”

I would hope that faith and reason would lead us to see through the falsehoods of leftist revisionists. Sadly, most people now are being fed the biases of the “Explainer Journalism” view of the world, so the record needs to be set straight.

Air and Space Reading

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Some things I’ve been perusing lately concerning aeronautics and aerospace

The WW2 flying wing decades ahead of it’s time

Flying wing designs gained some credence in the 1950s, mostly due to the efforts of Jack Northrop, who had been inspired by seeing some of the Horten’s sports gliders in the 1930s. The captured Ho 229 may also have encouraged him. Northrop’s unsuccessful YB-35 flying wing bomber design of the late 1940s, was hamstrung by massive vibration problems caused by the propeller-driven engines, showing that the Hortens were right to have used jets in the Ho 229. Northrop’s later jet-propelled YB-49 design used jet engines, and while it never went into service, it paved the way for the company’s B-2 Spirit stealth bomber decades later, a design which certainly shares some physical similarities with the Ho 229.

When U.S. air force discovered the flaw of averages

Out of 4,063 pilots, not a single airman fit within the average range on all 10 dimensions. One pilot might have a longer-than-average arm length, but a shorter-than-average leg length. Another pilot might have a big chest but small hips. Even more astonishing, Daniels discovered that if you picked out just three of the ten dimensions of size — say, neck circumference, thigh circumference and wrist circumference — less than 3.5 per cent of pilots would be average sized on all three dimensions. Daniels’s findings were clear and incontrovertible. There was no such thing as an average pilot. If you’ve designed a cockpit to fit the average pilot, you’ve actually designed it to fit no one.

The A-10 lives to fly another day

It’s a striking about-face from just a couple years ago when they were saying the A-10 was obsolete. Then again, they’ve been saying that for 30 years. The obsolescence of close air support in general has always been just around the corner for the past 70 years. Since now the A-10 won’t be allowed to phase out completely until a CAS replacement is ready, we need to start planning for the Warthog 2.0

According to Sprey, the A-10 is by far the most survivable aircraft for the low-altitude, low-speed CAS mission. But almost every aspect of the A-10 can be vastly improved using modern materials and construction techniques. However, The key to producing a new warplane quickly, on time and to budget is to use the best existing technology rather than trying to invent entirely new hardware and software.

The audacious rescue plan that might have saved space shuttle Columbia

As with every other task involved with the rescue, there was no room for error, and there would be no second chances. Atlantis would be launched with an all-veteran crew, with selection for the mission biased heavily toward astronauts who demonstrated fast adaptation to microgravity (there was no time to be space-sick) and high aptitude at EVA and rendezvous. The report names no names, but it does indicate that an assessment revealed a pool of nine EVA candidates, seven command candidates, and seven pilot candidates available in January 2003 whom NASA felt could have undertaken the mission.

Which brings us to one of the all time great movies about the space program

You’re damn right they are! Know what they accomplished living up there in a tin can for five months? Because of men like these, we’ve taken the first step off this little planet. The moon trip was a walk around the block. We’re going to the stars, to other worlds, other civilizations. Men will be killed in this effort just as they’re killed in cars and airplanes……and bars and…

After the Gold Rush

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3D printing industry leader 3D Systems announced last week that it plans to stop making consumer 3D printers. They’re going to concentrate on supplying the industrial markets. It’s the culmination of a significant reversal from just a few years ago when the media hype was fueling a bubble among these additive manufacturing makers like 3D Systems and Stratasys. The trend now is moving away from supplying the much publicized hobbyists and enthusiasts and towards the more reliable demand of professional customers

The company has indicated that the discontinued product line will account for < 2% of revenue, roughly $13M in sales, which is much less that the ~$45M in “Consumer” sales we had projected in our model. The primary difference is likely to be materials (which the company has indicated will still be supported), desktop printers, scanners and Gentle Giant studios.

The revenue numbers are a big disappointment because the printers were supposed to follow the time tested and much beloved razor blade model with most of the sales coming from resin filament. The markup on the filament in most cases is a holy grail level 1000% – 2000%. The fact that 3D systems, the pioneer of additive manufacturing, couldn’t make this work is bad news for the industry as a whole.

Stratasys, the other big competitor in the sector, isn’t doing much better. Last year after acquiring Makerbot, perhaps the current top brand in consumer 3D printers, they let go about 1/3 of the workforce (just after making the founders wealthy, of course). Now after seven years and several different updates and revisions, they’re still trying to make a product that works. The class action wolves are now circling, so it may be only a matter of time for their consumer business also.

Meanwhile, dead tree printing stalwarts such as HP and Toshiba are poised to enter the 3D fray, but they will be making industrial 3D printers. The plan is to leverage their already considerable strengths in sales and distribution to medium and small businesses. Mostly they’re drawing on their experience in the consumer sector where they long ago learned that consumer hardware is a commodity business with little prospects for the big growth expected of startups.

One business model for 3D printing that seems to be working isn’t selling the devices but making and selling the final product. Such is the case with Proto Labs.

Proto Labs, on the other hand, enjoys far less competition because the manufacturing services industry is highly fragmented and often slow to turn around orders. This dynamic has allowed Proto Labs to establish itself as lowest cost and fastest provider that can take a product developer through the entire design and manufacturing process — from conceptual model or prototype using 3D printing, to a mid-volume manufacturing run exceeding 10,000 units using injection molding — all in a matter of weeks.

Years ago, I used to do a lot of business with their rapid prototyping division, Fineline, before they bought them out. They were a nice little group of industry experts in the Research Triangle, and it was always super easy and inexpensive to get anything made and in your hands within a few days. There’s a wide moat, as they say, with this business because of capital requirements and technical skills, so I’m sure acquiring Fineline was a great value. This is a good example of the discipline of Proto Labs, unlike 3D Systems which gorged on any over-hyped acquisition it could find until it suffered its current debilitating indigestion.

Another business model that seems to be flourishing along with supplying industrial customers is metal 3D printing. In fact, despite today’s overall market drop, 3D Systems stock was up double digits on an announcement it would aggressively pursue this market. Aside from appealing to deep pocketed industrial customers, metal printing may have certain other advantages over plastic which could win it over in the consumer market.

Metal printing may have the fabled killer app that every innovation must possess to be successful and that has heretofore been so elusive for current 3D printers. Unfortunately, that killer app is firearms, and they are now fighting for their lives. 3D printed guns may save the desktop 3D printer, but first their advocates must save themselves against a State Department ban claiming the guns violate export controls on weapons.

This case is an exceptionally complicated one that hinges on several legal rulings that honestly I don’t see being resolved until it is kicked up to the Supreme Court. Namely, are digital files considered free speech or are they considered objects, and are 3D printable guns covered under the Second Amendment? Several court cases have been working their way through the courts asking similar questions for different reasons, but as of yet there has been no precedent setthough on the other side of the world New South Wales, Australia has been working to ban 3D printable gun files.

While everyone is waiting to hear how Obama plans to slap more regulations on gun sales, the additive manufacturing industry is waiting for the Supreme Court to finally potentially unleash their long awaited and much hyped consumer devices. So stay tuned. Defense Distributed is being represented by Josh Blackman, who as far as I can tell is one of the best experts out there on constitutional law. If he can get the case before SCOTUS he’s got a good chance in my estimation to win it, and with that salvage the consumer 3D printing business.