Taking Stock: The Point Where Logic Left the Room

James Lee Writes:

"A long-term fair return is better than a short-term maximum return, James."

I have never forgotten that conversation.

We were discussing two very different approaches to organising societies. On one side sat what I would broadly describe as the Nordic and Singaporean model - different countries, cultures, political systems, but built around a similar idea. Economic growth, capital creation, innovation all matter, but fairness matters too. The objective is not to maximise every outcome, it is to create a system that delivers prosperity while maintaining social cohesion and long-term stability.

On the other side sits the increasingly dominant American model.

To be clear, there is a lot to admire about America. It remains the greatest economic engine humanity has ever created, producing extraordinary companies, entrepreneurs and innovation. But increasingly the philosophy feels different. The objective is not balance - it is maximisation. Maximise shareholder returns, quarterly earnings, valuations, GDP, engagement, productivity. Maximise everything.

There is nothing inherently wrong with optimisation. In moderation it drives progress. The problem is that what begins as optimisation often ends as obsession. Systems designed solely to maximise outcomes eventually become fragile because they stop recognising trade-offs, stop recognising limits and, most importantly, stop recognising common sense.

In a capital market sense this concept of balance is the legal idea that you act in the interests of ALL stakeholders, not just to maximise short-term returns.

Globally there are different nuances. In the US, Delaware law suggests the duty is to the corporation and its stock holders. At the other end of the spectrum, Germany has co-determination laws giving employees board representation and they emphasise the enterprise as a social institution.

I have always believed in balance. Not because it produces the highest return in any given year (it does not) but balance is durable. A long-term fair return is often more valuable than a short-term maximum return precisely because it allows systems, businesses and societies to endure. For companies this means they trade at a higher multiple.

Japan is the clearest living indicator of where the maximisation road ends. It has an ageing population and will be approaching peak fiscal burden around 2040. Social security already consumes 56% of government expenditure, there are only 1.7 working-age people supporting each retiree, rural areas are emptying and 34% of the population live alone. The demographic relief from mortality only arrives meaningfully around 2050 - by which point the debt overhang may be the dominant problem regardless. It is not a cautionary tale about the future. It is a cautionary tale about the present, playing out in slow motion.

When future generations look back at parts of this period, I genuinely think there will be moments where they stop and ask themselves what on earth we were doing; not because the world was terrible, but because we normalised things that were obviously irrational.

We lived through a period where three major conflicts erupted simultaneously, governments borrowed extraordinary sums not to build productive assets but simply to fund spending they could not afford, and political systems increasingly rewarded popularity over competence. We reached a point where investors convinced themselves that passive ownership of an index was a substitute for independent thought, while companies celebrated firing thousands of employees to fund speculative capital expenditure.

Perhaps the greatest irony is that accounting standards continue to treat investment in people as a cost, while investment in unproven projects is an asset. The engineer, scientist, teacher, nurse or manager who creates real value is an expense; the speculative project consuming billions with no certainty of return is an investment.

It is worth pausing on that. The people who build real things, train the next generation, keep patients alive - they are a line item to be reduced. The moonshot with no revenue model is the asset to be celebrated.

Explained to someone fifty years ago, that logic would have seemed like madness.

And perhaps that is the point.

Maximisation

Whether you maximise margins at the expense of your customers, or you maximise how much you pay your staff at the expense of shareholders - eventually creates fragility.

We have seen it in politics, in energy markets, and today I want to talk about maximisation in financial markets and why this feels like the warning bells of change, not signs of success. Like most warning bells, I look at why we should be listening to what they are trying to tell us, not celebrating their music.

Let's start with passive investing. The original idea was brilliant - most active managers underperform, fees matter, and broad diversification works. Giving ordinary investors access to markets at low cost has been one of the great financial innovations of the past 50 years. But every successful idea eventually gets taken too far.

Today, an increasing share of capital flows not because something is attractive, profitable or sensibly valued, but because it is already large. At some point the distinction between investing and following got blurred.

Last week SpaceX listed at an extraordinary US$2.3 trillion, well over 100 times historic revenue.

Both OpenAI and Anthropic have announced their intention to list, which means this cohort will collectively bring approximately $5 trillion of new market capitalisation to public markets. These three companies, which are the largest direct and indirect customers of Nvidia, are together worth more than Nvidia itself (currently valued at around $5 trillion).

But here is where the logic test arrives. That $5 trillion cohort will likely generate combined annualised revenue of only $75 to $100 billion in the coming year, while sustaining tens of billions of dollars in losses.

Nvidia, by contrast, is expected to generate over $380 billion in revenue this year and earn over $200 billion in EBITDA. Both bets rest on the same question, can AI find a commercial model that justifies the investment? However the market is pricing the loss-making challengers at 50 to 70 times forward revenue while pricing the profitable infrastructure provider at roughly 13 times.

Nvidia earned $58 billion in net income in a single quarter, more than most countries produce in economic output in a year, yet the stock fell on the day because investors wanted more. That is what maximisation obsession looks like at its peak.

What concerns me more specifically is that some of the largest institutions in the world appear increasingly willing to bend established rules because certain companies are simply too BIG to wait for.

Investor protections, governance rules and free-float requirements exist for a reason. Yet we have seen most indexes decide to accelerate these companies into major indices because demand is overwhelming.

Thankfully S&P made a decision to apply caution, so investors get to decide whether they want to fund the losses required to see if AI can be commercially successful in the largest index.  Why this matters is that by indices allowing fast-tracked loss-making companies into their index, they are forcing the retirement funds of the average person to be used to fund those massive losses.  By the end of 2026, assuming Anthropic and Open AI list, they will have collectively raised over US$500B, and collectively will still be losing tens of billions a year. My view is that even the most seasoned investor can't make a sensible call on whether that makes sense. The idea that the average person can, is pure lunacy.

We are watching one of the largest concentrations of investment risk in modern financial history develop in plain sight, not because investors are consciously choosing it, but because the system is choosing it for them. The retirement savings of millions of people would become increasingly concentrated around a single idea (artificial intelligence) and not because they chose it, but because an index decided to skip their own rules to include them. If this bet does not work and the cost of AI is more than the benefit, then this $10T of market cap will fall 70% or more.

Think about how extraordinary that is. For decades, passive investors were told that both low-fee diversification and rules-based investing was a better way to invest. Yet we appear to be moving toward a world where retirement savings are funding, and becoming concentrated around, a single technological narrative and a handful of companies, because the gate keepers of the index we track changed their rules.

Perhaps artificial intelligence changes the world as many believe it will; the technology is extraordinary. But that is not really the point. The point is that nobody seems particularly interested in discussing what happens if expectations prove too optimistic. To give context to this bet, assuming Anthropic and Open AI list like Space X, 71% of the Nasdaq 100 would be in 14 companies and 11 of those 14 companies would be either fully reliant or partially reliant on the success of finding a commercial model that works for AI tools.

This bet should have been funded by experts that know that these types of companies don't always work. When listed they should be owned by people who choose to take that risk. What they should not have happen, is for traders to buy it because they believe they will be able to sell it to passive index funds (the bigger fool theory).

History is full of transformational technologies that changed the world while simultaneously disappointing investors. Railways changed the world. Telecommunications changed the world. The internet changed the world. In each case the technology succeeded, and in each case investors eventually discovered that technological success and investment success are not always the same thing.

Now if this frenzy towards AI was limited to $75B of investment int Space X, I think I would just shake my head and move on, but the same behaviour is becoming visible across corporate America.

Every earnings call, every board presentation, every strategy day sounds remarkably similar - larger AI budgets, more computing capacity, bigger investments and increasingly ambitious projects. There is a growing sense that nobody wants to be seen spending too little, even when nobody can confidently explain what the appropriate amount of spending actually is.

Recently, Uber acknowledged that it had effectively consumed its entire annual AI budget within four months and was still evaluating whether the returns justified the expenditure. One of the most sophisticated technology companies in the world was saying, in effect, that the money had been spent first and the return was still being worked out afterwards.

Ten years ago that kind of admission would have triggered alarm bells. Today it barely makes headlines.

Microsoft has reportedly begun reassessing parts of its AI deployment where adoption has not met expectations. Meanwhile, phrases such as “token maxing” are entering corporate vocabulary, as employees compete not to create more value or deliver better outcomes, but to consume more AI resources. A decade ago, that incentive structure would have been laughed out of the room.

That should concern investors, because history teaches us that the largest investment mistakes are rarely caused by people backing bad ideas. They are caused by people becoming too concentrated on good stories.

And AI is currently the greatest story ever told. Even the CEO of Open AI said customers have yet to find a commercial return for their investment because it's too new, but not to worry just wait a year. 

Which brings me to Bitcoin and Strategy.

Firstly, why does Bitcoin matter?

To me, an asset is worth whatever the largest pool of capital says it is worth at any given time. Simplistically, value investors look for earnings, growth investors look for sensible growth, and story investors look for narrative. Story investors often pay the most, but usually for the shortest period of time. Eventually, either the growth catches up with the story, or the asset needs to find the next group of story investors. Think Pacific Edge: more than 15 years of a compelling story and substantial volatility.

As companies or assets shift from one investor group to another, valuations can move materially. But when the story breaks, it can break quickly. For that reason, any sign that Bitcoin’s story is breaking would be an important bell to listen for.

Therefore, I do not view Bitcoin simply as an asset class. I view it as a useful gauge of how much risk tolerance the market has chosen to adopt.

What concerns me is leverage masquerading as certainty. At the start of the year, we said one of the cracks in the system to watch was Michael Saylor and Strategy, the world’s largest corporate Bitcoin buyer. The original Strategy thesis was simple: borrow money and buy Bitcoin. If Bitcoin compounds materially faster than the cost of capital, everybody wins. The framework was effectively built around the belief that Bitcoin would continue appreciating at rates that comfortably exceeded borrowing costs. The strategy works brilliantly when Bitcoin rises, and considerably less well when it does not.

Today we have Bitcoin, Strategy and now Stretch, a credit instrument paying 11.5% and soon to distribute semi-monthly, used to fund further Bitcoin purchases. These are three increasingly complex structures, all sitting on top of the same underlying belief.

What catches my attention is not the structure itself, but the messaging. I have learnt over time that when leaders begin changing the story rapidly, it is often because reality is changing underneath them. Bitcoin was digital currency, then digital gold, then digital energy, and now, apparently, the objective is for Stretch to become one of the best credit instruments in the world.

At some point, you stop listening to the explanation and start asking why the explanation keeps changing. The messaging increasingly feels reactive rather than strategic. Pressure has a way of revealing itself.

Today Michael Saylor has lost over US$10B following his strategy of borrowing money to buy Bitcoin. His credit instrument is trading underwater, his shares are down 20% this year and Bitcoin is down 25%. The narrative is changing rapidly, and the logic still doesn't add up.

Borrowing money to buy an asset in the hope it goes up is gambling, not investing.

This is a clear reminder that not every bet is straightforward. In fact over 50% of investors in Bitcoin are underwater.

The point is not that Bitcoin must fail, that AI must disappoint or that SpaceX is not remarkable. The point is that when narratives become powerful enough, people stop asking basic questions such as what is this worth, what can go wrong, does the structure make sense, is this risk consciously chosen or simply inherited through the system? That is usually when risk is highest. With the Bitcoin story starting to turn, I see that as the first bell to ring.

So while we are seeing bells ring with corporates saying they aren't seeing the benefits yet, our savings are being poured at record pace into this bet, and the risk appetite of the average retail investor is beginning to wane.

A solution

Now if we had competent leaders around the world we would see regulation and targeted investment start to emerge to control the risks of bad events. Unfortunately the same dynamic is playing out politically.

The past decade rewarded attention, outrage, division and performance over competence.

Compare the world today with 2016 and technology is better, artificial intelligence is extraordinary, computing power has exploded, yet many people feel less secure, less optimistic and less trusting of institutions than they did a decade ago.

That should concern all of us, because the purpose of progress is not simply to become wealthier. It is to build a better society.

Listening to the recent budget debate comments from Christopher and Chris reminded me of listening to my children argue in the back seat of the car (endless point scoring, endless interruptions, very little value).

New Zealand faces serious structural challenges. Productivity remains weak, infrastructure is under pressure, healthcare is struggling, housing remains unaffordable for many families and our energy system still lacks the resilience we will likely need over the next decade. These are not small problems. They require seriousness, discipline and a willingness to build things that may not produce immediate political rewards.

The challenge for New Zealand is not whether artificial intelligence succeeds, whether Bitcoin survives or whether SpaceX changes the world. The challenge is whether we remain capable of independent thought while everyone else is being swept along by the crowd.

New Zealand needs to remember it is competing globally with players who are better funded, more willing to bend the rules, and who do not care what happens to NZ, so we need to fight like a welterweight - faster, smarter and more nimbly.

The key strength a government has is simple. It doesn't need a market return for its investment. It should value what we started this discussion, with benefits to ALL stakeholders. So as we watch the warning bells ring, we need to focus on solving our own problems, and tackling things we often say are too hard.

As I often observe: Complaining without a solution is whining.

Fixing our energy supply in order to lower pricing isn't complex. Sell the government’s stake in Mercury and Meridian, nationalise Genesis and then use those surplus funds as the equity check for Genesis to "build, baby, build" using the government’s cost of capital. Start with wind and solar energy, then build a pipeline to build hydro reserves and finally when Rio Tinto next wants to leave New Zealand, buy them a plane ticket.

Fixing our banking system isn't complex. Levy every bank with more than $50B of assets an extra 50bps every year until it balances out and use that to fund Kiwibank to compete. Margin down across EVERY single asset class, not just home loans. Build expertise at Kiwibank in all financial products, stop trying to be the safest bank. Get back into KiwiSaver, wealth, Insurance, all forms of lending. Just hire the very best to do it.

I can hear the outcry now that it wouldn’t be fair to take money from corporates to fund social problems. But as the father of a friend of mine used to tell her, show me where it says life is supposed to be fair.

For investors, this is where it gets interesting.

Most portfolios are becoming increasingly concentrated in a very small number of ideas, with more and more retirement savings directed toward AI, whether directly or indirectly through passive flows, on the assumption that today's winners will remain tomorrow's winners. Maybe some will. But history suggests that periods of extreme concentration rarely end the way people hope.

What concerns me is not artificial intelligence itself, as the technology is extraordinary, but the behaviour surrounding it. When companies celebrate spending rather than outcomes, when employees compete to consume the most resources rather than create the most value, when investors stop asking what something is worth and instead ask how much more money can be directed toward it, I start paying attention.

The last decade rewarded maximisation (leverage, engagement, debt, valuations, outrage).

My suspicion is that the next decade rewards something different, balance. Not because balance is exciting, not because it produces the highest return every year, not because it makes the best headline but because balance survives.

In practical terms, that means looking carefully at businesses with real earnings, genuine pricing power, lower leverage and less existential dependence on a single technological narrative proving out.

It means asking not just what you own but why, and whether the concentration of risk in your portfolio was consciously chosen or quietly inherited through an index that changed its own rules.

It means valuing the companies that treat their people as assets and their customers as partners, not as variables to be optimised. It means being willing to accept a fair long-term return rather than chasing a maximum short-term one.

The world feels tired. Tired of the politics, the financial engineering, the outrage and the relentless pressure to optimise every decision for the absolute maximum outcome. The pendulum is swinging, and when I look around today I increasingly think people have had enough of the madness.

Now is not the time to passively follow crowds. It is the time to think carefully about what you own, why you own it, and whether the risks you are carrying are risks you consciously chose, or risks the system quietly chose for you.

Because when the crowd becomes obsessed with maximising everything, the opportunity often lies in remembering that balance matters. And history suggests that is usually the moment when logic finally starts finding its way back into the room.

Oceania Bond Offer

Oceania Healthcare has announced it is considering an issue of 6-year fixed-rate, senior, secured bonds.

No details have been announced regarding a margin or minimum interest rate. Based on similar bonds and current market pricing, we expect the bond to pay a coupon of around 5.50%. It is worth noting that swap rates have been particularly volatile of late.

Oceania is expected to pay the transaction costs, meaning clients would not pay brokerage. This will be confirmed next week, when the offer is expected to open.

Oceania produced its full year result in May, which saw record sales volume, a meaningful increase in its net assets, and a significant reduction to its net debt. Its debt now sits at 30.1%, the bottom end of its target 30% - 35% range. Although the company is not paying dividends, it is targeting 2027 for a return to dividend payments.

Investors interested in such an offer should contact us as soon as possible with their CSN and the amount they wish to invest.

Paraparaumu Seminar

The first of our seminars this year will be held at Southwards, Paraparaumu at 10.30am on July 7. Please contact us via email if you would like to attend.

New Financial Advisor Position

We are currently looking to add an experienced Financial Adviser to the Chris Lee & Partners team.

This is a long-term role based in Paraparaumu, working closely with our long-standing clients throughout New Zealand.

If you are interested in learning more, please contact us confidentially at office@chrislee.co.nz

Travel

24 June – Lower Hutt – David Colman

26 June – Napier – Edward Lee

Chris Lee & Partners Limited