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Market Pulse
Monday, March 27, 2023

The future of gaming, red hot UK inflation, and a shotgun DefenceTech wedding

Welcome to this week’s Market Pulse, your 5 minute update on key market news and events, with takeaways and insights from the Sidekick Investment Team.

In this week’s edition we have:

  1. DefenceTech. A shotgun wedding between Silicon Valley and the Pentagon?
  2. Red hot UK inflation and more interest rate hikes
  3. The future of gaming: AI powered user generated content?

It’s important to note that the content of this Market Pulse is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.

1) DefenceTech. A shotgun wedding between Silicon Valley and the Pentagon?

The peace dividend is a term coined after the fall of the old Soviet Union. It describes the economic benefit of a decrease in defence spending and an increase in spending on areas like education or healthcare.

Like citizens, governments have to budget carefully and choose where they spend their money. In economics, this choice between spending money on the military or other areas is called the ‘guns versus butter’ model. In 1982 global military spending was 4.3% of GDP. Since then it has fallen steadily thanks to the collapse of the Soviet Union. By 2021 it was only 2.2% [1].

Global GDP is around $85trn dollars and the difference between 4% and 2% is $1.7trn every year. That is a lot of money going to areas like social welfare, healthcare and education instead of tanks and missiles. Thanks to actions by China and Russia over the last few years, NATO member countries are responding with plans to once again start increasing their military spending [2][3].

The traditional acquisition model in the Western military industrial complex focusses on a few major defence contractors. China, on the other hand, operates what Steve Blank, co-founder of the Center for National Security Innovation at Stanford, calls the ‘Silicon Valley Model’. They make use of public-private funds and some estimate they have already invested more than $1trn into their tech sector. This approach seems to be paying off. Despite the US spending almost 4 times more than China on defence, China has taken the lead in some key technologies including small drones and hypersonic missiles [4].

This could all be about to change. Last year NATO launched a fund to invest in startups focussed on technologies like AI and novel materials with military applications. In the US, the Biden administration recently requested funds for a new unit at the Pentagon called the Office of Strategic Capital. Their goal? Attract long-term investment by VCs into startups producing technologies seen as critical to the military [5].

Investors on both sides of the Atlantic are paying attention to the emerging DefenceTech opportunity. But there are some challenges. You usually can’t hold a global auction to sell your startup if you are involved in a sensitive military project. This smaller pool of potential buyers could impact exit valuations. Military projects are also often much longer than 5-7 years where potential investors / VC’s might look to exit. But for now, these barriers don't seem to be holding back investment. Global deal activity in aerospace and defence averaged $25bn during 2021/2022, more than double the $10bn average between 2015 and 2019 [6].

It seems like NATO member countries might increasingly opt for guns over butter in the coming years. Startups from Silicon Valley to Europe are positioning themselves for what could be a big opportunity. We would much rather see public capital being spent on the transition to a green economy or areas like universal healthcare but we can’t ignore the rising likelihood of the remilitarisation of NATO member countries. If this happens, it could materially impact the global investment landscape.

2) Red hot UK inflation and more interest rate hikes

Despite rapid increases in UK interest rates, inflation is still red hot. Last week, inflation came in higher than economists expected and prompted the Bank of England to hike interest rates another 0.25%. This takes the base rate to 4.25% [7].

UK consumer price inflation was 10.5% in December last year. In January this year, it fell to 10.1% and raised our hopes that the worst was behind us. But, last week we got the number for February. Inflation re-accelerated to 10.4%, almost back to the December peak.

It’s not all bad news however. The higher number was driven by historically volatile clothing and footwear prices. Inflation in the services sector, considered by some a better indicator of the underlying price pressures, was lower than the Bank of England forecast. This is a positive sign. UK consumers are also a bit more upbeat. Retail spending increased 1.2% in February and consumer confidence continued to improve from the lows in September 2022 [8].

The Bank of England still expects inflation to fall fast over the course of 2023. They expect the reopening of China could help alleviate some of the pressures in global supply chains partly responsible for higher inflation. Energy prices are also falling and this should help stabilise prices. But this doesn’t necessarily mean we’ve seen the last interest rate hike this year. Some economists predict we could see one more hike in the base rate, to 4.5%, this year [9]. The Bank of England is adamant they need to see concrete evidence that inflation is falling towards their target before they will consider cutting interest rates.

While inflation is still high, underlying economic indicators suggest things are going in the right direction. Inflationary trends could improve as we head into 2024.

3) The future of gaming: AI powered user generated content

Gaming is a big business. Where it used to be a pastime for teenagers, those teenagers have grown up and they still love spending time playing games. Last year more than 3bn people globally played video games. In developed countries more than 60% of people play games, almost half of them women. The gaming industry is likely to expand faster than any broad entertainment category, including video and music streaming [10].

But people don’t just like playing games. A lot of them also like creating games and content for other users. Roblox is a global platform where millions of people gather to share experiences with each other in user generated 3D worlds. The Roblox vice president said he believes the future of gaming is user generated content [11]. High quality user generated content has taken video by storm and thanks to generative AI, gaming could be next.

Generative AI could disrupt the gaming industry by democratising game creation. The easier it becomes to create high quality 3D content and creative game mechanics, the more people will likely get involved in creating games. And, as games get better and more creative, it could lead to more gamers. This virtuous cycle has the potential to unleash explosive growth in the gaming industry.

But it’s not just traditional gaming that might benefit from the democratisation of the creative process. The success of the metaverse could depend on how easy it becomes for users to create new 3D content. Adobe and Youtube have empowered millions of content creators around the world. We believe that the integration of generative AI into creative workflows could accelerate the production of increasingly complex user generated content.

Initially we will likely see exciting new games for existing platforms like PCs, consoles and smartphones. But eventually it might bring us closer to the ever-elusive metaverse. And, if the metaverse becomes a place where we have hundreds of millions of monthly active users, it could unleash a wave of demand for new VR hardware that might one day rival the mighty smartphone.


[1] https://data.worldbank.org/indicator/MS.MIL.XPND.GD.ZS

[2] https://edition.cnn.com/2022/07/25/politics/mark-milley-china-aggression/index.html

[3] https://www.nato.int/cps/en/natohq/news_210091.htm

[4] https://www.wsj.com/articles/pentagon-woos-silicon-valley-to-join-ranks-of-arms-makers-38b1d4c0

[5] https://www.cto.mil/osc/#:~:text=OSC%20Mission,-The%20United%20States&text=Consequently%2C%20the%20Secretary%20of%20Defense,scale%20investment%20in%20critical%20technologies.

[6] https://www-ft-com.ezp.lib.cam.ac.uk/content/d70982dc-ffec-4055-847b-49ab0b2dd843

[7] https://www.ft.com/content/62dee402-9743-4f11-aafc-edcd39b2b13e

[8] https://www.ft.com/content/31398206-f8fc-41b0-8af3-c04504b2e3e0

[9] https://www.ft.com/content/62dee402-9743-4f11-aafc-edcd39b2b13e

[10] https://www.economist.com/special-report/2023/03/20/ready-player-four-billion-the-rise-of-video-games

[11] https://venturebeat.com/business/roblox-believes-user-generated-content-will-bring-us-the-metaverse/

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