Before and After the Storm or: Make America Good Again


Thanks for being part of the Epsilon Theory community. One of the other communities that matters to us is Brazoria County, a rural county south of Houston that is experiencing heavy floods in the wake of Hurricane Harvey. The United Way of Brazoria County is a charity focused on recovery for this heavily impacted region.


Mr. Advocate, the rotten tree-trunk, until the very moment when the storm-blast breaks it in two, has all the appearance of might it ever had. The storm-blast whistles through the branches of the Empire even now. Listen with the ears of psychohistory, and you will hear the creaking.
— Isaac Asimov, Foundation (1951)

Do you hear the creaking?

I don’t. It’s not that I don’t see what’s going on in America or that I’m not pained by an increasingly bi-polar distribution of political, social and ethical views. After all, the belief in narrative-driven politics and narrative-driven markets isn’t a belief in their virtue, only their existence. I also don’t know how we get out of this cycle, but I believe that we will. This is not a Seldon Crisis, and Trump is not the Mule.

That Nature smiles at the union of freedom and equality in our utopias. For freedom and equality are sworn and everlasting enemies, and when one prevails the other dies. Leave men free, and their natural inequalities will multiply almost geometrically, as in England and America in the nineteenth century under laissez-faire. To check the growth of inequality, liberty must be sacrificed, as in Russia after 1917. Even when repressed, inequality grows; only the man who is below the average in economic ability desires equality; those who are conscious of superior ability desire freedom, and in the end superior ability has its way.
— Will and Ariel Durant, The Lessons of History, 1968

Cersei Lannister: You should have taken the realm for yourself. Jaime told me about the day King’s Landing fell. He was sitting in the Iron Throne and you made him give it up. All you needed to do was climb the steps yourself. Such a sad mistake.
Ned Stark: I’ve made many mistakes in my life, but that wasn’t one of them.
Cersei: Oh, but it was. When you play the Game of Thrones, you win or you die. There is no middle ground.
Game of Thrones, Season 1, Episode 7

Perhaps the cause of our contemporary pessimism is our tendency to view history as a turbulent stream of conflicts — between individuals in economic life, between groups in politics, between creeds in religion, between states in war…but if we turn from that Mississippi of strife, hot with hate and dark with blood, to look upon the banks of the stream, we find quieter but more inspiring scenes: women rearing children, men building homes, peasants drawing food from the soil, artisans making the conveniences of life, statesmen sometimes organizing peace instead of war, teachers forming savages into citizens, musicians taming our hearts with harmony and rhythm, scientists patiently accumulating knowledge, philosophers groping for truth, saints suggesting the wisdom of love. History has been too often a picture of the bloody stream. The history of civilization is a record of what happened on the banks.
— Will Durant

  Unidentified man/hero/Texan

Reporter:  You guys going to jump in and help out?
Unidentified Man:  Yes, sir.
Reporter:  Where you coming from?
Unidentified Man:  Texas City.
Reporter:  What…what are you going to do?
Unidentified Man:  I’m going to try to go save some lives.

“Val”, said Father, “we don’t expect you to understand this, but some of the things that make Peter…difficult…are the very things that might also make him great someday.”
“What about me?” asked Valentine. “As long as you’re telling fortunes.”
“Oh, Val,” said Father. “All you have to do is live your life, and everyone around you will be happier.”
“No greatness, then.”
“Val,” said Mother. “goodness trumps greatness any day.”
“Not in the history books,” said Valentine.
“Then the wrong people are writing history, aren’t they?” said Father.
Orson Scott Card, Ender in Exile, (2008)

Damn right, they are.

It’s hard to stay focused on a lot of things in the face of human tragedy. Including markets.

I’m writing this on Tuesday, August 29 from my home office in Memorial, a village on the west side of Houston. We’ve gotten more than 30 inches of rain through this morning, we can still do our jobs, and we’re doing fine. The people to the west of us in Katy aren’t. Waters from rains upstream have led to overflowing reservoirs that will be released over time, keeping flood waters high. People to the east of us aren’t, either. Many of Houston’s most populated areas are under water. We have colleagues that have been evacuated from houses they evacuated to, and clients and friends who haven’t been able to leave their second floors for a week.

My little hometown in Brazoria, Texas, some 60 miles to the south, is about to have the screws put to it next. It sits between two rivers. One is a stream called the San Bernard River. The other is a Big, Nasty River called the Brazos. It puts nine times as much water through it as the Rio Grande. Come later this week when this piece is published, it will be putting through 45-60 times as much water — at my hometown maybe some 70-80,000 cubic feet per second. If extrapolations from this NWS projection are to be believed, it could be more like 120-140,000 cubic feet per second. As you can see from the missing right axis, it is both literally and figuratively an unfathomable amount of water — an Olympic-sized swimming pool flowing every 3 seconds through a channel where it usually takes two minutes.

We tend to think big thoughts when big things like this happen, and there’s been a lot of that going on. For me, those thoughts have turned local, but I know a great many people outside of the Greater Houston area are focused on other things that are going on: Charlottesville, the Trump presidency, Berkeley, Eclipses, Nazis. It’s a lot to take, and Ben has accurately predicted and is now observing how some of these issues are manifesting themselves in Competitive Games that force us all into positions where we must either fight or lose. He was absolutely right that the aftermath of the Trump presidency would break us, that it would destroy any chance at productive political, social — hell, even investment dialogue. Was the event that broke us irrevocable? How do we get out of this Competitive Game? Can we?

These questions form the central context for one of the greatest works of science fiction ever written: Foundation, by Isaac Asimov. Spoilers follow, but frankly if you haven’t read it, you should stop reading this note and read it instead. It’s better. The story of Foundation is the story of a massive multi-planetary civilization and the development of a robust, flexible system for understanding and modeling the sociopolitical trends of its very large societies: psychohistory. The main champion of this system, a generational genius named Hari Seldon, identifies the inevitable fall of the prevailing government and its devastating aftermath. While the collapse is unavoidable, he determines, not all subsequent outcomes are equivalent. He devises a plan to plant seeds of the civilization that would survive in two corners of the galaxy, predicting that the evolution of those societies over future generations would lead to the maximum possible peace and stability. The system of psychohistory hinges on the behaviors of very large groups of humans and the simplifying assumption that no individual could possibly have the influence or power to break these models.

There are two kinks in Hari Seldon’s system. The first is the idea that Foundation — but really, any civilization — will reach inflection points from time to time where one set of actions will break the path back to peace and harmony, and one set of actions will maintain it. These events require active intervention outside of the normal behaviors that those in power would otherwise pursue. These are Seldon Crises. The second kink is different in that it is unpredictable, or at least was unpredicted. It is the existence of a single individual who does reach the level of power — in this case through the development of abilities to influence the emotions and judgments of those he encounters — to change the inevitability of Seldon’s map of history. The Mule, as he is called, nearly breaks the Seldon model, until those who rediscovered psychohistory rebuild the models and determine the appropriate strategy to ensure that the Foundation civilization gets back on its long-cycle path back toward peace and stability.

This is fiction and there is nothing in political science , economics or sociology that approaches psychohistory’s fictional robust stochastic framework for predicting the ebbs and flows of history. But there is truth here. The long cycles of history do have repeating features, which have never been better described in a non-fictional sense than by Will and Ariel Durant. Despite already having recommended one book, I think very few books are truly “must-reads.” Still, every human should own and read The Lessons of History as well. Among many other lessons, the Durants present a framework in which the path of history swings between liberty and freedom on the one hand, and equality through social control on the other. That control may extend from a government, from the seat of a priest, spiritualist or imam, from a military strongman or warlord, or from a particularly influential social structure.

In the days and weeks since Charlottesville, I think that a lot of people are starting to see President Trump’s election as a sort of Seldon Crisis. The language people used — the language *I* used when I left the GOP to be a #NeverTrumper — was the language of statistical distributions. “Sure, Hillary Clinton has a lower mean, but Trump has a fat left tail” was the particular phrase I used to sound smart and inoffensive to friends and family who either supported or opposed him. In a lot of ways, this is the language of a Seldon Crisis, because it begins to characterize the threats to society posed by an event or person as existential. I don’t know exactly how to communicate to you that existential language is now our lingua franca, but do I really need to?

Source: Google 2017

A lot of people see the president as The Mule now, too, I think, by which they imply that Trump was both unpredictable and capable of disproportionately large influence on the direction of society relative to what we would have expected from the ordinary ebbs and flows of history. Of course, the Voxsplainer types would be happy to provide you with their latest patronizing explanation for why and how Trump was elected. They’ll also follow it up with a series of snide sub-tweets to give themselves ironic cover. But the many on the left who cannot understand his election or his continued support often have difficulty fathoming that his base did not form as the result of Mule-style manipulation of some sort of another. It’s a backhanded compliment for a big slice of humanity: they couldn’t possibly be this stupid. Of course, it’s also condescending as hell.

The truth is even more condescending. Trump is not a Seldon Crisis. Trump is not the Mule. Sorry. The rotation between equality and liberty continues unabated, peacefully or otherwise, over the centuries. And it’s all happening again. Except it is different this time. It is happening faster. Much faster. Not because of the existence of a Mule character like, say, Hitler, whose individual influence thwarts the ability of the psychohistorians like Hari Seldon or Will Durant to predict paths. And it’s not because of Trump, as much as many want to paint him with that brush.

It’s because of the internet.

Taxonomy of Tribalism

“All politics is local.”
— Tip O’Neill, Jr.

It wasn’t that long ago that Speaker O’Neill was right in saying that politics was local. Politics and civics were largely formed in a household, shaped by a local community and then influenced by a largely regional experience. Most people shared party affiliations with their parents, and if they shed them, it was a ritualistic shedding of those affiliations in favor of another held by a similar group — think Woodstock or Haight-Ashbury. Diversity of belief was protected by general isolation from other groups. You knew what the politics and civics of a small town in Oklahoma with one Baptist church would be. You knew what politics a union town in Ohio with a steel mill would adopt. The meeting at the community center in a poor district of a big city held few secrets. Our towns, our families, our communities were our echo chambers.

I come to bury this notion, not to praise it!

These structures fostered social stability, which was often a boon to those communities. People had structures for emotional and material support, people who would be there to keep an eye on their home when they traveled. People who would stop by with food after a funeral (which they always went to). People who provided accountability and comfort and resources to empower productive risk-taking. They show themselves in the wake of tragedies like Hurricane Harvey in huge quantity because — and I genuinely believe this — people are generally good. But as much as I sobbed like a baby watching the good-ol-boys of the Cajun Navy roll in from New Orleans, Lafayette and Baton Rouge, I’m not naïve, Kay. I know this won’t last forever. In a few weeks, maybe a couple months, we’ll be back to business as usual. A lot of people (these are not the generally good people I was talking about earlier, in case you were wondering) have already jumped the gun, trying to decide which political stance they want to justify through use of the disaster. If history is any guide, the rest of us will follow.

If Charlottesville and Berkeley are a reminder of anything, however, it’s that our community echo chambers were often vile, too. When a community jointly agreed that racism was acceptable, that a socialist revolution was imminent, that communists were under every bed, or that southerners were all provincial rubes, the forces compelling change in those views were few. Oh, sure, some bold ones would stand up from within the community to speak truth to power. These were virtuous men and women, those who accelerated the necessary conversations. People moved, television and radio and newspapers still communicated narratives, and thoughts still flowed through the country. But slowly. And slowly but surely change took place in gradual, predictable ways. For centuries, it was a conservative America, not in the modern issue-based political sense but in the more traditional Buckleyan sense of standing athwart history yelling, “Stop!” It wasn’t slow because of some strong political force, but because the force required to change the inertia of a geographically massive country with relatively low population density was not there. Politics instead followed the patterns of linguistic dialects, where isolation and proximity drove deviations in diction, syntax and grammar, and where the things that caused interaction like trade, diplomacy, television, culture and politics, led to their convergence.

Both virtue and vileness notwithstanding, everyone was generally still playing a Collaborative Game. Not because of any special virtue of the parties involved, but because there were so many pockets of difference in experience that any kind of engagement required identifying commonalities and finding compromise. Of course there was conflict. But these were (figuratively) isolated populations coming together to discuss radically different world views, which generally required explanation, empathy and patience. Going Competitive meant true isolation, because the other side didn’t have to play our game, not really. Politics were local. In the same way that people coming together who speak different languages had to find a means of communication to proceed to rubrics and translations, there was a natural need for collaboration — and the occasional threat of conflict bred out of mistranslation! But after any negotiation, there was a home to return to. The Competitive Game didn’t work, because people had the option to leave that game and join another. You couldn’t force people to play in your game and lose, because they could take their ball to their community and go home.

The internet broke that.

It didn’t happen immediately, in part because of the pace of adoption of the technology itself, but more because the forms that constant, broad communication would take took some time to settle on. The message board begat the chat room begat the personal webpage begat the blog begat closed social media networks begat open social media networks. That was the singularity. The open social media network — Twitter and, increasingly, Facebook — replaced the community. Even for those who weren’t active participants in the networks themselves, a critical mass of other of society’s structures became connected to it, its language and its norms. The media, corporate executives, politicians — even sports leagues — cannot escape the influence of the norms promoted by these networks.

You could argue that churches, community groups, neighbors, extended families, political action groups, and other causes still act as anchors for cultural values, but for the most part, you’d be wrong. The average child may spend 6-8 hours a day on social media. The average adult spends two. How many hours does the average American spend in Church/Temple/Mosque? Reading his Bible/Torah/Koran? Outside of a natural disaster, how often does he really talk to his neighbors? Add to this the network effect of other media that are inextricable from the ways in which news is consumed, evaluated and parsed, and it becomes clear that there is no community to run to. Choose your box, because the game has changed, and you can’t leave the table.

So what’s the big deal? The big deal is that this has driven much more rapid propagation, acceptance and incorporation of new ideas. In the same way that a meme is already the subject of meta-jokes about cynical responses to the original meme by the time that half the country is just seeing it, dizzying new social values emerge almost daily. It took 396 years for America to decide that it probably doesn’t make sense to criminalize being born as a gay person. It took 12 years after that for America to recognize that the world isn’t going to come crashing down around us if we recognize that gay people who love each other ought to be able to get married. It took 2 years after that for social media to decide that there are 183 shades of human sexuality, and read the sticky post on the top of the forum for the acceptable terms to use for each of them, because the old terms you used yesterday are now hateful. The world is moving very, very quickly.

The social liberal looks at this state of affairs and says, “Hell yes!” Maybe we overshoot sometimes, but that overshooting is overstated. If moving quickly and pissing people off along the way is the cost of taking away the safe places for bigots, racist and sexists, and starting the process of taking away oppressive systems put in place by rich white men, then it’s worth it. Look, I hear you. A lot of good people think this way.

The social conservative looks at this and is puzzled. We’ve transitioned from a society that cared what you did, to a society that cared what you said, to a society that cared what you thought, he says. I’m kind to my family, to my friends, and to strangers. I really do try to improve myself, and I know I’m not perfect. I really do care about what happens to people, and I’ll drive 300 miles with my pick-up truck, a boat and some hip waders, and I’ll work myself to exhaustion for a week for people I don’t know and will never see again. But I also have values and beliefs I grew up with, and they’re values that have worked for hundreds of years. I’m not ready to throw them away on a whim. I hear you, too. A lot of good people think this way.

Good or not, neither of these people can take his ball and go home anymore, because there is no home. If they would be a part of the process of making social, cultural and political decisions at all, they must play, whether it is a Collaborative Game or a Competitive Game. The steering wheel has been ripped away from them, but to make the game of chicken complete, someone must point the cars at each other and set the stakes. Those who would marshal these forces find an easy tool to achieve this, whether intentionally or subconsciously: convince people they’re part of a tribe, and tell them they’re under attack.

What I’m talking about here isn’t just applying names to things we or others attach ourselves to. It isn’t just saying that “You’re a democrat so you’ll think this” or “You’re a black/white/Hispanic man, so this must be your view on this topic.” No, what we are talking about is the scorched earth tactic that treats every defining issue as an existential one. It’s us or them. You win or you die.

This dynamic isn’t out of character with the path of history, some aberration caused by an unduly influential Mule. It is an emergent property of a society undergoing too-rapid change.

Manufactured Existential Crises

The forces that seek to manipulate the political right do so through the creation of wholly imaginary ideals that are assumed to be in need of defending. Since they are imaginary, to conjure threats against them is purely a matter of narrative creation of the sort that has graced these pages for years. Consider the white race or white culture. It is a myth — it doesn’t exist. Racially, admixture analysis finds a tremendous amount of diversity within Europe. Mediterranean populations often have more in common with those of the Levant than with Northern Europe. Modern and ancient DNA archetypes found within Scandinavia, Ireland and the Balkans are extraordinarily different. I belong to a Y-DNA sub-clade called A738, a relatively recent off-shoot of M-222 that includes a narrow set of names: Guinn, Egan, Keegan, Morgan, Goggins, Larkin. And I am more likely to share a direct male line ancestor with a man from N’Djamena than a man from Nuremberg or Nizhny Novgorod. The below is the spread today of the R1b haplogroup, which is even further up the chain.

The Lost Cause vision of the Confederacy is a myth. I say this as someone who will defend almost any cemetery installation celebrating the simple bravery and honor of the individual soldier, and as someone who thinks Robert E. Lee was sufficiently brilliant as a tactician to merit historical remembrance. But anyone who says the largely disposable plaques and generic statues churned out by a generic factory to celebrate the “spirit of the Confederate Cause” are those kinds of monuments to history is defending an imaginary construct. It is vapor, but useful vapor to those who would divide us. It’s forced us into a world where people who don’t know Paul Johnson from Paul Blart have become self-appointed defenders of history, and where people who learned about the Federalist Papers in a Broadway musical are deeply concerned about celebrating treason. Please.

The forces motivating and influencing the political left in America have cultivated an even more perfect, self-reinforcing tool for division, I think. The post-modern sensibilities of the movement are utterly Foucauldian. In a rather clever sleight-of-hand from the intent-, conviction- and character-driven views that drove the Civil Rights movement, the manipulators of the American left now fully embrace the language of the Panopticon. By presenting society as citizens operating within a controlled and monitored system, the left can argue at any juncture that those who oppose their arguments are simply agents of an oppressive system. Can’t find data to support your statement? Can’t develop a logical path to support your conclusions? You need only say that your opponent argues from a place of privilege or status within an oppressive system, and the argument is over. This kind of language that automatically asserts the pervasive existence of oppression as an argument-ender, whether it exists or not, is just another way to promote the constant existential crisis.

If after reading one of the prior three paragraphs we think to ourselves, “Yes, but ____ is a fake existential crisis. Mine is real, and here’s why,” then we have to consider whether we’re part of the problem. All of these things, and the politicians we elect to promote our narrow view of them, are natural patterns in the swing of the pendulum toward equality-motivated control.

So what do we do?

It is time now for us to rise from sleep.
— Benedict of Nursia

What does the path of history tell us? What does the aftermath of one of America’s greatest natural disasters and human tragedies tell us? What can we do to survive and escape a Competitive Game that doesn’t allow us to pull away from the table? If you’re reading this, you’re probably in the investment industry, or at least have an interest in financial markets. If you’re in the investment industry or in the financial markets, you like to win. So you’re not going to like my answer.

We play. And we lose.

The story of history, I think, is that the only way to defuse a Competitive Game is to win by eliminating your competition, or to choose to play a Collaborative strategy even when you know it is sub-optimal.

There is a time for war, and that is usually our instinct. But there is a time for sacrifice, too. In 529 A.D., Benedict of Nursia chose sacrifice. At a time where the Competitive Game had so gone off the rails that Rome fell into ruin, Benedict and his adherents isolated themselves from society and devoted themselves to service, industry and memory. The result of their efforts was isolation, poverty and celibacy. It was also the preservation and creation of much that was and is good about European culture and society. They preserved and practiced techniques for making foods and wines. They preserved writing, language, literature and histories. Agricultural methods and metallurgy. They were the Foundation during the collapse of the Empire.

What about us? What can we do?

We can start by laying down our right to take offense. We can be unfailingly committed not only to the principles of freedom of speech, but to the value of free expression and exchange of ideas. In other words, by not pursuing the counterproductive, obstructive aims of the worst cartoon the otherwise brilliant Randall Munroe ever made. We can be vulnerable, we can let our opponents assign us identities and titles we would never adopt for ourselves without complaint. We can believe the best about people, even if we know it may cause us harm. We can give up our right to be right.

This is true in our businesses and lives as investors as well, because most of you know as well as I do that the cynicism that pervades politics has invaded our world as well. So what can we do? We can be unfailingly honest with our clients, our families. We can hold loosely to the things we think about markets and our portfolios by focusing on a narrow group of things that matter. We can engage with our clients and build portfolios that will allow them to focus on the things that happen on the banks, and not in the bloody river. We can do all in our power to destroy the agency issues and career risk dynamics that influence decisions and cause harm to the people who put their trust in us. We can gas up the boat and try to save some lives.

In short, we can choose goodness over greatness. It only works if we do it together.

Join us!

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Always Go To the Funeral


I wrote this note in August 2017, soon after Charlottesville and Trump’s “very fine people” comment. It’s time to dust it off in the wake of “go back where you came from”.

Because this is what political entrepreneurs do – on both the Right AND the Left.

Because this is how all of our political institutions are transformed into competitive games.

Because this is how Trump and The Squad break us.


But Brutus says he was ambitious;
And Brutus is an honorable man.

Julius Caesar, Act 3, Scene 2

That’s Ray Fearon as Mark Antony on the left and Paterson Joseph as Brutus on the right, in the 2012 Royal Shakespeare Company production of Julius Caesar. You can see a video of Fearon’s funeral speech for the murdered Caesar here. It’s an insanely powerful performance of an insanely powerful scene, with the repetition of the famous Brutus lines twisting the crowd like a rope.

The Democrats, the longer they talk about identity politics, I got ‘em. I want them to talk about racism every day. If the left is focused on race and identity, and we go with economic nationalism, we can crush the Democrats.

That’s Steve Bannon, from his August 16 exit interview with Robert Kuttner in The American Prospect.

A spirit of national masochism prevails, encouraged by an effete corps of impudent snobs who characterize themselves as intellectuals.

That’s Spiro Agnew, Nixon’s Bannon, the voice of the “Silent Majority” (with an assist from speechwriters Bill Safire and Pat Buchanan). Resigned the Vice Presidency in 1973, pleading no contest to bribery and tax evasion charges. History never repeats, but it sure does rhyme.

Death has a cruel way of giving regrets more attention than they deserve.

That’s Elisabeth Kubler-Ross, author of On Death and Dying, developer of the five stages of grief: denial, anger, bargaining, depression, and acceptance.

I’ve gotten three irreplaceable pieces of advice over the years, two for business and one for life.

That life advice is courtesy of my partner Jeremy Radcliffe. I’m not sure who he heard it from. Now I’m passing it along to you.

It’s not easy to go to the funeral. Life closer to home has its demands. Travel on short notice is expensive. And god knows I’ve failed to live up to this advice as often as I’ve followed it. But every time I’ve made the effort, I’ve experienced a uniquely powerful and sustaining human connection that I really don’t have words to describe. Let me put it this way. Twenty years later, I remember who was at my father’s funeral, not in a sense of keeping score, but of abiding appreciation. There’s zero negative affect for those who weren’t there. Zero. I understand! But there’s a nuclear reactor of positive affect and energy for those who were.

Going to the funeral is part of the social contract we have with our families, our friends, and our tribe, both immediate and extended. It’s part of the social contract we have with ourselves. It’s part of the personal obligation that we have to others, obligation that doesn’t fit neatly or at all into our bizarro world of crystalized self-interest, where scale and mass distribution are ends in themselves, where the supercilious State knows what’s best for you and your family, where “communication policy” and fiat news shout down authenticity, where rapacious, know-nothing narcissism is celebrated as leadership even as civility, expertise, and service are mocked as cuckery.

Understanding the obligations we share in life and in death is the greatest lesson I’ve learned (and I hope passed on to my girls) from life on the farm. Because our obligations aren’t just to our human tribe, but to our animals, too.

I’m not a nut about this. The obligations we have to our animals aren’t the same as the obligations we have to our family. They aren’t the same as the obligations we have to other, more remote humans (hmm … sometimes I’m not too sure about that last bit, but let’s go with it anyway), but they’re obligations nonetheless. In life those obligations include water, food, shelter, and an environment that lets them express their sheepness or goatness or horseness or dogness or whateverness in a safe and healthy way. It’s all of those, especially fresh water. That’s a thing for me. In death, those obligations are a proper funeral, well attended. A grave plenty deep, well marked. A body positioned properly, well respected. Collars and bells and other instruments of control all come off, because there are no collars in death. That’s a thing for me, too.

I know this seems like a morbid topic, but it’s not for me, and I suspect it’s not for anyone who’s spent time on a farm. I’ve buried lots of animals. They’re born, they live, and they die. We give them a really good life. We respect our animals in life and we respect them in death. The care we give our animals when they die means nothing to the animals, obviously not to the dead but no more to the living. It means an enormous amount to us. It’s our personal obligation. We owe them, not the other way around, in life and in death.

Always go to the funeral.

Whew! Okay, Ben, let’s see you draw some lessons for investing and macroeconomics from that!

On the investing side, the lesson is that every discretionary investment needs a proper funeral at some point. Discretionary investments are born, they live, and they die. I’ve learned from a lot of great investors over the years, and one of the lessons that really stuck with me was that your portfolio should be one-third positions that hadn’t worked yet and you are getting into, one-third positions that are working now, and one-third positions that have worked and you are getting out of. It’s that last one-third that we all have the most trouble with. It’s not the positions that never work at all. We’ve all been trained to cut our losers, and so that’s what we do. In this business, you’re wrong about something every single day, and if you don’t learn early and well what to do when you’re wrong, then you won’t survive long. No, the much harder lesson is what to do when we’re right. We’ve all been trained to “let our winners run”, and there’s a lot of truth in that for a trader. Much less so for an investor. For an investor, it becomes an excuse to keep a discretionary position in the portfolio well past its natural lifespan, leading to a bloated portfolio, chock-full of merely good or used-to-be good positions. It’s the unforced error that I see more frequently than anything else out in financial advisor-land, because it’s really hard to say goodbye to an investment that’s served you well and faithfully.

I’ve buried lots of investments. You should, too.

That means a proper funeral, well attended. You communicate with your team and your clients. You tell them how and why the death occurred, and you invite them to learn more.

That means a grave plenty deep, well marked. It’s waaay too easy to resurrect a dead investment in a slightly new form, saying that there’s some new catalyst for the old stock when in truth you wouldn’t be there except for the prior history. The dead should stay buried.

That means a body positioned properly, well respected. You keep a record of the investment, and you describe why you were there, how it worked, and how it didn’t. Honestly.

None of this is as easy as it sounds. But it’s your obligation.

Now wait a second, Ben, it sounds like you’re preaching against buy-and-hold stock-picking, something that might get you stoned to death if you were making the hajj to Omaha along with the value investing faithful. Is that what you’re saying?

Nope. I’m an arborist. I love planting trees and investments that can last for decades. There’s nothing more powerful in the investment world than the power of compound returns. But spare me the forever stuff. Nothing lasts forever. Death and taxes … those are the only eternals.

Every highly successful stock-picking investor in the world, value oriented or not, has two things:

  1. A boneyard. You think the guys in Omaha haven’t buried a huge number of investments? Please. And they don’t just bury the dead. They cull the weak. Good for them.
  2. A duration match between assets and liabilities. To continue with the forest example, it’s all great and wonderful to plant some oak trees that you’re certain will be strong and majestic in 20 years, but not if you need the lumber in 5 years. If you’re pursuing long-lived investment returns, you better have similarly long-lived investment funding, or eventually you will fail as an investor. That’s not opinion, that’s math. So yeah, if you’ve got permanent capital, then you can make permanent investments. But no one has truly permanent capital.

These two qualities of successful investing — burying the dead and matching the lifespan of your assets with the lifespan of your liabilities — are part of the investment meta-game. They’re not the immediate game — picking this stock or picking that stock — but they’re the game behind the game. It’s more important to play the meta-game well than to play the immediate game well. It’s more important to see the forest than to see the trees.

Here’s another way to think about the meta-game. I was a fan of Shark Tank before it was cool to be a fan of Shark Tank, and I still am. I watch it with my girls, as it sparks all sorts of good conversations about entrepreneurialism and capitalism and the like. My favorite moments on Shark Tank, by an order of magnitude, are when Kevin O’Leary tells a presenter that their idea is dead and they need to bury it. He’s always right. The worst thing that can happen to you on Shark Tank is NOT that you fail to get an investment and go down in flames of embarassment. No, the worst thing that can happen is that you fail to get an investment but are encouraged to keep on pursuing a used-to-be-good idea that died a year ago. You will have another good idea! It’s far more important to play the meta-game well — to do nothing and wait for the next live opportunity — than to keep propping up the dead opportunity with extraordinary effort. Bury your dead. Have a proper funeral. Respect the dead. Never forget the dead. And move on without regret.

On the economics side, the lesson here is that central bankers today are grieving the death of the so-called Great Moderation, where productivity rocked, inflation was tamed, and the business cycle was muted. But they can’t move on. They can’t bring themselves to have a proper funeral. They are expressing their grief poorly — not through anything like the Kubler-Ross stages of denial, anger, bargaining, depression, or acceptance — but through magical thinking, through the pathological belief that if only the right words are said and the right thoughts are thought, then the dead will show up at the front door as if nothing had happened. To understand the human pathology, read Joan Didion’s wonderful book. To understand the policy pathology, you could do worse than to read the Epsilon Theory note.

I’m not going to spend a lot of time rehashing that Epsilon Theory argument, because there’s another death I want to talk about in this note, one connected with neither investing nor monetary policy. It’s the death of cooperative game-playing in American politics. I wrote a full note about this, too, titled “Virtue Signaling … or Why Clinton is in Trouble”, but after the events of the past two weeks, particularly Charlottesville and its political aftermath, I want to update those thoughts here.

I’ll start with what I wrote last September.

I’m thoroughly despondent about the calcification, mendacity, and venal corruption that I think four years of Clinton™ will impose. I think as a candidate she’s a bizarre combination of Michael Dukakis and Teddy Kennedy, and I think as a president she’ll be an equally bizarre combination of Ulysses Grant and Warren Harding, both of whom presided over a fin de siècle global economic collapse. Gag. But I don’t think she can break us, not as a society, anyway.

Trump, on the other hand … I think he breaks us. Maybe he already has. He breaks us because he transforms every game we play as a country — from our domestic social games to our international security games — from a Coordination Game to a Competition Game.

Blowing up our international trade and security games with Europe, Japan, and China for the sheer hell of it, turning them into full-blown Competition Games … that’s really stupid. But we have a nasty recession and maybe a nasty war. Maybe it would have happened anyway. We get over it. Blowing up our American political game with citizens, institutions, and identities for the sheer hell of it, turning it into a full-blown Competition Game … that’s a historic tragedy. We don’t get over that.

Case in point: the current “debate” about Confederate war memorials. In truth, there is no debate about Confederate war memorials. No one cares about Confederate war memorials. There is no “Southern identity” associated with Robert E. Lee statues. You know who thinks that Southerners care deeply about these statues? New York City real estate developers who know nothing about the South, but think that this is what motivates us dumb hicks, that’s who. A month ago, you could have taken down any of these statues and you’d get three wackos holding signs outside the city administration office and an angry letter from the local chapter of the Daughters of the Confederacy. I mean, it’s not like you’re canceling an SEC football game … there’s your Southern pride.

But frame the issue in terms of “THEY are coming to take your statues away from you”, show some pics of Antifa goons and campus goofballs, and absolutely people are going to care. Hell, these pictures make me care, and I’d get rid of the statues tomorrow if I could.

If getting rid of the statues is framed as capitulating to these idiots — and that’s exactly the narrative that’s been created — then every elected Republican in the South who wants to stay in office must now come out in favor of keeping the damn statues. They must be seen as opposing the idiot outsiders who are DEMANDING something that no one cared about a month ago, because that’s what it means to play a Competition Game.

Conversely, every elected Democrat in the South who wants to stay in office must now take action to dismantle the statues. Because otherwise you’re capitulating to these very fine people idiots.

Just like the incumbent Republicans, incumbent Democrats must be seen as opposing the idiot outsiders who are DEMANDING something that no one cared about a month ago, because that’s what it means to play a Competition Game.

You hear all the time about how these Trump tweets and the associated narrative construction are a “dog whistle” that motivates and calls forth the alt-right clowns. Okay. I guess. But what the tweets and the narrative really are — and this is what Steve Bannon understands perfectly — is a dog whistle for the Democrats and an obedience collar for the Republicans. It creates a Competition Game where none existed before, and it forces every elected politician, regardless of party, to play their appointed role, strutting and fretting upon the stage. Even though none of them like the script and none of them want to play the part.

It’s a political meta-game.

What’s happening today isn’t new in theory. It’s a tried and true strategy for political entrepreneurs throughout history, ancient and modern. It’s what Marc Antony did to reconfigure the narrative around Julius Caesar’s assassination in 44 BC. It’s what Richard Nixon and Spiro Agnew did with their “Silent Majority” narrative to win the 1968 and 1972 Presidential campaigns. It’s what George Wallace did in 1972 to win the Democratic primaries in Michigan and Florida. It’s what Pat Buchanan (who wrote a lot of the Silent Majority speeches) tried to do when he primaried George H.W. Bush in 1992.

But what’s happening today is very different in scale for two reasons, I think.

First, it’s different because of the unprecedented effectiveness of the technology and social media systems that drive what I call fiat news — highly political statements constructed and presented as apolitical fact. In exactly the same way that fiat currencies ultimately crowded out all hard currencies, so is fiat news now crowding out hard news. Political entrepreneurs today — a roster that includes Mark Zuckerberg and Jeff Bezos and Michael Bloomberg just as surely as it includes Steve Bannon — have a tool kit at their disposal for playing the political meta-game that Richard Nixon could only dream of.

Second, it’s different because of the goals of the political entrepreneurs themselves. Richard Nixon was a professional politician. Being president was his lifelong ambition, and he used the Silent Majority narrative as a means to that end. He didn’t want to blow up the System. He WAS the System. Whatever Donald Trump is, he’s not the System. My sense is that he really doesn’t care about the System one way or another, that so long as he and his family have the keys to the national car, he’s good with whatever happens. Steve Bannon, however, cares deeply about the System. Not to preserve it, but to reboot it. And not just to reboot it, but to reboot it with a new operating system.

So what’s the punch line? Why am I talking about all this in a cheery note about death and funerals?

Because once a Cooperation Game becomes a full-blown Competition Game, it never goes back to the way it was before. Once mustard gas is introduced into your trench warfare game, whether it was one of the other guys or one of your guys, it’s here to stay. Deterrence has failed. The cooperative Stag Hunt equilibrium is dead. I am, admittedly, still at Stage 4 of the Kubler-Ross scale on all this — depression — but we all need to get to acceptance ASAP. No regrets. No magical thinking. Just hard thoughts on how to design an operating system that can compete with and win against the billionaires’ operating system when the reboot happens. And who we want in our foxhole in the meantime. And how to build a gas mask.

Because it wasn’t that long ago when Southern identity was defined not by statues, but by civility, personal obligations, and service, particularly military service to … wait for it … the United States of America. That narrative is still out there. It’s still alive. We can get it back if we’re smart enough to play the political meta-game.

Because there’s a pose that very sick farm animals sometimes take when they’re near death, where they lie down and twist their head way back into their shoulder in a very unnatural way. It’s an odd sight if you don’t know what it signifies, a horrible sight if you do. Both the Republican Party and the Democratic Party are starting to twist their heads back into their shoulders. I don’t know if it’s too late to save them or not, but I’m increasingly thinking that it is. We need to start thinking about the funeral, who’s going to speak, and what they’re going to say.

But Brutus says he was ambitious;
And Brutus is an honorable man.


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Revenge of the Humans, Emojis & Mushrooms (by Silly Rabbit)

Revenge of the Humans Part II

This is a really terrific (long) piece of writing: Revenge of the Humans Part II: A New Blueprint For Discretionary Management:

The meat really starts to kick in the section ‘There Are No Shortcuts’ and reaches peak lucidity in the section ‘Organizational Structure’. Excellent work by Leigh Drogan, Founder and CEO at Estimize, laying out what I really do believe is the blueprint for success with ‘next gen’ strategies that are foundationally systematic and substantially software-encoded:

Portfolio Manager — Of all the roles this is where I think things really need to change in terms of who sits in this seat. It can no longer be hedge fund bros, they simply won’t survive here. Nor will the pure gunslingers and tape readers, gone. And you certainly don’t want the pure quants sitting in this seat. PMs of the future are going to be far more interpersonal and process driven…. This is a cross functional role, and one that needs to be based on the behavioral attributes of the person more than anything else. An MBA may be useful here, but I would even say that having experience working at the early stages of a startup as a CEO can add a lot. I’m waiting for someone to develop a firm to leverage psychometric testing for different investment strategies so that we can identify people tuned for momentum vs value. You’re talking about a completely different psychology between those two people and it’s imperative you choose the person correctly … PMs should have some training in statistical and quantitative methods in order for them to talk intelligently with the quants and trust the factor models. Without that trust, there’s simply no point in having them and you’ll only gain that by understanding how they are built. Should a PM know how to code, no. Should they understand what the code does and why, absolutely. Basic data science classes can provide this knowledge. Quantitative research methods 101 in college is a requirement … I believe that compensation structures for the PM need to change. This is no longer “his book”. He is another player on the team, who has a specific role, to coordinate the dance. But in many ways, he will have less impact on the alpha generated by the book than the analysts or the quants who create the factor models. The PM is now the offensive coordination calling the plays, not the quarterback on the field scrambling around and throwing touchdowns. We can now compensate analysts accurately for the efficacy of their calls, and the PM for how much alpha she adds above them. The rest of the team should be bonused out based on the performance of the book.

DeepMoji

Neat work by the good folks at MIT Media Lab:

Our basic idea with our DeepMoji project is that if the model is able to predict which emoji was included with a given sentence, then it has an understanding of the emotional content of that sentence. We are training our model to predict emojis on a dataset of 1.2B tweets (filtered from 55B tweets). We can then transfer this knowledge to a target task by doing just a little bit of additional training on top with the target dataset. With this approach, we beat the state-of-the-art across benchmarks for sentiment, emotion, and sarcasm detection.

Check out the online demo here, more detailed write-up here, and full technical paper here.

Useful skills like VR, NLP and… econometrics?

This list of fastest-growing freelancer skills compiled by Upwork, a job site that matches freelancers with employers, is just so odd I feel there is either some deep pattern coded in there that explains everything, or else some intern at Upwork is having a laugh.

Growth in VR and NLP makes total sense given the relative lack of experienced talent vs growth in demand, especially for VR developers. Neural network and Docker development for the same reasons. Adobe Photoshop freelancers — sure, I guess Photoshop is still operated by a priesthood although it’s unclear why the journeyman priesthood is growing rapidly.

But then Econometrics, really??!!? — never, ever, in my life have I thought “what I really need to do is to hire a random econometrician over the internet”, and for sure that thought has not been exponentially increasing of late.

And Asana work tracking, which had only around 20,000 paying customers a year ago?!!? — that’s like having ’Tesla car polisher’ on the list.

Anyway, I leave you to ponder. It certainly is an intriguing list — perhaps what we need is an econometric hireling to make sense of it for us…

Mushrooms

And finally and frivolously, we have this article which is pretty much a total waste of storage space as it is a 700-word, not-very-good takedown of a new not-very-good mushroom-identifying mobile app with sub-par mushroom image recognition. However, it warrants inclusion in this week’s Rabbit Hole for the one immortal line:

There’s a saying in the mushroom-picking community that all mushrooms are edible but some mushrooms are only edible once.

Surely the apothegm of the week!

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Data Access Battles, Creative Thinking & Full Script AI (by Silly Rabbit)

Data access battles

A couple of weeks back I shared a link to the story of ImageNet and the importance of data to developing algorithms. Ars Technica reports on two ‘at the coalface’ battles over data access with HiQ and Power Ventures fighting with LinkedIn and Facebook over data access. I’m not advocating a position on this but, to be sure, small — and currently obscure — court cases like these will, cumulatively, end up setting the precedents which will have a significant impact on the evolution and ownership of powerful algorithms that are increasingly driving behavior and economics.

Creative thinking

This speech from Claude Shannon at Bell Labs in 1952 has been circulating online for the past couple of weeks. It is a timeless, pragmatic speech on creative thinking which remains, 65 years later, fully relevant for developing novel computational strategies:

Sometimes I have had the experience of designing computing machines of various sorts in which I wanted to compute certain numbers out of certain given quantities. This happened to be a machine that played the game of nim and it turned out that it seemed to be quite difficult. It took quite a number of relays to do this particular calculation although it could be done. But then I got the idea that if I inverted the problem, it would have been very easy to do — if the given and required results had been interchanged; and that idea led to a way of doing it which was far simpler than the first design. The way of doing it was doing it by feedback; that is, you start with the required result and run it back until — run it through its value until it matches the given input. So the machine itself was worked backward putting range S over the numbers until it had the number that you actually had and, at that point, until it reached the number such that P shows you the correct way.

Facebook shuts down robots after they invent their own language

Facebook shuts down robots after they invent their own language has become a widely reported and wildly commentated story over the past month, referencing a story on ’Tricky chatbots’ linked here a couple of months back. For melodramatic illustrative effect, I like switching a couple of words in the Facebook headline so that it reads ‘Lehman (doesn’t) shuts down traders after they invent their own language’ as it illustrates that, in general, if you: put a bunch of agents (human or machine) together and set up a narrowly defined, adversarial, multi-player game with a strong reward function then the agents will develop their own task-specific language and protocols, keep adding complexity, lie to each other (yes, the FB bots also learnt to do that), be tempted to obfuscate behavior in order to reduce interference and maximize the reward function, and develop models which are positive for near-term reward maximization but do not necessarily deal with longer-term consequence or long tail events, and so become very hard for human overseers to truly assess…

DICK FULD (2008): 
I wake up every single night wondering what I could have done differently — this is a pain that will stay with me the rest of my life

FACEBOOK (2017):
Hold my beer

AI: From partial to full script

Thinking more broadly about the longer-term evolution of AI (and the nature of money and contracts, per Ethereum link last week), it has been interesting to re-read Sapiens: A Brief History of Humankind by Yuval Noah Harari which charts the rise to dominance of us Sapiens with especially interesting chapters on the development of written language and money. A concept which particularly grabbed me was that written language was initially developed as ‘partial script’ technology for narrow tasks such as tax accounting, and then evolved to be full script and so capable of much more than it was originally conceived for.

The history of writing is almost certainly a wonderful historical premonition of the trajectory of AI, except with the evolution being much faster and the warning that likely “the AI is more powerful than pen.”

Relevant excerpt from Sapiens:

Full script is a system of material signs that can represent spoken language more or less completely. It can therefore express everything people can say, including poetry. Partial script, on the other hand, is a system of material signs that can represent only particular types of information, belonging to a limited field of activity … It didn’t disturb the Sumerians (who invented the script) that their script was ill-suited for writing poetry. They didn’t invent it in order to copy spoken language, but rather to do things that spoken language failed at … Between 3000 BC and 2500 BC more and more signs were added to the Sumerian system, gradually transforming it into a full script that we today call cuneiform. By 2500 BC, kings were using cuneiform to issue decrees, priests were using it to record oracles, and less-exalted citizens were using it to write personal letters.

The beautiful mathematical explorations of Maryam Mirzakhani

And finally, at the risk of turning into The Economist, we conclude this week’s Rabbit Hole with a touching obituary of the Tehran-born, Fields Medal-winning mathematician Maryam Mirzakhani:

A bit more than a decade ago when the mathematical world started hearing about Maryam Mirzakhani, it was hard not to mispronounce her then-unfamiliar name. The strength and beauty of her work made us learn it. It is heartbreaking not to have Maryam among us any longer. It is also hard to believe: The intensity of her mind made me feel that she would be shielded from death.

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The Arborist

Shape clay into a vessel;
It is the space within that makes it useful.
Cut doors and windows for a room;
It is the holes which make it useful.
Therefore benefit comes from what is there;
Usefulness from what is not there.
Lao Tzu (c. 530 BC)

This is the only quote I’ve used three times in Epsilon Theory notes, previously in The Tao of Portfolio Management and Who’s Being Naïve, Kay?, because it’s such a powerfully wise observation about the vessels we create when we put together a portfolio.

But its wisdom goes way beyond investing. Our days are spent shaping clay into vessels … our homes, our businesses, our friendships, our marriages, our children … our lives themselves.

Not every empty space needs filling.

“It is hard to find good explanations for the low-inflation era being experienced by the U.S.”
Jim Bullard: St. Louis Fed Governor, waver of hands, charter member of the Epsilon Theory Self-Parody Hall of Fame.

I actually feel bad for Bullard. The cognitive dissonance between what the job requires and what any thinking human being observes must be crippling.

QE and negative real rates are ice-nine. If you don’t know what ice-nine is, read “Cat’s Cradle”, preferably both the Vonnegut book and the Epsilon Theory note.

Spoiler alert: the world ends.


Lianas are woody vines that climb up trees to get to the light. They’re what Tarzan would swing on from tree to tree. They’re also the incarnation of evil in the natural world.

The particular bane of my existence is a liana called Oriental Bittersweet, now endemic in the Eastern U.S. and Canada. Like other creeping plagues such as privet and kudzu, the Oriental Bittersweet was originally introduced as an ornamental plant, but found easy pickings in North America once it escaped captivity.

How do you kill the Oriental Bittersweet? Per the latest intel from the U.S. Forest Service, you need to cut the stem and then immediately douse it with Garlon 4 herbicide mixed with diesel fuel or kerosene. Just be sure that you don’t get any of that Garlon 4 on anything that, you know, you don’t want to kill. Or on your skin. And for god’s sake please don’t use it in wetlands or anywhere it might get into a stream or pond. That would be … umm … not good.

This is what crowding-out looks like in the forest. It’s no prettier in the real economy.

I’m a reluctant gardener. I’ll work in the dirt because I like the outcome, but it’s just that to me — work. I don’t get any intrinsic pleasure from the act of gardening, from the growing of plants from seeds to maturity, because I don’t see the human art in it. I can appreciate the form and function of the plant itself. But that’s nature’s art, not mine.

On the other hand, I’m an enthusiastic arborist. Working with trees isn’t about the growing, it’s about the pruning. It’s about identifying the natural, healthy lines of a tree and shaping the tree to follow those lines over time. It’s about having a vision in your head of what Treeness means in this particular place and this particular plant, and then bending nature to fit that vision. It’s this imposition of human will that makes working with trees an art, whether you’re expressing it in miniaturized form through bonsai or massive form through four acres of maple trees. That’s why I’m an arborist.

At the heart of being a good arborist is recognizing that less is almost always more, that the absence of a branch or limb is as necessary in expressing Treeness as presence. Filling space is easy. That’s the default because that’s nature’s blind imperative, to grow and spread and get more light, regardless of the internal or external consequences. Nature will grow itself into structural ruin, and the arborist must be imaginative enough to see the alternative and brave enough to act. The courage is always in the cut. The imposition of human will and vision is always in the cut. The art is always in the cut.

I rarely use a chainsaw to cut a living tree, or at least a tree that I want to keep on living. For starters, I’m even more scared of my chainsaw than I am of my tractor, which really only goes to show that I’m not scared enough of my tractor. More importantly, if you’ve gotten to the point where a limb is so thick that you need to use a chainsaw on it, then either you’re doing some sort of medically necessary surgery or you’re making a terrible mistake in the imposition of your vision for this particular tree in this particular place. No, my instruments of choice are the handsaw and the lopper. Just because the courage is in the cut doesn’t mean that you need to cut with abandon and leverage.

So as per usual with these Notes From the Field, I’ve got two arborist-as-metaphors to relate, one for investing and one for the economy.

On the investing side, this is the math-free companion piece to Rusty Guinn’s You Still Have Made a Choice, where we’re both saying the same things about portfolio construction and healthy diversification thereof, just in different dialects.

Left to its own devices your portfolio will grow wildly — not to structural ruin, but to structural inefficiency. Of course, by its own devices I really mean by your own devices, and by growth I mean number of positions, not value. The human tendency to keep adding “good ideas” to a portfolio as they come available is at least as powerful and natural an imperative as a tree growing more leaves for more sunlight, and unchecked is just as destructive. A tree pays a price for each branch and limb and leaf it grows. So do you in your portfolio. Each of these investments may be, in and of itself, truly a good idea. But they are merely good ideas. Show me a portfolio chock-full of good ideas and I’ll show you a tree that is not growing to its full potential, and here I do mean value.

A portfolio doesn’t grow to its full potential by having lots of good ideas. It grows to its full potential by having a few great ideas. Okay, that seems obvious. Here’s one that’s not. A portfolio will reach a better outcome by having fewer branches and limbs and leaves that all work together to create a harmonious whole — even if those branches and limbs and leaves are merely good, not great — than by having more branches and limbs and leaves of the same good quality.

The ordinary investor is always looking for a good idea to put into the portfolio. The arborist investor is always looking for a merely good idea to take out of the portfolio.

Now, there IS a science (or at least a methodology) for calculating whether or not the addition or subtraction of a limb in your portfolio adds or subtracts value compared to the shape of your portfolio now, and that’s where Rusty’s note ends up. My message is that there is also an art to this assessment, and that we end up in the same place. How? By the marriage of art and science within the mathematics of harmony and aesthetics.

Above is a depiction of the 15 classic bonsai styles, shapes, and forms. There are more, but pretty much every bonsai tree you ever see will be a variation on one of these themes or archetypes. This is the art of bonsai, and an experienced bonsai artist like Mr. Miyagi (you didn’t think I could write this note without a movie reference, did you? “Remember, best block, not to be there” is pretty much the finest advice ever on risk management) can instantly look at an actual bonsai plant and tell you its underlying archetype and how to shape the actual plant to fit the archetype more perfectly. OR (and this is the cool part) a true bonsai artist can tell you how to differ from the archetype to take advantage of something special about either the plant or its environment or its owner.

Each of these 15 classic bonsai themes can ALSO be expressed in geometry and math. I mean, you can see it pretty clearly with even a cursory knowledge of tessellation (turning everything into triangles), fractals (repetitive forms at different levels of aggregation or magnification), and catenary curves (self-supported minimal surfaces). You have to wave your hands a bit at some of the basing objects (although mountains are also fractals), but you get the idea. This is the science of bonsai, and I have no doubt that a modern scanner plus a rudimentary AI could also measure a real bonsai plant and tell you which archetype it most closely matched and how to optimize it to match the archetype more closely. It can’t do the cool part, though, of accounting for uniqueness in the specific plant or its environment and intentionally diverging from an archetype to make something truly special, at least not yet.

Robo-advisors today are based on the scanner + math approach to portfolio construction. A good human financial advisor embodies the Mr. Miyagi artistic approach. Both are arborists. Both know that it’s as important to leave things out of a portfolio as to put things in. Both are effective counters to the all-too-human impulses to build a portfolio myopically and without consideration of the whole. Both get you much closer to a more useful and effective portfolio.

In my opinion the best human financial advisor still has an edge over the best robo-advisor, in the same way that human artists still have an edge over non-human artists. Humans are clearly NOT as good in the optimization exercise, which is why robo-advisors have such an advantage in the mass market for financial advice. And to be clear, the robo-advisor is giving high quality advice, definitely not one-size-fits-all. But it’s never extraordinary advice. To be fair, the vast majority of human financial advisors don’t provide extraordinary advice, either. But if you can find that exceptional arborist, someone who knows when to deviate from the archetypes rather than just optimize … well, that can create extraordinary value.

So that’s my investment arborist-as-metaphor. I’m afraid my economics arborist-as-metaphor won’t be as uplifting.

That’s because we have no arborists today in the public spheres of politics and economics. We are overrun with Oriental Bittersweet, privet, and kudzu — or as I like to call them, monetary policy, the regulatory state, and fiat news — invasive species that crowd out the small-l liberal virtues of free markets and free elections. Even our strongest trees are girdled by the lianas, choked of resources and at risk when the next Nor’easter hits.

This is what I’ve been writing about in the recent Epsilon Theory notes on the death of productivity. Why do we have low growth, low inflation, and low productivity, despite the most accommodative monetary policy in the history of man? BECAUSE of the most accommodative monetary policy in the history of man. Why does the economic ground feel so unsteady beneath our feet, despite the immense power of the regulatory state providing insurance against every ill? BECAUSE of the immense power of the regulatory state providing insurance against every ill. Why are we so profoundly divided and mistrustful as a political society, despite the unprecedented quantity of political news and analysis available to inform us? BECAUSE of the unprecedented quantity of political news and analysis available to inform us.

What’s the solution? I don’t think there is a top-down solution. It’s not Donald Trump. It’s not the human equivalent of aerial spraying Garlon 4 on anything and everything. It’s not the usual suspects from Team Elite, the Jim Bullards of the world who are so … lost … in their mind palaces and hand waving and cognitive dissonance and magical thinking that they are hardly recognizable as human beings. I mean that seriously and with sadness. How do you ever come back from a stint as a Fed Governor?

I’m pretty sure that there is no single person, no miraculous candidate for the Fed or the White House, no Moses to lead us out of our liana-infested wilderness. I’m pretty sure that the answer is a Fight Club-esque grassroots movement devoted to Making, Protecting, and Teaching, where really old school notions like feudal bonds of personal obligation and trust are reinvigorated through modern technology like blockchain, mitigating both the limits of geography and the unblinking stare of the State. I’m pretty sure that it’s a work of decades in school districts and local elections, that it’s bird by bird, to paraphrase the wonderful book by Anne Lamott. And that’s okay. That’s as it should be. A bonsai tree is the work of decades. So is a four-acre grove of maple trees. So is a family office portfolio. So is a local community built on liberty and justice.

You don’t need anyone’s permission to be an arborist. You just decide to be one. You just start cutting down the evil vines in your backyard. And you cut them down again when they grow back, because they always do. And you teach your children and neghbors how to cut. And that’s how the future changes.

The courage is in the cut.

To remix Margaret Mead, never doubt that a small group of thoughtful, committed arborists can change the world; indeed, it’s the only thing that ever has.

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You Still Have Made a Choice: Things that Matter #2

Drummers are really nothing more than time-keepers. They’re the time of the band. I don’t consider I should have as much recognition as say a brilliant guitar player. I think the best thing a drummer can have is restraint when he’s playing — and so few have today. They think playing loud is playing best. Of course, I don’t think I’ve reached my best yet. The day I don’t move on I stop playing. I don’t practice ever. I can only play with other people, I need to feel them around me.

— Ginger Baker (founder of Cream), from a 1970 interview with Disc Magazine

La cuisine, c’est quand les choses ont le goût de ce qu’elles sont.
(Good cooking is when things taste of what they are.)

— Maurice Edmond Sailland (Curnonsky) — 1872-1956

There are those who think that life
Has nothing left to chance
A host of holy horrors
To direct our aimless dance

A planet of playthings
We dance on the strings
Of powers we cannot perceive
The stars aren’t aligned
Or the gods are malign
Blame is better to give than receive

You can choose a ready guide
In some celestial voice
If you choose not to decide
You still have made a choice

 — Rush, “Freewill”, Permanent Waves (1980)

For the kingdom of heaven is like a man traveling to a far country, who called his own servants and delivered his goods to them. And to one he gave five talents, to another two, and to another one, to each according to his own ability; and immediately he went on a journey. Then he who had received the five talents went and traded with them, and made another five talents. And likewise, he who had received two gained two more also. But he who had received one went and dug in the ground, and hid his lord’s money. After a long time the lord of those servants came and settled accounts with them.

So he who had received five talents came and brought five other talents, saying, ‘Lord, you delivered to me five talents; look, I have gained five more talents besides them.’ His lord said to him, ‘Well done, good and faithful servant; you were faithful over a few things, I will make you ruler over many things. Enter into the joy of your lord.’ He also who had received two talents came and said, ‘Lord, you delivered to me two talents; look, I have gained two more talents besides them.’ His lord said to him, ‘Well done, good and faithful servant; you have been faithful over a few things, I will make you ruler over many things. Enter into the joy of your lord.’

Then he who had received the one talent came and said, ‘Lord, I knew you to be a hard man, reaping where you have not sown, and gathering where you have not scattered seed. And I was afraid, and went and hid your talent in the ground. Look, there you have what is yours.’

But his lord answered and said to him, ‘You wicked and lazy servant, you knew that I reap where I have not sown, and gather where I have not scattered seed. So you ought to have deposited my money with the bankers, and at my coming I would have received back my own with interest. Therefore, take the talent from him, and give it to him who has ten talents.

For to everyone who has, more will be given, and he will have abundance; but from him who does not have, even what he has will be taken away. And cast the unprofitable servant into the outer darkness. There will be weeping and gnashing of teeth.

The Bible, The Gospel of Matthew 25:14-30

This note was featured in Meb Faber’s book The Best Investment Writing – Volume 2, alongside another Epsilon Theory note from Ben Hunt. Click here to get a copy.

I will never understand why more people don’t revere Rush.

With the possible exception of Led Zeppelin[1], I’m not sure there has been another band with such extraordinary instrumentalists across the board, such synergy between those members and their musical style and such a consistent approach to both lyrical and melodic construction. And yet they were only inducted into the Rock & Roll Hall of Fame in 2013. A short list of bands and singers the selection committee thought were more deserving: ABBA, Madonna, Jackson Browne, the Moonglows, Run DMC. At least they got in when Randy Newman did. I remember the first time I heard YYZ, the Rush tune named after the IATA airport code for Toronto’s Pearson International Airport, pronounced “Why Why Zed” in the charming manner of the Commonwealth. It was then that I decided I would be a drummer. I did play for a while, and reached what I would describe as just above a baseline threshold of competence.

That’s not a throwaway line.

There’s a clear, explicit line that every drummer (hopefully) crosses at one point. A step-change in his understanding of the role of the instrument. The true novice drummer always picks up the sticks and plays the same thing. Common time. Somewhere between 90-100 beats per minute. Eighth note closed hi-hat throughout. Bass drum on the down and upbeat of the first beat. Snare on second down beat. And then it’s all jazzy up-beat doodling on the snare for the rest of that bar until the down beat of four. Same thing for three measures, and on the fourth measure it’s time for that awesome fill he’s been practicing. I don’t know how many subscribers are drummers, but I assure you, literally couples of you are nodding your heads.

The fills and off-beat snare hits are all superfluous and not necessary to the principal role of a drummer in rock and roll: to keep the damned beat. But there are a number of reasons why every neophyte does these same things. Mimicry of more advanced players who can do the creative and interesting things without losing the beat, for one. We see Tony Williams, John Bonham, or Bill Bruford and do what it is we think they are doing to make the music sound good. The amateur often also thinks that these are the necessary things to be perceived as a more advanced player, for another. He doesn’t just imagine that his mimicry will make him sound more like the excellent players, but imagines himself looking like them to others. More than anything, the amateur does these things because he hasn’t quite figured out that keeping a good beat is so much more important than anything else he will do that he’s willing to sacrifice it for what he thinks is impressive.

This thought process dominates so many other fields as well. Consider the number of amateur cooks who hit every sauce or piece of meat with a handful of garlic powder, onion powder, oregano, salt, pepper and cayenne, when the simplicity of salt as seasoning dominates most of the world’s great cuisine. There is an instinct to think that complexity and depth must come from a huge range of ingredients[2] or from complexity in preparation, but most extraordinary cooking begins from an understanding of a small number of methods for heating, seasoning and establishing bases for sauces. Inventiveness, creativity and passion can take cuisine in millions of directions from there, but many home cooks see the celebrity chef’s flamboyant recipe and internalize that the creative flourishes are what matters to the dish, and not the fact that he cooked a high-quality piece of meat at the right heat for the right amount of time.

If you’re not much of a cook, consider instead the 30-handicap golfer who wouldn’t be caught dead without a full complement of four lob wedges in his bag. You know, so that he can address every possible situation on the course. The trilling singer of the national anthem who can’t hold a pitch but sees every word of the song as an opportunity to sing an entire scale’s worth of notes. The karate novice who addresses his opponent with a convoluted stance. The writer who doesn’t know when to stop giving examples to an audience who understood what he was getting at half-way through the one about cooking.

I’m guessing at least one of these things pisses you off, or at the very least makes you do an internal eye roll. And yet, as investors we are guilty of doing this kind of thing all the time, any time the topic of diversification comes up.

It comes from a good place. We know from what we’ve been taught (and from watching the experts) that we should diversify, but we don’t have a particularly good way of knowing what that means. And so we fill our portfolios with multiple flavors of funds, accounts and individual securities. Three international equity funds with different strategies. Multiple different styles in emerging markets. Some value. Some growth. Some minimum volatility. Some call writing strategies. Some sector funds. Maybe some long/short hedge funds. Some passively managed index funds, some actively managed funds. Definitely some sexy stock picks. And in the end, the portfolio that we end up with looks very much like the global equity market, maybe with a tilt here or there to express uniqueness — that flashy extra little hit on the snare drum to look impressive.

This piece isn’t about the time we waste on these things. I already wrote a piece about that a few weeks ago. This is about the harm we do to our portfolios when we play at diversifying instead of actually doing it.

The Parable of the Two FA’s

So what does actually diversifying look like?

There are lot of not-very-useful definitions out there. The eggs-in-one-basket definition we’re all familiar with benefits from simplicity, which is not nothing. In addition, it does work if people have a good concept of what the basket is in the analogy. Most people don’t. Say you have $100, and you decide that a basket is an advisor or a fund. So you split the money between the two, and they invest in the same thing. You have not diversified[3]. The other definitions for diversification tend to be more complicated, more quantitative in nature. That doesn’t make them bad, and we’ll be leaning on some of them. But we need a rule of thumb, some heuristic for describing what diversification ought to look like so that we know it when we see it. For the overwhelming majority of investors, that rule of thumb should go something like this:

Diversification is reducing how much you expect to lose when risky assets do poorly or very poorly without necessarily reducing how much total return you expect to generate.

Now, this is not exactly true, and it’s very obviously not the whole definition. But by and large it is the part of the definition that matters most. The more nuanced way to think about diversification, of course, is to describe it as all the benefits you get from the fact that things in your portfolio don’t always move together, even if they’re both generally going up in value. But most investors are so concentrated in general exposure to risky assets — securities whose value rises and falls with the fortunes and profitability of companies, and how other investors perceive those fortunes — that this distinction is mostly an academic one. Investors live and die by home country equity risk. Period. Most investors understand this to one degree or another, but the way they respond in their portfolios doesn’t reflect it.

I want to describe this to you in a parable.

There was once a rich lord who held $10 million in a S&P 500 ETF. He knew that he would be occupied with his growing business over the next year. Before he left, he met with his two financial advisors and gave them $1 million of his wealth and told them to “diversify his holdings.”

He returned after a year and came before the first financial advisor. “My lord, I put the $1 million you gave me in a Russell 1000 Value ETF. Here is your $1.1 million.” The rich man replied, “Dude, that’s almost exactly what my other ETF did over the same period. What if the market had crashed? I wasn’t diversified at all!” And the financial advisor was ashamed.

Furious and frustrated, the rich man then summoned his second financial advisor. “Sir, I put your $1 million in a Short-Duration Fixed Income mutual fund of impeccable reputation. Here’s your $1 million back.”

“Oh my God,” the lord replied, “Are you being serious right now? If I wanted to reduce my risk by stuffing my money in a mattress I could have done that without paying you a 65bp wrap fee. How do you sleep at night? I’m going to open a robo-advisor account.”

Most of us know we shouldn’t just hold a local equity index. We usually buy something else to diversify, because that’s what you do. But what we usually do falls short either because (1) the thing we buy to diversify isn’t actually all that different from what we already owned, or (2) the thing we buy to diversify reduces our risk and our return, which defeats the purpose. There’s nothing novel in what I’m saying here. Modern portfolio theory’s fundamental formula helps us to isolate how much of the variation in our portfolio’s returns comes from the riskiness of the stuff we invested in vs. the fact that this stuff doesn’t always move together.

Source: Salient 2017 For illustrative purposes only.

The Free Lunch Effect

So assuming we didn’t have any special knowledge about what assets would generate the highest risk-adjusted returns over the year our rich client was away on business, what answer would have made us the good guy in the parable? Maximizing how much benefit we get from that second expression above — the fact that this stuff doesn’t always move together.

Before we jump into the math on this, it’s important to reinforce the caveat above: we’re assuming we don’t have any knowledge about risk-adjusted returns, which isn’t always true. Stay with me, because we will get back to that. For the time being, however, let’s take as a given that we don’t know what the future holds. Let’s also assume that, like the Parable of the Two FA’s, our client holds $10 million in S&P 500 ETFs. Also like the parable, we have been asked to reallocate $1 million of those assets to what will be most diversifying. In other words, it’s a marginal analysis.

The measure we’re looking to maximize is the Free Lunch Effect, which we define as the difference between the portfolio’s volatility after our change at the margin and the raw weighted average volatility of the underlying components. If the two assets both had volatility of 10%, for example, and the resulting portfolio volatility was 9%, the Free Lunch Effect would be 1%.

If maximizing the Free Lunch Effect is the goal, here’s the relative attractiveness of various things the two FA’s could have allocated to (based on characteristics of these markets between January 2000 and July 2017).

Volatility Reduction from Diversification — Adding 10% to a Portfolio of S&P 500

Source: Salient 2017. For illustrative purposes only. Past performance is not indicative of how the index will perform in the future. The index reflects the reinvestment of dividends and income and does not reflect deductions for fees, expenses or taxes. The index is unmanaged and is not available for direct investment.

The two FA’s failed for two different reasons. The first failed because he selected an asset which was too similar. The second failed because he selected an asset which was not risky enough for its differentness to matter. The first concept is intuitive to most of us, but the second is a bit more esoteric. I think it’s best thought of by considering how much the risk of a portfolio is reduced by adding an asset with varying levels of correlation and volatility. To stop playing at diversification, this is where you start.

Volatility Reduction by Correlation and Volatility of Diversifying Asset

Source: Salient 2017. For illustrative purposes only. Past performance is not indicative of how the index will perform in the future. The index reflects the reinvestment of dividends and income and does not reflect deductions for fees, expenses or taxes. The index is unmanaged and is not available for direct investment.

If You Choose not to Decide

If there are some complaints that can be leveled against this approach, two of them, I think, are valid and worthy of exploration.

The first is that diversification cannot be fully captured in measures of correlation. If you read Whom Fortune Favors, you’ll know that our code recognizes that we live in a behaviorally-influenced, non-ergodic world. While I think we’d all recognize that U.S. value stocks are almost always going to be a poor diversifier against global equities (and vice versa), clearly there are events outside of the historical record or what we know today that could completely change that. And so the proper reading of this should always be in context of an adaptive portfolio management process.

The second complaint, as I alluded to earlier, is the fact that we are not always indifferent in our risk-adjusted return expectations for different assets. I’m sure many of you looked at the above chart and said to yourself, “Yeah, I’m not piling into commodities.” I don’t blame you (I’m still not satisfied with explanations for why I ought to be paid for being long contracts on many commodities), but that is the point. Not owning commodities or MLPs because you don’t get them isn’t the same as not expressing an opinion. If you choose not to decide, you still have made a choice.

When investors choose to forgo diversification, on any basis, they are implicitly betting that decisions that they make will outperform what diversification would have yielded them. It may not be optimal to own the most diversified portfolio you can possibly own, because anti-diversifying decisions might, in fact, be worth it. But it is exactly that thought process that must become part of our code as investors. It’s OK to turn down a free lunch, but you’d damn well better know that what you’re going to spend your money on is better.

So how do you quantify that implicit bet? Again, the Free Lunch Effect gives us our easiest answer. Consider the following case: let’s assume we had two investment options, both with similar risk of around 15%. For simplicity’s sake we’ll start from our naïve assumption that our assets produce, say, 0.5 units of return for every unit of risk we take. If the two assets are perfectly uncorrelated, how much more return would we need to demand from Asset 1 vs. Asset 2 to own more of it than the other? To own 100% Asset 1?

Well, the chart below shows it. In the case above, if you invest 100% of your portfolio in Asset 1, an investor who thinks about his portfolio in risk-adjusted terms is implicitly betting that Asset 1 will generate more than 3% more return per year, or an incremental 0.21 in return/risk units. If the assets are less similar, this implicit view grows exponentially.

Implied Incremental Return Expectation from Overweighted Asset

Source: Salient 2017. For illustrative purposes only. Past performance is not indicative of how the index will perform in the future. The index reflects the reinvestment of dividends and income and does not reflect deductions for fees, expenses or taxes. The index is unmanaged and is not available for direct investment.

A Chain of Linked Engagements

If we do not learn to regard a war, and the separate campaigns of which it is composed, as a chain of linked engagements each leading to the next, but instead succumb to the idea that the capture of certain geographical points or the seizure of undefended provinces are of value in themselves, we are liable to regard them as windfall profits.

— On War, Carl von Clausewitz

The point of this note isn’t to try to convince you to focus your portfolio construction efforts on higher volatility diversifiers like those highlighted earlier (although many of you should). It’s also not to argue that maximizing diversification should be your first objective (although most of us are so far from the optimum that moving in this direction wouldn’t hurt). It is to emphasize that portfolio construction and the decisions we make are a chain of linked engagements. It is to give you pause when you or your client asks for a ‘best new investment idea’. If your experiences are like mine, the question is nearly always expressed in isolation — recommend me a stock, a mutual fund, a hedge fund. These questions can never be answered in isolation. If you really must tinker with your allocation, sure, I can give you my view, but only if I know what else you own, and only if I know what you intend to sell in order to buy the thing.

Anyone who will make a recommendation to you without knowing those things is an idiot, a charlatan, or both.

Most of us, whether we are entrenched in financial markets or not, think about our decisions not in a vacuum but in terms of opportunity cost. If we buy A, we’re giving up B. If we invest in A, we’re giving up on B. If we do A, we won’t have time for B. Opportunity cost is fundamental to thinking about nearly every aspect of human endeavor but for some reason is completely absent from the way many investors typically think about building portfolios.

Look, if you didn’t completely follow where I was going with Whom Fortune Favors, I get it. Telling you to think about risk and diversification separately is more than a little bit arcane. But here’s where it comes together: an investor can only make wise decisions about asset allocation, about selecting fund managers, about tactical bets and about individual investments when he has an objective opportunity cost to assess those decisions against that allows him to make his portfolio decisions intentionally, not implicitly. That opportunity cost is the free lunch provided by diversification.

If we take this way of thinking to its natural extreme, we must recognize that we can, at any point, identify the portfolio that would have provided the maximum diversification, at least using the tools we’ve outlined here. For most periods, if you run through that analysis, you are very likely to find that a portfolio of those assets in which every investment contributes a comparable amount of risk to the whole — a risk parity portfolio, in other words — typically provides something near to that maximum level of diversification. I am not suggesting that your portfolio be the maximum diversification portfolio or risk parity. But I am suggesting that a risk parity portfolio of your investable universe is an excellent place to use as an anchor for this necessary analysis.

If you don’t favor it for various reasons (e.g. using volatility as a proxy for risk is the devil, it’s just levered bonds, etc.), then find your home portfolio that accomplishes similar goals in a way that is rules-based and sensible. Maybe it’s the true market portfolio we highlight in I am Spartacus. If you’re conservative, maybe it’s the tangency portfolio from the efficient frontier. And if you’re more aggressive, maybe it is something closer to the Kelly Optimal portfolio we discussed in Whom Fortune Favors. From there, your portfolio construction exercise becomes relatively simple: does the benefit I expect from this action exceed its diversification opportunity cost?

How do you measure it? If you have capital markets assumptions or projections, feel free to use them. Perhaps simpler, assume a particular Sharpe Ratio, say 0.25 or 0.30, and multiply it times the drop in diversification impact from the action you’re taking. Are you confident that the change you’re making to the portfolio is going to have more of an impact than that? That’s…really it. Now the shrewd among you might be saying, “Rusty, isn’t that kind of like what a mean-variance optimization model would do?” It isn’t kind of like that, it’s literally that. And so what? We’re not reinventing portfolio science here, we’re trying to unpack it so that we can use it more effectively as investors.

Recognize that this isn’t just a relevant approach to scenarios where you’re changing things around because you think it will improve returns dramatically. This is also a useful construct for understanding whether all the shenanigans in search of diversification, all that Chili P you’re adding, are really worth the headache. Is that fifth emerging markets manager really adding something? Is sub-dividing your regions to add country managers really worth the time?

In the end, it’s all about being intentional. With as many decisions as we have to manage, the worst thing we can do is let our portfolios make our decisions for us. Given the benefits of diversification, investors ought to put the burden of proof on anything that makes a portfolio less diversified. In doing so, they will recognize why this code recognizes the intentional pursuit of real diversification as the #2 Thing that Matters.


[1] I don’t want to hear it from the “but they stole people’s music and weren’t super nice about it” crowd. Zep played better rock and roll music than anyone before or after, and it’s not even close.

[2] And it can. Pueblan and Oaxacan cuisine feature moles with extraordinary complexity that does come from the melding of a range of seasonings and ingredients. Traditional American chilis, South Asian curries and soups from around the world often do as well. Dishes en croute (e.g. pate en croute, coulibiac, etc.) are notoriously tricky, too.

[3] Cue the fund-of-funds due diligence analyst pointing out that we would have, in fact, diversified our fraud risk. Die on that hill if you want to, friend.


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AI BS Detectors & the Origins of Life (by Silly Rabbit)

Confidence levels for the Social and Behavioral Sciences

DARPA recently put out an RFI:

…requesting information on new ideas and approaches for creating (semi)automated capabilities to assign ‘Confidence Levels’ to specific studies, claims, hypotheses, conclusions, models, and/or theories found in social and behavioral science research (and) help experts and non-experts separate scientific wheat from wrongheaded chaff using machine reading, natural language processing, automated meta-analyses, statistics-checking algorithms, sentiment analytics, crowdsourcing tools, data sharing and archiving platforms, network analytics, etc.

A visionary and high value RFI. Wired article on the same, enticingly titled, DARPA Wants to Build a BS Detector for Science.

Claude Berrou on turbo codes and informational neuroscience

Fascinating short interview with Claude Berrou, a French computer and electronics engineer who has done important work on turbo codes for telecom transmissions and is now working on informational neuroscience. Berrou describes his work through the lens of information and graph theory:

My starting point is still information, but this time in the brain. The human cerebral cortex can be compared to a graph, with billions of nodes and thousands of billions of edges. There are specific modules, and between the modules are lines of communication. I am convinced that the mental information, carried by the cortex, is binary. Conventional theories hypothesize that information is stored by the synaptic weights, the weights on the edges of the graph. I propose a different hypothesis. In my opinion, there is too much noise in the brain; it is too fragile, inconsistent, and unstable; pieces of information cannot be carried by weights, but rather by assemblies of nodes. These nodes form a clique, in the geometric sense of the word, meaning they are all connected two by two. This becomes digital information…

Thermodynamics in far-from-equilibrium systems

I’m a sucker for methods to try to understand and explain complex systems such as this story by Quanta (the publishing arm of the Simons Foundation — as in Jim Simons or Renaissance Technologies fame) of Jeremy England, a young MIT associate professor, using non-equilibrium statistical mechanics to poke at the origins of life.

Game theory

And finally, check out this neat little game theory simulator which explores how trust develops in society. It’s a really sweet little application with fun interactive graphics framed around the historical 1914 No Man’s Land Ceasefire. Check out more fascinating and deeply educational games from creator Nicky Case here.

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Horsepower

There is no animal more important in the ascendancy of Western Civilization than the horse, and no invention more important than the horse collar. It has nothing to do with warfare, and everything to do with farming and transportation.

Horses can work 50% faster than oxen, and they can go all day, particularly the draft horses of Northern Europe. But if you put an ox harness on a horse, the horse will choke to death. Very different bone structures, particularly with the shoulders.

When the horse collar was introduced into Europe in the 10th century (invented by the Chinese, of course, just like everything else of note prior to the Industrial Revolution) agricultural productivity skyrocketed. The resulting food surpluses led to a population boom, labor specialization and diversification, and the development of a merchant class. The horse collar (plus the horse shoe and the heavy plow) sparked a productivity revolution that totally reshaped European civilization and the history of the world.

A farm should have a foreman, a foreman’s wife, ten laborers, one ox driver, one donkey driver, one man in charge of the willow grove, one swineherd, in all sixteen persons; two oxen, two donkeys for wagon work, one donkey for the mill work.

Cato the Elder (234 – 149 BC), Roman senator, farming aficianado. Also Carthago delenda est.

I get about the same amount of work done with my John Deere 4610 as Cato accomplished with his sixteen people and five animals, particularly when I’ve got a 460 loader up front and a shovel mounted in back.

The parable of the man who has fled from an elephant

This is the story of a man who, in fear of an enraged elephant, has escaped into a pit, into which he has let himself down, hanging down and holding on to two branches at its edge. He looks down and there is a dragon, its mouth open, waiting for him to fall so that it can devour him. Then he raises his eyes to the two branches and sees two rats at their root, a black one and a white one, that are gnawing at the two branches untiringly and without flagging.

While considering his situation and worrying about his fate, he notices near him a beehive containing honey. He tastes the honey, and its sweetness preoccupies him and the delight of it distracts him from thinking about his plight, or from seeking a means to escape. Thus he remains diverted, unaware, preoccupied with that sweetness, until he falls into the mouth of the dragon and perishes.
Abdullah Ibn al-Muqaffa, from “Kalilah wa-Dimnah” (c. 750).

An Iranian who wrote in Arabic, Ibn al-Muqaffa had a knack for telling Persian fables with a political bent. He was killed for that, of course.

In 1917, Pierre Cartier bought the townhouse at 653 Fifth Avenue in exchange for his most valuable two-strand pearl necklace, valued at $1 million. Today, you can get a two-strand pearl necklace of similar length and pearl size from Macy’s for about $2,000. As for what 653 Fifth Avenue is worth today … well, it’s a lot more than $1 million.

Some of my happiest hours are spent on a tractor. The John Deere 4610 engine has 42.8 horsepower, which means that it generates the raw energy to lift 23,540 pounds one foot into the air in one second. That’s 32 kilowatts for people who think of energy in those terms. The tractor uses this raw energy to power both a drivetrain with enormous torque and a top speed of 30+ miles per hour, as well as a hydraulic system to which you can attach loaders and shovels and the like. It’s a beast, and the ability to control a beast like this is an absolute rush. My girls get this rush by riding and controlling an actual horse. I get it through a tractor that aggregates 43 horses into one hunk of metal.

The tractor isn’t just a powerful beast, but — like an actual horse — is also an incredibly versatile beast. It makes me a one-man wrecking crew if that’s what needs doing around the farm (and occasionally when it doesn’t need doing … I’ve inflicted my share of unintentional damage over the years). But my favorite and best use of the tractor is to Repair and to Make. Need to grade the quarter-mile driveway? Tractor. Need to carry the lumber and lift the roof to build the mustang’s run-in? Tractor. Need to shovel out the boot-sucking ankle-deep “mud” from the sheep and goat pen? Tractor. Need to brush hog a field and clear some trash trees to keep it healthy? Tractor. I am productive with my tractor to a degree and in a manner that I had no idea was even possible in my pre-farm life.

I’ve got two tractor-as-metaphor points I want to cover in this Note From the Field, one on investing and one on macroeconomics.

The investing metaphor is a simple one — a tractor leverages my personal strength a hundred-fold (assuming that I could lift 235.4 pounds one foot into the air in one second, which sounds about right for my maximum ability … on a good day … once … followed by a week in traction). I can accomplish amazing things with that untiring, never flagging, hundred-fold leverage. I can also kill myself.

In 2015, more than 400 people died in farm accidents in the U.S., and tractors accounted for about half of those fatalities. Interestingly, tractors only accounted for 5-10% of non-fatal farm accidents. When you screw up with a tractor, the consequences are deadly.

The source of a tractor accident (or in my case, thankfully, near accidents) is always one of two things: overconfidence or distraction. The machines themselves are phenomenally robust and well-engineered, which means that it’s never equipment error that gets you into trouble. It’s driver error.

Not coincidentally, the most careful, measured people I’ve ever met are professionals who drive big pieces of powerful machinery. There’s no bravado with these guys, no “sure, I guess you can stand on that, why not?”, no “yeah, be right with you, just wanna check my Twitter feed real quick.” It’s always measure twice, cut once, and if there’s anything that’s out of place or out of sight … the answer is no. They are, without exception, the antithesis of Donald Trump (in behavior I mean, not politics), which I suppose is a third tractor-as-metaphor story, given that the White House is the biggest piece of powerful machinery on Earth.

I’ve tried to bring this same sense of non-bravado professionalism to my farming activities, particularly whenever I’m around the tractor. I have to admit that it’s a work in progress, particularly on the overconfidence side. After all, I grew up in Alabama, where invitations like, “Hey, come on over, we’ve got a box of fireworks and a shotgun, so we’re gonna blow stuff up!” were not unknown. But there’s nothing like a slight feeling of “tippiness” while you’re sitting in that tractor chair with 2,000 pounds of gravel in the loader that you’re carrying juuuust a bit too high on a sideways slope that’s juuuust a bit too steep to refocus the mind into a more appropriate frame.

As importantly, and I think with more success, I’ve tried to bring this same measured sensibility to my investing activities, particularly whenever I’m around leverage. As with the tractor, the two devils to battle are overconfidence and distraction. That’s not to say that underconfidence — i.e., irrationally taking too little risk — isn’t a chronic problem for investment performance (Rusty Guinn’s recent notes are a must read on this!). An underconfident investor will inevitably suffer the cuts and sprains of underperformance. It’s the leading cause of high frequency, low severity investment accidents, and it’s hard to make a living in this business if you’re always banged up. But it won’t kill you. Not directly, anyway.

The tractor-as-metaphor is about fatal investment accidents, not non-fatal accidents. It’s about low frequency, high severity market events, which are almost always caused by the use of leverage in an overconfident or distracted manner. It’s not equipment error. It’s not a risk parity fund or an LBO fund posing some sort of inherent crash risk to markets. It’s the overconfident or distracted driver of a levered portfolio that poses crash risk to himself and to others, and that’s what we need to guard against in ourselves and in others.

How do we guard against overconfidence and distraction? By not confusing luck for skill (overconfidence), and by not getting bored with the long slog of compounded market returns (distraction). Or as expressed in Epsilon Theory-speak, by understanding the stochastic sea in which we swim. It’s not easy! And the smarter you are, the more prone you will be to hearing both devils whisper in your ear. Because you DO have skill, and it IS boring to invest with measured professionalism. But that’s the job. That’s the responsibility to yourself, your family, and your partners when you drive a tractor.

My macroeconomic story with tractor-as-metaphor also hinges on overconfidence and distraction, but the sources and mode are very different. The macroeconomic story focuses on the manufactured overconfidence and distraction that are intentionally imposed on us, creating a stable political equilibrium even as productivity growth grinds lower and lower.

Probably the biggest economic question in the world today is why productivity has stopped advancing, why we are no longer making more stuff with the people we’ve got.

US Labor Productivity Growth (2-year moving average)

Source: Bureau of Labor Statistics as of 7/13/17. For illustrative purposes only.

As I wrote in “Gradually and Then Suddenly”, how is it possible — with the most accommodative monetary policy in the history of the world, with the easiest money to borrow that corporations have ever experienced, with all the amazing technological advancements that we read about day in and day out — that companies have not invested more in plant and equipment and technology to improve their labor productivity? How is it possible that we’re not buying more and bigger tractors — not in the literal sense (although maybe that, too) — but in the figurative sense of doing more of what I do with my tractor on my farm: Repairing and Making in the U.S. economy.

My view: The reason companies aren’t investing more aggressively in plant and equipment and technology is BECAUSE we have the most accommodative monetary policy in the history of the world, with the easiest money to borrow that corporations have ever seen.

Why in the world would management take the risk — and it’s definitely a risk — of investing for real growth when they are so awash in easy money that they can beat their earnings guidance with a risk-free stock buyback? Why in the world would management take the risk — and it’s definitely a risk — of investing for GAAP earnings when they are so awash in easy money that they can hit their pro forma narrative guidance by simply buying profitless revenue?

Math is a funny thing. You can increase a ratio by enlarging the numerator OR by shrinking the denominator. But we are well and truly trained to focus on the earnings numerator of our most cherished metric for valuing stocks — earnings-per-share — not the share denominator. We’ve been well and truly trained to believe that’s what companies are supposed to do — grow earnings. So we don’t pay nearly as much attention to the total number of outstanding shares, either for a particular company or an overall market. In fact, the traditional meaning we attach to capital markets is that the total number of outstanding shares should naturally increase, either by new companies going public (IPOs) or existing companies issuing new shares to raise capital in order to buy “tractors” that will grow earnings faster than the cost of that new capital. This traditional meaning attached to capital markets — a transmission belt by which shares are issued for growth capital that increases the productivity of the firm — is dead and gone. Instead we have had a decade of shrinking share counts, as more companies leave public markets through acquisition or going private than enter through IPOs and as more companies use cash flow and debt to buy back shares. This — plus the aforementioned purchase of profitless revenue to satisfy a narrative of growth — is financialization. And it works. It increases both earnings-per-share and the multiple assigned to earnings-per-share (or revenue-per-share or bookings-per-share or whatever your market narrative demands) in a less risky and more predictable fashion than making more stuff at a lower cost and trying to sell it to more people at a higher price.

That’s what I think is going on with corporations, or at least the publicly traded companies that can easily tap into the magical elixir of financialization. Smaller companies and individuals don’t have this access. So why aren’t private companies buying more “tractors” to increase their productivity and make more money? Why aren’t individuals buying “tractors” to start a productive business where they make stuff to sell at a profit?

There are two popular explanations for this lack of productivity growth in the vast real economy of private companies and private individuals, both of which are two sides of the same coin, I think, as understood through the tractor-as-metaphor.

The first explanation is that we are measuring productivity all wrong today, that the glories of modern technology have succeeded in improving our quality of life even if they are not directly benefitting our gross national product. Put satellite position-tracking technology together with mobile telephony devices and electronic payment networks and voila! … on-demand driving services like Uber magically appear, making transportation a breeze. We’re not buying more cars, but we’re able to consume more driving. It’s what I’ll call “experiential consumption”, and it’s at the heart of all of these on-demand business models that absolutely dominate the modern economy, from transportation to education to food to retail to entertainment to politics. Yes, politics. Think about how you consume the experience of politics today, how it’s served up to you on a plate in on-demand fashion without requiring you to go out and actually participate in a political activity. If you don’t recognize that this is a conscious business model, no different than how Domino’s serves up pizzas in on-demand fashion, then I don’t know what to tell you.

The second (and related) explanation for productivity loss is that job growth since the depths of 2009 has been robust in low value-added sectors like healthcare services or leisure & hospitality, but meager in high value-added sectors like IT or financial services. By value-added we mean how much revenue or profits a human being, driving whatever “tractors” are common in that sector, can add to the firm’s coffers. A new hire in a software company or a bank, armed with all the leverage-increasing technologies and processes available in those fields, can add north of $300,000 to that company’s revenues. Unfortunately, there are fewer people working in IT today than there were in 2007 (!), and essentially no growth in financial services. On the other hand, a new hire in the leisure & hospitality sector adds only $50,000 or so to the hiring company’s revenues, but there are 20% more employees in that sector today than there were in 2007 (value added data from U.S. Commerce Dept. and job change data from U.S. Labor Dept.). The same phenomenon holds true for small business creation over the past decade, which has been dominated by low value-added gigs and personal services. It’s what I’ll call “experiential production”, and it’s at the heart of all the personal training and personal shopping and personal tutoring and “lifestyle” businesses that have cropped up after the Great Recession like mushrooms after a spring rain.

Over the past eight years we have thrown our money into relatively unproductive activities (experiential consumption), and we have thrown our bodies into relatively unproductive jobs (experiential production).

It’s as if we’ve intentionally returned to the recommended farming practices of Cato the Elder in 200 BC, where instead of a tractor with a 43 horsepower engine to get the work done, we’ve got “a foreman, a foreman’s wife, ten laborers, one ox driver, one donkey driver, one man in charge of the willow grove, and one swineherd”. Because god forbid we miss out on the experience of being a swineherd. Hey, with modern technology, you can drive for Uber herd swine whenever you like. Just imagine the personal satisfaction, not to mention all that extra cash, that comes with “being your own boss” as an on-demand swineherd.

It’s as if we’ve intentionally returned to the recommended farming practices of Cato the Elder because it IS intentional.

There is a very stable political equilibrium to be found in convincing a citizenry to trade, in Biblical terms, their birthright for a mess of pottage, or, in early 20th century terms, their townhouse for a string of pearls, or, in early 21st century terms, their sense of self-worth and self-actualization for the meme of “being your own boss” as an on-demand swineherd. There is a very stable political equilibrium to be found in convincing a citizenry to value experience and identity over stuff.

And yeah, I know this is coming across as all materialistic and crass. I know it’s rank heresy to say that it’s better to buy a tractor than to take your family on “the vacation of a lifetime”, that it’s better to stay an extra hour at work crunching on a project than to “take a little me-time” at the yoga studio. I know that it’s social suicide in red states to say that fighting over gender identity and who can use what bathroom is stupidity incarnate, just as it’s social suicide in blue states to say that diversity isn’t even a top three goal of anything that matters, much less an end-all-and-be-all goal, and by the way you’re bonkers if you think the Russians altered the 2016 election by one iota. These are all intentionally manufactured diversions of the first order, combined with a preening overconfidence generated by the wealth effect of intentionally inflated financial assets, creating a politically stable Western society of division, diversion, and debt. Yeah, that’s my heresy.

Why is it stable? Because it takes governments off the hook. Taken a ride on BART recently? The NYC subway? I have, and they’re appalling. But there’s no public outcry for Repairing and Making these systems and hence no need to spend the money that doesn’t exist or raise the taxes that can’t be raised or make any of the hard choices that can’t be made without running the risk of upending the entire municipal political system. There’s no public outcry because you’ve got an army of on-demand swineherds cruising the streets of the city providing driving services for everyone who wants to consume that experience. It’s the same tacit social equilibrium with EVERY government function and service in the modern Western world. Including defense. Including banking. Especially banking.

So what’s to be done?

Well … you’re not going to change this from the inside or from the top down. You’re going to change it from the outside and from the bottom up. It’s going to be a movement. It’s going to be a Maker movement and a Protector movement and a Teacher movement.

It’s happening now, at least on the Making side of things (Protecting and Teaching are a little more enmeshed with government monopolies, so that may take a bit of time). It’s happening with every Maker Faire and every public library with a 3D printer and every kid who learns to solder.

And every old guy with a tractor.

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Programmable Money & Auto Public Offerings (by Silly Rabbit)

Programmable money

I’ve recently — perhaps belatedly — developed an interest in blockchain, and particularly in Ethereum. Not so much in trading crypto-currencies, but more in the realm of the type of ‘Smart Token’ protocols being developed by Bancor. As I start to process the implications of smart contracts I’m convinced that we are currently at Day Zero of a massive disruption. To quote Mike Goldin on one dimension of this disruption: “What blockchains give us, fundamentally, is programmable money. When you can program money, you can program incentives. When you can program incentives, you can kind of program people’s behavior.”

Another week, another set of ‘human’ skills which algorithms are mastering: Google demonstrates both an algorithm for tastefully selecting landscape photography, which is almost as good as a pro photographer, and, from the DeepMind division, “a new family of approaches for imagination-based planning (and) architectures which provide new ways for agents to learn and construct plans to maximize the efficiency of a task.”

Rough translation: AI which has the rudimentary ability to consider potential consequences of an action (‘imagine’) and plan ahead result in a higher success rate than AIs without this ability.

ImageNet: the data that changed AI research

Long, terrific overview of the history and impact of the ImageNet data set: “One thing ImageNet changed in the field of AI is suddenly people realized the thankless work of making a dataset was at the core of AI research. People really recognize the importance — the dataset is front and center in the research as much as algorithms.”

Auto Public Offering

Generally, ‘automation of white collar work’ is such an obviously disruptive category of AI — and near-term economic earthquake for many industries — that there is not much to say about it. However, this short piece by Bloomberg a few weeks back caught my eye: Apparently Goldman has automated (or at least mapped out how to automate) half the tasks needed to prepare for an IPO, thus replacing the work previously done by associates earning $326,000 a year. As Bill Gates famously said: “Be nice to nerds. Chances are you’ll end up working for one.”

The paradox of historical knowledge

And finally, I shared a pretty hefty quote from “Homo Deus: A Brief History of Tomorrow” by Yuval Noah Harari last week related to algorithms and self. On a completely different topic, the book also contains a fantastic quote on the paradox of historical knowledge: “This is the paradox of historical knowledge: Knowledge that does not change behavior is useless. But knowledge that changes behavior quickly loses its relevance. The more data we have and the better we understand history, the faster history alters its course, and the faster our knowledge becomes outdated.”

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