A Game of You

Neil Gaiman, “A Game of You” (1993)

As Neil Gaiman says about this fifth collection of Sandman comics, “it’s most people’s least favorite volume, and I love it all the more for that.” I feel the same way about what I write, particularly on social media like Twitter.

We’ve reached a new height (depth, really) of what I call “mirror engagement” on social media. If you don’t see yourself in the Missionary you follow, you get mad. How dare you not reflect my views!

I’ve used this Terry Pratchett quote before, but after the past week on Twitter I’ve gotta use it again.

A European says, “I can’t understand this, what’s wrong with me?”

An American says, “I can’t understand this, what’s wrong with you?”

This quintessential American construct of discourse is in overdrive since the Kavanaugh hearings. I suppose it shouldn’t surprise me. It’s the perfectly natural outcome of what I wrote about in Schrödinger’s Senate Hearing, where people who could share the same political or social space before the hearings are no longer able to do so because they are now in mutually exclusive worlds. Either the cat is dead to you or the cat is alive to you. There’s no third state of the world where the cat might be alive or it might be dead.

But what I find so frustrating and so tiresome is the inability of large swaths of the social media world to accept that someone might see the world differently from them. That the reaction to “I disagree with you” is not “well, okay” but “WHAT IS WRONG WITH YOU?”

I think it’s because of the meaning of social media for most people. I think we all tend to follow people, particularly well-followed posters (the Missionaries of this shadow world, of which I suppose I am one), not because it’s a “conversation” or for “an interesting point of view”, but for a specific entertainment purpose. It’s either a mirror engagement (yes! a semi-famous person looks like me!) or a rage engagement (them’s fighting words, you imbecile!), and never the twain shall meet.

Even the rage engagement is not real rage. It’s a faux rage. No one writes a snarky reply to @realdonaldtrump because they’re really engaging with The Donald. No, they’re posting to their mirror engagement crew, who they know is also in a rage engagement with @realdonaldtrump. It’s not even virtue signaling. It’s pure entertainment. It’s a simulation where they can “engage” with the President of the United States in the company of their supportive mirror engagement crew. Plus dopamine!

What brings out the real emotion and the real confusion is when a mirror engagement goes awry. It’s also confusing when a rage engagement goes against type and agrees with you on something, but the reaction isn’t upsettedness … it’s boredom. The emotion when a mirror engagement goes against type is much more pronounced, much more urgent. It’s a betrayal.

Not a big betrayal. Not a personal betrayal. Not (usually) a permanent betrayal. It’s not even a Heel Turn, to use the pro wrestling phrase, when a Baby Face (a good guy) flips the script and becomes a Heel (a bad guy) in some shocking plot twist.

No, it’s more like when your favorite sitcom has a “very special episode” where they deal with some social issue du jour in a “serious” fashion that of course you find cringe-worthy. That’s not what you want from Three’s Company!

Interestingly (or interestingly to me, anyway) are the words that disappointed mirror engagers use to respond to a Missionary message that expresses an opinion that goes against perceived type. Almost without exception, they will respond with some variation of “YOU’VE LOST CREDIBILITY!” Now this has nothing to do with credibility. Missionaries are just as believable if they think chocolate ice cream is the best ice cream as if they think strawberry ice cream is the best ice cream. It’s not credibility that’s lost to the mirror-engaging strawberry ice cream-loving followers, it’s consistency. What’s lost is the feel-good entertainment they’ve come to expect and were counting on.

So they throw their shoe at the TV set. Go back to our regularly scheduled entertainment!

If they get really mad they change the channel. They unfollow you. Don’t know what happened to that guy! He lost all his credibility with me when he said what he said!

The underlying issue here is that social media is a game, but it’s a different game for different players. For the Missionary, the game is the ego boost and dopamine hit of getting more followers, of becoming more popular. It’s a ratings game. For the civilian, the game is the ego boost and dopamine hit of engaging on a kinda sorta equal footing with the popular kids, either in a rage engagement or a mirror engagement. For both, it’s a slow-twitch massively multiplayer video game, like Fortnite for geriatrics.

For very few, it’s a “connection” or a “conversation” with other human beings as ends in themselves.

But sometimes that happens. A connection. A conversation with a like-minded truthseeker, someone you’d have never met IRL. And that’s like the best thing! My god, I have so few friends IRL. Some amazing, true, lifetime, in-the-foxhole friends, for sure. But not many IRL friends. Through Epsilon Theory, though? They are legion. One of the best parts of my life.

That’s the real disappointment and frustration for me when these “decoherence events” like the Kavanaugh hearings get foisted on us by the Democrats and the Republicans, and everyone loses their goddamn minds if you don’t fall into line with your mirror-engaging community.

There are no friends to be made right now, no connections or conversations to be had on social media. It’s a war out there right now, and by war I mean game. We Missionaries are playing our ratings game, and the civilians are playing their rage and mirror engagement games. It’s all games all the time. Everyone is being highly entertained.

Bread and circuses, my friends, bread and circuses.

Time to take this conversation offline. Or at least off social media.

Announcement on Thursday. Stay tuned.


Schrödinger’s Senate Hearing

The cat isn't dead OR alive. It's dead AND alive.

“The world is given to me only once, not one existing and one perceived.”
– Erwin Schrödinger

“Schrödinger was wrong.”
– Ben Hunt

Most people confuse Schrödinger’s Cat with the Observer Effect. It’s a lot weirder and more important than that.

Here’s what Schrödinger’s Cat is NOT. There’s a live cat inside a box, and the act of opening the box to see the cat will break one of two glass vials also inside the box. If Glass Vial A is broken, a deadly poison is emitted that kills the cat. If Glass Vial B is broken, nothing happens and the cat stays alive. This is an example of an Observer Effect – that the act of observation determines the outcome.

In the true Schrödinger’s Cat thought experiment, the poison gas vial isn’t broken by the observer opening the box, but could break open by chance over some period of time. As in the Observer Effect experiment, though, there’s no way to know if the cat is alive or dead without opening the box.  After you open the box, the observer knows for sure whether the cat is dead or alive. But before you open the box?

The insight of Schrödinger’s Cat is that the cat is alive AND the cat is dead before the box is opened. It’s not merely unknown whether the cat is alive or dead. The cat is actually alive AND actually dead at the same time.

Wait a second, Ben. What do you mean the cat is actually alive AND actually dead at the same time? Obviously that’s not true. The cat is either alive OR dead. There is a state of the world where the cat is dead, and there is a state of the world where the cat is alive. Maybe we can’t know whether the cat is alive or dead, but it MUST be one or the other. That’s reality.

Schrödinger is saying no, that’s not reality. Schrödinger is saying that reality is – in reality – probabilistic. That the actual physical reality is that the cat is both alive AND dead at the same time. Maybe our human experience of reality does not allow us to have pets that are alive and dead at the same time, but that’s our fault, not reality’s fault.

I’m being a little facetious, because Schrödinger developed his famous thought experiment as a critique of quantum physics, and it’s now used to describe different theories of superpositioning in that weird world, where the smallest building blocks of nature should theoretically exist in multiple states of nature simultaneously. In the macro world of real-life humans doing real-life things, a cat is truly either alive or dead, not both.

I think, though, that it’s not just quantum reality where Schrödinger’s Cat exists. What we’re seeing with the Ford/Kavanaugh hearing yesterday is a social reality where Schrödinger’s Cat also lives.

It is the act of observing that resolves the superpositioning of a cat that is both alive AND dead. If you open the box to look at the cat, you will experience either a dead cat OR a live cat. There is no third state of the world here, no middle ground to be had where the cat is both alive and dead. Same with the Kavanaugh hearings. If you observed the hearings, you opened the box.

Before the Kavanaugh hearings, our social reality allowed the superpositioning of two states of the world, a cat that was both alive AND dead, a specific sexual assault that happened AND a specific sexual assault that didn’t. What do I mean by social superpositioning? I mean that we as citizens weren’t forced to take sides, that citizens who would only later find themselves within totally different states of the world could continue living in the same political reality.

After the Kavanaugh hearings, there’s no more social superpositioning. The cat is alive OR the cat is dead. Again, I’m talking states of the world, not credibility or evidence or arguments or whatever. There is a state of the world where Kavanaugh assaulted Ford in 1982, and there is a state of the world where he did not. Pick one. Now. And once you’ve picked, you no longer co-exist in the same political reality as someone who picked differently. You are truly – and I mean this in a very literal sense – in different worlds. Those different worlds are, in the terminology of one of the main strands of quantum physics, decohered, meaning that they have ZERO connection of any sort with each other. The respective universes go on operating as if the other did not exist. If we both open the box, and I experience a different state of the world than you, then I am – again literally – dead to you.

If you’ve spent a nanosecond on social media over the past 24 hours, you know exactly what I mean.

The last time I experienced a national Schrödinger’s Cat moment, where significant portions of the population experienced mutually exclusive and decohered realities? The OJ Simpson trial. That was a black/white thing. This is bigger, or at least more evenly divided. Which makes it worse.

And unfortunately, once your state of the world has been set, it can’t be reset. That’s the other thing about the Schrödinger’s Cat experiment … it doesn’t run backwards. Once you’ve resolved the superpositioning into one state of the world or the other, you can’t go back.

If you believe in the Ford state of the world today, there’s no waking up in two weeks and thinking, “hmm, maybe the Kavanaugh state of the world could be right. Who knows, really?” Ditto if you believe in the Kavanaugh state of the world. This isn’t a mean-reverting phenomenon. We never go back to a fuzzy probabilistic world where “both sides” can co-exist in a superpositioned social reality.

THIS is what it means to have a widening gyre of politics. There’s no reset button. There’s no walking back the experience of opening these boxes – what I call decoherence events – that are forced on us by both the Democrats AND the Republicans.

A dead Schrödinger’s Cat stays dead.

For more on what it means to have a widening gyre of American politics, see “Things Fall Apart (Part 1)”.

For more on what it means to have decoherence events forced on us by political entrepreneurs of both parties, see “Always Go To The Funeral”.

For an oldie but goodie Epsilon Theory note on Schrödinger and investing, see “Schrödinger’s Portfolio”.


Notes from the Diamond #1: Always Something New to Learn

Yazstremski waits for the bounce.

Don’t be afraid to take advice. There’s always something new to learn. — Babe Ruth

Trivia Question 1 of 108 — What baseball Hall of Fame catcher earned valedictorian honors while also posting a 75-3 record as a pitcher in high school? Answer furnished in main text. Ditto for an answer to the question, “Why 108?”

Boston Red Sox pitcher Brandon Workman at bat in the 9th inning of Game 3 of the 2013 World Series

The Wind Up.  Big differences in their physical demands aside, playing pro baseball and managing money for a living have much in common — a happy fact for those of us who find both endeavors engrossing and a godsend for money managers whose quarterly letters would be intolerably brief or dull absent baseball-related arcana.  Truth be told, the literature exploring parallels between baseball and investing is already so vast that Epsilon Theory (ET) faithful might reasonably pose the same question to ET management that Red Sox Faithful shouted at their TVs as the worst managerial miscue in living memory was unfolding before their eyes several years ago: “Why?!”  No, I’m not referring to Bosox manager Grady Little’s catastrophic act of omission in Game 7 of the 2003 American League Championship Series — acceding to star pitcher Pedro Martinez’s pleas that he continue pitching — but rather to the even dopier decision of Bosox manager John Farrell a decade later: letting pitcher Brandon Workman take his first-ever major league at-bat with the Sox and Cardinals tied 4-4 in the ninth inning of Game 3 of the 2013 World Series.  The Sox lost both games, of course, ending their season in 2003 and adding unnecessary angst to a stress-filled but ultimately triumphant season in 2013.  In due course, this series will explore both of the miscues just referenced plus other noteworthy hits, runs and errors in both money management and baseball, all with the aim of elevating readers’ investment games if not also their appreciation of America’s national pastime.[1]

Unwelcome Change.  I know, I know: in many folks’ eyes, football supplanted baseball as the national pastime long ago — a mutation as regrettable and seemingly irreversible as the shift toward extremism in American politics that Ben Hunt discusses so penetratingly in his multi-part note entitled Things Fall Apart.  Unable as I am to trump Ben (pun intended) in political punditry, I’ll generally avoid politics in this series, leaving it to Ben and other ET contributors to draw parallels if and as they see fit between the shifting fortunes of professional sports on the one hand and political factions on the other.  That said, I can’t resist quoting here the late political journalist Mary McGrory’s lament respecting mutually reinforcing trends she espied in the nation’s political and recreational proclivities long before POTUS 45 declined an invitation to throw out the ceremonial first pitch on Opening Day during his first year in office: “Baseball is what we were,” McGrory observed.  “Football is what we’ve become.”

The Pitch.  Shifting from wind up to pitch … ET faithful deserve an answer to this important question among others: why should they allocate a portion of their scarcest resource — time — to this note or indeed any of the 108 planned and presumably weekly missives comprising the series hereby commencing?  At least three reasons for doing so come to mind.  First, Babe Ruth had it right: there’s always something new to learn about any field of human endeavor, including the fun fact that, as the accompanying diagram confirms, baseballs have precisely 108 stitches.  Second, Ben Hunt has it right: sometimes the best way to replace bad habits with good ones in a chosen field is to look outside it for wisdom or inspiration — as Ben has done so effectively and entertainingly for us money management types with his Notes from the Field. Third, ET contributor par excellence Rusty Guinn has it right also: sometimes the best means of elevating one’s game is to take it on the road so to speak — to contemplate the origins and soundness of habits and beliefs outside one’s chosen profession or political persuasion with an eye toward assessing critically what Rusty refers to as an investor’s “priors”.  We all have ‘em, like it or not.

Anatomy of a baseball

No Guarantees.  I’ve put priors in quotes because I myself have never used that term in decades of writing about investing, nor do I expect to use jargon like it often if ever in this series.  But Rusty fancies the term; I like and respect Rusty (and Ben); and I’ve already learned much from Rusty’s series entitled Notes from the Road.  I won’t guarantee that readers will find these Notes from the Diamond comparably insightfulBut I will pledge that they’ll spawn chuckles on occasion, while also avoiding quotes from an overexposed baseball legend who’s understandably but unjustly remembered more for his malapropisms than for his central role in notching ten World Series titles for the Evil Empire (a/k/a New York Yankees).  After all, why subject readers to deja vus from Yogi Berra when the supply of edifying utterances from other baseballers is large and growing?

Superficial Stasis.  As skilled as Berra was behind the plate, the high school valedictorian referenced in the trivia question at page 1 was even more so, as well as a gifted philosopher in his own right.  Responding to a dinner companion’s jibe that the game he played for a living was intolerably slow, Hall of Fame catcher Johnny Bench intoned, “Baseball is a slow game — for slow minds.”  Rightly understood, investing as distinct from trading also entails prolonged periods of superficial stasis — superficial because effective investors must and do ponder more or less continuously whether newly arriving information necessitates portfolio changes, mindful that it seldom does.  Interestingly, the principle just flagged — favor inaction over action unless the latter is truly vital — is arguably the single most impactful insight spawned by the so-called Sabermetrics Revolution that’s transformed pro baseball in recent decades, i.e., the reshaping of what players, managers and — yes — umpires do or don’t do on the field based on advanced statistics not readily available before certain information technologies were developed.  Among many other insights these Notes will explore, Sabermetrics — a term derived from the acronym for Society for American Baseball Research or SABR — has confirmed decisively what baseball cognoscenti have long conjectured: that a base on balls or walk can be as good as a hit.   Indeed, for reasons to be explored in future notes, the “big data” revolution that’s transformed pro baseball no less than it’s transformed financial markets in recent decades has proven that walks can be better than hits for teams notching them under certain circumstances.

For the Love of It.  What other insights from baseball of potential utility to investors will these Notes explore?  At the risk of having Ben Hunt consign me to his necessarily large nursery of raccoons — i.e., finance types who pilfer Other People’s Money by, among other means, overpromising as habitually as Ted Williams reached base safely[2]  — I’ll answer the question just posed while also wrapping up this inaugural note by providing a sneak peek at insights I plan to explore in the 107+ notes to follow.  I’ve added “+” to 107 because, more than five decades after I first laid eyes on Fenway Park’s gorgeously green grass, and more than three decades after I sank into money management, I’m as intrigued as ever by both baseball and investing.  Whether such intrigue gives me an edge in the latter pursuit is unclear, but I like to think it does, just as I like to think that major leaguers who truly enjoy their work have an edge over those who don’t.  As in finance, which comprises a regrettably large sub-population of raccoons, professional baseball comprises numerous actors motivated primarily by money.  As in finance, it’s long been thus in baseball, as perhaps the edgiest player of all time confirmed when rebuking his fellow pros as his long and distinguished playing career (1905 – 1928) was nearing its end.  “The great trouble with baseball today,” Ty Cobb scolded, “is that most of the players are in the game for the money and that’s all. Not for the love of it, the excitement of it, the thrill of it.”

Coming Attractions.  Thrilling or not, the useful insights derivable by applying ongoing advances in baseball strategies and statistics to money management are legion.  I’m excited by the prospect of pinpointing many of them in future notes, including these:

  • Why it’s not merely useful but essential for professionals to “change their stripes” — a stubbornly enduring no-no in money management whose conscious violators include not a few investment pros as successful in their evolving endeavors as Johnny Bench was in his. Why did Bench switch from pitching to catching at a crucial point in his development as a player?  Because he and those advising him deduced correctly that his foremost physical skill — a strong throwing arm — would be optimally applied as a catcher, thus permitting Bench to use his smarts as well as his physical gifts as frequently as baseball rules permit.  We’ll explore Bench’s metamorphosis and its significance for investment pros in greater detail as this series unfolds.
  • How the metrics used to assess on-field performance condition the behavior of not only players but umpires — a phenomenon with great relevance to client-manager relations in institutional funds management. As we’ll see, the fleet-footed fellow whose most celebrated achievement as a baseballer was his breaking of Ty Cobb’s all-time stolen base record understood intuitively what many capital allocators understand dimly if at all . “Show me a guy who’s afraid to look bad,” said six-time All Star and Hall of Famer Lou Brock, “and I’ll show you a guy who can be beaten.”

Not afraid to look bad: Lou Brock (#20) in action in 1964

  • What practitioners pursuing excellence must do to maintain an edge as the information revolution advances. Quite apart from rules changes already implemented that preclude future career stats as stellar as those achieved by past outliers in each domain — e.g., Wes Crawford or Bob Gibson in baseball; Michael Steinhardt or Peter Lynch in money management — the relentless and mutually reinforcing advances of technology and transparency portend continued shrinkage in the pool of dominantly successful practitioners in professional baseball no less than in professional investing.[3]  By transparency, I mean the timely collection, compilation and dissemination of essentially all available objective data germane to the aforementioned professions.  As many readers are aware, and as future notes will discuss, enhanced transparency as just defined has reduced and will continue undermining the incomes of ballplayers as well as investment pros whose “edges” entail primarily their patrons’ imperfect understanding of their true as distinct from perceived skills.  In a baseball context, “patrons” as just used is defined broadly to include team owners and managers as well as fans — all of whom can easily and inexpensively access meaningfully large chunks of the roughly seven terabytes of data per game (including but by no means not limited to video bits and bytes) that major league baseball’s Statcast system collects via cameras and radar installed in every MLB stadium. That’s a quantum of data equivalent to the contents of 700,000 copies of Webster’s Collegiate Dictionary — and literally millions times the number of data points some of us learned how to record manually on paper scorecards back in the day.

Manual recording of Red Sox labors vs. Yankees 8/18/2006

Continuous Improvement.  Imagine if fiduciaries could evaluate investment pros as quickly, cheaply and thoroughly as baseball managements can evaluate players’ every movement  (or non-movement) using Statcast.  I’m unsure such enhanced scrutiny would produce uniformly better returns, but I’m sure that it would alter managers’ as well as clients’ behaviors, just as such scrutiny has altered how pro baseball gets played, who gets to play it, and for how much.  I’m sure too that even if investment pros’ labors remain as crudely understood as pro baseballers’ were before Statcast came along, future technological advances will compel investment pros seeking sustained excellence to change their stripes on a regular if not continuous basis.  How do I square the assertion just made with Ben’s championing of repeatable processes in Things Fall Apart? I’m not sure I can, or want to, his and Rusty’s invitation to contribute to ET being rooted in their laudable desire to foster diverse viewpoints under ET’s banner.  By my lights, choiceworthy processes in money management display the same cardinal virtue that my all-time favorite player displayed when fielding caroms off Fenway’s fabled Green Monster: such processes are less “repeatable” or static than they are adaptive and ever-changing.  The player in question, of course, was Carl Yazstremski, a Long Island native whose exceptional work ethic arguably made Puritan New England (a/k/a Red Sox Nation) a fitter venue for his sporting labors than his original home turf.  “I loved the game,” Yaz said after his 23-year career came to an end in 1983.  “But I never had any fun.  All hard work, all the time.”

Carl Yazstremski awaiting a carom off Fenway’s Green Monster in the 1967 World Series

Ernie Had It Right.  Like the best opening frame this Bosox fan has ever witnessed — a 50-minute masterpiece in which the Bosox scored 14 runs on 13 hits against the visiting Florida Marlins at Fenway in June 2003 — this initial installment of Notes from the Diamond has developed proportions more expansive than might reasonably have been expected.  As noted at page 1, readers can expect future installments to be shorter — but no less replete with pearls of wisdom from wizards of the diamond, including a gentleman who changed his stripes not once qua young Johnny Bench but multiple times en route to his own induction at Cooperstown.  Nicknamed “Mr. Sunshine” for his upbeat disposition, Ernie Banks (1931 – 2015) is forever known for his catchphrase, “It’s a beautiful day for a ballgame … Let’s play two”.  With so many useful parallels between baseball and investing to be drawn — and with so many members of ET Nation including yours truly wondering what comes next for the business of investing and their own roles within it — I’m keener than ever to craft the next note in this series … and the next.  Let’s play 108, why don’t we?

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[1] Workman’s first and to date only major league at bat went poorly, with a whiff plus two called strikes producing a blindingly quick out.  If the Red Sox, for whom Workman has played on-and-off since 2013, make the World Series in 2018, the odds are good that team manager Alex Cora will call on Workman to do some relief pitching.  That said, I’d bet my family’s most prized baseball-related possession — a ball inscribed for my children by Elden Auker — that Cora doesn’t let Workman bat, ever.  The last living pitcher to have faced Babe Ruth, Auker (1910 – 2006) showed his mettle early in his 10-year major league career: Ruth was the first batter Auker faced in the pitcher’s big league debut in 1933, striking out on just four pitches.

[2] Most readers know that Joe DiMaggio holds the record for consecutive games with a hit: 56 in 1941.  Some may be unaware of another seemingly unbreakable record, held by the best hitter in baseball in the 1940’s or indeed any other epoch: in 1949 Ted Williams reached base safely in an astounding 84 consecutive games.

[3] The all-time career leader in triples with 309, Crawford played before “live era” or post-1910 baseballs made home runs far more frequent than triples.  Gibson notched the all-time best single season earned run average (ERA) of 1.12 in 1968, a year before pitching mounds were lowered by a third to their current height of 10 inches.  Steinhardt made big bucks for himself and his clients during the first half of his career via block trading methods that were either illegal at the time or have since been outlawed.  And Lynch turbocharged his returns via the lawful exploitation of corporate disclosure protocols benefiting big institutions like Fidelity that post-2000 securities law reforms have rendered nugatory, including especially Regulation FD.

On Deck:

What baseball’s steroid era and private equity’s salad days have in common



Deadly. Holy. Rough. Immediate.

Stephen Fry and Mark Rylance engaging in Immediate Theatre

Baron Von Swieten: Mozart, music is not the issue here.  No one doubts your talent.  It is your judgment of literature that’s in question. Even with the politics taken out, this thing would still remain a vulgar farce.  Why waste your spirit on such rubbish?  Surely you can choose more elevated themes?

Mozart: Elevated?  What does that mean?  Elevated!  The only thing a man should elevate is – oh, excuse me.  I’m sorry.  I’m stupid.  But I am fed up to the teeth with elevated things!  Old dead legends!  How can we go on forever writing about gods and legends?

Von Swieten: Because they do.  They go on forever – at least what they represent.  The eternal in us, not the ephemeral. Opera is here to ennoble us.  You and me, just as much as His Majesty.

Kapellmeister Bonno: Bello!  Bello, Barone.  Veramente.

Mozart: Oh, bello, bello, bello!  Come on now, be honest.  Wouldn’t you all rather listen to your hairdressers than Hercules?  Or Horatius?  Or Orpheus?  All those old bores! People so lofty they sound as if they shit marble!

— Amadeus (1984)

A man walks across this empty space whilst someone else is watching him, and this is all that is needed for an act of theatre to be engaged.

— The Empty Space, by Peter Brook (1968)

We were going to send you all a survey, you know.

One month ago, Ben and I were feverishly preparing for next week’s launch. We had an exchange over email about the details of a survey we were going to include with Ben’s essay from early September. The idea was to ask our subscribers what they wanted from a subscription to Epsilon Theory. With that survey, we would also include a request for some demographic information. Income, gender, region, questions about what kinds of decisions you make at your place of employment. Things that would help us sell better, more valuable ads on the website.

Honestly, we already had a pretty good idea what we wanted to deliver through our subscriptions. What we were after was the data. We still kind of want it. We’re still probably going to ask for it some day. But there was an epiphany moment for both of us, I think, when we realized that if we were going to do that kind of thing, we should do it by telling our readers exactly what we were asking for and why. Instead, we were working up some thinly veiled artifice, creating some cartoon in which we’d leverage our goodwill to make our friends pretend they didn’t know what we were doing. What a contradiction it would have been, to launch our vision to help investors and citizens cut through abstractions and to become more honest participants in financial and political markets, by sending out a survey requesting a bunch of personal information under the auspices of interest in the things you care about.

Ben’s fond of quoting Whitman to those who call him out for contradicting what he has written in prior pieces – “Very well then I contradict myself. I am large, I contain multitudes.” We do contain multitudes. You contain multitudes. It is inevitable, when we write so much about the perils of abstraction, that we should begin to regard it as an evil.  It isn’t. Memes are self-sustaining ideas that live in the human brain, and they reflect both the good and bad about us. We celebrate Narrative when it is marshaled for positive change. We respect it when it is cleverly applied. We fear it when it is used to stir up fear and division. We loathe it when it seeks to control and direct our lives through nudges under the guise of libertarian paternalism. Language is always an abstraction from some true meaning, or at least from true intent. Consider even my little confession about the survey – was my intent to tell you an honest story in good faith? Or were the words just a convenient mechanism to convey my true intent – that I wish you to see us as honest voices in a wilderness of conflicted Wall Street advice?

There are thousands upon thousands of books from thousands of authors over thousands of years discussing philosophy of language and meaning, from Socrates to Bertrand Russell. It’s not that we think we’ve discovered something new here. It’s that we think we’ve got something to say about how things that are new – always-on news, social media and the class-free global connectivity of the internet – allow each of us to conjure those primal forces to wield the kind of influence that Wittgenstein could never have dreamed of. To stoke the kind of belief in our company’s stock that could endure multiple CFO resignations, multiple SEC investigations and a bizarre public attempt at an MBO. To bring down tyrants and sexual abusers. To solidify our political tribe at the expense of national unity. To sell shoes. To sell football. To increase confidence in financial markets and the collective belief in the political will of authorities to prevent their decline.

For well-intentioned citizens, all this requires a great deal of us. It requires us to have clear eyes when others are leaning on Narrative abstractions to produce a response from us. It requires us to decide how to discern their intent. It requires us to be more mindful of our own ability to manipulate the judgments of others, and to hold ourselves accountable for our intent in doing so. It’s not the kind of thing that political science, business or economic programs really cover. That’s because this isn’t really about politics or economics.

There is, however, a field for which these questions have been the stock-in-trade for 2,500 years. Its lessons are invaluable to anyone who would navigate Narrative-driven political and financial markets. One of its finest books – and a short read, at that – is my first recommendation for anyone who is looking to understand management, communication and civics. The book is called The Empty Space. It’s about theatre.

Deadly Theatre

“Over the centuries the Orphic Rites turned into the Gala Performance – slowly and imperceptibly the wine was adulterated drop by drop.” – Peter Brook

Peter Brook’s 175-page masterpiece seeks to categorize and define the ways in which theatre – which he defines as ‘a man walking across an empty space whilst someone else is watching him’ – is performed. In all, Brook identifies four varieties of theatre: deadly, holy, rough and immediate. Each of them is a pitch-perfect description of the ways in which any performative use of language interacts with an audience, whether it’s a theatre troupe performing a play, a politician giving a policy speech or a CEO discussing earnings.

Brook’s definition of Deadly Theatre will be familiar to anyone who goes to see the theatre from time to time. Frankly, it would be familiar to anyone who has an idea in their head of what a play or opera looks like, because Deadly Theatre is by definition the Common Knowledge about what theatre is. Deadly Theatre is every heavily affected To Be or Not to Be speech. It is every spear-toting, blonde-braided Brünnhilde in an absurdly contoured half-breastplate. It is the understudy of the nth Broadway casting of Alexander Hamilton, watching YouTube videos of Lin-Manuel Miranda from a Crown Heights apartment, desperately trying to recreate the mix of charismatic bravado, ambition and self-consciousness audiences remember from the original character.

Deadly Theatre is a performance that is so deeply abstracted from its source material that it has become painfully, obviously artificial to anyone who is paying attention. A stylish disaster, it looks right, but feels wrong to even the most untrained eye. All that we call political correctness falls into this category. We remember what it is like to be offended. We remember, or think we remember someone telling us about what battles for social justice in the 60s and 70s felt like, or maybe we saw it in a documentary. Then we go through the motions, performing the rituals of offense as best we can remember them. Our friends play the roles of heroes rallying to the defense of the offended.

The parallels with demonstrations of patriotic correctness are no accident, for they are Deadly Theatre, too. We witnessed love of country and acts of service by statesmen and warriors in the past, and instead of studying and internalizing the source of their passions, we perform the outward rituals we remember. The flags. The speeches. The lapel pins. That Lee Greenwood song – you know, the one he wrote before he adapted it to “God Bless You, Canada” for profitable distribution in the Canadian market. Like political correctness, each individual’s actions may stem from good intentions, but empty ritual is still empty ritual.

As investors, once we start looking for it, we realize that Deadly Theatre is all around us. There is the fussy baroque opera of operational due diligence on fund managers. Oh, it’s a flurry of busy-looking activity – the checklists, the ‘process’, the consultant grades – when no manager hiring decision in 10 years has been influenced by this activity, outside of the results of references and background checks. And yet, we – or more accurately, our clients – would take offense at its absence.

There is the big, bombastic, pyrotechnics- and celebrity cameo-laden Broadway show, which is the consultant-led strategic asset allocation review conducted by every institutional asset owner in the world every five years or so. Here are 300 pages of research from our 150 Ivy League-trained analysts telling you why we’ve modified our 10-year assumption for “Emerging Markets” returns by 50 basis points. In the end, because we’ve also modified our volatility assumption and currency expectations, it all comes out as kind of a wash, so we’re not actually recommending any changes. But don’t you feel better, safer after this whole experience?

There is the complex pageantry of pre-Stanislavski Russian theatre that is sell-side stock research. It is produced with flourishes of language, and the patina of knowing expertise. It is consumed by those who say “they don’t use it” to clients and “I only use it to see what others are thinking” to peers, when the way buy-side analysts really consume it is to copy the assumptions into a spreadsheet model, read about the company for a few days, and think really hard about what kind of twist on a ‘key assumption’ sounds like it would appeal to the portfolio manager. Yet all of these forms must be observed.

And these forms don’t emerge out of nothing. They are imitations of something which was once new and real before it was replaced by convention. Some of us remember doing these things when they mattered, or we remember how some professor who did them once described them to us.

To the Citizen and to the truth-seeking investor, Deadly Theatre is moribund. Worthless. To be observed but rejected wherever it manifests. To be ruthlessly rooted out of our own behavior.

Holy Theatre

“A false symbol is soft and vague; a true symbol is hard and clear. When we say ‘symbolic’ we often mean something drearily obscure: a true symbol is specific, it is the only form a certain truth can take.” – Peter Brook

Holy Theatre is theatre in which those parts of life which escape our senses become manifest. In other words, it is the theatre of true memes, the heuristics and recognized patterns that exert irresistible influence on eusocial animals in a culture that has survived for millenia on the basis of those heuristics and recognized patterns.

It is also, as Brook writes, the true dream behind the debased ideals of the Deadly Theatre. Deadly Theatre succumbs to the belief that somewhere, someone has found out and defined how a play should be done, and that we ought to replicate it. Holy Theatre, on the other hand, recognizes that reproducing the words and motions of a magnificient play at a different place and time will not faithfully reproduce its meaning.

Most of what we call ‘Narrative’ in these pages is Deadly Theatre. It is useful to recognize it, and at times it may be necessary to exploit the behaviors it engenders, but it is a primary source of abstraction in our personal, political and professional lives. As Ben has written, however, memes are often the building blocks of Narrative. Our natural vulnerability to memes lays the groundwork for a Narrative’s spread. So it is that much of Narrative is Holy Theatre. Its informational content is contained in the feelings, emotions, attachments and aversions that it evokes, rather than the meaning of its words. It emphasizes Truth over truth, which makes it a dangerous weapon (for good or ill).

Like anything that we describe by saying “you know it when you see it”, Holy Theatre is hard to describe in words. Except for Ben, who wrote at length about it some weeks ago, in an essay called Notes from a Birmingham Museum:

What makes the museum so effective in communicating a difficult story well? Just that. They present it as a story, as a narrative. Not a cartoon story of Superheroes, although it’s impossible to avoid some degree of hagiography when it comes to this stuff, and not a cartoon story of Social Justice™, either, although here, too, it’s impossible to eliminate completely the heavy-handed nudging of the Smileyface State. No, it’s mostly a story of … people. Of the actual lives of actual people. It’s immersive and it’s real. It creates a compelling narrative arc, but not in a way that feels scripted or forced.

The Birmingham Museum is Holy Theatre. The Julius Caesar production Ben mentioned in Always Go to the Funeral was Holy Theatre. Yet Holy, in the sense we mean here, should not be universally understood to mean ‘good’ like it did in Ben’s note. Just as Holy Theatre may be comedy or tragedy, its manifestations in political and financial markets may be directed toward good or bad ends. George Bush standing on the mound at Yankee Stadium in a FDNY jacket to deliver the first pitch after 9/11 is Holy Theatre, but so is Hitler delivering the Nuremberg Address in 1938. Enemy! is a meme of Holy Theatre, a spell cast by good and evil men alike, and a key source of our present political division. The Hero! meme of Holy Theatre induces us to seek out those who hold themselves out saviors, some of whom truly are, but most of whom are not. The Wizard! meme stokes our passion for genius, for those capable of making deflation or SEC investigations into an MBO-by-Twitter go away with a few magic words.

To the Citizen and to the truth-seeking investor, Holy Theatre should be consumed with eyes wide open. Open to the beauty that only its deep connections with our nature are capable of invoking. Open to see the way in which others who would manipulate us would use it to further their own ends.

Rough Theatre

“They analyzed the sounds made by clarinets, flutes, violins, and found that each note contained a remarkably high proportion of plain noise: actual scraping, or the mixture of heavy breathing with wind on wood. From a purist point of view this was just dirt, but the composers soon found themselves compelled to make synthetic dirt – to ‘humanize’ their compositions.” – Peter Brook

While all theatre – and indeed, any interaction relying on language – is inherently performative and full of abstraction from true meaning, not all of it is grand and reliant on meme in the way that Deadly and Holy Theatre are. Much of theatre is a joy not because it meets some deep-seated intrinsic longing, but because it meets us where we really are. Physically, emotionally, plainly. Brook calls this Rough Theatre.

Its definition will vary by individual. To Brook, it is salt, sweat, noise, smell: the theatre that’s not in a theatre, the theatre on carts, on wagons, on trestles, audiences standing, drinking, sitting round tables. To me, Rough Theatre is a minor league baseball game. It is a marathon session of D&D. It is a midnight showing of Henry V at the New Globe in Southwark in the rain, teeth chattering with other patrons as Hal strides into the audience to clap hands on strangers’ shoulders and deliver a shouted St. Crispin’s Day speech. It’s a no-BS financial advisor boldly telling prospects that she has no idea where the market is going, and that any FA who tells you that they do is a liar. Anywhere the play is play.

The Rough Theatre is not Truth, but truth. The stories it tells can be direct, foul-mouthed and profane.  While it is still subject to the kind of silly exaggerations of Deadly Theatre, there is no malice or attempt to summon memes for some lofty purpose. There may still be abstractions in the performance, but they are of the kind that exist in all language. The aim is authenticity.

And sure, authenticity! itself can be a meme, like an ‘artisanally crafted’ turkey sandwich at a Panera store. But that’s not what I’m talking about here. When I say authentic, I am talking about performances which are delivered in a language, at a place, and at a time that serves the audience, and not the speaker. Rough Theatre in our social and political lives doesn’t really scale, because it is nearly impossible to speak authentically to a big, broad audience. In its native environment among small groups, it is honest advice freely given, without calculation about how it will serve our reputations or our metagame. It is bad news delivered swiftly. It is self-deprecation and lack of pretense.

To the Citizen and the truth-seeking Investor, Rough Theatre is a necessary part our language. Sometimes small-t truth from a trusted friend or adviser is the only thing that can dispel the fear, anger, overexuberance and other emotions conjured by a parade of pompous Truths from Missionaries.

Immediate Theatre

“In the Russian tradition of Stanislavsky, the actor says, ‘I will tell you a story about me.’ In the German tradition of Brecht, the actor says, ‘I will tell you a story about them.’ In the Vietnamese tradition, the actor says, ‘You and I will tell each other a story about all of us.’” – Le Hun

Theatre of the first three varieties has one universal trait: its performers have a meaning in mind before the curtain goes up. That meaning – even in Rough Theatre, seeking to avoid affectation – has been meticulously planned for months. Imagine, if you will, the preparation for a typical play: dramaturgs cut scripts to a director’s specificiations, but also based on their training and experience. Actors memorize their lines, practicing them alone before they later rehearse them with the other actors. Costume and set designers begin their work as well, attempting to reflect the director’s intent, but also their own vision and ingenuity. Director and choreographer set the blocking before a single actor steps on the stage.

Before the first performance, each component of such a production represents an abstracted version of a director’s abstracted vision of what words and instructions on a page written years ago might have meant to a very specific troupe of actors. But even more, each component is necessarily abstracted from the unknowable environment in which the play will be presented on one night or another. The fourth type of theatre, which Brook calls Immediate Theatre – is a response to this problem. Immediate Theatre is dynamic theatre – responsive to time, responsive to venue, and most importantly, responsive to the audience.

It is impossibly tricky to pull off. As any improvisational musician will tell you, your understanding of the underlying chord structure and rhythm of the music must be greater, not less, if you intend to make up the melody as you go. As any portfolio manager keen on making large, seemingly idiosyncratic bets will tell you, it takes more of an understanding of risk and interrelationships between positions to navigate that kind of strategy, not less. So it is that Immediate Theatre requires a near-perfect understanding of the source material, of the other actors, of the meaning embedded in the play, to be capable of responsiveness and adaptation to setting and time, much less to the audience. When this works together, it is magical, if ephemeral. A moment that cannot be recaptured.

In the practical, non-stage versions of the three other kinds of theatre we practice, we engage with society and other people with some objective in mind. Perhaps we wish for them to feel a certain way about us, to see us as kind, or intelligent or credible. Perhaps we wish for them and their influence to diminish. Perhaps we wish for them to select us, to do business with us, to hire us. Every aspect of these interactions is theatre, and in pursuing these objectives, in using language as abstractions of some ulterior intent, we perform a role to an audience. Sometimes that’s the way it has to be.

But there is a beauty to choosing to tell a story about all of us instead of a story about ourselves. That’s what Immediate Theatre is. That’s also what we mean by finding your pack – people whose aims you make part of your own, and whose intentions you trust implicitly. Maybe that pack is your family, your friends, your neighbors. If you’re a financial advisor or investor, I hope it includes your clients. If you become an ET subscriber when we outline how you can do that next week, I hope it includes some like minds you find in some of our interactive features. With these people, we can speak as directly as language allows without fear. We can put words to our intents, as best we are able, and trust that they will be heard.

Even outside of our narrow networks of trust and shared aims, there is still room for incorporating the authenticity of Rough Theatre and the dynamism of the Immediate. The citizen and the fiduciary can still reject the monologues of the Holy Theatre and theatrics of the Deadly in favor of a more direct objective in our performative use of language: to understand and to be understood.

It is our hope that Epsilon Theory can play a small role in keeping this ethic alive. In the meantime, Narrative – both Deadly and Holy – surrounds us, and we will continue to point it out where it exists. Celebrating it, when we think it serves some good purpose. Subjecting it to derision when it is a tool of manipulation and power. Indeed, this is the underlying truth in the multitudes contained in all of us and all our contradictions. It is why we write to be wise as serpents and harmless as doves. It is why we write to act boldly but hold loosely. It is why we write to identify a strong set of core beliefs, yet to subject all else to harsh, regular scrutiny.

Ironically, all of this talk has me in a bit of a theatrical mood, so I hope you’ll forgive me (Socrates wouldn’t) one last bit of Holiness from Lord Tennyson, which I think a rather succinct expression of the full hearts with which we carry our vision for this new venture:

It may be we shall touch the Happy Isles,

And see the great Achilles, whom we knew.

Tho’ much is taken, much abides; and tho’

We are not now that strength which in old days

Moved earth and heaven, that which we are, we are;

One equal temper of heroic hearts,

Made weak by time and fate, but strong in will

To strive, to seek, to find, and not to yield.

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Missionary Body Language

Donald Trump Pointing at You

This is my favorite slide when I give an Epsilon Theory presentation. I created it by googling “[name] + finger pointing”. Try it sometime, for any politician you can think of. Odds are, there are several shots of him or her shaking his or her finger at you, admonishing you with body language to LISTEN UP, BUB. Because that’s what a Missionary does to create Common Knowledge. Their goal isn’t to tell you the news. Their goal isn’t to communicate facts. No, their goal is to tell you how to think about the facts. Their goal is to communicate an opinion as if it were fact – what we call Fiat News here in ET-land.

Body language is a critical part of that communication. The finger wag is a classic trope of the genre, and when you’ve got a self-styled master of body language as your Missionary-in-Chief, this is what you get:

But the Donald’s use of body language for Missionary effect doesn’t stop with the finger wag. Whatever you think of the Donald’s policies, you are missing the plot if you don’t realize that he is VERY good at playing the Common Knowledge Game. You are missing the plot if you don’t realize that he uses body language in a very studied manner, that it is part and parcel of his personal success as a politician.

Like so many things, once you start looking for the trained use of body language, you will see it everywhere.

This is called the “reverse steeple”, because it’s the upside-down version of the same move that you see in every James Bond movie when the Evil Genius sits around the Mastermind table, thoughtfully puts his fingers together, and explains his Nefarious Plan to rule the world. It’s a power move. An aggressive move. A dominance move.

In fact, google any “[aggressive egomaniac] + sitting down” and I bet you’ll get a reverse steeple shot. Here’s Conor MacGregor, for example.

Or you could just hold a cat. I never got the whole cat thing for Blofeld, even when it’s done so menacingly by Donald Pleasence, but the truth is that I don’t get any of this body language stuff. And as much as I’d like to say that cat holding is a body language move we will never see in real life, 2018 has managed to prove me wrong on that score plenty of times already.


The Chinese Panoptistate

Image of now-closed Cuban panopticon

Not gonna lie, I didn’t come up with the term “Panoptistate” to describe what China is doing with its social data monitoring effort, but I am definitely going to steal popularize it. I saw the word on Twitter, and if the genius who invented it wants to reach out to me, there’s a six-month free subscription to Epsilon Theory Premium waiting for her or him.

[Wait, what’s Epsilon Theory Premium? See, Nike isn’t the only one who can do a little clever pre-marketing.]

Anyhoo … I may not have invented the term, but I did write a long-form Epsilon Theory note on how the Panopticon – an idea for a self-enforcing prison invented by Jeremy Bentham and popularized in the 20th century by Michel Foucault – is THE metaphor for understanding how Narrative control policies work through the Common Knowledge Game to make us police ourselves.

But then China goes and makes the Panopticon for realz.

It’s one of my shorter long-form notes, so I’m just going to repeat it here. Enjoy.

The Panopticon: a new mode of obtaining power of mind over mind, in a quantity hitherto without example.
– Jeremy Bentham, founder of modern utilitarianism (1748 – 1832) 

But the guilty person is only one of the targets of punishment. For punishment is directed above all at others, at all the potentially guilty. 

– Michel Foucault, “Discipline and Punish: The Birth of the Prison”

Visibility is a trap. 

– Michel Foucault, “Discipline and Punish: The Birth of the Prison”

There is little doubt that hedge funds have entered a new era of transparency and public openness – a transformation that I believe will benefit investors, the public, and regulators… One immediate benefit of this requirement to your industry should be that transparency will enable you to shed the secretive, “shadowy” reputation that some would say has unfairly surrounded you.
– Mary Jo White, SEC Chair, speech to Managed Funds Association, October 18, 2013

The advance of civilization is nothing but an exercise in the limiting of privacy.
– Isaac Asimov, “Foundation’s Edge”

Whatever games are played with us, we must play no games with ourselves, but deal in our privacy with the last honesty and truth.
– Ralph Waldo Emerson (1803-1882)

In 1791, Jeremy Bentham published a book describing what was clearly a revolutionary design for prisons, factories, schools, hospitals – any institutional building where a few administer instruction, discipline, or care to the many. This design, what Bentham called a Panopticon, was trumpeted as “Morals reformed — health preserved — industry invigorated — instruction diffused — public burdens lightened — Economy seated, as it were, upon a rock — the Gordian knot of the poor-law not cut, but untied — all by a simple idea in Architecture!” No shrinking violet here, but the booming, confident voice of the father of utilitarianism, a man who wrote 30,000,000 words in a lifetime of social activism.

A Panopticon has a large circular watchtower in the middle of a larger circle of cells or offices or classrooms or whatever functional task space is appropriate for the building at hand. The outer circle of cells has inner walls and doors made of transparent windows, and the reverse is true of the central watchtower, which is completely opaque as seen from the outside. From the watchtower you can see perfectly into every cell, but from a cell you can see nothing in the watchtower. Importantly, any occupant of a cell can see pretty much every other occupant of every other cell.

The beauty of the Panopticon, per Bentham, was that the occupants of each cell would soon come to police themselves. That is, the only thing necessary to create the perception of being watched and monitored and punished for bad behavior was the constant possibility of being watched and monitored and punished for bad behavior, together with the communal witnessing of your fellow prisoners behaving as if they were watched and monitored and punished for bad behavior. It’s not necessary for a guard or overseer to watch each prisoner at all times; what’s necessary is for each prisoner to live in a perfectly transparent cell, so that each prisoner thinks that he is being watched at all times.

The Panopticon design was a means of controlling the minds of prisoners through mental force, as opposed to the traditional goal in 18th century prisons and workhouses of controlling the bodies of prisoners through brute force.

Just like the warden in Cool Hand Luke, just like Dick Clark with American Bandstand, Bentham understood the enormous power of the crowd seeing the crowd. What he added to the calculus of social control was the important catalyst of transparency.

Thinking of transparency and openness as an instrument of social mind control is a hard pill to swallow in an era of social media and reality TV. So many of us embrace personal openness and the sharing of our thoughts…so many of us, as Christopher Hitchens ruefully noted about himself, run towards a camera instead of run away…that it seems almost un-American, rather impolite, and certainly anti-modern to maintain privacy and secrecy in our social relationships. We live in an age where transparency is lauded as a personal virtue and touted as a hallmark of liberty, where public confession is a celebrated ritual and a trusty engine of popular entertainment, where our employers expect as a matter of course that our private lives will merge with our business lives to allow constant access and attention. We live in an age where government requires disclosure of private investment strategies and holdings under the guise of “risk management”, where failure to disclose a private opinion on public securities can be a crime, where – as Dave Egger’s chillingly writes in The Circle –  “Secrets are Lies”, “Sharing is Caring”, and “Privacy is Theft”.

Transparency has nothing to do with freedom and everything to do with control, and the more “radical” the transparency the more effective the control…the more willingly and completely we police ourselves in our own corporate or social Panopticons. This was Michel Foucault’s argument in his classic post-modern critique Discipline and Punish: The Birth of the Prison, which – just because it was written in an intentionally impenetrable post-modernist style, and just because Foucault himself was a self-righteous, preening academic bully as only a French public intellectual can be – doesn’t make it wrong. The human animal conforms when it observes and is observed by a crowd, at first for fear of discipline but ultimately because that discipline is internalized as belief and expectation.

To be clear, I’m not saying that transparency is a bad thing for the society or institutions that enforce it. I simply want to call it by its proper name…an extremely powerful instrument of social control, not a “benefit” for the watched. Firms like Bridgewater that famously require a culture of transparency are, I believe, far more efficient and robust than their competitors that don’t. To take a trivial example apropos in mid-March, do you think that a lot of time is wasted at Bridgewater during work hours by employees sending around NCAA tournament brackets? Yeah, right. Not because there’s some “rule” against researching your NCAA bracket while at work, but because it would be unthinkable (and I mean that in a purely literal sense of the word) to do so within the glass walls of an effective Panopticon. A Panopticon crushes any sense of complacency in its residents, and that’s a really big plus for a modern institution. For the residents themselves, of course, that lack of complacency may manifest itself as a wee bit of constant stress. Or to take an example from the investment industry as a whole, SEC Chair Mary Jo White is absolutely right when she says that transparency is good for regulators. Heck, it’s greatfor regulators. But she’s entirely disingenuous when she touts the removal of secrecy as a good thing for private investment funds.

What’s my investment point in this little diatribe? As investors in highly regulated public markets we are all operating within a Panopticon of sorts. Some of us more obviously than others, but we’re all similarly situated to a rough degree. It’s critical to understand the dynamics of the crowd watching the crowd within a regulatory environment of forced transparency so that we can have a realistic notion of what’s possible and what’s not as we try to achieve our personal or institutional investment goals.

Capturing alpha in an investment strategy requires private information. To the degree that forced regulatory transparency and Big Data technology reduce private information by turning it into common knowledge, there is less alpha in markets. That’s a cold, hard fact. Finding alpha has never been easy. It’s always been the rarest thing in the investing world, but now it’s truly an endangered species, particularly in the stock-picking world of fundamental analysis of public companies. We have moved from a regulatory environment where illegal private information was pretty much defined as stealing the orange growers’ crop report from the USDA a la Trading Places (Mortimer Duke: “Turn those machines back on!”), to an environment where the mere existence of market-beating investment returns is treated as prima facie evidence that you must have been doing something illegal to generate those returns. Professional investors today are scared to death of private information on public companies. It’s never been more expensive or difficult to acquire, and the regulatory assumption is that – if it works – then it must have been illegally obtained. No wonder, then, that so many hedge fund giants accustomed to investing on the basis of private information are sailing as fast as they can for the safe harbor of advocacy and activism, where a large position and a board seat or two may cost you dearly in terms of liquidity but allows you to legally obtain and act on private information as a company insider. And even if you don’t reach the promised land of board membership and true insider status, at least you can talk up your own book with incessant public statements about your “investment thesis” without drawing regulatory scrutiny. All of the big boys play the Common Knowledge game today, because that’s how they adapt to a Panopticon. They make themselves more visible to the crowd and make more public statements because they can create, for a while at least, their own investing reality. They know that if they speak loudly enough and long enough, enough of us little guys will follow their lead on the stock. It’s what little guys DO.

Wow, that’s a pretty bleak assessment, Ben. Isn’t there some hope for alpha still out there in the world, even for the little guys? Sure. It’s in your neighborhood. It’s in your family business. It’s in whatever you know really well, some endeavor that by dint of education or experience you happen to have private information about. That’s where you’ll find alpha. Remember Peter Lynch and “buy what you know”? There’s a lot of wisdom in that, so long as you keep in mind that in Lynch’s day you could know an Apple or a Microsoft in a way that is impossible and/or illegal today. In today’s public markets I think it’s still possible to find managers with private information, but you have to look in the cracks and crevices of the market, in relatively small niches where the traders and investors that I refer to as beautiful parasites still live. These managers tend to be relatively small, and they are almost always superb game-players, able to generate alpha by, as Keynes put it, “guessing better than the crowd how the crowd will behave.”

And remember, too, that finding alpha isn’t the only reason to invest in public markets. Liquidity is important. Tagging along with broad-based economic growth through a broad-based capital market is important. But most of all diversification is important. Harry Markowitz, the father of Modern Portfolio Theory, always bristles at that label, saying that there’s nothing modern about it at all. He’s exactly right. Portfolio theory is an old, wonderful idea. You can dress it up in scientific finery as MPT does, and there’s definitely a role for that, but there’s also a very real danger that the arcane language and self-appointed priesthood of modern economic science gets in the way of a personal appreciation of the very real benefits of a diversified portfolio. I’ve written recently about applying the Adaptive Investing lens to questions of diversification, and I’m going to continue focusing on that in the future. Because while alpha in public markets may be rare and getting rarer as private information vanishes before the onslaught of forced transparency, diversification is still there for the taking. And that’s an opportunity I’m happy to use my media microphone to encourage.


Guest Post: The Two Worlds of Data Infrastructure

Big brother from 1984 looking down

Leave no dark corner

China is building a digital dictatorship to exert control over its 1.4 billion citizens. For some, “social credit” will bring privileges — for others, punishment.

– by Matthew Carney, Australian Broadcast Corp, September 18

[Ben’s note: I don’t think there’s any more important issue in the world than the way our personal data flows through global data infrastructure and is controlled by owners of that infrastructure. China, of course, is constructing the Black Mirror version of all this, but I don’t feel like we’re too far behind in the West. So I asked my friend Neville Crawley, who is the single smartest person I know on questions of data infrastructure in general and data infrastructure in China in particular, for his thoughts. What Neville describes below as The Alternative System is worth everyone’s time, attention and effort. It certainly has mine.] 

Last week Eric Schmidt (the former CEO of Google and former exec chairman of Alphabet) made news when Tyler Cowen (an economist) asked him “What’s the chance, say, 10 to 15 years, we have just three to four separate internets?”.

In response Schmidt mused:

“If you look at China, and I was just there, the scale of the companies that are being built, the services being built, the wealth that is being created is phenomenal. Chinese Internet is a greater percentage of the GDP of China, which is a big number, than the same percentage of the US, which is also a big number.

If you think of China as like ‘Oh yeah, they’re good with the Internet,’ you’re missing the point. Globalization means that they get to play too. I think you’re going to see fantastic leadership in products and services from China. There’s a real danger that along with those products and services comes a different leadership regime from government, with censorship, controls, etc.

Look at the way BRI works – their Belt and Road Initiative, which involves 60-ish countries – it’s perfectly possible those countries will begin to take on the infrastructure that China has with some loss of freedom.”

I don’t disagree with any of this, but I do think that we are entering a much bigger and more important competition than one between two sets of internet services with marginal loss of freedom with the adoption of ‘the Chinese system’.

In my view the competition is not about internet services, it’s about foundational data infrastructure and protocols and whether they are designed for self-sovereignty and privacy or whether they are designed for centralized oversight and control.

‘The Chinese System’

‘The Chinese system’ looks broadly like:

  • Very high adoption of mobile services for core life needs (communications, payments, transport etc.)
  • Real name, government issued ID a requirement for all services
  • Centralized databases of consumer data that the government can access

If you have spent  time in China recently and used the WeChat ecosystem it should be pretty clear that the government has (or at least could have if it chooses) perfect knowledge of who you are, what you are doing, and who you are doing it with.

If you haven’t been to China, imagine using the same real name ID under one sign on for Facebook, Uber/Lyft, Amazon, Netflix, Airbnb, Tinder, all Apple and all Google products and services, and that all data produced by these services is perfectly available to the government in real time and is being processed by a really good version of Palantir (rather than a kind of lame Cambridge Analytica).

The ultimate feature (or bug, depending where you sit) of this system is that it allows hyper-targeted sanctions at the individual level.

For illustration, check out this recent super early beta implementation by China of using ‘social credit score’ to ban Chinese citizens from planes, trains and dating apps.

However, the problem isn’t with the crude beta implementation described in the Brookings article above. The issue is that as this system matures and sophisticated link and predictive algorithms are deployed across the many data sets, citizens learn what the algos are likely to deem as undesirable behavior. Then self-censoring kicks in, which is even more controlling than the direct government sanctions.

For example, Ben invites me for a beer on a Tuesday night, but I think he may have been hanging out with dissidents on the weekend, so I politely decline so that our WeChat accounts don’t show up at the same bar at the same time. I’d love to think that I’m above caving into this self-censorship but honestly, with a young family, a decent middle class life and a well performing stock market, maybe I’ll just skip the beer.

This is absolutely happening in China today.

‘The Alternative System’:

I’m calling it ‘The Alternative System’ rather than ‘The American System’ as Schmidt does, because the West doesn’t run on this system (it runs on a kind of fragmented, semi-private-ish version of the Chinese system)

‘The Alternative System’ looks broadly like:

  • Very high adoption of mobile services for core life needs (communications, payments, transport etc.)
  • Self-sovereign identity
  • Distributed data
  • Each individual with a unique encryption key to join ID to data, and the sole right to do so

The beauty of this system is that you as an individual have the sole discretion to reveal what you want to reveal, to whom, when you want. And because your personal data (credit history, for example) is distributed across a decentralized ledger, it’s impossible for governments to prevent you from revealing it. See, it’s not just the ability to keep your data private from government control that’s so important, but also the ability to reveal it without government permission.

To be clear, this system has not emerged yet. But it IS emerging with hundreds of scattered projects working on discrete self-sovereign digital identity and distributed ledger technology.

This is absolutely happening outside of China today.

I can’t really give a good, concrete example of what this would be like because, well, it would just be like being a regular human going about your day-to-day life using lots of technology, but with no one using your data to control you.

It would be kind like a really convenient version of the 90s, I guess. Imagine that!

— Neville Crawley

[Ben’s note: When he’s not writing guest posts for Epsilon Theory, Neville is the CEO of Kiva, which is an amazing company that you should get to know.]


Mailbag: Mastering the Art of French Cooking


Thank you for continuing to write an excellent blog. How funny to read your Julia Child post this morning, not an hour after walking down Washington Street as it becomes Kirkland. I’m visiting Cambridge where I too did my PhD, I too scraped together the Team Elite bona fides (even as its ethos eluded me), and I too lived in a crumbling shared apartment in Slummerville. That area’s now full of fancy lofts, by the way.

I was sipping a $4 coffee and daydreaming about, not kidding, how much longer we can collectively pretend Cambridge hasn’t already become Cambridge(TM), when I passed by Savenor’s and stopped to marvel at a sign in the window: “Wanted: Butcher’s Assistant and Cashier”. For a moment, I was spellbound. Here was the artisanal tradition, robust, unbroken, open to any passer-by willing to learn the trade.

And then I woke up and remembered when and where I was: the butcher’s assistant would need to ask his boomer parents for help with downpayment for the Union Square loft, of course. It’d be an Investment, just like the BA in French Lit.

And then I read your post.

— C.

I got a lot of wonderful email from my homage to Julia Child (“Mastering the Art of French Cooking”), including a note from my Mom! Now that made my day.

This email made my day, too. I found this picture on Savenor’s website, showing Jack Savenor and Julia hovering over some … NY strips (?). Julia is all over the Savenor’s website, and for good reason. Jack truly was a master butcher, and Julia truly appreciated the craft. He made a guest appearance or two on “The French Chef”, and Julia always plugged Jack’s work. She was the best marketing Savenor’s ever had.

And C. is absolutely right … in another day and age, the opportunity to apprentice at Savenor’s as a butcher’s assistant would have been a prototypical American story of labor mobility. It would have been some Portuguese kid from Somerville who had finished high school (maybe), and who would parlay four or five years’ experience with Jack into a professional career as a butcher. It wasn’t a cool job. It wasn’t a cool career. But it was a career that could support a family, buy a modest house, and send his kids to college. It was REAL. And yes, this sort of thing actually happened once upon a time in America. It’s not just mythology.

Today, as C. points out, it’s impossible for a working class kid to take that job. The logistics simply don’t work. But it’s a very cool job today, in sharp contrast to 30 years ago, so I’m sure that Savenor’s had no trouble filling the spot with someone who sees the position as art more than as industry, and has some sort of external support to make the economics work.

I’m still wrestling with what all this means, particularly as MY kids start to graduate from college and make career choices. Something has been gained here, in that the art and craft of butchery is now more widely appreciated. That’s interesting to me, and like I say, it’s a good thing. But something has been lost here, too.

It’s the gentrification not just of neighborhoods, but of commerce and skilled labor.

Keep those cards and letters coming …


It's a Floor Wax AND a Dessert Topping

It's a floor wax AND a dessert topping!

On September 18th, the New York Attorney General’s office released a scathing report on crypto exchanges. Three (Binance, Gate.io and Kraken) were referred for prosecution, and the largest crypto exchange – Coinbase – was described as maintaining a “proprietary trading” operation that faced Coinbase clients and accounted for 20% of total trade volume on the exchange. On September 19th, Coinbase posted a blog report stating that the NY AG’s report was untrue, and that Coinbase “does not operate a proprietary trading desk, nor does it undertake market making actions.”

So who’s telling the truth? Is Coinbase running a prop desk or not?

My belief – and to be clear I do not have a dog in this fight, and I am happy to be disabused of these opinions if I’m working from incomplete or erroneous information – is this: Coinbase is telling the truth. They do not run a prop desk.

It’s worse than a prop desk.

At least a prop desk takes risk. The Coinbase proprietary trading operation (yes, the NY AG is telling the truth, too) that faces their retail client base through “Coinbase Consumer” takes ZERO risk when it pockets a spread between their worse-than-market offer to retail clients and their on-market bid to professional clients. They are a middleman (while carefully avoiding the legal designation of “market maker”) that executes a trade with retail clients for $x per Bitcoin and then immediately offloads that risk with professional clients at a trade for $y per Bitcoin, pocketing the essentially risk-free profit between $x and $y.

AND they charge a commission on the trade.

Again, if I’m working from bad information here (1% per trade in commission fees, $30-40 spread over past few months of BTC price at $6,000-8,000, commensurately higher spread when BTC price was higher), then by all means set me straight and I’ll be happy to restate my conclusions here. I really mean that. Barring that …

A pretty good definition of a prop desk is this: do you make more money facing your clients in trades than you do in the commission fees you charge clients for executing the trades?

As I understand the way Coinbase makes money in Coinbase Consumer, where on EVERY transaction you have a commission fee of 1% AND a spread profit of something like 0.5%, the answer to that definitional question is clearly NO – this is not a prop desk. Yes, they have proprietary trading (so the NY AG is correct), but no, that proprietary trading is not “a prop desk”. Why not? Because Coinbase makes more money on commissions than they do on prop trading.

But the reason it’s not a prop desk isn’t that their proprietary trading profits are so small … no, it’s that their commission fees are so egregiously large! AND they are pocketing these proprietary trading profits with ZERO risk.

To use the OG Saturday Night Live line, it’s both a floor wax AND a dessert topping.

Coinbase says they do this “to provide an easy-to-use customer experience.”

I say, to steal the immortal Ron Burgundy line, “I’m not even angry … that’s AMAZING.”

We’ll see what financial regulators and Coinbase clients have to say.


The Curse of Category

A famous example of a Type 1 error

A student says, “Master, please hand me the knife,” and he hands the student the knife, blade first. “Please give me the other end,” the student says. And the master replies, “What would you do with the other end?”

― Alan W. Watts, “What Is Zen?” (2000)

We have a blueberry bush right outside our porch. It hasn’t had a great year, and here in the middle of September we are way past blueberry season in Connecticut. I know that. I’m from the South, so I’m familiar with pokeweed, which also has purple berries, but a cluster of pokeberries looks nothing like a cluster of blueberries. I know that. Pokeberries are poisonous. I know that, too.

So why did I eat one this morning?

I made a category error.

Bizarrely, we have a pokeweed plant growing exactly within the blueberry bush. I’ve been traveling a lot (so I haven’t paid any attention to the blueberry bush), I didn’t sleep great (so I was groggy), and I was thinking about my next ET note (so I was distracted). I saw a purple berry with the same shape as a blueberry in exactly the same place where I’ve grabbed blueberries before.

In that moment, I was literally Homer Simpson. Mmmmm … blueberries.

Now I only ate one, and pokeberries are only truly problematic if you eat a handful and you have the body mass of a small child or a dog. My body mass is … umm … some multiple of a small child’s, so I was fine. A bit of, shall we say, intestinal distress, but all short-lived and none the worse for wear and tear.

What’s a category error? It’s calling something by the wrong name. It can be a Type 1 category error, also called a false positive, which is what I did. I said, yum, here’s a blueberry, but it was really a pokeberry. There are also Type 2 category errors, also called false negatives, which would have been the case if these had truly been blueberries but I had said, nah, they’re pokeberries, and passed them by.

Now both Type 1 and Type 2 errors are problematic in life and in investing. In fact, Rusty just published a really good (and really fun) note about Type 1 and Type 2 errors, titled Roadkill. It’s well worth your time. For an older note I wrote about category errors in general, check out Ghost in the Machine. It’s well worth your time, too.

For this In Brief note, though, I just want to make two quick points about category errors. In my experience …

It’s the Type 1 errors that are most likely to kill you. Both in life and in investing. It’s when you’re oh-so sure that you’re chomping down on a really great trade … that’s when you blow up. Or get poisoned.

We’re most likely to make Type 1 errors on the basis of place. All the surface characteristics need to be similar, sure. But that’s just the necessary condition. The sufficient condition is PLACE, like a familiar sector or strategy where you’ve had investment success before. I am convinced that we are lulled into complacency by location more than anything else. Yes, we judge a book by its cover, but even more so we judge a book by what shelf it’s on.


Mastering the Art of French Cooking

Julia Child with a knife
If you’re afraid of butter, use cream.
— Julia Child (1912 – 2004)

I went to graduate school “in Boston”, which is the socially responsible, if risible, way of saying that I went to Harvard. My using the word “risible” just then instead of “laughable” was a dead giveaway, too. Have I ever said that I went to grad school in Boston instead of saying that I went to grad school at Harvard? Yes, I have. Talking about Team Elite education is the new talking about money. Both are uncomfortable to talk about in any, god forbid, non-Team Elite or mixed social settings, which leads to cringe-worthy responses like “in Boston”.

Why is it so uncomfortable to talk about elite college education? Because it really is the new system of landed gentry. Because as unequal and polarized as America is today on the dimension of wealth, we are even more unequal and polarized on the dimension of education. The difference in life impact between going to an elite school and going to your local community college is far greater than the life impact of being born really rich and being born really poor. It’s not correlative. It’s causative. And we all know it. It’s probably the deepest, most influential Common Knowledge in our society today. But that’s an Epsilon Theory topic for another day.

Harvard, of course, isn’t even in Boston at all, but in Cambridge. And of course, as a graduate student I was way too poor to live in Cambridge, so three friends and I shared one floor of a triple-decker house in Somerville, one town over from Cambridge. Or Slummerville, as we called it. I haven’t been back in 30+ years, so I’m sure it’s all gentrified now. Back then it was still a working class neighborhood, mostly Portuguese families, near Union Square.

Every day I’d make the walk down Washington Street to get to class, and every day, just across the Somerville/Cambridge border where Washington Street turned into Kirkland Street, I’d pass a grocery store and a liquor store. Both stores were named Savenor’s, but they were owned by different Savenor brothers, and they weren’t friendly with each other. As I heard the story, one brother got the grocery store, which was the crown jewel, and the brother who got the liquor store never forgave him for that.

Most days I’d stop into the grocery store on my walk home to buy something to cook for dinner. I like to cook … always have … and if sports were how I most easily connected with my father growing up, cooking was how I most easily connected with my mother. It connected my parents, too. Both my mother and my father enjoyed watching Julia Child on “The French Chef”, which ran from 1963 to 1972 on whatever your local PBS channel might have been. We had a black and white TV where my brother and I served as the remote control, and I remember my parents laughing along with Julia as she pulled dish after dish from that TV studio oven. I remember my father giving my mother the two-volume “Mastering the Art of French Cooking” for Christmas, and I remember my mother working her way through the dishes over the years.

There’s nothing like Julia Child on TV today. Every bit of TV cooking today is a contest. From the omnipresent and inescapable scold that is Gordon Ramsey to the celebrity chefs holding court on Top Chef to the rotating cast of “personalities” on the 24-hour programming that The Food Network must fill … it’s all contests all the time. Do I watch these shows? Yes, I do. They’re entertaining. They’re entertainment.

But, see, that’s the difference.

Julia Child was entertaining, but she was not entertainment. Julia Child was a teacher. Julia Child was a coach. Julia Child was laughing WITH you if you spilled a little wine or if you ran out of butter, not AT you. Cooking was not a contest for amusement. Cooking was art.

And there she was at Savenor’s. Standing at the butcher’s counter.

I knew that Julia Child lived “in Boston”, meaning in Cambridge, and I had heard from friends that she had a house nearby. But I had also heard that she spent her time in California and was rarely back in the neighborhood. I also vaguely remembered that a butcher would come on the TV show from time to time, but I had never put it all together with the old school butchery that was the heart of Savenor’s.

She spoke with the butcher for a minute and then walked back to the produce section. She was carrying a hand basket. I followed. I knew what I had to do. I was going to buy whatever Julia Child bought at Savenor’s that day. And before you ask, no, the thought never even entered my mind to say anything to her. It would have been … terribly rude … like asking Michelangelo what he saw while he was pondering giant slabs of uncut marble.

Julia Child only bought one thing from Savenor’s that day. She bought corn. White corn. In November.

Now look, I love corn. I’m from Alabama. Corn and the pig are nature’s two perfect foods. But corn is yellow and corn is summer and anything else is … not right. Worse than not right. Actively wrong. This is nuts.

I bought the corn.

I got home and thought about creaming it, but that’s not a small amount of work. So I ended up just boiling it … butter, salt and pepper. It was, naturally, a revelation. Just perfect corn … a slightly different, maybe cleaner or clearer taste than what I was used to. Totally delicious.

Over the past 30+ years, I’ve tried to recreate that dish a dozen times. It’s always been terrible. White corn, yellow corn, doesn’t matter. But of course it’s terrible. IT’S CORN IN NOVEMBER IN NEW ENGLAND, FFS.

The truth is this … it’s entirely possible that I willed myself into thinking the Julia Child corn was delicious. The power of Narrative is so strong, and this was such a powerful story for me as a 22-year-old kid away from the South for the first time in his life – to see freakin’ Julia Child in the grocery store – that this is surely the most likely reason that corn tasted so damn good. And there’s a powerful lesson in that.

But it’s also possible that Julia Child really did see something special in that November white corn at Savenor’s.

I’m wrestling with this a lot these days, here in the dawning of an age of Big Data and AI. Is there still room for art in politics and investing? Is there still room for an artist who can SEE things differently? Who can see the potential and the opportunity for something truly special where everyone else sees … corn in November.

And even if art is still possible in these core social arenas of human endeavor, is it possible to master our art as Julia Child did with hers?

I don’t have an answer yet. And like I say, it’s a powerful lesson even if the answer is NO.

But I sure am hoping the answer is YES.


But Our Interests Are Aligned!

Professor Harold Hill (Harold Hill!)

Harold Hill: Ladies and gentlemen, either you are closing your eyes to a situation you do not wish to acknowledge, or you are not aware of the caliber of disaster indicated by the presence of a pool table in your community!

— “The Music Man” (1962)

For those of you who have somehow never seen a high school production of “The Music Man”, the plot goes something like this. A con man by the name of Harold Hill comes to River City and convinces the town folk that their youth are on the slippery road to perdition, and that the only solution is to establish a wholesome marching band that Hill is happy to lead. Just pay in advance for those band uniforms and instruments, please.

The modern use of stock-based compensation is a confidence game, in the true sense of the word, that would be very familiar to Harold Hill. What’s the slippery road to perdition? My goodness, it appears that your management team doesn’t have enough skin in the game. Surely disaster is nigh! The solution? Why, stock-based compensation, of course. Wholesome profits for all will flow like water once management’s interests are “properly aligned” with shareholders. Just pay in advance, please.

I know it seems like I’m picking on Marc Benioff, the new savior of Time Magazine. I mean, I guess I did call him a modern-day robber baron in yesterday’s In Brief note. But honestly, I say that in the nicest possible way. Marc Benioff is a freakin’ genius, an absolute master coyote who plays the metagame better than anyone whose last name doesn’t rhyme with Mayzose or Stuffit. Hat’s off to anyone who figures out the market zeitgeist and parlays that into not only billionaire-dom, but liquid billionaire-dom.

No company has played the stock-based compensation game better than Benioff’s brainchild, Salesforce.com, to the benefit of not only Benioff, but everyone in management (particularly sales) at Salesforce. Here’s how it works.

Since Salesforce became a public company, its revenues have grown at a wonderful clip. It’s EBITDA (earnings before interest, taxes, depreciation and amortization) and net income available to common shareholders… not so much.

Source: Bloomberg

Where have all the revenues gone, if not into earnings and net income? Well, if you read the Wall Street analyst reports about Salesforce “beating its earnings estimates” every quarter, you’d think that this chart above must be wrong. Why, Salesforce has lots of profits! Sure, it trades at a high P/E multiple, as befits a company with such great revenue growth, but the consensus Wall Street earnings estimate for this quarter is $0.50 per share. With 756 million shares outstanding, that’s about $375 million in earnings this quarter alone. What gives?

What gives (among other things) is stock-based compensation. The earnings estimates that you’ll hear the CNBC analysts talking about Salesforce “beating” or “missing” are pro-forma earnings. They do not include stock-based compensation. Actual money paid to employees? Yes, that’s included. Stock paid to employees in lieu of actual money? No, that’s not included. If you included stock-based compensation (and all the other pro forma adjustments) as actual expenses, which of course they are, then the consensus Wall Street earnings estimate for this quarter is not 50 cents per share. It’s 2 cents per share.

Since it became a public company in 2004, Salesforce.com has paid its employees $4.8 billion in stock-based compensation. That’s above and beyond actual cash compensation. For tax purposes, it’s actually expensed quite a bit more than that, namely $5.2 billion. The total amount of net income available for common shareholders? $360 million. On total revenue of $52 billion.

Note that none of this includes the money that Benioff himself made in stock sales from 2004 through 2010, where he sold between 10,000 and 20,000 shares of stock in the open market PER DAY, EVERY DAY, for SIX YEARS.

In the immortal words of Ron Burgundy, I’m not even angry. It’s AMAZING what Benioff has been able to pull off for himself and his people. Nor am I suggesting in the least possible way that any of this is illegal or immoral or ethically suspect.

What I am saying is that this is a confidence game in the true sense of the term.

What I am saying is that investors have paid in advance for their band uniforms and instruments.

What I am saying is that you can sell a lot of software if you pay your sales team handsomely and investors don’t care about the expense or the profitability of those sales.

What I am saying is that this is only possible within a vast Wall Street and media ecosystem that tells investors not to care about the expense or the profitability of those sales.

What I am saying is that we have all seen this movie before.


Notes From the Road: Roadkill

Get well soon balloon

Most species do their own evolving, making it up as they go along, which is the way Nature intended. And this is all very natural and organic and in tune with mysterious cycles of the cosmos, which believes that there’s nothing like millions of years of really frustrating trial and error to give a species moral fiber and, in some cases, backbone.

This is probably fine from the species’ point of view, but from the perspective of the actual individuals involved it can be a real pig, or at least a small pink root-eating reptile that might one day evolve into a real pig.

— Reaper Man by Terry Pratchett (1991)

This is Part 2 of the multi-part Notes from the Road series, introduced with Bayes and the Boreen. The Series explores how popular, otherwise adaptive methods we use to develop theories about political and financial markets based on priors and lived experience can subject us to unexpected new risks. The series tells the story of a range of journeys in history, sports, the arts and nature to illustrate the sources of those risks.

If, as Ben has written, memes are self-sustaining ideas that live in the human brain, I think there’s one that may predate all of the rest: Only the strong survive!

It’s a dumb meme about how we think evolution works that has spread, ironically, because of the way evolution actually works. Despite growth in scientific literacy, the popular conception of evolution continues to celebrate the idea that better/stronger/smarter things will prosper, and worse/weaker/dumber things will fail. The reality is much less sexy. Evolution is the process whereby nature necessarily favors traits which improve the ability of an organism to suvive until it reproduces. The idea that we are successful because of objectively superior traits – because only the strong survive! – is an idea perfectly adapted to the human ego. But on almost no dimension would we have judged our mammal ancestors superior to the dinosaurs they outlasted. But outlast they did, because – by sheer luck – their traits were better adapted to a post-Chicxulub state of the world.

That last observation is an important one. When we consider evolution as it truly is, we still usually focus on the organism, or in an Epsilon Theory context, the idea or the investment strategy in isolation. An individual organism mutates a new trait, which either makes it more or less well-adapted to the current environment. If more, then over time the trait is more likely to propagate. If less, then organisms carrying the trait will probably die along with it.  But for all the value that there is in constant improvement of our processes and philosophies in similar ways, the survival of a species or idea isn’t just a function of its own changing traits – it’s a function of the changing states of the world and the people in it.

For our investment principles and strategies, like any organism, observing that evolution is both a function of the traits of our ideas AND changes in the state of the world reveals two types of risks to our models and frameworks for understanding it:

  • Type 1 – The False Positive: We think and act like our principles are based on immutable laws of nature. They aren’t, and we get a rude shock when the world changes.
  • Type 2The False Negative: We believe that principles others believe are immutable laws are only representative of some temporary state of the world. We try to predict the change in the world, and it never happens. We waste returns, fees and client goodwill in the process.

Evolution is a painful journey for the individual. There’s not much solace in our failures becoming Harvard Business School case studies that help the species – or other investors. We must find some kind of middle ground between allowing ourselves to become speedbumps to a change in the state of the world on the one hand, or victims to the coyotes who would tell us “This Time It’s Different” about every bit of normal variability in the world on the other. We have to find that middle ground in our non-investing lives, too. Which of our heuristics and principles for evaluating life decisions are objectively true, or are at least true enough? Which are adaptations to our past environments and experiences, and will those be relevant to our new situation? When we make big life decisions, are the priors we rely on, well…reliable?  In the end, we muddle through, and more often than not, make it up as we go along.

Incidentally, that’s exactly what I’m doing. Next week, it’ll be 27 hours with a 2- and 3-year old in a blue pickup on the 1,712 miles of Dwight D. Eisenhower’s asphalt dream between old home and new. In honor of this journey, since we’re talking about growth, evolution and risk, and since I’m moving up to a part of the country where I won’t be able to talk about this sort of thing in polite company any more, I figure it’s as good a time as any to write about roadkill. And that’s saying something, because it’s always a good time to write about roadkill.

Full disclosure. If you’ve read this far, you’ve read the word ‘roadkill’ five times: once in Ben’s email, once at the top of this essay, twice in the prior paragraph and once in this sentence. You clicked on it, and I kind of feel like you’re already in for at least a penny here. But if you were squeamish about Ben’s disgusting tick infestation picture from a couple months ago, this one may not be for you.

Profiles in Roadkill: Dasypus Novemcinctus

Now that we’ve gotten all that out of the way, we can start talking vehicular critterslaughter. Allow me to introduce you to someone special.  This handsome fellow on the left is a nine-banded armadillo – one of the three state mammals of Texas, because unlike the boring-ass state you live in, Texas gets THREE state mammals. Take that, James Madison and your exquisitely reasoned Federalist Paper 62. Armadillos are remarkable little creatures who followed an unusual and narrow genetic path that has produced some of the strangest land mammals alive today. In addition to its signature armor plating, the armadillo reproduces from an egg which separates into four parts after fertilization. That means that nearly all litters consist of 4 identical creatures of the same sex. What’s more, the implantation of that fertilized egg is typically delayed by the mother by several months to better align with the spring season. Very handy, that.

The armadillo can inflate its intestines to float. It can hold its breath for six minutes to submerge. And that armor really is as tough as we think it is. Tough enough to defeat a .38 revolver. Like its closest cousins, the anteater and tree sloth, the armadillo is a marvel of specialized adaptations. One of evolution’s many weird, slimy miracles.

Also, when an armadillo sees headlights, it gets so terrified that it jumps straight up in the air and gets slammed by a car that would otherwise have passed right over it.

Profiles in Roadkill: Odocoileus virginianus

The armadillo, however, probably isn’t the animal most people (outside of Texas, anyway) think of when they think of victims of automobile-related critter flattenings. In honor of the trek we will take through the beautiful and too-unfairly-maligned state of Mississippi (which is also probably better than your state since it has two state land mammals), it is time we recognize the famousest of roadkill, the white-tailed deer. So common is the sad sight of one of these beautiful creatures along US highways that it causes the otherwise stonehearted, rage-filled American motorist to descend into our country’s unique style of gallows humor. Get well soon, gross deer. Get well soon.

Like the armadillo, evolution has gifted the white-tailed deer with extreme traits that are well-adapted to the challenges it faced during its emergence as a species. First, it is a remarkable jumper. While deer fences tend to be around eight feet tall, the average individual can actually jump somewhat higher than that, in some cases as much as 12 or even 15 feet. Somewhat less when it needs to jump forward and not just up.

Second, probably because of the adaptive benefits of a better field of vision for spotting predators, deer’s eyes are positioned closer to the sides of their head than the front. That means that deer, like many other prey animals, sacrifice binocular vision and depth perception to, you know, get eaten less by things behind them and to their sides. The downside is that it is more difficult for deer to judge distance and the depth of objects in front of them. Incidentally, in addition to being particularly stupid, this is one of the reasons why white-tails don’t always jump over fences they almost certainly could – poor depth perception means that they can’t be sure if they’re going to clear it.

Third, whether because of the need to manage temperatures and heat, to avoid predators, or other reasons they keep to themselves, thank you very much, white-tailed deer are crepuscular, which means they are most active in the twilight hours of dawn and dusk. That adaptation means that their vision is attuned to modest levels of light.

Like the armadillo, the combination of these natural talents has done wonders for making white-tailed deer one of the most successful and widely distributed mammal species in the world.

It also means that when a deer leaps into a road, it spots your distant car in its remarkable peripheral vision, turns its head, is blinded by your headlights because of the attunement of the rods in its eyes to take in more light, and because of its lousy visual acuity and depth perception, can’t make out the closing distance of your vehicle until it’s too late, at which time it leans upon its remarkable leaping abilities so that it can take out your windshield because screw you AND your Volvo.

Profiles in Roadkill: Sciurus carolinensis

Although the deer is the most iconic roadkill animal, it’s not the most common. The most common is the state mammal of one of the most beautiful states in our fair union, but one that admittedly only manages to have a single state mammal, so take my kind words about its trees, mountains and coastlines for the damning faint praise that they are. It’s your time to shine, Interstate 85 and North Carolina.

The 1993 data from an ongoing survey of roadkill (weirdly created for schools as a testing ground for teaching the scientific method) reported just over 750 squirrels in its sample. If anyone is curious, there were only 308 raccoons and 4 coyotes. The noble possum comes in second, at 348. Squirrels are the undisputed kings of roadkill, and yes, the extremely disappointing state mammal of the State of North Carolina. By the way, this really IS disappointing, because North Carolina could have selected one of its many legitimately interesting and endangered/threatened species, like the Carolina Northern Flying Squirrel. The state is also one of the last homes east of the Mississippi for the Townsend’s big-eared bat, which adapted a whispered form of echolocation that probably serves as a countermeasure to the active sonar jamming skills of its primary prey – moths.

Now, obviously some of the reason so many squirrels become double-thumps in the road is because – despite my efforts as a kid with a BB-gun – there are a lot of squirrels. But that’s kind of the point. There are a lot of squirrels because squirrels are a very successful species. Part of why they are a very successful species is because they are very successful at avoiding predation, mostly by hawks and other birds with a taste for tree-rat.  Part of the reason they are so successful at avoiding predation is that they adapted an instinctive tendency to run in seemingly random zig-zag motions that involve unpredictable changes in both speed and direction. Very good defense against a hawk flying at high speed toward a fixed point.

Not so much against a speeding teenager driving his mom’s Yukon.

All three of these animals are incredibly successful and still growing their geographic footprint. All three are incredibly well-adapted to the challenges that they faced over the course of their evolution. All three are well-prepared for the challenges they face in most of their daily lives. All three get dead real quick when their evolutionary strengths are transformed into circumstantial weaknesses.

Part of the reason I wrote this, the second note in this series, was to make you look at that hilarious and morbid roadside pizza party deer. That and to pursue some tortured analogy to compare you, dear reader, to roadkill. But there’s an important investment lesson here, too: Survival is the only way we measure the success of an adaptation, and the species that treats past adaptations as timeless and universal – as laws of physics – will go extinct.  

The trick is in knowing what, among all the things we do as investors, reflects timeless and universal principles, and what reflects our adaptation to states of the world which will change. It’s not always easy to tell the difference.

Timeless and Universal Principles

For my part, I think timeless and universal principles of investing must be either tautologies or generalized reflections of human behavior. Heuristics which are based on states of the world (e.g. I like this asset class because it is cheap, I favor this sector because of its growth characteristics, I’m concerned about this country because of higher-than-usual geopolitical risk) don’t really fit. Philosophies which are driven by views on the superiority of certain constructs (e.g. asset classes, instruments, etc.) are similarly ephemeral. I think there are really four timeless and universal principles, and we’ve written about each before:

  1. Over very long periods, you will generally be paid based on the risks an average investor (including all of his liquidity sensitivities, his investment horizons, etc.) would be taking if he made that investment [1]. – Whom Fortune Favors
  2. We must be supremely confident that we have information about the returns on various investments to justify decisions which reduce the diversity of our sources of return.You Still Have Made a Choice
  3. Humans have evolved to demonstrate preferences for certain types of investments and returns. Those preferences – and the fact that other humans will shrewdly seek to exploit those preferences – will influence returns.The Myth of Market In Itself
  4. Taxes, fees and transaction costs will reduce returns.Wall Street’s Merry Pranks

I think it’s a good framework. You may not, in which case you should replace it with what you think these rules are. Or y’know, by sending me an email telling me how stupid I am. Both are fine. But identifying these rules means acknowledging that all of our other philosophies are either successful adaptations OR new things we’re trying out because we are guessing they will be better suited for some future state of the world. After all, if we’re going to update our Bayesian estimates, we’ve got to have some kind of experiment.

It isn’t hard to identify beliefs and strategies that look well-adapted over the last decade, by which I mean investment strategies whose reputations have survived. Structurally owning more assets in U.S. financial markets looks well-adapted during this age of the world. So has owning more stocks in technology companies. Believing that there is no need for an investor to have a financial adviser seems like a very well-adapted trait. Aversion to any strategies which try to pick which securities will outperform. Keeping things simple with a 60/40 portfolio of stocks and bonds. Leveraged strategies. Aversion to, skepticism about and usually derisive attitudes towards hedge funds. Those of us who saw what worked in 2009 and 2010 and stuck with it as the new normal probably have a pretty confident assessment of some of our adaptations. More than a few of us and our clients have adopted some of the above as heuristics – our rules of thumb around which we generalize our investment beliefs into process.

What does treating well-adapted-looking traits like permanent states of the world look like? Below is one innocuous-looking example from social media marketing. I’ve removed any author’s name to protect the innocent.

There are good principles in here. But look at these more closely to see temporarily well-adapted traits creep in. A decade of dominance from US stock markets and low volatility has created a world of investors who now think that saying “keep things simple” and “avoid excessive diversification”, which are smart-sounding dog whistles for “just buy US large cap ETFs”, is timeless and universal advice. It’s not. And it’s going to get a lot of investors hurt.

Unfortunately, the memeability of common sense! advice like this is is exactly how an adapted trait evolves into a species-defining characteristic. Survival and reproduction. And then extinction.

Identifying the line between timeless principles and adaptations gets even harder over very long periods. 30 years. 50 years. Owning more bonds than our timeless principles might otherwise recommend. Relying on those same bonds to be diversifying against stocks. Knowing that commodities are not really investable, that real assets should just be a personal asset. Trusting that risky assets will always generate positive returns over a long enough horizon. As periods get longer, our confidence that our heuristics are not situational adaptations, but timeless and universal principles, grows.

All of this is Roadkill thinking. Oh, we may not get run over right away. It may never happen – during our investment lifetimes, anyway. We may go quietly in our sleep like so many armadillos, convinced that we adapted to survive cars just because we never got run over. But believing that the strategies we developed are timeless and universal strategies just because they’ve worked for us during our careers so far, or because they have worked for others for what feels like a very long period of time, is Roadkill thinking.

This first kind of Roadkill thinking is of the Type 1 error variety I mentioned earlier – false positives when identifying timeless and universal truths about markets.

Type 2 errors in Roadkill thinking are usually the more pernicious. It’s easy to think that the solution to our fears that an investment environment may be changing is to be creative, to throw a bunch of ideas at the wall, because that’s what we think adaptation looks like. And it is, in a way. But while adaptation through (mostly) random mutation works at the species level, at the individual level, it is literally murder. If our adaptive strategy is trying to time the turn in value or the market top, we will probably fail individually. If our adaptive strategy is to hold a quarter of our portfolio in cryptocurrencies to insulate us against what’s next, we will probably fail individually. If our adaptive strategy is to drain the swamp by…sorry, lost my train of thought, there. And sure, our failures will inform and improve the odds of success of other investors at large. A fat lot of good that does us. There’s a reason why coyotes with no skin in the game are so drawn to fields where they can promise disruption, new ideas, and high risk/high reward opportunities: because they share in all the upside of the aggregate while subjecting us to the risk of individual ruin along the way.

What does matter is that pursuit of these strategies often comes at the explicit or implicit expense of the ideas that really are permanent. We have finite dollars and finite attention, and our attempts to do something about environments that confuse us are usually distractions. In the same way that we’re probably all Coyotes from time to time, I think we’ve got a lot of Roadkill in us, too. I certainly do, anyway. There’s no extricating it from our nature, but as with so many things, simply acknowledging it goes a long way toward being mindful of its influence:

  1. Roadkill doesn’t know what its timeless and universal investment principles are.
  2. Roadkill doesn’t discern between temporarily effective adaptations and timeless principles.
  3. Roadkill randomly tries new adaptations even when they violate timeless and universal principles.

If we would not be Roadkill – or worse, food for coyotes – we would do well to subject our priors to constant challenge. What assumptions are we making about our investments, intentionally or unintentionally? What priors are built into our portfolio construction and investment selection methodologies? Are they always true, or maybe artifacts of an environment or industry convention?

For my part, were I sitting on an investment committee during a period of slowing in population growth, after a sustained long-term rally in multiple types of risk assets, following an extended period of falling interest rates, in the face of historically significant household and government debt, with increasing abstraction sitting between valuations and value, I would hold very loosely to all but my core principles. During every regular review, I would subject my conventions – sectors, style definitions, benchmarks, asset class definitions, risk measurement methodologies, and the like – to scrutiny.

More to the point, when we write about Narrative, we write in part because we believe that Common Knowledge about investment strategies and investable assets is part of what makes them work. This is our theory, and not a fact, but I think that Narrative analysis can inform earlier, less individually risky attempts at adaptation as environments change. Big if true. And I think it is.

PDF Download (Paid Membership Required): http://www.epsilontheory.com/download/15644/

We had a little fun at North Carolina’s expense, but it’s a wonderful state and a wonderful place with a lot of people that are hurting – and will be hurting – for a long time. From my experience with Hurricane Harvey in Houston, there are few organizations that do as much good as the United Way. If you can, consider giving now to the United Way of Coastal Carolina. Or if you want to make amends for laughing at the balloon deer, the Outer Banks SPCA and the Dare County Animal Shelter will be in desperate need of help over the next few weeks.

[1] This is, incidentally, why I am not one of those who thinks that volatility is a terrible ex ante way of thinking about risk. If price sensitivity matters to individual investors – and it does – it matters to how the return investors will demand for taking that risk, even if that perception is completely irrational and they should be thinking about “permanent impairments to capital” or some other phrase that has survived because it sounds clever in marketing materials. My experience with investor behavior also tells me that unrealized returns often become realized when they’re big, negative numbers.


You Provide the Pictures and I’ll Provide the War


Time Magazine Sold to Salesforce Founder Marc Benioff for $190 Million

— Wall Street Journal, September 16, 2018

Real-life billionaires aren’t young Citizen Kane. They don’t buy media properties as vanity projects or as part of a crusading public interest. No, real-life billionaires are old Citizen Kane. They buy media properties because they understand the political and economic power of Fiat News. They buy them because these properties are the indispensable asset in an effective metagame strategy to maintain their empires.

Fiat News isn’t counterfeit news. It’s not an outright lie. Fiat News is opinion presented as news, and once you start looking for it, you will see it everywhere. For Charles Foster Kane, modeled after real-life billionaire William Randolph Hearst, the opinion presented as news could be as personal as a glowing review for the screeching operatic debut of his songbird wife, or as political as blaming Spain for blowing up a battleship. As real-life Hearst once said to a staffer, “you provide the pictures and I’ll provide the war.”

For modern-day William Randolph Hearsts, like Jeff Bezos (personal owner of the Washington Post) or Marc Benioff (the new personal owner of Time Magazine), I don’t think the goal is to start a jingoistic war in order to further a political career. But these modern-day Citizen Kanes DO have political goals in mind when they purchase these media assets.

As the old saying goes, you have to fight fire with fire. And to withstand the political barrage that the White House has rained down on Amazon over the past year … a barrage that is only going to increase in scope and intensity over the next decade regardless of who wins the 2020 election, as Bernie and Elizabeth and Kamala all get in on the Amazon-bashing act … Jeff Bezos needs the Washington Post to rain down a barrage of his own.

Salesforce.com isn’t getting the same sort of treatment from D.C. that Amazon is getting. Yet. But I think it’s coming. I think a hard rain is going to fall for modern-day robber barons like Benioff, men who have built multi-billion dollar personal fortunes out of serial acquisitions of profitless software companies and constant stock sales. And by constant I mean constant. From 2004 through 2010, under a series of 10b5-1 plans filed with the SEC, Marc Benioff sold at least 10,000 shares of Salesforce.com stock … Every. Single. Day. You can go on the SEC’s EDGAR website and look it up yourself. It’s really pretty awe-inspiring when you think about it.

What does Marc Benioff want from Time Magazine? He wants this. He wants the ability to create Fiat News. It’s the smart play for an Oligarch like Benioff. A really smart play.


True Freedoms / Hollow Freedoms

Author of The Rights of Man, Thomas Paine

I’m in a mood this morning, getting sucked down by what I see as the casual abdication of our individual autonomy of mind, the exchange of True Freedoms for Hollow Freedoms. And not even a begrudging exchange, but an enthusiastic one. A seller’s market, as it were, for Hollow Freedoms. Then I remembered this piece from a year ago (“Pecking Order” November, 2017). It helped me get back on track in thinking about a positive program forward. Maybe it will help you, too.

In January 1941, eleven months before Pearl Harbor brought the United States into World War II, Franklin Roosevelt gave his Four Freedoms speech, memorialized over the next few years by Norman Rockwell in these famous paintings.

What is autonomy of mind? It’s freedom. What freedoms? These.

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Lehman and the Meta-Game of Trading

Lehman Brothers sign being carried to auction.

A cornerstone of the Epsilon Theory research project is the meta-game. It’s the subject of the most popular ET note to date – “Too Clever By Half” – and I think it’s the most important game theoretic concept to master if you want to have a successful career in financial services. Or a successful career in anything, really. But what I haven’t written about is when the idea of the meta-game first really hit home for me. It was 10 years ago to the day – September 15, 2008 – the day that Lehman went under.

A “game” in the technical sense of the word is a strategic interaction, meaning that your decisions are contingent on my decisions, and my decisions are contingent on your decisions, and we both know it. Consciously or not, we are all playing games all of the time. A meta-game is a larger game that contains a bunch of smaller games. It’s typically a long-term strategic interaction, and it’s almost always harder to wrap your head around than an immediate game. It’s not the same thing as a repeated-play game, which is its own interesting thing, but not this interesting thing. A meta-game is the big picture. A meta-game is the forest, not the trees. A meta-game is the portfolio, not the trade. A meta-game is the career, not the assignment. And yes, there are meta-games on top of meta-games.

I can’t say this next part without sounding braggy, but I’ll make up for it by sounding quite meh and fallible at the end. 2008 made my career. Our hedge fund did well in 2005 and 2006 and 2007, but lots of hedge funds did well those years. Very few plain vanilla, stock-picking long-short hedge funds were up 20%+ in 2008, but we were. It was the best game I’ve ever played, and yes, it was by turns exhausting and terrifying, but also yes, by god it was fun!

Until Lehman went bust.

It was all funny money until September 15. It was all symbols and flashing numbers on your Bloomberg terminal. It was all playing the game of markets. It was all figuring out in your head how those symbols translated to a portfolio P&L for the day and what your cut of that would be. If you tell me you don’t know what I’m talking about, then you’re a liar. I know that few people had that experience in 2008, but everyone reading this note has had that experience sometime. It’s the experience of greed and it’s the experience of winning. It’s a damn good feeling.

So yeah, I’d love to tell you that my transformative meta-game moment associated with the Lehman collapse was my sudden realization that I had friends who had just lost their jobs, that I was stricken by empathy for their plight or that I was worried about the lives and careers and fortunes that had been ruined. But nah.

How am I gonna get paid if everyone goes under?

Yep, that was my utterly selfish and utterly real meta-game moment. I didn’t mean that I had counterparty risk with Lehman directly. No, I had rewritten (what’s called novation) all of my Lehman OTC contracts over to JP Morgan a couple of months earlier, just like I had gotten out of Bear Stearns prime brokerage a few months before they went belly-up. Like I say, best game I ever played.

But what if it’s ALL finished? What if ALL of the counterparties close their doors? What if the entire system collapses? Who’s going to pay me?

I remember that day with a fair amount of remorse and shame, but not for the reasons you might think. I’m not at all remorseful or ashamed for being self-interested and greedy. If you’re in the professional investment world and you’re going to feel bad for that, then you are in the wrong line of work. No, I feel remorse because as well as I played the game of markets in 2008, I played the meta-game of markets like a noob. Which I was, but still.

September 15, 2008 was the day to start planning a levered long position, if not a levered long product, if not a levered long business. Because if the system collapses then you’re just part of the carnage, and if the system doesn’t collapse then you win.

This was David Tepper’s famous “balls to the wall” thesis in 2010, and it’s why he’s a billionaire and I never will be. This was supposedly part of Warren Buffett’s rationale for selling billions of dollars of naked puts on the S&P 500 and placing Berkshire in existential jeopardy, and it’s part of why he’s the greatest coyote of all time. No one plays the meta-games better than Uncle Warren. No one.

But instead of thinking through the meta-game in any consequential way, I stayed mired in the immediate game of markets. I breathed a sigh of relief when the world didn’t end alongside Lehman, I got paid, and I went on my myopic way. I recognized the meta-game’s existence, but I wasn’t able to conceive of myself as a strategic actor within it.

And that’s why I write Epsilon Theory the way I write Epsilon Theory … because I’m not going to make that mistake again.


Hunt's Law: An Experiment

Dumpster Fire

Hunt’s Law (fake news drives real news out of circulation) applies everywhere today, even to Hunt.

I’ve started posting weekly short-form Epsilon Theory notes on LinkedIn. I’m always interested in finding new venues to spread the ET word, and the good people at LinkedIn corporate are soooo much more helpful and inviting than the good people at another social media behemoth that rhymes with crook.

The distribution feature I was most interested in testing with the LinkedIn posts was comments. I’ve never implemented a comments feature on the ET website, because on the one hand there’s no quicker way to ruin your equity value if you’re hijacked by a know-nothing commentariat a la Zerohedge, and on the other hand there’s nothing sadder than a deserted but oh-so clean comment section. When it works, though, it’s magic.

I’m still not sure where I’m going to end up on comments, but there’s a case study in the hijacking phenomenon happening with the most recent short-form note that I posted on LinkedIn – “Controlling Your Cartoon: Nike and the Necessary Meme” – which is a (very) lightly reworked version of the ET short-form note – “Controlling Your Cartoon: Nike and the Art of the Meme“. To recap what that note is all about, it argues that the polarizing Nike/Kaepernick ad is a smart business move in an already polarized society. In exactly the same way that centrist political candidates lose to more extremist candidates on both the left and the right, so do centrist marketing campaigns lose to more extremist campaigns on both the left and the right.

To be clear, I’m not upset about the hijacking. I expected this note to be hijacked, because it’s intentionally provocative with the Nike/Kaepernick ad teaser. And wow … it did not disappoint.

Most everyone reading this post is also a LinkedIn member, so I’m not going to take screenshots of all the comments and reprint them here. But here’s a representative submission:

Actually, it’s not really a representative submission, because it’s written well and isn’t over-the-top enraged. But it is representative of the 90% of comments that are responding VERY negatively to the Nike ad itself, and have NOTHING to say or do with the actual content of my note.

But here’s another interesting datapoint. In addition to being the most commented-on note I’ve published on LinkedIn, it is also the most LIKED note I’ve published on LinkedIn, both in absolute numbers and as a percentage of views!

Now … I’ve got a healthy ego, but I’m not so insane as to think that all of these Likes are for the actual content of my note, any more than the comments are for the actual comment of my note. No, the Likes are people who have a positive reaction to the Nike ad itself, but have zero desire to dive into the swirling waters of hater comments.

I’m still mulling over what this all means and whether there’s any way to design a more rigorous experiment here (if only LinkedIn had a Dislike button …), but I’ve got one clear conclusion already:

That social media behemoth with a name that rhymes with crook has already run these experiments and knows the answers.

Oh, and one more thing … Nike’s stock price hit an all-time high yesterday.


Hunt's Law

Queen Elizabeth I

Gresham’s Law: bad money drives good money out of circulation.

Hunt’s Law: fake news drives real news out of circulation.

I first came up with Hunt’s Law for an Epsilon Theory piece called “Fiat Money, Fiat News“. It’s worth your time to read, but out of respect for our TL;DR world, here’s the skinny:

Just as modern money is constructed out of nothing more than the confidence we have in the governments that print it, so is modern news increasingly constructed out of nothing more than the confidence we have in the Missionaries who proclaim it.

And just as counterfeit money drives good money out of circulation by encouraging holders of good money to hoard it rather than exchange it for what might be bad money, so does counterfeit news drive real news out of circulation by encouraging holders of real news to keep quiet rather than engage in an exchange with what might be fake news.

The money aspect of this was first codified in the 1500s by Thomas Gresham, an advisor to Queen Elizabeth I. The Queen was mighty vexed by the moribund English economy of the day, a distress that Gresham laid squarely at the feet of Elizabeth’s father, King Henry VIII. It seems that late in his reign, Henry had decided to start issuing silver coins with only half the silver content of his original silver coins. Once everyone got wise to the diminished actual silver content of the coins, the exchange of food or clothes or land or whatever for silver coins came to a screeching halt. Everyone wanted twice as many silver coins as before to make an exchange, because they weren’t sure whether they were getting the good old coins or the bad new coins. This was particularly problematic in the banking sector, where gold was the ultimate store of value. Rather than be forced by the Queen to exchange their good gold for suspect silver, bankers and anyone else with a gold coin either buried it in the backyard or, better yet, found a way to get their gold out of country entirely.

I thought of Gresham’s law the other day when the stories came out about Trump telling Gary Cohn to just “print more money” to solve our burgeoning budget deficit. He really is a Henry VIII cartoon, right?

And I thought of Hunt’s law this morning when Trump tweeted that only a handful of people had died in Puerto Rico from Hurricane Maria. JFC.

In the 1500s, the big problem was having your currency debased.

Today, the big problem is having your information debased.

To be clear, the debasement of information into Fiat News – the proclamation of opinion as fact – started waaaay before Trump. If you can’t see that EVERYONE in the mass media and mass political universe, on BOTH sides of the political aisle, isn’t engaged in the Fiat News debasement game … well, you’re blind. It’s just that Trump is really, really good at playing this game.

How does it end? Not well, I’m afraid, if history is any guide. Elizabeth I used the carrot and the stick of the State to force the general acceptance of the bad new coins over time. Want that government contract? Gotta play ball. Caught you taking your gold out of the country? Why you must be an Enemy of the People. Off with your head. Literally, not figuratively. Yep, the State has muscle and the State has time. We’ve got fear and greed. One guess how this plays out.


Repo 105

Dick Fuld

Branded a Villain, Lehman’s Dick Fuld Chases Redemption

Wall Street veteran, pilloried over bank’s collapse, has said his firm didn’t have to die. A new book agrees. – Wall Street Journal (September 6, 2018)

Every time Dick Fuld’s publicists succeed in getting a “redemption story” published in the Wall Street Journal or New York Times, I’m going to write an Epsilon Theory brief about Repo 105, the fraudulent scheme that Lehman Brothers ran for years to hide its deteriorating financial condition from investors and regulators alike.

Here’s what makes the world go round: you can borrow more money than you have in liquid assets.

That’s what a mortgage or an auto loan or a college loan is. You don’t have enough cash to buy that house or car or college tuition all at once, so the bank gives you the cash to make the purchase. But by the same token, banks are by necessity lending out more cash than they actually have deposited with them. This is both the gasoline and the oil for the modern economic engine, and if you and I didn’t go into debt and the banks didn’t lend more than they have in deposits, the engine would seize up and our entire economy would come to a screeching halt. This is, in fact, what causes Depressions.

But in exactly the same way that you or I might be in trouble if we borrowed a lot more money than we have stashed away in a bank account somewhere, a bank might be in trouble if it lends out a lot more money than its underlying customer deposits or invested capital or otherwise loan-supporting reserves warrant. And in exactly the same way that the banks review our financial records before giving us a loan to make sure we’re not borrowing too much money for the bank’s standards, so does the government review a bank’s financial records to make sure they’re not lending too much money for the government’s standards. And by government standards I mean laws.

Repo 105 was a multiyear scheme by Lehman to defraud the government and its own investors by falsifying the actual amount of loans it had on the books, making Lehman look safer than it actually was.

It worked like this. A few days before the end of the calendar quarter, Lehman would “sell” billions of dollars worth of loans to another bank. I put “sell” in quotation marks, because Lehman ALSO had an agreement with these other banks to buy the loans back a few days after the quarter ended for the same price as they were sold, plus enough money to cover whatever the going interest rate was on that cash for the few days it was in Lehman’s hands. This is what’s called a repurchase agreement, or repo, hence the name Repo 105 (the 105 refers to the 5% overcollateralization that counterparty banks required to lend the cash to Lehman even for a few days – they knew Lehman was in trouble). Since financial reporting happens at the end of the quarter, Lehman’s books would look like they had more cash and fewer loans than they actually did.

Surely, you say, no law firm would bless this blatant attempt to cook the books? And I say, don’t call me Shirley. I say, well … no US law firm would bless this, so naturally Lehman found a UK firm, Linklaters, to say that this was, in fact, technically a “true sale”. Even then, to pull this off Lehman had to run Repo 105 through their offshore subsidiaries, not through their US-chartered entities. It was really expensive for Lehman to run Repo 105. But also entirely necessary, or else the entire house of cards that WAS Lehman would have collapsed well before September, 2008.

What about Lehman’s auditors, you ask, surely no auditor would go along with this scheme? Again … Shirley. Again, Lehman found that Ernst & Young would indeed sign off on the program, in exchange, of course, for a sharp increase in fees. The state of New York filed civil fraud charges against Ernst & Young over Repo 105 in December, 2010. I believe they paid a (small) fine.

Dick Fuld claims that he knew nothing about the Repo 105 program. The only possible answer to this, and here I’ll apologize in advance for my language, but it’s really the best possible word – bullshit. Did I mention that Repo 105 was a really expensive program to run? Did I mention that Dick Fuld’s nickname was The Gorilla, that he was infamous for controlling everyone and everything at Lehman? Did I mention that Repo 105 was concealing existential risk for Lehman?

If you or I did what Lehman did with Repo 105, we would be charged and convicted of bank fraud. Happens all the time. It’s pretty much what Paul Manafort just got convicted on. This is a crime. It is not a minor crime. It’s an absolute slam-dunk case for any prosecutor in any jurisdiction in the country. And yet, with the exception of the civil fraud charges brought against Ernst & Young, no other charges – civil or criminal – were ever filed by the SEC or the Justice Department in connection with Repo 105. 

When was I radicalized?

When Dick Fuld walked away scot-free from the wreckage of Lehman after getting half a billion dollars in cash comp and stock sales during his tenure.

Never forget.


Whitestone Bridge

Whitestone Bridge under Construction

Everyone has their 9/11 story. Mine is in a car heading to LaGuardia for a 7 am flight to Los Angeles, crossing the Whitestone bridge and seeing the Manhattan skyline in that early morning glow. It was a perfect day. Crisp. Clear. Not a cloud in the sky, as they say. I remember that view so vividly. I remember thinking to myself: what a perfect day.

Read moreWhitestone Bridge