The Zeitgeist | 2.28.2019

This is our feature of the 10 (or so) most on-narrative (i.e. interconnected, highly similar) stories in financial media. It’s not a list of best articles, or articles we think are most interesting, or articles we agree with. But if you’re going to read 5-10 stories when you start your day, these are the ones that are most connected to the financial news that got published today.

Report: Blockchain Home Equity Loan Platform Raises $65 Million

UK house price growth ‘subdued’ as Brexit looms

Why Nintendo keeps returning to classics like Pokemon

MYSTERY SHOPPER BRISTOL; The shopper is considering investing her graduation gift – £50,000 – in safe haven assets such as gold

Doubts Over Trade Talks Weigh on Stocks (Ed Note: We haven’t seen “weigh on” in a while.)

The Perils Of Investing Idol Worship: The Kraft Heinz Lessons!

Deutsche Bank Shares Slip Lower After ECB Capital Increase Notice

Chinese Stocks Are Suddenly the World’s Best Trade in February

Trump-Kim summit fizzles; AB InBev surges; US GDP

They’re Not Even Pretending Anymore

Let’s take a walk down memory lane, shall we?


“My relations with the Fed,” Nixon said, “will be different than they were with [previous Federal Reserve chairman] Bill Martin there. He was always six months too late doing anything. I’m counting on you, Arthur, to keep us out of a recession.”

“Yes, Mr. President,” Burns said, lighting his pipe.

“I don’t like to be late.” Nixon continued. “The Fed and the money supply are more important than anything the Bureau of the Budget does.” Burns nodded. “Arthur, I want you to come over and see me privately anytime . . .”

“Thank you, Mr. President,” Burns said.

“I know there’s the myth of the autonomous Fed . . .” Nixon barked a quick laugh. “. . . and when you go up for confirmation some Senator may ask you about your friendship with the President. Appearances are going to be important, so you can call Ehrlichman to get messages to me, and he’ll call you.”

January, 1970 (John Ehrlichman, “Witness to Power”)

Nixon: [If I’m not re-elected] this will be the last Conservative administration in Washington.

Burns: Yes, Mr. President.

Nixon: This liquidity problem is just bullshit.

October 10, 1971 (Secret Nixon Tape No. 607-11)

Burns: I wanted you to know that we lowered the discount rate . . . got it down to 4.5 percent.

Nixon: Good, good, good.

Burns: I put them [the FOMC] on notice that through this action that I want more aggressive steps taken by that committee on next Tuesday.

Nixon: Great. Great. You can lead ‘em. You can lead ‘em. You always have, now. Just kick ‘em in the rump a little.

December 10, 1971 (Secret Nixon Tape No. 16-82)

Shultz: Money supply is beginning to move. The economy has to be good, strong expanding economy this year. So much at stake on that. He [Burns] recognizes that and he needs to do everything that he can do. Why worry about interest rates going down? . . . We want low interest rates. What’s the problem there? So, we don’t have a return flow of money from Europe? So what? Keep the money supply going up!

Nixon: Another defense he’s building up for not raising the money supply . . . I’d rather he weren’t so optimistic. … This is the last time I want to see him [garbled] or get the hell out of here. War is going to be declared if he doesn’t come around some. … He’s talking with the Jewish press.

February 14, 1972 (Secret Nixon Tape 670-5)

In 1971, Richard Nixon had a problem. The US economy was pretty strong and the Fed wanted to tighten. But Nixon had an election to win in 18 months, and he needed loose monetary policy to do that. Also, the global economy wasn’t that strong, and the rest of the world needed an expanding supply of dollars and an expanding US trade deficit to keep its motor running. Nixon didn’t really care about that, but a lot of his oligarch cronies did.

So Nixon alternately bullied and cajoled and threatened and rewarded his hand-picked Federal Reserve Chair, Arthur Burns, to do the right thing and keep the money spigot open … wide open. Complaints about too much liquidity sloshing around were “bullshit”, and so what if they were running the economy hot? Good lord, man, imagine who would take over the White House in 1972 if he were defeated! Imagine the insane fiscal spending policies that those Democrats would push on the country if he lost!

Donald Trump has EXACTLY the same problem.

Donald Trump has found EXACTLY the same solution.

Jay Powell is the Arthur Burns of our day.

The only difference is that Nixon did all of his bullying and cajoling and threatening and rewarding in private, and Burns wouldn’t dream of saying out loud what Powell is shouting about the “important signal” of financial market “volatility” on monetary policy decisions.

They’re not even pretending anymore.


The Zeitgeist | 2.27.2019

This is our feature of the 10 (or so) most on-narrative (i.e. interconnected, highly similar) stories in financial media. It’s not a list of best articles, or articles we think are most interesting, or articles we agree with. But if you’re going to read 5-10 stories when you start your day, these are the ones that are most connected to the financial news that got published today.

How To Build A World Full Of Elons (Ed Note: I’ll take ‘Questions nobody is asking for $400, Alex’)

Alaska Permanent allocates $1.6 billion in commitments, investments

Tech stocks: is the foldable, 5G and AI era really revolutionary

GE just spun off its locomotive unit. Workers immediately went on strike

AutoZone Rises Sharply After Beating Earnings Estimates

Asian Shares Rise On Dovish Fed Comments

Elon Musk’s SEC fight: Here’s what could happen next

Dow futures point to lower open ahead of Trump-Kim summit

Low Participation Levels Keep The Bull Alive

The Zeitgeist | 2.26.2019

This is our feature of the 10 (or so) most on-narrative (i.e. interconnected, highly similar) stories in financial media. It’s not a list of best articles, or articles we think are most interesting, or articles we agree with. But if you’re going to read 5-10 stories when you start your day, these are the ones that are most connected to the financial news that got published today.

Intel and Apple Among Stocks Set to Gain on Improving U.S.-China Relations

Stealing The Permian – Which Operators Are Next In Line For U.S. Onshore Mergers And Acquisitions Activity?

Barrick Gold’s Shocking Hostile Bid For Newmont Is A Lowball Offer

Hearings on ‘sky-high’ drug prices show how little has changed in 60 years

The Current Cost of Climate Change: $650 Billion and Rising

Rally in Cyclical Stocks Could Be a False Positive

SE Asia Stocks-Most fall on trade deal uncertainty

Aussie, NZ shares end lower as markets seek clarity on Sino-U.S. talks (Ed Note: Markets ‘seek clarity’! What a cool thing to be able to determine.)

Kraft Tests Buffett and 3G Ties — WSJ

A Stock That Rides Every China Bubble Returns Stronger Than Ever

The Seed Delusion

We may call Connecticut home now, but (as I’ve alluded to in prior notes) my family wasn’t willing to leave Texas completely behind. To that end, we bought a bag containing around 50,000 seeds of lupinus perennis, and we’ve begun to spread them around the property, including along the street-facing edge of our old stone wall.

Now, Lupinus perennis isn’t exactly the same thing as a Texas Bluebonnet, but the latter is a surprisingly poorly defined thing anyway. From 1901 to 1970, the State of Texas recognized only Lupinus subcarnosus as a true Texas Bluebonnet. From 1971 on, at the urging of a mass of increasingly opinionated citizens, it switched its allegiance to Lupinus texensis. Since then, one of the most outstanding and underrecognized institutions we have in these United States – the Ladybird Johnson Wildflower Center – has taken the more liberal stance of informally recognizing several blue-flowered lupinus species as Texas Bluebonnets. Whatever the official status, the seeds we’re spreading are native to Connecticut and unlike the Texas variants, don’t germinate in the fall in expectation of a mild southwestern winter. Their pale blue flowers will make an appearance later this year.

It’s a far cry from the kind of planting we did with our children last weekend. Being about 8 weeks from planting here, we carefully pulled pepper, tomato and onion seeds from packets, pressed 2 or 3 into an 1/8” divot in starter soil, and moistened the soil. With each pod set onto heat mats and resting under properly tuned and time-controlled LED lights, just about every one should produce at least one proper plant.

Not so with the wildflowers. With that many seeds, there’s little hope of getting them planted at the right depth and under perfect conditions. You can scarify them by freezing and removing the seeds to warm water – and we did – but beyond that you’re at the mercy of nature. So you cast them far and wide. A very modest yield would suit us just fine. There’s nothing wrong with either of these methods, but that’s only because (1) seeds are shockingly inexpensive and (2) I’m a homeowner and hobbyist farmer, not a professional trying to maximize my output per acre.

There is a point in every market cycle, too, where your average investor stops thinking like a professional and starts thinking like a hobbyist. I think we’re there.

Why do I think so, and how do you know when we’ve reached that point?

You know it when otherwise professional institutional investors start seriously talking about opportunistic positions in speculative investments like diversified 1-2% crypto footholds.

You know it when PE shops start pitching – and asset owners start subscribing to – massively oversized tweener funds with ‘the upside potential and opportunity’ of VC and the ‘confidence of an established growth equity franchise’ to capture the next leg of growth from the most adversely selected graduates from early-stage funding.   

You know it when family offices start pursuing more idiosyncratic one-off direct PE deals, not because they believe in the franchise, its business case or its cash flow potential, but because they know that there’s money out there to snap it up.

It isn’t that there is something inherently wrong with any of these investment ideas. It is surely possible that they might have arisen as part of an investor’s regular process for evaluating investment ideas and opportunities. More power to those investors. Yet the far more common justification for casting seeds into a field isn’t a real process, but the belief that establishing small positions with asymmetric or speculative return profiles is an inherently advantageous road to outperformance.

This is a delusion. It is the Seed Delusion.

The Seed Delusion is a natural response to three ideas and effects: (1) the Madame Bovary Effect, which biases us against anything that feels like boredom, (2) the undeniable fact that a true edge in estimating odds or payoffs will make these activities profitable, and (3) the delusion that we are likely to possess that true edge. The third idea is where the framework breaks down. It breaks down because of a feature of our behavioral response to observing returns, a response that inevitably creeps into our thinking regardless of our investment DNA. Stolen shamelessly from Ben, that response tends to follow this pattern:

Contrarian investors confuse outsized payoffs from long odds bets with edge.

Consensus investors confuse frequent payoffs from short odds bets with edge.

It’s worth being pretty direct about this one: If you are a professional subscriber to The Seed Delusion, over sufficient time your expectation should be that you will lose every seed you cast, because you are likely to consistently overestimate the payoffs and edge of your long odds bets. If you are routinely casting 25 and 50bp seeds – and my conversations with institutions, consultants, FAs and advisers indicate that many of you are doing exactly that – you run the risk of systematically eliminating just about every benefit you have gained from reducing fees over the last decade. Maybe worse.

The things that look to us like asymmetric payoffs are not magic beans, y’all.

(FYI – Commenters submitting a “but my deal flow” comment should do so with confidence that it will be referenced in a future Deal Flow Delusion piece.)

The Zeitgeist | 2.25.2019

This is our feature of the 10 (or so) most on-narrative (i.e. interconnected, highly similar) stories in financial media. It’s not a list of best articles, or articles we think are most interesting, or articles we agree with. But if you’re going to read 5-10 stories when you start your day, these are the ones that are most connected to the financial news that got published today.

As AI Software Replaces Thousands of Workers, One Company Will Benefit the Most

Are you paying higher fees to subsidise tiny ‘orphan’ funds?

How America Learned to Stop Worrying and Love Deficits and Debt

The Green New Deal: A Fresh Opportunity For Investors?

Stocks Gain, China Surges, as Trump Delays Tariffs Amid Trade Talk Progress (Ed Note: It’s a rare threefer – Gain! Surge! Progress!)

Trump predicts ‘very big news’ in China trade talks after breakthrough

Trump Extends China Tariff Deadline

Buffett’s Berkshire, hurt by Kraft Heinz, posts massive quarterly loss


Pricing Power (pt. 3) – Government Collaboration

I feel like Tim the Enchanter a lot, especially when I spend much time on Twitter.


When an inflation regime shifts, there’s only one question that really matters for your business model: do you have pricing power?

With apologies to the Monty Python troupe, I want to write about three forms of pricing power that often go unnoticed, but will be incredibly powerful as the great economic pendulum swings from deflation, falling rates and a wealth creation zeitgeist to inflation, rising rates and a wealth distribution zeitgeist.

Because if you don’t see that this is where we’re going – a sea change reversal of the BS supply-side narrative that dominated our political zeitgeist for the past 40 years, now becoming the BS MMT narrative that will dominate our political zeitgeist for the next 40 years – then you’re just not paying attention.

But these are the cards we’ve been dealt. Let’s play them as well as we can.

I’m focusing on the financial services ecosystem in these notes, because this industry has already been totally wrecked by financial asset inflation, a tide that lifts all boats and squeezes all margins regardless of skill or smarts.

It’s a margin-wrecking inflationary flood that is coming soon to all service industries.

The skinny of “Pricing Power #1 – Client Ownership” is that pricing power in a services industry is found in your proximity to the client relationship, not the product that the client is buying. The problem, of course, is that it’s really really hard to scale client relationships, or at least it’s hard to scale the relationships that are worth scaling.

The skinny of “Pricing Power #2 – Intellectual Property” is something of the reverse. If you ARE on the product side of your industry, then the only way to maintain pricing power is through narrative-rich if not mythic intellectual property. Conversely, relationship owners always think that they can scale their nice little client-facing businesses with Technology IP. They are always wrong. The one (rare) exception is the use of Content IP, but even here you are scaling your client relationship depth, not your client relationship breadth.

The skinny of “Pricing Power #3 – Government Collaboration” is that the most dependable way to protect your margins and maintain pricing power is to partner with the government to provide a politically useful service. I don’t mean an overt partnership. I don’t mean becoming a government contractor (although sure, that works, too). I mean identifying the social meaning of your services industry and implementing a business strategy that supports THAT.

I know it sounds all touchy-feely to talk about the “social meaning” of this or that, and it is, in fact, completely intangible and invisible to the naked eye. But it’s no less real for that.

Social meaning is another word for Zeitgeist, the spirit of the age. Here’s the long-form Epsilon Theory note on that:

For the financial services industry, the Zeitgeist boils down to one core idea, one core dynamic:

Capital Markets are being transformed into a Political Utility

After the systemic near-death experience of The Great War, French President Georges Clemenceau famously said “wars are too important to be left to the generals”.

After the systemic near-death experience of The Great Financial Crisis, all political leaders – of both the Right and the Left – are saying “asset prices are too important to be left to the investors”.

How have political leaders wrested control of price-setting from investors in the 2010s, just as they wrested control of war-setting from generals in the 1920s? I’ll start with a simple but (for many) painful fact, the end result of capital markets transformed into a political utility.

For the past 10 years, ever since the end of the GFC, active investing in general and value investing and quality investing in particular have failed.

And not just failed a little, but failed a lot.

The green line below is the S&P 500 index, including dividends. The blue line below is a market neutral Quality Index sponsored by Deutsche Bank. They look at 1,000 global large cap companies and evaluate them for return on equity, return on invested capital, and accounting accruals … quantifiable proxies for the most common ways that investors think about quality. Because the goal is to isolate the Quality factor, the index is long in equal amounts the top 20% of measured companies and short the bottom 20% (so market neutral), and has equal amounts invested long and short in the component sectors of the market (so sector neutral).

You’ve made a grand total of not quite 8% on your investment in this Quality-focused index … not per year, but over the last DECADE.

Over the same time span, your passive investment in the S&P 500 has almost quintupled. With dividends, it’s up more than 360%. 

For the past TEN YEARS, Quality has been absolutely useless as an investment strategy.

Have the Quality stocks in your portfolio gone up? Yes, but it’s not because of the Quality-ness of the companies. It’s because ALL stocks have gone up, Crap and Quality alike. In lock step, with nary a blip either way.

And yes, I’m using this Quality index as a proxy for active portfolio management of all types. Because it is. Sure, quality – like beauty – is in the eye of the beholder. But the core bias of every discretionary manager, regardless of asset class or geography or whatever corner of the investment world they play in, is always the same – buy the good stuff and avoid the crap.

For the past decade, all of your smarts … all of your efforts … all of your time … all of your money … every resource you have devoted to distinguishing between good stuff and crappy stuff in large-cap public equity markets … has been wasted. I’m not using the word “wasted” in a pejorative or judgmental sense. I’m using it in the technical sense. It has given you no better results than the less smart, less hard-working, less devoted, less well-resourced investors who just plopped their money willy-nilly into crappy stuff.

It’s not fair.

But it is the truth.

As a result, your business model – which requires you to charge enough in fees to cover the cost of all these resources you have wasted – has been squeezed and squeezed and squeezed. Because no one is going to pay you more for less. Marketing alpha can only go so far. And when that runs out … well, it’s “family office” time.

Now here’s the kicker.

The failure of active management is not an accident.

The political rule-setters for markets don’t give a damn about rewarding quality companies and punishing crappy companies, much less rewarding smart investors and punishing stupid investors. They care about not doing 2008 again. Ever. Under any circumstances. They care about providing a rising tide that lifts all boats. And so that’s what we’re going to get.

The intentional transformation of capital markets into a political utility is the common thread of ALL of it … all of the QE, all of the ZIRP, all of the negative interest rates, all of the forward guidance, all of the “communication policy”, all of the Fed puts, all of the Dodd-Frank theater, all of the regulatory blindness towards too-big-to-fail banks, all of the Trump tweets about the market, all of the CNBC appearances by White House apparatchiks, all of the Chuck Schumer “buy-backs are evil” op-eds, all of the Green New Deals, all of the show trials to come (and there will be show trials). All. Of. It.

This is what a change in the financial services Zeitgeist feels like. This is what a change in the financial services Zeitgeist IS.

The Zeitgeist is a little white bunny rabbit. With killer teeth.

If you’re an active manager or a value investor, the monster isn’t hiding behind the Zeitgeist.

The monster IS the Zeitgeist.

Now I know what you’re thinking, because I’ve thought it, too.

Is there some Holy Hand Grenade of Antioch available to blow the killer rabbit to smithereens?

Sorry, but no.

The answer here is that you don’t fight the Fed. You don’t fight City Hall. In fact, the real answer is that you fight on the SAME SIDE as the Fed. On the SAME SIDE as City Hall.

You know, like Saint Warren does on taxes.

I think that Berkshire Hathaway pocketed something like $29 billion from the Trump tax cuts. But hey, rail against carried interest taxed as capital gains and you, too, can insulate yourself and your company from the Democratic 2020 anti-oligarch jihad.

Or like the Winklevi do with crypto.

I know that crypto bros (and they’re all bros) love the anti-establishment mythos around Bitcoin. The social meaning of crypto – its Zeitgeist – was absolutely the halo effect of rebellion it provided. And what a convenient rebellion it was. Owning crypto was like getting a tattoo on your upper arm … you could tease it when desired as a signifier of your counter-culture bona fides, but you could also cover it completely while working for the Man. And maybe get rich, to boot!

That’s all gone today. Instead, you’ve got the Winklevoss Twins welcoming their new SEC overlords, intentionally setting themselves up as the squares. It’s the smart move. I don’t know if it will work … without the cool kid mystique, I don’t know how you drive crypto adoption anywhere but in the neo-gold bug “just you wait until the System collapses” crowd, and that’s such a depressing space. Sure, the Winklevi try to be personally cool, but it’s just ludicrous … they come across as Fonzies, not as James Deans. But it’s the smart move. IF crypto makes a comeback, I think Gemini will dominate the exchange space.

Or like Vanguard does with passively managed investment strategies.

The most amazing thing to me about Vanguard’s advertising strategy is that sometimes I don’t think there is a strategy. Does Vanguard even have a TV ad budget? My best guess on Vanguard’s annual advertising budget is $100 million, twice what they’ve said they spent a few years back. And yet the AUM just comes rolling in, billion after billion after billion … trillion after trillion after trillion. THIS is the power of a business model that fits the Zeitgeist of capital markets transformed into political utility. You don’t have to convince people to give you money. You don’t have to construct a winning brand or marketing alpha. The secret of Vanguard is not only that they’re not wasting resources on unrewarded active investment management (in 2017, 45 employees managed $2 trillion in AUM in Vanguard’s equity indexing group … that’s $44 billion per employee!), but also that their cost of customer and asset acquisition is so low.

I can’t emphasize this point strongly enough. Financial services companies live and die on distribution. Clients come and clients go. But if you can keep your customer acquisition costs low, you will ALWAYS live to fight another day. No matter what happens to performance.

On the other side of that spectrum, you’ve got TD Ameritrade and their incessant advertising campaign for all active management, all of the time. My god, but I weary of the smarmy dude with the beard, telling me that trading options is “just like playing pool”. And yeah, go ring that 24/5 bell, Lionel. All night long. Haha. How droll.

In 2018, TD Ameritrade spent $293 million in direct advertising expenses, three times my estimate of Vanguard’s spend for one-twelfth the net asset increase. Forget about all the employee comp associated with sales and marketing, I’m just talking about direct advertising costs. For this money, the company gained 510,000 net new accounts in the year, meaning that each net new account cost $586 in direct expenses. Now is there churn on accounts, so that gross new accounts are more than 510k and customer acquisition costs are proportionally less? Yes. But I can’t see any way it costs less than $500 for TD Ameritrade to get a new client, before you even start considering employee comp. And these costs are going up. TD Ameritrade is guiding to $320 million in advertising expenses this year. Lionel doesn’t ring that bell for free, you know.

I’m not trying to make a direct comparison between TD Ameritrade and Vanguard. They play in different ballparks. I’m also not trying to say that one is a better managed company than the other. What I AM saying is that Vanguard has taken an easy business path and a robust business path, and TD Ameritrade has not. Vanguard fits the financial services Zeitgeist perfectly, and TD Ameritrade fits not at all.

All of this applies to people just as much as it applies to companies. More so, really.

There’s a great scene in “The Holy Grail” when Arthur and his squire cloppety-clop their imaginary horses through a field where two peasants are toiling, and Arthur asks them about a castle up on the hill. The peasants aren’t nearly as star-struck by the “King of the Britons” as the King of the Britons expects them to be, and it leads to this exchange:

A lot of active managers are like King Arthur here.

They think that they are somehow OWED alpha because they’re really smart guys and they think really hard about 10-Qs and 10-Ks if they’re fundamental stock-pickers, or they think really hard about national accounts and balance of payments if they’re macro guys.

For a lot of years, active managers were the king. And they acted like it. They acted like it was somehow a divine right to … not just make a lot of money, but to make orders of magnitude more money than any other profession on earth. Why? Because it was Common Knowledge – everyone knew that everyone knew – that active management worked. Benjamin Graham or Warren Buffett or George Soros or Julian Robertson or some such had handed up an Excalibur of unfailing investment knowledge and process from the bosom of their waters to these knights and kings of active management.

Today, of course, the Common Knowledge is that this was all just a farcical aquatic ceremony.

Both views are silly. But I’ll give you one guess which view fits the current financial services Zeitgeist of a public utility better. I’ll give you one guess in which direction the investment world will continue to spin.

Here’s the Truth with a capital T – the market owes you nothing. No matter how smart you are and no matter how hard you work, the market owes you nothing. But if you’re very smart and you work very hard, you can take what the market is able to give you.

Today, unfortunately, the market is not able to give you a lot.

Not because prices are inflated or earnings growth is this or CAPE ratios are that.

Not because you haven’t studied the holy texts of your investment creed carefully enough.

But because private information – which is the one and only source of edge in the investment business – is being slowly but surely sucked out of public markets as part of this transformation into a public utility.

In 2009 the SEC established an Office of Quantitative Research and an Office of Risk Assessment and Interactive Data, and – for operational surveillance – an Office of Analytics and Research within its Trading and Markets Division. In July 2013, the SEC announced the creation of a Center for Risk and Quantitative Analysis, to “provide guidance to the Enforcement Division’s leadership.” Taken together, these offices form the equivalent of the SEC’s version of the CIA. These offices are extremely well funded, draw some really top-notch people from the private sector, and coordinate closely with the FBI. Today’s SEC may not quite be the functional equivalent of the NSA from a data gathering and pattern inference perspective, but it’s nothing to sneeze at, either. And on the traditional surveillance side, the DOJ has been given amazing latitude by the courts of late to pursue widespread wire taps across a wide swath of the financial services industry.

I can’t emphasize strongly enough the importance of these surveillance institutions as a tool in the political effort to transform capital markets into a political utility.

How? By taking sleepy regulatory edicts that were on the books but extremely hard to prosecute – such as the 2003 Global Research Analyst Settlement or, more importantly, Reg FD, originally adopted way back in August, 2000 – and using Big Data and Big Compute to turn them into powerful weapons.

Reg FD requires publicly traded companies to eliminate selective disclosure of any information that could be deemed to be material and non-public. Not only does Reg FD place a burden on company management not to disclose material and non-public information to anyone unless it is disclosed to everyone, but it also places a burden on the receiving party (typically the investor) not to act on the improperly disclosed information. Prior to 2009 it was very difficult for the SEC or FBI to identify any but the most egregious infractions of Reg FD, such as an email leaked by a disgruntled employee or a massive dumping or purchase of a stock. Since 2009, however, the SEC can sift through all of the trading in a company’s stock, look for what they consider to be suspicious patterns – which is by definition idiosyncratic outperformance, i.e., alpha generation – and then work backwards to create a link with, say, a 1-on-1 meeting at a sell-side conference between the company’s CFO and an analyst from the trading firm.

Let me say that again, with feeling: since 2009, the SEC treats any idiosyncratic market outperformance in strategies they can easily monitor – i.e., stock-picking strategies – as prima facie evidence that you may have broken the law.

To investigate this potential law-breaking, the SEC now routinely questions both active managers and corporate management teams who talk to active managers, if and only if stock-picking alpha has occurred in that company’s securities.

Before Reg FD, CEOs and CFOs would meet with active portfolio managers in private all the time. Active managers were your partners, and you told them what they needed to know. That does NOT mean that you told them this quarter’s earnings results, because that is NOT what active portfolio managers and their analysts need to know. Remember, these active managers are some of the smartest and hardest working people in the world. They don’t need to be spoon-fed with insider information. They’ve done their homework.

No, active managers only need the answer to one simple question to supply all of their private information / alpha generating needs.

Is it safe?

So … if you’ve never seen Marathon Man, you have my permission to stop reading this note and go watch the movie. It’s why Laurence Olivier is an actor’s actor. It’s why it’s taken me 40 years to get comfortable with a visit to the dentist, and I’m actually just saying that to be brave – I’ll never be comfortable with a dentist.

Laurence Olivier’s Nazi torture-dentist didn’t need a full download from Dustin Hoffman’s hapless grad student. He just needed to know if his overall plan had been blown. Is it safe?

That’s all that active managers need to know, too. Has our overall investment plan been blown by … I dunno, all you Kraft Heinz value investors, maybe an SEC investigation that hasn’t been announced publicly yet and will crater the stock for a while? You’re not looking to short the stock and you’re not looking to play the quarter. You just want to get out of the way while the company goes through this rough patch, and you’ll be right back in there buying the stock soon enough. Is that too much to ask? Because you believe in this company. You’ve done your homework. You’re a long-term investor. But is it safe?

THIS is the true source of alpha back in the golden age of active management. Not your adherence to the Value Investor Bible. Not some magical Excalibur of process and smarts. Not some obvious criminality like tipping an imminent acquisition or quarterly earnings. It was all conversations like this, only in a suite at the Mandarin Oriental instead of a dentist’s office, and with hotel catering instead of root canals. Is it safe?

Even after Reg FD was instituted in 2000, CEOs and CFOs still felt pretty comfortable communicating an answer to the “Is it safe?” question with a hem and a haw, maybe a reference to a prior period in the company’s history or a generic expression of caution or excitement … body language. Private meetings between active managers and corporate management became acts of theater, with a lot more private information “slippage” and a lot more active management “error”. The private information gathering process for active managers was damaged. But not ruined. Call it the silver age of the active manager.

And then came the Great Financial Crisis. Then came the 2009 SEC surveillance weaponization.

So how do CEOs and CFOs interact with active managers today? With the knowledge that every 1×1 meeting can and will be used against them if the manager is extra successful in the stock? Today CEOs and CFOs duck the conversation entirely and have the IR VP sit in for them. Today they have large group meetings with as many people as possible in the room. Today they say NOTHING that has not already been said, word for word, in a 10-Q or an 8-K filing. Unless you’re Elon Musk, of course, and look at what a lightning rod he’s become for behavior that would have been totally ignored 20 years ago.

Now put yourself in the active portfolio manager’s shoes. You don’t want to take that 1×1 meeting with the CFO, either! But you still have to take big swings, both because you’ve got a lot of money to put to work and you have to distinguish yourself against your benchmark. Maybe you can seek safety in the consensual validation of other managers, a Common Knowledge answer to the “Is it safe?” question, which is why there is such a pronounced herding behavior among active managers today. Or maybe you move towards an activist strategy, where you can once again acquire private information about a company and influence management directly, albeit at the significant risk of locking yourself into an investment you cannot easily exit. But these are awfully poor substitutes for the private information that used to be at your fingertips, the answer to that simple question: Is it safe?

This isn’t a chilling effect. This is a polar vortex effect.

This is why active managers, no matter how smart and how hard working, can’t beat the market even BEFORE you take into consideration all of the QE and forward guidance and extraordinary monetary policy and (coming soon) extraordinary fiscal policy.

They have no edge. They have no private information. Not just because monetary policy has swamped fundamental or company-specific information as a mover of asset prices, but also because since 2009, active management outperformance has been treated with regulatory prejudice.

Regulatory prejudice is part of the killer bunny Zeitgeist, too.

In fact, I think it’s the most important part of how capital markets have been transformed into a political utility. It’s just not the most obvious.

Which leads me to what I think is the core question that active managers must wrestle with if they are to reclaim market relevance and – yes – pricing power in the financial services industry.

Where can we find legal private information about publicly traded companies?

You can rail about the Fed all you like. God knows I do it a lot. They’re not going to listen and they’re not going to change. In fact, they’re going to do more. Scratch that, they’re going to do MOAR.

You can wish for the good old days of meaningful 1x1s to return. They won’t. There’s nothing mean-reverting about the Surveillance State or the political benefits of going after Axe Capital wherever and whenever possible.

You can continue to spout the same old canards about how “you know your companies better than anyone” or how “your process works over a credit cycle” or whatever it is that you tell yourself to keep the old faith burning. Or at least smoldering. But spare me all that, okay?

Active investing is hard. It was always hard. It has gotten a lot harder over the past ten years. It will get even harder over the next ten years. It will probably never get easier, at least not in our lifetimes. That’s the thing about golden ages. It’s a one-way path down, never up.

Still with me? It’s really okay if you’re not. It’s really okay to take the Don’t Fight ‘Em, Join ‘Em road. It’s really okay to take the Winklevi/Vanguard road. It’s the smart move.

But it’s not me.

I’d rather try to solve this really hard puzzle and fail than ignore the puzzle and be a successful soma distributor in this brave new world of political market utilities.

And I think we’ve identified a promising research program for solving this puzzle, at least in part. That research program is the game theory of narrative, and the research tool is natural language processing (NLP). That’s our approach to finding legal private information about publicly traded companies, and you’re welcome to join us. Here, take a look.

I don’t know if our research program will pan out. And that’s okay. You may not like this research program or want to do it your own way or try now for something completely different. And that’s okay, too.

What I know for sure, though, is that we’re asking the right question.

Where can we find legal private information about publicly traded companies?

That’s what makes active management work. It’s the only thing that has EVER made active management work. And it’s the only thing that will make active management work again.


PDF Download (Paid Subscription Required): Pricing Power (pt. 3) – Government Collaboration


Next up … yeah, I know I said this would be a three-part series, but it’s just too much fun … making do with what you’ve got, even if they’re just coconuts. The pricing power of real assets.


The Zeitgeist | 2.22.2019

This is our feature of the 10 (or so) most on-narrative (i.e. interconnected, highly similar) stories in financial media. It’s not a list of best articles, or articles we think are most interesting, or articles we agree with. But if you’re going to read 5-10 stories when you start your day, these are the ones that are most connected to the financial news that got published today.

Volatility Seems Here To Stay

House sales UP year on year in January as property market continues at ‘steady’ pace (UK)

UTIMCO to search for a custodian, strategic partners

Walgreens’ New Digital Refrigerator Doors Are Watching You. Here’s What They Know.

Restaurant Brands Yearns For Overseas Growth

European markets seen mixed amid US-China trade talks

Warren Buffett and the Insurance Business: A 52-Year Love Story

China and Russia have deep financial ties to Venezuela. Here’s what’s at stake.

Copper hits 7-1/2 month high on trade hopes, sliding stocks

The Final Frontier For SaaS Is CRM For Main Street

Gravity Sucks

Image result for gravity

Our two greatest problems are gravity and paper work. We can lick gravity, but sometimes the paperwork is overwhelming.

Wernher von Braun, in the Chicago Sun-Times

Alongside the unexpected reemergence of an old friend – the narrative of central bank omnipotence – trade and tariffs have been front-of-mind for investors since early December. It’s something we track in a recurring monthly series for our ET Professional subscribers.

In cases like the former, we think the narrative exerts a directional influence. When everybody knows that everybody knows that the Fed has a strong asset price protection mandate, then BTFD isn’t just a bit. It’s a rational response to that common knowledge. In cases like the latter, however, it is a bit more complicated. Market participants may be paying tremendous attention to tariffs and trade – and they are – but there isn’t yet a consistently directional story being told about them.

It’s an interesting mix of circumstances. No edge in trying to engage in fundamental prediction. Very little to make sense of in narrative space either. But the trade and tariffs issue still exerts significant gravity on all stories being told about markets. What’s the result?

Chaos and bullshit.

To each of those noble ends, let’s explore on a week-by-week basis just how financial media have told the story of US/China trade dispute. To do this, we explored all English language articles in the LexisNexis database about trade and tariffs from December 2 through the present. We further culled this list to include only stories that referenced ‘trade’ in the headline itself. There were 5,328 articles fitting these criteria.

What are the stories we have been telling about tariffs and trade since the negotiation window opened? How have we discussed their impact on financial markets? Well, within single weeks, financial headlines both explained how markets ‘rose on’ trade and tariffs news and how they ‘fell on’ trade and tariffs news.

Source: Epsilon Theory, Quid, Moreover

Within those same weeks, markets were ‘up on’ trade news on one day, and ‘down on’ trade news the next.

Source: Epsilon Theory, Quid, Moreover

If hyperbole is more your speed, you didn’t have to wait long. Markets ‘soared’ and ‘surged’ on trade news with some frequency, and ‘crashed’ and ‘plunged’ with almost equal frequency.

Source: Epsilon Theory, Quid, Moreover

It should be no surprise that financial media characterized these market movements as being the result of trade news. After all, market participants apparently moved from worries to optimism on a nearly daily basis.

Source: Epsilon Theory, Quid, Moreover

Or perhaps our motivations were more primal than simple worries or optimism. Perhaps markets soared and plunged on trade news because of our rising hopes and rising fears about trade and tariff resolution, which also apparently shifted on a daily basis.

Source: Epsilon Theory, Quid, Moreover

We are typically of the opinion that we can rarely afford to disregard media, research and other publishers that act as missionaries, or at a minimum, repeat and propagate missionary statements. Even if we think there is little substance to the ideas being presented, the statements and narratives which surround us still exert gravity. They still matter. Likewise, we are also nearly always of the opinion that “Stocks were up on X” articles are bad, widely understood to be bad, and unlikely to exert much influence.

But the gravity of a high attention narrative like trade and tariffs presents a sore temptation. Because we know that it is important, and because we know that everyone knows that everyone knows that it is important, the temptation to pay attention to updates, leaks and explanations of markets responding to this issue is strong. The temptation to incorporate our own interpretation of what others are discounting is strong. It is a recipe designed to appeal to confirm whatever bias we have about the issue, and to convince us that we have an edge in thinking about it.

So I will be less equivocal than usual. Until an announcement is made, continue to ignore it all. Ignore the news. Ignore the probability-based scenario research pieces. Ignore the daily ‘up on’, ‘down on’, ‘hopes and fears’ grind. The gravity of the trade and tariffs narrative means that every event, every market outcome, every surge and every fall, will be drawn into the stories being told about it. 

Gravity sucks. Resist it.

The Zeitgeist | 2.21.2019

This is our feature of the 10 (or so) most on-narrative (i.e. interconnected, highly similar) stories in financial media. It’s not a list of best articles, or articles we think are most interesting, or articles we agree with. But if you’re going to read 5-10 stories when you start your day, these are the ones that are most connected to the financial news that got published today.

Most European Bank Stocks Recover. Societe Generale Misses the Boat

People moves: New leadership for 406bn asset manager

UPDATE 2-GAM expects another challenging year, sacks suspended director

The S&P 500 Lost 11% of Value From Trump’s Trade War, Research Says

Cheesecake Factory Issues FY19 Outlook – Quick Facts (Ed Note: It may say Quick Facts, but it’s really 85 laminated pages)

Treasury yields move higher on US-China trade deal hopes (Ed Note: C’mon CNBC. ‘Move’? Are we really out of words already?)

Okta CEO: ‘We’re on the Right Side of History’ as Cloud Services Market Grows

DAX Inches Higher On Trade Deal Optimism (Ed Note: ‘Inches’ isn’t bad. Good job, good effort.)

Overnight Markets: Wall Street advances on US-China trade optimism (Ed Note: I’m really not making this up, people)

BAE’s Saudi Arms Deals Hit by German Export Ban Over Khashoggi


The Zeitgeist | 2.20.2019

This is our feature of the 10 (or so) most on-narrative (i.e. interconnected, highly similar) stories in financial media. It’s not a list of best articles, or articles we think are most interesting, or articles we agree with. But if you’re going to read 5-10 stories when you start your day, these are the ones that are most connected to the financial news that got published today.

Barclays fraud trial: ex-chairman ‘not aware’ of GBP280m Qatar deal

Devon Energy Makes A Huge Decision

C-SUITE INSIDER; For Calpine, going private means no more pesky stock analysts

Equinor presses on with drilling plans in Great Australian Bight

Warren Buffett’s annual letter shareholder is dropping on Saturday. Here’s what to expect.

LendingClub Corp (LC) Q4 2018 Earnings Conference Call Transcript

Stocks close higher with boost by trade talks (Ed Note: Alright, ‘Boost’ is off the board. This Trade War Descriptive Term Suicide Pool is getting exciting!)

EMERGING MARKETS-Emerging stocks jump on trade talks progress, S.Africa awaits budget (Ed Note: Sorry, ‘Jump’ has been off the board for weeks.)

Stocks Mixed as Trump Hints at China Talks Extension; Fed Minutes Loom For Doves (Ed Note: Oh no!)

JGBs follow global peers higher ahead of Fed minutes

Skyworks Collaborates with MediaTek on Innovative 5G Platform


The Zeitgeist | 2.19.2019

This is our feature of the 10 (or so) most on-narrative (i.e. interconnected, highly similar) stories in financial media. It’s not a list of best articles, or articles we think are most interesting, or articles we agree with. But if you’re going to read 5-10 stories when you start your day, these are the ones that are most connected to the financial news that got published today.

New voices in hospitals: Apple, Google

Greece Seeks European Commission’s Assent for Bank Plan

Are ETFs About To Rule The World?

Blame The Fed For The Plight Of The Average American

Stock Market Nerves Remain High, Volatility Futures Curve Shows

The Obstacle Between Credit Funds and a Giant Pool of Money

Why I Didn’t Invest In Nvidia

Global Stocks Edge Up as U.S.-China Trade Talks Progress

Everything you need to know about the Federal Reserve’s balance sheet – and how it could impact you

‘America First’ or America alone? In debut on world stage, acting Pentagon chief must answer for Trump.

C.A.F.

As regular readers will know, my wife and I bought a farmhouse in Connecticut when we moved up here last year. It was originally built in the late 18th Century, then rebuilt about 10 years ago. Still, the floorplan is of an older vintage, which is to say formal – separated into smaller, traditional spaces. For the most part, that’s what we wanted. We also have two boys (2 and 4), and they are…well, they’re 2 and 4. We wanted another more informal space where a little bit of healthy destructiveness could be permitted during the 7 or so months of winter we apparently have up here.

Starting today, we’re working on a project to build out a currently unfinished space where the boys can be rowdy, where we can play games together and watch movies. Among other things, that has meant doing a bit of research on a television and speakers, neither of which I’ve had cause to purchase in the last 5-6 years. I’ve forgotten a lot since the days I spent in my early 20s as a 2-channel stereo audiophile. But I hadn’t forgotten the acronym that often pops up in online forums dedicated to audio equipment.

WAF.

A decade or so ago, I’m confident this term meant ‘Wife Aggro Factor’, although Googling it now seems to indicate that the internet’s better judgment, if such a thing exists, has downgraded it to ‘Wife Acceptance Factor’. Either way, the idea is that there is some sound equipment that is so big, bulky and weird-looking that a partner who doesn’t care as much about audio fidelity is going to throw up all over having it in their living room. And y’all, there is some really weird-looking audio equipment out there. Drop this in your living room and see what happens:

Ultimately the buying decision requires some combination of accounting for what will sound the best, what’s in your budget and what isn’t going to earn you vicious side eye for the next 10 years. It’s…a complicated optimization. It’s also no different from the optimization every FA or IAR goes through in designing every client portfolio or financial plan. CAF – Client Aggro Factor – is a real thing, and it’s tricky as hell to juggle with the way we are usually trained to understand the role of a fiduciary.  

In my prior life, I ran the investment side of the house in a company with a $4.5 billion private wealth business. Mostly UHNW, a few family offices. We believed – as I still do today – that the best possible starting point for every investor was the one which expressed the least confidence in our ability to predict returns among asset classes, and the most confidence in diversification over any views we did have. The final destination of these two logical statements is risk parity. For a variety of reasons, we never ended there, but it was always where we started. It’s exactly what we did with institutional portfolios, too.

We were pretty forceful in making risk parity / risk balance the base recipe for our wealth business. Why? Because we believed it was the right thing to do. Because we believed that long-term, patient investing families deserved the same advice we gave to institutions. Because we believed that we could educate our clients to get on board with it. Because the speakers sounded better.

It was a mistake. It was my mistake.

The clients hated it. They hated it when it worked. They hated it even more when it didn’t work. They didn’t get it. It felt like a black box to most, even if we were fully transparent about the holdings, the trading and every calculation we made to build the portfolio from beginning to end. Our education program – which used a very light touch – came off as condescending and smarmy. Want to know why AQR changed the name of its risk parity mutual fund to “AQR Multi-Asset Fund” at the end of 2018, just like we did with our fund in 2016? Because even their massive distribution apparatus couldn’t sell a fund that FAs knew they couldn’t sell to their clients, even if they wanted to, and even if they thought it was the best portfolio for them.

If you work directly with clients, this conflict between doing what is in a client’s comfort zone and doing what you think would produce the best possible expected investment outcome for that client is the single hardest part of your job. If you are doing your job right, it’s the thing you will think about the most, that you will struggle with the most. There’s a sort of nobility you feel when you’ve convinced a client to trust you to implement a portfolio of things they don’t like or understand, but which you believe with all your heart are the best possible option. As much as we’ve written about these topics, we struggle with this, too. The intervening truth is that our evaluation of what is best for a client must always take into account the willingness of a client to stick with what we’ve designed for them. But unless we’re going to evaluate it on a case-by-case basis (please don’t), we need a framework for how we will answer the CAF problem.

I offer my humble submission, in three fairly easy rules:  

  • In matters of costs and independence, always do what you believe to be the best possible thing.
  • In matters of quantity of risk, always do what you believe to be the best possible thing.
  • In all other matters, seek the best possible thing wherever you can, but recognize that a client leaving the plan is likely to do him or her more harm than the good your best possible thing will achieve.

You may not come to the same conclusion. That’s fine. But if you’re managing money for clients and haven’t tried to explicitly define the places to take a stand and the places to show flexibility to prevent worse decisions, it’s time. Get it down on paper and make it part of your process.

The Alchemy of Narrative

[Ed. note: I’m often asked what authors have influenced me, or who they can read to get another perspective on narrative in markets. Top of the list should be Chancellor Palpatine George Soros, and the first book to read is “The Alchemy of Finance”. So glad to see ET contributor Demonetized rediscovering Soros with this note!

Also, if you want to read an oldie-but-goodie ET piece on all this, check out “The Music of the Spheres and the Alchemy of Finance“. It was one of my very first articles, and is also the origin story of my avatar, Claudius Ptolemy.]


I revisited some of George Soros’s writing on reflexivity over the weekend (thanks Ben!). In doing so, I realized my initial reading, years ago, had been extremely superficial. Back then, I focused on feedback loops as amplifying the usual cognitive and emotional biases we point to in investment writing. Things like confirmation bias and loss aversion and overconfidence. This reading of Soros wasn’t necessarily wrong. But it was narrow and incomplete.

When Soros writes about reflexivity, he isn’t just arguing cognitive errors made by market participants cause prices to diverge from the objective reality of the fundamentals in self-reinforcing feedback loops. He’s arguing the fundamentals are often, if not always, themselves subjective realities.  

In this 2009 piece published in the FT, for example, Soros wrote:

Feedback loops can be either negative or positive. Negative feedback brings the participants’ views and the actual situation closer together; positive feedback drives them further apart. In other words, a negative feedback process is self-correcting. It can go on forever and if there are no significant changes in external reality, it may eventually lead to an equilibrium where the participants’ views come to correspond to the actual state of affairs. That is what is supposed to happen in financial markets. So equilibrium, which is the central case in economics, turns out to be an extreme case of negative feedback, a limiting case in my conceptual framework.

When you model a stock, or an economy, or a real estate deal, you’re not transcribing objective reality. You’re drawing a cartoon. At best your cartoon will be a reasonable estimate of the probability-weighted present value of the future expected cash flows associated with your investment. But even that’s probably a stretch. Because most of the modeling we do is based on statements or assumptions with embedded reflexivity.

Soros again:

Consider the statement, “it is raining.” That statement is true or false depending on whether it is, in fact, raining. Now consider the statement, “This is a revolutionary moment.” That statement is reflexive, and its truth value depends on the impact it makes.

What Soros is describing here is Narrative–and in particular Common Knowledge. What isn’t made so clear in his writing, at least what I’ve read of it, are the precise mechanisms through which reflexive statements propagate. But it all clicked into place for me during my rereading. To borrow Soros’s framing: the truth value of a reflexive statement is a function of the credibility of the person or institution making it.

In other words, Missionaries drive reflexive processes. Why?

Because making reflexive statements with high truth values is something only Missionaries can do. Only Missionaries have the power to create and shape Common Knowledge

Consider the reflexive statement: “the fundamentals are sound.”

The statement has no truth value whatsoever if I write it on this blog. Not for any reason related to the intrinsic qualities of the fundamentals and their relative soundness or unsoundness, but because my writing on this blog will not have any impact on market prices. Form an Information Theory perspective, this blog contains very little information (if any).

Now, if Jay Powell says “the fundamentals are sound”, that’s an entirely different proposition. Because Jay Powell can do something I can’t. Jay Powell can move the market. Jay Powell can even alter the strategic calculus for his Missionary brethren. Most public statements Jay Powell makes are therefore chock full of information.

If the market accepts the statement “the fundamentals are sound” at face value, it may rise in acknowledgement of the sound fundamentals. On the other hand, the market might take the statement as meaning the Fed will raise interest rates to prevent the economy from overheating, and therefore fall in anticipation of tighter financial conditions. Likewise, the statement “the fundamentals are unsound” can have a positive effect, if market participants interpret it as a signal for looser financial conditions. Sound familiar? We have, after all, been living this subjective reality for the last decade or so.

The information content of Jay Powell’s statements is always high.

The truth value of Jay Powell’s statements varies with their impact. 

Missionaries use reflexive statements to create and shape subjective realities for the rest of us.

Fed Watching is the ultimate reflexive sport. If you believe there is some kind of capital-T objective Truth to be found in Fed Watching, I am sorry to be the one to tell you but you are one of the suckers at the table. The Fed knows we all know that everyone knows the information content of Jay Powell’s statements is high. (We call them Fed Days, for god’s sake) The Fed plays the Forward Guidance Game accordingly. Sometimes it uses its “data” and “research.” Sometimes it speaks through one of its other hydra heads. The tools and tactics vary, but they’re all deployed to the same end: to shape the subjective realities of various economic and political actors.

The thrust of Soros’s writing is that all social systems are subject to reflexivity.

In other words: it’s the Missionaries’ world, and the rest of us are just living in it.


The Zeitgeist | 2.15.2019

This is our feature of the 10 (or so) most on-narrative (i.e. interconnected, highly similar) stories in financial media. It’s not a list of best articles, or articles we think are most interesting, or articles we agree with. But if you’re going to read 5-10 stories when you start your day, these are the ones that are most connected to the financial news that got published today.

Facebook in talks with FTC as possible record fine looms

Tech Giants Are Increasingly Designing Their Own Custom Chips – How to Play It

Deere’s CEO Calls Out Tariffs and Trade as Profit Disappoints

How to Play the Fed’s Coming Rate Cut

Six Flags Sinks as Revenue Misses Estimates Because of ‘Challenging’ China

DealBook Briefing: The Bigger Picture Behind Amazon Ditching N.Y.

How Bill Daley became rich at the crossroads of government and business (Ed Note: My stars! Do tell!)

Nvidia Shares Pop as Earnings Top Estimates