Until Further Notice

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Since last week, we have received a number of requests to amplify our views on certain provisions of the CARES Act. Rather than opine on individual public shareholder bailouts likely to be executed under this act and its likely successor bills in 2020, we determined it would be easier to provide an easy-to-follow decision chart that will tell you in advance what our opinion will be.

Thank you for your understanding.

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The Miracle Max of MBS

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Miracle Max: Don’t rush me, sonny. You rush a miracle man, you get rotten miracles. You got money?

Inigo Montoya: Sixty-five.

Miracle Max: Sheesh! I never worked for so little. Except once, and that was a very noble cause.

Inigo: This is noble sir. His wife is… crippled. The children are on the brink of starvation.

Miracle Max: Are you a rotten liar!

Inigo: I need him to help avenge my father, murdered these twenty years.

Miracle Max: Your first story was better.

The Princess Bride (1987)

We have published fewer Zeitgeist notes in the last few weeks. The reason won’t be surprising: they’d all be about the same thing, more or less. Sometimes certain language dominates market attention.

This is one of those times.

Even then, there are occasionally articles which hit our screens and so capture the spirit of the age in multiple ways at once that it would be almost criminal of us not to include them.

This is one of those times.

Colony’s Barrack Urges Margin Call Moratorium in CMBS Market [Bloomberg]

In most Zeitgeist submissions, we excerpt enough of an article to give you a sense of what it is about and why we think its language brought it to the top of our Zeitgeist dashboard. In those cases maybe it isn’t necessary to read the full article. I hope you will make an exception for this one – read it in full. Once you do, I suspect you’ll get the same sense that I did.

This is not news.

This is not even fiat news.

This is a press release.

The article’s opening salvo permits its subject – Colony Capital Chairman Tom Barrack – to frame the issue of bailing out CMBS investors in morally loaded terms: doing so would represent “cooperation” and “support.”

“America needs the immediate cooperation and support from our banking sector,” Barrack, chairman and chief executive officer of Colony Capital Inc., said in a white paper he posted on Medium.

Source: Bloomberg, Colony’s Barrack Urges Margin Call Moratorium in CMBS Market (3/29/2020)

In the very next paragraph, the author helpfully provides contrasting ethical framing for what the banks are currently doing. Instead of cooperating and supporting, they are demanding and seizing.

The threat of widespread defaults has caused waves of selling in the market for commercial mortgage-backed securities. Banks in turn are demanding cash and seizing collateral from vehicles that borrowed to invest in CMBS and other forms of asset-backed debt, a practice that drives down prices even further. One index of mortgage REITs, or real estate investment trusts, has collapsed by more than 50%, in part because of those margin calls.

Source: Bloomberg, Colony’s Barrack Urges Margin Call Moratorium in CMBS Market (3/29/2020)

From there the article simply cribs the emotional appeal straight from Colony’s Medium article and Barrack’s Twitter feed.

At stake, he said, are trillions of dollars in securities owned by insurers, asset managers, pension funds — even banks themselves…If the investment vehicles get such relief, they can subsequently grant forbearance to the hotels, retailers, malls and other tenants and borrowers who can’t pay rent or interest while the economy is largely shut down because of the pandemic, Barrack said.

Source: Bloomberg, Colony’s Barrack Urges Margin Call Moratorium in CMBS Market (3/29/2020)

Then, because it’s 2020 and this is how we do it now, the article presents – verbatim – Barrack’s tweet arguing that the only way to help American enterprise is by bailing out leveraged investors in commercial real estate securities. Words fail.

The only way to accomplish relief for American enterprises is by receiving forbearances on the interest obligations that real estate owners and mortgage real estate investment trusts owe to the banks and their other security lenders.

Source: Twitter, Posted 8:57 PM, March 28, 2020

There are no challenges to factual assertions made by the subject. No alternative views are presented. No counterpoint is provided. No contextual facts are sourced. Do you, dear reader, think that Mr. Barrack’s role as the chairman of President Trump’s inaugural committee might be a newsworthy addition to the article’s cheerful characterization of him as a “longtime friend?” The article does nothing to shed new light on a topic. It provides a free lectern and and a megaphone for the advocacy aims of one particular market missionary looking to establish a preferred narrative.

Apparently it also serves as the promo for an interview – today on Bloomberg TV!


Look, I’m not mad at Tom for bringing his mostly dead asset class to Miracle Max and asking for a miracle. That’s his job.

I’m also not mad at the author for seeking out knowledgeable, well-known interview subjects to probe about current issues and news. That’s his job (and in full disclosure, many of his interviews are really very good).

But there is an emerging news practice of “presenting verbatim what famous people said” under the tenuous guise that what a wealthy, famous person said or tweeted is inherently newsworthy in itself, rather than newsworthy in context of some broader event of public interest. This practice played a not-insignificant role in the woefully unchallenged and uncontextualized repetition of talking points from WHO leaders, New York City health officials and others in many outlets over the past few months. It has been the on-air M.O. of financial media for far longer.

More importantly, the practice forms a critical part of the machinery of narrative construction and transmission.

Clear eyes.

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Once in a Lifetime

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Epsilon Theory PDF Download (paid subscription required): Once In A Lifetime



The Moving Finger writes; and, having writ,
Moves on: nor all thy Piety nor Wit
Shall lure it back to cancel half a Line,
Nor all thy Tears wash out a Word of it.

– Rubaiyat of Omar Khayyam (c. 1080)

That’s a poem attributed to Omar Khayyam, an 11th century Persian philosopher and all-around genius who lived near the modern-day city of Qom, the epicenter of the COVID-19 plague wracking Iran today.

Here’s another philosopher and all-around genius, David Byrne, saying the same thing one thousand years later.


And you may ask yourself
Am I right? Am I wrong?
And you may say to yourself
“My God! What have I done?”

– Once In A Lifetime (1981)

David Byrne lives in the modern-day city of New York, the epicenter of the COVID-19 plague wracking the United States today.

It’s all the same, you know. The dad in Qom coughing up a lung who loves his kids and is loved by them is exactly the same as the dad in New York coughing up a lung who loves his kids and is loved by them. I know we don’t think of it that way. Hell, I know plenty of people in my home state of Alabama who don’t even think a dad in Montgomery is the same as a dad in New York, much less a dad in freakin’ Qom, Iran. But they are. The same, that is. Exactly the same.

We will never win this war until we regain our sense of empathy, until we regain our ability to appreciate the pain that others endure in their struggle against this common enemy.

It’s how Gandhi defined religion.


I call him religious who understands the suffering of others.


Of course, most of our leaders wouldn’t know Gandhi from a hole in the head.

Instead, our leaders, if they think of empathy at all, think in terms of Steve Martin’s advice.


Before you criticize a man, walk a mile in his shoes. That way, when you do criticize him, you’ll be a mile away and have his shoes.


You know what people without empathy are, right? They’re sociopaths, and I use that word in an entirely clinical sense. Because that’s what we are today, clinically speaking, a society largely governed by high-functioning sociopaths in both our economy and our politics, humans devoid of empathy for any other human outside of the narrowest bonds of convention. And they’re training us to be just like them.

It’s not a left/right thing. It’s not a Republican/Democrat thing. It’s not an American thing. It’s not even a boomer thing.

It’s a Nudging Oligarchy thing. It’s a Nudging State thing. It’s a Long Now thing.

Why do high-functioning sociopaths and their Renfields manufacture bullshit “analysis” to convince you that the sky is green and it’s only the olds anyway so what’s the big deal and the really important thing is to go back to work and save their wealth the economy? It’s not really to minimize the disease. That’s just the text. The sub-text … the REAL message … is to minimize your empathy, to convince you to abdicate your autonomy of mind and heart to THEM.

The real message is to convince you that 2 + 2 = 5.

Iakov Guminer, Arithmetic of an alternative plan (1931)

In the end the Party would announce that two and two made five, and you would have to believe it. It was inevitable that they should make that claim sooner or later: the logic of their position demanded it. Not merely the validity of experience, but the very existence of external reality, was tacitly denied by their philosophy. The heresy of heresies was common sense.

And what was terrifying was not that they would kill you for thinking otherwise, but that they might be right.

— George Orwell, 1984

The Long Now is the Fiat World of reality by declaration, where we are TOLD that inflation does not exist, where we are TOLD that wealth inequality and meager productivity and negative savings rates just “happen”, where we are TOLD that we must vote for ridiculous candidates to be a good Republican or a good Democrat, where we are TOLD that we must buy ridiculous securities to be a good investor, and where we are TOLD that we must borrow ridiculous sums to be a good parent or a good citizen.

And where we are now TOLD that we must join our leaders in sociopathy and division to be a good American.

What do I mean by sociopathy and division?

I mean the way our political and economic leaders beat the narrative drum about how this virus prefers to kill the old rather than the young, as if that matters for our policy choices, as if older Americans are lesser Americans, as if we should think of them differently – with less empathy – than Americans who are more like “us”.

I mean the way our political and economic leaders beat the narrative drum about how this virus prefers to kill those with “pre-existing conditions”, as if that matters for our policy choices, as if chronically ill Americans are lesser Americans, as if we should think of them differently – with less empathy – than Americans who are more like “us”.

I mean the way our political and economic leaders beat the narrative drum about how this virus hits certain “hotspot” regions, as if that matters for our policy choices, as if hotspot regions are lesser regions, as if we should think of Americans who live there differently – with less empathy – than Americans who are in “our” region.


The future is already here – it’s just not evenly distributed.

– William Gibson

We are, all of us, old. We are, all of us, chronically ill. We are, all of us, living in a hotspot.

Some of us are already there. Some of us aren’t. Yet.

Age, illness, environment … they are unevenly distributed among us. But they are the future for all of us just the same. What is empathy? It is the recognition of this truth. What is our duty? To shout this truth from the rooftops. To require our leaders to bend to OUR will, and not the other way around.

Enough. It’s time for the Pack to howl.

The moving finger writes, and having writ moves on.

The policy decisions we make cannot be undone. We have one shot at this.

Nor all thy MAGA piety nor all thy Twitter wit shall lure it back to cancel half a line.
Nor all thy SJW tears wash out a word of it.

Given the irrevocable life-and-death nature of our policy decisions today … given the profound UNCERTAINTY that governs the impact of a pandemic on society, as opposed to mere RISK … we should not seek to maximize our utility.

Instead, we should seek to minimize our maximum regret.

A risk is an event where we can assign some sort of reasonable probability to its occurrence AND some sort of reasonable assessment of its potential impact, so that we can calculate what’s called an “expected utility” … in English, so that we can talk meaningfully about risk versus reward of some action or decision. To use Donald Rumsfeld’s oft-maligned but in-truth brilliant characterization, a risk is a “known unknown”.

When people talk about the trade off between the national economic impact of shutting down the country and the national health impact of shutting down the country, they are using the language and the calculator of risk.

It’s not that people are wrong to say there’s a trade off. There IS a trade off. Where they’re wrong is to think that there is some equilibrium here – some sort of balancing point in our policy so that we can maximize our national economic expected utility given our national health expected utility and vice versa.

Where they’re wrong is to think in terms of risk and expected utility in the first place!

This image has an empty alt attribute; its file name is rumsfeld-1.jpeg

“There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know.”

An uncertainty is an event where either we can’t know the probabilities at all or – as in the case of public policy in the face of a pandemic – we’re only going to play the game once.

To use a poker analogy, my decision-making process for playing a hand is going to be entirely different if I’m only going to be dealt one hand for the rest of my life or if I’m playing all night and every night. If I’m playing all night and every night, I’ll play the odds in every hand, trusting the odds to even out in my favor over time. If I’m only playing one hand, though, where an unlucky break cannot be salvageable over time … what’s my tolerance for that?

In Rumsfeldian terms, uncertainty is an “unknown unknown”, and in his mind (he was Secretary of Defense, after all) the classic example of an uncertainty was going to war. Our war is with COVID-19. We get to fight once and only once. Whether we win or we lose is an uncertainty, not a risk, and we need a decision-making process designed specifically for THAT.

The decision-making strategy designed specifically for uncertainty is Minimax Regret.

Minimax Regret was invented (or at least formalized) in 1951 by Leonard “Jimmie” Savage, one of the founding fathers of what we now call behavioral economics. Savage played a critical role, albeit behind the scenes, in the work of three immortals of modern social science. He was John von Neumann’s right-hand man during World War II, a close colleague of Milton Friedman’s (the second half of the Friedman-Savage utility function), and the person who introduced Paul Samuelson to the concept of random walks and stochastic processes in finance (via Louis Bachelier) … not too shabby! Savage died in 1971 at the age of 53, so he’s not nearly as well-known as he should be, but his Foundations of Statistics remains a seminal work for anyone interested in decision-making in general and Bayesian inference in particular.

As the name suggests, the Minimax Regret strategy wants to minimize your maximum regret in any decision process. This is not at all the same thing as minimizing your maximum loss. The concept of regret is a much more powerful and flexible concept than mere loss, because it’s entirely subjective. But that’s exactly what makes the strategy human. That’s exactly what makes the strategy real when the ultimate human chips of living and dying are on the table.

Minimax Regret downplays or eliminates the role that probability distributions play in the decision-making process.

Minimax Regret doesn’t calculate the odds and the expected utilities over multiple rolls of the dice. Minimax Regret says forget the odds … how would you FEEL if you rolled the dice that one time and got snake-eyes?

More technically, Minimax Regret asks how would you feel if you took Action A and Result 1 occurs? What about Result 2? Result 3? What about Action B and Result 4, 5, or 6?  Now out of those six potential combinations of action + result, what is the worst possible result “branch” associated with each action “tree”? Whichever action tree holds the worst possible result branch … well, don’t do THAT. Doing anything but THAT (technically, doing the action that gives you the best worst-result branch) is the rational decision choice from a Minimax Regret perspective.

The motto of Minimax Regret is not Know the World … it’s Know Thyself.

Because when faced with an uncertain event, where you only have one roll of the dice on a probabilistic event, that’s all we can know.

Ourselves.

So what do I know about myself? What’s MY maximum regret that must be minimized regardless of anything else in this single-play game of coping with a virus that has a natural R-0 of 3+ and is 10-20x more deadly than the flu? It’s losing one of these guys.

We’ve all got a photograph like this. An old picture of the people who matter most to us in the world.

Time flies. Fifteen years. That unhappy little girl in the front row just heard back from college admissions yesterday. Good news.

I’m eligible for AARP now. My mother is now in her late 70s. She has what you’d call a “pre-existing condition” I suppose, but so will I in another 15 years.

The future is already here in this picture. It just wasn’t evenly distributed.

Now here’s the trick. The trick to rejecting the sociopathy and division that our leaders inject in our veins. The trick to engaging the world with a full heart.

The trick is to take the love you feel for your family even if they are old, even if they are infirm, even if they live distantly from you, geographically or emotionally … and extend the knowledge of that love to everyone else.

I’m not asking you to love that dad in Qom like you love your dad. I’m not asking you to be a saint.

I’m asking for empathy. I’m asking you to recognize that there but by the grace of God go I, that in fact you DO recognize exactly that when it comes to your family, that in fact you DO recognize that the future and the present and the past are as one in love … just not evenly distributed at any given time. I’m asking you to recognize that everyone in the world shares this and deserves this. I’m asking you to treat every human as an autonomous being of free will, capable of love and being loved. Just as you would want them to do unto you.

It won’t diminish the love you feel for your family. I promise. Love and empathy don’t work that way. It’s not a transaction.

It’s not a trade off.

And once you stop thinking in terms of trade offs, once you stop thinking in terms of probabilities and projected mortality rates and cost/benefit analysis and this expected utility model versus that expected utility model … once you start thinking in terms of empathy and Minimax Regret … everything will change for you.

Specifically and in terms of policy, what does a decision-making structure of Minimax Regret combined with empathy require?

I don’t know all the details. I don’t know if I’m missing key elements. But I believe strongly that any plan requires these two elements.

Keep our healthcare workers and first responders safe.

If they fall, we all fall. Every worst outcome has this as a common denominator. How do we keep them safe? Massive quantities of personal protective equipment (PPE). Everywhere. On-demand. At a granular level of the front lines.

Create common knowledge of safe zones, safe towns, safe events, safe cities.

Every worst outcome has the opposite: everyone knows that everyone knows that the contagious walk among us, creating a giant Prisoners Dilemma game of constant defection everywhere you look. Every nation for itself. Every state for itself. Every county, every city, every company, every family for itself. How do we create common knowledge of safety? Ubiquitous and rapid testing. Everywhere. All the time.

And until we can manage those two things, we lock it down. We keep the R-0 of this bastard virus <1. Everywhere. As long as it takes.

Empathy + Minimax Regret = How to Fight COVID-19

2 + 2 = 4


I’ll close this with a personal note. Because that’s what this war is for all of us … personal.

There’s another Talking Heads song that everyone knows, and that’s Life In Wartime, which Byrne wrote in 1979, two years before Once In A Lifetime. Here are the lyrics you know by heart:

This ain’t no party, this ain’t no disco,
This ain’t no fooling around
No time for dancing, or lovey dovey,
I ain’t got time for that now

Certainly pertinent for today! But these are the lyrics I’m thinking about.

You make me shiver, I feel so tender,
We make a pretty good team
Don’t get exhausted, I’ll do some driving,
You ought to get you some sleep

Do you have a partner? Do you have a pack?

That’s how we get through a war.

That’s how we get through a lifetime.

Find your partner. Find your pack.


Epsilon Theory PDF Download (paid subscription required): Once In A Lifetime


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When the Story Bends

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The pandemic narrative changed this weekend. I’m guessing you felt it.

Let me show you what you probably felt.

Pictured below is a network graph of articles published by high-circulation US media outlets about COVID-19 the weekend of March 14th and 15th. Closely clustered articles and those connected by lines are more similar in the language they use. Bold-faced nodes and connector lines are those which we judge to be about the stock market, the economy, unemployment and a prospective recession. Colors reference different language-based clusters assigned by the graphing algorithm. The lighter, faded nodes and lines are those which are about other topics.

Source: Epsilon Theory, Quid

And here is a network graph of articles published this most recent weekend (in case you’re curious, we chose parallel weekends to minimize bias relating to the tendency of weekday news to skew towards financial markets).

Source: Epsilon Theory, Quid

Even if you know nothing about what these graphs are doing or what they mean, my guess is you will notice two things. You’ll notice there are a lot more bold-faced dots this weekend than last. That just means outlets published a lot more pandemic articles that referenced the economic impact, too. That isn’t nothing, but in our opinion it isn’t the most interesting feature of the graph. Much more interesting to us is that the articles with language about economics impact and financial markets are far more well-distributed AND far more central. They don’t exist alongside other pandemic-related topics: they are explicitly integrated into EVERY pandemic-related topic.

In less than one week, the narrative shifted from “COVID-19 is a public health crisis” to “COVID-19 is a financial crisis.”

Such is the power of the narrative missionary.


Don’t mistake me. It IS both. Obviously it is both. The economic crunch that will be felt by hourly workers, service workers, and small business owners will go beyond whatever Congress’s bill will have the ability to rectify. It is very real. There are second-order effects and frictional effects that are very real. An SBA loan facility may not be able to restart a restaurant that already closed. A relief check may not be able to pay rent on an apartment someone has already been evicted from. A world in which people are allowed to go back into public doesn’t mean people are immediately going to crowd back into theaters to watch performing artists. This is going to be bad. This is going to be unevenly felt. We cannot predict all of those effects. That’s why we should all be creative in looking for ways to provide bottom-up support for those communities. That’s why we should continue to prod targeted sacrificial giving to local communities from all Americans.

That’s also why any time and treasure spent thinking about large public equity-holders who knowingly took equity risk in for-profit enterprises is time and treasure wasted.

But even if COVID-19 IS both a public health crisis AND a financial crisis, it should still matter to us when we observe a rapid, coordinated shift in the framing of it across public figure statements and media.

As always, the most important question we can ask when consuming media is this: why am I reading this now?

I can’t tell you that there are not people who examined the situation last week and suddenly came to earnest conclusions that the economic costs to small businesses and families might be more extreme than they thought. Surely such people exist. But I can also tell you that the overlap between groups promoting this framing and those who two weeks prior called it a media-fueled panic and those who two weeks prior to that called it ‘just the flu’ is significant.

If I had been calling something a ‘hoax’ and a ‘panic’ only to find out that I was dreadfully wrong, can you imagine how seductive it would be to be handed a way to retcon a new reality? How delighted might I be to say what I was really doing all along wasn’t completely mismanaging an unfolding pandemic, but instead carefully weighing the pluses and minuses of subjecting the population to massive economic pain or a medical crisis?

I’m really not being cynical. It really is seductive. I really am empathetic. I really do think that public servants who want to do good and know they’ve messed up the response thus far are grabbing this as a lifeline. And I really do believe that many (okay, some) of them are NOT just worried about how stocks are doing, but about how families and towns and communities are doing.

But the answer is NOT the arbitrary, panicked rejection of the distancing and quarantine measures put in place across the country.


Friends, we can carry multiple ideas in our head at the same time. We can believe that this is a public health crisis AND that this is a financial crisis AND that it’s probably possible for people to exercise responsible social distancing in parks AND that the recent emphasis by public figures to frame reopening the economy as our direst need represents an attempt to effect early exits from social distancing measures in regions that have ZERO business exiting social distancing measures.

And maybe you carry one of those ideas with a bit more weight than another. That’s fine. Because it doesn’t matter. Regardless of what it is that you or I care most about, the best path to fixing it is the same:

  • We must give the health care system the time and breathing room to care for the known and as yet unknown clusters that exist in America;
  • We must take the uncertainty we created through weeks of universal undertesting out of the system;
  • We must give people confidence that there will be an end to quarantines by communicating how that will take place; and
  • We must give markets confidence that the economy will be restarted by communicating how that will take place.

We achieve precisely ZERO of these things by making vague assurances about “reopening America!”

We achieve EACH AND EVERY ONE of these things by developing and communicating a clear plan for how we will use widespread testing to craft a workable American version of the test-and trace approaches that have successfully brought multiple economies in Asia back online.

And we do it NOW.

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Getting PPE to Healthcare Workers and First Responders

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I think there are two critical logistical requirements to coming out of the current crisis.

Develop and distribute a quick, dependable CV-19 test. Everywhere. On-demand.

Manufacture and distribute effective personal protection equipment (PPE) to healthcare workers and first responders. Everywhere. On-demand.

Rusty and I can’t do much to help the first, except to continue to call attention to its urgent need and its current lack. But maybe we can do something to help the second.

First a disclaimer. It’s an important disclaimer and you should read it.

Everything we’re doing here is a personal effort. Meaning that nothing I am describing here is affiliated with Second Foundation Partners (the company that Rusty and I started) or with Epsilon Theory (the brand name for the publishing we do with Second Foundation Partners). We have zero experience with sourcing or distributing medical supplies. We are making zero guarantees or promises. We will almost certainly make mistakes. Don’t get your hopes up. But we’re going to try.

Second, we are definitely not alone in trying to help healthcare workers and emergency responders get the protective equipment they need. In particular, I would call your attention to Project N95: The National COVID-19 Medical Equipment Clearinghouse as an example of people trying to make a difference in matching supply with need. There are many groups trying to accomplish similar goals, and I doubt you can go wrong working with any of them.

Third, what we definitely do NOT want to do is get in the way of purchasing professionals within the healthcare system or within local, state and federal emergency response agencies who are seeking to make bulk PPE purchases. There is both an enormous amount of price gouging taking place in the medical supply market AND an enormous number of buyers chasing the same supply. We do not want to do anything that makes it more difficult or more expensive to accomplish the goal that we ALL share.

Here’s where we think we can help.

First, we can help collect information on protective equipment NEED at a very granular level, down to the individual nurse or clinic or fire department that needs N95 masks. We’ve put together a form below to take in that information. This is not the place to put in an order for 20,000 masks. This is the place to say you really really need 50 to 100 masks.

Second, we can help SOURCE protective equipment in novel ways, principally by working with the China-based employees of a major US corporation, who (for now at least) are able to purchase PPE on a personal basis, bundle it, and ship it to the US. Once the equipment is in the US, we can help distribute it on a granular level to the healthcare workers and first responders we know about. We can also try to source larger-than-personal-but-smaller-than-bulk orders (like 10k masks) directly from suppliers without screwing up the market for large purchasers.

Third, we can help PAY FOR this protective equipment by setting up a donation facility within an established 501-c-3 organization, where we can give our own personal money and accept donations from others.

Of these three things we can do, items #1 and #2 are happening now. Between us and the employees of this major US corporation, we’ve collected shipping information for about 250 US hospitals, clinics and first responders at a very granular level. The China-based employees of this US corporation have started buying whatever protective equipment they can. We are trying to supplement these efforts with larger-than-personal-but-smaller-than-bulk purchases. Again, no promises and no timetable for delivery. But this is happening.

Item #3 is getting off the ground, but will take the longest to set up. At some point we expect you will be able to make a donation to support these efforts, but not yet.


The form below is to collect information from individuals and organizations at a very granular level on their need for PPE. Right now we’re focused on N95 masks, although we’re also starting to work on isolation gowns. If you enter your information here, we WILL share this information with other organizations who we think might be able to get you supplies. We won’t share this information for any other reason without checking with you first, but please don’t assume confidentiality with anything you enter here.

We will keep you posted as best we can on progress, but again … no promises. Thank you! And stay safe!

#OurFinestHour

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Please enter your information so we can keep you posted on progress here.

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Pandemic Playbook Notes – 3/23

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This is a running set of observations of changes in the structures of narratives relative to our initial document published on March 17th. You can read it here for context.

We don’t see any material change in the Known Knowns or Unknown Unknowns as described in the prior document, and have not updated them here. That means that we continue to believe the right broad playbook relies on reduced use of leverage, reduced reliance on correlation and diversification assumptions, reduced position-level and risk-level concentration.

However, with the week’s news and unprecedented action by the Federal Reserve, we update our assessment of the narrative structure of what we previously coined the Known Unknowns: risks that it may be possible to model probabilistically. The two with material changes? Both in policy response land: the narratives surrounding Fiscal and Monetary Policy response.

TopicNarrative StructureNarrative Structure Changes Since 3/17
Current General Spread / Fear of Covid-19:Mixed (N.C.)No material changes.

We continue to think that means there is risk in both directions on bets on the speed / expansion of spread. 

That said, we do think, despite the fact that #DontTestDontTell is still rampant in many areas, the ramp this week in testing is real and probably underdiscounted. Numbers in the US are becoming less fictional and the reality of the situation is becoming more widely acknowledged. As we communicated in an early Pro note, testing steadily removes one source of uncertainty from the system.

Similarly, as argued here, we think it is entirely possible to change course from the overwhelmingly bearish transition from “short and deep” to a “long and brutal” narrative. Testing and screening is a fundamental part of how that would take place.

If you are outright short risky assets over anything other than a trading horizon, your bet is at least in part a bet against coordinated, coherent government messaging about the exit strategy from distancing and lockdowns. Not saying that’s a bad bet, but now more than ever, know what edge you are counting on to make you right.
Political SeriousnessConsensus (N.C.)No material changes.

Separating this from the slowness of fiscal response (covered below), the general sense of seriousness conveyed in media reports, especially about local and state governments, remains high. We are somewhat concerned about emerging language relating to agitation for a “date certain” that could change the narrative structure. (As one subscriber pointed out to us, this appeared to accelerate over the weekend, with more commentators expressing concern about the looming economic impact of distancing. We agree.) Either way, we think this remains mostly a one-way risk to the downside for the near term.
Depth of Economic OutcomesConsensus (N.C.)No material changes.

The common knowledge about GPS / Earnings / Unemployment outcomes for Q1 and Q2 continued to deepen – each of the banks came out with progressively more aggressive drops for these periods. Consistent with our expectations, this didn’t seem to cause much concern or consternation. We continue to think this strong common knowledge structure will create idiosyncratic opportunities (to the upside) in the coming weeks/months for companies who buck that common knowledge.
Length of Economic OutcomesComplacent (N.C.)No material changes.

The potential transition of common knowledge from “short and deep” to “long and brutal” remains our biggest concern. We think the tail of this issue is almost entirely in one direction. Given its attachment to the Unknown Unknowns, it also keeps our posture for most short-horizon investors as underweight risky assets.
Cases of Economic RuinComplacent
(with Exceptions)

(N.C.)
No material changes.

We still think markets remain focused on the obvious first-order ruin risks (airlines, hotels, etc.).
Emotional / Visceral ResponseComplacent (N.C.)No material changes.

This week through, say, April 10th will be the ones with the first images coming from crowded NYC hospitals with empty NYC streets. We think there is probably short-run risk associated with this that doesn’t yet seem present in the narrative structure we have observed. It is very hard to quantify these effects.
Fiscal Policy ResponseMixed (N.C.)Some change.

We still see this structure as mixed, with risk of creating volatility in both directions. But with bickering in the Senate, the focus of the narrative seems to be shifting from how large to how long is it going to take. We think this makes it a likely (and increasing) source of volatility this week if unresolved. As noted above on a separate issue, know that your short run bets are probably also bets on the timing of, discussion of roadblocks for, and ultimate sticker size of the senate’s fiscal plan.
Monetary Policy ResponseMixed (N.C.)Some change.

We observed in our initial assessment that the common knowledge that the Fed was “out of ammo” created some upside asymmetry in the market’s likely response to new information. This morning proved that to be the case, although truth be told, the perking up from limit down futures was still pretty limited given the remarkable expansiveness of the steps taken. We STILL think this narrative structure exists, and that the common knowledge that the Fed is out of bullets continues to support asymmetrically positive market response to rabbits they may pull out of hats from time to time. But probably less, barring a relaxing of restrictions on buying equity securities outright.
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Do The Right Thing

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Epsilon Theory PDF Download (paid subscription required): Do The Right Thing


I’m angry that I have to write this note.

I’m angry that when we have people dying left and right in this country, when there is an urgent need for ALL of us to spend ALL of our time helping our families, helping our neighbors, helping our emergency responders and healthcare workers and social service providers to DO THEIR JOBS … that I have to write a note about the airline industry and how to structure the bail-out of United, Delta, American and Southwest. And Boeing.

But I do have to write this note, because of course the raccoons and the high-functioning sociopaths are out in force on this, looking to get their private losses socialized and their private gains locked in. Looking to get their 30 pieces of silver.

So I’m not going to spend a lot of time on this. I’m just going to give all of you the facts and let you all take it from here. Because if this goes down anywhere near where I think it’s going to go down … well, one day when we’ve passed through this valley there’s going to be a reckoning, and we will visit our righteous anger on those who abused the public trust.

Like Disney:

Like Tesla:

But that’s for another day.

Today we’re going to talk about airlines, their CEOs, and their major shareholders. Trust me, there will be plenty of righteous anger to go around.

You know, back in the day, my hedge fund owned a chunk of Ryanair, the cut-rate Irish airline. We didn’t own it for long, because … Michael O’Leary … but it was actually a Michael O’Leary quote (he’s Ryanair’s founder and CEO) that got me interested in the company and the industry in the first place. I’ll try to paraphrase this to avoid the profanity.

You think airlines are a service industry? You *$#@ idiots. Airlines are a UTILITY.

So right. Airlines are exactly the same thing as an electrical generation plant. They provide the transportation outcome, the getting-from-point-a-to-point-b-in-a-short-time that our modern economy depends on just as much as it depends on electricity. Or banking. Or healthcare.

Commercial air travel isn’t a luxury. It isn’t a service that we can purchase or not, upgrade or downgrade as we like. Sure, the airlines present themselves as a service because they get you to pay more money if you think of them like that, but they are not a service.

Airlines are a utility.

While we’re at it, here’s another quote. You’ll never guess who said it.

Airlines are a public utility, and they should be regulated as such.

Sounds like something Bernie Sanders would say, right? Nope. That was George Will. Yes, ur-conservative free marketeer George Will. Know who passed the Airline Deregulation Act? Jimmy Carter.

Here’s one more quote.

Q. If you actually fire these people, won’t it put your air traffic control system in a hole for years to come, since you can’t just cook up a controller in — [inaudible]?

The Secretary of Transportation. That obviously depends on how many return to work. Right now we’re able to operate the system. In some areas, we’ve been very gratified by the support we’ve received. In other areas, we’ve been disappointed. And until I see the numbers, there’s no way I can answer that question

Q. How long are you prepared to run the air controller system — [inaudible]?

The Secretary of Transportation. For years, if we have to.

Q. How long does it take to train a new controller, from the waiting list?

The Secretary of Transportation. It varies; it depends on the type of center they’re going to be in. For someone to start in the system and work through the more minor office types of control situations till they get to, let’s say, a Chicago or a Washington National, it takes about 3 years. So in this case, what we’ll have to do if some of the major metropolitan areas are shut down or a considerable portion is shut down, we’ll be bringing people in from other areas that are qualified and then start bringing people through the training schools in the smaller cities and smaller airports.

This is from the 1981 press conference where Ronald Reagan announced he was firing 11,345 striking air traffic controllers, bringing all commercial aviation to a halt. He didn’t just fire them. He barred each of them from ever taking a federal job again. For life.

There were no replacement air traffic controllers. They brought in some military guys where they could, and otherwise just winged it with retirees and new trainees. And it worked. It ended up being minor blip in commercial air service for most Americans.

I’m starting with these quotes to make three simple observations.

No one is talking about putting the US airline industry out of business, least of all me. This is as strategically important an industry as exists in the country. We can and we should provide emergency financial assistance from the federal government to keep the airline industry healthy and fully functioning throughout this CV-19 crisis.

There is nothing sacrosanct or natural about our current regulatory and ownership structure for the US airline industry. Nothing.

Governments can do whatever the hell they want.

As the lawyers would say, so stipulated.

Now here are the facts about the airline industry and the rampant financialization that has infected them for the past 6+ years.

There are four publicly traded companies that account for almost all commercial air travel in the United States: Southwest, Delta, American, and United. That list is in order of passengers carried, with Southwest leading the way (>165 million people transported last year), although the other three beat Southwest handily on the industry metric of revenue-passenger-kilometers (Delta, American and United each flew their paying customers a total of about 330 billion kilometers last year).

Throughout this note, these are the four airlines I’ll be talking about. They’re the only ones that are necessary to preserve in any bailout legislation (although I’m sure all the smaller guys will be covered, too).


Fact #1 – Starting in 2014, each of the Big 4 airlines began a policy of massive stock buybacks, totaling $42.4 billion over the following 6 years.

Please, for the love of god, let’s not reignite the stock buyback wars of 2019 over this. I do not believe that buybacks are inherently evil or that they should be banned from existence. I DO believe, however, that they are intentionally used by management to obfuscate and sterilize ludicrous stock-based compensation schemes, so that much of the capital that is supposedly “returned to shareholders” through buybacks is not returned at all, but is hijacked directly into management’s pockets. I DO believe that this sterilization scheme is so widespread and so harmful to shareholders and to society that it is necessary to implement government restrictions on buybacks. You can read more of my thoughts on all this here, here and here.

Whether or not you agree with me on the evolution of stock buybacks into a ubiquitous instrument of management self-dealing, I hope that we can all agree on this: stock buybacks are a CHOICE.

I’m sorry that you airline management teams and boards of directors made a bad choice. I’m sorry that you and your shareholder base thought it was stupid and inefficient to hold more cash against the prospect of a global recession. Welcome to capitalism.

In any event, here are the numbers for stock buybacks in the airlines over the past six years, taken directly from their 10-K filings.


Fact #2 – These buybacks, together with increased debt (+78%), were the engine of an intentional strategy of heightened financial risk taking, such that buybacks were greater than free cash-flow for the group ($37.1 billion).

Speaking of choices …

Stock buybacks are only part of a corporate strategy of financialization, where leverage and capital allocation decisions are placed in service to the cartoon, market-world measurements of corporate performance – like stock price – rather than fundamental, real-world corporate performance itself.

At every turn over the past six years, management teams at the Big 4 airlines have increased debt and directed their free cash-flow towards anything they thought would prop up their stock price, at the expense of using this money to grow their core business OR protect their core business against a global recession.

This is financialization. It is the real-world hollowing out of our largest and most important private companies in order to maximize wealth generation for senior management and large institutional investors.

Here’s the data on debt and free cash-flow, as reported on Bloomberg. Debt is pretty self-explanatory. Free cash-flow (FCF) less so, so I’ll spend a moment on that.

Free cash-flow is the money you have left over after running your core business (cash-flow from operations) and after you’ve made whatever tax payments and interest payments and maintenance capital expenditures (capex) you are required to make. To be fair, different people have different ideas on how free cash-flow should be measured, particularly when it comes to these capex decisions. Your calculation of FCF for the airlines may be a bit different (I’m just taking the Bloomberg reported numbers as is), but they will be similar to what I’m reporting below.

The percentages at the bottom of the FCF chart are the percentages of free cash-flow spent on stock buybacks over the six year period. American has a negative percentage because the company bought back $13 billion worth of stock despite having negative free cash-flow over this span. As a result, American skews the overall ratio of stock buybacks to FCF for the group as a whole, but you can see that there are no choirboys here. Even the least profligate airline – Delta – spent 63% of their free cash-flow on stock buybacks.


Fact #3 – The operating fundamentals of the Big 4 airlines deteriorated over this period, with EBITDA, free cash-flow and cash-flow from operations all lower in 2019 than in 2015.

You’ve got the free cash-flow chart above. Here’s what earnings before interest, taxes, depreciation and amortization (EBITDA) and cash-flow from operations look like. High watermark in 2015, and downhill from there. Again, all data taken from Bloomberg.

It’s not conjecture that every major airline shifted its management focus from operational, long-term core business issues to financial, short-term market issues. It is fact.

Know who else stopped running their company for real-world excellence in exchange for market-world rewards? This guy.

Dennis Muilenburg, Boeing CEO and centimillionaire

Here’s my take on Boeing, a case study of how weaponized financialization and management greed destroyed a crown jewel of American industry.

This is from November of last year, btw.

And here’s my take on Dennis Muilenburg himself, the poster child for our modern Zeitgeist of outrageous management self-dealing.


Fact #4 – The CEOs of the Big 4 airlines received $430 million in stock-based compensation over this period, separate from their cash compensation, deferred benefits, etc.

Every airline CEO is just another Dennis Muilenburg.

As with Muilenburg (and with IBM’s Ginni Rometty if you want to read that take-down), I’m not going to calculate the salary and annual cash bonuses for these airline CEOs. I’m not going to count the corporate jet. I’m not going to count the perks and the club memberships and the board seats at other companies and the deferred comp and the remaining options and RSUs and all that. Nope, cash comp and deferred comp are for suckers. Just ask Jamie Dimon.

What I’ve done is go through every SEC Form-4 (this is the form that corporate insiders must file whenever they buy or sell stock) for the four current CEOs of the Big 4 airlines. Each of these guys has more than a hundred Form-4s, and each of them has to evaluated by hand. It’s a chore, and I think that it is intentionally made to be a chore (but that’s a note for another day). If you want to check my work, the SEC filing numbers are: Doug Parker (0001249552), Ed Bastian (0001289878), Gary Kelly (0001027716), and Oscar Munoz (0001237371). In all cases, I’ve combined personal holdings and family trust holdings. I’m not including all the stock-based comp these guys have received from other companies (board seats), and I’m just going back to the start of these financialization/buyback strategies in 2014.

For each CEO, I’ve compiled a comprehensive list of every share of stock in their company that they’ve sold (and the price they sold it for), every share of stock they still hold, and the price at which they’ve acquired the stock that they have sold or currently hold (usually the acquisition price is $0, but occasionally they exercise an option). Notably on that last item, there are ZERO examples of any of these CEOs buying stock in their own company in the open market. ZERO.

From these three data points (value of stock sold, value of stock held, cost of stock sold and held), we can construct the total profit each CEO has made on their stock transactions in their respective company. Realized stock sales + unrealized stock sales – cost basis = total stock-based value received.

Here’s the compiled data.

I know that I just said each of these guys was another Dennis Muilenburg, but that’s not really true, is it? When it comes to management self-dealing and enrichment, no one tops Doug Parker of American Airlines (although Ed Bastian of Delta seems intent on making up for lost time). I do not think it’s an accident that Doug Parker is not only the CEO of American, he is also Chairman of the board.

You’re not reading this chart wrong. Doug Parker has pocketed more than $150 million through his sale of 3.6 million shares in American Airlines. These sales were particularly egregious in 2015 – 2016, not coincidentally the period of American’s greatest stock buyback activity. How egregious were the stock sales? For a twelve month period from mid-2015 through mid-2016, Doug Parker pocketed between $4 million and $11 million in stock sales per month. How large were the stock buybacks? Two-thirds of American’s $13 billion in stock buybacks over this six year period occurred over these same months.

Here’s another fun fact about Doug Parker. For a brief shining moment, American Airline’s stock price went above $50 in early 2018. Wouldn’t you know it, Doug just happened to choose that moment to sell 437,000 shares of stock, more than twice as much stock as he had ever sold before and almost 5x the usual size of his stock sales. Barf.

On the other hand, both Gary Kelly of Southwest and Oscar Munoz of United are way back in the rearview mirror of Parker and Bastian. I’d also point out that Gary Kelly has been CEO of Southwest since taking over from Herb Kelleher in 2008, and that Southwest has by far the least levered balance sheet of the Big 4. Interestingly enough, Southwest has also been by far the best stock market performer of the Big 4 since 2014, and American has been by far the worst. I know it sounds weird to say that $75 million in stock-based comp is a sterling example of CEO restraint, but that’s the effed-up world we live in today.


Fact #5 – The primary shareholders of the Big 4 airlines today, together owning about 25% of each company, are two professional investors – Warren Buffett’s Berkshire Hathaway and Primecap Management.

I’m just going to leave this here for the most part and not get into a long discussion about Saint Warren and the guys at Primecap. But I will say this: we must call things by their proper names.

Both Berkshire and Primecap are hedge funds. And good for them! You don’t think they are, because you don’t want to think of them that way (actually, you’ve probably never heard of Primecap), and because both firms have gone to enormous lengths to create an alternative narrative in the public eye.

Both Berkshire and Primecap are ruthless investors. And good for them! Again, you don’t think they are, because you don’t want to think of them that way (again, you’ve probably never heard of Primecap), and because both firms have gone to enormous lengths to create an alternative narrative in the public eye.

If the tables were turned and Berkshire or Primecap were in the government’s position of dictating terms to the airlines and their shareholders, my promise to you is that they would either wipe out the common shareholders entirely or dilute them into oblivion. I promise.

And good for them.

Capitalism is red in tooth and claw, and Berkshire and Primecap are two of the biggest, hungriest tigers in that jungle. Sure, they’ll take your bailout if you give it to them. But they do not deserve it. Seriously. Please.


So those are the pertinent facts here. As I see it, anyway. So what do we DO with those facts?

There are 1,001 ways in which the government can structure the necessary financial rescue of the necessary airline industry.

The rescue structure we choose should not reward these self-dealing management teams or the hedge fund investors who support them.

Here’s my suggestion for how this can work.

First, impose regulated caps and clawbacks on ALL senior management compensation, including stock-based compensation, for the next decade, regardless of how quickly any loan support is repaid. If these guys aren’t willing to work for $1 million or $2 million dollars per year in total comp, I’m sure we can find a perfectly good replacement CEO who will.


Second, the current board Chair for each airline should be summarily dismissed and replaced by an independent director appointed by the government. This is also a 10-year right that the government maintains, regardless of how quickly any loans are repaid.


Third, require each airline to raise new equity capital in the open market dollar-for-dollar to whatever low-interest loan facility is backstopped or made available directly by the US government. In other words, if Delta wants access to $10 billion in loans, they must raise $10 billion in new equity at whatever price the market demands to clear the equity raise. We require banks to maintain a certain level of equity capital, because we’ve judged them to be too strategically important to fail. Let’s do the same for the airlines.


Fourth, until the loan facility is repaid in full, no stock buybacks and no dividends. Duh.


I’m not naive enough to think that the bailout is going to go down the way I’m suggesting here. Oligarchs gonna oligarch. Mob bosses gonna mob boss.

But all the same I think you may be surprised what can happen if we lift our voices here. I think you may be surprised what can happen if we HOWL, if we raise holy hell about the inequity of bailing out the effin’ Doug Parkers and the effin’ Warren Buffetts of the world … again. All of these guys, and particularly Warren Buffett, play a mean meta-game. They’ll get a sense of where the political wind is blowing and move over to get in front of it. If we blow hard enough.

I believe that our nation’s response to CV-19 will be our finest hour. I believe that no nation mobilizes for war better than the United States, and I believe that this airline bailout must be implemented as part of that wartime mobilization, not as part of the I-got-mine-Jack wealth inequality Zeitgeist of the past ten years.

It’s time for all of us to Do The Right Thing. Even airline CEOs. Even Warren Buffett.

Bailout the airlines and their rank-and-file employees? You bet.

Bailout the CEOs and Warren Buffett? Not a chance.


Epsilon Theory PDF Download (paid subscription required): Do The Right Thing


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The Non-Linearity of Need, Pt. 2

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3/21 UPDATE: Thank you to all of you who participated in the poll. Next week we’ll be sending an extra $3,500 to Save our Children in Elyria, Ohio. AND we received a pledge from a packmember to support the next in the list with an additional $1,000, which was the Issaquah Food Bank.

AND we’ve gotten notices of pledges (which we are trying to continue capturing in the comments below) to send along any fiscal stimulus directly to these and other local charities.

AND we learned that a long-time reader and packmember will be matching our $10,000 commitment to giving to community organizations 4-to-1. That’s $40,000. Incredible.

We are so grateful for all of you – and the work together isn’t done just yet. Keep looking for ways to connect with and help others.

Full hearts.


Ten days ago we asked the Pack for the organizations they believed would step in the gap for the unique, cascading needs of certain especially vulnerable parts of our community as part of the Covid-19 pandemic and the policy response.

You came through with 13 more great recommendations from around the country – and in the UK. Thank you!

We have another request.

We want to hear stories about how you and people you know are helping. Have you or others been giving? Tell us about it. Are you or someone you know a health care professional on the front lines? Tell us about it. Are you in food service? Working grocery lines, keeping our supply chains going or otherwise keeping all of us warm and fed? Tell us, so that we can tell everyone else and prod them to action. If you’re a subscriber, drop it in the comment section below. If you’re not, send an email to info@epsilontheory.com.

Here’s something else we want to do:

  1. We – the partners at Second Foundation – will give $6,500 ($500 each) to the organizations you brought forward (listed in the poll below). Thank you.
  2. To get to an even $10,000, we want you to tell us which you think most needs another $3,500. Call it paying any US government helicopter money forward. Tell us where you think the need is greatest and we’ll send that, too:

3/21 UPDATE: The poll is now closed. Thanks to all who told us where you felt the need was greatest.

Finally, if you are a financial or other professional who has been blessed with plenty, we’re asking you to make the pledge to pay forward any cash you receive from the US government, too. Tell us, then tell us more about the organization you’re pledging it to. We will share it here and on social media to prod others into action.

This is America. Here we do this thing from the bottom up.

Let’s make this Our Finest Hour.

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Our Escape Story

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Our work is based on a pretty simple premise: humans have a capacity for telling, listening to and responding to stories.

Sometimes – most of the time – our work criticizes a nudging oligarchy in politics, media and business that weaponizes these stories to influence our behavior in ways that benefit their personal aims. And yes, sometimes we celebrate the way in which story-telling brings us closer together as people.

Today is different. Today, we are asking for a story. Now is the time to tell us the story of how we get out of this.

Now is the time to tell the world our Escape Story.


We have observed in our institutional research that we believe there is now a cohesive narrative about the depth of the recession that Covid-19 and our mitigation response will induce. Everybody knows that everybody knows it will be deep. But as we very appropriately deal with the mechanics of keeping households and small businesses afloat, lending markets functioning and most importantly, our offensive against Covid-19 thriving, there is something else happening in narrative space:

Attention is slowly moving from the depth of the recession to its breadth and length.

Today, anyway, this framing is still pretty young. The narrative of “short and deep” pain is everywhere. Schools are holding on to two-week closures. Events are postponed, not cancelled. When I speak to local business owners, they tell me about their confidence and fears in context of a month of disruption. Maybe two. Newly minted work-from-home parents doubling as substitute teachers are posting their plans to cover a similar horizon. We observe largely the same thing in markets as well. Most sell-side research, macro letters and financial media commentary is focused on exactly this language. Short and deep.

Below is a shared language-driven network graph of articles published in financial media this month about a prospective recession. The bold nodes and connecting lines are those we think are indicative of language relating to the brief expected tenure of such a recession. This language is central, connected and everywhere.

Source: Epsilon Theory, Quid

There is a meta-game in this.

If you want to sound sober-minded and thoughtful – but you also want to sell something – the right game to play in this situation is absolutely to be as bombastic as you want about the depth of our present struggle, but to intimate that uneven breadth and briefer than usual length mean that it will create as many opportunities as challenges. That’s a chalk strategy for mayors, governors, presidents, macroeconomic researchers, sell side shops and fund managers alike.

Of course, the fact that there is a meta-game component to it does NOT make it wrong.

But it should raise the question in our mind as to how strong their confirmation bias is on this point. It should make us consider what that means if and when the narrative DOES shift from “short and deep” to “brutal and long.” And then, it should make us consider what it means if the reality underlying that narrative makes that transition, too.

Having lived in Houston after Hurricane Harvey, I remember what it was like to come home after mucking out houses and moving waterlogged furniture and heirlooms out of friends’, neighbors’ and strangers’ homes. For six, maybe eight weeks, we all did it. You strip off your moldy, soggy drywall-coated clothes, take a long shower, and you feel good. Wrong word. You are overwhelmed with a million emotions, but you feel energized. Engaged. It was NOT hard to get up the next morning to do it again.

I also remember what it was like after six to eight months, when the problems for some went from short and deep to brutal and long. When optimistic, helpful-sounding early conversations with insurance companies had soured and turned hostile. Dishonest. When savings, IRAs, 401(k)s and the generosity of family ran out. When the passage of time transformed preoccupation with a personal financial tragedy into a relationship tragedy and an occupational tragedy.

I have no idea if that’s the reality that awaits us here. Seriously. A brief, heroic struggle may be our lot. But when scenes from New York City hospitals hit the news later this month, and when scenes emerge from the next city in line, the first question we will ask ourselves is “How much worse is this going to get?” The next question we will ask ourselves is, “How much longer is this going to last?” It’s a question we will ask as citizens, community members, business people and investors alike.

There is hope:

We are not powerless against a transition of the narrative to brutal and long.

We are not powerless against a transition of reality to brutal and long.

To those in positions of political leadership: If you want to blunt the fear-based behaviors of American households, if you want to blunt the overhang on markets of a shift in narrative from short and deep to depression, if you want to sidestep some portion of the volatility which has the capacity to stifle every part of human ingenuity when faced with an interminable problem, tell America a story.

Tell America the story of how and when we will have ramped Covid-19 testing capacity and throughput so that vast swaths of Americans can be routinely tested.

Tell America the story of how presidents, governors and medical professionals are working together NOW to establish a detailed, explicit plan through which we will rely on this massive testing to permit us to systematically bring parts and regions of the American economy out of social distance and back online.

Tell America the story of how and when we will be able to see and hear the details of that plan everywhere.

Tell America the story of how and when those procedures will be put in place.

Tell America the story of how we will keep testing to ensure that we can move rapidly to contain any resurgence of the pandemic on our shores as we emerge from social distance.

Or if I’m wrong on the details – it’s happened before – tell America the true story.

Either way, tell us our Escape Story. And then make it real.

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Pandemic Playbook – 3/17

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Epsilon Theory PDF Download (paid subscription required): The Pandemic Playbook – 3/17



Beyond what we have published about Covid-19 itself since early February, we have also published a range of more explicit observations about Covid-19 from the perspective of a risk manager or asset owner over the past several weeks.

On February 27th we argued that the narrative of Covid-19 continued to be complacent. We argued that most investors should pursue the universal shrinking of active risk and gross exposure. We argued for a circumstances-based analysis to consider risk asset exposure reduction (i.e. net exposure). We also wrote what we thought would trigger a reevaluation of circumstances:

It means we’d be doing all of the above until the cargo cult of Covid-19 analysis turns back into science. In short, we’d be doing the above until we felt that the measurements being provided about the state of Covid-19 infections reflected some underlying reality.

Covid-19 Cargo Cults

Following the speech given by Donald Trump yesterday (3/16) and the change in strategy adopted by the United Kingdom that same day, we believe this is now the case. The two components of this change are the capacity and willingness/recognition to make testing the single highest priority. The former quality is identifiable. Covid-19 testing across (most of) the United States ramped up substantially over the weekend. Individual states like New York are now performing more than 1,000 tests per day. The latter is subjective. Watch both speeches for yourself.

What do we think that means?

It means we think that the narrative of market complacency about Covid-19 is officially over.

It means that data demonstrating the importance of asymptomatic transmission in earlier infected countries has supported a rapid sea-change in the seriousness with which countries have embraced social distancing measures that explicitly reduce tail outcomes (for the disease).

It means we think the uncertainty overhang related to non-testing and the lack of institutional inertia within business and government to act on testing and mitigation has been relaxed.

This is NOT an all clear, folks. But it does mean a change in the game being played and in our ability to play that game. We’d like to walk through our updated framework for thinking about the governing narratives and events we see for the Covid-19 pandemic (a term which you should understand we always mean in context of the medical, economic AND quarantine effects unless otherwise stated).


We recommend that institutions and asset owners construct their response framework from what we have referred to previously as the Koan of Donald Rumsfeld.

Decision-making under certainty – the known knowns. This is the sure thing, like betting on the sun coming up tomorrow, and it is a trivial sub-set of decision-making under risk where probabilities collapse to zero or 1.

Decision-making under risk – the known unknowns, where we are reasonably confident that we know the potential future states of the world and the rough probability distributions associated with those outcomes. This is the logical foundation of Expected Utility, the formal language of microeconomic behavior, and mainstream economic theory is predicated on the prevalence of decision-making under risk in our everyday lives.

Decision-making under uncertainty – the unknown unknowns, where we have little sense of either the potential future states of the world or, obviously, the probability distributions associated with those unknown outcomes. This is the decision-making environment faced by a Stranger in a Strange Land, where traditional cause-and-effect is topsy-turvy and personal or institutional experience counts for little, where good news is really bad news and vice versa. Sound familiar?

The Koan of Donald Rumsfeld

To that end, below we outline for each of the three categories the facts, narratives and events which we think will frame how information that matters to markets is conveyed. To the extent we can, we will identify the type of narrative structure which we believe exists and how we think new information will be processed.

Importantly, you should know that this will necessarily evolve. We will not always be in a position to update the state of each item. What we are recommending is incorporating aspects of this into your own framework in ways that suit your objectives, process and ability to take in rapidly evolving new information.

The Known Knowns

Other than “the sky is not falling” and “the sun will rise”, practically nothing falls into this category today.

I don’t mean this flippantly. It matters that this set is empty for all practical purposes, because it would usually include things like “markets will be open” and “you’ll be able to short” and “daily variation margin on centrally cleared derivatives is de facto riskless.”

That means that your framework must assume a non-zero probability that your hedges will not work. That means that your framework must assume that series of small trades structured to exploit asymmetry / volatility have a non-zero chance of not paying out.

We think that continues to argue for a smaller gross exposure or (for long-oriented investors) smaller active risk position than your perceived edge would otherwise lead you to establish.

We think that furthermore argues for some caution in thinking that options-based view expressions are a “workaround” for gross exposure aversion. If this were part of our strategy and we weren’t explicit about this in our risk management to begin with, we’d explicitly cap our negative carry from premium.

The Known Unknowns

We refer to the below as known unknowns because we think they are appropriately thought of as decisions that can be made under risk rather than uncertainty. But make no mistake: the level of risk attached to any predictions you might make on any of these categories is substantial.

TopicNarrative StructureNarrative Observations
Current General Spread / Fear of Covid-19:MixedAs noted above, we would no longer classify this as an Unknown Unknown, or as complacent. This may be too clever by half, as there is a non-zero chance that we allowed ourselves to get far enough out on the exponential curve that the downside risk of reality revealing itself exceeds any feasible prediction. But in general, we think the pandemic’s spread in this cycle is being transformed by effective policy back into a risk. However, we don’t see a single narrative here, but multiple narratives in competition. We think that means there is bi-directional risk on bets on the speed / expansion of spread. 
Political SeriousnessConsensusWe think that there is now common knowledge that there is political awareness, willingness and capacity to act on Covid-19-related policies. Everybody knows that everybody knows that policies proposed in one state are quickly manifested across the country. We think that means there is short-run one-way risk owing to any events giving the impression of politicization, lack of focus or excessive focus on short-term financial market responses.
Depth of Economic OutcomesConsensusThe potential economic effects of Covid-19 are both vast and vastly variable. Difficult to predict as they will be, we think they generally qualify as risks rather than uncertainties at this time, however. We think that there IS an expectation of very bad GDP and EPS prints. We aren’t saying they won’t have negative effects on asset prices when reported as news, but we do think in GENERAL that bad Q1 / Q2 prints will be tuned and framed and generally excused within that existing narrative. Not unreasonable to expect the odd less-nightmarish than expected Q1 prints to produce an asymmetrically positive response.
Length of Economic OutcomesComplacentWe saw flashes of this in what appeared to be the market’s response to”July or August” comments from the president on March 16th; however, in our judgment, the narrative of economic effects is that they will be short-lived. “One to two quarters” is common shared language among nearly ALL reports and research pieces. Given this complacency, we think there is mostly one-way risk (i.e. negative) on information relating to the length of EPS / GDP effects at this time. We would be very concerned about the emergence of the narrative – and obviously about the actual existence of – an extended global depression. We think this is a really significant long-term risk to markets that is being almost completely ignored in current narratives. We would take it very seriously.
Cases of Economic RuinComplacent
(with Exceptions)
Related somewhat to the “Bailout” unknown unknown in the following table, the narratives of industries at risk remains confined to first-degree effects: hospitality, leisure and transportation. There we think the narrative is consensus, subject to the binary risk of bailout policy posture. Outside of that and dalliances in feature coverage considering small restaurant businesses, there appears to be zero narrative about knock-on effects in adjacent / dependent / broader industries and sectors. We think there is significant, targeted one-way (i.e. negative) risk for some of these non-hospitality, leisure and transportation industries for contrarians. 
Emotional / Visceral ResponseComplacentEven though it has been predicted and seems almost statistically inevitable, there is practically no recognition or discussion of a prospective news cycle of overwhelmed New York City hospitals and ICUs. We think there remains complacency about the unique short-horizon impact of two weeks of news focused exclusively on the region where so much of the financial industry AND Covid-19 outbreaks are located: New York, Westchester County and Fairfield County, CT. We think this is largely a one-way risk, but over a short horizon that probably has potential to manifest in the last two weeks of March. 
Fiscal Policy ResponseMixedThere are enough policy proposal drafts and stalking horses in the wild at this point to treat this usually binary kind of event as a Known Unknown. It is difficult to pin down a narrative here, as there are clusters of commentary and missionary behaviors around multiple suggested strategies. There isn’t a global expectation of what the policy package will look like that has become common knowledge. If anything, we think the narrative tilts toward cynicism that households, families and small businesses will be helped quickly enough relative to industry backstops/bailouts. Accordingly, we mostly view this as two-way risk based on the size of the package, but our opinion (not really present in the data – purely subjective) is that there is some asymmetric upside sensitivity to a quicker or larger-than-expected package. 
Monetary Policy ResponseMixedWhile the data set is limited in scope, since Sunday (3/15) we think that a strong narrative with two dimensions – “out of ammunition” and “focused on liquidity and orderliness” – has emerged about central banks, and the Fed in particular. We think the former is a consensus narrative with more upside asymmetry in certain extreme cases (ie – everybody believes that everybody believes the Fed can’t take actions that will support asset price). We think the latter is supportive of framing most illiquidity-related news, data or research in a positive way, but also creates downside asymmetry if they aren’t as rapid dealing with issues in CP markets or other sources of market illiquidity.

The Unknown Unknowns

Part of the concept of unknown unknowns is, of course, that they are unknown, so the first allowance here that must be made is a general one: there are paths here that are not identifiable in advance. They all yield the same answers: Avoid leverage. Avoid reliance on ex-post measurements of cross-asset correlations. Avoid position-level and risk-level concentration. We’d add our previously communicated “avoid illiquidity” but it’s probably too late for that at this point.

But the Koan of Rumsfeld as we have it slots in the idea of unknown unknowns as uncertainty. In addition to the many paths which cannot be identified in advance, we think there are three other major categories of uncertainty which investors must take into account.

TopicNarrative StructureNarrative Observations
Seasonality Effects and Resurgence?We have some data now about the R0 influences of heat and humidity, and that data is positive. Positive but not enough for prediction. The parameters are still insufficient to tell us what life with an endemic Covid-19 looks like. Will its resurgence mirror 1918? How effective will vaccinations be from making Covid-20 just as bad? We think investors should expect that information which rapidly shifts this critical topic’s substance and importance into the Known Unknown range could still emerge at ANY time and in either direction. This alone should keep gross exposures and active risk budgets at very subdued levels. 
Industry Bailout Response?While we think there is a general focus on risks to certain obvious industries (as described in the known unknowns above) that should govern some forms of risk-taking, specific company outcomes are subject to a veil of binary uncertainty. This is obvious counsel, but still must be part of the framework: go-to-zero bets on airlines, cruise companies, aerospace companies and hospitality companies are not risky but uncertain. We would warn investors away from spending active risk on such positions based on a fundamental thesis unless they are explicitly cordoned and risk-managed behavioral bets on other investors (e.g. in vol markets). 
Election and Unrest?We are witnesses to what we think will probably be the single biggest sociopolitical event of our lives (so far, anyway). We are shutting off entire economies. For months. Soldiers are being deployed in free, democratic countries. A base rate of a return to normalcy is probably still correct! It’s our mean case, too. But these kinds of events create branching paths with no visibility beyond them. Unrest and political upheaval in many markets throughout the world are absolutely unquantifiable possibilities. We would continue to be apply deep skepticism to the diversifying properties of sovereign debt both against risky assets and against other debt assets in our portfolio construction.

Again, we will continue to update the general framework based on events that warrant it, but the rapidity of changes in narrative structure will likely exceed that frequency. We think any of these would be additive to whatever framework your institution or team is using to monitor and manage through this situation, and will benefit from your incorporation of monitoring and judgment of news flow and research relating to each narrative and event. If you have specific questions, of course, please feel free to reach out to either Ben or Rusty via email.


Epsilon Theory PDF Download (paid subscription required):  The Pandemic Playbook – 3/17


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Margin Call

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Epsilon Theory PDF Download (paid subscription required): Margin Call



There are two cartoons which lead both investors and nations to ruin.

The first kind treats a false measure as a true one.

The second kind treats a model of reality as if it were reality.

Both cartoons are perilous in the face of uncertainty. The first, the measurement cartoon, empowers actions based on a false confidence about the current state of a thing. The second, the model cartoon, empowers actions based on a false confidence about the future behavior of a thing.

Yet while both are perilous, their perils are not equal.

When we pretend our measurement cartoons tell us true things to guide our response to uncertain events, unless we are protected by a shield of time, law, arcane GAAP rules or an iron-clad, authoritarian grip on information, truth will typically out. It is difficult to hide bodies forever. Even if the true underlying reality being measured remains elusive, common knowledge about the cartoon in the face of sufficient contrary information may not. Eventually everybody knows that everybody knows that the cartoon is a fraud.

When we pretend that our model cartoons tell us true things about uncertain events, we may never realize that the predictions from our complicated models of reality weren’t necessarily so.

Often until it is too late.

The perils of measurement cartoons have been the chief focus of our essays thus far. These are stories about how various institutions acted to suppress the discovery, measurement and reporting of the true extent of infected individuals. They are also stories about how policies of governments, corporations and other institutions were designed around those constructed realities.

Stories about the CCP.

Stories about the WHO.

Stories about the US federal and state governments.

Fortunately, as (almost) the entire world has slowly come around to the realization of the reality underlying the measurement cartoon, policies have changed rapidly. Damage was done, but now further damage is being limited. It can be our finest hour, and we believe it will be.

True to form, however, it is the institutions who have relied on model cartoons who have not yet acted to limit damage.

In markets, that obstinacy is still coming to head today, especially for a swath of global macro, relative value and multi-strategy hedge funds. These institutions aren’t full of idiots. They no doubt saw the uncertainty associated with Covid-19 and its policy response. But they believed in their estimates of correlations among financial assets. Even so, it isn’t just that they believed in them. There is no shame in being process-oriented. It is that they continued to bet on those models of correlation with (often) significantly leveraged positions, despite everything in the world screaming at them that their models had become representations of something that looked nothing like the world that was unfolding.

Do you think only one horror story will come out of this? Do you think Sunday’s emergency Fed action had our credit availability in mind? That it was designed to make sure we could still apply for a Capital One card or refinance our mortgages and access short-term capital to keep paying our small business’s employees for a few weeks? Don’t get me wrong about this – a lot of good hedge fund managers will lose money in March. This isn’t about whether you got the trade right. It’s about whether your process empowered you – whether systematically or intuitively – to recognize when the world of risk and cross-asset relationships your models represented wasn’t the world at all, but a cartoon.

That’s why what I worry about more than anything today is the United Kingdom, which is continuing to pursue a strategy which combines vague, conflicting recommendations with targeted social distancing. It’s a strategy effectively built on a foundation of four models: (1) behavioral response models for quarantined humans, (2) seasonality models, (3) mutation properties and (4) ‘herd immunity’ models. I worry not because I have any special knowledge about whether they are correct. I worry because by knowingly permitting the spread of a pandemic of many unknown qualities on the basis of models with hugely uncertain parameters, they are effectively levering up 66 million lives to the accuracy of those models.

Only the call you get when these trades blow up isn’t a margin call.

Here, too, I have hope. The Brits are pragmatic to a fault. They don’t need the government to tell them to keep granddad at home. Many of them have been doing it for weeks. There’s a practicality to their academics, too, an army of which quickly emerged to voice their opposition to the plan unveiled by Boris Johnson’s government. There is some evidence that closures and additional recommendations are forthcoming. The claims of herd immunity aims have been softened. I believe that the UK government will get it right. Eventually. For God’s sake, I named my firstborn son after Churchill, so I’ve got to be pretty sure they’re going to get their shit together at some point.

But for our readers and friends there, please don’t wait for that to happen. As Taleb and Norman wrote correctly yesterday, our civic obligation to the whole in the situation is individual overreaction. The best time was two weeks ago, but the second best time is now.



Epsilon Theory PDF Download (paid subscription required): Margin Call


MARCH 17 UPDATE

Good news on this front. The UK government is taking this seriously and has moved in the right direction – knew y’all had it in you! Pressure from, er, non-behavioral science nudging experts across the pond has to be given a lot of credit for this.

https://www.thesun.co.uk/news/11184059/boris-johnson-to-step-up-coronavirus-fight-as-he-chairs-another-emergency-cobra-meeting/
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Lack of Imagination

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It has been a long week.

I am hopeful that an optimistic Friday close – or better yet, some time with family and (er, appropriately small) groups of friends – has allowed you to put some of it in perspective.

I suspect that perspective won’t be entirely pleasant. Yes, realizing that those we love are what matter may assuage the anxieties of one of the most volatile weeks in US financial markets history. But it also means that a lot of the real anxiety, frustration and pain is still ahead of us. We are on the front end of whatever Covid-19 curve we end up experiencing. At long last, we are making plans to look more like Singapore and less like Italy, but the speed, competence and consistency with which we execute those plans will determine whether that is, in fact, what we experience. We aren’t ashamed to say we think this will prove to be our finest hour.

I am less sure that this will prove to be our finest hour as investors. I don’t mean returns, although most of us are bleeding. I don’t mean undue fear and greed behaviors, although many of us are demonstrating them. I mean that I fear investors are thinking about their gameplans today in ways that could damage their outcomes over long horizons. Unfortunately, the worst of these frameworks are being actively promoted by market missionaries in financial media and academia.

Sometimes at the same time.

Jeremy Siegel has taught Finance 101 at Wharton for a long time. Not “taught it to Donald” long, but certainly “taught it to Ivanka” long. The course is more along the lines of a monetary economics class there, but the man has trained bankers and PE guys to put together DCF models for decades. And that’s fine. Really. What is less fine is that Siegel, like many other academics, has found additional sources of revenue and book sales by applying the bottom-up thinking about company-level cash flows to CNBC on-air macro commentary.

The result is often very much like the below, which I extracted from an on-air interview on March 2.

“I’d like to first repeat what I said last week, and that is that over 90% of the value of a stock is due to its profits more than one year into the future. So as bad as this year can be…we could really have a short quick recession, the long-term value is not significantly impaired…let’s face it, this is mostly going to be a demand-induced slowdown.”

Dr. Jeremy Siegel to CNBC (March 2, 2020)

If you watched CNBC at all the last couple weeks, you probably heard variants of this prediction. “How much should valuations really drop if they only impact two quarters of EPS? Even if we lost a WHOLE year, it would be irrational for stocks to go down by more than 10%!” It is comforting, rational-sounding and calm. Professorial, if you will.

It is also utter hogwash.

I am absolutely NOT saying that investors shouldn’t build investment philosophies around the judgement-based valuation of cash flow streams. The raison d’etre for this entire website is the belief that this is still what investing ought to mean, that our efforts should be focused on reinforcing the primary intended function of markets as the appropriate pricing and direction of capital! I AM saying that treating the markets like a first-year banking analyst at Morgan Stanley – organizing a model completely around a single key variable – is a recipe for tunnel vision on that variable to the detriment of a million other things that matter. Not just things over some short, ‘irrational’ period – I’m talking about things that really matter to asset prices and returns over extended periods.

This behavior makes one blind to all sorts of things.


The first blind spot, as we have argued in more detail in our institutional research, is that it treats uncertain events – items of unknowable incidence and severity – as if they were risks that could be estimated probabilistically. Even if we remain in purely fundamental space, there are specific facts about the coronavirus pandemic and its impact on cash flows which utterly confound probabilistic estimation. Will its future mutations prove yet more virulent? Will challenges in vaccine efficacy for those strains make an endemic coronavirus a transformational, recurring long-term issue? Will summer heat in the northern hemisphere kill it nearly to the ground? Will governments conjure epic, MMT-level stimulus response? How quickly will governments work to implement and enforce aggressive mitigation measures? How far along the exponential curve are we actually today given our systematic undertesting?

These thoughts shouldn’t paralyze you, although the fact that they each contain embedded series of uncertain and dependent outcomes of potentially significant magnitude should absolutely influence your active risk budget, portfolio concentration and use of leverage! Yet this is not an inherently bearish argument. The veil of uncertainty contains both uproariously positive and fiendishly negative series of events.

The problem is that analyzing these events and their effects probabilistically isn’t hard. It is impossible. Yet the machinery of our industry cannot go into quarantine. It must produce research! It must produce estimates! It must produce predictions! How does it do it?

It picks a reasonable-sounding central assumption, then shows that even if you doubled it, things would still fit within your estimation range.


The second blind spot still sits within the world of pure fundamentals, and is exposed to both uncertainty and risk. It is the tendency to underestimate the length and magnitude of chains of dependent events. Estimating how 2-6 months of a global cratering of demand and interruption in supply will manifest in knock-on effects is hard. Really hard. Assuming that you’re going to capture those knock-on effects by applying a low baseline demand shock estimate on EPS is ludicrous.

It IS easy enough to think in advance of some anecdotal examples to illustrate this, even though handicapping them today is a practical impossibility (in large part because they are dependent on binary assumptions about key policy actions). Even without going into the availability of credit and other primary capital markets, there is a lot to consider.

Let us say that the crisis in air travel places a major domestic airline in financial distress. Now assume that the government does not bail them out. It goes through some kind of BK or liquidation. What if they had accounted for 60% of the travel capacity of a half-dozen medium-sized cities? 100% of the economics of two dozen local mechanical and aerospace services companies? What of their replacement parts contracts and those 25 A320s they have on order?

Alternatively, take a look at the data published by OpenTable on daily restaurant activity across major markets (mostly in North America).

No photo description available.
Source: OpenTable

What happens if and when the 50% drop we see on Thursday of this week in some markets becomes the story in every town and city in America for the better part of two months? If your average local restaurant grosses $10,000-15,000 a week and operates on a sub-10% margin, how long until they have to stop paying the waitstaff and line cooks? How long until the credit line with the First Community Bank of Podunk runs dry or gets pulled? When they stop paying rent, how long until the local businessman who owns their building is forced to pull capital earmarked to fund the growth of his valve-fitting shop to service the debt he used to buy it? How does that impact the growth and returns of the small factory in the region that had counted on their order being delivered on time?

And how long do these types of effects ripple through multiple businesses and multiple industries?

What happens to consumer behaviors after a month or two of social distancing? After a month or two of adapting to a life without available daycare? After a month of effectively homeschooling children? Is there a tranche of the public that remained loyal to local brick-and-mortar retail for some category of their consumption that will undergo a permanent transition to online shopping? Do consumption patterns change permanently in other ways?

And what of tourism? How long do tourists eschew Covid-19 hotspots? Cruise ships? Casinos? Ride-sharing? Will ALL the fashion and real estate and investment conferences that huddle in Milan come back in 2021? How long will the overhang on tourism more generally last? Will tourists shy away from Thailand, Cambodia and Belize, countries heavily dependent on tourism? If they do, how long can those industries hang on before capital flees to other endeavors, domestic or otherwise?

If and when we flatten the curve, and Covid-20 pops up in the winter, how reflexively and violently do briefly allayed fears shift behaviors back to the state we know today?

Again, please do not see this as inherently bearish relative to current prices. Let me take the other side of this.

What if many of the companies and industries that die were negative ROI, good-capital-after-bad companies and industries that probably should have died long ago, but for the sweet succor of interventionist government? What if the forced utilization of remote work technology finally becomes truly transformational, permanently reducing the operating expenses and capital requirements of a dozen industries? What if the federal stimulus in the US and elsewhere results in rapidly expanded networking infrastructure investments across secondary and tertiary cities to support it?

The point, again, is not that we should allow ourselves to become overwhelmed by the range of potential outcomes or the fact that many of them simply cannot be predicted. It is to recognize that the effect of events on other events at times like this is to make fools of forecasts built on some expectation of cash flows over a defined period. That’s why (thankfully) actual fundamental investors taking risk in equity markets have been busy exploring, such as they can, questions like all of the above for the last few weeks. That’s why they’ll continue to do so, no matter how many two-quarter-shock-to-the-ol-DCF cartoons get trotted out to pump up stocks.


The “10% of NPV!” approach also creates a blind spot to a class of path-dependent effects which exist outside of pure fundamentals – that is, in the world of narrative. Consider, if you will, these declarations from important political missionaries across the political spectrum from the three most important economies in the world in only the last two days.

Like German Economic Minister Peter Altmeier.

Germany would like to localize supply chains, nationalization possible, minister says [Reuters]

Like Senator Ted Cruz.

Coronavirus Spurs U.S. Efforts to End China’s Chokehold on Drugs [NY Times]

Like Chinese Foreign Ministry spokeman Lijian Zhao.

Chinese diplomat accuses US Army of creating coronavirus epidemic in Wuhan [Washington Examiner]

Think this emerging narrative of global decoupling and deglobalization is isolated to healthcare and pharmaceutical supply chains? Tell that to US Senator Marco Rubio.

And to the think-tanks who are already furiously spinning out pro-autarky thinkpieces in recognition of the rapidly changing zeitgeist on international trade links.

Make America Autarkic Again [Claremont Institute]

I suspect that Ben and I are both going to be writing a lot more about the de-globalization narrative as it emerges. I can’t tell you today how probable it is that any one company or industry will move more production back to domestic shores. I can’t tell you how probable it is that regulation will be put forward in this administration or the next to force (explicitly or implicitly) some of this to take place. I can’t tell you how that will impact cost structures and corporate margins. I can’t tell you how that will impact the expectations and multiples investors are willing to pay, or their home country bias, or countless other dimensions of the collective determination of asset prices. I can’t tell you if this is long-term bullish or bearish…OK, probably a little bearish.

I CAN tell you that if your analysis of market and prices is completely abstracted from the path of events that could lead to a significant movement toward global economic decoupling, you’ve got blinders on. And if you think applying “conservatism” to widen the range of your best guess at a deterministic period hit to EPS is the right way to accommodate its potential, you’ve lost the plot completely.


Cartoons constructed from deterministic EPS macro analyses have one more trick to play on us. Only this one isn’t about blinders on the future. It’s about blinders on the past.

Buried in the sour grapes responses some on the buy side and in the financial adviser community have had to the (IMO pretty subdued) victory laps from bearish funds and traders is a seed of really dangerous thinking. Paraphrasing from a half dozen or so, the claims go something like this: “None of these bears predicted a pandemic. This bear market is the result of the pandemic, so the people who are short because they thought the market was expensive or being propped up by the Fed or whatever reason they were always bearish don’t get credit for getting it right.”

I’m not linking to specific people here for a few reasons. First, a lot of people are publishing things like this in letters and I don’t want to single anyone out. Especially because I believe most of them are perfectly smart, good people trying to do right. Second, it’s hard to deal with being down this much in a rough couple weeks, and I’m empathetic to the annoyance. Third, there are absolutely people who have been really bearish for a very long time and are STILL underwater for their investors. They still have a lot to prove before they have any business claiming to be right.

But the sentiment is still wrong. Really, really wrong.

Look, of course just about everybody involved in markets in any active sense is responding to the impact of Covid-19 and the broad economic impact of our global mitigation effort. But for all of us who are in the business of investing, we must understand this: asset returns are never just a mechanistic reflection of changes in forward-looking estimates of some fundamental thing. They are also a reflection of inertia. Of path-dependence.

The fact that a stock traded at a particular multiple today is often as much (and in many cases far more!) driven by the fact that it traded at that multiple yesterday as it is by the market’s aggregated expectations of future growth and appropriate discounting of those expectations. When the market declines sharply in response to some suspected (or in the case of Covid-19, obvious) proximate cause, do you not think that some investors who deemed yesterday‘s price appropriate in part because of expectations of asset price-motivated central bank activities or the expectation of unduly growth-hungry or yield-hungry behavior by other investors calibrated their actions today to consider how those other factors might be affected, too?

Investing in ways that reflect a belief that asset classes have embedded inertial assumptions (like say, multiples) but with uncertainty about a catalyst for changing them is not unusual at all. It’s the basis for a huge swath of classic investment strategies! Uh, value? Even when we feel like the catalyst of market action is plain, believing that the magnitude of the market’s response to it is wholly related to that catalyst and not the catalyzed reexamination of other factors will not lead to a useful forward-looking analysis of positioning.


When Ben and I went independent back in 2018, one of the first things he wrote was the Things Fall Apart series. In the third installment, he focused on distinguishing between the big recurring macro risks faced by investors, and one big unknown. He used the example of the Oldest Game from the marvelous Neil Gaiman’s Sandman to illustrate the difference in kind – not magnitude – of accommodating uncertainty in our investment frameworks.

The Oldest Game is a clever construction in which two players in turn conjure identities capable of defeating the identity selected by the other player on his prior turn.

There are many ways to lose the Oldest Game. Failure of nerve, hesitation, being unable to shift into a defensive shape. Lack of imagination.”

Neil Gaiman, from Sandman

The structurally bullish will warn us against failure of nerve. The traders will warn us against hesitation. The structurally bearish will warn us about being unable to shift into a defensive shape.

What we should be worried about is a lack of imagination.

I know it feels like you are sitting in your home office in the middle of a pandemic quarantine, because you probably are. But you are also sitting in the middle of a period of historic change and upheaval. Do you think that it is possible that an almost complete shut-down of many forms of trade, tourism, travel, retail activity for 1-2 quarters or MORE will not result in some kind of transformation? Of consumer behaviors? Of regional industry? Of local industry? Of investor preferences? Of the shape of globalization?

Take off the blinders and LOOK.

Or better yet, do what the winner of the Oldest Game did.

Choronzon: I am anti-life, the beast of judgement. I am the dark at the end of everything. The end of universes, gods, worlds… of everything. Sss. And what will you be then dreamlord?

Dream: I am hope.

Sandman, by Neil Gaiman

The people who win THIS game (and the people who help us ALL win the bigger game) aren’t going to be the ones wasting ink raining on the parade of so-called ‘perma-bears’. They aren’t going to be the ones putting together pseudo-empirical analyses for their fund investors explaining what happened in the subsequent 5 1/2 week period in 17 out of the last 28 drawdowns of 20.49% or more. The people who win this game will be the ones who can smile at the end of universes, gods and worlds and say, “I am Hope.”

That doesn’t mean being bullish.

It means having imagination.

Imagination to see with clear eyes the shocking capacity of uncertainty to embarrass probabilistic frameworks used incorrectly to model it.

Imagination to see with full hearts how vast the range of paths and outcomes can be when they are dependent on the path of critical, potentially transformational events.

Like it or not, you live in interesting times. Don’t waste them on a lack of imagination.

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The Python and the Pig

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Seattle-area emergency room

NYC declares state of emergency, de Blasio says coronavirus ‘could easily be a 6-month crisis’ (CNBC)

The city now has 95 confirmed COVID-19 cases, with 42 of them reported in the last 24 hours, he said. More than 1,780 people are under voluntary quarantine in the city, with an additional 29 people under mandatory quarantine, he said. By next week, the number of cases in the city is projected to rise to 1,000, he said. 


Here’s what I think de Blasio (and every mayor of every big city in the United States) is looking at. This is data publicly available from NYC Health.

The graph below is a count of the number of NYC emergency room visits PER DAY over the past twelve months where the chief complaint was an influenza-like illness. You see a big spike from November through January. That is seasonal flu. But you also see a new spike over the past two weeks. This is coronavirus.

I really don’t think this is some resurgence of seasonal flu for two reasons. First, for the entire online NYC Health dataset (goes back to 2016), there is no second spike in any year. Second, look at the demographics for ER-reported influenza-like illnesses broken down by pre-Feb and post-Feb. During the seasonal flu spike, the most impacted age group was children age 0-4 years. During this more recent spike, the most impacted age group (by far) was adults age 18-64. This is not the seasonal flu.

CV-19 is not coming to New York City. CV-19 is here. It’s been here for a while. It’s going to get much worse before it gets any better.

By much worse I mean that the NYC healthcare system – one of the finest in the world – is about to be slammed beyond anything they have ever seen. ER visits and patient testing is where it begins. It moves from there through the system, ending in ICU wards. The process is like a python swallowing a pig, except this isn’t a pig. It’s a whale.

From what I read and hear, I think that de Blasio and Cuomo are fully aware of the situation and taking every possible step to prepare the healthcare system for the deluge. It would be nice if we had this sort of leadership on a national scale, but I’m not holding my breath. Frankly, I’ll be thrilled if the White House is just not actively hampering the efforts that need to be made here.

Every local and state leader needs to look at what’s happening in New York and understand that this is your crystal ball. This is your future. You can ignore it or you can prepare. It’s truly your choice.

Every citizen needs to understand that your local and state leaders have the ability to make that choice. They will listen to YOU. So make your voice heard.


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First-Level Foolishness

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PDF Download (paid subscription required): First-Level Foolishness


“I’d like to first repeat what I said last week, and that is that over 90% of the value of a stock is due to its profits more than one year into the future. So as bad as this year can be…we could really have a short quick recession, the long-term value is not significantly impaired…let’s face it, this is mostly going to be a demand-induced slowdown.”

Dr. Jeremy Siegel to CNBC (March 2, 2020)

In a severe pandemic, infrastructure can be disrupted at a national level, such as healthcare, transportation, commerce, and utilities. This is due partly to risk mitigation measures but also potentially higher rates of patients on sick leave, employees taking care of children or other family members, or general population anxiety about gathering in public places.

The direct and indirect U.S. healthcare costs of a moderate pandemic, like those in the 1950s and 1960s, were estimated at roughly $180 billion in 2005 by the U.S. Department of Health and Human Services, assuming no intervention, but this does not include potential for commerce disruption. According to the Congressional Budget Office, a pandemic could cost the U.S. more than 4% of GDP in a severe situation (similar to the Spanish flu of 1918) or 1% of GDP (if the pandemic is more mild, similar to 1957 and 1968 pandemics).

Overall, we think the costs of coronavirus will mirror those of a milder pandemic. As we assume a lower death rate that primarily focuses on patients over the age of 65, we think there could be a significant short-term hit (1.5% of 2020 GDP) but minimal hits beyond, as the economy should be in position to rebound quickly.

Morningstar’s View: The Impact of Coronavirus on the Economy (March 10, 2020)

It is an uncertain time, but I’m willing to bet on a couple things: I know what your personal email inbox looks like. I know what your professional email inbox looks like.

And I bet yesterday – March 11th – felt like a dam breaking for both.

There wasn’t any real change in the facts on the ground about Covid-19 in that time. Nothing fundamental. China continued to report few new cases. Korea continued to report improvement, with a little new concern in Seoul, perhaps. Italy continued to be grim. Germany and France had pockets of growing concern. America looked to be somewhat closer to the path of southern Europe than East Asia. The fact pattern on the morning of March 11th was consistent with the day before and the week before.

What changed was common knowledge. What changed was what everybody knew everybody knew.

It changed because powerful missionaries who had been in the grip of “just the flu” and “panic would be worse than the disease” memes – memes promoted in financial media beginning in January, as we highlighted previously here – threw in the towel. The WHO, which for weeks pretended it could be agnostic about the “p” word, relented. Harvard sent students home, and a raft of schools followed within hours.

That change in common knowledge is why yesterday you received a dozen or two “Here’s what we’re doing” emails from your kids’ schools, your local fast food chain, the airline you have frequent flier miles with, and the hotel flag you used to be loyal to until they merged and made your points worth half as much. A long-time friend and reader informed us of a Covid-19 CYA Communication from a…<checks notes>…food truck. Apparently they got his email through Square.

It’s also why (along with a little bit of feisty market action) your professional inbox filled up with new sell side reports, buy side update letters and – unless you were lucky – one or two “can we talk after the close?” emails from a fund manager or two this morning.

Will you permit me one more wager? I will also bet more than a few of THOSE emails probably looked like the lukewarm garbage that produced the two quotes above.

Both the Siegel appearances and the pseudo-scientific “scenario analyses” Morningstar and others are pumping into your inboxes are emblematic of the same thing: first level thinking, the mistaken assumption that markets function by assessing the first order effects of events. But it is far worse than that. They are also emblematic of ergodic thinking, which is a ten dollar way of saying that someone is using their estimate of the potential range of current outcomes as a proxy for the potential range of how outcomes may unfold in sequence over time.

Just one problem with that:

The path that events follow matters.

Path-dependence is why a disease that is only moderately more deadly than the seasonal flu becomes a Big Deal when its characteristics give it the potential to overwhelm hospital capacity. Path-dependence is why every college, school, sports team and corporation made their decisions in unison once missionaries finally created common knowledge. Path-dependence is why uncertainty in markets should inform your portfolio risk management.

The first-level thinkers miss this, and they miss it in three big ways.


1. They treat the market as if it were a clockwork machine, constantly repricing everything about issuers and securities. In reality, the market is a bonfire, unevenly assessing investors’ expectations of other investors’ responses to information at the margin.

The Siegel style of analysis is perhaps the most emblematic of this idiotic framework. That shouldn’t be surprising – the notion that market participants wake up every day and reassess everything in their portfolio and what it ought to be worth is a foundational abstraction of academics in finance, even today. To be true, it IS useful for teaching DCF-based thinking on a bottom-up basis. But it is utterly nonsensical for explaining asset prices changes at a top-down level.

At any given time, millions of people setting prices at the margin treat the prior day’s price as a Thing In-Itself. In other words, the prior day’s price becomes the thing that matters, completely independent of whatever information was being considered by the participants who participated in the prior day’s price setting activities. Take that back a week or a month and you start to realize something very important about markets: at any given time, simple inertia is a very important part of why people believe the price of a thing is correct.

When prices move after an event, first-level thinkers say, “Well, only X has changed, so the price should only change by the effects of X.” The problem, of course, is that when prices change by a sufficient amount, investors who AREN’T first level thinkers don’t just question how much Event X ought to have changed the price; they begin to question the inertia that led to YESTERDAY’S price.

One financial markets commentator observed the following today (March 12th):

All the permabears are coming out now and saying, “I told you so.” It’s just too bad that not a single one of their theories is the reason why we are in the current sell off. But don’t worry, they will congratulate themselves anyways.

No!

Thinking that the sell-off we are observing can be completely divorced from all of the assumptions that led to the prices yesterday that are being subjected to closer scrutiny TODAY is first-level thinking. All those things the “perma-bears” straw men theorized cannot be ignored. The expectations of undue central bank asset price support and profligacy that led to those prices is going to be questioned. The appropriateness of multiples that led to previous prices is going to be questioned. The behavioral expectations investors had for other investors that led to previous prices is going to be questioned.

In short, any event of sufficient size is capable of influencing asset prices BEYOND the scale of the event itself, and that influence must NOT be considered an inherent overreaction. It is a fundamental part of the long-cycle process whereby markets periodically reevaluate endemic assumptions that exist on the basis of inertia alone!


2. They treat market events as if they were isolated from the non-market events they influence, especially in political and regulatory spheres.

Ben is going to be write about this in a great deal more detail for a note next week, so I won’t belabor it too much here. But analyzing purely market fundamental events through probabilistic analyses to estimate market outcomes is worse than useless if it abstracts from the range of potential non-market responses.

Some of those events under a cloud of uncertainty are bullish! A massive landmark fiscal package coupled with aggressive state government aid would be a seminal such event, and could dramatically change the complexion of the market event.

Some of them are not so bullish. Some of those bearish outcomes manifest in major structural changes, such as changes to the narrative of globalization Ben and I have both hinted at observing as an emerging narrative. This is a potential multi-year outcome that could become part of core market narratives much sooner than most investors expect. The effects of a forced return of manufacturing and supply chains to North American shores would go far beyond the Siegel Cartoon of a 1-year share of a stock’s present value.

Some of the more bearish potential outcomes are almost impossible to bake into prices in ANY way prior to them taking shape. Your septuagenarian president hung out for a good bit with a Covid-19 exposed (and potentially infected) Jair Bolsonaro a week ago. How much of today’s price decline would you estimate accounts for the probability that our >10% CFR bucketed administration will announce infection next week? Some? None? Lots? A little?

You have no idea. I have no idea. There are a hundred events exactly like this – both bullish and bearish (but probably more bearish, if we’re being honest) – lurking in the fog of uncertainty, of unknowable incidence and severity. The idea that some sell side guy on CNBC thinks he can tell you what S&P earnings level for 2H 2020 the market is discounting should offend your spirit. The idea that there’s a clockwork machine pricing a risk premium on this basis should produce pain deep within your capitalist soul.

Image

3. They miss that nearly all financial assets exist in and cannot be divorced from their portfolios. When events change the interaction of those financial assets, those events can have reflexive responses in asset prices that we cannot assume are temporary or irrational!

Ben and I have both written frequently about how critical the narrative of stocks and bonds as mutual diversifiers is for the plumbing of the asset management industry, much of which has formed around that assumption during the last 35 years. If an event like the Covid-19 response produces compression of rates on US sovereign debt toward zero and an extended period of zero to positive correlations between rates and risk assets, modeling the event itself without accounting for how these assumptions would dramatically change the behaviors of institutions from pensions to insurance companies to family offices to yield-sensitive high net worth individuals is incomplete to the point of irrelevance!

And a reminder, since this is Epsilon Theory after all: to be IMPORTANT, these things don’t have to be long-term true in fundamental space so long as they are true in narrative space. If everybody knows that everybody knows that bonds don’t diversify stocks, or if everybody knows that everybody knows that you don’t buy bonds for yield but for duration bets alone, the game has changed on dimensions that go far beyond what one might model for the event.


What does all this mean?

It means that the appreciation for uncertainty that we have counseled throughout this process should remain. There are single events ahead of us which will completely change the complexion of this situation. They will shift the incidence and severity of outcomes on their head. Some may even bring probabilistically modeling outcomes back into the realm of the reasonable.

We should manage risks for an uncertain market, and monitor the signs investors’ are transitioning back to a risky market.

What do we do?

The same thing you did the last two weeks. By far the most important play in this playbook, because it responds to EACH of these three problems, is this:

Shrink your book.

Keep your use of leverage at a minimum.

Keep your reduced reliance on covariance estimates.

Keep your trimmed down gross exposure.

If you’re deciding between a selling and hedging, sell.

The most important place that path-dependence rears its head to create unexpected risks is in the breakdown in relationships among assets. A limited gross and skepticism about covariance estimates is how you reduce your exposure to THAT. And keep it down.

What do we look for?

We counsel looking for signs of an emerging narrative that uncertainty is changing back to risk.

I’ll be more explicit. I think bearish behavior subsides for some period if and when everybody knows that everybody knows that US testing is happening and is representative. There are enough analogs in Korea and Italy to frame the problem. Once this data exists, missionaries of “quantifiable risk” narratives will be more successful.

But let’s be clear on another point. We think that is a tradeable phenomenon in the short run. We also think that it doesn’t necessarily change the real, fundamental uncertainty of some long-term outcomes precipitated by Covid-19.

More on that to come next week.

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Tick-Tock

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Death inspires me like a dog inspires a rabbit.


If Hitler invaded hell I would make at least a favorable reference to the devil in the House of Commons.


That first quote is from Twenty One Pilots and the second is from Winston Churchill. I thought about both while listening to Donald Trump’s address to the nation last night.

I think Trump’s speech last night was constructive. Weeks late? Yes. Too late? Maybe. But it was his first public statement on CV-19 that reflected seriousness and resolve in the national interest. It was his first public statement that wasn’t overtly corrupt. It’s a start.

Tick-tock.

As for the policy specifics and the bizarro delivery and the walk-backs afterward? I don’t care. As Churchill also said, “war is a series of blunders,” and god knows there is no end to the blunders we have gotten and will continue to get from this guy.

But for the first time our federal government is treating the fight against this virus like the war that it is.

Is it pathetic and sad that it took this long? Of course. But now here we go. And there is no country in the world that mobilizes for war more effectively than the United States.

As for the market reaction to Trump’s speech today? Please.

The fact that the market doesn’t “like” Trump’s speech is exactly what made it a constructive speech in the national interest.

Like it or not (and I hate it) Donald Trump is President of the United States for the next TEN MONTHS. My reaction to his speech is not about giving him “credit”. It’s not about giving him a “grade”. It’s not about gnashing my teeth and rending my garments over a man who I think has betrayed the public trust at every turn and is the most damaging President in the history of the Republic.

Screw all that. I’m way past THAT.

The ONLY thing I care about now is fighting this war. The ONLY thing I care about now is saving lives.

Welcome to the fight, Mr. President. Hope you stick around.

Tick-tock.


How do we save lives?

First, and most importantly, we help our neighbors.


The Non-Linearity of Need

In a potential recession, need isn’t evenly distributed. In a pandemic, that’s even more true. The time to start helping is now.   … Continue reading



Second, we end #DontTestDontTell.

#DontTestDontTell is not just a policy embarrassment. It is not just simple bureaucratic incompetence. #DontTestDontTell is a willfully corrupt betrayal of our country and its citizens, and it is our moral duty to howl our anger and discontent.

You can read about #DontTestDontTell in Epsilon Theory notes here and here.

You can see it here, in Alabama.

Alabama Secretary of State John Merrill: “We don’t need for people to be concerned about something that may not ever happen.”

Alabama has tested 10 people for coronavirus. TEN.

5 million people live in Alabama. Including my 78-year-old mother who’s a substitute teacher and uses a prednisone inhaler for her asthma and her more-than-occasional pneumonia. Shelter in place, Mom, shelter in place.

Alabama, like all states, is getting a chunk of the $8 billion in federal funds recently allocated to fight CV-19. For Alabama that comes to $8.15 million. Know what they’re gonna spend their money on? “Public health communications.” In Alabama-speak, that means posters. Wash-your-hands posters.

Also, a task force has been assembled. Like the Avengers.

Here’s what the task force wants you to know about CV-19. This is from March 6th.

“The Alabama Department of Public Health has issued guidance to hospitals and healthcare centers regarding testing for the virus and encourages Alabamians to take the standard protocol for cold and flu season.”

Yep. Alabamians like my mother and my brother and my sister-in-law and my nephew and my nieces and my childhood friends are “encouraged to take the standard protocol for cold and flu season.”

And you wonder why I am so angry.

Tick-tock, Alabama, tick-tock.


Third, we move to a war-time footing to protect our emergency responders and healthcare professionals, and to bolster our healthcare system.

Specifically that means a national mobilization of manufacturing capacity to make personal protective equipment (PPE), respiratory and anti-viral therapeutics, ventilators, and ECMO equipment to support the surge in CV-19 patients who will require not just hospitalization, but intensive care treatment. It means a broadening of patient under investigation (PUI) criteria and a complete revamping of patient testing and ingestion protocols, including airborne-secure (negative air pressure) facilities inside and outside hospitals and clinics … wherever healthcare professionals come into contact with potential or actual infections.

Specifically that means utilization of domestic military bases as treatment facilities and isolation wards. It means coordination of state and local authorities with the Dept. of Defense to establish regional command, control, communication and intelligence (C3I) capabilities at tertiary medical centers. Yes, direct coordination with the DOD. It’s the most competent, well-resourced C3I organization in the world, and they are present in every domestic battlefront in this war. Yes, tertiary medical centers. They are the most competent, well-resourced medical organizations in the world, and they are also present in every domestic battlefront in this war.

Whether we have a >4% death rate from CV-19 (Wuhan) or a <1% death rate (Singapore) is entirely up to us. It is our choice! If we prevent our healthcare system from being overwhelmed, then we win. If we don’t, we lose. It’s really as simple as that.

Are we almost out of time?

Absolutely. Tick-tock.

But we all see the danger now. All of us rabbits see the virus dog chasing us. Even Donald Trump.

I said it at the start of this note and I’ll say it again, there is no country in the world that mobilizes for war more effectively than the United States. And I know you won’t believe me, but I tell you it is true:

This will be our finest hour.


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Minimax Regret

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This email is the foundation of a much longer ET note that I hope to publish next week, but wanted to share the basic idea with you and get your feedback.

The title of the note is going to be Minimax Regret, which is a game-playing strategy referring to minimizing your maximum regret. It’s a very different approach to playing any game, whether it’s investing or voting or living with our families, than the approach we almost always take in life, which is straightforward Utility Maximization. I don’t think I need to spend a lot of time describing what Utility Maximization is, except that it’s so embedded in our social psychology that sometimes people have a hard time imagining that there is any other way to think about their choices in a game … or in life. Certainly it’s embedded in everything we do as professional investors, from the very definition of an “efficient frontier” in economics and portfolio construction to the monomaniacal focus we have on evaluating “performance”.

One aspect of Utility Maximization that usually goes unnoticed, however, until it bites us in the ass when something like the coronavirus comes around, is that it’s based on a “normally distributed underlying stochastic process”. Now there’s a mouthful! In English, that means that when we engage in Utility Maximization (which we are always doing, whether we recognize it or not) we assume that there is some sort of a probabilistic bell curve that sits behind our guesses about the answer to a question we’re pondering. Like I say, this is so embedded in our human psychology that we don’t even recognize that we’re doing it.  

But you can see this phenomenon clearly in surveys about things which people have NO IDEA about.

A screenshot of a cell phone

Description automatically generated

This is a “snap survey” from one of those independent market research firms that you may subscribe to, and I want to call your attention to the first question: when do you believe the maximum impact from the coronavirus will be felt?

Now what I will tell you, from years and years of constructing surveys like this in a prior lifetime, is that if you give humans three dates as possible answers to a question like this, the middle date will ALWAYS get the most votes. If you give them seven dates, the middle date will get the most votes, and the dates just before and after will get the second-most votes. If you give them 15 dates (yes, you always give an odd number of possible responses in survey questions like this, for this reason), you’ll see the same pattern take shape. Doesn’t matter what the dates are (I mean, within reason) … the votes will take the form of a bell curve, aka a normal distribution.

Again, this is for questions where the respondents have no freakin’ idea what the right answer is … like asking investors when the maximum impact of the coronavirus will be felt.

The problem, of course, is that we assume there is some information to be taken from surveys like this, some sort of “wisdom of the crowd” to be gleaned from this exercise. There’s not. There’s zero information here. What we’re seeing is nothing more than the bell curve probability distribution that we human utility maximizers apply when we have no idea what the future holds.

The larger problem, of course, is that SO MUCH of market price setting and market behavior is based on “surveys” like this. For example, all of CNBC’s coverage of CV-19 has been a form of a survey like this … asking professional investors what they think about the “impact” of coronavirus on these Markets in Turmoil ™. There’s zero information here. Zero. All you are receiving is different votes for an underlying bell curve of possible outcomes. That’s it. There is literally nothing more to the entire exercise than that.

To be fair, usually this isn’t a problem at all. Usually this is nothing more than harmless entertainment, because usually the reality of something like corporate earnings or a jobs report (technically, the difference in our guesses about things like corporate earnings and the reality of things like corporate earnings) truly does fit some sort of bell curve distribution. There’s a reason we’ve been so well trained to be utility maximizers in our social lives … it usually works!

But when reality doesn’t fit a “normally distributed underlying stochastic process”, then all hell breaks loose. Like happened in 2008 with mortgage-backed securities. Like is happening now with CV-19.

All of our thinking about CV-19 is wrong and all of our decision-making about CV-19 is wrong because we believe we’re getting “information”, when actually all we’re getting is an irrelevant error distribution.

Investing (or just living for that matter) under the shadow of CV-19 is not decision-making under risk. It is decision-making under uncertainty, and for that you need Minimax Regret.

Here are four older ET notes that talk about Minimax Regret (there are others, too):

The Koan of Donald Rumsfeld

It’s Not About the Nail

Why Take a Chance

Things Fall Apart (Part 3) – Markets

My goal is to take some elements from these older notes and write a couple of notes on how I think we have to change our thinking about investing in an age of CV-19. Because I believe that CV-19 is bringing forth permanent and secular changes to our world, changes that will not show their “maximum impact” by … [[checks survey]] … April.

CV-19 is the catalyst that not only slows down globalization, but reverses it.

I’m trying to figure out the first, second and third order consequences of THAT. And I’d love your help. If you have any thoughts or ideas, I’m all ears.

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The Non-Linearity of Need

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I am writing this at home because I can.

I will guess that many of you are reading it at home because you can, too. The effects of tail events are not perfectly distributed, the burdens not equally shared.

Since some of you are also probably reading this during an NYSE-instituted circuit-breaker timeout, it is entirely reasonable to wonder where we are in the market’s digestion of the coronavirus. What seems clearer is that we are still in the early innings of the disease as a public health and household economic issue. Maybe summer heat or a miraculous change in US policy give us some relief from the more dire potential public health outcomes. Maybe they don’t. Either way, many of the economic outcomes have already been crystallized. Why?

Because among corporate, community and non-profit leaders, everybody knows that everybody knows that they will be forgiven for a couple bad quarters, but not for letting the coronavirus run amok on their watch.

Amazon, Google, Facebook and Microsoft have heavily pushed work-from-home policies, especially in Washington State. Each has also placed restrictions on employee travel. So, too, have Apple, Chevron, JP Morgan Chase, Morgan Stanley, Bank of America, P&G, Intel, Wells Fargo and hundreds of other US companies.

Conferences are canceled. SXSX in Austin. Adobe Summit. F8. I/O. IBM Think. Dell World. WWDC’s coming. Nearly all others of size through mid-summer probably will be, too.  

If you must make a decision today, defecting from this consensus and continuing with a large-scale event is an expression of pure risk. There is practically no upside and significant public, political downside to pressing on. There is practically no public cost (i.e. excluding event sunk costs) at this stage to cancelation.

To you, anyway. To those organizations.

But there are costs.  

There are costs to the roughly 15 million Americans who work in service jobs in leisure and hospitality – restaurants, hotels and bars.  

There are costs to the roughly 15 million Americans who work in retail sales.

There are costs to the roughly 15 million American single-parent households who are raising children who would typically be in schools every day for the next 2-3 months.

In a pandemic event like Covid-19, these costs are not linear. They interact. They make each other worse for the people affected.

There will be families who rely on schools during the day to permit them to work, who also work in service jobs in public places which expose them unduly to the risk of infection, who also have poor health insurance options. These are families who would struggle financially to grapple with any one of these problems. Millions of them may soon have to deal with all of them at once: kids unexpectedly at home, reduced hours or eliminated jobs in retail sales and hospitality after weeks of below historic levels of compensation, and in the very worst cases, a significant illness themselves.

Even if Coronavirus the Disease falters its advance as we all hope that it will, Coronavirus the Economic Event is already here. It is a life and food security event for many Americans, and the time to act is now.

What can full-hearted Americans do?

  1. Take care of service vendors: If we own or run a business where we can do so ethically, we can find a way to keep paying the people and businesses we have worked with and may not be able to soon because of social distancing. Do we cater a weekly lunch from a local restaurant for the team? Do we regularly visit a local bar for drinks on Thursdays? Then we can take care of the people who have taken care of us. As long as it’s possible for us to do so – and in most places in America, it is – go there and tip generously.
  2. Let friends and neighbors know NOW how you’re ready to serve: We have elderly neighbors who in some regions will soon be discouraged from – or may just be personally frightened about – going out, even just to the store. We have neighbors who are single parents or households with two working parents who don’t have any idea what they’d do if schools or daycare centers they rely on were closed for any period of time. We can talk to these people now. We can decide what we can do to help and commit to it. Yes, including watching children for friends and neighbors.
  3. Give to local organizations who support these needs: Coronavirus the Disease doesn’t care who we are. Coronavirus the Economic Event, on the other hand, does. Its burdens will fall unevenly on the millions of families with children who rely on retail and hospitality sources of income. Some will very likely have basic material needs – food and shelter. Find the organizations who provide these things. Support them generously.

Today my family will be supporting the Bridgeport Rescue Mission, a wonderful group in our own backyard. They provide those who need it with three hot meals every day of every year. They provide short-term emergency housing and other resources. They’re a godsend for people in need. Ben’s family are supporting Filling in the Blanks, a Norwalk-based charity that is dedicated to bridging the weekend meal gap for Connecticut children in low income families, a gap that could grow substantially in the coming months.

And that’s another thing you can do: If there is an organization in your area which provides these services that you would like us to feature here, first give. Then send us information about it at info@epsilontheory.com, or post it in the comments below. We’ll continue updating it.

Ben has been working to deliver a Clear Eyes perspective on the coronavirus for weeks now. We hope you’ll join us in showing how Full Hearts can help, too.


Places that can help

US:

National Domestic Violence Hotline

Arizona:

The Community Food Bank of Southern Arizona

Bay Area, CA:

Mobility Matters

Alameda County Food Bank

Los Angeles, CA:

Manhattan Beach Business Association

Gardena Valley Japanese Cultural

LA Regional Food Bank

Fairfield County, CT:

Bridgeport Rescue Mission

Filling in the Blanks

New Haven County, CT:

Cheshire Community Food Pantry

New Mexico:

RoadRunner Food Bank

New York City:

Food Bank for New York City

West Side Campaign Against Hunger

Elyria, OH:

Save Our Children

Oklahoma:

Regional Food Bank of Oklahoma

Houston, TX:

Houston Food Bank

Springfield, VA:

ECHO

Seattle, WA:

Kitsap Rescue Mission

Issaquah Food Bank

UK:

Oxford Food Bank

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Don’t Test, Don’t Tell (10 Days Later)

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Last week, Claire Lehmann, the founder and editor in chief of Quillette, asked if I’d be interested in publishing a new version of Don’t Test, Don’t Tell on the Quillette platform. I’ve never published anywhere except the Epsilon Theory platform in the seven years I’ve been doing this, and to be honest I find many of the articles published on Quillette to be more than a little problematic.

I immediately agreed.

As Rusty described in his magisterial note, The Elton/Hootie Line, what we need so desperately here in The Long Now are, to use the ten-dollar phrase … epistemic communities … opt-in places of thought and speech for truth-seekers. Or, to use the ET lingo … packs.

Quillette is a pack. It’s not my pack, but so what? We truth-seekers gotta stick together.

So here’s the article I wrote for Quillette, reprinted below. You’ll notice a few differences in the text, as Claire’s editors toned things down in a few places!


Anyone who wants a test can get a test.

On Thursday, February 26th – just as President Donald Trump was finishing up his initial White House press conference on the coronavirus … the one where he appointed Vice President Mike Pence as coronavirus czar and talked about “the fifteen cases that could go to zero” – I received a Twitter DM from a physician that included screenshots of an email that had been sent to staff at the UC Davis Medical Center in Sacramento, California earlier that afternoon. After checking for authenticity, I posted the screenshots in a tweet of my own.

And that’s when, as the kids would say, my Twitter feed blew up.

Since that night, the original email has been confirmed by UC Davis and reported on by multiple news organizations. Here’s a copy of the email as reported by NPR.

I want to highlight a couple of quotes from this email.

Since the patient did not fit the existing CDC criteria for COVID-19, a test was not immediately administered. UC Davis Health does not control the testing process.

The facts here are clear cut. A patient came in from another hospital on Wednesday, Feb. 19 – this is one week before the email – already intubated and on a ventilator, and the doctors at UC Davis – who have treated other coronavirus cases – immediately suspected a coronavirus infection.

But the US Center for Disease Control (CDC), the organization with the sole authority and ability to administer a coronavirus test, refused to test.

Why? Because this patient didn’t fit their “criteria” for testing. These criteria – what are known as Patient Under Investigation (PUI) guidelines – have been set in stone in the United States since coronavirus first burst onto the scene a few months back. Do we know for sure that the UC Davis patient was either a) in mainland China within the past 14 days, or b) in close contact with another confirmed case? No? Well then by definition this UC Davis patient could not possibly have a coronavirus infection. No test for you!

It’s not that testing was not available. It’s that testing was not ALLOWED.

This is “Don’t Test, Don’t Tell” and it is the single most incompetent, corrupt public health policy of my lifetime.

But wait, there’s more. It’s not only this patient who was directly harmed by Don’t Test, Don’t Tell.

When the patient arrived [Wednesday], the patient had already been intubated, was on a ventilator, and given droplet protection orders because of an undiagnosed and suspected viral condition. … On Sunday, the CDC ordered COVID-19 testing of the patient and the patient was put on airborne precautions and strict contact precautions.

Translation: for four days, every healthcare professional treating this patient at UC Davis was exposed to airborne transmission of coronavirus. And so was every healthcare professional at the hospital before UC Davis, particularly during the intubation process. Because the CDC refused to test this patient for coronavirus in a timely manner, all of the doctors and nurses and technicians caring for this patient were put at risk.

Sure enough, over the next few days about 124 UC Davis Medical Center staffers – including at least 36 nurses – were ordered into self-quarantine because of their exposure to this one patient. Worse, three staff members at Northbay VacaValley Hospital – the facility where this patient was treated before being transferred to UC Davis – have already tested positive for coronavirus infection, with an unknown number of additional healthcare professionals from that hospital now in self-quarantine. That’s all from one coronavirus infection.

Now imagine this same story repeated day after day across the United States for the past two months, where those infected with the virus fail to receive the care they need, spreading the disease not only to their community when their symptoms do not require hospitalization, but spreading the disease directly to emergency responders and healthcare professionals when their symptoms do. Even today, more than a week after the consequences of Don’t Test, Don’t Tell were revealed in that first case of community-spread coronavirus from Sacramento, the number of tests performed in the US is laughably low, particularly in states that were caught flat-footed when the CDC abdicated control over test production. Missouri, a state with a population of more than 6 million, has performed only 17 tests. Michigan, with a population of 10 million, has performed only a few dozen tests. Pennsylvania, with a population of almost 13 million, can perform all of 33 tests per day. Amazingly enough (sarc), these states do not have a confirmed case of coronavirus within their borders.

Now imagine this same story repeated day after day across the globe.

The statistical anomalies would be comic if they weren’t so tragic. As I write this essay on March 5th, there are more confirmed coronavirus infections in Harris County, Texas (five) acquired by Americans who traveled to Egypt than there are confirmed cases within the entire country of Egypt (three). Why? Because Egypt has only tested a few hundred people in this country of 100 million. There are more confirmed coronavirus infections in the city-state of Singapore (three) acquired from Singaporeans who traveledto Indonesia than there are confirmed cases in the entire country of Indonesia (two). Why? Because Indonesia has only tested a few hundred people in this country of 265 million. Can’t make it up.

With the exception of South Korea and Italy (and you can throw the UK in there, too, I suppose), pretty much every nation in the world has adopted some form of Don’t Test, Don’t Tell. The offenders include rich countries like the United States and Japan, vast countries like Indonesia and India, communist countries like China and Vietnam, theocracies like Iran and Saudi Arabia, oligarchies like Russia and Nigeria, social democracies like Germany and France … Don’t Test, Don’t Tell knows no geographic or ideological boundary.

And so you might ask: is this a difficult or expensive test to make? Is there some fundamental reason of technology or economics why a country might find itself forced to pursue a policy of Don’t Test, Don’t Tell?

Nope. It’s a relatively simple test to develop and administer in vast quantities. I figure there are half a dozen university and industry labs in Jakarta or Nairobi, much less Moscow or Chicago, that could crank out a few thousand test kits per week if they wanted to. Or rather, if they were allowed to.

Now that doesn’t mean that you can’t screw up the coronavirus test if you really set your mind to it. And in fact, that’s exactly what the CDC did in January, when they rejected the World Health Organization’s proposed test panel for SARS-CoV-2 (the official name for this particular novel coronavirus which causes the disease COVID-19) in favor of a gold-plated test panel of the CDC’s own design. After all, why just test for SARS-CoV-2 when you could also test for other SARS and MERS viruses? Unfortunately, with complexity came error, and these initial CDC triple-test kits had a flaw in one of the multiple tests, ruining the entire test. Now the CDC is producing a solo test for the SARS-CoV-2 virus, but this fiasco set us back weeks in test-kit supply.

So if it’s not a difficult or expensive test to make, why are so many countries pursuing a policy of Don’t Test, Don’t Tell?

The answer, of course: to maintain a political narrative of calm and competence.

It’s what the Best and the Brightest always do … they convince themselves that their citizens can’t handle the truth, particularly if the truth ain’t such good news. They convince themselves that they can buy themselves time to figure out a winning strategy against a disease like COVID-19 if they employ a constructed “communication strategy” like Don’t Test, Don’t Tell.

Until they run out of time.

Like they ran out of time in China. Like they ran out of time in Wuhan.

From The Fall of Wuhan:

A city falls when its healthcare system is overwhelmed. A city falls when its national government fails to prepare and support its doctors and nurses. A city falls when its government is more concerned with maintaining some bullshit narrative of “Yay, Calm and Competent Control!” than in doing what is politically embarrassing but socially necessary.

That’s EXACTLY what happened in Wuhan. More than 30% of doctors and nurses in Wuhan themselves fell victim to COVID-19, so that the healthcare system stopped being a source of healing, but became a source of infection. At which point the Chinese government effectively abandoned the city, shut it off from the rest of the country, placed more than 9 million people under house arrest, and allowed the disease to burn itself out.

And so Wuhan fell.

The disaster that befell the citizens of Wuhan and so many other cities throughout China is not primarily a virus. The disaster is having a political regime that cares more about maintaining a self-serving narrative of control than it cares about saving the lives of its citizens.

We must prevent that from happening here. From happening anywhere. Yes, containment has failed. But that does NOT mean the war is lost. We can absolutely do better – SO MUCH BETTER – for our citizens than China did for theirs.

China’s brutal handling of the coronavirus in Hubei province, from its muzzling of doctors like Li Wenliang for “rumor-mongering” to its forced quarantines of tens of millions to its carefully falsified “data” regarding the spread of the disease to its influence over World Health Organization recommendations … it was all guided by Don’t Test, Don’t Tell (with Chinese characteristics).

The Chinese experience with coronavirus is not a “lesson” for the West. It is a cautionary tale!

How do we do better by our citizens than China did by theirs?

By prioritizing the protection of our emergency responders and our healthcare professionals, through better equipment and facilities, yes, but most of all through better policy and organization, starting with the abandonment of Don’t Test, Don’t Tell.


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The Elton/Hootie Line

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Epsilon Theory PDF Download (paid subscription required): The Elton/Hootie Line


We’re talking about things that are going to change the world and change the way people listen to music and that’s not going to happen with people blogging on the internet…There’s too much technology available. I’m sure, as far as music goes, it would be much more interesting than it is today.

Elton John, Interview with The Sun (2007)
Image result for bob dylan

The records I used to listen to and still love, you can’t make a record that sounds that way. Brian Wilson, he made all his records with four tracks, but you couldn’t make his records if you had a hundred tracks today. We all like records that are played on record players, but let’s face it, those days are gone. You do the best you can, you fight that technology in all kinds of ways, but I don’t know anybody who’s made a record that sounds decent in the past twenty years, really.

You listen to these modern records, they’re atrocious, they have sound all over them. There’s no definition of nothing, no vocal, no nothing, just like – static. Even these songs probably sounded ten times better in the studio when we recorded ’em. CDs are small. There’s no stature to it. I remember when that Napster guy came up across, it was like, ‘Everybody’s gettin’ music for free.’ I was like, ‘Well, why not? It ain’t worth nothing anyway.’”

Bob Dylan, in an interview with Rolling Stone (2006)
Image result for hootie and the blowfish live

We’ve wanted to bring a party; it’s high-energy, and it’s about fun. The worst thing for me when I go to a concert is a whole bunch of ballads. You get bored.

Darius Rucker, who absolutely does not want you to call him Hootie, to the St. Louis Post-Dispatch (June 2016)

This will not be fair to Hootie.

Or the Blowfish, for that matter. He didn’t start it. He didn’t really make it worse. For God’s sake, he doesn’t even want to be called Hootie anymore. That’ll be Darius, if you please.

It is just bad luck that his was the best-selling album in the United States the year that a minor trend among heavy metal, punk and the occasional rap artist went mainstream. It’s not his fault that Elton John topped the charts with a musical-inspired soundtrack album to The Lion King that stood in stark contrast the prior year.

That year was 1995. The year we crossed the Elton/Hootie Line.

The Elton/Hootie Line is not a demarcation of musical genre. It isn’t the border between good and bad music, or between one media format and another. It hasn’t got anything to do with Napster or the RIAA or anything like that.

The Elton/Hootie Line marks the last time that we allowed popular music to be quiet sometimes.


Loud and quiet are easy ideas to understand. There’s not much gray area in the formal definition. It is trivial to measure the difference in air pressure against ambient levels caused by sound waves. Plot those measurements on a log scale, and you’ve got what you know as a decibel.

In practice, however, the human experience of loud and quiet relies heavily on context. Other qualities of a sound – its pitch, its timbre and the sustained level of its volume – influence the individual experience of loud and quiet. Many people might listen to a thrash metal album with a pressing, ostinato rhythm from a distorted electric guitar, crashing open hi-hats and double bass drum pedals and say, “that’s louder”, even if a sweet, gentle cello sonata was being played and heard at a nominally identical decibel level.

The most important context to loud and quiet, however, relates to how music is recorded and reproduced. For obvious reasons, the volume that instruments were played at passes through a mixing and mastering process that normalizes sounds for whatever medium will be sent to the consumer. Celine Dion belting an adult contemporary power ballad was a lot louder in the studio than what you’d hear if you were standing next to a pre-autotune Selena Gomez. But on Spotify, Apple Music or a CD? Not much difference. Er, with the loudness, I mean.

Through a combination of adjusting the gain, or sensitivity of the microphone used to record, and through both hardware and software tools used to adjust levels of tracks post-recording, their voices will hit a record at largely similar volumes. Yes, different genres of music have different levels of reliance on the lead vocal track that will drive marginal differences, but by and large the peak levels of vocals will reach roughly the same volume on most modern recordings.

Much of this normalized level is defined by the fact that there are limits to how loud something can be in a recording at a certain bitrate before it begins to distort. In other words, the loudest segments of a recording are going to be just a bit below where they’d create distortion.

That creates a problem for the engineer and producer alike: if the peaks – the loudest parts – of every recording are being normalized to similar levels for reproduction and you want to make your music stand out from the rest as energetic, powerful or exciting, how do you do it?

The answer: you crank up the volume on everything but limit or cap the peaks in the recording from getting so loud that they will distort.

And that’s exactly what the music industry did. They cranked up the volume of anything remotely quiet, limited the peaks from distorting, and compressed the overall dynamic range of everything we listen to. (The software and hardware tools used to achieve this are literally called compressor/limiters)

Now, they didn’t really start with Cracked Rear View in 1995, obviously. It was something that engineers and artists had experimented with many times over the years. Some pressings of Hotel California did it in 1976. Queen tried it on Sheer Heart Attack that same year. AC/DC and Ozzy, for example, released a number of records in the early 80s that were designed to crank things up. Metallica dabbled with several in 1983. The Who’s soundtrack to Tommy that same year. Twisted Sister in 1985. It wasn’t just a rock music phenomenon, although it’s clear to see why those artists and engineers thought it was an appealing strategy to make their recordings stand out for their audience. Live music also often relies on compressor/limiters to handle uncertainty, bad microphone technique, blending with crowd noise, feedback and other issues. Even live music with a decidedly relaxed groove, like Bob Marley’s live album Babylon by Bus, stands out on this dimension.

There were also some albums that still allowed some Dynamic Range after the Elton/Hootie Line had been crossed in 1995. Most were in what people outside of Texas call country music (e.g. Shania Twain’s The Woman in Me and Garth Brooks’s The Hits) and in corners of rap and hip-hop (e.g. Coolio’s Gangsta’s Paradise). By 1997, country music was the only holdout. Engineers for George Strait (PBUH) and his album Carrying Your Love With Me kept a light touch on their compressor/limiters. Same with Leann Rimes’s Unchained Melody. But for basically any other charting album and every other genre, the line had been permanently crossed.

Just as we can measure loudness with decibels, we can measure the extent to which the dynamics of music have been compressed with a measure called Dynamic Range. It is a variant of crest factor, which measures the ratio of the peak value of a waveform to a representation of its general level (RMS). Basically, a Dynamic Range of 14 or more usually means music that has not been compressed very much. Dynamic Range of 11-13 might imply a moderate level of compression that we’d usually associate with the normal process of normalizing levels in a typical mastering setting.

Below that? Either you’re listening to some weird Philip Glass album that’s like 45 minutes of a sine wave, or your engineer is dialing up the compression. All to make the music stand out to you, dear consumer. You like energetic music, don’t you? Exciting music? Stirring, thrilling, powerful music?

Making music sound more energetic and exciting through the use of heavy compression was initially a dominant and escalating strategy in an industry that was playing a Coordination Game. That doesn’t mean that there wasn’t competition, or even that it wasn’t frequently cutthroat. It meant that the nature of that competition was not to take actions which harmed the ultimate product AND forced everyone else to do the same thing.

It was what game theory calls a Stag Hunt, something we’ve written about several times in context of politics and markets. The basic idea is that if both parties coordinate their hunt, they both end up taking home a stag. Lots of meat to go around. If one party decides to go off on his own to hunt a rabbit instead, the other party will miss out on the stag and any meat altogether.

It’s a game that has two equilibria in repeated plays: when players are cooperative, pursuing a better outcome for both is an equilibrium. When one party defects and decides that they’d prefer to win a relative game more than they want to take home the most meat, they’ll win for a while. But that isn’t a stable equilibrium. Everyone else quickly realizes that the defector cares more about winning than getting a better outcome. The only way they can eat at all is to defect and settle for a rabbit, too. The worse outcome for everyone becomes a new equilibrium.

epsilon-theory-virtue-signaling-september-30-2016-hunt-together-alone-chart

You see, when you heard it on the radio or on a CD player at your house, a Hootie and the Blowfish album that had been heavily compressed did feel more energetic. Pop in something else before or after, and even if it was more musical, more expressive and more interesting, it would be missing something. Once the top-selling albums all defected, NOT defecting to heavy compression would mean coming home from the hunt empty-handed.

And so they defected. All of them. Here is the Dynamic Range of the top-selling album by year for every year from 1968 to 2019. There was no going back.

Source: Epsilon Theory, Billboard, Dynamic Range DB

For most listeners, even this probably understates the experience. In addition to the audio compression being applied at the studio, beginning in the late 1990s many users began to consume audio in forms that applied additional digital compression to reduce the size of a recording. MP3s, and later, streaming. One of the frequent side effects of reducing the file size of a digital recording is a further reduction in its Dynamic Range.

Once the game changed, something else happened, too: the process of creating commercial music changed. What I mean is that if you knew that your music was going to be heavily compressed, the music that you would write, perform and produce would probably be different.

It was.

The music being recorded changed in ways completely unrelated to audio compression at almost the exact same time. As we crossed the Elton/Hootie Line, we also saw dramatic compression in lyrical diversity. Colin Morris at The Pudding put together a fascinating analysis of exactly that a couple years ago: how much you could compress a song’s full lyrical set using the Lempel-Ziv algorithm. You know it as the basis for most “zipping” programs you use because your IT department inexplicably limits your mailbox size at some absurdly small number.

Just like with zip files, we can compress the lyrics of a song based on repeated words and characters. The more compressible a song is, the more repetitive its lyrics. Here’s what Colin found. Essentially, pop lyrics were at a pretty consistent level for most of the 80s and early 90s. Then, around 1995/1996, lyrical complexity plummeted.

Oh sure, we may be mixing up cause and effect here. That’s OK. I’m not really saying that there’s some linear causal relationship between audio compression and lyrical compression. I’m saying that when you turn up the volume on anything, you’re defecting from a working game structure. You’re pushing the game from a Coordination Game to a Competition Game.

And it matters.

When we transform our interactions into Competition Games, it doesn’t just mean that we’re mean and yelling at each other all the time. It also means that optionality disappears. Degrees of freedom disappear. Creativity disappears. Diversity disappears. True risk-taking disappears. More of our decisions are optimized toward cartoons, abstracted versions of reality. More of our information is based on narratives and memes.


The Elton/Hootie Heuristic: When you turn up the volume, the signal to noise ratio drops.


Volume is a literal thing when it comes to music. But it’s a thing in politics and media, too. It’s extreme language. It’s big metaphors. It’s framing each issue in nearly existential terms. It’s the Flight 93 Election, every election for the rest of our lives.

In 2016, Ben wrote a seminal Epsilon Theory piece about how Donald Trump turned up the volume of our political discourse in a way that would break us.

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

Virtue Signaling , or…Why Clinton is In Trouble (Epsilon Theory, September 2016)

You can disagree about whether Donald himself is responsible. You can say he was an inevitable outcome of a prior defection in the Stag Hunt by a now almost entirely left-wing news media and academy. That’s maybe a little bit closer to my personal view. It doesn’t matter now. Whatever the proximate cause, the volume of our political discourse has been cranked to 11.

That volume manifests in our emotions about political opponents:

Growing shares in both parties give ‘cold’ ratings to those in opposing party

It manifests in extremes in the differences of our views, like the record gap in approval rating for President Trump observed between Democrats and Republicans in 2019. Like the research compiled indicating that out-group loathing was a greater political motivator than in-group preference.

But turning up the volume also does something else. It compresses the range of acceptable political ideas, policies and discourse. Through political correctness, patriotic correctness and things like cancel culture, views which don’t hew to the protective sphere of one political pole become socially impossible. There is rarely one governing narrative for any social sphere or institution, but views, opinions and actions which deviate from one of the compressed set of acceptable narratives are ruthlessly ostracized and eliminated.

But none of that is surprising. You already know that the volume has been turned up. You’ve seen the data showing our political polarization. You’ve seen the language framing each election and each issue in existential terms. You also already know that the compression is happening. Like us, you’ve probably despaired at the absence of nuance and any semblance of a political center. It’s not important to see all that data again.

What’s important is recognizing that the concepts of volume and the compression are linked. When you turn up the volume and make politics existential, you will ALWAYS limit the range of feasible views. You will ALWAYS end up with more institutional paralysis. You will ALWAYS make policy compromises far more difficult. You will ALWAYS constrain the emergence of good new ideas.

A loud political environment IS a compressed political environment.


That is just as true in media as it is in politics.

As with music, as with politics, the higher volume environment has created a tendency toward compression. What does that mean in this context? It means that when language becomes more extreme, when society becomes more polarized, narratives take on a more dominant role in defining and framing news coverage.

Consider each of the biggest news events of 2019 where it felt like the volume was turned to 11. Think about the nature of the articles you read. How long did it take for them to arrive at a discrete set of narratives, stories that everybody knew everybody knew about that event? How long did it take until you felt like you could predict exactly how each publication would frame updates about the event?

I’ll work back from the answer: A week. In 2019, it rarely took more than that to crowd out off-narrative takes on a high volume story.

Consider this list of the major news events of 2019:

  • Mueller Report
  • Impeachment of Donald Trump
  • Death of Jeffrey Epstein
  • Celebrity Admissions Scandal
  • Notre Dame Fire
  • Hong Kong Protests (Ongoing)
  • Australia Fires (Ongoing)

Imagine that you could take in every article written about these events in the first week after they took place. Now imagine that you could look at every article written in the second week. Now imagine that for each of those blocks of articles, you could measure how similar the language used was to every other article published that week. For the ongoing events that took place over multiple months, imagine you could compare the stories written in the first major news month for the event (e.g. June 2019 for US coverage of Hong Kong protests) and compare them with articles written in December 2019.

If what you wanted to identify was how much off-narrative news was permitted to exist, you’d set some threshold for that measure of linguistic similarity that represented an unusually low degree of connectedness to the rest of the coverage. Then you could look at the two periods to see whether the share of articles falling below that threshold rose or fell. If off-narrative news was being sloughed off, you’d expect it to fall.

So that’s what we did. And that’s exactly what happened. Specifically, we present below the Period 1 to Period 2 change in the percentage of articles whose normalized mean harmonic centrality in a network graph of stories about each topic fell into the bottom 10% of values we’d expect in average network of news of that size.

Around a week after a major event, more than 20% of the off-narrative angles got compressed into on-narrative takes. And while the point here is a more general one about the volume level of our volume in the aggregate, I don’t think it takes much to observe that the more political articles appear to have been more subject to compression in off-narrative perspectives between the initial and subsequent period after the event.

A loud environment for information is also a compressed environment for information.


A few weeks back I wrote a piece called We Hanged Our Harps Upon the Willows. The intent of the piece was to reiterate our long-standing belief that the only answer to Competition Games is not to play. I think some readers thought it was an argument for not doing anything. For blogging and hiding in a walled garden.

That isn’t it. At all.

Let me tell you how the Loudness War Competition Game was solved, because I think it’s instructive not only for media, but for every kind of political, financial market and other Competition Game in our world today.

The Loudness War was solved when enough people who really loved music and had had enough of overcompression got together to create a sustainable environment…for vinyl records.

That’s it. They didn’t boycott the big labels. They didn’t try to draft people into being installed as executives to shift the direction of music. They didn’t push for regulatory standards on bitrates or streaming compression. They refused to sing their songs. They refused to play their games. They created a community. They grew it. They invested themselves in it. They paid way too much for vintage tube pre-amps. They converted artists to their passion. That conversion made other adjacent communities, like those built around digitally distributed music encoded with lossless codecs, stronger, too.

Don’t get me wrong. If you’re not acting intentionally, most music you will hear today is still hilariously simplistic and overcompressed. The point is that you now have a choice. But in most – not all, but most – of the battles we will fight today and in the future, this is what victory will look like: the creation of a sustainable, opt-in world for people who want to be free from a life in which we are obliged to invest our passion, treasure and energy in cartoons. In other words: epistemic communities.

Epsilon Theory is one. There are others.

Jonathan Haidt, Debra Mashek and the Heterodox Academy are building such a community, a response to compression and volume in academia.

Claire Lehmann and Quillette are building such a community, a response to compression and volume in media.

Eric Weinstein is building such a community. It responds to compression and volume across multiple social spheres.

Yes, even the Bitcoin community fits the bill in many ways.

So, too, do local institutions connecting people in narrow geographies that are too many to count. We’ve also expressed our admiration for organizations like Let Grow and Strong Towns in the past. They are involved at a national level in empowering our lowest-level institutions: families and towns.

If your response is to say that you have an issue with one or more of the ideas that have come out of these groups, well, all I can tell you is to join the club. Me too. That’s not the point. The point is that they are organized on axes other than the prescribed axes that result from a compressed environment. They are places where creativity and autonomy of mind can exist, where quiet can exist, where cooperative, coordinated game play can be promoted.

They are arenas in which we are each free to seek out the signal amid the noise.

Find your pack.


As regular readers will know, the graph included earlier in this note was referenced without identifying information in a brief competition held here. We asked subscribers to tell us what they thought the graph presented. No one guessed it exactly, but one long-time packmember came unnervingly close with what he later disclosed was a joke submission. All the same, we’re declaring Michael Madonna the winner of this competition.

Epsilon Theory swag incoming.


Epsilon Theory PDF Download (paid subscription required): The Elton/Hootie Line


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