Lucifer’s Hammer


Epsilon Theory PDF Download (paid subscribers only): Lucifer’s Hammer

The perversity of the Universe tends towards a maximum.

The gods do not protect fools. Fools are protected by more capable fools.

Ethics change with technology.

Quotes by legendary science fiction author Larry Niven, none of which are from Lucifer’s Hammer.

I was 14 years old when I read Lucifer’s Hammer, the post-apocalyptic novel by Larry Niven and Jerry Pournelle about a comet hitting the Earth. It’s pretty standard end-of-the-world fare, with mile-high tsunamis and volcanos emerging from earthquakes and billions dead and an intrepid community of surviving scientists/libertarians defeating the cannibal, faux-religious, statist army-remaindered horde that attacks without warning or honor.

It was one of those books that I read at just the right time, so I remember entire passages almost verbatim.

I remember how the odds of the comet hitting the Earth were minuscule at first, but every day would go up ever so slightly. I remember how smart people paid attention to that … to a 1/100th of 1% chance moving to a 1/10th of 1% chance moving to a 1% chance, when the probabilities are converging on the same event.

I remember how the sentry’s signal to the sniper that all was well was to raise his arms as if he were being held hostage, because of course that’s the action that any would-be bad guy would forbid the sentry to take under any circumstances.

I remember how the battle with the cannibal, faux-religious, statist army-remaindered horde is ultimately won by getting them into a valley and them lobbing homebrew mustard gas canisters at them, and how the lung-destroyed survivors are dispatched by crossbow bolts so as not to waste any bullets.

I remember how the scientist hero saves the future of humanity by wrapping a full set of Encyclopedia Britannica and The Way Things Work in double-sealed plastic bags with mothballs, and then hiding them in a septic tank.

But most of all, I remember the voice of Ego whispering this in my ear:

“You know, this whole post-apocalyptic thing doesn’t sound half bad!”

Sure, I’d have to survive that initial strike. And sure, it’s all quite sad that people I love (i.e., my parents) would have to die. But tbh, they had a good run, and I’m sure it would be a painless death. And this post-apocalyptic society … why, it’s a meritocracy, where my hidden genius and quiet courage and (very) untapped virility would finally be appreciated!

Those whispers of Ego, those post-apocalyptic fantasies of a 14-year-old boy, have never left me.

I’m 56 years old, and I still fantasize about how I could take out a motorcycle gang assaulting the farm. I’ve figured out where to set up the enfilade line of fire, where to plant the IED and how big it would need to be to take out a half-track armored vehicle. I’ve spent many a pleasant hour figuring out how to construct a laser-guided RPG for when, you know, the cannibal, faux-religious, statist army-remaindered horde sends their helicopter out in support of the (now dead) motorcycle advance troops and half-track APC.

If I were a betting man – and I am – I would place a large wager that every first-world post-pubescent reader of this note similarly burdened with a y-chromosome harbors similar fantasies. Not just Harry Potter/Disney/comic book oh-I’m-a-special-orphan-destined-to-lead-a-grand-struggle fantasies, but “real” post-apocalyptic how-do-I-kill-the-motorcycle-gang fantasies.


The world after the comet hits is not a meritocracy, but a brutal dictatorship without end, where boys like you are used as fodder and feed. And girls like your daughters are used as worse.

Death is pain incarnate, always and without exception. And yet there are worse pains that await you after the comet hits.

This is not a fucking game.

It has taken me a lifetime to hear the Narrator more loudly than the Ego.

It has taken me a lifetime to see clearly not only what deserves burning down but how to burn it down.

The What is the inequitable social structures of power in our normal, quotidian lives, both in the halls of secular mightiness and – even more so – in our own freakin’ hearts.

The How is the unrelenting willingness to Make, to Protect and to Teach away from and in resistance to those inequitable social structures of power, creating a social movement that ignores the institutionally nudged and amplified whispers of Ego, that turns the other cheek as it builds and builds and builds and builds a new nation of … believers. Believers in the white-hot power of making, protecting and teaching to burn away the accumulated crud of decades of I-got-mine-jack sociopathy. Believers in the flamethrower of change that is political participation through community action, not just the sparkler of change that is political participation through voting once every four years.

Turning the other cheek doesn’t mean you don’t get angry. Trust me, I am SO angry! That’s why I use angry words, like BITFD – Burn. It. The. Fuck. Down. – words intended to galvanize and shock, yes, and also words that embody the cold rage that first engulfed me during the Great Financial Crisis and has grown and grown with every moment of the Long Now. But anger is not enough. In the history of social change, mere anger has never been enough.

Turning the other cheek – which is just the OG phrase for nonviolent protest – is a strategy for channeling our anger and weaponizing our voice.

It’s a choice.

It’s choosing the clear eyes needed to recognize that the institutions and the high-functioning sociopaths who wield today’s inequitable social structures of power WANT you to strike back with your fists rather than your words. It’s choosing the full heart needed to take a hit for the Pack through nonviolent protests, sure, but nonviolent actions even more – unwavering, constant nonviolent actions of exit, sacrifice, voice and mutual support from the bottom-up – creating a decentralized epistemic Fight Club of citizens who make their way IN this fallen world without being OF this fallen world.

It’s the smart play.

As wise as serpents. As harmless as doves.

2,000 years ago, this was pretty good advice for changing the world when the wolves of powerful, entrenched interests were looking for any excuse to rip your throat out, and it’s pretty good advice today.

And yes, this is how we change the world. This is how we BITFD. For real. For good.

Unfortunately, we believers have a problem. That problem is that no one gives a damn about burning down the systems of control and nudge when their actual house and their actual car are actually burning.

But that’s the comet that’s speeding our way, a comet of endemic urban violence.

And for so many people – especially young men with the voice of Ego now shouting in their heads as the whispers are turned up to 11 by the amps of party and media – they think that sounds just dandy.

This has all happened before.

Back in the day, when I was a young pup of a poli sci professor at NYU, actual Marxists roamed the Earth. In my experience, Marxists are infallibly delightful conversationalists, and at an academic dinner I got to talking with two of these ancient dinosaurs (one of whom remains an avowed Marxist to this day and the other who had forsworn his faith) about the 1968 riots in Paris. They had both been there, manning the barricades! The Mother of All Protests! A national uprising against the police powers of a far rightwing President hellbent on reshaping the French republic!

I asked them to describe their experience. What was it like to be a part of May 1968, a student-led protest that mobilized the working class and shut down the entire country of France? That forced de Gaulle to (briefly) flee the country?

The old Marxist looked at his friend, the now disavowed Marxist.

“Well, I remember I got laid a lot.”

“Yes,” said his friend with a wink, “it was quite a lot of fun.”

And there you have it, ladies and gentlemen, the dirty little secret of every riot and protest and looting that ever existed in the history of mankind … IT’S FUN.

And not to be outdone, here’s the dirty little secret of every counterprotest and posse and vigilante group and “militia” that ever existed in the history of mankind … IT’S FUN.

I felt weightless. I felt that nothing would happen to me. I felt that anything might happen to me. I was looking straight ahead, running, trying to keep up, and things were occurring along the dark peripheries of my vision: there would be a bright light and then darkness again and the sound, constantly, of something else breaking, and of movement, of objects being thrown and of people falling.

I had not expected the violence to be so pleasurable.

That’s Bill Buford, literary editor and SJW, who started off writing an anthropological study of Man United “hooligans”, only to be embraced as part of the crew and to discover the atavistic joys of a good rumble.

Among the Thugs is the best book you’ll ever read about the human nature of riots and group violence.

Know who’s having fun tonight? Know who’s running on adrenaline and endorphins and the rush of cops and robbers? Know who simultaneously believes that nothing can happen to them and that everything could happen to them? All of the BLM “organizers” and all of the Antifa “cadres” and all of the Proud/Boogaloo “boys” and all of the MAGA militia “soldiers”, that’s who.

Man, they’re all having a blast.

All with the voice of Ego running through their minds, all secure in the knowledge that they matter and will be recognized for their meritorious service to this mighty cause.

How do we stop the violence and the carnage of these bullshit and criminal “fiery but mostly peaceful” night time waves of destruction, and – increasingly – the bullshit and criminal confrontations between rival English soccer team political supporters?

How do we stop burning down the wrong things so we can get started on burning down the right things?

We change the narrative that these burners and looters and counter-burners and counter-looters tell themselves. We make it not fun, for the burners and looters as well as for the counter-burners and counter-looters.

We change the narrative by removing the oppositional foil of the rioting and looting story arc – we make it impossible to believe that the criminals are part of an unrequited struggle against The Man and his inexorable injustice – so that all that is left is the petty (and not so petty) criminal behavior which cannot be excused. We accomplish this with accommodation. Not by agreeing to “demands” … usually there are no demands by daylight nonviolent protesters … but by elected leaders resigning and/or establishing new elections/plebiscites so that there is a clear and meaningful alternative outlet for nonviolent protesters’ voices.

Portland mayor Ted Wheeler, who refuses to defund the police in the way that Portland protesters mean the word (i.e. abolish), should resign. AND he should run in the special election called to replace him. AND the Portland protesters should put up their own candidate who will, in fact, defund the police to oblivion. Then vote. Let’s do this next week. Let’s see who the people of Portland put into office. Either the dog catches the car or the car runs over the dog. Either way, the story arc of this particular protest narrative ends there.

We make it not fun by removing the thrill of the chase and the thrill of the fight – we contain the rioters and the night time looters – so that all that is left is the boredom of walking around and yelling into the wind all night. We accomplish this with numbers and curfews. We request the assistance of the National Guard – of course we request the assistance of the National Guard! – so that we have the sheer numbers of trained personnel to contain the bullshit looters and keep out the bullshit “militias”.

That’s how we work our way through this.

We accommodate protester voice through new elections/plebiscites, and we contain criminal tag-alongs with sheer numbers of trained public safety officers.

Together, these actions change the story that we tell each other about the crimes that are committed in the name of a just struggle, AND these actions change the story that the wannabe and the confirmed criminals are able to tell themselves.

That’s exactly how the May 1968 riots in France were defused.

De Gaulle, under pressure from his #2, Georges Pompidou, finally accommodated demands for government change by agreeing to new elections. At the same time, the Parisian police, backed by the French military, contained the protesting students by avoiding pitched conflict and preventing the takeover of government buildings.

But that’s not going to happen in 2020 America. In fact, the opposite of this is going to happen. Why?

Because it’s not just the Antifa/MAGA Militia goonies who are positively giddy with excitement at the prospects of this post-apocalyptic world. It’s not just these clowns and criminals and wannabe culture war heroes. It’s also every media organization that covers the night time “protests”. It’s also the Republican party AND the Democratic party, both their elected officials AND their party apparatchiks, who are intentionally amplifying the Ego whispers to their proxies through their MSM and social media platforms for a perceived electoral advantage.

It’s not the Russians or the Chinese doing this to us.

We’re doing this to ourselves.

Four years ago, when I wrote that I thought Trump would defeat Clinton, I said that Trump breaks us by turning every one of our domestic political games from a coordination game – where cooperation in the national interest is at least possible – into a pure competition game where that potential cooperation is impossible. He did. That’s exactly what happened.

So today, neither the Trump campaign nor the Biden campaign can see the United States through anything other than the lens of a pure competition game.

Neither campaign or party will take the necessary steps to defuse the growing violence in American cities, like Biden calling for Democratic mayors to request National Guard support or like Trump doing anything to accommodate the voices of nonviolent protesters, because they both think that to do so would place them at a competitive disadvantage in the November election.

Neither campaign or party is appropriately afraid of this comet hitting the United States, because they both think that they’ll do just fine in a post-comet world. They both think that they can handle the aftermath of this comet strike after November 4th. They both are listening to their institutional Ego rather than to the Narrator.

They are both sowing the wind.

And they will both reap the whirlwind.

Neither the Democratic party nor the Republican party survives a defeat this November in anything close to their current form. I think several people are starting to think about that.

But here’s what’s also true:

Neither the Democratic party nor the Republican party survives a victory this November.

And no one is thinking about that.

Oh, and a quick post script. In case you were wondering about that snap election that de Gaulle called in May 1968, the election that the Socialists expected to win in a walk given the initial popularity of the student protests and the early ham-handed reactions by de Gaulle and his “Law and Order” / “France First” party … it was, in fact, a landslide.

For de Gaulle.

Epsilon Theory PDF Download (paid subscribers only): Lucifer’s Hammer


The Inflationary Shock Recipe


Before I share the two charts that have kinda thrown me for a loop, a quick housekeeping item. The screenshare recording and presentation deck for the webinar we hosted last Thursday on our new narrative monitor – Security Analysis Methods – has been posted on the ET Pro website here: If you didn’t get a chance to join us live (or even if you did), I hope you get a chance to check out the work we’re doing with this narrative monitor. Understanding whether market participants are primarily focused on either multiplesfundamentals, or technicals in the way they talk and think about investing is both an important signal in and of itself (IMO), and is the starting point for asking and answering a lot of crucial questions about how investing actually works today.

And now onto the charts …

The first chart shows US Household Formation (the annual change in the number of occupied housing units, both owned and rented) on a monthly basis over the past 30 years.

A picture containing sitting, blue, game

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It’s rare to find a chart that speaks for itself, but this one does. Most of this spike is people buying empty homes. The rest of this spike is people renting empty apartments. Together, this is maybe the most bullish data point I’ve seen since the GFC for real-world spending and economic dynamism. This is the sort of real-world behavioral change that absolutely drives real-world inflation higher. Maybe much higher.

The second chart shows the 21-day correlation between the S&P 500 and 10-yr US Treasury yields. It was part of a Credit Suisse report by their derivatives strategist, Mandy Wu (who I think does solid work), and reprinted in a Bloomberg article titled “Bonds No Longer Work to Diversify Stock Risk, Credit Suisse Says”.

A close up of a map

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Unlike the Household Formation chart, this one doesn’t speak for itself. The crux of the chart is the little red box at the bottom right … for the first time in a long time, when stocks go down, yields are going up. And since yield is the inverse of price in bond-world, we’re seeing the price of both stocks and bonds move in tandem … stocks go up in price AND bonds go up in price or stocks go down in price AND bonds go down in price.

To be sure, we’ve seen this movie before. You can find lots of periods in US market history – many quite recently, and some which last for years – where there is a positive correlation between stock prices and bond prices (I prefer to call it a positive correlation between stock and bond price rather than a negative correlation between stock price and bond yield … just seems cleaner to me). But here’s what’s special about today. There has never been a positive correlation between stock prices and bond prices with Treasury yields so low. Never.

Combine these two charts with Jay Powell’s Jackson Hole-remote speech today, where he basically announced that it will be years before the Fed even thinks about raising rates because of inflation, and you get this: the time to start preparing your portfolio for an inflationary shock and the havoc it will wreak on what you think is a well-diversified portfolio of stocks and bonds is NOW.

I’m not saying you sell out of your bond portfolio now. I think we could have the Mother of Deflationary Shocks if we have a close election (that’s the subject for another note!), so I wouldn’t be making any big Treasury sales between now and Nov. 4th. I’m saying you figure out NOW what you’re going to do with your portfolio once we’re through the election.

Massive real-world household formation growth + positively correlated stock and bond prices + ZIRP forever and ever amen = an inflationary shock to your portfolio.

I don’t know when, and I don’t think it happens before the election, but this is the recipe.


Webinar on Security Analysis Narrative Monitor


Here’s the replay for the Security Analysis Narrative Monitor webinar we held via conference call and screenshare for ET Pro subscribers.

We think we can identify the periods where market participants are primarily focused on either multiples, fundamentals, or technicals in the way they talk and think about investing.

Each of these narrative regimes – multiples-focused, fundamentals-focused, and technicals-focused – generates a powerful signal of subsequent market dispersion (cross-sectional volatility) and subsequent market performance.

I’ve also attached the slide deck we used in the presentation here: ET Pro Narrative Monitor deck.

If you weren’t cheesing with the Vick-led Falcons in a head-to-head game of Madden 04, you probably lost.

Even when Vick faded from Madden, cheesing didn’t. In future editions it might not have meant playing with a dominant player, but instead repeatedly and unrealistically calling two or three plays and formations to which that year’s AI was especially vulnerable. In some years, that might mean constant QB draws and rollouts. In some years, that might mean some trick play like a play-action end-around, which was nearly unstoppable with the right personnel. In some years, that might mean seam routes or lobbed streaks when the game introduced different throw trajectory types. In some years, that might mean a ridiculously short punt that confused the AI into muffing it nearly every time. To a greater or lesser extent there may have been unpredictable (and equally unrealistic) defensive counters to those repetitive and disproportionately effective plays, but competitive and online play has often been typified by play-styles that executed extreme strategies to exploit the weaknesses of the simulation engine.

There have also always been extreme gameplay behaviors that sat just outside the periphery of cheesing, too. These are behaviors in which the exploitation took some measure of skill, but still represented a winning in-game strategy with no real-life corollary. For example, certain animations for players (especially linemen) made them perfectly, predictably vulnerable to a particular pass rush move or positioning of a defensive player. If you were skillful enough to put your player in the right positioning vis-a-vis that animation and execute a particular pass rush move, you would always win. Micro adjustments to the positioning of defensive players to best match up with the way the AI processes contact between them and blockers is an almost indispensable skill for competitive players of the game. Most players don’t consider it cheesing – because you’ve got to be able to execute it – but these tactics still represent extremes at odds with the real-life game and the intent for randomness on the part of the game’s developers.

Even in modes in which players manage franchises over full seasons, there have always been ways to exploit the game’s sensitivity to extreme and unexpected behaviors. For example, because the logic which made AI-controlled teams evaluate trades has never been consistent with the logic concerning free agency signings and roster cuts, it has nearly always been possible to sign a quality older player from the street and immediately turn him around to an AI-controlled team for draft picks. Likewise, because EA’s focus on developing the casino-for-teenagers it calls Madden Ultimate Team has meant the abandonment of any development on the traditional franchise mode, it has been possible to force AI teams to do things like cut the best player on their team by trading them mediocre players at the same position for several editions now.

If there is a lesson here, it is this:

There is a certain class of games for which winning the game largely becomes a function of how good you are at exploiting the inability of the game’s mechanics to properly model edge cases and extreme behaviors, and how quickly you realize that other players are executing this strategy.

Sound familiar? It should.

In the 2020 edition of our political, financial and social games, it is not the most expertly executed strategies which are richly rewarded. It is strategies which most brazenly identify how to exploit the newly vulnerable mechanics of the Widening Gyre. Have you said or heard any of these things in the past three years? This isn’t how capitalism is supposed to work! This isn’t how elections are supposed to work! This isn’t how politics is supposed to work! This isn’t how free speech is supposed to work! This isn’t how the Fed is supposed to work (they’re out of bullets)!

Good! You’re familiar with the idea.

And yes, it is political markets which provide the most obvious examples of these more extreme strategies designed to fit a particular set of mechanics.

As Twitter itself recognized through one of its classic discourse-suppressive overreaches, this is not normal. Similarly, one of our readers made a very reasonable observation to this tweet in the comment section of one of our recently published briefs.

Am I the only one who sees the desperation in a tweet like the one this morning “They are not Covid sanitized?” I’ve said often lately, that this election has some scary outcomes, but it also feels like DT is getting more and more desperate, which can’t be good for “ratings”. Not sure what the October surprise will be, but if we have a president who believes he needs a “Hail Mary” to keep his title…

User Comment to The Fujiwhara Effect

And yes, in a normal environment I would have agreed wholeheartedly. But a strategy which lobs various terrifying theories of dubious provenance is one for which a polarized political environment has very little answer. In the rules we thought we understood, it doesn’t work. In the way we understand the world, it doesn’t work. But we live in an age of cheesing. This isn’t a sign of desperation. It’s much worse than that.

It is the new dominant strategy. It is a sign of the new normal.

Yet even if political markets provide the most obvious examples, our other social markets are just as prone to the advantage of seeking out edge strategies for the absurd current environment against expertly executed strategies designed for the way those markets are supposed to work.

Cheesing of those edge strategies is how Kodak happens.

Cheesing of those edge strategies is also how Tesla creates a hundred billion dollars in paper gains (and, presumably, many more in shareholder value-extractive non-paper gains for executives paid on incentives), not through execution of a true value additive strategy but through a tautologically value-neutral stock split. All this has happened before, and all this will happen again.

Don’t Be Fooled By Stock-Split Mania LOOK FOR EARNINGS, NOT HYPE [Fortune, February 1999]

The challenge, as always, is considering how the investor-citizen or executive-citizen who is not a sociopath responds to a game in which everyone else is cheesing and winning. Here’s what I think.

Clear eyes:

If you’re running a company and you’re not thinking about the low hanging fruit edge strategies in which you do non-value-additive things that add value to the stock price, you are nuts.

If you’re running an investment strategy and you’re pretending that the world is NOT one in which management cheesing by paying homage to administration officials or announcing a stock split to “allow young investors to participate” is rewarded with return, you are nuts.

If you’re running an election campaign and you think that you can win on being nothing more than a straight-shooter without recognizing the way in which meme and narrative interact with the mechanics of the Widening Gyre, you are nuts.

Full hearts:

Just because you recognize the world as it is does not mean that you must extract value from the edge cases for your own benefit. If bailout money is being thrown at you, you don’t have to turn it down. But you also don’t have to accept it to benefit your share grants, RSUs and options before you write some saccharine letter describing dumping tens of thousands of middle- and lower-income employees as a shared sacrifice. If you’re building narratives to argue for your election, make them Holy Theatre. Don’t justify lies on the basis of the Widening Gyre’s permanent fixture of manufactured existential threats, and don’t justify deadly theater built on a basis of deception just because you think its heart is in the right place.

Alternatively: Neither left guy nor right guy be.

Money Printer Go Brrr | Know Your Meme

In world awash with cheesing, being lawful good doesn’t mean being lawful stupid.

But for God’s sake, don’t lose your soul in the process.


Sacrifice for Thee, Vast Wealth for Me


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Doug Parker, American Airlines CEO and Chairman, flashing his winning smile

American Airlines to Cut 19,000 Jobs by Oct. 1 When Federal Stimulus Ends (WSJ)

American Airlines Group Inc. said it would shed 19,000 workers by Oct. 1 as the carrier prepares to downsize to cope with the coronavirus pandemic’s blow to travel demand, which isn’t expected to rebound for years.

The reductions include 17,500 furloughs of pilots, flight attendants, mechanics and others, as well as 1,500 cuts from management and administrative ranks.

Airlines received $25 billion in federal aid to pay workers through the end of September to avoid mass layoffs.

Unions and airline officials have advocated for another round of funds to keep employees on the job through March 2021.

Doug Parker, American Airlines CEO and Chairman of the Board, wrote a letter to his employees today that pretty much defines high-functioning sociopathy.

I’m going to reprint excerpts from that letter – which is couched in the saccharine vocabulary of modern team-speak, but is in truth a shakedown letter to employees and a ransom note to the US government – and then I’m going to tell you a few things about Doug.

Dear fellow team members,

We respect and greatly appreciate the sacrifice these team members have made, and continue to make, for American and their fellow team members.

Even with those sacrifices, approximately 19,000 of our team members will be involuntarily furloughed or separated from the company on Oct. 1.

The one possibility of avoiding these involuntary reductions on Oct. 1 is a clean extension of the PSP.

If you haven’t already done so, you can let your elected officials know just how important a PSP extension is to you, your families and our economic recovery.

The American Airlines team is no stranger to adversity, and in adversity, we always come through.

We will come out on the other side of this crisis. Until then, take heart that we will get through this together.

The professionalism and care this team has shown over the past six months has been nothing short of extraordinary. We are all American Airlines, and we will survive, and one day, thrive again. Thank you for all you are doing now, and tomorrow, to carry us through.

Know who’s not sweating the October 1 firing line? Know who’s surviving and thriving just fine, thank you very much?

Doug Parker, that’s who.

Here are some fun facts about Doug Parker and his “leadership” of American Airlines since he became Chairman and CEO of the company in 2013, after its merger with US Airways. All of this (and more) can be found in a long note I wrote on the airline bailout back in March.

Do The Right Thing

I’m angry that I have to write this note about the airline industry and how to structure the bail-out of United, Delta, American and Southwest. But I must, because the raccoons and the high-functioning sociopaths are looking to get their private losses socialized and their private gains locked in. Bailout the airlines and their rank-and-file employees? You bet. Bailout the CEOs and Warren Buffett? Not a chance. Read more …

From 2014 through 2019, Doug Parker pocketed more than $150 million in cash through his sale of 3.6 million shares in American Airlines. That’s in addition to the $50 million in stock he still owns (and net of the pittance that Doug has paid for all of these shares). That’s in addition to the $100+ million in cash salary and cash bonuses and deferred comp and stock options and incredible perks that Doug has received. Nope, cash comp and deferred comp are for suckers. Just ask Jamie Dimon.

These stock sales were particularly egregious in 2015 – 2016, where for a twelve month period Doug pocketed between $4 million and $11 million in stock sales per month, and again in 2018, when for a brief shining moment American Airline’s stock price went above $50. 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.

But surely, compensation like this is well earned. Surely, American Airlines has outperformed its competition, built a solid franchise, and delivered nice returns to its investors.

LOL. Don’t call me Shirley.

From 2014 – 2019, the same years that CEO and Chairman Doug pocketed $200 million in real money stock-based comp, American Airlines had *negative* free cash flow of $3.2 billion.

And took on an additional $14 billion in debt.

And bought back $13 billion of its stock.

How did all this work out for American Airlines shareholders from 2014 – 2019?

That’s American Airlines in white, Delta in yellow, United in purple, and Southwest in Green.

Over this six year period, AAL stock was up 13%. Not 13% per year, but 13% over SIX YEARS of the best bull market in history.


Doug Parker is not an entrepreneur. Doug Parker is not a founder. Doug Parker has never built a goddam thing in his life. Doug Parker is not on your “team”.

Doug Parker is a financial analyst. Doug Parker is a manager. Doug Parker is a risk taker with other people’s money and other people’s lives.

And for that, Doug Parker is a centimillionaire many times over.

One day we will recognize the defining Zeitgeist of the Obama/Trump years for what it is: an unparalleled transfer of wealth to the managerial class.

It’s the triumph of the manager over the steward. The triumph of the manager over the entrepreneur. The triumph of the manager over the founder. The triumph of the manager over ALL.

Welcome to the Long Now.



The Fujiwhara Effect


Source: NBC 15 Mobile

Early next week, two tropical systems are expected to be present in the Gulf of Mexico at the same time. Both are currently projected to strengthen to at least Category 1 hurricanes at some point before making landfall. The current plots have moved a bit from my screengrab above, such that the lovely people of Lafayette and Lake Charles now sit within the official National Hurricane Center forecast cones for both tropical systems.

I won’t insult you by making the obligatory 2020 remark.

Now, as I’ve written before, the tropical weather community is a funny thing. Especially the online tropical weather community. They are practitioners of the most cringeworthy, obvious kind of Kabuki Theater imaginable. Everyone – everyone – performs exaggerated, tortuous expressions of genuine hope that the storms will not harm life or property as preamble to what they really feel. And what they really feel is an unquenchable desire for something magnificent and historically destructive to take place. It is the natural reaction when you love storms, want to see a monster storm and don’t know anybody down in Beaumont anyway…but still feel a little bit ashamed about it.

Sansa Stark: They respect you, they really do, but you have to… Why are you laughing?

Jon Snow: What did father used to say? Everything before the word “but” is horse shit.

Game of Thrones, Season 7 Episode 1: “Dragonstone”

Still, when you’ve got two almost overlapping tropical systems abrewin’, it’s hard to keep the disaster-porn aficionados from wishcasting a superstorm on the central gulf coast. And so there are two kinds of stories you’ll see this weekend. The first will be stories that try to suck you in with dramatic descriptions of the two hurricanes combining into a single frankenhurricane. The second will be stories that highlight how interesting it is to have the storms in such proximity, describe that yes, they will influence each other’s path and growth, and reinforce that they will probably have the net effect of impeding their respective development. At a very minimum, that they make predictions about what both will do somewhat more difficult.

The effect describing the fascinating mutual interactions of complex cyclonic weather systems is called the Fujiwhara Effect, and you’ll be hearing a lot about it over the next week or so.

And then probably never again.

In narrative world, we have got two complex systems on a similar collision course. They are already interacting, already creating new common knowledge and already trying to shape our language. They both reflect the best efforts of missionaries to guide how we are thinking about both issues. And unlike Marco and Laura, by all appearances they are combining into a single storm. The real Fujiwhara Effect of 2020 sits at the intersection of the narratives of COVID-19 and the 2020 US Presidential Election.

So how influential are the narratives of COVID-19 on the US Presidential elections right now?

Using the updated methodology from our ET Professional narrative monitors, we examined the relative influence of various topics on the language used so far in the month of August to discuss US elections. The narrative strength measure is our composite of the (1) volume of and (2) similarity of language used by media outlets, blogs and press releases to discuss those topics in context of elections. The scores are normalized against our typical expectations for an election topic’s narrative strength. A score of 1 means we think that topic exerts influence that is higher than only 10% of comparable topics. A score of 10 means the topic exerts influence that is higher than just about any we have observed.

Source: Epsilon Theory, Quid

While economy narratives are important to this election, they are nearly always important. While narratives about the likely right to nominate at least one Supreme Court justice are important, they are nearly always important. Race and identity play more of a role as electoral issues than they have in the past, as does wealth inequality. As we’ve noted previously, both of those were dominant topics for the DNC primary process. But at least in narrative space, 2020 is now a COVID election.

You probably have a picture in your head of what that means. That picture probably isn’t complete.

To some Americans, the dominant COVID narrative is that the government utterly failed to take the steps that other countries took to reduce the impact of the virus on human lives and the economy alike. To others, the dominant COVID narrative is that opportunists in the government saw a pandemic as the opportunity to push policies and government mandates that they long desired, shutting down entire sectors of the economy without any kind of cost/benefit analysis to doing so.

But here’s the thing: COVID’s relationship to the election in narrative world isn’t about either of those things. Not really. Not any more. It isn’t about the human toll. It isn’t about freedoms taken. It isn’t about unnecessary shutdowns. It isn’t about simple steps that weren’t taken on masks and testing. The perfect storm forming out of the intersection of COVID and US elections is circulating around the narratives of the need for mail-in voting and the risk of widespread fraud.

Source: Epsilon Theory, Quid

Yes, of course this topic ranks higher in August because there have been news events worthy of reporting that referenced it. But it is the overwhelming similarity of the language being used that should concern every citizen. Narrative missionaries on both sides are weaponizing this topic. They are all on the same page. They are sticking to the talking points.

The visualization below should give you a picture of just what I mean. It is a network of all COVID-related election news during the month of August, constructed through natural language processing-based analysis that compares the words and phrases of meaning in each article to those in each other article. Each node represents a single article. The bold-faced nodes and connectors relate to articles demanding broad mail-in voting and articles asserting the risk of fraud, delays and errors in such voting. Nodes that are closer together and have more connecting lines are more similar in language. Those that are further apart are less similar. North-south and east-west have no meaning. Distance and concentration are the only dimensions that matter here.

The nodes defined by language associated with the narratives of mail-in voting fraud (in bold) dominate the network and are far more tightly clustered and connected than other clusters and language. What you see here is what we measured above. It is what we mean when we say that everyone with an opinion on this is staying very on-message.

Network Graph of COVID-Related Election News – “Fraud” Language in Bold

Source: Epsilon Theory, Quid

When we write about the widening gyre, what we mean is a political environment in which two randomly selected Americans of differing political alignments are increasingly living in two completely different worlds. They see the same events with the same facts and understand them through two separate lenses.

I think this issue has great potential to accelerate that widening process.

We would be far from the first to note the inherent divisiveness of assertions by President Trump that mail-in voting will certainly result in widespread fraud, ballot destruction and delays. Selectively neutering the USPS to prevent its use by the several states to manage their election processes as delegated to them under the law was about as transparently political a use of the office as possible. The implication of fraud at in-person voting has made its appearance again, too, with the chilling indication that police will be present at polling locations to prevent it. Yet two things can be true at once: that there doesn’t seem to be a lot of evidence that this has happened in the recent past AND that mass mail-in voting is a whole other beast from anything we’ve tried to-date.

And yet the political left have not ignored every lesson from Donald Trump. They are good at the common knowledge game, too. The time it took for the self-evident need for widespread mail-in voting because of COVID-19 to become common knowledge was immeasurably short, despite in-person voting with accommodations for certain vulnerable populations being perfectly feasible in nearly every region in the US. The narrative that there is no risk of fraud also took root in left-leaning media outlets almost immediately. Nearly identical language popped up almost simultaneously across hundreds of outlets claiming that the risk of fraud, ballot losses and delays has been fact-checked as “false”, despite there being no existing study that matches the potential scale of what is being contemplated in the 2020 election that could justify that kind of statement.

The network graph below zooms in on just those election articles referencing the assertions of mail-in voting fraud. The bold-faced nodes are those referencing those pseudo-authoritative claims of “proof” based on a non-representative historical analog.

Network Graph of Election Fraud News – “Fact Check = False” Language in Bold

Source: Epsilon Theory, Quid

Let’s be real about what’s happening here:

Donald Trump is building a bullshit narrative about fraud to keep as many marginally politically involved voters as possible from voting – and to keep open potential avenues to dispute the election on the basis of fraud.

The DNC is building a bullshit narrative about COVID to allow as many marginally politically involved voters as possible to vote – and to keep open potential avenues to dispute the election on the basis of voter suppression.

If you’re typing ‘whataboutism’, you can stop now. I am not comparing the two intents obscured by these narratives. I think one intent is worse than the other. Way, way worse. But you’re smart enough to think for yourself on that point, and don’t need my opinion to make up your mind about how to weigh that along with whatever else you think is important to determine how you will vote.

More importantly, we must realize that even if the underlying aims that gave birth to the narratives are not moral equals, it still matters that we are being manipulated. It still matters that both methods are going to contribute to a more divided America in which each half literally lives in a different reality. Both methods are narrative nuclear options which almost guarantee a disastrous civic and social outcome. If Biden loses, the approaches taken by the two parties ensure that half the country will consider it illegitimate because of voter suppression. If Trump loses, the approaches taken by the two parties ensure that half the country will consider it illegitimate because of fraud.

These are truths told with bad intent, sweeping narratives built on the shaky ground of assertions about the risks of mail-in voting on a scale not yet attempted and the feasibility of in-person voting during the COVID-19 pandemic.

Citizens who would resist the transformation of the widening gyre into a perfect storm must be capable of holding multiple ideas in our heads at once. We can make judgments about the relative merits of the underlying intents of two political powers with full hearts. AND we can make our judgments about the mutual use of manipulative, divisive narratives with clear eyes.

Neither requires us to forgo the other.


Facebook Delenda Est


Epsilon Theory PDF Download (paid subscribers only): Facebook Delenda Est

Trump hosted Zuckerberg for undisclosed dinner at the White House in October (NBC)

President Donald Trump hosted a previously undisclosed dinner with Facebook CEO Mark Zuckerberg and Facebook board member Peter Thiel at the White House in October, the company told NBC News on Wednesday.

Zuckerberg also gave a speech at Georgetown University the week before, detailing his company’s commitment to free speech, and its resistance to calls for the company to crack down on misinformation in political advertisements.

It is unclear why the meeting was not made public or what Trump, Zuckerberg and Thiel discussed.

The White House declined to comment.

Facebook’s Hate-Speech Rules Collide With Indian Politics (WSJ)

The company’s top public-policy executive in the country, Ankhi Das, opposed applying the hate-speech rules to Mr. Singh and at least three other Hindu nationalist individuals and groups flagged internally for promoting or participating in violence, said the current and former employees.

Ms. Das, whose job also includes lobbying India’s government on Facebook’s behalf, told staff members that punishing violations by politicians from Mr. Modi’s party would damage the company’s business prospects in the country, Facebook’s biggest global market by number of users, the current and former employees said.

Facebook’s Zuckerberg promises Merkel action on hate speech  (Deutsche Welle)

“Facebook founder Mark Zuckerberg on Saturday promised German Chancellor Angela Merkel that his company would work on measures to combat racist and hateful comments on the social media platform.

This comes after German Justice Minister Heiko Maas met with Facebook representatives in Berlin in mid-September following the posting of a number of right-wing extremist and racist comments about refugees.

Maas had expressed bewilderment that photos considered to be indecent were quickly deleted, while hate speech postings were often left on Facebook pages even after users had complained. Merkel had also called on the company to take measures to fight mass incitement.”

So … I’m pretty close to being a free speech absolutist. Or at least I have an old-school small-l liberal John Stuart Mill-esque belief in free speech, with an extremely high bar for the “harm” that speech must directly inflict on other citizens before a rightfully constituted government, based on the consent of its citizens, has a legitimate duty to regulate that speech.

And I believe that the US Supreme Court has been pretty much spot-on with its free speech decisions like Brandenburg v. Ohio and R.A.V. v. City of St. Paul, where they said (roughly speaking) that even speech calling for violent protest against the government is protected speech and that hate speech isn’t a thing. Let me repeat that last one. The US Supreme Court has repeatedly held that hate speech is not a thing.

I think this is exactly right.

To be clear, I also believe that a private organization has the right to apply hate speech standards (or any other speech standards) to its members, if those members have the ability to leave the private organization AND that organization does not enjoy unique government support. So, for example, if I choose to attend a private religious college, and they have rules against hateful/blasphemous speech, then it’s fine for them to kick me out when I start doing my hateful blasphemous speech thing. I’d never go to that college in the first place, and there are plenty of other schools I can attend. But if ALL colleges started imposing hate speech standards, or if the ONLY college started imposing hate speech standards, or if ANY public college started imposing hate speech standards … well, I’d have a real problem with any of these circumstances.

And I believe that a just government has a duty to intervene in these circumstances.

Now I also believe that the US Supreme Court got it terribly, terribly wrong with Citizens United, where they decided (again, roughly speaking) that non-real life citizens – like corporations or other constructed legal entities – enjoy the same protections for political speech that real life citizens do. I’ll repeat that one, too. The US Supreme Court has held that constructed entities of pooled capital (corporations) or pooled labor (unions) or pooled political influence (parties) have the same protection for their political speech as unconstructed/unpooled you and unconstructed/unpooled me.

I think this is nuts.

To be clear, I also believe that limitations on how much money or time real life citizens can spend on their political speech are similarly nuts. So, for example, I believe that really rich American citizens like Bill Gates or Jeff Bezos or George Soros or Charles Koch can spend as much money as they please – literally billions of dollars if they want – to proclaim whatever cockamamie political idea they want to proclaim. What is unacceptable in my view – but is exactly what Citizens United allows – is for really rich guys to spend unlimited amounts of money on political speech after they are dead, or (worse!) for corporations and unions and parties to spend unlimited amounts of other people’s money on political speech, with the same legal protections as real life citizens.

Government does not exist to protect the rights of a dead rich guy’s money. Government does not exist to protect the rights of corporations, unions and political parties. Government EXISTS to protect the unalienable rights of its citizens, and that among these are life, liberty and the pursuit of happiness.

Do foundations and corporations and unions and political parties have rights? Do they enjoy the protection of our laws? Of course!

Can foundations and corporations and unions and political parties speak on the issues of the day? Sure!

But foundations and corporations and unions and political parties are conveniences, not citizens. They exist because they are useful efficiencies, not because they possess unalienable rights. They are not the same as voting citizens, and a government of the people, by the people, and for the people is under zero obligation to extend the same protections to the political voices of these non-people as it must to its actual people, much less MORE protections.

But that’s where we are today.

These non-people … these non-citizen, non-voting, artificially constructed legalistic entities of pooled capital, labor or influence … they enjoy MORE free speech protections than you and me.

And I believe that a just government has a duty to do something about that, too.

Now if you don’t mind, please hold those two thoughts …

1. Ben doesn’t think that hate speech is a thing. Ben also thinks there are (limited) circumstances where a just government must reach into private organizations to prevent them from applying hate speech standards.

2. Ben doesn’t think that constructed entities like foundations and corporations and unions and political parties should enjoy the same free speech protections as real life citizens. Ben also thinks – and this is at the heart of what he wants to BITFD – that these constructed entities actually enjoy far more free speech protections from our government than the real life citizens our government was established to protect.

… and let’s talk for a minute about Facebook.

The following facts are, I believe, not contentious. They are, I believe, clear and obvious facts to any observer of Facebook policy in the three markets that are most important to Facebook – the United States, India and Europe.

Fact #1: Facebook has constructed a standard of what they consider to be political hate speech and announced that they intend to apply it on their platforms within the United States, India and Europe.

Fact #2: Facebook applies this hate speech standard with rigor and unswerving attention against specifically the group who (IMO) should never have a hate speech standard applied against them … individual, real life citizens of the United States, India and Europe.

Fact #3: Facebook does NOT apply this hate speech standard with rigor and unswerving attention against the group who (again IMO) might well have a hate speech standard applied against them … powerful non-citizen entities of pooled capital/labor/influence both internal and external to the United States, India and Europe. In fact, the more powerful the non-citizen entity of pooled capital/labor/influence might be over Facebook’s business model, the more Facebook turns a blind eye to any violation of the hate speech standard by that entity and the more Facebook cracks down on any violation of the hate speech standard by that entity’s political opponents … particularly the small and helpless ones.

Sure, the Facebook hate speech policy is all wrapped up in powerful narratives of “Yay, Science!” and “Yay, Democracy!” and “Boo, Terrorists!”, and sure, Mark cleans up real nice when he goes to Georgetown and name drops Elijah Cummings, Frederick Douglass, #BlackLivesMatter, #MeToo, Air Force moms, the war in Iraq, and Martin Luther King Jr. (I am not making this up) all within the space of a few paragraphs in his speech, Zuckerberg: Standing For Voice and Free Expression“.

That’s the actual title of his speech, as provided by Facebook to the Washington Post, where they published it verbatim: “Zuckerberg: Standing For Voice and Free Expression”. You know, just in case you weren’t sure what cartoon Mark was trying to project. Again, I am not making this up.

But in truth, this is all just Free Speech Theater.

Facebook is not a content-delivery platform. Its business is not to “give people voice and bring people together”, as Zuckerberg says in his best cartoon voice.

Facebook is an advertising-delivery platform.

Facebook’s business – its entire reason for being – is to sell as many ads as possible based on free, user-generated content. Contentious, inflammatory user-generated content is great for selling ads – particularly if it IS an ad – but the content can’t be so contentious that it generates a popular backlash, reducing demand/usage, or that it makes the ruling powers-that-be angry, generating a fine or some other profit-reducing regulation.

THAT’S the algorithm that Facebook is trying to solve. THAT’S the determining constraint on Mark Zuckerberg’s “commitment” to free speech.

In every crucial jurisdiction where Facebook does business, Mark Zuckerberg meets privately with the chief executive of that market and works out a political accommodation.

What’s your biggest “free speech” concern [wink, wink], Mr. or Mrs. Chief Executive, and how can Facebook tailor its policies to help you out?

  • In the United States, Zuckerberg has dinner with Trump. Amazingly enough, Facebook does not apply its “fact-checking” or “hate speech” controls to political ads.
  • In India, Zuckerberg has dinner with Modi. Amazingly enough, Facebook does not apply its hate speech controls to prominent members of the ruling BJP party.
  • In Germany, Zuckerberg has dinner with Merkel. Amazingly enough, Facebook expands its hate speech controls to shut down and marginalize content critical of German refugee and immigration policy.

And in return, across all of these crucial markets, Facebook enjoys unique government support for a communications and social media platform – Facebook, WhatsApp and Instagram – that is impossible for a US citizen or an Indian citizen or a German citizen to escape.

And that’s the rub.

Swearing off Facebook/WhatsApp/Instagram is no solution here. There is no meaningful way to opt out of a ubiquitous and universal communications and social media platform, because the system of a ubiquitous and universal communications and social media platform is impervious to your individual decision. It’s like saying that you’re going to opt out of Covid-19. Sure, you can move off the grid into the Alaskan wilderness and not get sick. Knock yourself out. But that’s not a meaningful definition of opting out. Barring that sort of absurd action, however, your exposure to the virus, whether it’s the virus of SARS-CoV-2 or the virus of Facebook/WhatsApp/Instagram, isn’t so much dependent on your actions as it is on everyone else’s actions.

These are the conditions under which a just government must reach down into a private organization like Facebook and turn their pernicious hate speech standards completely on its head.

Which leads us to the George Costanza legislative fix for Facebook.

Like George, every instinct that Mark Zuckerberg has regarding free speech is wrong, and so Facebook should be required by law to do the exact opposite of what they’re doing today.

Specifically, that means that it is precisely the slick political ads and user-generated content from non-real life citizens like corporations, unions and political parties that Facebook should scrutinize carefully and hold to some fact-checking and hate speech standard. It is precisely the gross and insulting and hateful and mean-spirited user-generated content from real life citizens that Facebook should let slide.

I know. LOL. There’s a snowball’s chance in hell that any legislative body in the world would ever pass this sort of law. But a guy can dream, right?

Barring this sort of legislative fix to the core Facebook business model, the only other solution I see is to tear down Facebook on antitrust grounds, by which I mean force Facebook to divest WhatsApp and Instagram (Messenger, too), and maybe hive off the Indian and European operations from the US mothership. Over time – over a LOT of time – I think that this sort of Ma Bell solution could maaaaybe weaken core Facebook to the point where users have a real choice in what communications and social media networks they use, making Facebook’s hate speech standards no less pernicious but allowing a true opt-out. But I’m not holding my breath on this solution, either.

It’s frustrating.

We can see so clearly how Facebook is undermining our democracy and our most integral political rights.

We can see so clearly how Facebook has bought and paid for political cover at the highest levels of American, Indian and European government, political cover that prevents any of the actions we might take as a society to rid ourselves of this cancer.

What do I mean when I say BITFD? What is it that I want us to burn the fuck down?


This system of bought and paid for political patronage that companies like Facebook use to nudge us into social ruin.

More than 2,000 years ago, the renowned Roman soldier and orator Cato the Elder would end every speech, regardless of topic, with the phrase Carthago delenda est … roughly translated, Carthage must be destroyed.

It wasn’t that Carthage posed an imminent threat to Rome. No, Rome had already defeated Carthage soundly in two wars, and Carthage was no longer a competing empire but merely a wealthy city. It was the idea of Carthage as an alternative to traditional Roman principles that Cato believed was so dangerous … the potential of Carthaginian wealth and business prowess to subvert Rome from the inside through law and custom that Cato believed had to be stopped.

It’s exactly the same thing with Facebook.

Mark Zuckerberg’s idea of free speech and its proper limitations – where “hate speech standards” are rigorously enforced when it comes to individual citizens and conveniently set aside when it comes to the most powerful entities of pooled capital/labor/influence in our society – is a profound threat to liberal democracy, whether that’s in India, Europe or the United States.

Not because it competes with us from the outside. Not because it presents itself as a competent external alternative. Facebook is not China.

But because it subverts our most important principle of representative government – the free expression of a citizen’s political views – from within.

Facebook delenda est.


Epsilon Theory PDF Download (paid subscribers only): Facebook Delenda Est


Why Publish Academic Research?


A few days ago, we read a tweet from Corey Hoffstein saying that after a six month review process, an academic journal decided not to publish an investment research paper written by Corey and two colleagues.

We reached out to Corey and team to see if they would be interested in publishing their research on Epsilon Theory, and today we’re delighted to publish Rebalance Timing Luck: The Dumb (Timing) Luck of Smart Beta, by Corey Hoffstein, Nathan Faber and Steven Braun.

We think this is an important paper. Here’s why.

Sensible-sounding abstractions, sometimes acknowledged perfunctorily and sometimes considered so self-evidently reasonable as to be passively accepted, are the bane of social science research and are at the heart of the reproducibility crisis – the frequent inability to duplicate the findings of published research.

This is especially true in financial markets.

Studies of systematic investment strategies and factors are far more sensitive to assumptions about rebalancing, time horizons, rolling windows, calculation methods, etc. than researchers are typically willing to indicate in their papers, and as a result their conclusions usually need to be taken with a substantial grain of salt.

We think this paper is an excellent illustration of how this phenomenon plays out in smart beta benchmarks, and it might have been buried forever if there were no alternative to academic journals and an inherently flawed peer-review process.

So we’re not stopping here.

Epsilon Theory is more than happy to occasionally publish academic research of merit pertaining to financial and political markets.

If you have something that you think expands our collective understanding of those markets, send it to us at [email protected].

Why are we committed to publishing academic research?

Because we think the peer review process of academic journals cannot avoid embedding bias in paper selection.

We think peer review is useful, and that the vast majority of peer reviewers are serious and ethical people. But in the social sciences in particular, we also think that methodology and priors are often inextricably linked. That means that what you think the answer will be influences how you set up the problem and how you try to answer it. That also means that what you want the answer to be may affect whether you, as a reviewer or editor, think the methodology used by another to explore the question is sound. We believe that the peer review process often rejects papers on the superficial basis of methodology and rigor when the true underlying basis is dissatisfaction with its conclusion, problem framing or priors.

Because we think academic research in finance tends to be excessively backward-looking.

We think there is an emphasis in academic finance on empirical studies of asset prices, security-level fundamental characteristics and quantitative economic variables that do a magnificent job of creating an explanation for things that happened and not much else. There is a role for this sort of economic history, but it is a bit part, and not the leading role we have made it. There are reasons why financial markets research tends to not reflect live testing of hypotheses like it absolutely could, and most of that reason is “because we’d usually end up with nothing to write about.”

Because academic journals’ focus on novelty weakens collective understanding.

For commercial and philosophical reasons, academic journals in the social sciences prioritize the publishing of entirely novel research and topics. It is an understandable aim, but one that doesn’t always serve the expansion of the collective understanding of important topics. In our experience, finding new ways to illustrate a truth is every bit as important as discovering it in the first place. Ditto for trying out a hypothesis and finding that the empirical evidence does NOT support that hypothesis.

Because we think our readers are smart enough to evaluate this research on their own.

We think that journals have a legitimate challenge in determining how to accept or reject papers. There are a LOT of submissions. Some submissions are better than others. We think that good people truly do their best to publish the higher quality papers, but we also think that reputation and credentials play a role in these decisions. If, say, Harry Markowitz decides to send you a new paper, you keep your red pen in your damned desk drawer. But what’s true at that extreme is true in the in-between as well: there are reasons that a paper might be rejected or accepted, edited or taken as-is, that sometimes have nothing to do with its importance or quality. We think you’re smart enough and capable enough to decide on the usefulness of research for yourself.

A few ground rules …

We can’t commit to publishing everything. Your paper might be objectively bad. Your paper might be objectively incomprehensible. And by objectively, we mean subjectively to Rusty and Ben.

We can’t commit to giving you feedback and comments on a paper that you send us, whether we publish it or not.

We can’t commit to timing on any of this. Some weeks we’ll be really quick on this, and other weeks we’ll be swamped with other stuff.

We absolutely, positively will NOT commit to publishing your corporate white papers.

But if we don’t publish your academic research on financial or political markets, it will never be because we don’t like the conclusions, the topic, or the methodology.

It will never be because you don’t have a certain set of academic credentials or a certain set of academic connections.

And if we do publish your research paper, our commitment to you is this:

  • We won’t charge you anything, ever.
  • We won’t put it behind a pay wall.
  • We won’t edit or modify it.
  • We won’t keep you from publishing it somewhere else, and if getting it published somewhere else means you need us to take it down here, we’ll do that, too.
  • We will make it visible and searchable, and we will give it access to our network of 100,000+ investment professionals, asset owners, academics and market enthusiasts.

There are many institutional gatekeepers. There are many powerful guilds and socially embedded practices that seek to limit our voices and ideas. Are academic journals the worst of these? Not by a long shot. But they ARE one of these.

This is how we change the world. This is how we unleash our voices and ideas. Not by attacking these institutional gatekeepers from the top-down with yet another institutional gatekeeper, but by making the institutional gatekeeper irrelevant through our bottom-up, decentralized actions.

Will making academic journals irrelevant save the world? No.

But it’s a good start.


“Rebalance Timing Luck: The Dumb (Timing) Luck of Smart Beta” by Hoffstein, Faber and Braun


Epsilon Theory will occasionally publish academic research of merit pertaining to financial and political markets.

You can read about our reasons and our guidelines here: Why Publish Academic Research?

If you have publishable academic research that you think expands our collective understanding of financial or political markets, and you’d like to give it access to our network of 100,000+ investment professionals, asset owners, academics and market enthusiasts, please send it to us at [email protected]

Will making academic journals irrelevant save the world? No.

But it’s a good start.

PDF Download: Rebalance Timing Luck: The Dumb (Timing) Luck of Smart Beta


Corey Hoffstein is Chief Investment Officer at Newfound Research. 380 Washington Street 2nd Floor, Wellesley, MA 02481. E-mail: [email protected]. [1]

Nathan Faber is a vice president at Newfound Research. 380 Washington Street 2nd Floor, Wellesley, MA 02481. E-mail: [email protected].

Steven Braun is a quantitative analyst at Newfound Research. 380 Washington Street 2nd Floor, Wellesley, MA 02481. E-mail: [email protected].


Prior research and empirical investment results have shown that portfolio construction choices related to rebalance schedules may have non-trivial impacts on realized performance. We construct long-only indices that provide exposures to popular U.S. equity factors (value, size, momentum, quality, and low volatility) and vary their rebalance schedules to isolate the effects of “rebalance timing luck.” Our constructed indices exhibit high levels of rebalance timing luck, often exceeding 100 basis points annualized, with total impact dependent upon the frequency of rebalancing, portfolio concentration, and the nature of the underlying strategy. As a case study, we replicate popular factor-based index funds and similarly find meaningful performance impacts due to rebalance timing luck. For example, a strategy replicating the S&P Enhanced Value index saw calendar year return differentials above 40% strictly due to the rebalance schedule implemented. Our results suggest substantial problems for analyzing any investment when the strategy, its peer group, or its benchmark is susceptible to performance impacts driven by the choice of rebalance schedule.


The popularization and distribution of equity factor strategies has been a boon to investors, providing low-cost access to a range of systematic investment styles. However, there is no precise method of measuring or executing these strategies. Differences in the approaches to constructing these strategies can lead to significant dispersion in results even for strategies targeting the same investment style (Ciliberti and Gualdi (2018)). While substantial effort is spent researching new factor signals, refining previously discovered signals, and developing portfolio construction techniques, the seemingly innocuous activity of choosing when to rebalance these strategies is largely absent from the existing literature.

Blitz, van der Grient, and van Vliet (2010) first documented this impact for an annually-rebalanced fundamental equity index, finding a large discrepancy in realized results. This fundamental index, as described in Arnott, Hsu, and Moore (2005), weights its constituents in proportion to the companies’ fundamentals (book value, cash-flow, and dividends), in contrast to the conventional approach where the constituent weights are proportional to their market capitalization. Blitz et al (2010) documented that a fundamental index annually rebalanced in March outperformed an identically constructed index rebalanced in September by over 10 percentage points in 2009, despite the two indices being identical in process and rebalance frequency. Further, the authors found that the realized performance dispersion resulting from the different rebalance schedules [2] was not mean-reverting, generating a permanent remnant in the performance of the indices; an effect large enough to influence investment decisions long after the initial dispersion was manifested.

We label the potential performance dispersion between two identically managed strategies with different rebalance schedules rebalance timing luck (RTL). When applied to a single manager or fund, this concept is theoretical in that the effect lies in the investment decisions that could have been made (e.g. annually rebalancing in March rather than September). The realized performance of a fund cannot be changed and RTL can only be explicitly measured ex-post through the lens of a theoretical universe of identically-managed investment strategies with varied rebalance schedules. Importantly, the effects of RTL can also present itself when comparing a manager’s performance to another manager or even to a benchmark. Given different rebalance schedules, positive and negative RTL impacts can make a given manager appear more or less skilled. [3]

To illustrate these effects, we first construct long-only U.S. equity strategies designed to capture value, momentum, quality, and low volatility tilts, where the universe of eligible securities is obtained from the S&P 500 universe and fundamental data is obtained from Sharadar Fundamentals. For each style, we vary the target number of holdings as well as the rebalance frequency to target specific sensitivities to these explicit decisions. In line with the analytical derivation of RTL from Hoffstein, Sibears, and Faber (2019), we find that the realized RTL is directly influenced by the number of holdings, the portfolio turnover realized by the strategy, and the rebalance frequency. Our results also align with the expectation that strategies with low average turnover tend to exhibit less RTL.

To further illustrate the real-world effects of timing luck, we then replicate popular smart beta indices in the United States Large-Cap equity space. Our findings suggest that the choice of rebalance schedule is material and has affected annualized returns by as much as 200 basis points for higher turnover strategies, with one-year performance discrepancies as high as 40 percentage points.

Through the results in our study, we extend the literature by validating the existence of RTL in indices corresponding to popular equity investment styles. Further, by utilizing the framework identified in Hoffstein et al (2019), our results empirically validate the influence that portfolio concentration, portfolio turnover, and rebalance frequency choices have on the realized results of an investment strategy. By explicitly testing the RTL framework on different equity investment styles, we also show that the analytical derivation of RTL unveils significant insights for analyzing the realized performance of an investment strategy.

Our results suggest significant potential problems for return-based strategy comparisons and analysis.  For example, failing to inoculate a benchmark against the effects of RTL can cause a strategy to appear skilled or un-skilled by relative comparison when the performance dispersion is actually an artifact of luck.  This is a particularly timely topic given the popularization of “smart beta” strategies and other systematic funds over the last decade.  Our results show that the spectre of RTL is an ongoing influence on portfolio results and the prioritization of portfolio construction, through the use of an overlapping portfolio solution, leads to more consistent outcomes for the end investor and successfully mitigates the unpalatable effects of RTL.


We begin by constructing long-only, U.S. large-cap factor portfolios, using the S&P 500 as the parent universe. For each factor, securities are first ranked by corresponding characteristics and the top-ranking securities are purchased in equal weight. The characteristics defining our factor strategies are as follows: [4]

To estimate RTL for a given factor, we first construct sub-indexes reflecting the different potential rebalance schedules and then we use those sub-indexes to construct an RTL-neutral benchmark. For the latter, we follow the suggestion of Blitz et al (2010) – proved optimal by Hoffstein et al (2019) – and implement an “overlapping portfolio” solution (also referred to as “staggered rebalancing” or “tranching”) by holding the sub-indexes in equal weight.

By construction, the performance differences that occur between the sub-indexes and the RTL-neutral benchmark are due only to differences in rebalance schedule. Therefore, by calculating the differences in monthly returns between the sub-indexes and the RTL-neutral benchmark, we can empirically measure RTL. Specifically, we measure RTL as the annualized volatility of these differences.

Hoffstein et al (2019) derived an intuitive closed-form solution for an ex-ante estimate of RTL (Equation 1). From this equation, it becomes clear that RTL (L) is affected by a portfolio’s turnover rate (T), rebalance frequency (f), and the opportunity set allotted to the portfolio (S). [5]

A higher turnover rate implies that the holdings of a portfolio have a higher potential for meaningful divergence for different rebalance schedules. Consider a portfolio with 100% average annual turnover; it would follow that a portfolio such as this, with an annual rebalance schedule in January versus a portfolio rebalanced in July, would have a low level of holdings overlap, thus increasing the role of RTL in the two portfolios’ performance results. Conversely, a strategy with close to zero turnover would have a high level of holdings overlap between rebalance schedules, implying a lower amount of performance dispersion from RTL alone.

We should think of T as an intrinsic, continuous turnover rate of the strategy driven by the decay speed of the driving signals.  In practice, however, portfolios are typically refreshed at a discrete frequency (f) to balance signal freshness with implementation costs.  For faster moving signals (e.g. momentum which has a particularly short half-life as opposed to a slow signal such as value), the level of signal decay in between rebalance dates can introduce RTL into the portfolio’s performance as the signal begins to decay, favoring more recent information.

With this in mind, we also construct a number of specifications for each factor by varying (1) the number of holdings and (2) the rebalance frequency. Portfolio holdings range between 50 and 400 securities in increments of 50. Rebalance frequency is either annual, semi-annual, or quarterly. [6]

Exhibit 1 depicts the calculated RTL of the four factor portfolios for different concentration and rebalance frequency specifications. [7]

Exhibit 1

In this table, we show the empirical estimate of timing luck of Value, Momentum, Quality, and Low Volatility U.S. Large Cap equity factor portfolios for annual, semi-annual, and quarterly rebalance frequencies, varied by the number of holdings in the portfolio. The Momentum portfolio is constructed by sorting on 12-1 month realized returns; the Value portfolio is constructed by sorting on trailing twelve-month earnings yield; the Quality portfolio is constructed by sorting on the average rank of trailing twelve-month return on equity, accruals ratio (negative), and leverage ratio (negative); the Low Volatility portfolio is constructed by sorting on trailing twelve-month realized volatility (negative). The time-period for these results is July 2000 to September 2019.

Source: Sharadar. Past performance is not an indicator of future results. Performance is backtested and hypothetical. Performance figures are gross of all fees, including, but not limited to, manager fees, transaction costs, and taxes. Performance assumes the reinvestment of all distributions.

In line with Equation 1, the empirical results show that higher turnover styles, such as momentum, exhibit higher realized RTL as opposed to lower turnover styles such as low volatility. Further, higher portfolio concentration (i.e. fewer holdings) increases the magnitude of RTL as more concentrated portfolios would reduce the level of holdings overlap between rebalance versions, while more frequent rebalancing tends to reduce it. Surprising, however, is the actual magnitude of RTL; for a semi-annual rebalance schedule, annualized RTL is as high as 2.5%, 4.4%, 1.1% and 2.0% for 100-stock value, momentum, low volatility, and quality portfolios, respectively.

A portfolio that takes a long position in one of these sub-portfolios while being short another, could then explicitly capture the relative effect of timing luck between the two portfolios. If we assume that the impacts of RTL are independent from one another, we can calculate the volatility of this long-short portfolio through Equation 2, where vi and vj are the different sub-portfolios of the same strategy.  From this, a confidence level can be generated to capture the potential return range that a strategy would be expected to achieve, simply from the rebalance choices the strategy had made. For the 100-stock value, momentum, low-volatility, and quality portfolios, we could, therefore, infer that a strategy targeting one of these styles could have resulted in performance dispersions of +/- 7.1, 12.5, 3.1, and 5.7 annual percentage points due to RTL alone. 

These results complicate the manager selection process as the annual returns of two managers tilting towards the same style could be several hundred basis points apart strictly due to different rebalance schedules and nothing else.  Conversely, the skill of a manager may appear diminished (inflated) when compared to a benchmark that realized positive (negative) RTL. 

To highlight the effects of dispersion caused by RTL, Exhibit 2 depicts the various equity curves of the sub-indexes for a semi-annually rebalanced, 100-stock momentum strategy. We also construct the RTL-neutral benchmark (labeled “Tranche”). Exhibit 3 details the realized performance statistics of the sub-indices as well as their tracking error to the RTL-neutral benchmark. We find that the minimum tracking error realized is 2.9%, which happens to also arise from the best-performing rebalance schedule over the analysis period (MAY-NOV), while the greatest tracking error realized over this period is 4.6%.

While the sub-index rebalanced in May and November had the highest realized returns, the performance difference is not statistically significant and suggests that the realized excess performance of this parameterization is not persistent.  Rather, the May and November rebalance schedule simply benefited from positive RTL shocks relative to its peers.

Exhibit 2

In this figure, we show the equity curves of 100-stock equity momentum portfolios constructed from the S&P 500 universe. These portfolios depict the different rebalance schedules of a semi-annual rebalance frequency. The tranched portfolio is also shown which represents a composite of the different rebalance schedules.

Source: Sharadar. Past performance is not an indicator of future results. Performance is backtested and hypothetical. Performance figures are gross of all fees, including, but not limited to, manager fees, transaction costs, and taxes. Performance assumes the reinvestment of all distributions.

Exhibit 3

In this table, we show the annualized performance statistics of the six rebalance schedules available to a semi-annually rebalanced equity momentum portfolio sorted on 12-1 month realized returns, as well as the tranched composite of these rebalance schedules. Tracking error is calculated relative to the tranched composite.

Constructing portfolios that are long one sub-index and short another for all iterations isolates the relative RTL between the two sub-indices.  We find that the overall significance of any persistent outperformance is low, indicating that no rebalance schedule shows significant outperformance over other versions of the strategy. Out of the fifteen permutations of the momentum style, no combinations were found to be statistically significant,[8] and similar results were found in the remaining styles (pairwise t-stat tables can be found in Appendix A). 

Importantly, this test of significance serves the purpose of disproving whether there exists a rebalance schedule that is inherently superior versus the others. The lack of evidence for schedule superiority suggests that RTL is an uncompensated source of risk in portfolio construction. The manner in which this risk manifests is in the dispersion of terminal wealth achieved, and the RTL shocks that lead to this dispersion not expected to have mean-reverting characteristics, as shown in Blitz et al (2010).

To further isolate the dispersion due to RTL, Exhibit 4 plots the rolling 252-day performance difference between two different rebalance schedules for a semi-annually rebalanced 100-stock momentum strategy. Shockingly, the seemingly trivial decision to rebalance the portfolio in May and November resulted in a twenty percentage-point return difference when measured against the same strategy, with its rebalance shifted by only one month (April and October).

Exhibit 4

In this figure, we show the rolling 252-day performance difference between a 100-stock momentum portfolio rebalanced in May/November and a 100-stock momentum portfolio rebalanced in April/October.

Source: Sharadar. Past performance is not an indicator of future results. Performance is backtested and hypothetical. Performance figures are gross of all fees, including, but not limited to, manager fees, transaction costs, and taxes. Performance assumes the reinvestment of all distributions.


To bridge the gap from hypothetical to use-case, we replicate the process behind the S&P 500 Enhanced Value, Momentum, Low Volatility, and Quality indices. Specifically, we implement the rules disclosed in the index methodology as follows:[9]

Building from these rules, we construct all possible rebalance schedule variations of these four indexes.[10] Exhibit 5 highlights the terminal wealth realized from the portfolios along with the best and worst performing rebalance schedules. The resulting portfolios are shown to exhibit significant amounts of performance dispersion, flowing through to meaningful differences in the terminal wealth accumulated. Again, it is important to emphasize that the only difference in these portfolios is the rebalance schedule: all other aspects of the portfolio construction process are held constant.

Exhibit 5

In this figure, we show the terminal wealth results from a one-dollar investment in different replicated S&P equity factor index variations from January 2001 to September 2019.

For the Enhanced Value, Momentum, Low Volatility, and Quality indices, the annualized return dispersion between the best- and worst-performing rebalance schedules is 100, 192, 25, and 106 basis points, respectively. Importantly, a pattern does not exist as to which rebalance schedule shows consistent under- or out-performance between factors.

Exhibits 6, 7, 8, and 9 plot the calendar year returns in excess of the average sub-portfolio return for that year, for different rebalance schedules. The annual returns of the factors highlight that periods of elevated market volatility can exacerbate performance dispersion. The S&P 500 Enhanced Value replications, for example, see a highly significant dispersion arising in 2009, whereby the indices rebalanced in FEB-AUG and JAN-JUL significantly outperformed the other versions. Between the JAN-JUL and JUN-DEC rebalance schedules, the performance differential in 2009 is an astounding 41.7 percentage points.

Exhibit 6

In this figure, we show the calendar year excess returns of the replicated S&P 500 Enhanced Value index relative to the average sub-portfolio calendar year return, varied by rebalance schedule.

Source: Sharadar. Past performance is not an indicator of future results. Performance is backtested and hypothetical. Performance figures are gross of all fees, including, but not limited to, manager fees, transaction costs, and taxes. Performance assumes the reinvestment of all distributions.

Exhibit 7

In this figure, we show the calendar year excess returns of the replicated S&P 500 Momentum index relative to the average sub-portfolio calendar year return varied by rebalance schedule.

Source: Sharadar. Past performance is not an indicator of future results. Performance is backtested and hypothetical. Performance figures are gross of all fees, including, but not limited to, manager fees, transaction costs, and taxes. Performance assumes the reinvestment of all distributions.

Exhibit 8

In this figure, we show the calendar year excess returns of the replicated S&P 500 High Quality index relative to the average sub-portfolio calendar year return, varied by rebalance schedule.

Source: Sharadar. Past performance is not an indicator of future results. Performance is backtested and hypothetical. Performance figures are gross of all fees, including, but not limited to, manager fees, transaction costs, and taxes. Performance assumes the reinvestment of all distributions.

Exhibit 9

In this figure, we show the calendar year excess returns of the replicated S&P 500 Low Volatility index relative to the average sub-portfolio calendar year return, varied by rebalance schedule.

Source: Sharadar. Past performance is not an indicator of future results. Performance is backtested and hypothetical. Performance figures are gross of all fees, including, but not limited to, manager fees, transaction costs, and taxes. Performance assumes the reinvestment of all distributions.

The S&P 500 Momentum replications show that the overall dispersion in performance throughout the period analyzed tends to be more consistent, given that the turnover of this strategy tends to remain high, as the majority of the years realize a difference of at least four percentage points.[11] For each of the factor replication strategies, minimum annual performance dispersion, as measured by absolute difference in calendar year returns, are 1.3, 4.5, 1.8, and 0.1 percentage points for Enhanced Value, Momentum, Quality, and Low Volatility, respectively. The maximum return differences were 41.7, 14.6, 8.6, and 2.9 percentage points, respectively.  Elevated bouts of broad market volatility tend to increase the amounts of absolute dispersion (e.g. 14.6 percentage points in 2002 and 14.1 percentage points in 2009).


While the concept and execution of rebalance schedules has been glossed over in the existing literature, a decision must be made as to when a strategy is measured and executed.  This decision does not come without consequence. Empirical evidence has shown that performance results can vary drastically and leave a lasting impact on wealth outcomes.

In this piece, we explored the impact of rebalance timing luck on the results of smart beta / equity style portfolios with varying portfolio characteristics. We empirically tested this impact by designing a variety of portfolio specifications for four different equity styles (Value, Momentum, Low Volatility, and Quality). The specifications were varied by holding concentration as well as rebalance frequency.

We then constructed all possible rebalance variations of each specification to calculate the realized impact of rebalance timing luck over the test period (2001-2019). In line with the mathematical model from Hoffstein et al (2019), we generally find that those strategies with higher turnover are more sensitive to timing luck, while those that rebalance more frequently exhibit less timing luck. Additionally, a higher number of portfolio holdings reduces the impact timing luck has on realized returns, all else equal.

The sheer magnitude of timing luck, however, may come as a surprise to many. For reasonably concentrated portfolios (100 stocks) with semi-annual rebalance frequencies (common in many index definitions), annual timing luck ranged from 1-to-4%, which translated to a 95% confidence interval in annual performance dispersion ranging from +/-1.5% per year for low turnover strategies to +/-12.5% for higher turnover strategies, though, we identify periods in which this estimate falls drastically short of empirical results.

These results call into question one’s ability to draw meaningful relative performance conclusions between two strategies, or a strategy and its benchmark, even if other variables such as factor definition and portfolio constructions methods are controlled.

We then explored more concrete examples, replicating the S&P 500 Enhanced Value, Momentum, Low Volatility, and Quality indices, which are tracked by live assets. In line with expectations, we find that Momentum (a high turnover strategy) exhibits significantly higher realized timing luck than a lower turnover strategy rebalanced more frequently (e.g. Low Volatility). For these four indices, the amount of rebalance timing luck leads to a staggering level of dispersion in realized terminal wealth.

Given that most of the major equity style benchmarks are managed with annual or semi-annual rebalance schedules, even the benchmarks that investors use for comparison and analysis may be realizing hundreds of basis points of positive or negative performance luck a year. While identifying and testing the impacts of RTL in a systematically managed strategy is certainly feasible, conducting the same exercise with a discretionary, actively managed strategy becomes non-trivial. Given that an active manager would not necessarily operate on a set rebalancing schedule, one might argue that timing is an active decision within an active manager’s process. Nevertheless, while difficult to explicitly measure, the specter of RTL would still play an important role in the manager’s result and therefore comparison against an RTL-neutral benchmark would be prudent.  With such a large emphasis on identifying and quantifying the skill of investment managers, investors should always bear in mind that supposed skill, seemingly beyond passive smart beta investing, might merely be attributable to dumb (timing) luck.

Appendix A

This appendix shows the t-statistics of the annualized realized returns of long-short portfolios for each equity style. The portfolios are constructed by creating a portfolio that is long one rebalance schedule and short another from January 2001 to September 2019.  The t-stats depicted in these tables show the significance of average outperformance of the rebalance schedules, where the existence of statistically significant results would indicate the existence of a superior rebalance schedule over a long timeframe.  Bolded values indicate statistical significance at the 5% level.

Pairwise t-stat table of constructed Long-Short Value portfolios of different rebalance dates. 5% statistical significance is indicated in bold.

Pairwise t-stat table of constructed Long-Short Momentum portfolios of different rebalance dates. 5% statistical significance is indicated in bold.

Pairwise t-stat table of constructed Long-Short Quality portfolios of different rebalance dates. 5% statistical significance is indicated in bold.

Pairwise t-stat table of constructed Long-Short Low-Volatility portfolios of different rebalance dates. 5% statistical significance is indicated in bold.


Arnott, R.D., Hsu, J., and Moore, P. (2005), “Fundamental Indexation”, Financial Analysts Journal, Vol. 61, No. 2, 83-89.

Blitz, D., van der Grient, B., and van Vliet, P. (2010). “Fundamental Indexation: Rebalancing Assumptions and Performance,” Journal of Index Investing, Vol. 1, No. 2, 82-88.

Ciliberti, S., and Gualdi, S. “Portfolio Construction Matters.”, October 19, 2018.

Doran, J., Jiang, D., and Peterson, D. (2012). “Gambling Preference and the New Year Effect of Assets with Lottery Features,” Review of Finance, Vol. 16, No. 3, 685-731.

Haugen, R., and Lakonishok, J. (1988). “The Incredible January Effect: the Stock Markets Unsolved Mystery”. Homewood Ill.: Dow Jones-Irwin.

 Hoffstein, C., Faber, N., Sibears, D. (2019). “Rebalance Timing Luck: The Difference Between Hired and Fired,” Journal of Index Investing, Vol. 10, No. 1, 27-36.

Keim, D. (1983). “Size Related Anomalies and Stock Return Seasonalities,” Journal of Financial Economics, Vol. 12, No. 1, 13-32.

Sias, R. (2007). “Causes and Seasonality of Momentum Profits.” Financial Analysts Journal, Vol. 63, No. 2, 48-54.


[1] The authors would like to thank (in alphabetical order) Adam Butler, David Cantor, Conrad Ciccotello, Antti Ilmanen, and Pim van Vliet who offered their opinions and insights.

[2] Herein we distinguish between rebalance frequency (e.g. semi-annual or annual) and rebalance schedule (e.g. every June and December or each May). The frequency defines how often the strategy is rebalanced while the schedule determines when, specifically, the rebalances occur within a year.

[3] When analyzing active portfolio managers, it is important to highlight that there is no evidence that managers make deliberate rebalance choices with the objective of maximizing performance, so any rebalance choice from actively managed portfolios is an active decision with unmeasured risk.

[4] The characteristics chosen to construct our factor portfolios were selected as these definitions generally align with the existing literature and popular indices tracking each style.  These characteristics are meant to be representative only, but our research suggests they are without loss of generality.

[5] The S variable in Equation 1 is technically the estimated volatility of a long/short portfolio where the long leg of the portfolio is what the portfolio is invested in and the short leg captures the residual assets that the portfolio could be invested in at a given time. See Hoffstein et al (2019) for a further discussion of this variable.

[6] Data comes from Sharadar and utilizes all available pricing history at the timing of writing (2001 to 2019).

[7] All return results presented are gross of transaction fees or advisory expenses, so any increases in portfolio turnover from more frequent rebalances would negatively influence net returns, all else equal.

[8] There is existing literature citing a seasonality effect in momentum profits, known as the “January Effect”.  This anomaly is credited to window-dressing (managers removing losing holdings from a portfolio before holdings are released at year-end), liquidity conditions in the market, higher investor risk appetites, as well as from tax-loss selling of underperforming stocks. The January Effect has been shown to boost common factor strategies returns in January, while impairing the returns of momentum strategies. Conversely, this effect originates in December, where institutional buying of recent winners pushes momentum profits higher in the month of December.  See Keim (1983); Haugen, Lakonishok (1988), Sias (2007), and Doran, Jiang, Peterson (2009) for further descriptions and evidence of this phenomenon.

In the scope of this study, we found the results of the MAY-NOV (rebalanced and remeasured at month-end in May and November) momentum strategies to outperform other rebalance schedules; however, when analyzed through the lens of long-short portfolios, no combinations were found to be significant.  Further, by instantiating simulation-based analysis of significance, there were no pairings that resulted in returns that were statistically dissimilar from zero.

[9] These methodologies were referenced from the S&P Dow Jones Indices website in December 2019.

[10] For indices with semi-annual rebalance schedules, there are six unique sub-indices that can be constructed, while there are three sub-indices available for an index that rebalances quarterly.

[11] The factor replication minimum performance dispersion, as measured by absolute difference in calendar year returns, are 1.3, 4.5, 1.8, and 0.1 percentage points for Enhanced Value, Momentum, Quality, and Low Volatility, respectively. The maximum return differences were 41.7, 14.6, 8.6, and 2.9 percentage points.

PDF Download: Rebalance Timing Luck: The Dumb (Timing) Luck of Smart Beta


Carny Barkers


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Jim Cramer calls on 10 companies, including Amazon and Alphabet, to issue stock splits (CNBC)

“I think the idea of getting newer, younger people involved into the stock market who aren’t just brainwashed to put money into index funds is terrific.” 

“If you want the market to keep climbing, these ten companies — and many more — need to start taking their cue from Tim Cook and Elon Musk,” Cramer said. “Remember, the size of the price tag matters with this crowd.”

Sometimes you have to work hard to divine the Zeitgeist of the modern age.

And other times the Zeitgeist just walks right up and smacks you with a 2 x 4.

Or a sack of oranges.

I understand from my exhaustive research (i.e., Wikipedia) that in actual carny lingo, there was no such word as “barker”, that instead the hustlers and grifters who talked you into paying two bits for a glimpse of Zeena the Mind Reader and Molly the Electric Woman were called “talkers”.

Fair enough. To-may-to, to-mah-to. I’m fine with referring to Jim Cramer as a carny talker if you like that better, but there’s a punch to “barker” that really fits the bill here.

Yes, that’s heart throb Tyrone Power in “Nightmare Alley” (1947). Doesn’t end well for him.

Of course this has always been CNBC’s business model and Cramer’s shtick, to be nine parts entertainment for one part financial news/advice, but now we’ve traded the rolled-up shirt sleeves (gotta work hard and do your research!) for a carny barker’s striped suit and cane (hey now, step right up to see the egress!).

I mean … “brainwashed to put money into index funds”? AYFKM?

They’re. Not. Even. Pretending. Anymore.

Or as Rusty put it yesterday, the grift is now the thing. In the age of capital markets as carny show, we are told by barkers like Cramer that this is what a smart investor or management team does … they should look to the grift du jour for their edge.

For years, we’ve been writing that capital markets have been transformed into a political utility, but now it looks like that was just a waypoint in the metamorphic lifecycle. Kinda like the cocoon stage for a moth.

Or, I suppose, the chest-bursting stage for an Alien xenomorph.

Certainly that’s been the experience for value investors.

No, it wasn’t enough for these high-functioning sociopaths to turn capital markets into a political utility.

Today, capital markets are being transformed into a carny show.



Can’t Fight This Feeling


Source: The historically bad video to REO Speedwagon’s 1985 hit power ballad “Can’t Fight This Feeling”

When I left home for college, the dot-com bubble was bursting.

The unfortunate events of March 2000 were already in the rear-view mirror, but the summer months gave at least some renewed hope to speculators and investors alike. That was the certainly the spirit on-campus at Wharton, anyway, where it seemed that just about every other undergrad was still supplementing work-study income (or draws from mommy and daddy’s trust fund) with stock speculation using the miracle of E*Trade on university-provided high speed internet.

Not me. Not really. Sure, I sold the shares of stock in the way-too-boring-for-1999 Dow Chemical Company I had gotten from them as part of a scholarship when I graduated and played around a little bit. But I was terrified of risk, didn’t really care about trading stocks and hadn’t the foggiest idea where to start. I also didn’t have any money.

But I remember how I felt.

I remember how class working groups broke down into late-night discussions of upside-maximizing options strategies. I remember upperclassmen talking about how the hardest class at Wharton to get into – by a HUGE margin – was speculative markets, the name for the options course. I remember penny stock discussions, the perfunctory nonsense that passed for “doing your DD”, which is very much the same perfunctory nonsense that passes for “doing your DD” today. I remember the elaborate hoops everyone jumped through to obscure the fact that they were just screening for excitement, sentiment and trailing price performance. I remember how clear it was that people explicitly looking for price, technical or other analogs to stocks that had been 8-baggers the year before, were wrapping their interest in made-up stories that would sound better to b-school students who would still have Graham and Dodd stuffed down their hungover gullets the next morning. I remember the validation that everyone sought from others about their particular elaborate charades, and how willing everyone was to provide that same validation to others.

I remember when discussions of strategies became discussions of tips became discussions of plays. When everything sort of shifted from figuring out how to evaluate a stock to figuring out how to identify what the smart money was doing to…well, maybe figuring out what people who had real, insider knowledge were doing. Not that anyone said that out loud, but c’mon. It was the tail end of a dying bull market, and we were grasping for whatever was left.

I remember how all of this felt as if it were yesterday, and I haven’t felt that way in a long time.

Mark Cuban, on the other hand, has felt that way. Several weeks back he joined our friends at RealVision to make a video about his experiences in the dot-com bubble, how he was able to protect the value of his position in Yahoo, and why some of what is happening today reminds him very much of the frenzy of leverage, risk-taking and asymmetric position-seeking that typified late-90s speculation in technology stocks.

I didn’t agree with Mark when he said it in June. I think our unprecedented connectedness today makes historical comparisons really difficult. It’s the same problem we all run into in our news consumption: are so many ridiculous things really happening, or are we just hearing about it more because we are so connected to news and instant-reaction social media? Are people really more sensitive, more aggressive, more divided and more hateful, or are the mechanisms through which missionaries promote that common knowledge more ubiquitous?

I don’t know. But after the past couple weeks, I can’t fight this feeling any more. I think Mark Cuban is right.

No, I don’t have any reason to think we’ve got a bubble that’s about to burst. No, I don’t think we’re looking at a crash in markets supported explicitly by a comically overzealous and inflation-indifferent Federal Reserve. But for the first time, the boundary-testing behaviors of retail speculators really do remind me of how I felt in 1999 and 2000.

The implications of these behaviors are big, even if I think they are likely to be very different this time around.

Let me share with you a post I read this morning.

This fare will be familiar to any who have perused the more casual Robinhood-inspired masses of /r/Stocks or /r/Wallstreetbets on Reddit. Let me assure you, it will be downright banal in comparison to what you’d find on the associated private Discord channels designed to avoid regulatory recordkeeping requirements and public disclosure.

If you follow financial markets much at all, the big news today for markets and for the company in question was the Trump administration’s announcement of a deal with Moderna, Inc. for 100 million doses of an experimental vaccine candidate for COVID-19. That is what the Reddit post above refers to. Moderna stock traded up more than 11% before the buy side and sell side alike did the math to realize that barely profitable vaccines were much better news for the market and economy in general than to producers that had been trading on far higher prices per dose.

The curious part, of course, is that there is a direct allusion to there being some indication of deep out-of-the-money options activity before any announcement was made. That is made less curious by the limited scale of that activity, but more curious again by the casualness with which retail participants bandy about the expectations that it might indicate insider activity.

The post, and many other posts in both subreddits, link to a service – “not advice”, naturally – that tracks unusual volume and activity in both stocks and options markets. The service itself is not novel. This has been basic stuff for traders and institutional investors since well before even I entered the industry. What is novel is that the service’s pinned tweet references early indications on a stock whose activity is now under investigation by the SEC for allegations of insider trading.

What is novel is that the very next promoted post, a retweet of an earlier promo, is a celebration of indications of unusual and early insider volume on a pending split by the ur-stock of the Robinhood revolution – Tesla.

I don’t really care about these guys, this service, or what they’re doing. Truly, I don’t. It’s (probably) not illegal, it uses information available to anyone willing to pay for it, and it is far more of a crapshoot than anecdotal examples where unusual activity was beneficially predictive will ever show. If that weren’t the case, the stat arb guys and other short-horizon quants would have mined this to oblivion before you could animate Stonks! into a GIF featuring the sea-dwelling mammal of your choice. Far more importantly, whatever mild impropriety exists here would pale in comparison to the actions of the grifters at the actual issuers, their political allies and the banks who serve them who know that they can get away with just about anything right now.

No, the real implication here is far more powerful: there is a new common knowledge. Everybody knows that everybody knows that the way you make a killing is to bet that grifters are gonna’ grift, and nobody’s going to lift a finger to stop them.

For most of the late 90’s through the summer of 2000, when you heard the rumors from energy traders you knew about what was going on at Enron and saw them get away with it, when you had heard of a hundred guys who’d made a killing on a stock tip from a guy they knew at a bank, you knew that you could either play or get left behind. When the courts came for Enron and when evaporating institutional asset price support came for tip-following retail speculators, those who bet on grifters learned a powerful lesson.

But this time? This time I don’t think the lesson the world is delivering is “bet on inside info at your own peril” or “bet with leverage on aggressive, sexy new business models that are probably frauds and get burnt along with management.” This time I think the lesson is different:

That nobody gives a shit what you do.

It doesn’t sound like much of a lesson, I guess. But if you care about why we do capital markets at all, about why we designed our economy to rely on markets to funnel rewards to the most productive owners of capital, it is a far more terrifying lesson. If you care about why we believe that governments should operate for the general welfare of the people and not for the concentrated pecuniary interests of a particular privileged few, it is a far more terrifying lesson.

It doesn’t matter that retail investors are trying to figure out what shenanigans Kodak insiders are able to get up to to see if they can tag along. It doesn’t matter that retail investors might be doing the same with Owens and Minor or 3M or Honeywell. It doesn’t matter that retail investors want to detect ways to ride the coattails of grifters at Tesla or Moderna or anywhere else.

What matters is that the transformation of capital markets into political utilities also appears to be the transformation of capital markets into entertainment and gambling utilities.

What matters is that no one in any position to do anything about it seems to care.

What matters is that none of that will change until you and I DO.


The Grifters, Chapter 2 – N95 Masks


Epsilon Theory PDF Download (paid subscribers only): The Grifters, chapter 2 – N95 Masks

The Grifters (1990)
Pat Hingle as Bobo and Angelica Huston as Lilly

Bobo Justus: Tell me about the oranges, Lilly…

[kicks over a bag of oranges]

Bobo Justus: While you put those in the towel.

Lilly Dillon: [kneels on the floor and starts picking them up] You hit a person with the oranges wrapped in a towel… they get big, ugly looking bruises. But they don’t really get hurt, not if you do it right. It’s for working scams against insurance companies.

Bobo Justus: And if you do it wrong?

Lilly Dillon: [terrified] It can louse up your insides. You can get p… p… p-p-p-p-p

Bobo Justus: What?

Lilly Dillon: P-permanent damage.

The best movie about con games is The Grifters, and the best scene in that movie is “Bobo and the oranges”, where mob boss Bobo terrorizes and punishes Lilly for screwing up one of his money laundering schemes. It’s one of the top-ten brutally compelling scenes in any movie I’ve seen, not so much for the physical violence as for the psychological violence.

We’re all Lilly Dillon today.

Our political and market worlds have become an unending sea of grift … small cons, big cons, short cons, long cons … and every day the distinction between grifters and squares becomes more and more blurred.

Day after day, we’re all getting smacked by Bobo and his bag of oranges, hoping to god that we only get badly bruised in the process.

But we all know that we’re past the point of permanent damage.

We’ve been assaulted by three grifts in just the past few week … three smacks from Bobo and his bag of oranges … each deserving of an Epsilon Theory note. Chapter 1 was about Kodak.

Here’s chapter 2.

Last week, Mike Pence shook his finger at us and said that there were no outstanding requests on federal PPE stockpiles from any governor, and thus any urgent requests for N95 masks from doctors or nurses were isolated incidents to be quickly resolved by state authorities.

SMACK goes the bag of oranges.

In truth, both the supply and the distribution of N95 masks in the United States remains a national disgrace, a squandered opportunity to fight Covid with something other than death cultism or lockdown defeatism.

In truth, what could have been our finest hour is turning into our worst.

For the past six months, a big part of my life has revolved around getting PPE directly to doctors, nurses, EMTs, first responders, social workers and other frontline heroes in this war against Covid-19.

Thanks to the amazing generosity of donors big and small, we raised close to $1 million. Thanks to the inspired work of a dozen friends-for-life-most-of-whom-I-didn’t-even-know-before-this, we first set up an “underground railroad” of N95 and high-quality KN95 masks from China, and later a steady network of PPE suppliers. Thanks to the daily, unwavering commitment of a small team (literally my wife and daughter, literally working out of our garage), we’ve been able to distribute more than 120,000 medical respirators in batches of 100-200 to more than 1,100 hospitals, clinics, police departments, fire departments, prisons and shelters across 47 states. So far. We’ll get out another 4,000+ this week. And next week. And every week until we win this war.

Clear eyes. Full hearts. Can’t lose.

Is the overall PPE situation for healthcare workers and first responders better today than it was in April? Absolutely. In April we were sending masks to desperate ER docs and nurses at major hospitals in the biggest cities in America. Today there is neither an urgent need nor even a shortage of PPE in these big city ERs and ICUs.

Why not? Because, distribution of PPE from our massive federal and state stockpiles is designed for big cities and big hospital systems. Because that’s how the American system of trickle-down everything … in this case PPE … works.

Eventually, Andrew Cuomo sucks it up and asks Mike Pence for help, and eventually Mike Pence makes a call to FEMA, and eventually all the requisition forms get filled out and signed by all the right people at the governor’s office, and eventually a truckload of 1 million N95 masks makes the trip from the FEMA warehouse to the New York-Presbyterian warehouse, and eventually a NY-P van starts shuttling a pallet of masks every week to every NY-P hospital loading bay, and eventually the boxes of N95s get allocated to the individual medical departments. Eventually.

At the same time, NY-P has half a dozen people in their requisition and supply department wading through all of the private channels and PPE distribution networks to place giant orders of their own. It takes twenty failed orders for one to come through, but eventually that one big private order shows up at the warehouse. Eventually.

Of course there are shortages and delays and weird distribution snafus and rationing for the non-emergency medical departments within these big hospital systems within big cities. Of course the system is kludgy and slow and absolutely maddening for anyone involved. But it kinda sorta works. Eventually.

Outside of these big hospital systems within big cities, however, PPE supply is a joke. A killing joke.

Trickle-down PPE is not an eventually thing for small towns and for poor, rural counties. It’s a never thing.

The tragedy of our nationalized and oligarchized PPE system is not just our inadequate production system. It is also and much more so our failed distribution system.

There’s never a truckload of N95 masks that goes to Dothan, Alabama or Harlingen, Texas or Lake Charles, Louisiana, much less the towns and rural clinics and county health offices and nursing homes these small cities serve. There is no van to shuttle PPE on a regular basis from the warehouse filled with this stuff. There is no well-staffed requisition department with the resources to make private orders. The requisition “department” is Rafa the volunteer EMT, who has to fill out three forms and wait six weeks to get reimbursed for the box of useless-as-PPE surgical masks he bought at the local Staples.

But it’s in Dothan and Harlingen and Lake Charles and a hundred small cities just like them where an endemic Covid-19 is working its worst evil today. It’s in Hale County and Cameron County and Beauregard Parish and a hundred poor or rural counties just like them where people get sick at home and mostly recover at home but sometimes die at home. This virus is no longer just a big city disease. It’s an everywhere disease. Et in Arcadia ego.

None of these communities have sufficient PPE for frontline medical personnel and emergency responders, much less secondline clinics like a dialysis center or a maternity ward, much less chronic care facilities like a nursing home. At best they get some hand-me-downs from an affiliated big city system. Usually they buy something crappy from a friend of a friend distributor. Often they have nothing. In all cases, they are on their own.

And don’t get me started on the schools.

I don’t think I have the words to communicate just how screwed up our PPE distribution system is in this country.

I don’t think I have the words to describe what a profound betrayal it is for our government to support this perverse system of personal greed and corporate ambivalence in exchange for campaign soundbites and photo ops.

But I’m gonna try.

Every PPE manufacturer in the world – from the largest like 3M and Honeywell to the smallest like some retrofitted Chinese factory – relies on private distributors to resell their masks. If you don’t have access to FEMA stockpiles, you must work through these private distributors to buy N95s or KN95s (the functional Chinese equivalent) or FFP2s (the functional European equivalent).

Calling this private distribution system “the Wild West”, which is how I often see it referred to in the press, is laughable. It’s not the Wild West. There were sheriffs and marshals in the Wild West. There were repeat transactions in the Wild West. There was a functional market for goods and services in the Wild West. This is not that.

One company – 3M – dominates global N95 mask production, making about 100 million masks per month. Roughly 40% of that total is made in the US, and roughly 40% of that total is made in China. For all practical purposes, the domestic US number is the only number that matters, as China no longer allows 3M to export Chinese-made N95s to the United States. Two other companies – Honeywell and Owens & Minor – round out the vast majority of domestic N95 mask production. The President says that we will produce 80 million N95 masks in the US this month. Let’s take that with a big grain of salt (the Defense Dept. says we should hit that number by the end of the year), and say that the actual domestic N95 production number for these three companies combined is 50 million.

I’ve been buying PPE for six months, spending hundreds of thousands of dollars, and I have never successfully purchased a legitimate batch of 3M or Honeywell or Owens & Minor N95s. Never.

Everyone assures us that 3M and Honeywell and Owens & Minor make 50+ million N95s per month in the United States, and I’ve never seen ONE.

I’m not saying they don’t exist. I’m saying that they are a) hoarded by private distributors who sell them to sovereign buyers at an enormous mark-up and/or big hospital systems at a large mark-up, and b) hoarded by the US government who – eventually – trickles them down to big hospital systems in big cities.

There is no market for domestically produced N95s in the United States.

That market simply does not exist, and anyone who approaches you as a broker or a contact or a distributor of a distributor of 3M or Honeywell N95s is a liar. Without exception, they are – if not petty grifters themselves – caught up in someone else’s grift.

By the way, Mark Cuban was saying exactly this four months ago. He was right then and he’s even more right today.

So what we’re left with – and by we I mean every American purchaser of medical respirators who is not a big hospital system in a big city – is the international KN95 distribution market. Again, not the Wild West. That’s far too polite. This is a Hobbesian state of nature, where (economic) life is brutish, nasty and short. I’ve endured dozens of bait-and-switch operations, including a literal switching of packages at a Chinese air freight facility. I’ve seen documents that were forgeries of a known forgery. I’ve been forced to learn the niceties (and not so niceties) of Chinese currency transfers and customs law. I’ve tried to ship masks via diplomatic pouch and via Tesla’s special export channel. I’ve heard hundreds of earnest assurances that dried up like the morning dew. I’ve met outright con men (rare) and pseudo-grifters (common).

I’ve also met some really good people.

I’ve also purchased some really high-quality KN95s at a fair price.

That’s what makes the current system so frustrating. There ARE good actors in this system. There ARE high-quality products being manufactured by entrepreneurs all over the world. But right now the good actors and the good products are overwhelmed by a tsunami of misinformation and grift.

Right now, there are tens of millions of N95 masks that are NOT being distributed because they are hoarded by resellers and governments, including our own.

Right now, there are tens of millions of N95 masks that are NOT being made because of regulatory barriers and crony capitalism.

We could fix this today, you know.

Today, the White House could crack open the supply chain and distribution networks of 3M and Honeywell, the two giant corporations that dominate N95 mask production in the United States, but who do so as an afterthought, as a pimple on the butt of their strategic plans.

Today, the White House could require NIOSH (the regulatory body that approves a mask as N95-compliant) to expedite its ridiculous 6+ month approval process for new entrants, including KN95 mask producers.

Today, the White House could take a fraction of the money it’s giving to politically-connected companies like Kodak or Owens & Minor, and make that funding available to American entrepreneurs – the most powerful force for positive change in the world today – to get involved directly in the manufacturing and (even more importantly) the distribution of PPE to ALL Americans. Even if they live in Dothan, Alabama or Harlingen, Texas.

None of these things will happen today, of course.

Today, the White House will continue to run its political grift, exchanging crony capitalism and status quo preservation for campaign photo ops and talking points.

For megacorps like Honeywell and 3M, both members of the S&P 500 and both with market caps close to $100 billion, life is good if you play ball with the White House – meaning you say nice things about Trump and you “invite” him to use your factories for campaign speeches and photo ops – and life is difficult if you don’t.

That’s Honeywell Chairman and CEO Darius Adamczyk – a “fantastic man” as Trump reminded us twice in his speech that day – presenting the President with a framed N95 mask after touring a Honeywell facility in Phoenix, Arizona on May 5th. Also attending were Arizona Governor Doug Ducey (“a fantastic governor”) and Arizona Senator Martha McSally (“a fantastic person” who is “bringing tremendous amounts of dollars back to her state”).

After noting the fantasticness of all involved, Trump introduced Jorge and Betty Rivas, the owners of Sammy’s Mexican Grill, who had recently been featured in a Trump tweet and so “they became very rich”. Jorge informed the cameras that “we represent the Latino community” and that “all the Latinos are going to vote for you”. Trump made sure to note that he (meaning his campaign) would be paying for the food provided by Sammy’s Mexican Grill that day. After a few more local testimonials, Trump wrapped up the photo op, and staffers cued the Trump Rally mixtape. New for the Honeywell event: the Guns N’ Roses cover of “Live and Let Die”.

I am not making this up.

What was the payoff for Honeywell from playing ball with the White House?

Well, part of the payoff was the $148 million awarded to Honeywell by HHS and the $27 million awarded to Honeywell by the Defense Dept for increased production of N95 masks, both contracts inked three weeks before the Phoenix trip. But these are drop-in-the-bucket contracts for Honeywell, which does more than $30 billion a year in revenues.

The real payoff from playing ball with the White House is smooth sailing for the $6 billion in revenues that Honeywell will get from the US government this year within its Defense and Space division.

Honeywell’s long-term growth model – the thing that will make Darius Adamczyk’s 600,000+ stock options worth hundreds of millions of dollars if he plays his cards right – is selling stuff to the Pentagon, and as a result his company – like all defense contractors – makes an art form out of schmoozing everyone with appropriations influence in Congress or the White House. Usually that means campaign contributions. Usually that means letting a Senator use one of the company jets. Usually that means a job or a board seat or an advisory council position once they’re out of office. Usually that means our elected officials at least pretend that they’re not on the make. But as we’ve seen again and again with this White House …

They’re. Not. Even. Pretending. Anymore.

At least Honeywell got the joke. 3M, on the other hand …

This tweet sent 3M stock down more than 3% on April 3rd, costing the company a couple of billion dollars in market cap.

What did Mike Roman do to bring down the Trump Twitter wrath on his head?

Why, he made the White House look bad. He took away a talking point.

The saga begins on February 29th, when Pence had to scramble at that afternoon’s press conference to back up Trump’s off-the-cuff claim that “we have more than 40 million masks available today”. Supporting the Boss, Pence announced:

“We’ve contracted now with 3M to … [long pause] … 35 million more masks per month will be produced, and we’re also going to be working with other manufacturers.”

Apparently, no one was more surprised by this “contract” than 3M. In an email around midnight that Saturday night, a 3M representative wrote, “Just to clarify, we are not yet under contract for the volume mentioned today. However, we are preparing to respond to the US administration’s request for a proposal for respirators.”

Preparing to respond to a request for a proposal.


So a week later, Pence makes a hastily scheduled trip to Minneapolis, along with our fave scientist, Dr. Birx, to meet with 3M CEO Mike Roman and Minnesota governor Tim Walz.

You can just feel the electricity, right?

I think this is what Trump would call “low energy” if it were a political adversary and not, you know, the Vice President. But wait, it gets better.

CEO Mike told VP Mike that 3M couldn’t just snap their fingers and make 35 million N95 medical respirators magically appear, but they did happen to have 35 million N95 masks made for the construction industry laying around somewhere. If, by chance, the White House could see their way clear to having someone at FDA or NIOSH approve a liability waiver for 3M as pertains to these N95 construction masks, why then by definition they would be available as N95 medical masks.

It took a couple of weeks, but sure enough Pence and team got the waivers in place for 3M. They let the company know, and a week later VP Mike called CEO Mike to ask him when they can expect the 35 million N95 masks. To which CEO Mike roughly said:

Oh, YOU wanted those masks? Gosh, there’s been a terrible misunderstanding. I thought we were clear that the waivers were just to make the masks available as medical PPE. Sorry, man, but we’ve already sold all those masks to our resellers. They’re already on their way to Canada and Latin America. We’ll be sure to get you on the next batch, though!

And that’s when Trump brought in the big guns.

Jared Kushner, the president’s son-in-law, has been leading administration contacts with the company to learn where the masks went and why some were not available as promised. The situation led Trump to invoke the Defense Production Act, said the official, who spoke on condition of anonymity to discuss events that have not been made public.

Trump, 3M clash over order to produce more face masks for US (Associated Press, April 4, 2020)

Honestly, it’s like a plot line from Veep.

Why did 3M cross the White House when Honeywell did not?

Because 3M’s existential client isn’t the government … it’s their resellers and distributors.

This is a company that depends as much on their distribution channels as Honeywell depends on the Pentagon. So when a windfall like 35 million N95s cleared for medical export comes available, in the early days of a global pandemic, when your CCP landlords have been breathing down your neck for months (3M manufactures as many products in China as any company on the face of the Earth) … are you joking? Sure, CEO Mike would love to make the White House happy, but he also knows exactly where his bread his buttered – in keeping his distributors happy.

But fear not, all you 3M shareholders, a face-saving solution was soon found for all concerned. By April 21, the Defense Dept. ponied up a $76 million contract for 3M, and followed that up with another $126 million on May 6. Trump stood down from Twitter Defcon 2, and his imposition of the Defense Production Act was a complete nothingburger – 3M was commanded to work closely with Jared and give him what he wanted. As a result, the stock price never saw the lows of April 3rd again. Whew!

What did Jared want? It’s all the White House ever wants. They wanted praise. They wanted a big number for a talking point. Just do THAT and it’s all good. So that’s exactly what Mike Roman gave them. He stopped complaining about the Trump tweets and started thanking the Trump administration for helping 3M help the American people. He promised to increase domestic N95 production to some big round number over the next 12 to 18 months. The precise number is impossible to lock down because everyone interchangeably talks about mask production increase and mask production totals – sometimes it’s 50 million masks a month total by October, sometimes it’s 50 million masks more per month by October – but hey, 50 million is a big number! And next year … well, who’s to say that won’t be 100 million masks per month? That’s an even bigger number!

What happens to all of those masks? Where will they go? Well, some will need to go to the national stockpile because … you know, we need a big number there, too. And you can’t export too many of these masks to Canada or Brazil like you did with those windfall 35 million we gave you the waivers on. But otherwise you can do whatever the hell you want with the masks, CEO Mike. Taking care of your distributors at the expense of the health and safety of Americans was never the problem. It was the embarrassment you caused the White House that was the problem.

One last vignette on the 3M saga. On the Q2 earnings call, CEO Mike starts off by, again, thanking the Trump administration for all of their help and coordination in making more N95 masks right here in the good old US of A. Want to know how many analyst questions he got about N95 masks in the Q&A after his prepared remarks? Zero. Why? Because N95 mask production is 2% of 3M’s global revenue. Because now that there were no more angry Trump tweets and no more public relations concerns, they could go back to asking questions that really matter.

Andrew Obin — Bank of America Merrill Lynch — Analyst

So just going back to capital allocation. What do you need to see in terms of things getting back to normal? To go back to share buybacks, to go back to looking at M&A, what does it take?

Joe Ritchie — Goldman Sachs — Analyst

OK. All right. And then maybe one follow-on question. Just going back to the comments around capital deployment and when you could potentially get more aggressive with a buyback or M&A.

Yep. When share buybacks? Can’t make it up.

Look, I can go on forever about this stuff. I mean, I haven’t even talked about the contracts with Owens & Minor, a public company with a sub-$1 billion market cap.

Here’s Trump a week after the Honeywell photo-op in Phoenix, taking the stage at the Owens & Minor production facility in Allentown, PA, flashing his America First salute. He’s about to introduce Jared and … wait for it … Jared’s college bud and the CEO of the US International Development Finance Corporation, Adam Boehler. Yes, the team that brought you the Kodak fiasco is exactly the same team that brought you Owens & Minor, through exactly the same funding mechanism. Adam is, of course, described as “fantastic”. From there we have the usual stump speech about America First and Sleepy Joe Biden. But don’t call it a campaign appearance.

It’s always the same thing, in big ways and in small ways – play ball with the White House and you can feed at the trough.

Nothing matters. Everything is for sale. An unending ocean of political grift.

Meanwhile, another 50,000 Americans will get sick with Covid-19 today.

Meanwhile, another 1,000 Americans will die.

Hey, it is what it is.

Nope. It isn’t. It really, really isn’t.

From a policy perspective, I’ve already told you what I think we should do. This part is easy.

Today, crack open the supply chain and distribution networks of 3M and Honeywell, the two giant corporations that dominate N95 mask production in the United States, but who do so as an afterthought, as a pimple on the butt of their strategic plans.

Today, require NIOSH (the regulatory body that approves a mask as N95-compliant) to expedite its ridiculous 6+ month approval process for new entrants, including KN95 mask producers.

Today, take a fraction of the money we’re giving to politically-connected companies like Kodak or Owens & Minor, and make that funding available to American entrepreneurs – the most powerful force for positive change in the world today – to get involved directly in the manufacturing and (even more importantly) the distribution of PPE to ALL Americans.

The policy perspective is easy. It’s the personal perspective that’s hard.

How do we live with the NOW? How do we make our way in a fallen world, where this sort of banal evil flourishes with such abandon and success?

It’s inhuman not to feel anger. So yeah …

Burn. It. The. Fuck. Down.

But also …

If you are a healthcare worker or first responder in urgent need of PPE (or you know someone who is), go to and let us know. No promises. But we will do everything we can to help.

We’re going to change the world, you know … you and me.

Hope has two beautiful daughters – Anger and Courage.

Anger at the way things are, and Courage to see that they do not remain as they are.

St. Augustine (supposedly)

Epsilon Theory PDF Download (paid subscribers only): The Grifters, chapter 2 – N95 Masks


ET Live! – 8.13.2020


In today’s episode…will the boys overcome the basic perils of 21st century networking technology? Will they once again be thwarted by devils living among the wires? Tune in at 2PM today to find out on the August 13th edition of Epsilon Theory Live!

As usual, we look forward to your participation in the chat during the livestream. If you have any issues with video, you may need to refresh your browser after the livestream begins. For best results, we recommend Chrome (and no, Google does not sponsor this feature!).


Get Me Tools and a Beer!


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Homer: That’s it. They have awoken a sleeping giant!

Marge: Homey, what are you going to do?

Bart: <chanting under his breath> Crazy scheme, crazy scheme, crazy scheme…

Homer: Get me tools and a beer!

The Simpsons, Season 13, Episode 15 “Blame it on Lisa”

The crazy Kodak scheme we wrote about a week and a half ago is still an influential part of the Zeitgeist.

It sits atop the Zeitgeist this week for two reasons. First, there has been another event in this absurd saga, and coverage of it has been significant. To wit, on Friday, the U.S. International Development Finance Corporation announced that it was putting the announced loan on hold because “allegations of wrongdoing” raised “serious concerns.”

This is good news.

The announcement from the DFC also spawned a lot of articles with shared language, including this one from CNBC that ranked near the top of our list of financial articles with the most structurally similar language over the weekend.

Kodak pharma deal held up over reported questions about stock move [CNBC]

There is a second reason for the high degree of connection around this topic, however. It is being forcefully attached by political and media missionaries to the rapidly emerging narrative of deglobalization and reshoring of critical American manufacturing. This narrative will be an old friend to most Epsilon Theory readers, who read about its emergence in March in a note we published called Lack of Imagination.

Since we spotted those early missionary drum beats in early-mid March, the narrative exploded in coverage volume across financial media, reaching its peak this summer.

Source: Epsilon Theory

To be fair, there is a very good case to be made that COVID-19 laid bare how the globalization of pharmaceuticals supply chains and manufacturing created unacceptable fragility and vulnerability in exchange for an extended period of higher margins and capital efficiency. Depending on your political proclivities, there is a very good case to be made that government policy will necessarily play a role in reversing, or at least patching, those vulnerabilities. There is room for disagreement, but there is nothing crazy about believing that it is strategically important that America have a strong, complete domestic pharmaceuticals manufacturing industry.

But the gap is WIDE between that belief and the belief that the only way to achieve this is by demanding your tools and a beer so that you can come up with a crazy scheme like tagging the International Developement Finance Corporation to facilitate that transition through a no-strings-attached loan to a government official-linked company that hasn’t had competitive expertise at scale in chemicals, pharmaceuticals or really anything else since it shuttered or sold such businesses over the last few decades.

This topic sits at the top of the Zeitgeist in part because narrative missionaries are aggressively trying to tell each of us how to think about the gap between those beliefs. They are telling us that the gap doesn’t exist. They are telling us to think that extending no-strings-attached financing to Kodak is inextricably related to – no, synonymous with – “doing something about reshoring pharmaceuticals manufacture.”

We are told that they are the same because the narrative missionaries want to be able to produce an unassailable, physically compelling response in us if we or anyone else express doubts. If we say, “Wait, why Kodak?”, they want to be able to respond, “Why don’t you care about restoring American pharmaceuticals manufacturing?” It is the oldest trick in the memetics playbook – the abstraction of A into B, where B is a thing that everybody knows everybody knows is unassailably important. In this case: The Kodak deal is the restoration of American pharmaceutical manufacturing.

In other words, Yay, reshoring!

Here’s what it looks like when a political missionary promotes this narrative with a “Yay, reshoring!” meme attached.

Here’s what it looks like when a media missionary promotes this narrative with a “Yay, reshoring!” meme attached.

And here’s how the echoes of those missionary statements begin to reproduce in the mouths of others. Like the original missionary statements, they ignore the criticisms of the Kodak grift and reframe them as assertions about the need for pharmaceuticals reshoring.

The trick to seeing through these forced abstractions is always the same: we remember that two things can be true at the same time. In this case, it is true that restoring domestic manufacturing capacity in certain critical industries is a legitimate policy aim. AND it is true that the Kodak grift is exactly the crazy scheme it appears to be on the surface.

Anyone who implies that these two assertions are in opposition is selling you on an intentionally constructed narrative.


Deep Sociopathy


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We don’t pay taxes. Only the little people pay taxes.

That’s Leona Helmsley, New York City hotelier and billionaire by marriage, pictured and quoted above. Not a direct quote, mind you, but what one of her housekeepers testified to hearing at Leona’s tax evasion trial.

Leona – who, among many other infamous Queen of Mean escapades, sued her son’s estate for the cost of flying his casket back to New York after he died of a heart attack at age 42 (and evicted her daughter-in-law and four grandchildren from their Helmsley-owned home) – may have been the most flamboyantly villainous NYC cartoon character of the past 40 years, but scratch any New York real estate development family and you’ll find tales of sociopathy that will make your skin crawl. And no, I’m not just sub-tweeting the Trumps. But yes, definitely them, too.

People get all worked up over the Deep State. Not me.

I get worked up over the Deep Sociopathy, the seemingly universal view among the humans who manage the most powerful corporate and social organizations in the world that both laws and social norms are nothing more than speed limits – arbitrary behavioral constraints that have no intrinsic meaning, but are merely part of an annoying cost-benefit analysis that must be performed as they drive merrily down the road at top speed.

Is murder bad? Hmm, I dunno. What are the chances I will be caught and what price will I pay if that happens? If the odds are high enough and the price steep enough, then yeah, I guess THAT would be bad. But the act of murder itself? I mean, I’m sure whoever I murdered – if I were to murder someone, that is, because I really don’t think you can prove that I did – was getting in the way of something that was very important to me. When you really think about it, they were doing the bad thing! Why do you ask?

I thought about Deep Sociopathy when I read this article about BNP Paribas exiting or at least sharply curtailing their commodity trade finance business, following in the footsteps of SocGen, who did a similar pullback recently in Asia.

BNP Halts New Commodity Trade Finance Deals Amid Unit Review (Bloomberg)

The French bank, one of the largest lenders to global commodity traders, has recently told clients that no new deals will be concluded unless there’s a contractual obligation, said the people, who asked not to be identified because the information isn’t public. BNP is currently reviewing options for the future of its EMEA commodity trade finance business, the people said.

The move comes after the bank took a hit from commodity trade houses facing financial stress from Dubai to the U.S., the people said. BNP’s commodity trade finance team suffered heavy losses from the bank’s exposure to companies including crop trader Phoenix Group, energy firm GP Global Group as well as coffee dealer Coex Coffee International Inc., the people said.

It’s not BNP getting out of the commodity trade finance business per se that’s revealing of the Deep Sociopathy at work here, but rather this gem of a quote:

“The bank has been shrinking its commodity trade finance business since 2014, when it was fined $8.9 billion for violating U.S. sanctions.”

From 2004 through 2012, BNP Paribas was the go-to money launderer for Cuba and Iran, funneling tens of billions of dollars worth of transactions and assets around the world, as well as the functional central bank of Sudan, all in egregious violation of multiple US laws and sanctions.

Because that’s what commodity trade finance IS … providing loans and processing transactions for the middlemen who run the shell companies who move the oil and other commodities that finance every murderous despot on Earth. Unfortunately for BNP, these particular murderous despots in Cuba, Iran and Sudan – not to be confused with all the murderous despots on friendly terms with the United States – were on the wrong side of US law at this particular time, and BNP got caught. Oops, gotta pay that speeding ticket. An $8.9 billion speeding ticket.

But wait, there’s more.

See, this article isn’t quite right when it describes the $8.9 billion that BNP paid in 2015 as a fine.

No, the fine was only $140 million.

The balance – more than $8.8 billion – was just a forfeiture of the fees and trading profits that BNP made in its decade-long criminal conspiracy with these three regimes and their cut-outs.

And here’s the kicker, from a Reuters article describing the final plea deal and settlement in 2015:

BNP’s sentencing had been delayed for months while it awaited word on whether the U.S. Labor Department would allow it to continue to manage retirement plans despite the plea. The department granted BNP that exemption this month.

I mean, organized crime has got nothing on banks like BNP. Organized crime is a bunch of pikers compared to banks like BNP.

Imagine running this sort of criminal enterprise for years, and then negotiating a deal where you agree to forfeit your profits and pay a wrist-slap fine, BUT ONLY if you’re allowed to keep running your legit businesses with no repercussions.

And as if that weren’t enough to make you sick to your stomach …

Now imagine the criminal enterprise that AGREES to this plea deal.

That’s Deep Sociopathy for you. Deep State ain’t got nothing on that.

Or maybe, come to think of it, it’s all one and the same.



The Mountain and the Molehill


The best thing about 2020 is that if you don’t know where your close friends, family and colleagues stand on something, now you do.

The worst thing about 2020 is that if you don’t know where your close friends, family and colleagues stand on something, now you do.

There isn’t any avoiding it when you’ve been stuck in tight quarters with some of those people every day of the week for four months. It probably doesn’t help that being distanced from everyone else leads to spurts of collective oversharing on social media, either. Or that more than a few of y’all have become a bit too comfortable with day-drinking on a Tuesday. I know, I know, it’s very European.

But if you came into this hellscape of a year yearning to know just what your vaguely-gesturing-in-the-direction-of-racism high school classmate or your aggressively anti-everything-in-society-that-actually-works niece thought about every damned thing that might happen, well, then 2020 is coming up roses for you, my friend.

Less so for the rest of us, I fear.

For my part? Most of my friends and nearly all of my extended family are conservative. My uncle is a minor conservative celebrity on Twitter and thinks he has remained mostly anonymous. I know what your dog looks like, Uncle Dave, and also your pool looks really lovely. I’m conservative, too, or at least I was when that term was still defined by a desire to defend institutions that have survived hundreds or thousands of years from the majority’s occasional flights of passion. I’ve heard a lot from people who think about the world like I do this year, and I’m charitable enough to presume that only a portion of what I’ve heard was motivated by the now-ubiquitous 11:30 AM take-out frozen margarita.

Fellow conservatives, I suspect we don’t agree on as much as we usually do right now. For instance, I think that the militarization of police goes beyond a race-related problem to an issue for all freedom-loving peoples who would see the government fear them and not the reverse. I think that racism is absolutely embedded in some of our institutions, even if I cringe as much as you every time I hear it described in the postmodern terms invented on university campuses to create further division. I think protests are energizing and fiercely American, and that would-be anarchists trying to take over their agenda doesn’t make the authentic expressions of resistance less valuable or important. And yes, I think missionary-promoted narratives are working hard to skew your takes on these issues, and I’m pretty sure they’re trying to do the same thing to me.

AND I know why most of you are uncomfortable expressing support for Black Lives Matter and some of the ongoing protests. For most of you (alas, not all), I know it has literally nothing to do with the narrative that national media desperately want to promote about you. I understand.

I know that you struggle signing on to protests that in too many cases have devolved into or been accompanied by violence and vandalism. I know why the “defund police” message sits very badly with you, and turns you off completely to anything else that person has to say.

It is because you cherish a belief in the rule of law.

I know why you believe that the protests are being driven by – or at the very least have been co-opted by – organizers whose goal is to subvert capitalism. It’s not hard to know given that many of them literally say as much, whether through stated policies or signs. I know why a movement that doesn’t adequately police the destruction of private property and the ruining of livelihoods by a group of its participants, no matter how small, isn’t one you feel you can sign up for.

It is because you believe that capitalism works. That without it the American Dream doesn’t work.

And I think you are right. On both counts. But I know something else, too. I know that whatever threat these divisive elements co-opting an important social movement pose to our cherished values, at a national level it is a molehill.

If it is the threat to capitalism that concerns you, let me ease your mind; its end will not be at the hands of a 24-year old ukelele-strumming Oberlin grad with a man bun and a “capitalism kills” sign.

If it is the threat to the rule of law that concerns you, let me give you peace; it will not perish from this Earth by the will of a mustachioed software engineer in a $120 t-shirt and paintball mask who busts the windows of small businesses because something something equality, then goes home to unironically post a meme comparing himself to the soldiers who stormed the beaches of Normandy on his $3,000 MacBook Pro.

If it is the threat to either of those things that concerns you – and it should – then I implore you: Pay attention to what is happening right now at the intersection of political power, financial markets and corporate power. Because this, friends, THIS is a mountain. We needn’t be hyperbolic. Capitalism will survive this. So will the rule of law. But if there is a threat to either, you won’t find it on the streets of Seattle or Portland.

You will find it here.

Trump Says U.S. Should Get Slice of TikTok Sale Price [WSJ]

Trump Says U.S. Should Get Slice of TikTok Sale Price, Wall Street Journal (8/3/2020)

If you aren’t plugged into financial markets, you probably haven’t seen that much about this story yet. A bit of background is in order.

TikTok is a social application developer. Their main product is an ultra-short-form video sharing app for mobile devices. If you have kids, they probably have it on their phones. It is owned by a Chinese company. It collects a lot of identifying information about its user base, more than 2/3 of which is between the ages of 13 and 24. It says it doesn’t share that information with the Chinese government, which you are free to believe if you want. It says it never will, which you are free to believe if you are illiterate. Whether TikTok’s parent regularly shares your kid’s keystroke data with the CCP or not today, don’t delude yourself – by Chinese law we are never more than a single phone call from a party official away from exactly that.

It is also true that TikTok has become a part of the escalating disputes conjured to serve the domestic political interests of the CCP and US government alike. Various government agencies, including the US Army, have banned its use. Some corporations have, too. In early July, the Trump administration began to publicly float the idea of banning TikTok in the United States. On July 31st, it announced that unless TikTok’s Chinese parent company divested 100% of TikTok, its operations in the United States could be banned by executive order. Shortly thereafter, in a conversation with the White House press pool on Air Force One, President Trump was less equivocal. TikTok would be banned and it would not be sold to a US corporation.

Source: David Cloud via Maggie Haberman

A day later, President Trump met with Microsoft CEO Satya Nadella and changed his tune. It would be OK if Microsoft bought TikTok from its Chinese parent company. If it did, however, the treasury would have to receive a payment. And then he set a deal deadline.

Let us recap.

  1. The President of the United States threatened the use of executive power to unilaterally ban a foreign company from the distribution of a product in the United States.
  2. He then met with the CEO of one of the two biggest US-based public companies to negotiate permission to acquire the company distributing that product.
  3. He then demanded a payment to the US government to facilitate the approval of such a transaction.

The rule of law we cherish hasn’t anything to do with the overaggressive enforcement and policing of laws. It means a system in which permissible activities under the law are clear and unequivocal to all. It means a system in which the adjudication of conflicts with those laws is conducted without favor or prejudice against any party. It means a nation in which citizens, investors and businesspeople need have no fear that the outcomes of their behaviors will be subject to the arbitrary determinations of a single individual. The rule of law is the answer to the rule of man.

The capitalist system we cherish is about a belief in markets, the superior power of a collection of individuals expressing their preferences to arrive at the correct prices and values of things, against, say, the beliefs of a small group of ‘experts’, or worse, ‘politicians’, or even worse than that, ‘academics’. It is about a belief that the flow of rewards to capital creates a relationship between risk and reward that produces society-supporting growth. Is it the belief that the system does the best job possible – if often imperfect – of achieving that while providing competitive incentives to reward and attract labor.

That US corporations must now consider their actions based on how they believe they will align with the person and preferences of the president in order to conduct business is a basic betrayal of the rule of law. That we have now established a precedent to enforce or not enforce regulations or orders based entirely on whether a citizen or corporation pays a financial tribute to the US treasury is a brazen betrayal of the rule of law. That the ability to pursue corporate actions and investments is now not determined by the forces of competition but by which institutions can secure an audience with the king and most afford to pay it tribute is a shameless and destructive betrayal of the capitalist system.

The Microsoft / TikTok affair is a betrayal of both the rule of law and the capitalist system on a scale that dwarfs anything being done by the cosplayers in the Pacific Northwest that dominate the conservative news cycle right now.

And yeah, when those people scream “fascism”, what they are usually referring to is “a bunch of policies I don’t really like.” Sure. But fascism IS a thing. And while fascist governments vary wildly in economic models, all share one trait: they rely on the use of arbitrary executive power to coerce or incentivize powerful corporate institutions into obedience and alignment with the aims of a political party or individual.

Fellow conservatives who care deeply about the rule of law and quality-of-life improving miracle of capitalism, now is our time to howl.

How about we focus on the mountain instead of the molehill?


A Banner Day


Not just a two-fer to start off the dog days of August, but a three-fer.

First, the August edition of the Central Bank narrative monitor is out today. We’re still in an inflation-focused narrative regime, which is a positive regime for stocks (and an even more positive regime for precious metals). But the narrative strength of ALL of our Central Bank regime measurements is weakening, including the inflation focus. Combined with an insanely positive market sentiment towards Central Banks (the highest on record in the past five years), we think this is a VERY complacent market narrative structure when it comes to Central Bank support.

Second, we’re publishing today a one-off narrative monitor on Covid Vaccines. It’s the question we get more than any other: “Are Covid-19 vaccine narratives moving the market?” The short answer is yes, and exactly the way you think they are. The longer answer is yes, but it’s a short-term trading impact that only lasts for about a day and a half. I think you’ll really like this research note, and it’s a great example of the power of the Narrative Machine over different time frames.

Third, today we’re launching our second monthly narrative monitor – Security Analysis Methods. That’s a mouthful and it sounds boring, but I promise you it’s anything but. Even more so than the Central Banks monitor, I think this is the most powerful investment application we’ve developed yet. In a nutshell, we think we can identify the periods where market participants are primarily focused on either multiples, fundamentals, or technicals in the way they talk and think about investing. Each of these narrative regimes – multiples-focused, fundamentals-focused, and technicals-focused – generates a powerful signal of subsequent market dispersion (cross-sectional volatility) and subsequent market performance. These signals are particularly useful when regimes transition from one to another, and that’s exactly what we’re seeing going into August: a transition from a technicals-focused market narrative to a fundamentals-focused market narrative.

As we did with the Central Banks narrative monitor, we’ll be holding a webinar on Tuesday, August 11 at 2p ET to walk Professional subscribers through the Security Analysis Methods monitor. I’ll send out a calendar invite later this week, and we’ll have a replay and deck available if you’re not able to attend live.

Also on the calendar, we’ve moved our next ET Live! webcast from this Tuesday to this Thursday, August 6 at 2p ET. Hope you can join us as Rusty and I take your questions and talk about all things Epsilon Theory, including these new research projects. And one final note … with the incorporation of signals from both the Central Banks narrative regime research and the Security Analysis Methods narrative regime research, our Epsilon Theory Narrative Alpha (ETNA) model portfolios are, IMO, the most interesting thing happening in systematic investment strategies today. I’d love to show you what we’re doing and how we make these model portfolios available to institutional investors and asset owners, so if you’re interested in learning more, please give me a shout and we’ll set up a call!


It’s a Mad, Mad, Mad, Mad Market


This piece is written by a third party because we think highly of the author and their perspective. It may not represent the views of Epsilon Theory or Second Foundation Partners, and should not be construed as advice to purchase or sell any security.

Tyler Fitzgerald (Jim Backus aka Thurston Howell III from Gilligan’s Island): Anybody can fly a plane, now here: I’ll check you out. Put your little hands on the wheel there. Now put your feet on the rudder. There. Who says this ol’ boy can’t fly this ol’ plane? Now I’m gonna make us some Old Fashioneds the old-fashioned way – the way dear old Dad used to!

Benjy Benjamin (Buddy Hackett): What if something happens?

Tyler Fitzgerald: What could happen to an Old Fashioned?  

It’s a Mad, Mad, Mad, Mad World (1963)

I’m guessing some readers won’t remember this all-star, Oscar-winning classic. Indeed, it was made well before even my time, but I remember watching it on the ‘tube’ on more than one Sunday night in the late 1970s. I’d watch it with my Dad, who’d howl with laughter. I decided to watch it once again with my son. If you’ve never seen it, it’s worth the time. They just don’t make existential comedies like this one anymore. The story begins after a reckless driver named Smiler Grogan (Jimmy Durante) roars past a handful of cars on a winding California road and ends up launching himself over a cliff. Before (literally) kicking the bucket, he cryptically tells the assembled drivers that he’s buried a fortune in stolen loot… under a mysterious ‘Big W.’ He says: “350G’s. I’m givin’ it to ya’ but watch out for the bulls. They are everywhere.” Yes, they are, albeit he had a different sense in mind. [1] With little moral reservation, the motorists set out to find what they now consider their fortune.

The characters exemplify some of human nature’s best and worst qualities. At times, they are wildly creative and improvisational. However, they work together only to the extent necessary – double-crossing each other repeatedly. They lie. They cheat. They steal without a second thought. They have a singular focus: treasure – at any cost. Their sense of entitlement is overwhelming. In the scene quoting Tyler Fitzgerald, who is a high-society alcoholic, two of the treasure seekers (played by Mickey Rooney and Buddy Hackett) convince him to fly them to Santa Rosita in a brand-new Beechcraft twin. Blinded by greed, they seem to care little that he is too drunk to stand. In the end, they all find the Big W together along with the treasure beneath – but only to be bamboozled out of it. Eventually, the money ends up being lost completely and redistributed from atop a fire escape to a crowd in ‘Santa Rosita Square.’ Helicopter money of sorts – easy come, easy go. Greed is not only their foremost motivation, but it’s their ultimate undoing.

There are more than a few similarities between the Mad, Mad, Mad, Mad World characters and today’s market participants. So far at least, myopic greed and speculation have paid well. Analysis has been a handicap. Unprecedented fiscal policy stimulus combined with the Fed’s debt monetization has thus far maintained a pretense of normalcy in markets. There will be consequences to ballooning balance sheets (both corporate and federal). Few seem to be considering that the ultimate consequence of massive deficits is at the very least potentially crushing taxation.[2] Or worse, as rates would likely rise steeply if the Fed ever stops QE in an attempt to normalize policy by shrinking its balance sheet (soon to be an anachronistic concept). The Fed is too busy bailing out the bottom of the boat to raise the sails.

Deficits are now so large that Treasury issuance monetization must occupy the vast majority of the Fed’s attention. This close to the zero bound, the Fed can no longer significantly lower rates, it simply must prevent rate market dislocations due to massive supply. Fed action is no longer stimulative; rather, it is only palliative.[3] Importantly, it’s not Fed ‘liquidity’ that is feeding market participants’ emotional impulse. While the Fed remains an enabler, it is fiscal policy that is putting money directly into gamblers’ bank accounts. This distinction is crucial to whether fiscal policy continues to provide enough liquidity for a return to the casino later this year.[4] It seems that equity markets are priced for an aggressive second round of fiscal policy action, an efficacious vaccine by year end, and a healthy corporate America – free from defaults.


  • This time, there’s no treasure under the Big W. It’s just a big ‘W.’ We remain in a bear market with highly unfavorable return characteristics for large and small cap U.S. equities alike.
  • Equity and credit market performance is no longer all about monetary policy; it’s mostly about market participant emotion, which is largely dependent upon the pandemic fiscal policy response.
    • The Fed that is now hamstrung – now ‘forced’ to monetize massive, and otherwise unsustainable, policy deficits.[5]
    • Fiscal policy stimulus has found its way directly into U.S. equity markets – particularly speculative names and technology.[6]
  • Pre-existing fragility – especially excessive leverage – will make escape velocity for markets and the economy particularly difficult to achieve.
    • Liquidity will likely evaporate when personal and business defaults eventually sop up fiscal policy liquidity. The Fed is ill-positioned to act efficaciously. It’s too busy mopping up Treasury issuance.
    • Loans create deposits and without creditworthy borrowers, even a continued, fiscal-policy driven expansion of M2 may not result in higher asset prices.[7]
      • Risk-asset markets are not correctly pricing the coming explosion in prospective personal, corporate, and commercial real estate (CRE) defaults.

Liquidity Trap

Let’s start with the oft-cited reason to be long equity markets now. As the story often goes:

“Take a look at the money supply. The Fed has printed money… so much money. Just look at the monetary base and M2. It has exploded. It’s bound to find its way into equities. Don’t fight the Fed.”

Old Fashioned, anyone? Proponents of this rationale may be right on the result (higher equities) for a time, but they’d be right for the wrong reason. This time is different. First, the Fed ‘printing money’ is an anachronistic phrase I wish strategists would stop using all together. The Fed’s creation of excess reserves (‘money printing’) and subsequent purchases of assets are no longer lowering interest rates sufficiently to stimulate real economic growth. Rates are already low. Its’s not the quantity of money that stimulates growth or increases inflation; it’s first and second order effects of lower capital costs – i.e. lower rates or yields. Today, the Fed’s reserve creation is solely for the purpose of preventing a rates market dislocation. After the GFC, the Fed lowered capital costs considerably; today, it’s simply treading water to keep them low.[8] Importantly, not only does this make it more difficult for the Fed to stimulate the economy, but it also makes it tough for the Fed to help prevent corporate loan defaults when cash flows deteriorate. Thus, the Fed’s direct impact on risk-asset markets has diminished greatly, and I’ll soon explain why it matters.

For one, it’s helpful to understand that the Fed has often implemented QE without a consequent outsized increase in M2, to which so many have pointed as supporting equities now. The connection is more complicated. First, risk assets have often rallied without any M2 increase. Contrary to popular belief, the more or less consistent growth in M2 (due to natural growth of currency in circulation as loans are made) generally sees spikes when there is aggressive fiscal policy response. As Figure 1 shows, the Fed’s balance sheet expansions (the asset side of the balance sheet identity for reserve liability creation) often do not correspond well with significant M2 increases. This is particularly clear during the $1 trillion 2013 quantitative easing program; money supply growth didn’t budge above trend.[9] In contrast, in both 2008, 2011 and most recently, M2 did increase. Those instances accompanied fiscal policy stimulus, and in each case M2 increased in line with the amount of the fiscal stimulus. For obvious reasons, the impact of recent fiscal stimulus on M2 has been outsized.

Figure 1: Top Panel – M2 (blue) and Fed Balance Sheet (orange); Lower Panel – Change in M2 (blue bars); Source – Bloomberg Data

To cut to the chase, M2 growth is supporting equities, but it’s not a monetary policy phenomenon – it’s fiscal policy one. While fiscal policy is driving both investor sentiment and the beginnings of an economic recovery, the Fed still plays a critical role. Without its current “QE to infinity” approach, the massive supply of Treasuries would have little place to go.[10] Rates would likely move considerably higher, especially on the long end of the curve as demand would most certainly fall short of supply. Why? Precisely because of the massive policy deficits – already supersized even before the pandemic – required to combat the enormity of the pandemic shock. Fiscal policy is now the key – the Fed is the enabler but no longer the main actor.

Indeed, especially near the zero bound, low rates may lose their real-world stimulative efficacy.[11] A liquidity trap typically occurs when interest rates are low yet consumers and businesses tend to save. Indeed, since last year, I have advocated for gold (in part) because of this phenomenon.[12] Such behavior renders monetary policy ineffective. First described by economist John Maynard Keynes, during a liquidity trap, investors may choose to keep their funds in cash savings because they believe interest rates could soon rise, because they need to repair balance sheets, or because they wish to prepare for upcoming financial stress. At the same time, central bank efforts to spur economic activity are hampered as they are unable to lower interest rates sufficiently to incentivize corporations and consumers to invest or to consume, respectively. This is precisely why central bankers had been advocating for a fiscal policy response long before the pandemic shock. Ironically, because market participants no longer seem to perceive equities as a risky asset, saving appears to manifest vis-a-vis equity market speculation!

Fiscal Dominance [13]

So, what is next on the fiscal policy front? Well, it seems this stimulus round is shaping up more modestly than the initial round. Over $500 billion in paycheck protection (PPP) and another almost $300 billion in direct to consumer programs (including supplementary pandemic unemployment insurance relief) accounted for the lion’s share of a ~$1 trillion increase in M2 (Figure 1).[14] According to Bloomberg, after the White House dropped the idea of including a payroll tax cut, White House and Senate Republicans now have a “fundamental agreement” on a GOP plan for another round of pandemic relief. Instead of a payroll tax cut, the GOP will now back $1,200 checks for individuals who make up to $75,000 a year, just as in the March stimulus bill. Moreover, last week, Treasury Secretary Steven Mnuchin told CNBC that the Republican coronavirus relief plan will extend enhanced unemployment insurance “based on approximately 70% wage replacement.” [15] Presumably, this will be something less that the current $600 for most Americans. In aggregate, the Republicans reportedly are looking to propose $1 trillion in relief versus over $3 trillion from Democrats. The timetable for releasing legislative text, which is key to beginning negotiations with Democrats, is uncertain. One thing seems clear: the package’s scope will be more limited than the initial round of stimulus.

While likely smaller, the second round of fiscal policy response will once again put cash into checking accounts. This will once again help increase M2 and may also help to support equities. This is what’s so different about this equity market. With an assurance that the economy will be directly supported by more consumer directed stimulus, retail market participants are driving the rally – not unlike the late 1990s. [16]

Just this weekend the WSJ put an exclamation point after the sentence. Figure 2 from the Journal shows the number of new E*Trade accounts retail investors opened in march. It dwarfs any previous month. It’s generally the same dynamic for the Robinhood platform which I began writing about in September of 2019. My favorite quote from the story is a woman who proclaims that her trading style is aggressive because ‘scared money makes no money.’ According to the Journal, “she read ‘Trading for Dummies,’ watched YouTube videos, opened an E*Trade account and dove in.” That sounds about right.

This is now the sixth month of a pandemic that has not yet significantly abated in the U.S.  In order to continue unwaveringly towards the Big W, it would seem to require market participants believe an efficacious vaccine is not only assured but that it is also distributed quickly to the population. Moreover, there remains much unknown about the immune response and evidence is growing that immunity may be short-lived. [17] Nobody even seem to recall the slowdown that was already afoot before the pandemic occurred. [18] In light of an extended first wave of virus cases and with continuing unemployment claims still above 16 million, how much longer might market participants throw caution to the wind? (Figure 3 illustrates just how enormous that unemployment statistic is.) Just how long will banks and investors continue to loan money based on a stimulus-based recovery thesis? The answer to the latter question is critical to not only asset prices but also to the main-street economy.

In the absence of unusual fiscal policy stimulus programs (as present) and under normal circumstances, loans create deposits. [19] Deposits, in turn, contribute to a capital base for yet more loans. Defaults and delinquencies are surely one thing that destroys the loan-deposit cycle. Defaults will slowly start to sop up liquidity – as they always do. Lending standards, which had already begun to tighten in 2019, are now tightening significantly… it’s likely just the beginning (Figure 4 above). [20] Corporate and consumer lending will continue to slow, and as the corporate sector begins to experience even more strain as leverage grows, speculative behavior should begin to dissipate. That’s when the narrative changes from ‘there’s so much liquidity out there’ to ‘what the heck happened to all the liquidity.’ Easy come, easy go.

Corporate sector leverage – particularly speculative grade loans and bonds – has been at the top of the list of concerns for at least the past twelve months. If it was a concern pre-pandemic, it is of far greater concern now – even taking into account the scope of fiscal and monetary policy action. Banks typically slow their lending and non-bank lenders typically curtail their funding when credit fundamentals begin to deteriorate. Policy action, especially fiscally funded support for performing corporate credit, has helped suspend lower-rated paper from wires above. While prices have rebounded, credit fundamentals are not improving. As Bloomberg’s Philip Brendel puts it:

“Distressed-debt supply fell by $3 billion in June to $195 billion, a 47% correction from the cycle’s March peak of $366 billion. The stock market’s rally, seemingly without a conscience, seems to be comforting credit markets as investors shrug off record Covid-19 cases and an upcoming parade of horrific 2Q earnings results. Yet sharp corrections are common in highly volatile distressed cycles, and we think the exuberance may mirror spring 2008’s similar two-month window of calm, which didn’t last.”

According to Bloomberg data and analysis, despite 26 issuers in North America already having become fallen angels as of June 30, about 47% of corporate debt carrying BBB tier ratings has either a negative outlook or is on credit watch negative. That’s about $2.6 trillion of BBB tier debt that carries a negative outlook or is on credit watch negative. This includes over $89 billion at risk of becoming high yield. Importantly, financials are the most at risk accounting for about 33% of the total (including issues from Intesa Sanpaolo, Discover Financial and Deutsche Bank).

Importantly, non-bank lenders and loan syndication vehicles are also challenged – specifically, collateralized loan obligation (CLO) and business development companies (BDCs). The CLO market is about $700 billion and supports the $1.2 trillion speculative grade loan market. BDCs account for over $200 billion of speculative grade loans outstanding. CLOs provide banks with a syndication mechanism, which helps them keep loans off their books and shifts the risk to third parties. BDCs on the other hand, originate loans and rely upon equity issuance to help fund loans. While best of breed BDC equities have rallied, second tier lenders have continued to struggle greatly. This will leave the smaller, capital constrained companies they were designed to serve without capital access. [21] As reported by Bloomberg, about 30% of CLOs are forecast to have tripped OC tests with some being able to trade their way out by selling the CCCs and buying BBs at a discount. [22] While playing defense, it’s difficult for CLO sponsors to promote new vehicles; thus, this important source of investor loan demand begins to evaporate. Credit expansion is an essential source of liquidity and M2 growth. It will be difficult for even extreme fiscal policy measures to supplant credit expansion indefinitely.


As I suggested in the Portnoy Top in early June, recklessness and bravado had become so extreme it seemed likely to have reached a crescendo that might correspond to a market top. Such extremes are indeed difficult to gauge – after all, what’s irrational can stay that way for some time. So far at least, the broader indices like the NYSE composite and the Russell 2000 appear to have topped on June 8th. Breadth has continued to narrow as a handful of large cap tech names are responsible for the advance in the S&P 500 ad Nasdaq. Technology shares have pushed even farther beyond the limits of rationality. [23] When over a third of the S&P 500’s market cap is large-cap tech, that is a bad sign for market health. Trading for Dummies should add a chapter on that. [24] Scared money may not make money today, but at least it lives to fight another day… The monetary policy guardrails upon which so many have come to rely are flimsy. Monetary policy is no longer providing the safety it once did. Why is that important? Because we must all now be focused on fiscal policy above all else when assessing near-term sentiment and market action. Even with fiscal policy support increasing money supply by direct deposit, a liquidity trap is likely. Perhaps even more ironically, for now at least, this trap is somehow supporting equities because of a new breed of reckless equity market participant, who regards the equity market as a form of saving. Ultimately, defaults and corporate distress will steamroll greedy bravado and force a reconnect of equity prices and economic reality. It’s happened once already this year. It will likely happen again. We don’t know for sure, but presumably Smiler was on his way the Big W when he went over the cliff. As he said, he spent twenty years earning every penny of that fortune, but he failed to live long enough to see it. Today, there’s no treasure under that Big W – it’s just a big ‘W.’ Live to fight another day, Smiler.

[1] Bulls is apparently a German slang for police somewhere in between pig and cop.

[2] Please see No Free Lunches.

[3] The flaccidity of Fed action is but one reason I’ve been writing about the preexisting fragility in markets since this time last year. Others include excessive corporate leverage, weak corporate earnings (throughout 2019), and a slowdown in global growth that began in 2018. Moreover, the global trade war has continued. Please see The Art of War versus the Art of the Deal.

[4] This presumes that most of the flow into equities is coming from retail investors. Please see my June 8th Check In entitled the Portnoy Top. The evidence keeps piling up that the marginal buyer is in fact retail. Please see:

[5] Without fiscal policy action (Treasury-funded SPVs) required under Section 13(3), the Fed could not ‘lend’ to corporations or support corporate bonds.

[6] Recently, breadth has deteriorated considerably with broader indices like the Russell 2000 and the NYSE Composite failing to break above their June 8th local highs. Technology, a group particularly subject to retail sentiment, is at risk of any hiccup this earnings season with several large-cap tech names reporting at the end of July.

[7] M2 consists of broad money supply which includes deposits.

[8] Exacerbating the Fed’s predicament, with Treasury yields so close to zero across the entire Treasury curve, there’s massive convexity risk to a backup in yields.

[9] Risk-asset markets rallied significantly because the Fed was focused on lowering yields on MBS, and that QE program purchased mostly MBS securities. This program had palpable economic impact through lower borrowing costs for homes. Recall that this program was announced in September 2012, and while focused on MBS, it also helped keep longer-dated yields down – that is, until the Fed announced a taper in June 2013. The 10-year yield rose quickly in expectation of taper and the Fed was ultimately forced (in September 2013) announce no taper would occur and the 10-year yield fell again throughout 2014.

[10] The Treasuries market alone could see more than $1 trillion in net bond supply in the six months through Dec. 31. According to some Treasury analysts, sales may contain fewer bills and more, longer-dated notes. While many expect a further curve steepening, it seems more likely that the Fed will remain committed to keeping some steepness while controlling the overall level of longer-dated yields.

[11] See Edward Koo’s work at

[12] About three weeks ago, in an Aura of Treasure, I advocated for long gold and silver positions. The piece was picked up in Barron’s here:

[13] Yes, it’s being used tongue in cheek here.

[14] A company that received PPP funds faces the choice of paying employees on its own dime after the funds run out, or implementing the layoffs it put off for eight weeks and thus foregoing loan forgiveness. This choice is currently upon many companies.

[15] According to Bloomberg, Republicans would cut unemployment benefits “to $200 weekly from $600 until states are able to create the system that would provide 70% of a laid-off worker’s previous pay up to the state-set cap.”

[16] As the authors write, “it appears even bigger—and broader—this time around, amplified by digital communities on Twitter and Discord, a popular online chat hangout. Investors have transformed those social-media platforms into virtual trading desks, a place to swap tips, hype stocks and talk trash as they attempt to trade their way to a quick fortune.”


[18] Excessive corporate leverage, weak corporate earnings (throughout 2019), an inverted yield curve with slowing loan growth, and weak global growth (beginning in 2018) were among the many signs.

[19] The relationships of loans to deposits is a circular one, but deposits ‘funding loans’ is a fiction of bank’s balance sheets. Without loan growth, system deposits do not grow.

[20] An inverted yield curve beginning in early 2019 had already caused loan growth to slow, and it suggested a recession might be coming within 18-months. This had been my assessment then… alongside a steepener later in the year on early action by the Fed to cut rates.

[21] The Main Street Lending program was fully launched July 6, but the Fed only started buying loans on July 15. Banks that make eligible loans to small- and mid-size businesses are able to sell 95% of each loan to the Fed. Loans can range in size from $250,000 to $300 million for an expansion of existing credit. It has done little to fill the BDC hole.

[22] Generally speaking, CLO structures with more than 7.5% (higher in recent structures) of their loans falling into a CCC have to start refilling the over-collateralization basket (OC basket).

[23] ‘Big tech’ (AMZN, AAPL, FB, GOOG, MSFT, NFLX) now comprise 38% of the S&P 500 (Bloomberg).

[24] To be clear, I’m not ‘concerned’ for reckless retail investors, I’m simply making an observation that equity markets are reflecting the irrationality of their participants.