Portrait of a Very Serious Investor

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Hello again, ET readers! I have been struggling with a lack of inspiration on the writing front recently. Fortunately, recent events have jolted me out of my creative malaise. Today, I am writing to share a cartoon I have been sketching.

Meet the Very Serious Investor.

Back in the halcyon days of 2012, during the sturm und drang surrounding the US budget deficit and credit downgrade, Paul Krugman began using the phrase “Very Serious People” to describe politicians he deemed better at sounding serious than developing policy solutions. As another blogger once put it: “being Tom Friedman means never having to say you’re sorry.”

Love or hate Krugman, I’ve always found this a useful little cartoon. Recent events have caused me to extend it to the concept of the Very Serious Investor (pictured above). Very Serious Investors are a direct product of the Wall Street money machine. For the Wall Street money machine greases its gears with credentialism. If you have made your career in finance, you are almost certainly aware that credentialism and its attendant rituals are essential to the smooth generation of fee income.

There is a difference between sounding correct and being correct about a thing. The business of investing (as opposed to the actual act of making money in financial markets) is much more about the former than the latter.

Very Serious Investors, and the discipline of Very Serious Investing, are first and foremost rent-seeking. The Very Serious Investor wears the face of a risk-taker. An optical resemblance to risk-taking is of critical importance to Very Serious Investing. In actuality, Very Serious investing is focused on the extraction of large and (relatively) predictable revenue streams via “heads I win, tails you lose” (HIWTYL) fee structures.

The best thing that ever happened to Very Serious Investors was the transformation of markets into political utilities.

Now, no Serious Investor will ever admit this in conversation. There are appearances to be maintained. There are fists to be shaken at a burdensome regulatory state. Clouds to be shouted at while justifying charging 1.5 and 15 on market beta to LPs (even Very Serious Investors are not immune to some fee compression these days). There are compelling stories about top stock positions to be told.

Through all of this, it is of the utmost importance that the seriousness of investing be conveyed. Investing is not some game to be played. It is not a source of amusement or crass “lulz.” Investing is a science to be practiced by a properly-credentialed, properly-educated, properly-connected professional. Such professionals ought, in turn, to be compensated in a manner befitting their station and breeding.

Thus, the Very Serious Investor is quite disturbed by recent goings-on in illiquid, small cap stocks with high short interests. These happenings represent an assault not only on the Very Serious Investor’s livelihood, but his entire cosmology. For the Very Serious Investor, this offends the natural order of things. Imagine! People placing profitable discretionary trades in the financial markets when they lack even a single Ivy League degree. How dare the plebians challenge their betters?

 Ordnung muss sein.

The Very Serious Investor couches his objections in the language of finance.

“stocks divorced from fundamentals”

“inefficient capital allocation”

“significant mispricings in the cost of capital”

By dazzling the unwashed masses with his scientism, the Very Serious Investor endeavors to put them in their proper place. What matters most to the Very Serious Investor is that a particular cosmic order is preserved. A great chain of being with the plebs located somewhere above the oyster and the Very Serious Investors somewhere up near the seraphim. 

Yet how often does the Very Serious Investor take to CNBC when his long positions become badly divorced from fundamentals?

How often does the Very Serious Investor bemoan the ways in which explicit government policies of rock-bottom interest rates and permanent liquidity support distort his portfolio’s value?

Where was the Very Serious Investor’s shame when she beseeched the Fed to reverse course on rates in December 2018 after blaming the Fed for the prior four years’ underperformance in every quarterly investor letter?

Where were the Very Serious Investor’s anxieties about the integrity of corporate finance when his airline holdings levered up their balance sheets to engage in reckless and unsustainable returns of capital? Where were her high-minded ideals when she tweeted in favor of an airline bailout?

Of course, to pose these questions is beside the point.

The Very Serious Investor does not care about any of these things. What the Very Serious Investor cares about is money. He can hardly abide when others are making more of it than him. Least of all when those people are his inferiors.


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The Invulnerable Hero*

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Die Nibelungen: Siegfried (1924) : Hollywood Metal
Siegfried bathes in dragon’s blood, from Fritz Lang’s Die Nibelungen (1924)

The Invulnerable Hero* is among our most treasured and recurring tropes.

It is the core feature of the great German epic, the Nibelungenlied. You probably know it better as the story of Siegfried from Wagner’s treatment of the story in his famed Ring Cycle. Siegfried slays a dragon and bathes in its blood, that is, everywhere except for the spot on his back covered by a drifting linden leaf. He thus becomes invulnerable to harm except in this very spot.

To those of you more familiar with the Greek epics, you will no doubt see the parallels with the story of Achilles. Thetis takes an infant Achilles to the River Styx and dips him into its waters. He thus becomes invulnerable at every spot but the one covered by the fingers by which his mother held him beneath the Styx: his ankle.

For the more cultured among us, we have our Superman story. Our invulnerable hero with practically every possible advantage and a weakness to one substance that, like the Achilles heel, is so iconic an expression of the trope that it is now a euphemism for a singular weakness or point of failure. Kryptonite. And no, nerds and/or Ben, please do not email me your pedantic notes on red sun radiation, etc.

Still, there’s a funny thing about Invulnerable Hero* stories. Though we know the hero is all but invulnerable, and though we know that the only real conflict in our story is one which might threaten their single point of vulnerability, the stories are rarely about the vulnerability itself. The stories are about their great battles, their great triumphs and the roles they play in the other stories of their time. Stories which pose them practically no threat.

And even though those stories aren’t the real story, they still matter.


I know that we all want to believe that the story of GameStop is really about regular people sticking it to institutions that have done the same thing to others for years. That a revolution has taken place.

I could give you my suspicions that most of the volume and capital that have driven the short squeezes have come not from Reddit or other retail investors but from institutions (read: other hedge funds) who quickly devised strategies to predict where the energy produced by these groups would be directed next. But they would be only suspicions. Pretty strong ones, mind, but still suspicions all the same.

I also think there’s a certain misguidedness to so much of what has taken place, driven by the belief that it’s short-sellers who are the ones who most aggressively manipulate the system and do harm to the average investor. I can think of many cases where this is specifically true, and I can think of many cases where this is categorically false, cases in which this group of investors have been among the only truth-tellers left, opposed by the same financial media that patronizes retail investors today. Lazy fund-of-fund diligence analysts, hubris-and-implicit-debt-laden macro funds and 2-and-20 long/short funds minting decamillionaires by delivering 30% net exposure to the S&P and the occasional branded Patagonia vest have each extracted far more real value from the average investor and citizen.

But leave both of those things aside. Because it’s still a good story. It’s a story I think people will remember. It’s a story that still matters, even if it isn’t 100% true and even if its target was maybe a bit off-the-mark.

But it also isn’t the real story. It isn’t the Invulnerable Hero* story.

The real story is the one that lies underneath: it is the story of the source of cascading events in markets, of short squeezes and events in which those squeezes lead to large de-grossing events in which funds rapidly reduce their exposure and cause the kind of broader market events that do have real-world effects. It is the story of the heel of Achilles, the shoulder of Siegfried, the kryptonite of Superman.

It is the story of leverage.

It is the story of the gross exposure which we have collectively decided is the birthright of these institutions.

As they have many times before, regulators, financial media and financial institutions are responding to make sure that this Achilles heel doesn’t lead to the kind of wildfire event that it very well could. As they have many times before, they are doing so not by addressing the Achilles Heel of leverage and excessive gross exposure, but by seeking to prevent whatever proximate cause threatens to expose that weakness. Last year it meant our government providing a bid for assets that had none. In this case, that means our government and institutions doing what they can to prevent the establishment of new positions by retail investors.

When the dust settles in the next couple days, you’ll get the usual laughing “This time it’s different…not!” thinkpieces from Very Respectable Investors, and they’ll be mostly right. Short squeezes aren’t new. De-grossing events aren’t new. Goofy run-ups happen all the time. But there is a new common knowledge that applies to a much broader audience.

The place where Achilles was held when he was dipped into the River Styx is now common knowledge. The spot covered by the linden leaf on Siegfried’s back is now common knowledge. Superman’s home planet is now common knowledge.

Soon, the fact that hedge funds have long been and are now even more actively scraping, watching, predicting and pouncing on public, pseudo-private and private social networks will become common knowledge. Their realization that they can free-ride on asymmetric, illiquidity-driven trades that don’t create the same regulatory risk as their own public agitation and collusion might will become common knowledge.

That an entire industry is vulnerable to and will itself join in cannibalistically with this kind of coordinated attack will soon become common knowledge.

I suspect that the gatekeepers and regulators will have to face the choice: do they want free and fair markets for the pricing of capital in which everyone plays by the same rules, or do they want to protect the birthright of the hedge fund industry to run high levels of gross exposure and substantial explicit and implicit leverage that will continue to necessitate these impartial emergency restrictions and rescue packages?

We know what they’ve chosen before.

Maybe this isn’t the revolution some were hoping it would be. But it might be a policy inflection point. There might be an opportunity to build a movement around fairness, truly free markets and the rule of law.

Let’s tell those stories.

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The Zimbabwe Event

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Covid funeral in Harare

Over the past two weeks, three senior Cabinet officials in Zimbabwe (including the Foreign Minister and the Infrastructure Minister) have died from Covid. Not gotten sick. Died. More broadly, reported Covid cases and deaths have exploded in this country of 15 million just in the month of January. The unreported numbers are certainly much higher, as about 90% of Zimbabwe’s population works outside of the formal economy, and the majority of Zimbabweans have little to no access to the healthcare facilities that report these official case and death numbers.

through Jan. 21 (source: worldometers.info)
through Jan. 21 (source: worldometers.info)

The societal unraveling that is taking place in Zimbabwe – a desperately poor country where per capita GDP is less than $1,500 and declining – is staggering.

Two days ago, the government’s Information Minister tweeted that his fellow Cabinet members had been “eliminated” and called the nation’s doctors “medical assassins”. He deleted the tweets yesterday and apologized “if anyone was offended”. Nurses at a major hospital in the capital city of Harare are on strike because they are provided a single cloth mask and bakery aprons as PPE. The Defense Minister has accused China of “botched experiments” that brought Covid to Zimbabwe, and has said that she will only accept a vaccine if it is manufactured locally. Today, the government announced that it “plans to buy” cheapo Chinese and Russian vaccines, but can only afford to cover two-thirds of the country’s population. The Harare elite have taken to hoarding – not food, but oxygen– to the point where hospitals are placing newspaper ads promising to pay top dollar for any remaining supply.

This is the ‘Zimbabwe Event’, and I believe it has significant real-world and market-world consequences.

Like the ‘Ireland Event’ I’ve been writing about recently, what is happening in Zimbabwe (and every country in Southern Africa) is driven by a combination of relaxed social mitigation policies AND the introduction of a more infectious SARS-CoV-2 virus variant.

What is different is that Zimbabwe is a “weak state”, not a strong, stable state like Ireland.

What is different is that Zimbabwe is being hit by the South African-variant (501.V2), not the UK-variant virus (B117). 


The “Weak State” Difference

The stress of the Covid pandemic is enormous in ALL countries, and it is stress at EVERY stratum of society. The poor are dying. The middle class is dying and getting poorer. The elite are not dying quite as much, but they’re not getting richer and the difference in outcomes between some elites and other elites is enormous.

This broad societal stress results in popular discontent and elite conflict in every country on Earth.

Rich country or poor country, weak state or strong state, big nation or small nation … doesn’t matter. ALL nations are experiencing much higher levels of popular discontent and elite conflict today, which means that ALL governments are experiencing much higher pressure for regime change and leadership transitions.

In a strong state – meaning a nation that has the institutions, traditions, narrative legitimacy and state-supporting common knowledge to accommodate a peaceful leadership transition even under times of intense stress – you can survive a Covid Event without violent regime change.

In a weak state – meaning a nation that does NOT have the institutions, traditions, narrative legitimacy and state-supporting common knowledge to accommodate a peaceful leadership transition under times of intense stress – you cannot.

Weak states do not have an effective political steam valve for popular discontent and elite conflict, resulting in war and violent regime change when a Covid Event hits.

The United States is a strong state. It is, arguably, the strongest state in the world, with an institutional legitimacy and broad-based popular loyalty to those core institutions that has few peers. The United States has many political steam valves for the expression of popular discontent and elite conflict.

If the events of January 6th and the storming of the Capitol can happen in the United States, can you imagine what’s possible in Harare? In Tehran? In Moscow?

In a desperately poor country like Zimbabwe – and there are a lot of Zimbabwes in the world – the violence of popular discontent and elite conflict is obvious enough. When the core functions of a domestic government effectively collapse, civilian life in these circumstances quickly becomes, as Hobbes would say, nasty, brutish and short. The outcome of these circumstances is ALWAYS war. First a war of all against all, then a war of organized factions, then (often) a war of nations. Some of these wars in the Zimbabwes of the world will be entirely internal to existing borders. Some of these wars will cross those borders. Some of these wars will include major powers. 

I think 2021 will be a Year of Civil War in weak states that are desperately poor.

The market couldn’t care less about that, of course, whatever the human enormity of this violence might be.

But the dynamics I’m describing are not only true for an insanely poor weak state like Zimbabwe, but are also true for a relatively wealthy weak state like South Africa. Or Iran. Or Russia.

If you don’t see that the Navalny protests and the growing popular discontent with Putin and his billion dollar palace and all that is both made possible and accelerated by the enormous stress that Covid has placed on the Russian economy and public health … well, I think you’re missing the larger picture here. By the same token, I also think it’s clear that there is real and significant elite conflict behind the protests you see on TV, similarly stemming from that stress on the Russian economy. Clausewitz famously said that war is the continuation of politics by other means. In weak states, though, the reverse is also true: politics is the continuation of war by other means. Right now, Russia is a political war of all against all. Can Putin survive this political war? Sure. But if he does, it won’t be pretty. My bet is that he “retires for health reasons”.

I could absolutely see the same thing happening with Khamenei in Iran. Or MBS in Saudi Arabia.

I think 2021 will be a Year of Unexpected Regime Change in weak states that are relatively wealthy.

The market will care about this a great deal.


The S. African-Variant (501.V2) Difference

My notes about the Ireland Event focused on two questions:

1) how likely is a rolling series of B117-driven Ireland Events in the United States? (very, in my opinion)

2) where are we in the timeline for the first of these US-based Ireland Events? (2 to 3 weeks from today, in my opinion)

There was a third question embedded in all this, of course, which is what the market response might be to an Ireland Event here in the United States. Again imo, I don’t see this as a similar risk as last March. I really don’t see this as an epic major market smackdown, provided that the Fed and the White House say all the right things about unlimited liquidity support for S&P 500 companies … which they will. But I DO see this as a sharp punch in the nose to all of the dominant investment themes and narratives today: “dollar debasement”, “reflation”, “number go up” (Bitcoin), “commodity supercycle”, “cyclical recovery”, “earnings recovery”, “pent-up consumer spending”, etc. etc.

Is it just one good punch to all risk assets before we return to our regularly scheduled market entertainment of looking through previously unthinkable numbers of deaths and cases to some happy day of fully vaccinated business as usual?

Probably. But more and more I’m thinking it’s a very solid punch. More and more I’m thinking that this is a tradable punch. I say this for four reasons:

1) There is a sharp difference in general media coverage of the risk of viral variant spread versus financial media coverage of the risk of viral variant spread. 

While there’s an almost willful ignoring of the virus variants in major financial media, this is not the case with major non-financial media, where coverage of the news and risks of viral variant spread shows both “coherence” and “strength”, to use our narrative structure terms. Notably, however, even in non-financial media, the sentiment associated with articles about viral variant spread is oddly … positive. Like it’s really not a big deal and with Team Biden at the helm we got this covered! Yay, Team Biden! I think this is a classic example of narrative complacency, particularly in financial media, where all of the narrative risks right now are to the downside.

2) There are now four independent medical studies showing that the B117 variant is both more infectious AND more lethal than the baseline virus, versus zero medical studies showing only the same lethality (you can download a PDF copy of the most recent NERVTAG paper here). 

While the mathematical truth is that increased lethality is not nearly as “dangerous” from a public health perspective as increased infectiousness, from a popular perspective just the reverse is true. Stories of increased lethality carry a lot more narrative punch than stories of increased infectiousness. When there’s a confirmation of the lethality data (and I think it’s a when, not an if), that’s a hard hit to the “variants aren’t a big deal” narrative.

3) We now have multiple examples of a B117-driven Ireland Event, not just in Ireland and the UK, but also now in Portugal, Spain and Israel, and coming soon to the rest of continental Europe. 

The ‘Israel Event’ is particularly chastening, as the explosion in Covid cases occurred despite the most advanced vaccination program in the world, with close to 40% of the population vaccinated even as the Event occurred. As I wrote last week, one of the major consequences of a more infectious viral strain is that the percentage of the population that must be vaccinated before herd immunity brings down the R-number is significantly higher than with a less infectious viral strain, so that even 40% is only a modest help in limiting new infections. Also, and this is even more problematic news, Israel reports that a single dose of the vaccines that originally contemplated a two-dose regimen is notably less effective than was suggested in clinical trials. Whether this reduced efficacy for one dose of a two-dose vaccine is because of something particular to the B117 variant is unknown. Either way, that gets us to the last and more important point.

4) The potential for reduced vaccine efficacy is at the heart of why I think the 501.V2 variant is so important, both in real-world and in market-world. 

On Monday, we got the first hard evidence on vaccine efficacy versus 501.V2 (you can read the full Moderna press release here), largely duplicating the findings of South African studies earlier this month of antibody protection from prior baseline Covid infections. These are in vitro tests (lab tests) on the sera (blood) of vaccinated (Moderna analysis) or previously Covid-infected (S. African analysis) patients to measure how much “neutralizing” the antibodies in this vaccinated or previously Covid-infected sera gives you against the new virus variant. There will always be some degradation in neutralizing efficacy, but it’s a matter of degree as for whether you can keep going with the existing vaccine or whether you need a booster shot or whether you need to develop a new vaccine or what. The results from both studies, showing a “six-fold reduction in neutralizing titers” (vaccine protection) and an “eight-fold reduction in neutralizing titers” (prior Covid-infection protection) are on the okay side of “meh” but are still pretty “meh”. These are “yes, but” results.

YES, the current Moderna vaccine appears to be technically effective against 501.V2, meaning that it should provide a greater than 50% chance of protection against serious illness from contracting Covid. My interpretation of a “six-fold reduction in neutralizing titers” is that it’s roughly as effective as last year’s flu vaccine would be for this year’s flu (happy to be corrected on this by anyone who knows better). That’s not nothing! It’s a lot, in fact. BUT it’s a far cry from the efficacy we’ve seen in clinical trials against the non-variant virus, which is really outstanding.

In market-world, I think it is impossible to overstate the destabilizing impact of a Covid variant that is vaccine-resistant.

And to be clear, 501.V2 is probably not that variant. If it were, then I’d be worried about a lot more than just a transitory punch to the market’s nose. Also to be clear, I don’t think 501.V2 in the United States is even in the case, case, case phase of the nothing, nothing, nothing … case, case, case … cluster, cluster, cluster … BOOM! cycle of exponential virus spread. B117 is the immediate threat here, not 501.V2.

But what we DO have with 501.V2 is the start of a vaccine-resistant Covid variant narrative.

I hope that’s all it ever is … the start of a vaccine-resistance story that never develops into a vaccine-resistance reality! But for market-world, the mere existence of a narrative like this, even in an embryonic state, is enough to drive tradeable market events.

Put this together with recent developments with B117 … put the imminent impact of a US-based Ireland Event together with the long-term and geopolitical impact of Zimbabwe Events … and yeah, I think you’ve got a tradeable punch coming to markets.


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For Leon Black is an Honorable Man

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You can read the full report filed by Dechert LLP on behalf of the Board of Directors of Apollo Global Management here.


We are told by the lawyers hired by the Board of Directors of Apollo Global Management to investigate the Chairman of that same Board of Directors that the $158 MILLION Leon Black transferred to his personal friend and convicted child sex trafficker Jeffrey Epstein was for “legitimate advice on trust and estate planning, tax issues, issues relating to artwork, Black’s airplane, Black’s yacht, and other similar matters”.

We are told that the bulk of the funds were transferred “on an ad hoc basis based on Black’s perceived value of Epstein’s work”, with no agreements signed or unsigned. We are told that the bulk of the funds were paid for tax advice that would only realize potential gains well in the future, advice that was later determined to originate not with Epstein but with Black’s regular tax lawyers.

Payments of this magnitude and in this manner seem unlike the behavior of any enormously wealthy person in the history of the world, particularly a man whose enormous wealth has been notoriously built on precisely the opposite behavior, but Leon Black says this is the truth.

And Leon Black is an honorable man.

We are told by the lawyers hired by the Board of Directors of Apollo Global Management to investigate the Chairman of that same Board of Directors that they have “seen no evidence that Black or any employee of the Family Office or Apollo was involved in any way with Epstein’s criminal activities at any time”.

We are also told that Black’s friendship with Epstein goes back to the mid-1990s, and that before and after Epstein’s 2008 conviction for solicitation and procuring of minors for prostitution, Black “regularly visited” Epstein at his New York townhouse for afternoon “social visits”, as well as Epstein’s Paris apartment, his Palm Beach home, his Santa Fe ranch, and his private Caribbean island.

Yet Leon Black says that he merely saw Epstein as “a confirmed bachelor with eclectic tastes, who often employed attractive women”, a man whose criminal offenses were “limited to a single instance of soliciting a 17 year old prostitute” who “had shown Epstein false identification suggesting that she was not underage”. Yes, Leon Black believes “in giving people second chances”.

And Leon Black is an honorable man.

They’re all honorable men. Men of stature. Lions of Wall Street.

Leon Black. Les Wexner. Jes Staley. Glenn Dubin. Larry Summers.

I speak not to disprove what Leon Black spoke,
But here I am to speak what I do know.

I know that the evil of Jeffrey Epstein would not have been possible without the actions of these honorable men, regardless of what remorse might be in their words today.

O judgment! thou art fled to brutish beasts,
And men have lost their reason. Bear with me;
My heart is in the coffin there with the American dream that once was,
And I must pause till it come back to me.


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The Zimbabwe Event

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Covid funeral in Harare

Over the past week, three senior Cabinet officials in Zimbabwe (including the Foreign Minister and the Infrastructure Minister) have died from Covid. Not gotten sick. Died. More broadly, reported Covid cases and deaths (the unreported numbers are certainly much higher) have exploded in this country of 15 million just in the month of January.

Unlike the ‘Ireland Event’ I’ve been writing about recently, the engine of this human and political tragedy is not the UK-variant virus (B117), but the South African-variant virus (501.V2). This is the ‘Zimbabwe Event’, and I believe it has significant real-world and market-world consequences.

My emails to you about the Ireland Event – an explosion in Covid cases in Ireland over the last few weeks in December, driven by a combination of relaxed social mitigation policies and the introduction of a more infectious SARS-CoV-2 virus from the UK – focused on two questions:

  1. how likely is a rolling series of B117-driven Ireland Events in the United States? (very, imo)
  2. where are we in the timeline for the first of these US-based Ireland Events? (2 to 3 weeks from today, imo)

There was a third question embedded in all this, of course, which is what the market response might be to an Ireland Event here in the United States. Again imo, I don’t see this as a similar risk as last March. I really don’t see this as an epic major market smackdown, provided that the Fed and the White House say all the right things about unlimited liquidity support for S&P 500 companies … which they will. But I DO see this as a sharp punch in the nose to all of the dominant investment themes and narratives today: “dollar debasement”, “reflation”, “number go up” (Bitcoin), “commodity supercycle”, “cyclical recovery”, “earnings recovery”, “pent-up consumer spending”, etc. etc.

Is it just one good punch to all risk assets before we return to our regularly scheduled market entertainment of looking through previously unthinkable numbers of deaths and cases to some happy day of fully vaccinated business as usual?

Probably. But more and more I’m thinking it’s a very solid punch. More and more I’m thinking that this is a tradable punch. I say this for four reasons:

  1. There is a sharp difference in general media coverage of the risk of viral variant spread versus financial media coverage of the risk of viral variant spread. While there’s an almost willful ignoring of the virus variants in major financial media, this is not the case with major non-financial media, where coverage of the news and risks of viral variant spread shows both “coherence” and “strength”, to use our narrative structure terms. I consider this is to be a classic example of financial market narrative complacency, where all of the narrative risks are to the downside for markets.
  1. There are now four independent medical studies showing that the B117 variant is both more infectious AND more lethal than the baseline virus, versus zero medical studies showing only the same lethality (the original PHE study showing similar lethality has been revised upwards). While the mathematical truth is that increased lethality is not nearly as “dangerous” from a public health perspective as increased infectiousness, from a popular perspective just the reverse is true. Stories of increased lethality carry a lot more narrative punch than stories of increased infectiousness.
  1. We now have multiple examples of a B117-driven Ireland Event, not just in Ireland and the UK, but also now in Portugal, Spain and Israel, and coming soon to the rest of continental Europe. The ‘Israel Event’ is particularly chastening, as the explosion in Covid cases occurred despite the most advanced vaccination program in the world, with close to 40% of the population now vaccinated. As I mentioned in last week’s note, one of the major consequences of a more infectious viral strain is that the percentage of the population that must be vaccinated before herd immunity brings down the R-number is significantly higher than with a less infectious viral strain, so that even 40% is only a modest help in limiting new infections. Also, and this is highly problematic new news, Israel reports that a single dose of the vaccines that originally contemplated a two-dose regimen is notably less effective than was suggested in clinical trials. Whether this reduced efficacy for one dose of a two-dose vaccine is because of something particular to the B117 variant is unknown.
  1. The potential for reduced vaccine efficacy AND increased infectiousness AND increased lethality is at the heart of why I think the Zimbabwe Event is so important, both in real-world and in market-world. We don’t yet have any hard evidence on diminished vaccine efficacy for 501.V2, but what we do know is that antibody protection from prior baseline Covid infections, which has shown itself to be very effective in preventing a subsequent baseline Covid infection, is much less effective in preventing subsequent 501.V2 Covid infections. This suggests, of course, that our current vaccines, which largely duplicate the antibody protection that you would get from a prior baseline Covid infection, will be similarly less effective against 501.V2. As for increased infectiousness and increased lethality, we also don’t have as much hard evidence as we do with B117. But the observations in case numbers and deaths we have throughout Southern Africa for 501.V2, from South Africa proper all the way up to Rwanda, are at least as staggering as we see in the UK, the EU and Israel for B117.

In real-world, I think it is impossible to overstate the destabilizing impact of 501.V2 on the politics of a weak state. That’s true in a relatively wealthy weak state like South Africa, much less an insanely poor weak state like Zimbabwe. I mean, the power vacuum that currently exists in Zimbabwe, where three prominent Ministers die within a week and every function of civil government has effectively collapsed … is staggering. Civilian life in these circumstances quickly becomes, as Hobbes would say, nasty, brutish and short. The outcome of these circumstances is ALWAYS war. First a war of all against all, then a war of organized factions, then a war of nations. Some of these wars will be entirely internal to existing borders. More of these wars will cross those borders. Some of these wars will include major powers. War and regime change. That’s the real-world legacy of the spread of these SARS-CoV-2 variants like B117 and 501.V2, and not just in countries like Zimbabwe. South Africa, too. Iran, too. Russia, too.

In market-world, I think it is impossible to overstate the destabilizing impact of a Covid variant that is vaccine-resistant. To be clear, I don’t know that we have that in 501.V2. If I did, then I’d be predicting a lot more than just a transitory punch to the market’s nose. But what we DO have is the start of a vaccine-resistant Covid variant narrative. I hope that’s all it ever is … the start of a vaccine-resistance story that never develops into a vaccine-resistance reality. But for market-world, the mere existence of a narrative like this, even in an embryonic state, is enough to drive tradeable market events. Put that together with recent developments with B117 … put the Ireland Event together with the Zimbabwe Event … and yeah, I think you’ve got a tradeable punch coming to markets.


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Off Wall Street and Off-Off Wall Street

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Rusty and I are thrilled to announce that Brent Donnelly will be joining us as a guest contributor to Epsilon Theory.

Brent is a senior risk-taker and FX market maker at HSBC New York and has been trading foreign exchange since 1995. He is the author of The Art of Currency Trading (Wiley, 2019) and his latest book, Alpha Trader, hits the shelves in Q2 2021. Brent writes a daily email focused on FX markets that is my go-to source for understanding that enormous corner of the market, but in truth his writing is applicable to every aspect of investing. You’ll see what I mean when you read his latest post below!

You can contact Brent at [email protected] and on Twitter at @donnelly_brent.

As with all of our guest contributors, Brent’s post 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.



What is off-Wall-Street and off-off-Wall-Street?

In New York City, there is Broadway, where the lights are bright and the famous plays like Hamilton, Rent and The Lion King run. Then, there is Off Broadway, venues with seating capacity from 100 to 499 that show some fairly well-known but obviously less epic productions. Third, there is Off-off-Broadway, which began as a “complete rejection of commercial theatre”. These are the sub-100 seat venues that show experimental drama and theatre.

Similar, but different, is the information ecosystem for trading and investing. While we tend to focus on the highbrow outlets like FT, Reuters, The Economist and others, there are other less highbrow outlets that carry useful information and market-moving clout.

The point of this note is to do a medium-deep dive into a few off and off-off Wall Street joints that you may not know about and may find useful.

Here’s a diagram that shows my best effort to classify the major investment and trading information outlets according to the year they were founded and whether they are highbrow or lowbrow. This classification is subjective and was not as easy as I thought it would be. For example, which is more highbrow … The Economist, or The Wall Street Journal ?

I hope no one is insulted by my choices and just to be 100% clear: lowbrow is not synonymous with bad! Some of my favorite things are lowbrow. To me, lowbrow just means something that is not highly intellectual; something that appeals to the median  person on the street. For me, that can be good (movies like Old School, music by Post Malone, and quality chicken wings) or bad (American Pie sequels, music by Pitbull and boiled peanuts). The matrix is inspired by those New York Magazine matrixes from the 2000s. Here it is:

The curvature of the chart over time is interesting. The only publications that survive in the long run are highbrow. This makes sense to me intuitively as parody and lowbrow tend to be more faddish and fashionable while intellectual rigor is timeless.

But before we get into the discussion of FinTwit, Reddit and TikTok, you may wonder: Why does any of this matter? There are four reasons:


1. There is interesting and unique analysis on Twitter and Reddit that you won’t see anywhere else.

This is true whether you trade macro (best stuff is on Twitter) or single names (craziest stuff is on Reddit).


2. Retail opening new accounts and gambling with stimulus checks is the rocket fuel driving bubblicious, crazy moves in single names.

You cannot fully understand this until you witness the amount of overconfidence, indiscriminate buying, straight up silliness and outright gambling going on. In 1999, I belonged to a bulletin board called The Underground Trader. When a stock started to trend on there, it might rally 3%-5% in a few hours. Now, when a stock starts to trend on r/wallstreetbets, it can go up >100%. See GameStop (GME) in recent weeks, for example.

The chart at right shows the rocket ship formation in GME as the massive short interest ran head on into the r/wallstreetbets hype machine. There are other factors behind the rise in GME but even Jim Cramer has been talking about the subreddit’s influence on this particular single name.

These next charts from Bloomberg and FinTwit give you another indication of the explosion of interest from retail. Note that retail investors tend to prefer things that are cheap and things that have significant leverage.

This stuff matters hugely at the penny stock level as retail interest can completely overwhelm supply. There was a day last week where 20% of all US equity volume was made up by five microcaps and 6 of the top 10 most active stocks were priced under $1. Obviously it’s easier for cheaper shares to trade higher volumes but this sort of activity in microcaps is highly unusual. To quote from this Bloomberg article:

“I thought it was pretty odd,” said Saluzzi, co-head of equity trading at Themis Trading. “I’ve been around for a long time, I’ve seen people in chat rooms and retail investors saying ‘we can make some money – it’s easy.’ There’s a risk it may not end well.”


3. Retail is an important driver of the bull market / bubble in financial assets.

While retail is the dominant player in many single names now, there is most likely an impact at the index level as well with TSLA, AAPL and other index members attracting much of the new long-only money. You cannot go short in a Robinhood account and very few people seem to buy puts so the money is either long or levered long with some multiplier above 1. Every stimulus announcement sees a massive inflow into crypto and retail equities and there is no reason to expect that to change.

Poorly-targeted stimulus (See Scott Galloway here, for example) and ultra-loose monetary policy are driving assets higher. The more you understand the retail story, the more you will be prepared to take the other side of the bubble when it comes crashing down. As I have said many times, but would like to say again: It’s easier to make money long a bubble, not short. The two recent USA bubbles (internet 1999 and housing 2005) both popped well after the Fed’s first rate hike. Even if you think this bubble is crazier and that markets learn from the past, the bursting of the current bubble is still somewhere way, wayyyy down the road. Here’s a Bloomberg story:

Stock froth boiled after $600 checks. Now $1,400 may be coming.

Here’s what happened in the market around the time the government sent people $600 earlier this month. Penny share volume mushroomed. A company that sounds like a word Elon Musk tweeted rose 1,100%. Tesla added $130 billion, IPOs doubled and options trading exploded.

Coincidence? Maybe — though a lot of people doubt it. They can’t help notice how tiny traders with money to spend keep turning up in the vicinity of almost every market spectacle these days. Now, more federal aid may be on the way, and Wall Street pros are bracing for what comes next.

“If the additional $1,400 goes to the same income levels it did before, we are highly likely to see additional speculation in stocks, which could continue to inflate an already-existing bubble,” Peter Cecchini, founder and chief strategist of AlphaOmega Advisors LLC, said in an interview.


4. It’s fun!

The fourth reason to spend some time on FinTwit and Reddit is that there are a ton of smart and funny individuals posting hilarity. Recall the fun and games around Davey Day Trader in April and May. Here are a few examples from one of my favorite follows on Twitter, a parody account called Dr. Parik Patel.


So what are these things anyway?

What is FinTwit?

Let’s talk briefly about Twitter, then move on down the spectrum. I am finding more and more in recent years that FinTwit can be a source of unique and super smart information. (In case you don’t know: FinTwit sounds like a putdown but it’s just short for “Finance Twitter”). Writers like Jon Turek, Lyn Alden, and Nathan Tankus rose to prominence on FinTwit and are among the gurus that share in-depth writing on the site. Jens Nordvig publishes great stuff all the time, and you can get a view of what pre-eminent thinkers like Ben Hunt, Tim Duy, and Scott Galloway have on their minds. Hard to say if FinTwit is lowbrow or highbrow: It’s both.

It takes a while to properly curate a list of Twitter handles to follow and it’s not as simple as just cutting and pasting someone else’s list because it’s a matter of taste and preferred topics. That said, next week I will send out a survey and try to aggregate everyone’s favorite Twitter handles and see if we can come up with a nice master list.

As you drop down the highbrow axis, you eventually get to r/wallstreetbets.

What is r/wallstreetbets?

Let’s start from the top level and work down. Reddit is a community-curated message board where posts of value are upvoted and content deemed unworthy is downvoted. The result is a marketplace of ideas that is nearly impossible for marketers and corporations to infiltrate and a system where quality mostly rises to the top. The culture is smart, snarky, funny, self-referential and full of in-group lingo. Reddit is broken into over one million topic-based communities called subreddits. One of those millions of subreddits is a beautiful and amazing cesspool of intellect and degenerate financial market gambling called r/wallstreetbets.

The main screen says: “r/wallstreetbets: Like 4chan found a Bloomberg terminal”. Members of the community are called “degenerates”. The r/wallstreetbets subreddit currently has 1,888,019 members.

If you go into r/wallstreetbets (WSB for short), you will find a community of funny, rude, self-deprecating and reckless speculators riffing on various market-related activities. The focus tends to be one or two stocks and the primary investment thesis is almost always to YOLO as many calls as possible in the thing that is about to…

There is a lot of despicable and sophomoric language but mixed in there are some good ideas and some well-informed speculators. For every dumb post, there is  (for example) a quality analysis of the SEC uptick rule and how its enforcement or lack thereof can impact a stock with more than 100% of free float outstanding.

In WSB lingo, strong hands are called “diamond hands” and weak hands are called “paper hands”. Profits are called “tendies” as in chicken tenders, as in the ultimate luxury food. One sample post I just scrolled to reads as follows: “TSLA – Best $100K I’ve ever spent. When do I hop off the tendie coaster???” and then shows a screenshot of an absurd gain on super low delta calls in a Robinhood account.

A lot of the memes and posts and culture are self-effacing, self-deprecating and traders brag just as much about huge losses as they do about huge gains. It’s ridiculous but much of what is on there is clearly real and it’s serious money being wagered, much of it borrowed money or entire 401ks.

Under the fun headlines and silly posts, you will see some impressive deep dives usually under the flair: “DD” for due diligence. Every post is headed with a “flair” or heading. The most popular flairs are: Meme, gain, loss, YOLO, and DD. At right you see a DD post that then goes into some CFA type analysis that you might otherwise have read on Seeking Alpha or some similar site.

The community is heavily invested in hopes for a continuation of the GME short squeeze right now, so there are many posts like the one on the left below (turning the $1,200 stimmy check into more than $10,000) and random cheering:

Obviously some of the screenshots could be faked but overall it seems to me that many, many young traders have a majority of their net worth ($25k to $100k) invested in one or two stocks or a few OTM calls with hopes that those stocks will continue to rocket. So far so good for them!

Bull market, dude.

You can have a look for yourself, just Google r/wallstreetbets.

As you follow the y-axis lower and lower on my original “investment information ecosystem” chart on Page 2, you will notice way down in the corner, down below zero on the 0-1o lowbrow/highbrow scale is: “TikTok Finance”.

What is TikTok finance?

TikTok Finance is generally an extremely hype-heavy cringey place where inexperienced traders pump questionable strategies to an audience of inexperienced investor-trader-gamblers.

A CNBC story explained it this way:

TikTok for financial advice? Young people are turning to the video app for tips to weather the recession. Amid TikTok’s surge in popularity, a growing number of users are turning to the app for personal advice. As of mid-June, the #investing tag on TikTok had racked up 278 million views. Experts caution that accounts offering guidance may be skipping important lessons and hawking get-rich quick schemes.

If you are brave, watch this clip where two TikTok influencers describe their stock market strategy. If you are easily triggered, just read my abridged excerpt below. And keep in mind as you read it, that these two TikTokkers have 115,000 followers. Here is an excerpt:

We get this question all the time and honestly the answer is very simple… How do we make money from home? So basically, we just trade stocks on Robinhood. It’s free to sign up and they actually give you a free stock to sign up … so they’re paying you to sign up.

I know trading sounds intimidating…

Here’s my strategy in a nutshell: I see a stock going up and I buy it … And I just watch ‘til it stops going up. Then I sell it and I do that over and over and that’s how we pay for our lifestyle. What I like about this is … the fact we don’t have to go to a 9-5 job. We can focus on things we actually enjoy doing.

This month I turned $400 into $14,000 (see screenshot at right)

The terminology! “You get a free stock when you sign up” makes me cringe and it comes up all the time in the TikTok, Robinhoodie world. Here it is again at 7:34 of this video from a poker vlogger looking to sign up new Robinhoodies and WeBulls via an affiliate link. Key quote: “Last time I did this, I got an Apple stock, which is ka-razyyy!?”

You get the idea, but here are a few of the comments below that TikTok influencer video:

It’s not as funny as it seems

While much of what I have posted above is comical and good clean fun (and certainly something I would have been actively engaged with in my 20s!), it also points to a less funny issue: the ongoing gamification of stocks and the lack of seriousness with which many now view financial markets.

As asset prices decouple further and further from the real economy and a rising percentage of unprofitable companies come to market, a new generation buys a stock not because they believe in the company and its products and want to share in its future profitability. They buy stocks as a substitute for sports gambling or to stifle the unending boredom of the pandemic. They bet their entire stimmy check on deep OTM options in a YOLO move to bragpost @ their online friends.

In 1999 the main overriding thesis was “internet gonna change the world”. Now the overriding thesis is “stonks only go up”. The market is turning into a meme machine, a cartoon of its former self, as Neb Tnuh might say.

Brain science shows the prefrontal cortex is not fully developed until age 25. Young men crave novelty and risk-taking as their prefrontal cortex develops and this risk-taking is a healthy part of growing up. Now the real world is shut down and does not offer much risk. There are no cliffs to jump off, or skate parks open, or places to drive way too fast to. So the risk-taking happens on a stock betting app fueled by extreme and experimental monetary policy geared toward higher asset prices. Funded with stimulus checks.

I am not claiming superiority here, I took more than my share of unnecessary and excessive personal risks from ages 18 to 25. It’s what you do at that age. But there were better things to do at that time then play the stonks game on my phone.

The orthodox view of financial markets (or “the boring Boomer view” as they would say on Reddit) is that the stock market is where companies go to raise money for investment and expansion in the real world. Now, the cynical view is the majority view: the market is a place where founders and insiders cash out and executives turbocharge stock-based compensation via buybacks. That’s not good. When capital markets are a source of ridicule, not respect, it hurts capitalism and it inevitably hurts America. It’s all fun and games until someone loses their 401k.

Anyway … As this bubble takes on more and more air and I witness most of the exact behaviors that defined the euphoria in 1999, I feel more and more like an old man yelling at clouds.

Until the Fed reacts, just keep on dancing!


Brent Donnelly is a senior risk-taker and FX market maker at HSBC New York and has been trading foreign exchange since 1995. He is the author of The Art of Currency Trading (Wiley, 2019) and his latest book, Alpha Trader, hits the shelves in Q2 2021.

You can contact Brent at [email protected] and on Twitter at @donnelly_brent.


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A Different Game

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The Zeitgeist on the day after a presidential inauguration is unlikely to catch anyone by surprise. It was the only topic of any significance in political news. It was the only topic of any significance in market news. The language used to describe this inauguration was central to nearly every topic over the last three days. Even sports.

The quantity of that coverage which would fit squarely into what we call Fiat News – news which is designed not to inform but to instruct the reader how to think about an event or topic – would also be unsurprising, I think. We could not shock you with an argument that the editorial side of nearly every national news outlet has been drawn into one end or another of our polarized politics. You would not gasp, I suspect, to learn that this often bleeds into the newsroom.

So I don’t expect you to do more than shrug that this was the inauguration coverage angle chosen by the New York Times, promoted on social media with the following, um, austere copy:


“Whether or not related to the former president’s absence, a bipartisan lightness seemed to prevail across the stage at President Joe Biden’s inauguration. Snow flurries gave way to sun.”

Washington Breathes an Uneasy Sigh of Relief [New York Times]

The piece is part of a feature series on the inauguration, but it is clearly being positioned as news, or at least news-adjacent. It’s got Washington in the dateline. It’s not marked as an editorial or opinion content in any way. And yet it contains descriptions of events which “evoked a mood”, which were “the most striking”, which “felt like a friendly gathering”, which “conjured a sense of respite”, and of “lightness which seemed to prevail across the stage.” In a helpful definition of Fiat News, the author offers a literal translation he’d like you to use for Biden’s speech: “Phew.” As it happens, I happen to agree with the author, yet I enjoy the peculiar benefit of realizing that this is an opinion and not a fact.

The usual suspects on the other side of the political spectrum are in the same business, of course, just in a smaller form factor. This brief Fox News article manages to jam in a lot Fiat News language. In only a couple hundred words, the reader gets multiple scare quotes, an “appears to be”, a subjectless “perceived” and multiple references to the loaded expression “pushing a progressive agenda.”

So if you were hoping that Trump’s departure would herald the triumphant return of the national media to its historical role as an agent for the people rather than a principal acting on its own account, your watch is not yet ended. Sorry.

All the same, I’d like to pose a brief question. If you were asked, “Was national media coverage of the inauguration of President Joe Biden more or less positive and friendly than it was for the 2017 inauguration of President Donald Trump,” what would you say?

Again, I think I can hazard a guess.

But by one objective – and woefully incomplete – lens, they were almost exactly the same.

I am talking about the lens of calculated sentiment, by far the most common method by which those commenting on markets, scraping news and scraping social media evaluate the nature of opinion language.

Using the standard sentiment scoring library from our friends at Quid, we estimate that the mean sentiment of 2017 coverage of the Donald Trump inauguration by national US media outlets from the day before to the day after the event itself was actually 15% MORE positive than the 2021 coverage of the Joe Biden inauguration.

What are the possible reasons this could be the case?


1 – Maybe media actually were more positive in 2017 coverage than they were in 2021;

2 – Maybe the sentiment library isn’t well-suited for this kind of analysis;

3 – Maybe the coloration from the connected Trump-related and COVID-related news made 2021’s coverage more negative than it would otherwise have been;

4 – Maybe affect creeps in not so much through explicitly positive or negative language, but primarily through framing, editorial coverage decisions, non-affected language of meaning and the decisions to include or exclude certain information from a news article;

5 – Maybe most news outlets and publishers have long since realized that the metagame – the strategy which survives repeated play – that permits shaping how people think about the news without them being acutely aware of it requires outlets to shy away from explicitly “positive” or “negative” biases in their language in favor of these techniques.


I won’t tell you what to think, but I’ll tell you what I think. I absolutely don’t think #1 is the case. That flurries-gave-way-to-sun nonsense wasn’t a New York Times exclusive, y’all. I think #2 and #3 probably are true – at least a little bit. But #4 and #5? I think they are the real story here. That story isn’t new. And I think that story has two lessons for us:

First, don’t expect the creep of editorial bias into news to hit you over the head with big, opinionated-sounding language like the articles referenced here. Framing and the willful or subconscious inclusion/exclusion of facts are the tools with which news is shaped into explanatory news without looking like it.

Second, if someone is selling you on natural language processing-based research about markets, politics or anything else that is built on the shifting sands of a calculated sentiment and nothing else, it is unlikely that what you are getting is useful.

A game in which the players know the rules against which they have been measured is a different game.


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UK-Variant SARS-CoV-2 Update

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That’s a London scene from the post-apocalyptic zombie flick 28 Days Later on the left, and a London scene from the pre-apocalyptic March Covid lockdown on the right. I say pre-apocalyptic because today’s Covid situation in London with a 70% prevalence of the B117 SARS-CoV-2 virus is a lot worse than the situation last March. No zombies yet, but 2021 is young.

Last Wednesday we published our analysis of behavioral Covid fatigue + UK-variant SARS-CoV-2 spread in the United States.

And we released a podcast on our work, also available on Spotify and iTunes

Last Friday, the CDC held a press conference and released an analysis showing that they expect this more virulent UK-variant strain (B117) to account for 50% of Covid cases in the United States by the end of February. We’ve stored a PDF of the CDC analysis on the Epsilon Theory website here, and you can read a summary of the findings in this WSJ article

Over the weekend, the two most prominent US Covid missionaries – Scott Gottlieb and Tony Fauci – both publicly reversed their stance on the trajectory of Covid spread. Gottlieb’s twitter threads on the B117 threat were particularly urgent, noting that “new variants may change everything. They’ll be 1% of all cases by end of next week, with hot spots in Florida and Southern California.” 

While on the one hand it’s gratifying that the CDC is validating what we wrote, on the other hand it’s pretty scary to contemplate the consequences of the B117 UK-variant virus accounting for 50% of all US cases 40 days from now. That’s what this update note is focused on – the consequences – because they are sorely underplayed in the WSJ article summarizing the CDC report. 

Consequence #1: if B117 is the dominant US strain, vaccination will need to reach 80%+ Americans for effective control of the Covid pandemic. That’s at least 10% higher than current vaccination policy contemplates, meaning that not only will 35 million additional doses need to be sourced, distributed and administered, but also the finish line in this race for herd immunity between an exponential process (B117 spread) and a linear process (vaccine delivery) just got pushed back. That’s bad news for the linear process. 

Consequence #2: if B117 is the dominant US strain by the end of February, the daily number of new Covid cases by the end of February will be significantly higher than today. This is the point that was completely missed in the WSJ article. B117 doesn’t become the dominant strain because it “defeats” the baseline strain. This isn’t a football game. B117 becomes the dominant strain by spreading even faster than the current fast-spreading baseline virus. The math here is as inexorable as it is sobering, and it means that the rollover in Covid cases and hospitalizations we are currently seeing is a temporary reprieve in advance of an even tougher battle. 

How tough? I dunno. Depends on how much we ignore the B117 threat and take this rollover in the holiday Covid surge numbers as an all-clear sign. An ‘Ireland event’ is a combination of two things – introduction of a more infectious virus AND a relaxation of Covid mitigation behaviors like social distancing and avoidance of indoor groups. Right now, we have it within our power to move both of these necessary conditions in the right direction. But we’re not. On the contrary, we’re moving both of these necessary conditions in the wrong direction, and by the time it becomes clear that we’re risking an Ireland event … well, it’s too late to prevent it. You can only hope to control it.

How do you control it? How do you respond politically to an Ireland event in the United States, where (extrapolating current UK numbers to the US) you could have 8,000 Americans dying from Covid every day? You shut down. And I don’t mean a Covid theater shutdown. I don’t mean an LA County shutdown, with its 50+ exemptions for any politically relevant constituency. I mean a true shutdown. I mean businesses and individuals shutting themselves down.

If B117 becomes the dominant SARS-CoV-2 strain in the United States over the next few weeks, I believe it will create a chain of events that are profoundly life-killing, job-destroying, and misery-producing. 

And I don’t believe that ANY of this is priced into markets.

I don’t believe that ANY of this is contemplated by the most popular trades and investment narratives du jour – “dollar debasement”, “reflation”, “number go up” (Bitcoin), “commodity supercycle beginning”, “cyclical recovery”, “earnings recovery”, “pent-up consumer spending”, etc. etc. – all of which are based on the core narrative of “Whew! The vaccination glidepath to recovery may be bumpy, but it is assured.” 

But does it matter?

Does it matter to market-world if this profoundly deflationary, risk-off, dollar higher, flight to safety chain of events occurs in real-world?

Will markets look through all this, particularly if the Fed and White House say all the right things?

LOL. Of course they will.

I have zero doubt – ZERO – that markets will ultimately look through the B117 threat, even if that threat is realized through unprecedented real-world shutdowns and trauma. 

But between today and that ultimate look-through, I also believe there is a significant chance of a narrative shockwave hitting risk assets, particularly those securities tied to a “Covid recovery” theme. You can’t jawbone the virus. You can’t declare by fiat or by narrative that B117 isn’t happening. This IS happening, and the common knowledge that this IS happening will punch our now dominant investment narratives of “earnings recovery” and “reflation” and “the worst is over” square on the nose. Maybe its just one good punch. But it’s a punch nonetheless.

What creates the B117 common knowledge that impacts markets?

I think it’s whenever we get news of the first cluster of B117 cases in the US. 

Right now we’re still in the case, case, case phase of the nothing, nothing, nothing … case, case, case … cluster, cluster, cluster … BOOM! cycle of exponential spread. You can still close your eyes and pretend B117 isn’t happening in the case, case, case phase. But once that first cluster hits the news … well, you can’t ignore that. That’s when B117 becomes common knowledge. That’s when every market missionary starts talking about it, not just Covid missionaries like Gottlieb and Fauci. That’s when every investor knows that every investor knows that our glidepath to recovery is not assured. 

When do we hear about the first B117 cluster in the US? No idea. If Gottlieb is right about 1% of US Covid cases originating from B117 by this Sunday, that’s a big number that would almost surely contain clusters and significant community spread. I think that news would hit risk assets pretty hard. But if Gottlieb is wrong and it takes longer to move into the cluster, cluster, cluster phase, then there’s more time for market-supportive “we can look through B117” narratives to develop. Bottom line: the longer it takes for B117 clusters to appear, the less the impact of B117 common knowledge on markets. 

But the cluster IS coming. As the kids would say, it’s just math.


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Ireland Event Follow-up: Shockwave

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Yesterday the CDC held a press conference and released an analysis showing that they expected the more virulent UK-variant strain (B117) to account for 50% of Covid cases in the United States by the end of February. I’ve attached the CDC analysis here, and you can read a summary of the findings in this WSJ article: https://www.wsj.com/articles/u-k-covid-19-variant-likely-to-become-dominant-u-s-strain-in-march-cdc-says-11610733600?page=1.

For reference on our work on this topic, you can read the full ET note here: https://www.epsilontheory.com/the-ireland-event-2/. We’ve also released a podcast on our work, available on the ET website https://www.epsilontheory.com/et-podcast-3-the-ireland-event/ , and on Spotify and iTunes.

While on the one hand it’s gratifying that the CDC is validating what I wrote you last weekend, on the other hand it’s pretty scary to contemplate the consequences of the B117 UK-variant virus accounting for 50% of all US cases 45 days from now. That’s what this email is focused on – the consequences – because they are sorely underplayed in the WSJ article summarizing the CDC report.

Consequence #1: if B117 is the dominant US strain, vaccination will need to reach 80%+ Americans for effective control of the Covid pandemic. That’s at least 10% higher than current vaccination policy contemplates, meaning that not only will 35 million additional doses need to be sourced, distributed and administered, but also the finish line in this race between an exponential process (B117 spread) and a linear process (vaccine delivery) just got pushed back. That’s extremely bad news for the linear process.

Consequence #2: if B117 is the dominant US strain by the end of Feb, the daily number of new Covid cases by the end of Feb will be MUCH higher than today. This is the point that was completely missed in the WSJ article. B117 doesn’t become the dominant strain because it “defeats” the baseline strain. This isn’t a football game. B117 becomes the dominant strain by spreading even faster than the current fast-spreading baseline virus. The math here is as inexorable as it is sobering.

I don’t believe that ANY of this is priced into markets. I don’t believe that ANY of this is contemplated by the most popular trades and investment narratives du jour – “dollar debasement”, “reflation”, “number go up” (Bitcoin), “commodity supercycle beginning”, “cyclical recovery”, “earnings recovery”, “pent-up consumer spending”, etc. etc. – all of which are based on the core narrative of “Whew! The path to recovery may be bumpy, but it is assured.”

If B117 becomes the dominant SARS-CoV-2 strain in the United States, that is a profoundly deflationary, risk-off, dollar higher, flight to safety event.

Will markets ultimately look through that event, particularly if the Fed says all the right things (which they will) and particularly if we get the JNJ vaccine in wide distribution soon (fingers crossed)? Sure. Absolutely, markets will ultimately look through the B117 threat.

But between today and that ultimate look-through, I believe there is a significant narrative shock coming to markets. You can’t jawbone the virus. You can’t declare by fiat or by narrative that B117 isn’t happening. This IS happening, and the common knowledge that this IS happening will hit every risk asset like a ton of bricks.

When does that narrative shock occur? What creates the B117 common knowledge that hits markets like a ton of bricks? I think it’s whenever we get news of the first cluster of B117 cases in the US. Right now we’re still in the case, case, case phase of the nothing, nothing, nothing … case, case, case … cluster, cluster, cluster … BOOM! cycle of exponential spread. You can still close your eyes and pretend B117 isn’t happening in the case, case, case phase. But once that first cluster hits the news … well, you can’t ignore that. That’s when B117 becomes common knowledge. That’s when every market missionary starts talking about it. That’s when everyone knows that everyone knows that our glidepath to recovery is not assured.

When do we hear about the first B117 cluster in the US? No idea. And the longer it takes, the less the impact on markets. But the cluster IS coming. As the kids would say, it’s just math.


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ET Podcast #3 – The Ireland Event

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The Epsilon Theory podcast is free for everyone to access. You can grab the mp3 file below, or you can subscribe at:

Spotify: https://open.spotify.com/show/3ZXOnreiGGiUtuGHzbin6d

Apple: https://podcasts.apple.com/us/podcast/epsilon-theory-podcast/id1107682538



In episode #3 of the Epsilon Theory podcast, Rusty and I discuss the dramatic spike in Covid cases in Ireland over the last two weeks of December, and the risk of seeing a similar “Ireland Event” here in the US.

Unfortunately, once it becomes apparent that an Ireland event is occurring, it’s too late to stop it.

The time to act is NOW, not with indiscriminate lockdowns, but with strong restrictions on international and domestic air travel to contain the UK-variant virus while we accelerate vaccine delivery.



If you’d like to sign up for a free email to let you know what we’ve published in the prior week, please go here. We have about 100,000 email recipients, and your contact information will never be shared with anyone.

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The Ireland Event

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Daily reported new Covid cases, Ireland, through Jan. 7, 2021

For the past year, I’ve been consumed with how Covid numbers are used/manipulated to create political narratives. From China to WHO to don’t-test-don’t-tell to Covid Trutherism in all its forms … that’s been the windmill I’ve tilted at for almost 12 months now.

Last week I became consumed by a new twist on all this – Covid numbers that were being largely ignored. Insane infection numbers coming out of UK and Ireland, apparently driven by a new virus strain, that we acknowledged over here but didn’t seem to be too mussed about.

It reminded me of the Covid numbers coming out of Italy last February. Was Europe once again our crystal ball? Were we once again going to ignore THAT?

And when I say “insane infection numbers” I mean a 30x spike in Covid cases in Ireland over the span of two weeks in late December, where the R number – the basic reproductive rate of the disease – went from something around 1.2 to something around 3. Where you suddenly went from a few hundred new Covid cases every day to more than six thousand cases every day. All in a country the size of Alabama (which, btw, currently has about 4 thousand cases every day).

So I’ve been trying to figure out what happened in Ireland, and whether it could happen here.

To do that I had to research this new UK-variant of the virus. I had to research the way in which Covid is explosively spreading in Ireland, and whether that was similar or different to US. I had to research what it MEANS to have an R-number go from 1.2 to 3.  And finally I had to dig into why this ‘Ireland Event’ was not being discussed by US Covid missionaries (to use an Epsilon Theory term) like Scott Gottlieb or Tony Fauci.

I’ll start with the conclusion.

I believe there is a non-trivial chance that the United States will experience a rolling series of “Ireland events” over the next 30-45 days, where the Covid effective reproductive number (Re not R0) reaches a value between 2.4 and 3.0 in states and regions where a) the more infectious UK-variant (or similar) Covid strain has been introduced, and b) Covid fatigue has led to deterioration in social distancing behaviors.

A single Ireland event is a disaster. A series of Ireland events on the scale of the United States is catastrophic. If this were to occur, I’d expect to see a doubling of new Covid cases/day from current levels in the aggregate (today’s 7-day average is 240k/day), peaking somewhere around 500,000 new daily cases before draconian economic shutdowns (more severe than anything we’ve seen to date) would occur in every impacted major metro area. Hospital systems across the country would be placed under enormous additional strain, leading to meaningfully higher case fatality ratios (CFRs) as medical care was rationed. Most critically, this new infection rate would far outpace our current vaccine distribution capacity and policy. Assuming that vaccines are preferentially administered to the elderly, aggregate infection fatality ratios (IFRs) should decrease, but the overall burden of severe outcomes (death, long-term health consequences) would shift to younger demographics.

Current US government policy rejects the possibility of an Ireland event, largely because of what I believe is a politically-motivated analysis by the CDC that models more than 100 million Americans already possessing Covid antibodies, prior to any vaccination effort. Using data from flu monitoring programs in prior years, the CDC models project that 70 MILLION Americans have already gotten sick with symptomatic Covid, but decided to just write it off as a bad cold and never got tested. I am not making this up. Add in another 10 million or so Americans who the CDC models as having already had asymptomatic Covid, add in the 23 million Americans who we know have had Covid, and voila! – per the CDC, one-third of the American population is already effectively immunized against getting Covid in the future. And obviously enough, if >30% of Americans are already effectively immunized against Covid because they’ve already gotten sick, then it’s very difficult to hit the Re numbers of 2.4 – 3.0 that Ireland is currently experiencing.

I think this model is wrong, and I think the CDC knows that it’s wrong.

I think it’s wrong because the 2021 behavior of someone who thinks they might have Covid is very different from the 2015 behavior of someone who thought they might have had the flu, but the CDC assumes it is the same in their models. You don’t ignore Covid. You don’t just brush it off. I’d say that no one just brushes off Covid symptoms the way they might have brushed off flu symptoms in the past, but of course that’s not true. I’m sure there are millions of Americans who have, in fact, had symptomatic Covid and ignored it, particularly in spring and early summer when our national testing capability was pathetic. But 70 MILLION Americans? Twenty percent of ALL Americans? More than three times the number of known Covid cases? C’mon, man.

I think the CDC knows this model is wrong because if it were true – if they actually thought that one-third of Americans were already effectively immunized by having Covid antibodies – this would be an ENORMOUS factor in determining vaccination policy. Otherwise, you are going to be wasting one-third of your precious supply of vaccines on people who don’t need it.

I think the CDC knows this model is wrong because if it were true, how do you make sense of Covid hospitalization rates?

Again, were there millions of undiagnosed and “brushed-off” Covid cases in the spring and early summer when Covid testing was ridiculously sparse? Absolutely. But unless you’re prepared to say that either the SARS-CoV-2 virus is much more dangerous today than it was in the spring or that hospital Covid admission policies are much more lenient today than they were in the spring, I think it is impossible to reconcile actual Covid hospitalization data on 23 million symptomatic-and-diagnosed Covid cases with a model of 70 million symptomatic-but-undiagnosed Covid cases.

So yes, I think this model is nuts. I think this was a politically-motivated Trump Administration exercise to “prove” that the US infection fatality rate (IFR) is really tiny and you’ve got nothing to worry about. One of many such politically-motivated efforts across many institutions to minimize the risk and impact of Covid-19.

But this CDC model is why prominent Covid missionaries like Scott Gottlieb and Tony Fauci have said that they expect daily case numbers to decline from here on out, not accelerate, and this is why I think a potential Ireland event is NOT priced into any mainstream market expectations or political expectations for 2021.

Unfortunately, once it becomes apparent that an Ireland event is occurring, it’s too late to stop it.

In our human-scale, linear world, we experience exponential growth like this: nothing, nothing, nothing … case, case, case … cluster, cluster, cluster … BOOM! But by the time we start to really pay attention to an exponential growth process – typically at the cluster stage – the process is already too entrenched to stop it, absent incredibly harsh social measures like you see China reinstating today in Shijiazhuang, a city of 11 million. No government in the West is prepared to even talk about these measures, much less implement them. So we’re always surprised by the BOOM. If an Ireland event occurs here, it will be no exception.

A full-blown Ireland event is driven by both the more virulent UK-strain AND a deterioration in social distancing behaviors. Either taken alone is bad enough. It’s the combination, though, that creates a regional superspreader event. Irish health authorities estimate that their starting point for Covid Re was something between 1.1 and 1.3 (meaning that, on average, one person infected with the SARS-CoV-2 virus would pass it along to 1.1 – 1.3 new people). They blame deteriorating masking/social distancing for the majority of their “event” (say, a 0.9 – 1.1 increase in the Re number), and the UK-variant for the balance (say, a 0.5 – 0.7 increase in Re). This is very much in line with the latest research from Public Health England, which estimates that the UK-variant Covid virus is approximately 40% more infectious than the baseline virus. Notably, the UK-variant shows an even greater increase in infectiousness for “close contacts” (not necessarily face-to-face, never touching and perhaps up to 2 meters apart) rather than “direct contacts”, meaning that the UK-variant virus is particularly successful at bridging the air gap between strangers or short-duration contacts in an indoor space. This is … ummm … troubling. As lax as we all have gotten with our mask wearing and our social distancing outside of the home, the UK-variant virus dramatically reduces the margin of error we have with mask wearing and social distancing outside of the home.

For the same reasons that we humans typically don’t recognize an exponential growth process prior to the cluster, cluster, cluster stage, we have an even harder time appreciating the impact of even a small increase in the effective reproduction rate of Covid. A 40% increase in Re has an enormous impact on how many people will be infected by Covid. For example, let’s assume that the current Re for the United States is something like 1.4 (I think it’s probably higher than that in areas like SoCal, and going up everywhere as Covid fatigue takes hold). With a 5-day infection cycle (assume you pass along the virus to 1.4 new people within 5 days of contracting the virus yourself, i.e. before you become symptomatic), a single Covid case will result in a grand total of 2,296 Covid infections over a 100-day period. Now let’s increase that Re by 40%, so that it’s not 1.4 but is 2.0 … now that single Covid case will result in more than 2 MILLION total Covid infections over a 100-day period.

This is the power of exponential growth. The numbers get silly … I mean, take that Re up to 3.0 (the high end of the current Ireland estimate), and a single Covid case will result in 5.2 BILLION total cases over a 100-day period, about 60% of the entire human population on the planet. Obviously our social behaviors around the disease would change dramatically well before we got to that point. But the real challenge of all this from a social behavior perspective is the nothing, nothing, nothing … case, case, case … cluster, cluster, cluster … BOOM! nature of any exponential growth process.

That Re of 2.0 that results in 2 million total infections from a single Covid case over 100 days? On Day 30 there are only 127 total cases. Not noticeable at all. On Day 50 there are just over 2,000 total cases. Barely noticeable. Let’s say you’re an elected political leader. Are you really going to take the steps that are necessary to stop this process – like shutting down domestic travel to and from an infected area, like physically quarantining entire cities – over a few hundred cases? Not a chance. Even if you’re right … even if you prevent a catastrophic outcome through your actions on Day 30 or Day 50 … your voters will never know that you were right. They will only experience the lockdown pain, and they will never credit you for the catastrophe averted.

I think we’re already at Day 30 in a dozen states. I suspect we’re already at Day 50 in a few.

So look, maybe I’m wrong about all this. Maybe we’re already well along the path to herd immunity, and one-third of Americans currently have Covid antibodies through prior exposure, just like the CDC models say. Maybe we’ll all rediscover that old-time religion when it comes to mask wearing and social distancing outside of the home. Maybe governors and the new Administration will focus on containing the UK-variant through domestic travel restrictions. Maybe we’ll wake up tomorrow with a new urgency about vaccine distribution.

Maybe.

But my spidey-sense is really tingling on this one.


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Reap the Whirlwind

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Image: Congress Holds Joint Session To Ratify 2020 Presidential Election

The dirty little secret of every riot and protest and looting that ever existed in the history of mankind … IT’S FUN.

Lucifer’s Hammer on Epsilon Theory, August 31, 2020

During the summer of 2020, as widespread non-violent protests for racial justice gave way to steadily creeping violence and property destruction, we published our concerns on these pages that there was practically zero political will – and zero political incentive – by either party to do what was necessary to reduce that violence.

Republicans and Donald Trump believed that the violence at a number of BLM-related events would be framed alongside deeply unpopular “defund the police” narratives as long as they continued. They believed, I think, that this framing would be electorally helpful. However perverse, from a purely electoral perspective I believe they were right on both counts. They did not win the presidency, of course, but on most ballots the GOP outperformed very low expectations. I think antipathy toward the events of the summer played a significant role.

Still, if he wished to do so, Donald Trump possessed and did not exercise meaningful power to de-escalate and reduce this violence at multiple points.

Democratic leaders at state and local levels had even more power, I would argue. They also largely elected not to exercise that power, if for very different reasons. In their case, I think there was genuine concern that calling in resources like the National Guard to maintain order would be seen as a betrayal of the very arguments about the nature of state power deployed against black communities being made by those protesting. More practically, I think they believed that this action would have the effect of increasing voter apathy for an already moderate-looking slate. More perversely, I think they felt some confidence that generally sympathetic national media would be very unlikely to pay very close attention to what was happening at some of these rallies, lest doing so unduly influence the electorate to make a Wrong Decision. I think the Democrats were right about each of these things.

No, they weren’t right. They were correct. They – and the GOP – were correct in their evaluation of optimal electoral strategy under the conditions of a competition game. But there was nothing right about allowing the destructive LARPing that took place in the late summer by activists and counter-activists alike to continue unabated.

Bad things happen when the equilibrium state of national politics is to be nearly always correct and nearly never right.

Or, in the words we published in August:

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.

Luficer’s Hammer on Epsilon Theory, August 31, 2020

The GOP is reaping the whirlwind today.

The sowing of militaristic language and existential Flight 93 Election rhetoric by the political right led directly to one of the most embarrassing days in the history of our Republic. No, I don’t think those Clown Putsch buffoons attempted to stage a coup. But a crowd of 330 million just watched a crowd of 330 million watch thousands of pastors, pipefitters, engineers, Q activists and business owners together wrap themselves in Trump flags and parade through the halls of the US Capitol. They watched them charge into the chambers with plastic cuffs and Tazers. They heard the “hang Mike Pence” chants. They saw a mob with thin blue line flags literally try to beat Capitol Police officers with them.

And then those 330 million saw lockstep claims by some half of sitting GOP representatives and most of their favored news anchors that these were the actions of Antifa. Without evidence. And without apology.

If you think the media purposefully made less of the violence this summer than an institution less transparently politically invested in the defeat of Donald Trump might have done, I think you are correct. If you think that what happened on 1/6 will ever be seen by a country that watched last week’s images in real time in the same category as the events of the summer, I think you are insane.

As Ben wrote before, the Republican party probably does not survive this in anything close to its previous form.

But make no mistake about it: The sowing of affinity for The Right Kind of Violence we saw in the summer and affinity for The Right Kind of Concentrated Power that we are seeing manifest today on the political left will have lasting results, too. The collective and collusive de-platforming of individuals and app developers happening over the last few days is, by any reasonable account, entirely within the legal rights afforded to Twitter, Facebook, Apple, Google, Amazon and scores of associated service providers under current law. In the very short run (i.e. over the period of a week), I think it is very likely that these actions could reduce the potential for violence.

In the long run?

Friends, the political forces that galvanized support for Trumpism were built on the foundations of a belief that conservatives are not given a fair shake in media, a belief that Big Tech firms run by wealthy, liberal, elites seek to control the lives of hard-working American families, and a belief that a coordinated political-technological infrastructure has led directly to their political marginalization. You can think they are incorrect. You can even think that they are wrong. But if you think that these actions will reduce the influence of Trumpism, political division, polarization and willingness to do violence, so are you.

There is substantial territory that exists between flaccid permissiveness toward the people who committed, sought to commit or directly incited violence to influence the outcome of an election on the one hand, and gleefully instituting widespread political purges that will exacerbate the long-term consequences in exchange for warm justice fuzzies today on the other.

There is a brief window where I think we have the opportunity to commit to building a common national identity together. Seizing this opportunity will mean a lot of us demonstrating corporate humility for actions we may not have taken ourselves, actions of which we bristle at being called guilty, but which in our heart of hearts we know we could have spoken up or taken more action to help prevent. Seizing this opportunity will mean a lot of us leaving a wellspring of anger we will feel is entirely justified at the door.

Not seizing it, I fear, will mean that we all reap the whirlwind.

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The Ireland Event

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Daily reported new Covid cases, Ireland, through Jan. 7, 2021

I’ll start with the conclusion. I believe there is a non-trivial chance that the United States will experience a rolling series of “Ireland events” over the next 30-45 days, where the Covid effective reproductive number (Re not R0) reaches a value between 2.4 and 3.0 in states and regions where a) the more infectious UK-variant (or similar) Covid strain has been introduced, and b) Covid fatigue has led to deterioration in social distancing behaviors.

A single Ireland event is a disaster. A series of Ireland events on the scale of the United States is catastrophic. In the aggregate, I’d expect to see a doubling of new Covid cases/day from current levels (today’s 7-day average is 240k/day), peaking somewhere around 500,000 new daily cases before draconian economic shutdowns (more severe than anything we’ve seen to date) would occur in every impacted major metro area. Hospital systems across the country would be placed under enormous additional strain, leading to meaningfully higher case fatality ratios (CFRs) as medical care was rationed. Most critically, this new infection rate would far outpace our current vaccine distribution capacity and policy. Assuming that vaccines are preferentially administered to the elderly, aggregate infection fatality ratios (IFRs) should decrease, but the overall burden of severe outcomes (death, long-term health consequences) will shift to younger demographics.

Current US gov’t policy rejects the possibility of an Ireland event, largely because of what I believe is a politically-motivated “analysis” by the CDC that models more than 100 million Americans already possessing Covid antibodies, prior to any vaccination effort. Using data from flu monitoring programs in prior years, the CDC models project that 70 million Americans have already gotten sick with symptomatic Covid, but decided to just write it off as a bad cold and never got tested! I am not making this up. Obviously enough, if >30% of Americans are already effectively immunized against Covid because they’ve already gotten sick, then it’s very difficult to hit the Re numbers of 2.4 – 3.0 that Ireland is currently experiencing. I think this is nonsense, because NO ONE brushes off Covid symptoms the way they might have brushed off flu symptoms in the past. But this CDC model is why prominent Covid missionaries (to use an Epsilon Theory term) like Gottlieb and Fauci have said that they expect daily case numbers to decline from here on out, not accelerate, and this is why I think a potential Ireland event is NOT priced into any mainstream market expectations or political expectations for 2021.

Unfortunately, once it becomes apparent that an Ireland event is occurring, it’s too late to stop it.

In our human-scale, linear world, we experience exponential growth like this: nothing, nothing, nothing … case, case, case … cluster, cluster, cluster … BOOM! But by the time we start to really pay attention to an exponential growth process – typically at the cluster stage – the process is already too entrenched to stop it, absent incredibly harsh social measures like you see being reinstated (!) in China. No government in the West is prepared to even talk about these measures, much less implement them. So we’re always surprised by the BOOM. If an Ireland event occurs here, it will be no exception.

A full-blown Ireland event is driven by both the more virulent UK-strain AND a deterioration in social distancing behaviors. Either taken alone is bad enough. It’s the combination, though, that’s catastrophic. Irish health authorities estimate that their starting point for Covid Re was something between 1.1 and 1.4 (meaning that, on average, one person infected with the SARS-CoV-2 virus would pass it along to 1.1 – 1.4 new people). They blame deteriorating masking/social distancing for the majority of their “event” (say, a 0.9 – 1.1 increase in the Re number), and the UK-variant for the balance (say, a 0.5 – 0.7 increase in Re). This is very much in line with the latest research from Public Health England, which estimates that the UK-variant Covid virus is approximately 40% more infectious than the baseline virus. Notably, the UK-variant is, relatively speaking, significantly more infectious than the baseline virus for “close contacts” (not face-to-face, up to 2 meters apart) rather than “direct contacts”, meaning that the UK-variant virus is particularly successful at bridging the air gap between strangers or short-duration contacts in an indoor space. This is … ummm … troubling. As lax as we all have gotten with our mask wearing and our social distancing outside of the home, the UK-variant dramatically reduces the margin of error we have with mask wearing and social distancing outside of the home.

For the same reasons that we humans typically don’t recognize an exponential growth process prior to the cluster, cluster, cluster stage, we have an even harder time appreciating the impact of even a small increase in the effective reproduction rate of Covid. A 40% increase in Re has an enormous impact on how many people will be infected by Covid. For example, let’s assume that the current Re for the United States is something like 1.4 (I think it’s probably higher than that in areas like SoCal, and going up everywhere as Covid fatigue takes hold). With a 5-day infection cycle (assume you pass along the virus to 1.4 new people within 5 days of contracting the virus yourself, i.e. before you become symptomatic), a single Covid case will result in a grand total of 2,296 Covid infections over a 100-day period. Now let’s increase that Re by 40%, so that it’s not 1.4 but is 2.0 … now that single Covid case will result in more than 2 MILLION total Covid infections over a 100-day period.

This is the power of exponential growth.The numbers get silly … I mean, take that Re up to 3.0 (the high end of the current Ireland estimate), and a single Covid case will result in 5.2 BILLION total cases over a 100-day period, about 60% of the entire human population on the planet … and obviously our social behaviors around the disease would change dramatically well before we got to that point. But the real challenge of all this from a social behavior perspective is the nothing, nothing, nothing … case, case, case … cluster, cluster, cluster … BOOM! nature of any exponential growth process. That Re of 2.0 that results in 2 million total infections from a single Covid case over 100 days? On Day 30 there are only 127 total cases. Not noticeable at all. On Day 50 there are just over 2,000 total cases. Barely noticeable. Let’s say you’re an elected political leader. Are you really going to take the steps that are necessary to stop this process – like shutting down domestic travel to and from an infected area, like physically quarantining entire cities – over a few hundred cases? Not a chance. Even if you’re right … even if you prevent a catastrophic outcome through your actions on Day 30 or Day 50 … your voters will never know that you were right. They will only experience the lockdown pain, and they will never credit you for the catastrophe averted.

I think we’re already at Day 30 in a dozen states. I suspect we’re already at Day 50 in a few.

So look, maybe I’m wrong about all this. Maybe we’re already well along the path to herd immunity, and one-third of Americans currently have Covid antibodies through prior exposure or vaccination. Maybe we’ll all rediscover that old-time religion when it comes to mask wearing and social distancing outside of the home. Maybe governors and the new Administration will focus on containing the UK-variant through domestic travel restrictions. Maybe we’ll wake up tomorrow with a new urgency about vaccine distribution.

Maybe. But my spidey-sense is really tingling on this one.


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Just a Fantasy

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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.


Is this the real life?
Is this just fantasy?
Caught in a landslide
No escape from reality
Open your eyes
Look up to the skies and see
I’m just a poor boy, I need no sympathy
Because I’m easy come, easy go
A little high, little low
Anyway the wind blows, doesn’t really matter to me, to me

Queen – My Secret Fantasy

Takeaways

  • Tactical Long. On November 24th in The Merger Is Complete, I wrote: “Buy the bull*&-t for a trade into Christmas on fund flows, but don’t buy into the nonsense narratives permanently. [1]I reiterated this tactically bullish position after Christmas in the Bloomberg What Goes Up podcast with Michael Meyer and Sarah Ponczek (stating it would persist into January).
    • Close It Out. It’s now time to close out that long equities trade, especially in small caps, which in any rational universe are wildly overvalued and technically hyperextended; the small cap reversion to reality should occur regardless of whether the Senate swings Democrat (albeit this would be a more bearish outcome despite the reflation narrative to the contrary). Today’s almost 5% rally in small caps could only happen in a fantasy world of avatars and magical thinking. [2]
  • Real Rates. The rationale that recent new lows in real rates justify yet higher equity prices is misplaced because breakevens are volatile and, more importantly, inflation expectations are coming from the nuances of pandemic impacts and stimulus rather than from organic growth expectations.
  • Deficits. Upward pressure on long yields from deficit issuance will surely continue. Even with the Fed sitting on long yields with QE, it will have much work to do to sop up new issuance. This situation could worsen should the Senate swing to the Democrats (i.e. – more Treasury issuance to fund fiscal largesse). I circle back to the two risks I’ve articulated from months: higher taxes and higher long yields. The latter are particularly troublesome for tech and small caps.
  • Taxes and Yields versus Direct Deposits. Three words come to mind on a Democratic win in both Senate races: taxes, taxes, taxes. Over the next four years, under the Biden administration and even in a split Senate, taxes will certainly go no lower, especially when considering proposals like Senator Wyden’s 2019 proposed tax on unrealized gains in investment assets at the same rates as other income. [3]  Does this sound reflationary? Perhaps its reflationary for equities if money supply from direct deposits continues to find its way into the stock market, but it won’t be reflationary for corporate profits or disposable income for those with the highest propensity to spend. [4]
    • Risk to View. The biggest risk to this view is that new stimulus (supplementary direct deposits) will continue to fuel the speculative bubble in equities despite the substantial economic tradeoffs in the form of higher taxes and rising yields and without regard for hyperextended valuations. It’s certainly a difficult set of vector forces to assess.

Discussion

The idea that low yields – most recently the focus of the narrative has shifted to low real yields – is somehow giving market participants’ confidence that equities will continue their ascent. There are a number of objections to this assessment. First, Figure 1 shows that the breakeven 10-year is relatively volatile. The U.S. breakeven 10-year is the difference between nominal 10-year yields and 10-year TIPS. Simply because the breakeven 10-year sits above 2% does not mean it will remain there. Second, it’s necessary to ask ‘why’ it’s there. Is it really productivity growth that will sustainably drive ’good’ inflation? That’s unlikely. Recent wage inflation has been a function of a change in employment mix and goods inflation a function of supply shortages.

The GDP recovery has largely been a function of stimulus. Market participants seem to be betting on massive pent-up demand, but notwithstanding a higher savings rate, much of that that demand may have already been pulled forward by lower rates and massive fiscal stimulus. In fact, given the historical volatility in breakevens and given the Fed’s inability to do anything to achieve its inflation target, real rates are more likely to rise than fall (i.e. – breakevens will fall). If anything, Figure 1 shows that this is just about as good as it gets for breakevens, which almost always retrace after such an advance. [5] Figure 2 decomposes nominal yields, real yields and the breakeven rate. Nominal and real yields have tended to move in lockstep, so the focus on real yields, while important, adds something less than perceived.

While it has served investors well for over 35 years, the old adage ‘don’t fight the Fed’ is on its last legs. Bill Dudley simplified it relatively well: “The stimulus provided by lower interest rates inevitably wears off. Cutting interest rates boosts the economy by bringing future activity into the present: Easy money encourages people to buy houses and appliances now rather than later. But when the future arrives, that activity is missing. The only way to keep things going is to lower interest rates further — until, that is, they hit their lower bound, which in the U.S. is zero.” [6] (By Bill’s logic, this is yet another reason why inflation isn’t coming.) [7] The incremental benefit from lower rates (whether nominal or real) is extremely limited. Indeed, even if reflation were in the cards, higher long yields would likely lead to an equity market reaction similar to late-2018. Risk-assets, when priced to perfection, tend to be quite sensitive to higher yields. Lastly, because cash flows have been so weak, the probability that the credit cycle is over is low; S&P Global Ratings seems to agree. Its 2021 speculative grade default forecast is about 9%. This level of defaults should impact small caps most.

Figure 3 above shows that the Russell 2000 has tremendous work to do to grow into its elevated multiples, which are unjustified by lower rates. Rates are this low for a reason. I’ve made this argument on many previous occasions, and (other than Mr. Dudley’s quote) I will spare readers of it yet again. What this Figure shows is that elevated multiples often precede Russell 2000 selloffs. It is sometimes true that index multiple expansion precedes rallies, as company earnings recover and grow into multiples, but this interpretation would ignore the fragile state of Russell earnings prior to the pandemic. For all companies (including those without earnings) Russell earnings were down about 15% year-over-year for 2019. Importantly, with 10-year yields creeping up on more deficit spending and the Treasury issuance it requires, smaller capital-cost sensitive companies (like those in the Russell) are increasingly at risk as real rates rise on lower-than-expected inflation or on higher nominal yields (on Treasury supply). [8]

From a ‘technical’ standpoint, Figure 4 shows the Russell 2000 overlayed with a ‘power’ regression. The regression prediction is banded by +/- 1-SD in yellow and 2-SD in red. The ‘innovation’ here is the choice of power regression, which fits the price trend extremely well and takes into account an accelerating trend that a linear regression would not. What it shows is that the 2-SD band (red) above the price trend (dotted blue) has served as resistance (as one would expect given the confidence interval). The Russell pulled back significantly at that 2-SD level in 2000, 2007, 2014, late 2015, and again in January 2020. It failed to do so in late 2018 as a rotation narrative took over. Currently, it has also failed to serve as meaningful ‘resistance’ as retail mania is driving a similar rotation on an even more hollow rotation and reflation narrative. However, the Russell did pull back at just over 3-SD above trend in 2018, and that’s where it is again right now. So, even if the price trend is accelerating (changing the regression prediction and making it less accurate), there’s lots of ‘cushion’ to this assessment. Lastly, today’s rally pushes the Russell 2000 into long term uptrend resistance, which began just after the 2009 low, as shown in Figure 5. [9]

There are arguments to be made that the one’s expectations for the performance of the Russell 2000 should change, as its composition has now changed somewhat (over 20% healthcare). What ‘healthcare’ really means is small cap biotech, which has been a darling of the retail crowd as many look to profit on the next Moderna. On the other hand, this might be considered yet another reason to dislike the Russell 2000, as many of these names are highly speculative (i.e. – unprofitable) and have contributed to the overbought and overvalued condition of the index. The bulk of the index still consists of consumer discretionary (~11%), broad financials (18%), materials and industrials (~19%), and real estate (7%). All of these sectors rallied on January 6th with financials and materials outpacing most other sectors. If anything, while the speculative bubble in 1999 was mostly in communications technology, it may now be in biotech, which is dragging along other sectors through ETF buying. The Russell has of late become the posterchild for speculation in biotech – along with the new ETFs ARKK and ARKG.

Conclusion

Todays 4%+ rally in small caps likely isn’t sustainable. They are simply priced to a fantasy world that is unlikely to ever exist. It wouldn’t be the first-time small caps experienced manic highs (or lows). The reflation narrative on a Democratic sweep (more profligate stimulus) ignores the impact of higher taxes and the potential for higher long-yields. Sure, it’s tough to ‘get things done’ in Washington, but you can bet taxation will be the first order of business should a blue wave sweep through Washington. Even without that wave, the reflation narrative makes little sense. Much of the narrative is based on higher breakevens, which are often not predictive of future inflation. This is particularly important to point out on a day when the reflation narrative is being plastered everywhere.

Small caps, in particular, are subject to more extreme swings in sentiment than even technology companies, many of which are now mature cash flow generators. Certainly, the money supply has exploded on fiscal stimulus, which has increased deposits. As I’ve pointed out, those deposits – coupled with easy access to markets through mobile-based trading apps – have found their way directly into equity markets, and especially into the most speculative stocks (i.e. – small caps). As the pandemic begins to abate and money supply begins to contract, despite a modest but determined economic recovery, small caps will once again fall out of favor. Today’s strength is an opportunity to lighten small cap exposures or hedge aggressively versus implicit or explicit long small- cap exposures.


Disclaimer

AlphaOmega Advisors, LLC (AOA) does not conduct “investment research” as defined in the FCA Conduct of Business Sourcebook (COBS) section 12 nor does AOA provide “advice about securities” as defined in the Regulation of Investment Advisors by the U.S. SEC. AOA is not regulated by the SEC or by the FCA or by any other regulatory body. Nothing in this email or any attachment to it shall be deemed to constitute financial or other professional advice, and under no circumstances shall AOA be liable for any direct or indirect losses, costs or expenses that results from the content of this email or any attachment to it. AOA has an internal policy designed to minimize the risk of receiving or misusing confidential or potentially material non-public information. The views and conclusions expressed here may be changed without notice. AOA, its partners and employees make no representation about the completeness or accuracy of the data, calculations, information or opinions included in or attached to this email, is based on information received or developed by AOA as of the date hereof, and AOA shall be under no obligation to provide any notice if such data, calculations, information or opinions expressed in this email or any attachment to it changes. Any such research may not be copied, redistributed, or reproduced in part or whole without AOA’s express written permission. The prices of securities referred to in any research is based on pricing as of the date the research was conducted, may rise or fall at any time thereafter, and past performance and forecasts should not be treated as a reliable indicator of future performance or results. This email and any attachment to it is not directed to you if AOA is barred from doing so in your jurisdiction. This email and any attachment to it is for informational purposes only and does not constitute an offer or solicitation to buy or sell securities or to enter into any investment transaction or use any investment service. AOA is not affiliated with any U.S. or foreign broker dealer. AOA or its principals may own securities discussed herein.


[1] Jeremy Grantham and I remain on the same page with GMO reiterating its bubble warning yesterday. After becoming bullish in March and cautious in late June, I felt the same pain into November.

[2] As of this writing, the Ossoff-Perdue race looks too close to call.

[3] https://www.wsj.com/articles/top-democrat-proposes-annual-tax-on-unrealized-capital-gains-11554217383

[4] https://www.yodlee.com/many-americans-used-part-their-coronavirus-stimulus-check-trade-stocks

[5] As I’ve noted, for many companies, ‘price’ will be difficult to achieve (other than in areas where there are pandemic-related supply disruptions) because of overcapacity. According to Bloomberg, almost 600 corporations of 3,000 of the country’s largest publicly-traded companies no longer have EBIT/Interest > 1. The same companies added almost $1 trillion of debt to their balance sheets since the pandemic began, bringing total obligations to $1.36 trillion. As the article suggests: “But in helping hundreds of ailing companies gain virtually unfettered access to credit markets, policy makers may inadvertently be directing the flow of capital to unproductive firms, depressing employment and growth for years to come.”

[6] https://www.bloomberg.com/opinion/articles/2020-10-28/the-federal-reserve-is-really-running-out-of-firepower

[7] Here’s a caveat. His is an incomplete description of how monetary policy works for at least two reasons. First, it fails to convey the intertemporal impact of monetary policy on investment. Second, it fails to appreciate the offsetting impact on the income channel. That is, the benefit to consumers or companies to consume or make capital expenditures because of lower rates is offset (at least in part) by the loss of income to savers. The basic macroeconomic equality that investment is equal to the sum of foreign and domestic savings suggests that a reduction on one ought to be offset by the other. The argument becomes a qualitative one that the income benefit to savers has a lower multiplier than the benefit to consumers or companies. Indeed, some might argue that this means monetary policy is itself no effective at stimulating ‘real’ economic activity, and fiscal policy is the only impactful alternative.

[8] The steeper yield curve won’t be good enough to pull small cap banks (~13% of Russell 2000) out of their malaise. Credit losses for regionals and the impact of higher rates on loan demand will more than offset the positive impact on NIMs.

[9] Unfortunately, implied volatility remains elevated, so it makes sense to sell some options to cheapen up any synthetically constructed short trade on the Russell 2000. This often makes the return profile a bit more linear, but one can still fashion something interesting. The IWM is 1/10 the Russell 2000 index with very little tracking error. One possible way to express the sentiment I articulate would be an IWM ‘put spread collar.’


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What Does Inflation Mean For Your Portfolio?

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We published our January Narrative Monitors earlier this week, which you can grab online here and here (also, if you need a refresher course in how to read these Monitors, don’t forget our webcasts and primers here and here). I’m going to focus on the Central Bank Monitor in this email, because we’re seeing something in this analysis that is unique in our historical dataset.

We think there are five narrative “archetypes” when it comes to central banks in general and the Fed in particular: Fed Put (signal for strongly positive market returns), Inflation (signal for moderately positive market returns), Dovish (signal for weakly positive market returns), Unemployment (signal for moderately negative market returns), and Hawkish (signal for moderately negative market returns). As has been the case for the past 9 months, the Inflation archetype is the strongest among these five. Nothing new or unique there. But …

  1. ALL of the narrative archetypes are now very weak. Inflation is only slightly stronger (meaning more central to the entire financial media conversation) than Hawkish, and all of these archetypes are near all-time lows in terms of the “gravity” they exert on our overall investment narratives.
  1. ALL of the narrative archetypes have absurdly positive sentiment. Meaning that for every possible narrative or sub-narrative scenario, the conclusion is that this is a positive for markets. Inflation about to run rampant? Bullish! Inflation concerns overblown? Bullish! Massive fiscal stimulus on the way to reduce unemployment? Bullish! Meh stimulus on the way and unemployment remains high? Bullish! Fed is on autopilot? Bullish! Fed is highly vigilant? Bullish!
  1. WITHIN these individual narrative archetypes (with the exception of Unemployment), there is almost zero narrative consensus or cohesion. For example, within the Inflation archetype, there are equally strong and extremely disparate (very little shared language) sub-narratives/memes/claims happening simultaneously, from “inflation is already here!” to “inflation is impossible!” to “the Fed won’t respond for years!” to “the Fed will respond now!”. There is no coherence to the Inflation narrative, no narrative agreement on what inflation means today, to a degree that we’ve never seen in the data.

This is what it looks like when common knowledge – what everyone knows that everyone knows – is being formed.

Here’s how it will play out in your own head.

Your first instinct will be to try to figure out on your own what inflation really and truly means for your portfolio. You will read about the history of inflation and think really hard about it. You will have some ideas and, depending on your ego, more or less confidence in those ideas. But then, on reflection, you will decide that you want to understand what everyone else thinks inflation really and truly means for your portfolio. You will do this by watching CNBC and reading Bloomberg Opinion articles and Goldman Sachs research reports and portfolio manager letters and the like. You will call this “doing your research” and “listening to smart people”. Over time you will begin to recognize a common thread running through what you hear and what you read. You will call this common thread an “investment thesis”, and you will find yourself nodding your head by the fourth or fifth time you recognize this common thread on what inflation really and truly means for your portfolio. You will begin to recognize this common thread in more and more of what you hear and read, and you will provide positive feedback in one form or another to the creators of this content. You will congratulate yourself on being smart enough to tease out this common thread from your “research” and you will begin to implement your “investment thesis” in your portfolio. Soon you will have conversations with other smart investors who have similarly identified this investment thesis from their research, and you will take great comfort in that. You will increase your position in the investment thesis.

I am not saying that your investment thesis is wrong. I am not saying that you will lose money with your investment thesis. On the contrary, if you are early with your investment thesis and that thesis evolves into common knowledge, I think you’ll make a lot of money.

I am saying that what you call an investment thesis is a narrative.

I am saying that the business of Wall Street and financial media is to create an investment thesis that makes you nod your head. I am saying that you will always find an investment thesis that makes you nod your head, and that this process of selling you an investment thesis that makes you nod your head is as predictable and as regular as the sun rising in the east and setting in the west.

Right now, Wall Street is trying to identify which inflation narrative will be an investment thesis that makes lots of people nod their heads.

Recognizing THAT – and maybe even trying to get ahead of THAT – is how you play the game of markets successfully.


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