US Fiscal Policy Monitor – 10.31.2018

  • After climbing as usual (and, we think, in more muted fashion) in connection with mid-term elections, attention to US Fiscal Policy narratives ticked down modestly in October.
  • We are not observing higher than usual fiat news or advocacy journalism effects, although we note that the aggregate level of fiat news for fiscal policy topics is very often much – between double and triple – that of similar topics we track. 
  • The tone and sentiment of topics has continued to plummet in the lead-up to elections, which we anecdotally attribute to coverage of political rhetoric, attack advertisements and the like. We expect this to recover following elections, but would be focused on potential import if sentiment remained as negative as it is today. 
  • While attention is high for the elections – stories are reporting many of the same themes – if anything, the narratives around US Fiscal Policy appear to be anti-austerity rather than anti-deficit. The most central topics are not market debt fears or spending levels, but rather inequality and funding of education, health care and disaster services at the federal level. 

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Sentiment Index

Source: Quid, Epsilon Theory

Key Articles

Lower For Longer Is No Longer Certain

The Credit Cycle is On the Turn

The Credit Crunch Cometh

Are Republicans seeking to get rid of Medicare, Medicaid and Social Security?

No, Trump’s Tax Cut Isn’t Paying for Itself (as Least Not Yet); News Analysis

The U.S. Economy is Booming. So Why Is The Federal Deficit as its Highest Level Since 2012?


Credit Cycle Monitor – 10.31.2018

  • While articles including key credit terms continued to rise in October, their internal coherence continued to fall. This means that stories tended to cover individual countries, regulators, companies or debt markets without explicitly or implicitly identifying connections between them. 
  • Even within similar topics, articles varied between reviews of compressing spreads and strong lending markets and a new group of articles exploring potential risks for these funds going forward, especially in CLOs and leveraged loan topics. 
  • While it is a narrow data point, we have seen a small up-tick in fiat news and advocacy journalism in a topic that is already fairly well-populated by such pieces. 

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Sentiment Index

Source: Quid, Epsilon Theory

Key Articles

More house prices falls look likely unless regulators intervene

IL&FS fallout: Finance firms face fund crunch

Italian banks caught in vicious circle as bond spreads hit danger threshold

There is a new IMF in town and it’s called China

Ameritech Financial: Could Almost Half of Student Loan Borrowers Be in Default by 2023?

Asset Gatherer versus Asset Manager: What Happens When a Core Bond Strategy Gets Too Big?


It’s Twue, it’s Twue!


We are rapidly accelerating toward mid-term elections that will be described as the most important in our lifetimes (until the next election, that is), and the ones that will decide whether our Democracy lives or dies (until we miraculously survive until the next one, that is). What that means, of course, is that we should all expect to be subject to peak fiat news. For the uninitiated, fiat news is a term we use at Epsilon Theory to describe news which does not include incorrect facts (i.e. we aren’t talking about fake news), but which treats statements, analysis and conclusions as facts themselves, usually because they were derived from those facts.

In short, it’s news that tells you how to think about something, instead of giving you the tools to make up your own damn mind.

Reuters, a good service and not the one I would usually peg for this kind of thing, published a textbook, innocent-looking example of what we mean by fiat news this morning. The headline is just glorious: “Elections could put Wall Street’s favorite lawmaker in top finance role.” Now, typically I’d counsel withholding judgment on the story itself until you read it. After all, headline writers looking for clicks (and their bosses badgering them for clickworthy headlines) can be a bit overzealous. But I’ll spoil the surprise: The lede uses the same language.

Let’s be fair. There is obviously nothing inherently wrong about using the term Wall Street. It can be a loaded term, but it is also a useful term. It’s more specific than “the financial services industry” and also has a more expansive definition that can go beyond specific companies and individuals to convey its lobby, its government influence and the like. Furthermore, assuming that people have the same understanding as we do of a loaded term is a recipe for counterproductive interactions. Full Hearts.

But the context for a loaded, pointed and intentional use of the expression “Wall Street’s favorite lawmaker” is compelling. Mr. Luetkemeyer’s sources of campaign funding are the focus of the article. They are linked (along with the potentially loaded language), to his rise to the Chairmanship of the Financial Services Committee and to his policy views. Congresswoman Waters, on the other hand, is referred to as a “vocal Wall Street critic”, with little in the way of exploration of any funding-related inducements that might guide that view. On this basis alone, it doesn’t seem at all unreasonable to guess that “Wall Street’s favorite lawmaker” was consciously or subconsciously used as a pejorative – and expression of opinion as fact.

When pressed, I suspect that the authors would contest that, and defend the assertion as being exactly that: a fact. After all, look at what the Center for Responsive Politics data says about donations from commercial banks. It’s true, it’s true! Maybe there’s a bit of poetic license here in calling this candidate ‘Wall Street’s favorite lawmaker’ just because commercial banks gave him the most money this cycle, but is that so bad? No. It’s worse. The problem is that CRP’s definition of ‘Commercial Banks’ isn’t ‘Wall Street’, something Reuters and the authors – both of whom are actually quite effective journalists who have written some dazzlingly good pieces – know quite well. It doesn’t take much digging to start calling the narrative here into question. Five minutes at the CRP website is enough. I wonder what it would say if we started with the CRP industry categorization that best aligns with what most people on Wall Street would call ‘Wall Street’: Securities and Investment Firms.

Oh. OH. That’s not the right story. OK, change the channel, change the channel. HEDGE FUNDS!

“(Annoyed Grunt)” What I meant to say was Venture Capital!

No, I didn’t say “Venture Capital!” I said “Bend your cap a little.” The flat bill look is way too Gen Z. What I really meant to say was Investment Management Companies and Private Equity. I’m just SURE he’ll show up here, in the category I really meant. 

Hey, would you look at the time?

First of all, people’s definitions of ‘Wall Street’ differ, but basing the central narrative of a news story on a cherry-picked definition that didn’t include at least the firms in CRP’s Securities & Investment category is complete nonsense. Not including the other categories is more or less forgivable depending on your perspective. Part of the Full Hearts responsibility for all of us means recognizing that this could have been an honest mistake. The people who wrote this story are good journalists. One of them covers the financial regulator beat as well as anyone. But when we are reading financial news, it is imperative that we look at loaded words like “Wall Street’s favorite lawmaker” with Clear Eyes and Full Hearts. Clear Eyes to understand that intentional and unintentional bias creep into articles that would tell us how to think about an issue. Full Hearts to recognize that sometimes words are just words, and that we’ve got to have some grace for the natural way in which each our subjective views creep into analysis that we would like to present as objective.

If you’re following along at home, this is our running guide to fiat news and how to spot it:

  1. Ask “Why am I reading this NOW?”
  2. Look for the tells of fiat news: “but, because, therefore”
  3. Be on guard for overdetermination and overconfident attribution of causality.
  4. Look at loaded words with Clear Eyes and Full Hearts

An Ocean of Indifference


If I tried to imagine the public as a particular person…I should perhaps think of one of the Roman emperors, a large well-fed figure, suffering from boredom, looking only for the sensual intoxication of laughter.

Søren Kierkegaard in The Present Age (1846)

From time to time, readers point out to us that when we explore individual stocks and investments, we tend to focus on stocks that are more obviously in the news. Mea culpa. In our defense, it’s usually more interesting, and it helps us to demonstrate narrative patterns more clearly. It is also true that not all stocks and investments are equally influenced by narrative. But even that can be useful to know. Especially for those of us more attuned to value investing.

As always, the reason it is useful relates to investor behavior. We think that the absence of clear narrative is often indicative of complacency or conditioning. When a stock has performed consistently well or poorly over an extended period of time, it is natural for the attention paid to the drivers of the company’s returns and results to wane.  The missionary’s job is done, so to speak. When the owners of a positively trending stock become complacent, the logic goes, bad news is often shrugged off and ignored more than it would be for a comparable stock. Likewise, for a stock or company stuck in a long-term rut, investors may become so conditioned to a continued stream of lousy news that green shoots pass by with a corresponding kind of under-reaction effect.

To value-with-a-catalyst investors, these are archetypal opportunities: companies which have regained some operating momentum, but for which active price setters in the market are too conditioned to malaise to update their views as much as they ought to. Figuring out the catalyst is its own challenge, but identifying the signs of conditioning and malaise? Here’s what they look like in narrative space:  

Source: Quid, Epsilon Theory

You can probably guess which company this from the tags, but in case it isn’t familiar, this is the narrative map from the last 3 months for General Electric. Folks, this is what an ocean of indifference looks like.

Like many industrial conglomerates (which it still is, even if less conglomerated than it once was), GE has products and businesses in far-flung markets. In addition, as you might expect, market research and consulting firms constantly publish commentary and discussions of those segments, products and businesses. So while there are people – wonks and people trying to sell slides for decks to banks and competitors, mostly – who care deeply about what General Electric is doing, the Financial media are not among them.

When financial media has written about General Electric lately, the central focus of the articles has been ‘the turnaround’, language used in almost every piece. Those articles include the kinds of things you’d expect in a turnaround: write-downs, cash flow questions and one-time charges. For obvious reasons, these ‘turnaround’ articles also bear a lot of similarities to articles about the recent change in CEO. And while there is a bit of humor to be had in how the tone of the articles about Larry Culp changed after a brief pop in the stock, the new CEO stories and the turnaround stories are part of one narrative, and really the only narrative being told about the stock right now. Both of these topics are, understandably, linked to GE’s languishing but critical GE Power business, struggling to deal with gas turbine demand that is far outstripped by global manufacturing supply. It is a big part of the mess Culp was charged with fixing.

But this is a surprisingly narrow set of topics for a company like GE. Tellingly, even the financial media reports that incorporate changes in ownership, or sell-side / buy-side participants talking about their opinions, are completely untethered to the fairly disinterested turnaround narrative. Aviation, healthcare, renewables, oil & gas and transportation are all pictured outside the frame. It isn’t that the sentiment attached to all of these topics is profoundly negative or anything. People just don’t seem to care. Beyond telling me that people have just given up and gotten bored, what else would this tell me?

  • I think it tells me we’ve now got a universe of investors who are well and truly conditioned to perma-turnaround GE.
  • I think now is the time I’d be looking more closely for signs of underreaction to good news on things I believed were potential positive catalysts…I mean, if they ever have any.
  • If and until that happens, the narratives strike me as being conducive to the current trend.

As a more general observation, we think that behaviorally oriented investors in a Three-Body Market would do well to more actively incorporate complacency and conditioning of market participants into their thinking. Price and market structure analysis can give investors some sense of those things. We think an understanding of narrative helps fill out much of the rest.


Innocent Monsters


“Another such victory over the Romans, and we are undone.”

Pyrrhus, from Plutarch’s Apophthegms of Kings and Great Commanders

 “What strange phenomena we find in a great city, all we need do is stroll about with our eyes open. Life swarms with innocent monsters.”

The Parisian Prowler, by Charles Beaudelaire (1864)

Ben and I have both been challenged by what to write about the events of the last week.

Writing about any of this in context of narratives can feel cheap, especially because of those who use the term to dismiss something as ‘a story that doesn’t fit my pre-existing views.’ There are eleven people dead in Pittsburgh at the hands of an anti-Semitic white nationalist. Two are dead near Louisville in an apparently racially motivated attack. At a nearby predominantly black church, there are many who now live knowing that the murderer was after them. There are political leaders and citizens, and hundreds of people who work for them, who now live their lives a little less freely, knowing they could have been caught up in the attempted pipe bombings. No one needs to read anything we have to write more than they need to sit in empathy for these people and their families.

It is also challenging to write about events like this for logistical reasons. We write about narratives, but narrative in our parlance is the cultivation of common knowledge, where a large group of people knows that they all know something. More often than not, that something is some several layers of abstraction away from what the thing actually is, or was. Establishing the existence of something like this takes time, and the events are fresh. But the seeds of those abstractions are there, and we are watching them grow in real-time. They aren’t pretty.

We are further challenged by the fact that the immediate aftermath of events like this exacerbates our emotional sensitivity. All of us. No matter how we write about this topic, some will think we are simply joining the fray when we should be above it. Others will think – a topic that will come up again – that by expressing a view, we make ourselves complicit in some tragedy. Fortunately, both of those views are bullshit and I don’t care. I’m going to do my best to tell you what I’m observing and how someone who believes in adopting Clear Eyes and a Full Heart ought to respond. So what am I observing?

The widening gyre is transforming all of us into innocent monsters.

I know this is a heavy charge. For posterity’s sake, let’s take a look at a network of the articles written about the mail bomber between the 24th and the 27th. We define this as news articles referring to ‘bomb’ and any one of the words ‘pipe’, ‘mail’, ‘Clinton’, ‘Obama’, ‘DeNiro’ or ‘Biden.’ Cluster names are mine.

Source: Quid, Epsilon Theory

The first thing that stands out is that – and this is common when examining evolving news over short periods of time – the stories cluster strongly on a time dimension. The colors in the chart above reflect when they were published, starting from blue hues on the 24th to red hues on the 27th.  The reason for this is intuitive: stories released at a particular time reference the events that have taken place so far, and include the statements and comments made by officials, victims and others recently. For this reason, it is almost – not completely, but almost – possible to simply read this network as beginning in the upper right on Wednesday and cascading around to the upper left by Saturday.

You don’t need the raw adjacency data here to see the center of this network, the topic that permeates and connects to nearly every other cluster. You can see it right now. False Flags, a cluster of both conspiracy theories and responses to them. Only slightly behind this cluster is the network of articles linked by statements by Hillary Clinton and Barack Obama telling Americans “to elect candidates who will try to [bring our country together]” and that the “character of our country is on the ballot”, respectively.

The gravity of this entire topic is formed around abstractions.

What do I mean by that? I mean the process by which we use things to stand in for other things even when the facts and a logical process don’t exactly allow us to make those intellectual leaps.

For many – maybe even most – on the political right, the story ceased to be about the story almost immediately. The story, you see, was really about the lengths to which shady left-wing political operatives would go to promote their cause and make Republicans look bad. It was really about the unbalanced treatment of left-wing and right-wing violence by a biased press. Even among conservatives who didn’t come out directly and embrace the false flag theory, most news outlets, pundits and commentators were on the defensive against any attempt to use the events to imply that this had anything to do with conservatives or Donald Trump.

For those on the political left, a story about mail bombs was just as quickly really about Donald Trump and what he had done to inflame people toward hatred and violence. Then it was about the MAGA movement. And then, in the wake of a further tragedy in Pittsburgh, we were three layers of abstraction deep, with noteworthy personalities from the political left not only implying, but directly attributing ongoing responsibility for all violent tragedies to anyone who would dare to vote for Republicans. Sure, we can pretend that isn’t really what Dan Rather is saying here, but everyone knows that everyone knows it is what Dan Rather is saying here.

This week’s events have provided a perfect synopsis of what I believe is the primary source of our widening gyre: a narrative from the political left that the members of the political right are irredeemably committed to an ‘environment of hate’, and a narrative from the political right that the media and academy are committed to a ‘maliciously dishonest’ scheme to influence how citizens think about social and political issues. These are the narratives that will govern all future engagements.  

These two narratives have incredible meta-stability and incredible polarizing power, because almost any conceivable event serves to strengthen each side’s priors. When we posit the existence of an ‘environment of hate’, every act of violence or threat, every policy that can be seen to harm one party or another, regardless of its true relationship to Trump, conservative policies or the broad conservative masses, will be attributed to them by those attached to that narrative. When we posit the existence of a ‘maliciously dishonest media’, every report with tilted language, every news report sprinkled with obvious opinions, every columnist who tries to attach every regular guy with conservative principles to psychopaths of the far right, will be seen to confirm its existence.

The two narratives will continue to reinforce each other. We will want to believe – and we will be told to believe – that speaking truth to power! or the next election, the most important in our lives! will be the solution. Sometimes they are. This time they aren’t. The more every party tries to ‘win’ this Competition Game, the deeper and wider this gyre will grow. Even when we are right, we innocent monsters will make things worse. There is no Answer to this, but there is a process:

Clear Eyes and Full Hearts. Clear Eyes to recognize and grapple with underlying truths that lie beneath the layers of our opponents’ narrative about us. Full Hearts to hold our own narratives in abeyance while we engage one another in good faith.

Good faith doesn’t mean not arguing or debating. It doesn’t mean believing both sides are always equal. It doesn’t mean not holding people, policies or parties accountable. It doesn’t mean not being angry. Furious, even. It doesn’t mean not campaigning, and doesn’t mean avoiding acts of civil disobedience. It means a longsuffering willingness to believe what other people say about their intentions. Don’t get me wrong – good faith is a terrible electoral strategy. It is, much as we might like to pretend otherwise, also a terrible way to win in the court of public opinion. But if you think, like I do, that regaining a functioning civil society is more important than the likely tangible differences in any short-term political outcome, it’s our only way there.




The dancers on stage are flopping around, dancing awkwardly in the absence of any music. They look uncomfortable as the Emperor Joseph II enters the rehearsal for the first performance of Mozart’s The Marriage of Figaro.

Emperor Joseph II: What is this? I don’t understand. Is it modern?

Kappelmeister Bonno: Majesty, the Herr Director, he has removed a balleto that would have occurred at this place.

Joseph: Why?

Count Orsini-Rosenberg: It is your regulation, Sire. No ballet in your opera.

Joseph:  Do you like this, Salieri?

Antonio Salieri: It is not a question of liking, Your Majesty. Your own law decrees it, I’m afraid.

Joseph:  Well, LOOK at them! No, no, no! This is nonsense. Let me hear the scene with the music.

Amadeus (1984)

Of all the investment strategies that force investors to hold their noses and take their medicine, we are most uncomfortable with those based on historical price movements. We know that they work, up to a point. And so we balance in our heads the ideas of participating in trends with some vague notion that we will make enough money doing so to compensate us for it all blowing up in our face one day. Alternatively we hope that we will be able to buck the trend before it reverses, whether through a contrarian analysis of price movements or some statistical model of investor behavior. Even when the models work, it can feel unsettling, like dancing a ballet without music.

Music’s exclusive function is to structure the flow of time and keep order in it.

Igor Stravinsky, as quoted by Geza Szamosi in The Twin Dimensions: Inventing Time and Space

In a Three-Body Market, narratives are the music. Understanding how they influence the structure and flow of price-trending behaviors is not a cure-all. But it can be a useful tool.

If you would dance, my pretty Count, I’ll play the tune on my little guitar. If you will come to my dancing school I’ll gladly teach you the capriole. I’ll know how; but soft, every dark secret I’ll discover better by pretending. Sharpening my skill, and using it, pricking with this one, playing with that one, all of your schemes I’ll turn inside out.   Se vuol ballare, signor contino, il chitarrino le suonerò, sì, se vuol venire nella mia scuola, la capriola le insegnerò, sì. Saprò, saprò, ma piano, meglio ogni arcano dissimulando scoprir potrò. L’arte schermendo, l’arte adoprando, di qua pungendo, di là scherzando, tutte le macchine rovescerò.
  • The Marriage of Figaro, by Wolfgang Amadeus Mozart from a libretto by Lorenzo da Ponte (1796)

If narratives are the music, we must be conscious of the musicians.

This is Part 4 of the multi-part Three-Body Alpha series, introduced in the Investing with Icarus note. The Series seeks to explore how the increasing transformation of fundamental and economic data into abstractions may influence strategies for investing – and how it should influence investors accessing them. 

  Economic Models Behavioral Models Idiosyncratic Models
Systematic Security Screening Econometric GTAATrend-Following
Value Factor Investing
Statistical Arbitrage
High Frequency  
Discretionary DCF / DDM / Price Target
Credit Work
Growth Equity
Relative Value
Asset Value
Sentiment Value + Catalyst Discretionary Macro
Other Trading Strategies
Activism Distress

Trend-following is an odd little corner of the market.

Well, not little, I suppose. When taken in the aggregate, trend-following strategies – by which I include all strategies which use historical price behavior as a primary component in determining current positioning – account for at least $400 billion, and some multiple of that in exposure. If we included all the momentum-inclusive quant equity strategies and related factor portfolios, too, we’re easily wandering into the trillions.

And yet it still has an uneven reputation.

It wasn’t long ago that the most reputationally aware institutional money (i.e. endowments and foundations) wouldn’t touch anything that looked like it was trading based on price movements. Some still don’t. It was considered this sort of uncouth thing, a place for daytraders and charlatans. The real adults were investors! Value investors, business buyers, participants in the process of setting the proper price of capital! It didn’t help, of course, that many of the go-go momentum shops of the late 90’s were pretty sloppy, or that many so-called trend-following strategies were just some guy drawing dumb lines on a Bloomberg chart. And then later getting a computer to draw dumb lines for him.

Now, the empirical premises of the most basic trend-following strategies are not really all that much in question. They work. The data are pretty clear that they work. Of course, don’t tell that to the professor at Wharton who taught me 18 years ago that technical analysis was only so much superstitious hogwash. And yes, as much as we might protest that the reversal pattern of long-term underperformers that DeBondt and Thaler identified in 1985 or the short-term trend continuation pegged by Jegadeesh and Titman in 1996 are different, it is still technical analysis, y’all.

So yes, it works. But investing because of how the price has moved doesn’t FEEL like investing, and this feeling is a hump that a lot of investors still can’t get over. It’s too simple. As it happens, a lot of professional investors are really uncomfortable telling their clients and boards that they buy things just because they’re going up and sell them just because they’re going down. This is a predictable outcome, given that many of those professional investors have sold themselves to their clients and boards on the basis of, y’know, not being the kind of poor sap who just does what everyone else has been doing.

And so it is that there are all sorts of stories about why trend-following and momentum strategies work that are meant to lend them credibility. Maybe it’s because dispersion of fundamental information takes time. Maybe it’s because we overextrapolate earnings growth. Maybe it’s because price trends are really just a proxy for intangible business momentum.  I’m sure there are many very bright people who earnestly believe these stories. Hell, they may even be right. But for my money, the simpler explanation – and to be fair, it’s one that is usually recognized by those proposing the other explanations – is the easier one. Things that go up feel better and safer, a natural emotion that we have institutionalized through Morningstar ratings, consultant buy lists, ‘approved lists’ and hyper-frequent portfolio reviews designed under the auspices of weeding out ‘bad investments’, by which we mean ‘investments that have done poorly over the last 12-24 months.’

The problem is that while most of us can get our heads around why price and performance trends ought to continue, we also know that they can’t and don’t continue indefinitely. We also know that, if value investing works, too – and it does – there’s a point at which our view probably ought to shift to an expectation of a contrary relationship between future returns and stocks with strong historical performance. As you might imagine, there are a lot of implementation choices here. In fact, I’m not sure there is a space that provides the potential for as much diversity in signal design as trend-following.

Lest you get too frightened (or excited), no. This isn’t going to be a survey piece. There are great primers available on trend-following, and I’m not going to write a better one. If you’re in the market for a survey course in investment strategies, AQR’s Antti Ilmanen wrote the Bible. I’d also add that if you aren’t following the work by Corey Hoffstein at Newfound Research, you may find it even more useful. He researches implementation questions in the open, and since doing is invariably the best way to learn, I suspect you will gain immeasurably from following along. I have.

If you do want to understand the smorgasbord of strategies which incorporate price as an input, I do have a small number of suggestions, none of which is groundbreaking, and all of which would be a standard part of the arsenal of questions to ask any trend, CTA, managed futures or systematic macro fund manager:

  1. Understand the difference between time-series momentum and cross-sectional momentum, and know which your managers are relying on. They perform more differently than you would expect.
  2. Understand time horizon diversity among the signals being used, and how you might expect those signals to work differently.
  3. Understand how non-price data is being used in models, as primary signals or conditioners.
  4. Understand how positions are sized, and how gross and net exposures are managed.

I’m not making recommendations here, but at their very likely great distress, I’ll also share the names of a few people who, in my experience, are preternaturally good at discussing the hows and whys of these strategies. And this is me suggesting, not them offering, y’all:

  • Ewan Kirk at Cantab Capital, to explain anything trend-following or managed futures.
  • Rob Croce at BNY Mellon (and in full disclosure, a former colleague), to sell you on the religion of pure trend.
  • Jason Beverage at Two Sigma, to explain shockingly complicated quant portfolio construction concepts in ways you will understand.
  • On anything on the shorter end of the time-horizon spectrum (where a lot of mean reversion strategies live), you will never go very wrong by asking your AQR rep for a chat with Michael Mendelson.

But again, the intent behind this piece – as with the rest of the series – isn’t to tell you how and why these strategies work. It is to discuss whether we think a more abstracted market with greater always-on awareness of what other investors are thinking and doing ought to change the way these strategies work. The short answer? Yes. It should also change the way some of the strategies are designed and incorporated into portfolios.

What we are NOT talking about is parsing the news for sentiment. Sure, tone and sentiment are a component of any narrative. But a lot of money has been spent by hedge funds and others over the last decade and a half to mine news for sentiment, first by building huge manual research teams in India, and later by assigning those tasks to computers. Most of those efforts have been huge flops. The relationship between narrative and price trends is different, and I want to show you why.

This foray will necessarily cover the relationship between narrative and trend-following more generally, and not with individual strategies. After all, if we’re going to tell stories about how prices dance to the music of the stories that Wall Street tells, we must hold some things constant. So let me tell you a story about just three companies. They existed over the last 3 years. Conveniently, all of them are called Tesla Motors.

A Ballet in Three Acts, Act I: Resilient Tesla

Since calling them all the same thing will be confusing, let’s call the first of our companies “Resilient Tesla.” Resilient Tesla existed between for six months, from November 2016 to May 2017. In what will be familiar to regular readers, we rely on natural language processing technology from Quid to relate and graph news articles from a very broad universe of sources based on content, context, phrasing and sentiment. We provide some of our own characterizations of the clustered content to aid interpretation.

What did media reports have to say about Resilient Tesla? Well, they didn’t ignore bad things that were going on. Media reported on issues with autopilot, and on reported safety issues. It reported on issues with dealership access in states. But those stories were curiously isolated. With few exceptions, they shared no language or other similarities with the core of the conversations taking place about Tesla.

The center of gravity around which the Resilient Tesla narrative orbitted was management guidance, in particular around Tesla’s desire to raise capital to grow. The stories about management guidance and capital raising were usually also stories about the Model 3 launch. They were also about Tesla taking over as the most valuable carmaker in the US. Importantly, they were also stories about Wall Street positioning, and what big investors and sell side analysts thought about the company. And – for the most part – the tone and sentiment of all of these categories were good and positive. What is more, all of these linked positive topics were things where Tesla was the only game in town. That lent stability to the overall narrative, and that narrative was growth. We need capital, but we need it to launch our exciting new product, to grow our factory production, to expand into exciting Semi and Solar brands. Sure, there were threats, but always on the periphery.

Source: Quid, Epsilon Theory

Resilient Tesla was a positive trending stock. Over all but short bursts over this period, it would have been a long position for most long-, medium- and short-term models. Sure, models and strategies incorporating liquidity, volume, daily price action, large block trade activity or other esoteric anomalies may have had different exposure, but Resilient Tesla was a classic long for most.

Source: Bloomberg, Epsilon Theory. Note: This is not a recommendation to buy or sell any security, or to take any portfolio action. Past performance is not indicative of future results. You cannot invest directly in an index, and we do not invest directly in any individual securities.

A Ballet in Three Acts, Act II: Transitioning Tesla

The stories started changing in summer 2017. Act II tells the story of Transitioning Tesla, a company which existed for three months, from May 2017 through August 2017.

Source: Quid, Epsilon Theory

The overall sentiment and the language used in stories about Transitioning Tesla were still positive. In fact, they were actually slightly more positive than they were for Resilient Tesla. But gone was the center of gravity around management guidance and growth capital. In its place, the cluster of topics permeating most stories about Tesla was now about vehicle deliveries. Articles about Tesla used to be Management says this AND Model 3 is coming AND did you know that Tesla is now the most valuable US carmaker AND here’s Wall Street’s updated buy/sell recommendation stories. For Transitioning Tesla they were The Model 3 launch is exciting AND the performance of these cars is amazing, BUT Tesla is having delivery problems AND can they actually make them AND what does Wall Street think about all this? The narrative was still positive, but it was no longer stable.

In other words, two things happened here:

  • Transitioning Tesla lost control over the narrative. It failed to control its cartoon.
  • The main connectivity among the stories people tell about Tesla became concern about deliveries and production.

We’ve previously described narrative as providing meta-stability to an overall market: the ability to shrug off contrary new facts that are inconsistent with the narrative, and to incorporate new facts that were previously considered tangential. Instead, the excitement about non-Model 3 opportunities like Solar, Gigafactory and Semi moved further to the periphery, less linked to most content about the company. Debt concerns, competition and partnership issues, previously easily shrugged off, were now being mentioned in articles that were ostensibly about something else. This is what it looks like when meta-stability fails. This is what it looks like when the narrative breaks.

You wouldn’t necessarily have sensed a difference in how the Tesla story was being told. It was still positive in tone, still almost universally optimistic. Investors and the public alike were still excited about the vehicles’ uniqueness. They still saw value in the periphery businesses. You probably wouldn’t have thought much of the price performance over these four months, either. Long-term cross-sectional momentum models would have shrugged off the addition of four choppy months of ultimately in-line performance. Time-series models would have scored a still-rising stock.

But it was already broken.

Source: Bloomberg, Epsilon Theory. Note: This is not a recommendation to buy or sell any security, or to take any portfolio action. Past performance is not indicative of future results. You cannot invest directly in an index, and we do not invest directly in any individual securities.

A Ballet in Three Acts, Act III: Broken Tesla

The third Tesla – Broken Tesla – existed between August 2017 and the present.

The growing concern about production and vehicle deliveries entered the nucleus of the narrative about Tesla Motors in late summer 2017 and propagated. The stories about production shortfalls now began to mention canceled reservations. The efforts to increase production also resulted in some quality control issues and employee complaints, all of which started to make their way into those same articles. When stories about suppliers not getting paid were coupled with a failed MBO, writers all too easily related these concepts with the management and oversight of the company. Once writers connect these items, then the previously peripheral issues of autopilot crashes, recalls and union disputes start finding their way in as well.

Now, almost all of these things were obviously very real, very tangible problems. That’s not the point. The point is that there was already broad private knowledge that there were issues with Tesla’s manufacturing process. There was already broad private knowledge that senior finance executives had been leaving the company. There was already broad private knowledge that Elon was eccentric. There was already broad private knowledge about the previously peripheral problems for the company. But none of those things really mattered until they became part of the common knowledge around the stock. Once that happened, a new narrative formed: Tesla is a visionary company, sure, but one that doesn’t seem to have any idea how to (1) make cars, (2) sell cars or (3) run a real company that can make money doing either.

Source: Quid, Epsilon Theory

But that’s all the music. So what is the dance? Well, the performance of the stock in this period is probably familiar. This was a model trade for most trend-followers, especially those with more basic strategies. A long-term positive trend, followed by a flat period to roll off old signals, followed by relatively quick transition to a new trend. The funds incorporating more basic long-term cross-sectional signals only probably got hurt a little in Q3 2017, but have been in the money since then.

Source: Bloomberg, Epsilon Theory. Note: This is not a recommendation to buy or sell any security, or to take any portfolio action. Past performance is not indicative of future results. You cannot invest directly in an index, and we do not invest directly in any individual securities.

The Epilogue

If you’re reading this note on Tuesday, October 23rd, you’ll know that Tesla has moved up its earnings call to tomorrow evening. As of mid-day today, TSLA stock is up about 5.6%. As always, these things are overdetermined, but it’s hard to think that responses to chirps from management about a ‘near-profitable’ quarter and record production and deliveries don’t have something to do with it.

Tesla valuations are built on the basis of phenomenal projected future growth. The idea that anyone is going to update some model assumption after tomorrow’s results and legitimately come up with a massively different valuation is nonsense. And yet. If I were short the stock based on the supportive environment for a continued negative price trend, I’d be looking very closely at the following:

  • Can Elon and team put on a performance that starts to put distance between how media and Wall Street talk about the company in the same breath that they talk about credibility issues for management? Can they stay on-point and look like adults?
  • Will the ‘near-profitability’ story and facts dispel the swirling attachment of debt / cash flow / failed MBO concerns to the principal stories about Tesla?
  • Will they be able to bring the topics that have remained positive (e.g. China production, Panasonic’s progress, even Semi, believe it or not) into the main narrative about the stock?

Perhaps most importantly, can Elon step back into the role of Missionary? Or will he continue to let other people determine his cartoon?

The Story of the Three Acts

Let me address a couple legitimate criticisms of this way of complementing trend-following in advance.

The first is that this all seems very easy to see in retrospect. Would I have seen this in advance? Would you? Not sure. There is predictive power in this, but it is hard. It is also systemizable. It is also a new way of looking at things that requires us to build some new muscles to see clearly – and to avoid the confirmation bias that inevitably creeps into this kind of analysis.

The second criticism – and this one comes up a lot – is that professional investors and analysts don’t make judgments about companies and securities based on the content of news pieces. Assuming that this is a serious observation, I would only respond by recommending that you talk to more fund managers and read more sell side pieces. Still, there is a lot to be gained by understanding how common knowledge and broad private knowledge alike DO differ by and among different groups – from broad media, to specialized media, the sell side, long-only fund managers, hedge fund managers and macro strategists. This is something we are working on expanding as part of our research effort.

The third is skepticism that the existence of what we’re calling narrative can predict the direction of a stock. Well…yeah. I mean, I agree. I’m not at all convinced that it can, and there’s nothing I’ve written here today that should convince us that we could have used this ex ante to bet on or against TSLA. This isn’t about predicting the direction of a stock. It’s about updating our predictions about whether it is an environment more or less conductive to investing with or allocating to various types of trend-following strategies. You may not be able to predict the trend, but you may have some ability to project its stability. It’s about understanding how the music changes the dance. It’s not about the answer, it’s about the process.

What else do we take away from all this? What else do I think?

  • I think allocators should be more actively engaging our trend-following managers to be curious about why their signals work. Ask questions about how they try to develop economic intuition for them. They don’t have to buy into how we are conceptualizing this. But they should be constantly curious.
  • I think I’m more inclined toward simple strategies that are heavy on long-term trend. While abstractions are just as capable of creating choppy periods, I think  conducive environments for long-term trends will be more common. I think the cause will be broader awareness of these tools by CEOs and other missionaries. . That’s pure conjecture on my part. But even if I’m wrong, long-term trend’s traits in major equity market drawdowns are a very nice second prize.
  • I’m less inclined toward the managed futures / CTA behemoths. By definition, I think more adaptable strategies capable of turning off models that aren’t suited for the environment – maybe on similar grounds to what we’re arguing, and maybe on more sophisticated ones – will be the winners. The megashops in this space have created capacity and liquidity through strategy stratification that tether them to relatively more static approaches, or else would force them to significantly reduce risk budgets (which many have already done as they’ve transformed themselves into management fee shops).
  • I think, at the margin, I prefer strategies more heavily driven by absolute time-series momentum vs. cross-sectional strategies, although they are perfectly acceptable complements, as well. Both have a role. But I think the bigger abstractions and narratives will require us to capture beta effects (i.e. I want strategies more capable of making non-offsetting directional bets).
  • As an aside, I think if Elon Musk wants to get this thing back on track, he needs to control his own cartoon and embrace his role as Tesla’s missionary again. Among…uh…a few other things. I’ve never owned the stock and I never will. But unlike most people at this point, I really do want Elon to succeed. Yes, really.
  • Maybe most importantly, we have all intuitively adopted ‘trend-following’ thinking in our normal portfolio construction behaviors. After a pleasant decade for risky assets, most of us have internalized a sense of stability in the trend in something like the S&P 500. It won’t allow you to predict the future. But awareness of narrative stability may help you to understand if and when the narratives supporting the “just keep it simple and buy SPY” heuristics start to break down.

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They ALL Came in Through the Bathroom Window


Revolver usually gets the critical nod, but for my money Abbey Road is the superior album.

The A-side is a discontinuous mélange of styles, a sampler of everything the Beatles had to offer at the peak of their powers. The pressing rock beat of Come Together, John’s apparent anti-Reagan theme song. Something, the second best love song of the 1960s, after the Beach Boys’ God Only Knows, which remains the best love song yet written. After that, it’s a granny song, screaming doo-wop, octopuses and a dragging blues riff that washes out into white noise and then abrupt silence. The A-side of Abbey Road alone would still be in the top 50 rock albums of all time.

The B-side couldn’t be more different. Instead of experimenting with the juxtaposition of a silly Ringo song with a sonically and nominatively heavy bit of John and Yoko-style philosophy, the B-side is a medley of interconnected musical and lyrical vignettes. After the interlude of one of the Beatles’ most richly harmonized and probably most polarizing songs (Because), the rest is a single piece in eight parts. It starts with an overture and carries through various obviously and sometimes less obviously linked little stories, ending with the famous closing karmic line: ‘And in the end, the love you take is equal to the love you make.’ Perfect.

After a brief period of thinking my wife (named Pam) would get a kick out of Polythene Pam that ended when I remembered the rest of the lyrics, I settled on my favorite number in the medley: She Came In Through The Bathroom Window. The reason I was always fascinated by the song, I think, is that of all the stories told on the album, its story was the one that sounded like it had to be true. Like something that really happened.

And it did happen. Sort of. You see, there are all sorts of different claims to being the inspiration for the song.

The Apple Scruff

The most popular version of the story goes that a fan named Diane Ashley – one of the Apple Scruffs who waited around the studio all day for a glimpse of one of the Beatles – found a ladder from the garden up to the bathroom in Paul’s home. Once when he was away from he house, Diane claims to have entered the house and stolen a few things, including a framed picture of Paul’s father that was later returned. This, so Diane’s widely accepted story goes, is the inspiration behind the brilliant line: ‘She could steal, but she could not rob.’  

The Moody Blues

Moody Blues keyboardist Mike Pinder says something different. He claims that he, fellow bandmember Ray Thomas, and Paul McCartney were hanging out one day, regaling Paul with the story of a young woman and fan who, ahem, found her way into Thomas’s room through – you guessed it – a bathroom window. Mike says Paul picked up a guitar, started strumming and sang the words, ‘She came in through the bathroom window…’

The Dancer-Thief

More recently, a third story has emerged on the internet. A dancer named Susie Landis – who now goes by Landis Kearnon – claims to have been paid $1,500 to steal the master of A Day in the Life from David Crosby’s house. They climbed through a muddy backyard to (yup) a bathroom window that gave them access. They found the master and drove it across town to their employer, who copied it and engaged them once again to return it. Why did he want the copy? As the story goes, a local radio station (KHJ) paid to be able to air the song, which had been previewed for a number of artists and had developed quite a reputation before its first public airing. Apparently the early airing infuriated Paul, giving him ample cause to pen a song about it.

The story is a bit suspect, perhaps, given the number of dimensions on which the storyteller fits her story to the song. For example, she claims that her father had blackmail material on Crosby, which apparently motivated the ‘protected by her silver spoon’ line. And of course this thief was usually a dancer (‘she said she’d always been a dancer’), and knew a Detective Monday, who called producer Billy Monday, who called Tuesday Weld, who called Paul, about the incident (‘Sunday’s on the phone to Monday, Tuesday’s on the phone to me’). A bit too on-the-nose, but true-sounding details around events that did happen are always enticing.

The Artist

Of course, when it comes to any Paul rumor, you could always count on John to lob in an off-hand comment that confused the whole matter. In a 1980 interview included in David Sheff’s All We Are Saying, Lennon said the following:

That’s Paul’s song. He wrote that when we were in New York announcing Apple, and we first met Linda. Maybe she’s the one that came in the window. I don’t know; somebody came in the window.

The Conspiracy

While not nearly as popular as the Dark Side of the Moon / Wizard of Oz urban legend, some Beatles fans claim that between five and six seconds into the track, after “Oh, Look Out!”, you can hear someone quickly saying “Linda Eastman.” I…don’t hear it. But someone is definitely muttering something, and OK, maybe it sounds a little bit like ‘Eastman.’

Stories like this are interesting enough. They’re more interesting when they tell us about the relationship between narratives and facts. One of the reasons that “but, because, therefore” are such good tells for abstracted, fiat news is that direct strings of causality are extraordinarily hard to identify. When we read a story that seeks to attach facts to an explanation, or which seeks to tell us what those facts mean, or which seeks to tell us why the market or a stock is doing this or that today, we not only subject ourselves to the judgments of the author. We also subject ourselves to the fact that most realities are heavily overdetermined. That’s a $10 word for the kind of thing that is so related to so many different drivers that we could easily use those drivers to explain more than 100% of the thing. And if you’re not careful, you’ll buy into explanations that try to do exactly that.

I would be shocked if at least two of the Bathroom Window theories weren’t at least partially true. I would be shocked if there weren’t several other experiences that influenced the lyrics, too. I would be shocked if half the lyrics weren’t simply the fanciful output of a generation’s best songwriter.

But the lesson adds a bit to our rules for reading financial news:

  • Ask “Why am I reading this now?”
  • Look for the tells of fiat news: “but, therefore, because”
  • Be on guard for overdetermination. Confident attribution of causality is another tell of narrative, and of fiat news.

O God, Make Me Humble


Caesar: What’s under the sheet?

Marcus Vindictus: Sheet? Oh! Oh, the sheet. Yes. To begin with, number one, a beautiful hand-carved alabaster bathing vessel!

Caesar: Nice. Nice. Not thrilling…but nice.

– History of the World, Part I (1981)

There is only one prayer I know which God always answers: ‘O God, make me humble.’

When I was growing up in Minooka, Illinois, I was a nice kid. I was also an insufferable know-it-all. To be fair, I wasn’t the smartest in my school. That honor belonged to Andy Kimble, a math genius who went to USC to study film. He’s now an editor for several television shows. Still, I had a reputation for knowing way more than I ought to have about far too many topics.

There was more than a little bit of small pond effect to this. I have already confessed, after all, to my status as Medium Talent. It’s a big world, and the sooner you realize how many millions of people can think circles around you, the sooner you find your place in it. Ben and I both participate in a fairly competitive online trivia league. Within the hierarchy of the league, I am placed in what is called the “B-rundle”, which is exactly what it sounds like. Nice. Not thrilling…but nice.

My one great recurring memory of being young and in school, however, was the joy with which people responded to discovering that I didn’t know something. My fifth grade teacher. That time I spelled ‘handkerchief’ wrong in a spelling bee in 7th grade. The first time I said the word ‘banal’ out loud. The time I pronounced ‘Mussorgsky’ as ‘Musso-gorsky’ in an orchestra rehearsal, and embarrassingly insisted that it was an accepted alternate way to say it. The scarier thing, of course, was how I responded to all these mostly harmless jokes at my expense. How desperately and successfully I hid the fact that there were a LOT of things I wasn’t understanding, and topics I didn’t completely follow.

At a young age, I found that I enjoyed the idea of being thought of as knowledgeable and intelligent, maybe as much as I enjoyed actually being those things. I also realized with some surprise that the payoffs of the two were usually pretty similar – the tangible payoffs that were immediately evident, anyway. And pursuing the former was a hell of a lot less work.

No self-flagellation here. As it turns out, there’s a growing body of research into how the real and perceived value of ability-signaling is effectively stunting true pursuit of education across the board. Bryan Caplan writes about it a great deal in his recent, provocative book The Case Against Education. Much more recently (i.e. this month), two Harvard researchers and one from Stanford released an NBER working paper on the topic called Signaling, Shame and Silence in Social Learning (h/t @RobinHanson). It’s an academic paper, but it is an interesting read. It will also be useful to anyone more generally interested in the intersection of narrative and metagame playing. But at its core, it seems to confirm that the negative ability-signaling associated with implying that we don’t know something keeps us from asking questions even when we should. This is a major problem of social organization. These people are not acting irrationally. In just about every major social sphere, we have created a system in which it is absolutely in our socioeconomic best interest to maximize our ability-signaling, even at significant cost to the thing we are supposedly signaling.

I have never seen an investment firm that has really solved this problem.

Bridgewater has famously, valiantly tried. They’ve done better than most. ‘Radical transparency’ goes a long way toward addressing the costs and benefits of expertise vs. perceived expertise. So does the embrace of mistakes and the attractive concept of a meritocracy of ideas. But even the Bridgewater code systematizes ability-signaling through ‘believability-weighting’.  If you don’t think managing your reputation – even at the cost of asking questions when you don’t know the answer – is as important on Glendinning Place as it is on Wall Street, you’re kidding yourself.

But at least they’ve tried.

And so must we all. It is critically important. To the extent we incentivize ability-signaling, we impair humility. To the extent we impair humility, we degrade every decision-making process we may have. The problem I described in the Cornelius Effect was one in which, beyond a certain point, increases in talent and expertise of advisers and investment professionals tend not to manifest in better outcomes. This problem is partially external. With a world full of brilliant people, believing we can find the person who can tell us the answer through singularly brilliant insights is a fool’s errand. It is also partially internal. Humility is a necessary precondition for a talented person to make himself or herself part of a process.  

But the prayer required of the organization that would actively stamp out the trappings of ability-signaling – O God, make me humble – is perilous. When you tell everyone about your vision, they will say that it is such a good idea! So long overdue! We love how transparent you are! Break the old patterns of our industry! Twelve months later, when they’re flipping through your deck, it will be different. They’ll read the bios. Hmm…what school is that? I like the strategy, but the PM’s background looks spotty…I haven’t even heard of these firms she worked at. The analyst they introduced us to seemed to be really well connected to the PM’s thinking, but remember that analyst at the other firm? He knew everything about that company! Now that was impressive!

I’m making this up, but we both know that I’m not really making this up. This isn’t an indictment of allocators or decision makers or fund managers or…anyone, really. It’s an indictment of the fact that we built an industry on professionals exploiting the knowledge gaps of their clients. It’s an indictment of the fact that the solutions we created to prevent charlatans and criminals from pursuing that exploitation were prudent man and other standards designed to minimize the appearance of risk instead of minimizing undesirable/uncompensated risk.

It’s time to revisit these standards.

This won’t be the last time we write about this.


The Tells of Fiat News


I was reminded of an old video this week (h/t author Robert Kroese) featuring two of the most creative people in America: Trey Parker and Matt Stone. They are, uh, pictured on the left and right above, respectively. The creators of South Park and Book of Mormon, Parker and Stone are famously irreverent, productive and capable of creating surprisingly incisive social commentary on 2-3 days’ notice. They have a lot to say about storytelling. At an NYU writing seminar back in 2014, they said a lot.

You can watch the video clip here, but a transcript of the key bit is below:

Trey Parker: Each individual scene has to work as a funny sketch. You don’t want one scene that’s just like, what was the point of that scene? We found out this really simple rule that maybe you guys have all heard before, but it took us a long time to learn it.

We can take these beats, which are basically the beats of your outline, and if the words ‘and then’ belong between those beats, you’re f***ed. Basically. You’ve got something pretty boring.

What should happen between every beat that you’ve written down, is either the word ‘therefore’ or ‘but’. So what I’m saying is that you come up with an idea, and it’s like ‘so this happens’ right? And then this happens,’ no no no no! It should be ‘this happens, and therefore this happens. But this happens, therefore this happens.’

Literally we’ll sometimes write it out to make sure we’re doing it.

We’ll have our beats, and we’ll say, ‘okay this happens, but then this happens’ and that effects this and that does to that, and that’s why you get a show that feels like this to that and this to that but this, here’s the complication, to that.

And there’s so many scripts that we read from new writers and things that we see …

Matt Stone: F*** that. I see movies, f*** man, you see movies where you’re just watching, and it’s like this happens and then this happens, and this happens — that’s when you’re in a movie and you’re going what the f*** am I watching this movie for?. It’s just like: this happened, and then this happened, and then this happens. That’s not a movie. That’s not a story. Like Trey says it’s those two, ‘but’, ‘because’, ‘therefore’ that gives you the causation between each beat, and that’s a story.

This is among the more concise, actionable advice I’ve seen about storytelling and writing, fields which tend to attract uselessly impractical or vague recommendations. But it is also a perfect illustration of how news is transformed into fiat news. News is and ought to be exactly the thing which Parker bemoans – a series of linked ‘and then’ statements. Holding multiple truths in our heads (#AND) in this way is powerful. It is also boring.

But more often than not, too many journalists, so many of whom entered the industry out of a desire to ‘change the world’, now approach a topic having already decided the ‘beat’ toward which they must steer the story. Ideas, principles and conclusions they consider self-evident, powerful or provocative. Important. Instead of descriptions of what took place, stories are connected with ‘but’, ‘because’ and ‘therefore.’

These are the mechanics of effective storytelling. These are the tells of Fiat News.

When you open news, get in the habit of searching for ‘because’, ‘but’, ‘therefore’ and ‘however.’ Search for ‘nonetheless’ and ‘as a result.’ More often than not, it will give you a sense of the underlying intent of the author outside of the facts being presented. 


The Grammar of Risk


Butch: Alright. I’ll jump first.

 Sundance: No.

Butch: Then you jump first.

Sundance: No, I said.

Butch: What’s the matter with you?!

Sundance: I can’t swim!

Butch: Are you crazy?! The fall will probably kill you!

Butch Cassidy and the Sundance Kid (1969)

Now, I’m going to love you
Till the heavens stop the rain
I’m going to love you
Till the stars fall from the sky for you and I. 

Touch Me, by the Doors (1969)
Not even the Gods above
Can separate the two of us
No, nothing can come between You and I

You & I, by One Direction (2013)
Oh yeah, well, I’d rather die
Without you and I.

You and I, by Lady Gaga (2011)
Ain’t nobody in the world but you and I.

You and I (Nobody in the World), by John Legend (2013)
Between you and I darlin’,
Nothin’ could get better baby.

Between You & I, by Jessica Simpson (2006)
As long as I got you
As long as I got me
As long as we got you and I.

You and I, Kenny Rogers (1983)

I saw a funny little poll earlier this week from Bloomberg Opinion writer Noah Smith. “Which do you think,” it asked, “is correct grammar?” It then provided readers with two options:

  • “Come with Bob and I”
  • “Come with Bob and me”

Nearly one-fifth of what one would presume is a reasonably literate bunch picked the wrong answer. But this error is unlike the many other common language gaffes. You know the ones I mean. They’re/their/there. It’s/its. These are the kind of mistakes that are usually the result of someone simply not knowing what’s correct. Or forgetting. Or not caring.

But “come with Bob and I” isn’t the result of ignorance or indifference. It is the result a lesson badly taught and badly learned.

You see, there is no more present problem for elementary and middle school English teachers than the rampant misuse of the objective first-person pronoun in a series. In other words, just about every kid in America grows up saying, “Me and my friends are going to the park!” I am not sure why it is that every school and in America is so laser-focused on this quirky usage, which is far too ubiquitous and colloquial at this point to stamp out.  Say it in a school in America, and it will be corrected. Every time. Which is probably fine, I guess.

And it would be fine, except that the lesson inevitably becomes part of a recurring lesson plan on using nouns and pronouns in a series. Students are hammered year after year with “Jack, Jill, and I” exercises that unintentionally reinforce the idea that what matters is using the first-person subjective/nominative when referring to yourself in a series, and to always put yourself last. The latter lesson is utter hogwash, and the former lesson is fine as far as it goes – that is, until it becomes clear that most young English speakers have internalized a non-existent relationship between series of nouns and the subjective/nominative ‘I’. That’s how we end up with the lyrics to all those songs that will now set your teeth on edge every time you hear them.

You’re welcome. Since I’m already wielding this power, you now also have the Kars-4-Kids jingle in your head.

The confusion about ‘I’ is also one of the clearest examples I know of to describe what happens when you learn or teach people the answers to questions, instead of the process by which they will find answers in the future.

By the way, Happy Black Monday anniversary. You know, the day that we read opinion and feature articles about what went wrong and what lessons we learned?

One or more of the pieces usually turns into a brief survey-of-crashes piece. Here’s an intro to those portfolio insurance products back in ’87. Here’s what LTCM did just a decade later. Here’s a summary of the 2007 quant meltdown. Here are the proximate causes of the Global Financial Crisis. After this, you will learn about the actions that investors took to ensure that those things couldn’t happen to their portfolios and strategies again. We introduced this new risk measure. We stopped buying this kind of product. We sold this fund that didn’t work right during the crash. We stopped trusting computer models to run our money. We fixed this faulty assumption in our model. Finally, you will learn about the scary parallels today. Program trading! Trade disputes with Asia! Risk-targeting asset allocation strategies built around correlation estimates!

If you don’t know what I’m talking about, stop and find a hedge fund that publishes stress tests with their quarterly fact card or investor deck. Talk to them about how those stress tests are conducted. Then come back to this note when your brain asks itself, ‘Wait, you mean they’re just telling me what their current positions would do if every asset performed exactly like it did in that event 30 years ago?’

These are answers. They aren’t just not useful. They have negative value. They make you see ghosts. They waste your time. They prevent you from taking what are perfectly prudent steps to diversify, hedge and get the right level of risk in your portfolios. So in celebration of this anniversary and the opportunities it affords to learn lessons badly, let me instead offer a heuristic and a process I learned from Brad Gilbert, Matt Strube and Todd Centurino, my friends and former colleagues on the hedge fund team at Texas Teachers. It has served me well.




You can almost always get away with one. You can almost never get away with three. In a normal market you can handle two. In a bad market you can’t. I’ve been toying with adding Abstraction to my little list, but it’s tough to measure. This is the grammar of risk. These – not algorithms, not derivatives, not some specific mix of news events that matches a prior crisis, not some other lesson badly learned – are what will blow you up. 


Investment Diligence and the Cornelius Effect


Earlier this week Ben wrote a note about the Curse of Some Talent. There is a related idea that comes with a story. This is one of my favorite stories. It recounts a seminal event from the earliest days of Saturday Night Live.

The inaugural cast was a gifted one. If, like me, you weren’t there, it included John Belushi, Gilda Radner and Dan Aykroyd, among other generational talents. It also included Chevy Chase. His stint would be brief. After one full season in 1975 and a few episodes in the 1976 season, Chevy left the show. He claimed that he did so because his fiancée wasn’t willing to live in New York, which may have been true. The cast and many others, however, believed he left to quickly cash in on the platform and fame their young repertory company had provided him. He was a star, and they weren’t (yet). He was Chevy Chase, and they weren’t. And by all accounts, his behavior quickly started to reflect that belief.

And then, just as quickly, he was gone.

Chevy was replaced by a 26-year old actor named Bill Murray, only six years removed from having been arrested at O’Hare for possession of 10 pounds of marijuana. True to form, he was only caught because he made a joke about smuggling weed to the passenger sitting next to him.

Bill and Chevy overlapped a bit during Chevy’s transition, and did not get along. But John Belushi and Chevy really did not get along. And when Chevy came back to host the show in 1978, Bill, being the force of nature that he was, was enlisted by John and the rest of the cast to confront Chevy. The entire week of rehearsals was a mess of accusations and rancor. It escalated into insults, first about Murray’s complexion, and then about…well…Chevy’s prowess, to put it delicately. The confrontation culminated in a physical altercation at one of the final rehearsals. Upon being separated, a furious Murray pointed at Chevy and delivered the real pièce de résistance:

Medium Talent.

God, what an amazing line. It was the most cutting possible blow. Unanswerable. It wasn’t so absurdly critical that it could be brushed off as a mere insult. Instead, Murray found the thing that a star quickly elevated would most fear, and laid it bare for everyone to hear. To be fair, Cornelius Crane Chase is talented and funny. Far more, probably, than you or I. Do his natural gifts exceed those of 99% of Americans? 99.9%? 99.99%? Almost certainly. But at least in the opinion of his castmates, that wasn’t enough. And while I don’t know enough about the craft of comedy to issue my own opinion, I know enough to agree with Bill Murray, Jane Curtin and John Belushi on the subject.

Alas, the investment world, too, is cursed with the problem of Medium Talent.

I am an investor of Medium Talent. Ben is a Medium Talent. Most of the investors I’ve ever worked with were Medium Talents. Almost every fund manager I’ve ever invested with, and almost every analyst I’ve hired. Unlike Bill Murray, I don’t mean this as an insult. The term simply describes the reality in which, beyond some baseline threshold, further increases in talent, intelligence and skill are not the factors which influence outcomes. What’s more, it describes the basis on which our expectations for ourselves and others continue to rise despite the declining relevance of increases in those traits. Maybe this phenomenon already has a name. In honor of Chevy, however, let’s call it the Cornelius Effect. Here’s a No Talent sketch of what I mean:

The Cornelius Effect pervades the identification of talent across many – although certainly not all – fields. It is ubiquitous in financial markets. It governs how we hire analysts. It governs how we hire fund managers. It governs how we hire financial advisers. It governs how we invest in management teams.

If your organization is like any investment organization I have been a part of or have performed due diligence on, each of those talent identification processes can be distilled into a simple philosophy: hire or invest with the smartest-seeming person everyone seems to like. Oh, we almost always make some attempt to find useful proxies for these traits that permit us to feel like we’re evaluating some other characteristics as part of a targeted process. This is a cartoon. As an industry, we hire based on our perception of intelligence. Maybe you think you or your organization don’t do this. And maybe you really don’t. But I’d ask you to really think about your last few decisions before you draw that conclusion.

Up to a point, emphasizing intellectual talent is kind of what we should be doing. The work isn’t trivial, and simple measures of intelligence are still a far better indicator of outcome than the skill inventories so many HR departments emphasize. You know, the kinds that search for resume keywords of skills that the average human could pick up in a week or so? It is also certainly the case that there ARE some legitimate investment activities which require a bit more horsepower. But in context of the very high average intelligence of people in this industry, the threshold of intellect at which the traits we are seeking out should shift to traits related specifically to our process – or theirs – is low. Much lower than most people think. By and large, if you are hiring managers, advisers and staff by trying to find the smartest PM/FA/consultant/analyst you can find, this practice will lead you to constant surprise and disappointment.

I’ve got a lot more to say about how the Cornelius Effect ought to influence our diligence processes for these advisers and professionals, but all of these concepts orbit around the belief in emphasizing process over the idea that we’re going to find someone with the answers. When we are hiring, doing this requires us to have a clear-eyed view of the part of our process which we believe is truly value additive, and for which aspect of that process this individual would be responsible. When we are selecting a fund manager or adviser to work with, we must first develop a clear (or as clear as it is really possible to be in this muddy mess of markets) mental model of what it is about their process that should theoretically be capable of producing better outcomes. Our diligence questions then become less about ascertaining just how blindingly brilliant and knowledgeable they are, and more about judging whether they have the intellectual and temperamental traits necessary to execute that process.

The alternative is to be stuck with the constant disappointment of Medium Talent.


Locusts’ Lament


After publishing a few In Brief pieces featuring Quid-based narrative maps, we received a number of emails from subscribers asking us for analysis on other topics. 

For those who have read prior notes, you will know that what I usually find most interesting are areas in which otherwise similar topics or words engender very different sentiment and narratives, or in which different universes of authors, commenters and missionaries conjure up different narratives tailored to produce separate responses from distinct audiences. When one long-time reader expressed curiosity about narratives around private equity, I was intrigued. Its results surprised me. But it wasn’t until I checked it against a comparable topic that I found the narrative dimension I really wanted to explore.

First, let’s take a look at the narrative map – as usual, with major cluster names joyfully designated by me with both flippancy and bias – for private equity in 2018.

Like the historical treatment of the big tech stocks in media I highlighted last week, media treatment of private equity in 2018 has been glowing. Of the more than 3,100 news stories referencing private equity this year, the positive-to-negative sentiment ratio was nearly 16-to-1. What is more interesting, perhaps, is that a huge number of these stories are using very similar language, terminology and structure. Shown graphically, you see this as the almost non-existent distance between the various clusters. The stories about what allocators are doing are frequently also about dry powder, and frequently also about operational improvements and valuations. In rare cases, they spare a moment to reference the loss of generational businesses, factories, storefronts, high street shopping districts and jobs.

You would be forgiven – especially after the big tech piece – to question whether my priors about the infrequency of this kind of sentiment about financial topics are inaccurate. So let me show you another narrative map. This time? Hedge funds. Same period. Same sources.


First, let’s talk about the sentiment. Remember how the ratio of positive-to-negative for private equity was nearly 16-to-1? For hedge fund stories, that ratio is about 0.3-to-1. In other words, that’s a 3-to-1 ratio in favor of articles written with negative language, terminology and structure. To be clear, some of that is going to be picked up in periods of bad performance just by factually representing that performance. But interestingly for 2018, hedge fund performance has not been especially bad relative to traditional assets or other alternatives. In fact, some hedge funds are having a decent year.

More importantly, the negative sentiment pervades the stories that cover hedge funds on just about every topic. The same glowing discussions of operational improvements by private equity are all about the uncomfortable language of shareholder activism when it comes to hedge funds. Basically the only clusters with non-toxic sentiment are (1) excited discussion of cryptocurrency fund launches and (2) exposés into how difficult it is to get hedge fund jobs.

Fascinatingly, as you see from the relatively distinct clusters, there isn’t a recurring narrative. Nothing that really creates strong links between all these articles, besides the idea that hedge funds are bad. It is simply a topic about which common knowledge is so strong that just about any pot shot will land. There’s no need for any art – just mail it in. Hedge funds are the range pickers at any driving range in America – an irresistible target, and one for which the attacker is unlikely to ever get anything more than the most perfunctory tsking from another golfer.

You won’t find me or Ben arguing that there isn’t truth in some of the stories. We’re on record, for example, opining that the most positively selected trait for hedge fund PM success is probably sociopathy. But the idea that every activist PM is Gordon Gekko and every MD at a buyout shop is Mother Theresa is pure narrative.

Ultimately, however, this is what the lazy, complacent cartoon formed around a view that has been correct for a very long time looks like. Lest we let all this discussion of narratives get in the way of the facts, let’s recall that hedge funds have had a very bad run of performance in almost every category in comparison to nearly any other alternative strategy or traditional asset class. On an absolute and on a risk-adjusted basis. Private equity has performed much better, and because it is usually treated as an either/or with hedge funds by financial and broad media who don’t really understand the very different roles they play in portfolios, some measure of difference in treatment is appropriate.

But there are still some lessons to be gained here:

  • Hedge fund managers: Start playing some metagame again, for God’s sake. Aren’t half of you supposed to be WSOP headliners?
  • Private equity fund managers: Yes, you’re very smart. Everybody says so. But if you care about the long-term integrity of your franchise and your investments, be especially cautious about believing your own bullshit right now.
  • Allocators to alternatives: I would be obsessively focused on finding hedge fund managers with process that has been resilient to the last 10 years, even if it hasn’t worked, and on private equity managers with humility and introspection about the sources of their success over the last 10 years.
  • Everyone: I would be cautious of consultants or advisers whom you observe painting either strategy with a broad brush today. If someone is pushing private equity to you aggressively as a panacea, or seems to constantly, strangely bring up vague criticisms of hedge funds, you’ve probably found the easy mark the missionaries were looking for. That is usually a good sign that this consultant or adviser is not the guy or gal YOU are looking for.

If you’ve got other topics you’d like us to examine under this lens, be sure to drop them into the comment section here.


When Good Words Go Bad


More than four years ago – when Epsilon Theory was still young – Ben wrote a marvelous note that discussed the importance of the meaning of words. Called The Name of the Rose (after the movie, the book and the Shakespearean reference, in that order, I think), Ben’s piece remains a must-read. It is the origin essay of our repeated encouragement to call things by their proper name.

Ben’s essay was also an early call to Clear Eyes and Full Hearts. Pursue with full hearts, he exhorts, communication with one another at the lowest possible level of abstraction. Walk with clear eyes, he cautions, knowing that those we encounter may communicate in heavily abstracted language, desiring to influence us to act against our best interests.

The complicating factor is that words also change meaning for innocent reasons. It’s something linguists call semantic shift. I don’t think it’s fair to ascribe ill intent to anyone for the fact that the last person who legitimately felt awe when he said awesome or awful was decades ago. We write about narrative, and so you, dear reader, should know that we are probably a bit wired to commit Type 1 errors on this topic. We are prone to occasionally see narrative and intent behind natural shifts in meaning. Mea culpa.

Even so, it can still be interesting to observe how words align with differences and changes in narratives among different participants in social, political and economic dialogue. For example, I’ve noticed anecdotally that the implication attached to a couple of words – acronyms, actually – seems to have changed a bit over the last year. So I took a closer look at it, and I think it’s true:

FANG and FAANG appear to be transitioning into pejorative terms.

Here’s why I think so.

First, a couple of Quid-based narrative maps. Each of these maps shows articles which referred to each of Facebook, Amazon, Netflix and Google, but did not use the term FANG or the Apple-inclusive FAANG. The map on the left is from all of 2017, and the chart on the right is since June of this year. The topics and their connectivity have changed. For one, these articles aren’t talking nearly as much about privacy, our trust in these companies or their reputation. Their sentiment, however, has remained very positive, and has even improved slightly. For every such article in 2017, there were five scored with positive sentiment for each negative one. In Q2 2018, that number was five-and-a-half.

Not much there.

Now take a look at the articles over the same periods which did use the terms FANG or FAANG. Like with the Fang-less group, we observe some shift in the major topics. In particular, Q2’s articles were far more likely than either the fang-less articles OR 2017 to start linking the concepts of privacy, reputation, valuation and what was going on in markets. More importantly, the sentiment of these articles declined by a lot. Articles referencing FANG/FAANG were just under twice as likely to be positive as negative in 2017. In the more recent period, more articles were negative than positive.

We have to acknowledge the obvious chicken-and-egg question here. Does the inclusion of the word FANG/FAANG in an article simply set it off as a piece that is likely to be from a markets-related publisher? Sure, although recall that the first set are articles that must reference ALL of the members of the group in the same article, so there is more overlap in sources than you might think. Does a bias toward markets-focused publishers mean that the negative sentiment shift is mostly representative of those articles covering weaker market performance of these stocks more than articles that are more generally about the companies and their products? In part, although it is worth noting that the ratio doesn’t change if you exclude the October stub period. More importantly, we don’t just observe that negative sentiment shift within stories about markets. The shift is taking place in articles about content, streaming and privacy. The shift is taking place in articles about the outlook for these companies that don’t really reference market activity.

What does all this mean?

  • I don’t think there’s enough to say it means that there’s a negative general narrative forming around the big tech companies.
  • I do think it is interesting to observe that as broader media seem to be developing fatigue and drifting away from any narrative about these companies that is linked to privacy, anti-trust and regulation, market-related news seems to be much more frequently integrating these concepts into the stories they are telling about price, valuation and market activity.
  • I do think it’s worth observing that FANG and FAANG have shifted to terms with negative meaning, even (in my opinion) beyond their relationship to market activity.
  • I don’t know if that’s part of bias or intent by any party to promote a narrative.
  • I do think that I would be asking “Why am I reading this NOW?” when I saw these terms used for the time being.

Why Am I Reading This NOW? 10/12/2018 Edition


In the spirit of Ben’s In Brief from last Sunday – Why Am I Reading This NOW? – I thought I would share a few others that popped up in my daily news routine today.

Uber CEO pulls out of Saudi conference after journalist’s disappearance – CNN – 10/12/2018

Richard Branson pulls out of $1bn investment talks with Saudi Arabia over missing journalist” – Independent – 10/12/2018

Report: Turkey has proof showing Saudi journalist Kashoggi was killed – CNBC – 10/12/2018

Silicon Valley’s Saudi Arabia Problem – NY Times (Opinion) – 10/12/2018

This story has been percolating a bit, and for good reason. Some of the implications of this situation are positively vile, and there’s no indication that any of this is ‘fake news.’ It is, frankly, far more encouraging than discouraging that prominent personalities and leaders are starting to take a stand on this kind of behavior from S.A. But if you’ve been paying any kind of attention to the Arabian Peninsula over the last few decades, shock and surprise at the murder of a journalist are, shall we say, odd reactions, if long overdue. So why am I reading this NOW?

Behind Market Turmoil, Potentially Good News” – WSJ – 10/12/2018
Interest rates are far below historical definitions of normal. Optimistic analysts believe the economy could have years left to run, and that the stock market selloff will prove to be a temporary bout of indigestion.

“Sector Focus” section of (10/12/2018)

There’s nothing wrong with the sentiment or content in the WSJ piece or the Barron’s section here. Most sell-offs do prove to be temporary. As a rule, most economic environments DO have years left to run. But announcing these truisms as ‘good news’ above the fold on the web edition? And sure, Delta hanging in there is an interesting story, and…yeah, I guess things could obviously be a lot worse. But why am I reading this NOW?

“Treasury Secretary Mnuchin describes Wall Street’s 2-Day plunge as a ‘natural correction:’ economic fundamentals strong” – Lead story on, Banner Headline on, Chyron on CNBC – 10/12/2018

I won’t insult your intelligence by even posing the question, y’all. They are clearly just interested in making sure you didn’t miss this important…news.

FOX News First Alert: Kanye-Trump meeting drives Hollywood crazy” – Fox News – 10/12/2018        

Analysis: Why Kanye’s lunch with Trump was a disaster” – CNN – 10/12/2018

“T.I. says his patience with Kanye is dead and gone” – CNN – 10/12/2018

Sometimes the question is ‘Why am I reading this at all?’

How the Red Sox Eliminated the Yankees, Inning by Inning” – NY Times – 10/10/2018

Why I am reading this NOW? Because the Yankees stink on ice. Thanks, Boston – shoot it, Houston Texas, go Astros!


Complacency and Concern in Robo-Land


Both Ben and I have had a lot of conversations about robo-advisors lately. I wrote an ET In Brief piece a few days ago to discuss some of my own thoughts about Vanguard moving into the periphery of the space. Robos have also come up in discussions with early-stage and VC investors, individual high net worth investors, traditional competitors and staff from the robo-advisors themselves.

The sentiment I’ve gotten from these discussions? Concern.

In some cases, that’s exactly what you’d expect. Traditional wirehouses and RIAs obviously dislike the model, because even if it isn’t directly competing away all that much business, it is starting to influence margins. But among fintech investors and company principals we have spoken to, the level of concern is similar, even if the issues are different. I am hearing about painful customer acquisition costs, rapidly accelerating competition eroding whatever margins there might have been, and a general sense of fear about what a real downturn in equity markets – if such a thing ever happens again – would do to a client base whose stickiness has yet to be proven.

Maybe I’m wrong, and maybe I’m projecting, but I haven’t had a positive conversation about robo-advisors with anyone in months.

So I thought it would be interesting to run the topic through Quid’s natural language processing engine, as Ben and I have been known to do from time to time. It clusters news stories from a wide range of sources around general themes based on various measures of similarity, links them to other nodes, and then qualifies the language to assign sentiment.

Below is the Quid map for Q2 and the beginning of October 2018 for robo-advisors. The boxed categories are mine.

My first observation is that when the financial and general media cover robo-advisors, the stories they tell cluster around one of two distinct Narratives:

  1. Robo-advisors are an exciting part of a machine-learning and AI-fueled set of innovations, including blockchain applications, that will revolutionize banking (the 3 clusters on the right).
  2. Robo-advisors are forever changing how financial services companies marry product, technology and advice (the 3 clusters on the left).

The only strong topical link between these two similar but clearly distinct Narratives? Millennials. C’mon.

My second observation, and probably the more important, is that the news treatment of robo-advisors isn’t just positive. It is incandescent. Of all the stories written, Quid’s engine categorizes fewer than 3% as carrying generally negative sentiment. That is very, very unusual for anything relating to financial services. In fact, I’m not really sure that I’ve ever seen it before.

I don’t have a strong take from this, other than to say that topics where different sources have vastly different perspectives tend to be the most interesting. It may also simply be the case that my anecdotal evidence is exactly that – just anecdotal, and not at all representative.

But I don’t think so.


Et in Arcadia ego


“And I said: Don’t you know that he said I will foller ye always even unto the end of the road…Neighbor, you caint get shed of him”

– Blood Meridian, by Cormac McCarthy

And rear a tomb, and write thereon this verse:

‘I, Daphnis in the woods, from hence in fame

Am to the stars exalted, guardian once

Of a fair flock, myself more fair than they.’

– Eclogues, No. V, by Virgil

There is a field at the end of a lane in Tennessee that sits long abandoned. A rusting livestock gate is held fast to the fence by heavy gauge wire, twisted by hand to keep it from swinging open. It may be that a caretaker once allowed sheep to graze here to keep the brambly bushes at bay. They have been absent for some time.

The name of the lane is Caldwell Cemetery Road. At its end is a graveyard of graveyards, a field of broken monuments and faded inscriptions set into soft Tennessee limestone. There are perhaps a dozen raised tombs besides. One hopes they are architectural and not sepulchral, because most are now little more than broken lean-tos, exposed on at least one side to the world and the elements. Far to the back of the burial ground, through tall weeds and bushes, a broken headstone lies on the grass. Rev. W. G. Guinn, it reads, born August 15, 1795. He was my fourth great-grandfather.

His son, one of the last of his short dozen children, died at 41. A few years later in 1892, that son’s wife dragged their seven children between the ages of 7 and 21 to Texas, where they became tenant farmers. It was a steep fall. You see, the Rev. William Guinn was an Important Man.

You would not go very wrong to say that the Methodist minister in the deep antebellum south was the most important man in town. While the Calvinists have since given way to the Baptists there, the swelling masses of pioneers and settlers who braved the Great Wagon Road through the Great Appalachian Valley of Virginia were, as a rule, Scots-Irish. Which meant that they were Presbyterian. Which meant that they were one camp meeting and a preacher on a horse away from being Methodists.

The preacher in a small town officiated marriages. He was the trusted arbiter of disputes. He was a voice of civil authority in letters to far-off politicians and governments. He blessed new homesites and new businesses. His church on Sunday would house the most concentrated version of a dispersed community. His home often served as the orphanage, homeless shelter and welfare office. All of this was true for the Rev. Guinn, beyond which he served as postmaster, justice of the peace and in many other roles over the course of his life. He may not have been the richest man in town. He may have been the most important.

And now his grave is forgotten and his monument broken, the fatal cracks no doubt caused by the fall of some ancient tree themselves already smoothed by rains and time. How long did it take for people to forget that they had even forgotten him? One generation? Two? Thirty years? Fifty?

There is a phrase I hear from time to time among investors and allocators: ‘our time horizon is infinite’. It is a phrase used to justify performance over other-than-infinite horizons, often very fairly. It is a belief used to justify illiquidity in investments, often very fairly. It is an expression sprinkled casually over all manner of short-termism and knee-jerk responses from boards, committees, bosses and constituencies. But within that truth, there is another that we should remember:

Your time horizon is not infinite. Your institution’s time horizon is not infinite.

To those who would roll their eyes and respond, “It might as well be. For all intents and purposes, it is effectively infinite,” please accept this amendment:

Your time horizon is not effectively infinite. Your institution’s time horizon is not effectively infinite.

‘Et in Arcadia ego’ is a stylization of a theme from Virgil’s Eclogues: even in Arcadia, there am I. The I, my friends, is death. Even in paradise, death is coming, and death is there. Even for our great institutions, for our university endowments and our great charitable foundations, death will come. This isn’t fatalistic. It isn’t morbid. It isn’t bearish. It can be bullish! It can be optimistic! Like a fire through the floor of a stagnant forest, the death that comes for these institutions may be their reformation into something newer and better. It may be great or small changes in the way society is ordered. It may be a change in their mission brought about by its achievement! One day we will conquer the diseases foundations have been established to research, and even that will be a death of a kind.

There are other deaths we cannot avoid. Smaller ones. Changes in governance. Changes in law. Changes in tax schemes. Changes in securities law and regulation. Changes in student loan markets. Changes in philanthropy and in centers of wealth. These are all a death for us as investors, because they may change what we ought to be doing, and because they may invalidate the strategies we employed before. Amid those deaths, we have one governing rule: 

Your time horizon is the shortest period over which you may be forced by circumstance, behavior, prudence, constituencies, governments or outside forces to sell what you own.

This may still be a very long time! And so it may be the case that this reality should have no influence on our portfolios. But it must have an influence on our frameworks, our process and our risk management. It should color our strategic asset allocation reviews, and it should be part of the language of our engagement with oversight boards and other constituencies.

If I may be permitted a post-script, it is my personal belief that it should have one more effect: Our great universities and grand foundations should be spending more of those endowments to better execute their missions today. A lot more. Et in Arcadia, ego.


Punting and the Tyranny of Risk Memes


Last Sunday, with just under six minutes remaining on the clock in overtime, the Dallas Cowboys faced a 4th down and 1 from their opponent’s 42-yard line. Jason Garrett, the Dallas coach, sent out his punting unit. In a matter of minutes, they would go on to lose to their in-state rival Houston Texans.

It was a monumentally and objectively bad coaching decision. It would have been a bad decision for any team in the league. It was an even worse decision for the Cowboys, a team with a quarterback/running back combination with a historical success rate of 94.7% converting 4th and 1 situations. As ESPN pointed out later that evening, that is a marginally higher success rate than the rate at which kickers have converted extra points since they were moved to the 15-yard line. If you are not a fan of American football, the extra point is typically regarded as a mere formality – an early chance to visit the restroom.

Because of their location on the field, the punt’s value was also lower. A punt into the end zone would cause a touchback and yield only 22 yards of field position. Because of this risk, punters in this situation are often accordingly more conservative, targeting higher punts that terminate around the 10-15 yard line to avoid the touchback. For the Cowboys on this day, a well-executed kick still netted only 32 yards of field position. In exchange for those 32 yards of field position, the coach of the Dallas Cowboys rejected a play which – for this team – had the success rate of an extra point, and which would have provided multiple additional opportunities to advance into scoring range. You could spend hours mining historical scenarios, splits and advanced statistics for some kind of support for the decision. You won’t find it.

The press conference that follows is inevitable and all too easy to predict. The coach will explain away the decision with the sort of milquetoast response we simultaneously demand and bemoan from entertainers. You know you will hear a variant of ‘We believed in our defense’. It’s a nonsense statement, of course, since the defense could just as easily make a stop at the 42-yard line if they failed to convert. You will hear an appeal to experience and being ‘on-the-ground.’ You will hear a plea that ‘every situation is different’ and a vague allusion to what was ‘unique about that situation’. But that isn’t the point. The point, like with so many memes and narratives, is to make us sit down and shut up. The meme used to produce this response was field position!

The coach who summons this meme wants to be seen as wise – a sage, prudent leader. And it works. Every time. No one ever got fired for punting for field position! Oh sure, the media and fans will criticize him for 3-4 days. It will get mentioned the following Sunday, and then never again.

Risk-related memes are everywhere in the investment industry, too. Like the memes in football, most are built on sage-sounding ideas.

The risk management! meme is probably the most popular. It shuts down discussion by subtly implying that others in the conversation are not sufficiently focused on prudently managing risk. If you want to get someone to stop arguing with you in an investment discussion, just imply that they aren’t being prudent. One senior investor at a prior stop in my career loved responding to well-considered investment recommendations from younger investors with some variant of, ‘It’s not about the doing all the good deals, but avoiding all the bad ones.’  It’s not that there isn’t some shred of truth in this. It’s that everyone in the room who hears this knows that the discussion is over, ended by someone who wasn’t prepared to discuss the actual merits of the investment.

Most others are built around the client’s best interest! meme. Want to get a sharp, ethical professional on your team to sit down and shut up? Imply he or she isn’t considering what is best for the client. It doesn’t have to be true. Once this meme enters the room, other discussions stop. Other considerations end. Don’t you care about the client? 

These memes are so powerful because our true obligations to prudently manage risks and act in clients’ best interests are so sacred. Like any other meme or narrative, they force us to take a side. To signal.

But make no mistake. When we take score – and we do – the institutions that allow executives and PMs to use risk memes to get staff to sit down and shut up will be the losers.

Every time. 


Mailbag: Deadly. Holy. Rough. Immediate.


A challenging question from reader David S. He quotes from and responds to an excerpt from Deadly. Holy. Rough. Immediate.

“Over very long periods, you will generally be paid based on the risks an average investor (including all of his liquidity sensitivities, his investment horizons, etc.) would be taking if he made that investment.” (from Deadly. Holy. Rough. Immediate.)

Isn’t this idea built on risk spreads, building up from the risk-free rate?  But in a world where central banks set risk-free rates for other reasons, is the concept of a risk-free rate even coherent?  In other words, does anyone really think Italian government debt is safer than U.S. government debt right now?

Again, it’s a useless theoretical question.  I think risk spreads work; will continue to work; and, even if I felt otherwise, I wouldn’t be foolish enough to try to predict the timing.  But how solid is the theoretical foundation on this one?

Over a sufficiently long horizon, I’d say it’s about a 6 out of 10 (which is about as good as it gets in this game).

There are probably more finance papers on the topic of the relationship between risk and return, or premia for the fancy among us, than any other. Many of them are purely empirical (e.g. what are the long-term Sharpe ratios of different asset classes over various horizons?). Many are purely theoretical (e.g. how should markets with mostly rational actors function to price risk?). Some are a bit of both (e.g. how much of variability in stock prices is driven by changes in expectations vs. changes in discount rates?). Even as a Hayekian who thinks that prices separate us from Communists and the animals, I’m kind of with you. To practitioners, the explanations and frameworks offered by these papers are often unsatisfying.

Over many very long horizons, the data will show you that the Sharpe ratios of major asset classes are similar. In other words, the relationship between the variability in price and long-term returns above a risk-free rate appears to be pretty consistent across assets. You’ll hear this factoid a lot in defense of the idea that long-term risk-adjusted returns of assets should be comparable if investors are at all rational. But this is one of those cases where I think we’ve got to be a little bit skeptical of a surprisingly geometric cow. One exaggerated example?


Their long-run Sharpe ratio is not far off from those of financial assets (this obviously depends on horizon – you’ve, uh, gotta go back for this one). But any sort of attempt to build a theory about why our return expectations for commodities should have anything to do with how volatile their prices are ends up looking like a dog chasing its tail. The practitioner sees this, because he sees how much of a commodity’s price changes are directly driven by non-economic actors, substitutability, seasonality, weather, extraction costs, storage costs, hedgers, etc. Plus, y’know, supply and demand.

This is part of the reason why many practitioners do NOT treat commodities – and this includes things like Bitcoin and other cryptocurrencies, by the way – as investable asset classes. We may have some expectation of their rise, but it is hard to determine in any meaningful theoretical way why we should expect to be paid with returns in any proportion to the risks we are taking on by owning them. Incidentally, I don’t think you need to believe there is a commodity risk premium to justify holding commodities in a portfolio. I would say the same thing about cryptocurrencies if I believed there was a state of the world in which they wouldn’t be treated as a highly correlated speculative asset in any kind of sell-off event for risky assets.

This isn’t just a commodity phenomenon. To David’s point, I think it is obvious that there is a portion of the risk we take in owning financial assets – stocks, bonds and other claims on cash flows – that we probably ought not to expect to be paid for either, or at least for which the smooth, ‘rational actor’ transmission mechanism between risk and the price demanded for it is perhaps not-so-smooth. Low-vol phenomenon, anyone? A half dozen other premia? But prices for financial assets are also hilariously overdetermined. That means that if we line up all the things that influence those prices, we will explain them many times over. It’s a topic that occupies the entire lives and careers of people smarter and more dedicated to the subject than I am, so I hesitate to give it the short shrift I am here. But in the interest of responding somewhat substantively, let me tell you in short what I think:

  • I think that the risk differences caused by placement in capital structure and leverage should have a pretty strong long-term relationship with return, because they describe an actual cash flow waterfall connected to economic reality. This is why I feel confident that I’m going to be paid some spread – even if it isn’t completely proportionate – for risks I take by owning risky financial assets.
  • I think that the risk differences caused by country and currency have a weaker relationship with return. You’ll be able to find examples where this isn’t true, but in general, capital markets still exhibit very local characteristics. Assuming that the differences in realized risk between markets in two countries will give us reliable information about how participants in those markets are pricing their relative risk may be pretty unrealistic.

In practice, I think that the first bullet alone is powerful enough to make it a foundational principle of portfolio construction. Perhaps the most important. I also think it is strong enough that it matters even if you think that a significant portion of price variability and movement is driven by abstraction, game-playing and narrative.

P.S. Folks, if you’re thinking about writing me that volatility isn’t risk, please don’t.


Surprisingly Geometric


“For pigs, the ideal was a football shape. Cows were rectangular, and sheep tended towards oblong.” – Ron Broglio, as told to Anne Ewbank

I came across a delightful piece in the marvelous Atlas Obscura this weekend (h/t to a similarly delightful thread on this topic from @ZeenaStarbuck). Written by Anne Ewbank back in 2017, the piece is all about livestock – and livestock art – in late 18th and early 19th Century England. It’s also a charming illustration of Narrative at work.

You see, the ultimate status symbol to a gentleman farmer in the early 19th Century wasn’t a framed photo in the subject’s 54th Street office of him sitting, wearing a John Deere vest and John Deere hat, on a perfectly clean John Deere tractor that is three or four series too large for his property. It was a painting of his cow. And in a perfect world, this painting would tell the story of a very large, very rectangular, surprisingly geometric cow. An absolute unit, if I may use the expression.

The prevalence of this art form raises a question: in what proportions is fat, rectangular cow art the result of (1) 19th century cows being more muscular and more rectangular, (2) 19th century dilettante farmers instructing artists to display exaggerated muscles and geometry, and/or (3) 19th century British artists being a bit shit?

It’s hard to know for sure. But the unrealistic body image foisted on this poor sheep, made manifest in a couple body parts I’ll leave you to identify, leads me to believe that our second reason above probably bears the lion’s share of responsibility. It was mostly story-telling.

But the things that were happening to cows, sheep and other increasingly geometric animals in the real world still played an important role in the storytelling process. Incremental improvements in certain desirable (I guess?) features through selective breeding permitted ever more fantastical imaginings of just where a sheep might develop a bulging new fat deposit. Those fantasies, in turn, were used as models in the breeding and improving of yet more animals. This bears a lot of similarity to how Ben characterizes bull markets as “climbing a wall of worry.” It’s an expression which describes how investors create artificial hurdles to pretend that they are performing critical analysis, but then construct ever more ridiculous extrapolations when those largely meaningless hurdles are miraculously scaled. Yes, but have you seen their growth in pro forma adjusted EBITDA per pixel?

In other words, beware the sheep with legs too skinny to support its body weight, and beware small truths used in service of big lies.


The Power of ‘AND’, and the Walmartization of Advice


Growing up in the beautiful swamp that is Brazoria County, Texas, you learned quickly that you took entertainment where you could get it. I’m not saying that it was boring, but having fun did require a certain amount of creativity. Some of the kids, by which I mean the ones who weren’t the drum major of the band and a member of the madrigal singing ensemble – y’know, cool kids – were rumored to collect in the fields owned by absentee cattle ranchers for pasture parties. I did not get invited to these parties. I’m not convinced they really existed.

The rest of us? Yeah, we hung out at the mall. Oh. Late Millennial readers, a ‘mall’ was a large structure which housed a variety of different stores, pretzel restaurants and a kiosk that offered, but to my knowledge never actually sold, small bits of ice cream flash frozen with liquid nitrogen.  Gen Z readers, a ‘store’ is like Amazon, but…anyway, the problem was that around 9PM, the mall closed. But there was a place, a magical place, which never closed. A place where the small town Texas kids who didn’t drink and were too awkward for words could go at any hour to have slightly-above-replacement levels of fun.


I don’t have to defend myself to you, and I won’t. I have an affection for Walmart. Even beyond my affection for the place, I think it has probably done more than any one other company to improve the quality of life of the everyday American. Walmart, along with generally free trade, have allowed the average lower and middle class American to enjoy technology, home amenities, foods and conveniences that we could only have dreamt of 50 years ago.

If you’ve got a “yeah, but” forming in your head, save it. I know what Walmart has done to many small businesses that offered a valuable niche service. God, I desperately miss having a small town butcher. I also know that a job at Walmart probably doesn’t offer the quality of life that most people imagined for themselves. If we’re going to survive the widening gyre, however, there’s a trick we have to learn.

We’ve got to learn to say ANDa heck of a lot more.

Yes, Walmart has improved the tangible quality of life for hundreds of millions AND I’m not sure any of that made us happier AND I’m not completely sure how to balance those things, which is why I’d prefer to let the market do so. We must be able to hold multiple truths in our head at once. The second ‘BUT’ and ‘OR’ escape our lips, we implicitly insert beliefs about the relationship between those facts, and about the weighing of those facts. We will have to do that at some point if we’re ever going to come to conclusions about things, but when we’re exploring questions – and when we are engaging with people about ideas – we ought to stick with ‘AND’.

So here are a few finance ‘ANDS’ for you: I think Vanguard may have done more for the average person than any financial institution in the last several hundred years AND I think that their aggressive move into financial advice will be a net good AND I think that it will lead to harm for many individual investors.

If you don’t know what I’m talking about, it’s this: Vanguard believes the next step in making investing work for normal people is making financial planning and advice less expensive. This is self-evidently true. The less investors pay, the more they keep. But it’s a bit more complicated than that.

There is a big difference between a fund manager and your financial adviser. For the average investor, the specific stocks and funds in a portfolio really don’t – and shouldn’t – matter that much. John Bogle realized this and changed the world. On the other hand, for the average investor, the decisions made with a financial planner and adviser matter a LOT.

Does that mean you should pay a lot for them? No, not necessarily. A lot of the decisions that matter a great deal have perfectly reasonable answers that are generalizable – by which I mean applicable to a lot of people based on shared traits – with just a little bit of information about the client. How much risk to take. What the diversification should look like. How liquid the portfolio should be. How to adjust allocations over time to reflect changing life circumstances. If someone tells you that you need to pay a lot for their advice on these topics, they are misleading you.

But here’s the thing: none of those topics are why you hire a financial adviser. You hire a financial adviser to keep you from doing something stupid. You hire a financial adviser to tell you the truth about that stock you’re thinking about buying with a huge chunk of your assets that they don’t manage. You hire a financial adviser to tell you ‘No’ when you call in to ‘place an order’ to a discretionary account that doesn’t take orders but the industry still kind of allows to take orders. You hire a financial adviser to keep you from endlessly tweaking to find the next big thing. You hire a financial adviser to keep you sane, and to keep you from firing them so that you can do something stupid, like sell, generate capital gains and go to cash after a 30% drawdown in the stock market.

Vanguard, Schwab, and many of the others are wisely expanding their advice models to include humans capable of doing these things. That’s a good thing. Not because the humans will add any valuable investment insight (sorry), but because most of us need both technological and human algorithms to manage our behavior. A lot of people will find that person at one of those institutions – which is great! Do it! AND I worry that a lot of investors are going to be drawn to these robo-plus-a-call-center solutions instead of pursuing a relationship with whichever adviser is going to keep them from hitting sell, sell, sell or buy, buy, buy at exactly the wrong time, even if it costs 30 or 40bps more.

For better or worse, we are entering the Walmartization of Advice. I know that sounds bad, but that’s only because you don’t like Walmart as much as I do. I say it with equal parts admiration and concern.