Margin Call


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

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

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

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

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

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

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

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

Often until it is too late.

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

Stories about the CCP.

Stories about the WHO.

Stories about the US federal and state governments.

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

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

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

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

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

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

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

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

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


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

Lack of Imagination


It has been a long week.

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

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

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

Sometimes at the same time.

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

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

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

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

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

It is also utter hogwash.

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

This behavior makes one blind to all sorts of things.

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

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

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

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

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

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

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

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

No photo description available.
Source: OpenTable

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

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

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

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

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

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

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

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

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

Like German Economic Minister Peter Altmeier.

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

Like Senator Ted Cruz.

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

Like Chinese Foreign Ministry spokeman Lijian Zhao.

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

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

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

Make America Autarkic Again [Claremont Institute]

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

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

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

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

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

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

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

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

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

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

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

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

Neil Gaiman, from Sandman

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

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

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

Take off the blinders and LOOK.

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

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

Dream: I am hope.

Sandman, by Neil Gaiman

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

That doesn’t mean being bullish.

It means having imagination.

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

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

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


First-Level Foolishness


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Just one problem with that:

The path that events follow matters.

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

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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


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

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

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

What does all this mean?

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

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

What do we do?

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

Shrink your book.

Keep your use of leverage at a minimum.

Keep your reduced reliance on covariance estimates.

Keep your trimmed down gross exposure.

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

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

What do we look for?

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

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

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

More on that to come next week.


The Non-Linearity of Need


I am writing this at home because I can.

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

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

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

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

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

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

To you, anyway. To those organizations.

But there are costs.  

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

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

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

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

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

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

What can full-hearted Americans do?

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

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

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

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

Places that can help


National Domestic Violence Hotline


The Community Food Bank of Southern Arizona

Bay Area, CA:

Mobility Matters

Alameda County Food Bank

Los Angeles, CA:

Manhattan Beach Business Association

Gardena Valley Japanese Cultural

LA Regional Food Bank

Fairfield County, CT:

Bridgeport Rescue Mission

Filling in the Blanks

New Haven County, CT:

Cheshire Community Food Pantry

New Mexico:

RoadRunner Food Bank

New York City:

Food Bank for New York City

West Side Campaign Against Hunger

Elyria, OH:

Save Our Children


Regional Food Bank of Oklahoma

Houston, TX:

Houston Food Bank

Springfield, VA:


Seattle, WA:

Kitsap Rescue Mission

Issaquah Food Bank


Oxford Food Bank


The Elton/Hootie Line


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

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

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

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

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

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

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

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

This will not be fair to Hootie.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

Source: Epsilon Theory, Billboard, Dynamic Range DB

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

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

It was.

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

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

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

And it matters.

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

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

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

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

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

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

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

That volume manifests in our emotions about political opponents:

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

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

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

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

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

A loud political environment IS a compressed political environment.

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

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

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

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

Consider this list of the major news events of 2019:

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

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

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

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

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

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

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

That isn’t it. At all.

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

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

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

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

Epsilon Theory is one. There are others.

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

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

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

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

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

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

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

Find your pack.

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

Epsilon Theory swag incoming.

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


Covid-19 Cargo Cults


In the South Seas there is a Cargo Cult of people.  During the war they saw airplanes land with lots of good materials, and they want the same thing to happen now.  So they’ve arranged to make things like runways, to put fires along the sides of the runways, to make a wooden hut for a man to sit in, with two wooden pieces on his head like headphones and bars of bamboo sticking out like antennas—he’s the controller—and they wait for the airplanes to land.  They’re doing everything right.  The form is perfect.  It looks exactly the way it looked before.  But it doesn’t work.  No airplanes land.  So I call these things Cargo Cult Science, because they follow all the apparent precepts and forms of scientific investigation, but they’re missing something essential, because the planes don’t land.

Richard Feynman, The Cargo Cult Science (Speech at Caltech in 1974)

A friendly reminder: this is general commentary and IS NOT investment advice. You should act based on your own situation, because this analysis is generalized and doesn’t take it into account. We don’t have a crystal ball. If we make forward-looking statements about the markets, they will often be wrong. Because we’re discussing tail risks, it may be INHERENTLY MORE LIKELY than not that we are wrong. Clear Eyes, Full Hearts.

I tease Ben sometimes for devoting his graduate studies to political science. Not because it isn’t a worthy field of study. I tease him because the idea of politics being a science is absurd on its face. And then he usually reminds me that my economics degree is nominally referred to as a science degree, too.

I am immediately chastened.

There are a lot of scientifically minded people in the investment industry. In general, this is for the good. I mean, of course it is. Investing in risky assets constantly appeals to our baser tendencies toward fear and greed. Worse, we do not respond to those appeals in isolation. We are surrounded by others who are watching us and responding to our actions for their own benefit. Process is a gift to investors.

And yet.

When we are free to be, shall we say, uncommercial, outside of the behavioral benefits accruing to process-adherence it is very difficult to find much that we do in the investment industry that is not what Physicist Richard Feynman called cargo cult science. When he wrote and spoke about cargo cults, he usually referred to very obvious pseudosciences like phrenology, astrology or reflexology. But his fundamental analogy is much more expansive, and in classic Feynman style, works in micro, macro AND meta. It is simultaneously an illustration of the practice of pseudoscience and the philosophy underlying pseudo-scientific practice.

If you imagine the islanders trying to recreate the landing of the airplane that brought goods and supplies, you are seeing the frustration yielded in the practice of pseudoscience. They observed a pattern: runway is cleared, fires are lit, man sits in a shack with things on its head, plane with goods and supplies lands. Easy peasy. They want to reproduce the final result, so, they get to clearing and manufacturing a makeshift set of wooden headphones.

It sure looked better in the backtest.

But Feynman’s analogy is not just an illustration of what cargo cults do. It’s also an illustration of why they do it. Instead of thinking about the airplane as an illustration of some feature of the world a scientist might be trying to research, think about the airplane as science itself. People who earnestly want to be more scientific see what scientists do. They do experiments. They measure data. They write it down. They perform calculations based on the data their experiments yielded. They build things based on those experiments. Alas, adhering to the cartoon of sciencey-looking process is not science. Neither is the closely-related meme of Yay, Science!

I don’t mean to be unkind. I’m also not condemning inductive reasoning in full, since in sciences where it can be combined with observation in ways that aren’t available to us in financial markets it has been responsible for some of our great discoveries.

But if your adviser or consultant does a lot of slicing and dicing of quintiles and quartiles on some good-sounding fundamental dimension and showing you the returns over the last 20 years if you’d bought this one and sold that one, you’re probably paying a cargo cultist to clear you a runway. Many quantitative managers do a lot better than this, of course. Some are, I think, doing something that is close enough to science to warrant the name. But even then, the airplane landing is dependent on some actual transmission mechanism to make it land. And the actual transmission mechanism in markets after removing abstraction layers is always – ALWAYS – another human making a decision for whatever reason they make decisions. This thwarts a lot of good theories. Ours included.

The right question to ask, both in science and in the maybe-science variant we perform in financial markets, is always this:

Why do you believe the measurements you are producing and the actions you are taking based on those measurements are related to the actual mechanic in the real world which produces the thing being measured?

It’s the right question if you’re thinking about what Covid-19 means for your portfolio, too.

The biggest concern I have as a risk manager is related to this question. It isn’t that I am concerned (as an investor) about how many people are infected with Covid-19 in the United States today. It isn’t even that I don’t know how many people are infected.

It’s that it isn’t knowable.

It isn’t knowable because we completely botched testing on initial suspected cases, and we have continued to permit that error to compound. To be clear, I don’t mean “unknowable” in the sense that we will always be inexact in our predictions. I mean unknowable in the sense of uncertainty: that you could produce a dozen different estimates of where we are at today in the development of Covid-19, and any attempt to assign probabilities to each of those estimates would be no better than an arbitrary guess. If your epistemic uncertainty about the predictive power of any of your models is not keeping you up at night, I think you’re making a mistake.

I think that has two implications for investors and asset owners.

The first is that we must be extremely cautious of anyone peddling quantitative, predictive or scenario analysis of what this means for your portfolios. Anyone who is acting positively on the belief that they know something is a cargo cultist. Anyone showing you charts of prior contagions and pandemics and showed you what happened next – whether they intend to frighten you or calm you – is a cargo cultist. Ignore it. And for God’s sake, don’t act on it.

Not until measurement has meaning again.

The second is somewhat related to the first. Acting positively because you think you know something is not the same as responding to the fact that you don’t. Every position in our portfolio is an implicit bet on a variety of things. Your active security positions – overweights and underweights – are bets that other investors will recognize or change how much they care about certain traits that exist today or that you are predicting will exist in the future. How confident are you that the kind of bets you are making will not be swamped by bets and responses other investors will inevitably make about Covid-19?

Your exposure to risky assets in general represents an implicit bet, too.

It’s a bet on functioning economies and trade. It’s a bet on available credit and liquidity. It’s a bet on productivity and the way capital marshals that into equity value. And, uh, I’d be going a bit off-brand if I didn’t mention that it’s a bet on a friendly and accommodative institutional apparatus that includes both central banks and the cadre of MMTers who occupy both political parties. Most importantly, it’s a bet that investors still care about those things. I still think they’re good bets in the long run. I actually still think they’re good bets in the short run, by which I mean that if your central case is that the world will largely continue to spin in 2020, history tells us that you are more likely than not to be correct.

But distributions get a bit funny in the face of the unknowable, folks. While the chest-pounding prediction game practiced by the media, banks and asset managers coerced by their head of sales to go on CNBC IS about acting on what’s more likely than not to be true, investing is not.

In short, if your confidence that the models leading you to active positions will matter in the near term is high, or if your confidence that the aforementioned uncertainty is already being discounted is high, we think you are wrong.

Part of the reason is epistemological. Uncertainty alone may be enough. But that isn’t all. We’re concerned about where we are on the Covid-19 narrative, too.

Our analysis of narrative structure shows that Covid-19 is dominating the last two weeks of markets coverage in a way that no topic has since we begin tracking macronarratives. Here’s the activity in traditional media:

And here’s the activity in social media.

But here’s the thing: our attention measure for Covid-19 over the same period is LOWER than each of Trade War AND Central Banks. It’s lower than the AVERAGE of all financial markets news. What does that mean? It means that authors reference the Fed when they’re talking about banks, when they’re talking about consumer borrowing activities and mortgages, when they’re talking about fears of Covid-19 and other market risks, when they’re jawboning for more easing, and when they’re talking about President Trump. It means that authors reference the Trade War when they talk about Boeing, and Tesla, and farmers, and consumer prices, and Trump’s reelection, and factory shutdowns, and supply chains.

But Covid-19 news? Right now, it’s mostly just about Covid-19 and the initial investor response. There’s a smattering of supply chain linkages, and a couple of companies reporting and warning about its impacts. But generally speaking, we haven’t yet seen the deluge of linking-everything-to-Covid-19 that we expect is coming. Even at a high volume of coverage, it’s its own beat. A sideshow.

As of February 27, even after a 10% drawdown, we believe the narrative about Covid-19 is complacent.

What would we be doing if we were an asset owner or adviser? Most importantly, we’d be ignoring the cargo cultists. We’d avoid actions predicated on predictions, and respond instead to the fact that we don’t know. What does that mean?

  1. It means we’d be actively trimming the risks of ruin. That means leverage, concentration and illiquidity. The last one’s definitionally tougher to trim, so focus would be on the first two.
  2. It means we’d put off hiring new active managers in search of idiosyncratic alpha, and we’d avoid paying for existing active strategy exposure if frictional costs were low (e.g. anything on swap, accessed through platforms like DB Direct, etc.)
  3. It means we’d be thinking long and hard about our dependence on backward-looking covariance estimates. If I was a steward for investors with a short investment horizon or a low risk tolerance that was based on some conversation I had with them about a remote probability of a major loss, I’d be inclined to pull back exposure to risk assets.
  4. It means we’d be couching our investment committee conversations for the near future in terms of insurance. In short, are you an institution whose objectives are better served by paying a 10% premium on your equity book by locking in this drawdown and avoiding potential tails? Or does your agency structure, investment policy and institutional temperament permit you to self-insure and avoid the uncertainty of foregone gains from the brutal difficulty of timing re-entry?
  5. It means we’d be doing all of the above until the cargo cult of Covid-19 analysis turns back into science. In short, we’d be doing the above until we felt that the measurements being provided about the state of Covid-19 infections reflected some underlying reality.

A friendly reminder: this is general commentary and IS NOT investment advice. You should act based on your own situation, because this analysis is generalized and doesn’t take it into account. We don’t have a crystal ball. If we make forward-looking statements about the markets, they will often be wrong. Because we’re discussing tail risks, it may be INHERENTLY MORE LIKELY than not that we are wrong. Clear Eyes, Full Hearts.


Join Us. No, Really.


Second Foundation Partners builds technologies to research narratives, the stories we tell one another about the world, from financial markets to political news to daily life. We write about those narratives. We consult with companies, investors and governments about narratives. We build investment models based on narratives.

Second Foundation is growing. We are now hiring a Senior Project Manager to work directly with Ben and Rusty to lead the expansion of the data and computational infrastructure underlying our narrative analysis efforts.

What We Need:

We need someone who knows a lot about best practices and tools for ingestion, metadata extraction, metadata enrichment, indexing and querying of pretty substantial quantities of unstructured data.

We need someone who has managed a small team of developers on a project for at least two years. Really, truly managed: Identified key tasks. Assigned them. Held people accountable for deadlines.  

We need someone who can show us that they’ve finished projects that they’ve worked on – and can tell us about them.

We need someone who knows enough to evaluate whether their team’s code does what they say it does.  

We need someone who has participated materially in hiring decisions before and can tell us about their philosophy.

We need someone who has made and is comfortable making business decisions. We want you to tell US which libraries you want to work from, whether you think Azure or AWS or something else is the right choice for various applications. Not the other way around.

We need someone who is not an asshole. If you apply, at some point we will absolutely call people you know and ask if you are an asshole.

What We Want:

We want someone who is willing to work from Fairfield, Connecticut at least 4 days a week. It’s commutable from Manhattan, Westchester County, NY, Fairfield County, CT and New Haven County, CT. If you can show us that you’ve had project success working remotely, we’ll consider it. Maybe.

We want someone who has at least some familiarity with Python, but need someone with enough general development experience to oversee Python developers.

We want someone with an interest in financial markets, media, civics and politics.  

We want you to know we don’t care where (or if) you went to college.

We want 100% of your working attention. Assume W-2. We’ll listen to compelling 1099 proposals.

What We’re Offering:

It’ll pay 150k-300k all-in. We have a good health insurance plan.

The comp range reflects that we’re open to hiring someone with a little bit less or a little bit more experience – as long as they’re the right person.

What You Should Do:

Send us something to that tells us why you have what we need and want. If a resume or CV does that, great. If it’s a letter, great. If it’s a video or something else, weird flex, but OK.  

Send this link to someone else who you think fits the bill.


Kitchen Sink It

Sometimes it’s best to go straight for the trident.

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I have been under withering (if modestly deserved) friendly fire recently for posing a riddle and sitting on the answer. It is with some hesitation that I pose another.

Relax. I won’t make you wait for the answer this time.

What is every marginally competent CEO AND every financial journalist on the Coronavirus beat planning right now?

Kitchen sinking it.

Let me show you what I mean. Here are three of the top five most linguistically connected financial and market news articles published a couple days ago. If watching Michael Bloomberg self-immolate on stage isn’t crowding out all of your short term memory, maybe you’ll remember these articles:

Apple Shares Drop After Virus Warning Rattles Tech Investors [Houston Chronicle]

Apple’s coronavirus warning wasn’t a total surprise, but magnitude rattles Wall Street [DJ Marketwatch]

Apple Investors Get Nervous After Tech Giant Cautions on Coronavirus Impact [The Street]

Yeah, me neither. Why? Because in two trading days the stock bounced right back to where it was before Apple gave markets its guidance on Coronavirus impact. As I’m writing, it’s about 10 basis points away.

A similar story hit the Zeitgeist yesterday for Puma – who reported half their stores in China being closed – and Adidas, who reported an 85% drop in sales compared with the same period last year. And that’s just sales impact.

Adidas and Puma warn of coronavirus sales drag [Financial Times]

Those stocks, on the other hand, barely attempted a headfake downward before bouncing well into positive territory. Let’s make the obligatory (and important!) observation that stock prices are driven by a billion things. Let’s make the second observation that investors are not stupid, and that active investors who owned these stocks probably knew before formal guidance that they had stores in China. They have probably read something about the Coronavirus. Presenting that day’s price behavior as a simple, straightline function of the announcement event alone is obviously silly.

And yet: if you were CEO of a company that’s been sitting on some bad assets, postponed cash outlays or ugly one-time expenses that you needed an excuse to vomit out, and you saw the collective yawn with which markets have viewed other negative Coronavirus-related guidance, what would you do?

You’d kitchen sink it. Let it all out, fellas. You’ll feel better afterward.

We’re seeing an entirely different type of kitchen sink on the side of institutional missionaries in central banks and financial media, and it’s a familiar story. Here’s one of the most connected stories in today’s Zeitgeist run:

Fed Flagged Coronavirus Risk at January Meeting [NY Times]

The Fed wants us to know they’re on it. Financial media wants to make sure that everybody knows everybody knows that the Fed is on it. It’s our old friend “The Narrative of Central Bank Omnipotence.” Is that why stocks guiding on Coronavirus fears have been greeted with a yawn? Why a serious regional health issue with non-zero global pandemic risk hasn’t really manifested in risky asset prices? I think you’d be kidding yourself to say that it’s not at least playing a role.

But what’s more interesting to me is how media calls for us to connect our expectations for central bank action with the Coronavirus problem have been positively related to the level of focus on the pandemic itself. In other words, when the share of equity market news that is focused on the Coronavirus increases, the share of THAT news which is focused on central bank response increases too. When the day’s updates feel a little bit more dire, we immediately start talking about throwing the kitchen sink at it. When you hear us talk about the drum beats of narrative, this is what we mean.

What does it all mean? Well, we won’t tell you that good or bad news on Coronavirus won’t matter to markets or stocks, especially in the short run. Clearly there are people who are going to try to trade on news and their predictions of it. But if I had genuine concerns about Coronavirus-related risk for a portfolio position, at least for now I’d be a little less focused on predicting, and a little more focused on observing missionary statements about Fed/ECB policy.




The most interesting person I know died on Saturday.

I met John Blaisdell in 2008. Salient, where he was CEO, wanted to replace a local financial institution that had participated in a first leg of growth for their fund-of-funds business. I was an associate at a private equity firm that existed to do deals like this. Our brilliant idea was that we’d pay a sub-equity multiple for a self-amortizing share of revenues, which is a fancy way of saying it just goes away after a certain number of years. Did I say brilliant? I meant terrible. Yes, the idea was to produce nice, clean transitions for asset-light, founder-owned investment businesses. The problem was that we always got outbid on the best companies and ended up with too many adversely selected ones – firms who did a deal with us because they couldn’t really get an offer from anyone else.  

We were outbid by Summit.

Most of the investment management companies we looked at buying a piece of were niche investment operations run by a Founder-CIO who begrudgingly took on the CEO title. Salient was not that. John was definitely not that. I honestly didn’t know what to think of him at the time, but I don’t think he ever did anything grudgingly. The man was a dynamo in the most literal sense of the word – in a constant state of physical, intellectual motion. Ever planning. Ever adjusting those plans. Ever tuning his words describing those plans to best reflect the mood of the moment in the room.

I think I didn’t like him.  

I didn’t meet him again until 2012. Lee Partridge was trying to introduce us. I was at Texas Teachers. My best friend Todd (another Texas Teachers PM) and I both thought most OCIO providers we’d met were designing a scale product to appeal to the optics sensibilities of risk-averse boards. Lee wasn’t. He wanted to deal with their fundedness issues and extreme reliance on robust returns for US equities head-on. And he was at Salient. We wanted in.

So I went to meet John and his partners. I still didn’t know what to think.

Imagine a map of the world, only instead of a map of geography, it is a map of temperaments and personalities. Put a pin in Auckland, New Zealand and call it Greg Reid, who ran the midstream energy infrastructure franchise. Put another in Kamchatka. That one is Lee. Put your third pin in Tierra del Fuego and call it Jeremy Radcliffe, John’s right hand man. Then drop a fourth on the Aleutian island of your choosing and call it Andrew Linbeck, who ran the Houston-based wealth business.

There was no pin for John Blaisdell. And there was no pinning him down to any sort of pithy description.

Oh sure, you’d think you had him nailed, but then he would tell you a story about his years as a dancer on the Puerto Rican version of Soul Train. Once you had him pegged, you’d learn another tidbit about his time as Miami city manager during the vice years. And as soon as you thought you finally had the measure of him, you’d walk with him into a restaurant you’d been to two dozen times in the last six months without him as a regular, only to have every server, host, valet, sommelier and unoccupied line cook in the place line up to shake HIS hand and exchange pleasantries with him in perfect Spanish.  Then the next week he’d fly to San Francisco for a closing dinner, stand up in the middle of the winery owned by the billionaire who sold him a company, and belt out a raucous Cielito Lindo, utterly indifferent to whether anyone else joined him on the chorus that normal people know.

I think a lot of people who didn’t know John very well often felt that this dynamism – this intentional tailoring of his words and actions to each person and circumstance – had to be some kind of attempt to manipulate them. Or at the very least, a kind of intellectual inconsistency. I was one of them. For a while.

No one event changes this kind of perception. But some stand out. Like when my wife was due with our first child on Thanksgiving Day in 2014, and John stayed up the night before making a second thanksgiving dinner in addition to the absurd feast he prepared for his own family celebration. Sous vide turkey breast, gravy, dressing, salads, casseroles and pies, with hand-written instructions for the best way to reheat and prepare each. He showed up with full bags at our hungry house, unlooked-for and unannounced. I think the only person who knew was his assistant, whom he asked for our address.

We weren’t alone. Ours was one among a hundred similar stories.

Ultimately, I came to believe that John’s great gift was his ability to spot the innate, under-the-surface potential for connection between people. His great joy, I think, was to forge those connections in the most surprising ways possible. He always wanted to do good deals, yes, but better yet if that deal could shock and surprise, something no one else had thought of. He always wanted to hire good people, but far better if it was a person vastly different from his current partners, in whom he saw the potential for powerful and unexpected connection. And yes, he wanted to be the chain that forged those connections, the hidden link between those pins on every corner of the map.

But those simpler commitments to doing right by his clients and partners were real, too. And not in the obligatory way that all of us must be committed to our clients. In one of the last conversations I had with John, he shared with me something that he had shared many times before. It’s something I know would be familiar to each of his other partners and families. He told me that he had never once delivered a bad result for a family – or his partners – who stuck with him. We all build narratives of identity. This was John’s, an identity that I think he would go to any ends to defend.  

Death is usually a sort of overdetermined thing, influenced and compounded and explainable by more things than any proximate cause. That is a lucky thing for the rest of us. It lets us off easy. We can comfort ourselves by saying “it wasn’t our fault” when someone we love dies way before they should have. And we’re right. It isn’t our fault.

But that doesn’t mean we’re not responsible.

Don’t get me wrong. A life well-lived is a life of investing in the lives of others and accepting their investments in our own. Are you uncomfortable that others’ commitments to you sometimes wake them up in the night? Are you uneasy that someone’s desire to make you safer, happier or more prosperous costs them something? Even if that cost is tough to quantify? Even if it’s one among a million reasons their health began to fail?

I’m not.

This glorious, flawed, messy and big-hearted giant of a person loved me. He invested part of his life in me, and I accepted it with a full heart. I also accept with clear eyes the responsibility that comes with that.

John, you delivered on everything you ever promised me you would. You didn’t need to do a damn thing more to be part of my sons’ legacy.  



Source: Chris Arnade, via Medium

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In full disclosure, we didn’t identify today’s article in our NLP-driven screen of political and financial markets news. Medium posts don’t make our database. But it felt like part of our Zeitgeist to me. I think it will to you, too.

We have mentioned Dignity and its author Chris Arnade in our livestream feature on a few occasions. Why? First, because it’s a lovely book and worthy of your time. Second, Chris is a former markets professional, which makes a lot of what he has to say relevant for a big part of our audience. He understands our language. But we also think his framework for thinking about class in America – and his willingness to uncondescendingly apply it to better understand the frustrations of a huge, demographically diverse swath of Americans – is useful. And powerful.

He shared a piece yesterday that he had written last year called “D in the McDonald’s.” It is an interview with a former computer worker with a passion for math who also happened to be living in a truck in the parking lot of a McDonald’s. I don’t want to reprint it in full, because I think you should read it there. But I want to share a piece that did jump out at me. As you’ll find, Arnade doesn’t offer many simple answers.

It’s a good thing, too, because there aren’t any.

As I drive away I think I must be missing something, some simple explanation for why D is homeless, some reason why a man who worked with computers for 30 years is living in a truck. I spend lots of time with homeless people and I usually can say within a few seconds a glib reason for them being on the streets. It is usually mental illness, or drugs, or a physical handicap, or aggression, or a lifetime of jails and prison. Or all of that. With D there is no obvious simple explanation.

D in the McDonald’s (Chris Arnade on Medium, June 2019)

I’m not even an armchair sociologist, but if you’ve lived in different parts of what Arnade calls back-row America, even as a lucky-as-hell front-row (if McDonald’s-loving) son of an engineer, you can’t help but see the shared trait among the poor: a belief that they have few or no options. Sure, the reasons are different, but those reasons coalesce into the same feeling in a small oil-bust town in southeast Texas that they do on inside-Broadway Washington Heights and outside-University City West Philadelphia.

A lot of policy and a lot of charity is directed to fixing the sources of that belief that are external and tangible. In other words, we focus a lot of our energy on fixing the ways in which some people in America really don’t have many options. We invest in education and job-training, we regulate prejudicial hiring, we create social safety nets to prevent some forms of bad luck from eliminating optionality in life for our fellow Americans. A hundred other angles to address the many ways in which life choices might be limited. We disagree as a country about the scale and scope of these policies and who ought to be executing them. Still, I think that if you asked most full-hearted Americans if they wanted a political and social system that permitted unbounded mobility, you’d get resounding agreement.

The other side to the belief in the lack of options – and the one that is very hard to come up with answers for – exists in the stories we tell. Our narratives about the poor. We have a lot of them. But here, Chris puts his finger on one of the most powerful: in America, everybody knows that everybody knows that poverty is inextricably related to immorality. Conservative politicians circle the wagons around and campaign on welfare abuse and unhealthy / fraudulent use of food stamps as if they were a widespread budgetary disaster. Hundreds of charismatic and pentecostal churches (and yes, both principally white and black churches among them) embrace a prosperity gospel attaching God’s favor or anger as the sole cause of financial circumstance. Liberal leaders gloat about educational attainment in the Deep South as a predictor of Bad Political Views. The people who “cling to their guns and religion” will remember that characterization for a generation.

This idea is deeply, broadly shared cultural common knowledge.

But here’s the thing: forget about whether you think any of the above cases have some basis in fact. Yes, sometimes people are poor in part because they did bad things. Dumb things. And sometimes they get rich for the same reasons. I’ll leave it to someone else to parse through root causes, because I’m not here to lionize or condescend to anyone. Even if I were, I don’t know how to weigh goods and bads.

What I do know is that the narrative of immorality-based poverty has power far beyond whatever truth lies underneath it. It changes how WE behave. It changes our perceptions of the dignity of other Americans and of their agency. It colors our perceptions of their motivations and it permits us cover for ingratitude and unkindness. And yes, I think it also affects the willingness of many who would benefit from getting back on their life’s path – or just being shown the trailhead, for God’s sake – to ask for or accept that assistance. How much help would you or I accept from someone we suspected offered it as a good deed to an undeserving wretch like us?

I don’t know if one of us being in a position to tell D in McDonald’s something practical about graduate school, or to offer love and help in a moment where a belief in a lack of options was crystallizing in his mind, or to connect him with someone we knew who needed someone with his skills might have opened up a new path for him to change his life for the better, or at least to make him happier. I do know that there are a thousand thousand others where we can and do have that power. Full hearts.

Clear eyes, too. We published a short piece this week about many of the memes that influence our behavior. We argued that there would be a time to sing new songs – once we’ve stopped singing the songs our powerful institutions required of us.

I think this might be a good one to start with.


We Hanged Our Harps Upon the Willows


By the rivers of Babylon, there we sat down, yea, we wept, when we remembered Zion.

We hanged our harps upon the willows in the midst thereof.

For there they that carried us away captive required of us a song; and they that wasted us required of us mirth, saying, Sing us one of the songs of Zion.

Psalms 137:1-3

Each year around this time we make the journey back home to Texas.

It’s an opportunity to see family. It’s an opportunity to surrender our bodies to enchiladas. It’s an opportunity to take our youngest son to check in with the neurosurgeon who took his skull apart and the plastic surgeon who made sure it came back together correctly.

OK, I’m being a bit dramatic.

The procedure he underwent has remarkable success rates, and in expert hands has pretty low risk. Empirically. But let’s make a deal: you hand over your sleeping two-month old to a group of doctors who have told you they intend to put him under general anesthesia for three hours to cut out five strips of his skull and see what kind of stoic Enlightenment scientist you turn out to be.

But even as I say that, I know I shouldn’t. Many of you have experienced this kind of powerlessness before – and worse. After all, our inability to control every circumstance we face is, shall we say, a fundamental feature of the world.

It’s also a good reason not to turn over any more of that autonomy than we must on those rare occasions when we actually have a choice in the matter.

Last week I made a comment on social media saying that I found it really hard to dislike Andrew Yang. A commenter told me they couldn’t understand how that might be possible. After all, his policies were absurd and expensive.

Opinion gatekeeping like this is an occupational hazard. If you haven’t been informed that an opinion you expressed isn’t allowed because someone else perceived some measure of inconsistency with another opinion you expressed, then you simply haven’t said enough. Give it time. When it happens, you too shall marvel at the gaps in your views others are willing to fill in for you.

Someone else told me they were surprised. Wasn’t Yang’s use of “Freedom Dividend” the sort of Orwellian newspeak I usually rail against?

It was an earnest question. And fair. As it happens, I don’t have a problem with the branding because I don’t think Yang’s campaign is summoning “Yay, Freedom!” memes to tell me how to think about the policy. No one is positioning his UBI proposal in a way that would characterize my opposition to it as a lack of belief in freedom itself. I think the guy truly believes his policy is like a successful business’s dividend – sharing more broadly the prosperity that free enterprise brought about.

Corny, yes. Misguided? I think so. Malicious? Meh.

When we attune ourselves to the special dangers of a world we experience and understand through stories, it is easy to become cynical about every analogy, every example of symbolism, every bit of branding that abstracts the reality of something into some other frame chosen by the speaker. There is no cure for this paralysis. Sorry. The difference between the harmful, malicious use of meme to tell us how to think and what to fear, and the empathetic use of shared imagery to establish common understanding is often one of magnitude, not of kind. Of intent. No flashing lights. No klaxons.

I wrote an essay a couple years ago about this unusual challenge.

It is a lesson in two parts: Life is too short to surrender autonomy of mind. Life is also too short to see a tyrant in every poet.

We obnoxiously intone the mantras of clear eyes and full hearts because they generalize a process to evaluate something that is unavoidably subjective. Only you know and only you can judge if someone’s words or the collective common knowledge being promoted by a missionary is affecting your autonomy of mind. When we DO actively assert the belief that someone is acting as a missionary for a narrative in an objectively harmful way, it is almost always because that person occupies a seat from which we are right to demand an uncolored description of facts: The media. Government officials. Scientists. Chief financial officers.

Anyone in one of those seats who tells you how to think would carry you away as captive and require of you a song. They would steal your autonomy of mind.

It’s really that simple.

Except in most other cases, it isn’t that simple. Not remotely. Most of the stories we will be told and memes we will be subjected to in a day won’t come from scientists and journalists. They will come from friends, loved ones, colleagues, prospective business partners, community leaders and national political leaders. Or from ourselves. Some missionaries, some not. That means that citizens of a world awash with meme and narrative face two risks to our autonomy of mind: that we would become paralyzed, perceiving manipulation in every empathetic use of symbol, or that we would ignore or fail to perceive true acts of manipulation.

Both are real, but I think the second is the greater risk. Why?

Well, in small part, it’s because we already have a good answer to that inevitable cynicism when we feel like we see narrative everywhere: full hearts. Grace and mercy, and a willingness to consider intent go a long away. But the bigger reason lies elsewhere:

Because the danger of powerful memes, cartoons and narratives is not that they demand our acquiescence. It is that they demand our participation.

When we are asked to hold up our Yay, Democracy! signs, we are not only told how to think about the importance of elections and our role in collective oversight of government institutions. We are compelled to participate in voting for ridiculous candidates who do not deserve the office on the basis of manufactured existential fear. You don’t want to be to blame for Trump being elected again / the socialists destroying our capitalist foundations, do you?

When we are asked to hold up our Yay, Military! signs, we aren’t just being told how to think about the right kind of moral, financial and spiritual support we should provide to our veterans and active warriors. We are being compelled to participate, told that if we do not stand up, salute the flag and support every expenditure, every conflict, and every explanation provided to us for the same, that we are failing them. You don’t hate the military, do you?

When we are asked to hold up our Yay, Peace! signs, we aren’t simply being told how to think about the right posture on foreign policy. We are being compelled to participate, told that we must support and vote for political candidates who cyncially claim that he or she will be the one to “end our endless” wars, only to once again shift the goalposts like so many officeholders before. You don’t hate peace, do you?

When we are asked to hold up our Yay, Work Ethic! signs, we aren’t simply being told how to think about the classic American values that unleashed capitalism. We are being compelled to participate, told that if we don’t willingly invest ourselves in pointless work divorced from its underlying purpose we have somehow repudiated some entrepreneurial spirit. You don’t hate hard work, do you?

When we are asked to hold up our Yay, Alignment! signs, we aren’t just being told how to think about the right way for principals and agents to align. We are being asked to participate, told that resistance to a particular compensation model represents an opposition to alignment per se. You don’t hate being aligned with your clients, do you?

When we are asked to hold our our Yay, College! signs, we aren’t just being told how to think about the importance of higher education to a functioning, growing industrial society. We are being asked to participate, to turn a blind regulatory eye to the ever more bloated cost and administrative strucures of American universities, to support their ongoing growth through debt forgiveness, to join in the rousing chorus of “Well of course smart kids should to go to college.” You don’t hate education, do you?

When we are asked to hold up our Yay, Capitalism! signs, we aren’t just being told how to think about the indispensible role a system which rewards risk-takers has played in creating a prosperous world. We are being asked to participate, to be always-on, always-long and always-indexed in US large cap equities, regardless of valuation and regardless of potential sources of artificiality in the costs of capital for many companies. We are told to treat management teams like entrepreneurs, voting for conflicted boards, extravagant salaries for an army of EVPs and rich buyback-immunized share grants in exchange for sector benchmark matching returns. You don’t hate capitalism, do you?

Ben has already written about the way out. It’s included in one of the links above to a note called a Song of Ice and Fire. He suggests the only way for those with clear eyes to do battle against the songs used to steal our autonomy of mind is to remember that we may sing our own songs, too. There are words we can write and symbols we can revive. We can use them to tell true stories – sing new songs – about education and equality and freedom and faith and capitalism and country and entrepreneurialism and risk-taking and sovereignty.

We can create new common knowledge that, within our community at least – at first – is in fact a reflection of what we all believe and not what we all want others to believe.

We are the human animal.

We are non-linear.

We ARE a song of ice and fire.

It’s a song that has built cathedrals and fed billions and taken us to the moon.

It’s a song that can do all of that and more … far, far more … if only we remember the tune.

A Song of Ice and Fire (Epsilon Theory, May 2019)

If you are interested in maintaining autonomy of mind in a world awash in narrative, This is The Way. But before we can sing a new song, we must stop singing theirs.

So deny them the mirth they require. Deny them the song they demand. Withhold your participation in their cynical game.

It’s time for the clear eyed to hang their harps upon the willows.


US Recession Monitor – 1.31.2020

  • Like other topics, Recession narratives rose somewhat in attention and cohesion, but less dramatically than other categories.
  • We believe that this is because coronavirus outbreak fears manifested most in fear about asset prices, leading to rapid missionary behavior with respect to central bank / interest rate activity.
  • In contrast, while the impact of the virus on global economic growth – and potential recession fears – was a topic, it was far less connected.
  • For that reason, we think that there is still a very weak global narrative around recession. In the US that narrative is even weaker.
  • If there is such a narrative, however (as seen in our sentiment and fiat news trackers), missionaries are telling us that there is little risk or reason to be concerned.
  • We have no edge / opinion on whether that is factually accurate. We do believe that markets and media are complacently accepting of it.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Sentiment Map

Source: Quid, Epsilon Theory

Narrative Attention Map

Souree: Quid, Epsilon Theory

Narrative Attention

Narrative Cohesion

Fiat News Index

Narrative Sentiment


Credit and Debt Monitor – 1.31.2020

  • The decline in the strength of the Q4 narrative of a risk of “collapse” in credit markets continued in January.
  • Uniquely among our macronarratives, cohesion actually dropped for debt and credit market narratives.
  • We think that the heightened attention on the coronavirus outbreak and generally positive news about the China Trade War were largely absent from the leveraged loan and private credit-focused discussions that dominated in late Q3 and early Q4.
  • We don’t think that these markets are as mass media-driven as equity markets and asset allocation / macro – so while we would generally argue that this has created a complacent narrative, we don’t counsel establishing any active positions on that basis.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Sentiment Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Narrative Cohesion

Fiat News Index

Narrative Sentiment


US Fiscal Policy Monitor – 1.31.2020

  • Like other topics, Recession narratives rose somewhat in attention and cohesion, but less dramatically than other categories.
  • We believe that this is because coronavirus outbreak fears manifested most in fear about asset prices, leading to rapid missionary behavior with respect to central bank / interest rate activity.
  • In contrast, while the impact of the virus on global economic growth – and potential recession fears – was a topic, it was far less connected.
  • For that reason, we think that there is still a very weak global narrative around recession. In the US that narrative is even weaker.
  • If there is such a narrative, however (as seen in our sentiment and fiat news trackers), missionaries are telling us that there is little risk or reason to be concerned.
  • We have no edge / opinion on whether that is factually accurate. We do believe that markets and media are complacently accepting of it.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Sentiment Map

Source: Quid, Epsilon Theory

Narrative Attention Map

Source: Quid, Epsilon Theory

Narrative Cohesion

Fiat News Index

Narrative Sentiment


Trade and Tariffs Monitor – 1.31.2020

  • Attention on Trade and Tariffs topics rose somewhat, but the inclusion of coronavirus language proved a distraction to the stories being told about them rather than a unifier.
  • More importantly, we think that the Phase 1 agreement between US/China led to a far more positive, Pollyannaish narrative structure on Trade.
  • We think that the fatigue over Trade news and the vacuum of the generally weak narrative structure in Q4 created a readiness to move on to other topics, including events like Iran and coronavirus.
  • We still have no edge (and believe it is impossible to have an edge) predicting long-term trade deal outcomes, but we are concerned that the Trade narrative is highly complacent, more likely to respond surprisingly to bad news than good.
  • We think any asset owners / managers with active positions on exposed assets should manage their risks accordingly.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Sentiment Map

Source: Quid, Epsilon Theory

Narrative Attention Map

Source: Quid, Epsilon Theory

Narrative Attention

Narrative Cohesion

Fiat News Index

Narrative Sentiment


Central Bank Omnipotence Monitor – 1.31.2020

  • Attention on and cohesion of Central Bank macro narratives rose sharply in January.
  • We believe that this is largely the result of a (hopefully!) short-term crystallization of language on many topics around language describing coronavirus-related risks.
  • In short, the narrative being promoted by missionaries is that central banks can and must step in quickly to stabilize any risks created by a potential outbreak.
  • We think that the emergence of this narrative is largely responsible for the return of an explicit bad-news-is-good-news regime in early February.
  • We wouldn’t understate this one – the fiat news utilization is at highs since we have tracked it, and the missionary behavior on this issue is strong.
  • Separately we observe that climate change and inequality topics continue to move toward a central part of the Central Bank narrative. Take note.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Sentiment Map

Source: Quid, Epsilon Theory

Narrative Attention Map

Source: Quid, Epsilon Theory

Narrative Attention

Narrative Cohesion

Fiat News Index

Narrative Sentiment


Inflation Monitor – 1.31.2020

  • Attention on inflation rose rapidly and surprisingly in January, we think in response to two developments:
    • The very modest emergence of inflation in even heavily cartoonified macroeconomic data; and
    • The attachment of very similar coronavirus language to articles about nearly ALL topics, including inflation.
  • It is hard to discern just how much to attribute to both, but we expect it will become apparent if/when the outbreak fades from the news cycle.
  • The inflation narrative appears to be “There are some signs of modest inflation, but it is still not near enough to justify moving away from an easy posture.”
  • We also note for the first time in quite some time that gold / precious metals coverage has attached itself to the core narrative structure (it is usually well distant on its own island with its own peculiar language).

Narrative Map

Source: Quid, Epsilon Theory

Narrative Sentiment Map

Source: Quid, Epsilon Theory

Narrative Attention Map

Source: Quid, Epsilon Theory

Narrative Attention

Narrative Cohesion

Fiat News Index

Narrative Sentiment


The Inevitable Afterbirth


Such balmy words he pour’d, but all in vain:
The proffer’d med’cine but provok’d the pain.

Aeneid, Book XII, by Virgil

I sent for Ratcliffe, was so ill,
That other doctors gave me over,
He felt my pulse, prescribed his pill,
And I was likely to recover.

But when the wit began to wheeze,
And wine had warm’d the politician,
Cured yesterday of my disease,
I died last night of my physician. 

The Remedy Worse than the Disease, by Matthew Prior (1664-1721)

And of course, with the birth of the artist came the inevitable afterbirth – the critic.

History of the World, Part I (1981)

The idea of a cure worse than the disease it is meant to remedy is old. Old enough and resilient enough that it wouldn’t be a stretch to call it a meme. It is one of those perfunctory Latin idioms: Aegrescit medendo. It finds its way into poor-to-mediocre English poetry and brilliant Mel Brooks comedies, too.

Now, with all this talk of cures and diseases, you might think this is going to be a brief about 2019-nCov, the Wuhan Coronavirus. It isn’t. It is a brief about the news and narrative that emerged in response to the Wuhan Coronavirus.

I’d like to show you what I mean.

This new strain has been out there since December at least, both in the wild and in media. It was initially described in media accounts as a mysterious series of hospitalizations for pneumonia-like symptoms; that is, until December 31st, when the WHO formally acknowledged it. By early January, some coverage embraced the novel coronavirus nomenclature. Even then, it was not yet seen as newsworthy in the US. The coverage in the first week of 2020 was very limited, and what existed was mostly framed in context of the WHO response. Bloomberg was among the first to give it a full article’s treatment. They published this on January 4th:

China Pneumonia Outbreak Spurs WHO Action as Mystery Lingers [Bloomberg]

Coverage in US media increased in the second week of 2020 in tandem with the first announced deaths linked to the virus. Still, most of the coverage could be found in medical blogs and light journals. Other outlets published an initial piece or two and moved on. The New York Times and CNN explored it first on January 8th. Washington Post on January 9th. It wasn’t really until the third week of 2020 that the news became more dire. That is when coverage of nCov in the US went mainstream, with more than a thousand articles published that week alone.

It was the following week, however, when coronavirus coverage exploded. US media published more than 15,000 new articles between the 22nd and 28th of January, a 700%+ increase over the week prior. Coverage rose a bit more between January 29th and February 4th, but it was already at roughly the maximum level we see in US media for any extraordinary “event” coverage.

The chart below presents that series in the darker-colored line, with corresponding values on the left axis. The other series – in light blue and plotted on the right axis – presents a subset of this coverage. This is the percentage of that universe of articles which used language advising readers that they should be more worried or concerned about the plain old seasonal flu. This is a percentage. The frequency of these articles didn’t just increase along with coronavirus coverage – it increased at a markedly faster rate than the coverage alone.

You might also note that the acceleration in this subset of coverage took place the week after the acceleration in coronavirus articles. More on that in a moment.

Number of Coronavirus Articles Published in US Media vs. Share of “Worry More About the Flu” Articles

Source: LexisNexis, Epsilon Theory

In context of all the coronavirus coverage, the above may not seem like a massive share; however, the above series reflects a simple query that almost certainly misses all sorts of other ways articles chose to phrase similar admonitions. To that end, we also explored the linguistic similarity of all US coronavirus coverage the week of January 29th through this morning – February 4th. What we found was that the single most interconnected, most central cluster in the network graph of articles (in our parlance, the “highest attention” cluster) was a cluster defined by various comparisons of coronavirus to the flu and the common cold, especially by relating counting statistics of historical mortality. You can see this as the highlighted pink cluster below.

Why does this matter?

Because as of February 4th, we believe the most cohesive, most aggressively promoted narrative of 2019-nCov in US media is “Don’t worry about this. You should worry more about the cold and the flu.”

Source: Quid, Epsilon Theory

I am not a medical researcher. I don’t have the foggiest idea how widely this disease will spread or how many or how few people will end up succumbing to it. I don’t have an estimate for how much fear and quarantines will impact Chinese production, global trade or the global supply chain. I certainly don’t know what kind of drag that will put on Q1 global GDP. I don’t care. OK, of course I care, but I certainly don’t have an edge in predicting any of it, I rather suspect very few others do, and in any case none of that matters to the point I am trying to make.

What I can tell you is that in the last week, many media outlets decided in the wake of an explosion in coverage from the prior week that you and I did not interpret their articles about coronavirus correctly. They decided that you and I needed to be told how to think and how to feel about what the facts presented in those stories meant, and they told us to think that coronavirus was not as big of a deal as we thought it was after reading last week’s news. That doesn’t mean they’re wrong. It doesn’t mean their predictions don’t reflect some central expectation that may end up proving to be true.

But missionary behavior is still missionary behavior, and this behavior tends to follow a predictable pattern.

After a surprising event of global significance, initial media coverage is typically dominated by the reporting of facts, such as they are known. Within 1-2 weeks, the response shifts. Reporting of available facts transitions to attempts to manage, shape and direct the common knowledge that emerged from our collective interpretation of those facts.

Narrative is the inevitable afterbirth of news – especially big news.

Right or wrong, it’s happening again. Clear eyes.