Epsilon Theory: A 2019 Retrospective


After a year (well, 11+ months, anyway) in which we published 225 standalone pieces and numerous additional multi-topic Zeitgeist posts, we thought it made sense to take stock of what we’ve actually been telling you lot. Instead of the usual “The Year in Review” or “The Year Ahead” nonsense you don’t want to read and we don’t want to write, what we’ve got for you is a quintessentially Epsilon Theory experience.

In short, what we want to do is help you:

  • Recall some pieces that were among our most-read and most popular;
  • Find some new pieces which may have slipped underneath your radar, but which have a lot of influence and explanatory power on the overall Epsilon Theory output for 2019;
  • Find some philosophical rabbit holes to follow for a while, perhaps helping you find connections between concepts and notes we’ve written that aid in understanding or putting them to use.

So, true to form, the first thing we’ve got for you is our 2019 Discovery Map, an NLP-based clustering and graphing of all of our content (other than Zeitgeist pieces from the first half of 2019 which bounced across multiple topics). What you will find is a few high-level, linguistically related clusters with a fair amount of internal diversity and fascinating points of connection to other topics.

Simply mouseover any node / article to see its name and, if you want to read it, click it and go.


Where should you start?

By Navigating the Discovery Map

Highly Central / Influential Articles: Your eye probably gets drawn to the middle of the screen, maybe a couple of those Big, Red Circles at the middle of the central-most cluster. Mouseover them and you’ll see The Long Now, Pt. 2 and The Long Now, Pt. 3, two of our most-read but also most linguistically connected notes of 2019. Starting here, you could follow language and narrative-based relationships to the outer quadrants of the topics we cover by simply following some of the connecting lines.

Highly Interconnected Articles: You may also be attracted to multi-disciplinary articles which bridge the gap between some of the higher level concepts that we write about here. Look for the nodes which connect across to one or more clusters of a different color. For example, the top-most article in the yellow cluster – The Citizen’s Response to the Long Now – is an article called How to Live Safely in a Wall Street Universe, a gem from Ben which includes one of the most powerful bits of advice I think he’s ever written: “Never ask for a cut on an existential trade.”

You’ll find another similarly interconnected piece in my contribution of A Holy Day from earlier this year, or The Stereogram, which bridges our criticisms of Fiat News media with a more intense focus on China this year.


By Reading What Others Read

If you’re looking for a more traditional marker that an article might be worth your time, here are our most-read pieces from 2019:

#1 Most Read: This is Water


#2 Most Read: Yeah, It’s Still Water


#3 Most Read: The Spanish Prisoner


#4 Most Read: Modern Monetary Theory or: How I Learned to Stop Worrying and Love the National Debt


#5 Most Read: The Long Now, Pt. 1


By Reading What Others Didn’t Read…But Should Have

We also have a range of notes which people didn’t read as much, but which are among the richest examples of connectivity between core Epsilon Theory concepts. If you’re a frequent reader but looking for some gems you might have missed, this is where you’ll find some good jumping off points to explore other notes.

#1 By Our Own Petard


#2 Send Lawyers, Guns and Money


#3 The Patsy, Revisited


#4 The Age of the High-Functioning Sociopath


#5 In Praise of Work

However you decide to navigate the 2019 Epsilon Theory oeuvre, we hope you find it thought-provoking, enjoyable and worthwhile. For those of you navigating it as pack-members, we remain grateful as always for your support. And for those who, in navigating these notes, find something you want to be a part of, we hope you’ll consider Joining the Pack.

By Our Own Petard


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For ’tis the sport to have the enginer
Hoist with his own petard; and ’t shall go hard
But I will delve one yard below their mines
And blow them at the moon. O, ’tis most sweet
When in one line two crafts directly meet.

Hamlet, Act 3, Scene 4, by William Shakespeare
Image result for office space the bobs

Peter Gibbons: It’s a problem of motivation, all right? Now, if I work my ass off and Initech ships a few extra units, I don’t see another dime. So where’s the motivation? And here’s another thing, Bob. I have eight different bosses right now!

Bob Slydell: I beg your pardon?

Peter: Eight bosses.

Bob: Eight?

Peter: Eight, Bob. So that means when I make a mistake, I have eight different people coming by to tell me about it. That’s my real motivation – is not to be hassled. That and the fear of losing my job, but y’know, Bob, it will only make someone work hard enough not to get fired.

Office Space (1999)

I would like to start, as every good essay ought to do, by offering you a heuristic I have pulled completely out of my ass. Or out of a career dedicated to understanding the behaviors of the people who allocate to investment managers, which basically amounts to the same thing:

Ask the novice adviser or allocator what matters most, and their answer can usually be reduced to historical performance.

Ask the journeyman, and the answer you receive will be reducible to the identification of #edge.

Ask the master, and they will tell you about alignment.

I don’t mean this to be condescending. Truly, I don’t. I also don’t mean it to be dismissive of any methodology or philosophy for the selection of professional investment advisers and managers. But the incredible degree of difficulty (read: mathematical impossibility) of achieving results consistently worth the fees paid to external advisers, coupled with the tendency of the math to bang that reality into our heads over the course of a career, is almost tautologically geared to this intellectual progression in the evaluation of investment strategies:

Induction -> Deduction -> Deconstruction

Scientism -> Kinda-Sorta Empiricism -> Evo Psych

Historical Performance -> Analysis of Edge -> Alignment

The inevitable final form of the professional allocator or adviser is not so much the nihilist as the practitioner of serendipity. They recognize that randomness reigns and control what they can control. In a perfect world, they control what they can control by leaning on lasting, demonstrable, biologically determined human behavioral traits to try to guide someone they think is talented and process-oriented to results that will benefit both principal and agent alike. It is a stoic, right-sounding, eminently reasonable, perfectly justifiable framework. There’s just one problem. A tiny, insignificant problem that I almost hesitate to mention:

We will never – can never – be aligned with our agents.

As citizens, shareholders and investors, we worry with good reason that the agents working on our behalf – our political representatives, corporate management teams and the investment consultants, advisers and managers we rely on, respectively – actually will work on our behalf. Preferably for a reason that goes somewhat beyond ‘not going to jail’ or ‘because they seem like someone you could have a beer with.’ We want them to feel like they have skin in the game. Like we both win if either of us wins.

When we, as a principal, select an agent, we have every reason to shout “Yay, alignment!” from the rafters.

And because we have every reason to shout “Yay, alignment!”, our agents have every reason to sell us compensation structures which permit them to extract undeserved economic rents by demonstrating the superficial trappings of alignment. This job is made a hell of a lot easier by the fact that we investment professionals – nominally principals in the relationship – are often ourselves agents of some other party. We are using delegated authority to act on behalf of a client, a family, an institution, a board. People to whom we need to demonstrate alignment.

Necessity being the mother of invention and all, our need for a story that will make us or our own charges shout “Yay, alignment!” makes us vulnerable to structures and features from our agents which don’t deliver anything of the sort – but seem to.

Hoisted by our own petard, as it were.

And here’s how it happens.


Let’s start with what has long been Common Knowledge – what everyone knows everyone knows – about alignment in our little corner of the world:

Commission-based models are bad.

What we all know that we all know is that fixed commission-based compensation models represent poor alignment of incentives because the adviser who is paid on commissions has an incentive to generate commissions by executing trades. Even Chuck here, who is nearly a deca-billionaire because of the decades he charged clients commissions, knows that the tide is going out on him. He wants to re-cast himself on the right side of history.

Charles Schwab

Just so we are 100% clear about this, the single human being who may have built the greatest personal wealth by charging clients commissions is now shaking his finger at us to tell us how much he hates them, and how we ought to think about them. Just marvelous.

Whether Chuck’s come-to-Jesus is authentic or not, we are now all in on the joke. The natural incentive implied by commission-based compensation is to take actions which would harm the client. Simple enough. Fair. Some will make the ‘Yes, but if I don’t make good trades I’ll lose the client and I don’t want to do that, etc.’ argument, but I feel confident that even those folks get the basic criticism. Full-hearted FAs can absolutely deliver good client outcomes under a commission structure. But their incentive is not to do that. It isn’t complicated.

I also think most people understand intuitively the disconnect between paying a transactional fee for something and expecting that person to want to do a better job on that thing. We structure many of our commercial relationships around the introduction of performance-based variability. In America, anyway, we pay restaurant and bar service professionals primarily through variable compensation: tips. We structure our companies’ compensation around bonuses (which, truth be told, almost universally tend to vary around corporate results far more than personal performance). In significant swaths of the legal profession (excluding corporate law, where the goal is to find lawyers we can pay enough to offload the career risk of a botched deal structure), we pay on contingency.

If an agent’s primary incentive is to get you to do a specific deal – and that is very frequently the case with those paid on functionally fixed commission – it’s easy to see how that doesn’t satisfy our desire for alignment. The cases where high, fixed, transactional fees for one-off services are still the norm are accordingly almost always industries protected by forms of occupational licensing. In some cases, like, say, medicine, those licenses and the fixed compensation models they contemplate seem legitimate. To me anyway. Feels a bit unseemly to pay someone a bonus for doing an especially good job removing a cancerous mass. In other cases the fees are simply the result of lobby-protected oligopolistic behavior. Classic rent-seeking. Real estate agents, we are all looking square at you and your patently absurd 6%.

(And yes, if you send me a bulleted explanation of why that 6% is justified, straight out of some brochure given to new agents by the National Association of Realtors, there is a 100% chance it will be reprinted on these pages with all sorts of friendly annotations from yours truly.)

In almost all of those cases, and certainly in the investment industry, the next step in our evolution toward Yay, alignment! was to move to a relationship-driven, asset-based fee or fee-for-service model. This form of better alignment is the rallying cry of the independent registered investment adviser and investment adviser representatives against their brethren at banks, wirehouses and independent brokerages.


So is this industry-wide move from commission-based to fee-based advisers good? Did it actually move us in the direction of better alignment?

Of course it did.

But not nearly as far as we all want to pretend.

Asset-based fees, management fees, advisory fees – whatever term of art your corner of the industry wants to use – eliminate the incentive to churn, but aligned? Come on. And in case you were wondering, this is absolutely a trope that is marketed to you to exploit the Yay, alignment! meme. For example, before Fisher Investments professionals were festively describing to conference-goers how selling to individual investors was like ‘getting into a girl’s pants’ (no, really, this is an actual thing that happened), they were spooning out hot garbage like this advertisement below.

Remember this?

The name of the ad spot is, “We do better when you do better.” This is the Yay, alignment! hook as she appears in the wild. I guarantee you the script to this thing recommended casting a substantially taller guy with an unbuttoned suit as the Fisher guy. In practice, some 90% of the amount of any asset-based fee without a fulcrum structure in a given year is going to be driven by whatever capital you gave the adviser to manage to start the year, and the lion’s share of the remaining difference will be driven by market returns outside of the adviser’s control. For an average balanced portfolio, the amount of the asset-based fee that reflects the job that was done? Maybe 2%, if you’ve got someone generating some tracking error by overweighting value indexes and emerging market stocks a little bit.

So, yes, the Fisher ad is bad and they should feel bad. Still, even if advisers don’t really do better when you do better in any real way that measures up to the meme, surely whatever incentive replaced the incentive to sell whatever you could sell is better.

What, then, IS the incentive for the fund manager, adviser or consultant in an asset-based fee framework?

To keep clipping coupons on your account.

In our heart of hearts – that is, when we aren’t justifying to someone else why people in our industry should be paid what we all get paid – we know that working hard enough to not get fired isn’t alignment, Bob. Not even close. But we’ve all perfected the tortured way in which we pretend that it is. The best part is that we get to summon the Yay, alignment! meme in a particularly special way while we do it. And what an empowering message it is: ‘If the client isn’t happy with the results, we don’t get paid. What could be more aligned than putting all the power in the hands of the client?’

See how easily bullshit rolls off the tongue when it’s wrapped in these seductive memes?

Don’t get me wrong. We can wish that paying people in this industry weren’t so expensive, or that accessing the circa-1987 technology in a Bloomberg terminal didn’t hit our P&Ls to the tune of a new Camry every year, but wishing won’t make it so. You’ve got to charge management fees. We do too. And doing so is usually going to put us in better alignment than commission-based compensation. But let’s drop the theatrics, people.

Paying asset-based fees won’t align you with your agents.


Except most of us rather like the theatrics.

So instead of dropping them, we double down. No, that’s not right. We lever it up ten times and call it super-aligned. How? By looking for and preferring equity ownership on the part of fund managers and financial advisers.

And look, I get why this is such a good-sounding thing. There is such a native appeal to the narrative of the guy-with-his-name-on-the-door who has real skin in the game, who would never let any of his clients be mistreated, lest his good name be besmirched. I get it. But the idea that this is the primary incentive created by equity ownership strains credulity. Take an honest look at what’s happening in the RIA space. Record number of M&A deals in 2016. We broke that record in 2017. Then we broke that record again in 2018. Similar consolidation cycles in many segments of the asset management space, too.

Folks, if you do business with an investment company that charges you an asset-based fee, there is a spreadsheet somewhere on their network drive with your name in Column A, your most recent AUM in Column B, your effective annual fee rate in Column C, and the number 10 (12 for people who hire aggressive bankers with shady comps) in Column D. In Column E is the amount of money they take off the table by selling your account to somebody. Buyers don’t pay very much for performance fees, and they aren’t crazy about things they perceive as being one-time in nature, like financial planning fees or estate planning fees. But recurring asset-based fees? Money in the bank.

Incentives don’t follow a direct path to behavior, of course. They pass through all sorts of work ethic, moral and process layers on their way, and so a decent human being with bad incentives may end up producing better results than a real jerk who ought to know where his bread is buttered. But find me an RIA principal thinking about selling his firm in the next 18-24 months, and I’ll find you a guy who doesn’t say no as often as he should to his clients’ insane IPO requests, who hews to US stocks and vanilla high-grade laddered munis, who wouldn’t give a thought to working to identify that higher volatility source of diversification for you. There are few incentives which I have observed having as direct an influence on realized behavior as an interest in the capitalized value of a management fee stream.

Now again, the point here isn’t to say that these aren’t things you should accept, or that they are Very, Very Bad. They aren’t. For better or worse, this is how our industry works right now. But if your diligence guidelines describe how you think equity ownership aligns an investment professional with long-term financial prudence and fiduciary principles and blah blah blah, you are deluding yourself. Sorry. I should know. I deluded myself on this point for a very long time. It aligns them with not pissing you off until they can get someone to pay them 10x against the run-rate revenue on your account.

This incentive not to piss you off doesn’t make them evil. It doesn’t make it worse than other bad forms of alignment.

But it also doesn’t make them aligned with you.


Most of us get this. Grudgingly, perhaps, but as long as someone isn’t trying to get us to agree to this in context of an argument about the level of compensation in the investment industry, we will usually go along with it. And if the SEC didn’t make it nearly impossible to charge performance or pseudo-performance fee structures (e.g. fulcrum fees, etc.) for retail investors or in the most common retail vehicles, I think many of us would do more than go along with it. We’d put our money where our mouth was and slap performance-based fees on everything.

Except, well, it’s probably performance fees that sing the most seductive Yay, alignment! song.

On the surface, it is hard to imagine anything more aligned than performance-based fees. You pay when you get performance. You don’t pay when you don’t.

Except that, like, you do.

There are two reasons why this is true. The first is well-trod, and so I won’t dwell on it too much. I will, however, say this: anyone who is paying performance-based fees for beta in 2019 is a sucker, and anyone who is charging performance-based fees for beta in 2019 is a raccoon. While there are blessedly fewer than there were a decade ago, there are still long/short equity and credit managers with persistent net exposures of 40-60% who argue that their net is not really beta but the outcome of an alpha process. It’s a garbage argument. They know it. You know it. And no matter how confident we might be in their edge or alpha generation potential, the odds against that ever realistically measuring up to 15-20% of that 40-60% beta exposure are astronomical. A performance-based fee on functionally static beta is a management fee. Again, this wouldn’t have been a novel observation even 10 years ago, but in the interest of completeness, a client paying performance-based fees on beta is in no way aligned with their manager.

There is a second issue, however, which consistently and structurally favors the chargers of performance-based fees against the payer: we systematically understate the experienced asymmetry of realized performance fees as a percentage of gross portfolio returns.

Here’s what I mean.

Let us say that you are an asset allocator with the opportunity to invest with a hedge fund charging a 20% performance fee. Let us be generous and presume that you would be likely to terminate this manager only if they (1) lost more than 10% in absolute terms since inception or (2) experienced a drawdown of more than 20%. Now let us assume that this manager has absolutely zero skill. A real Greenwich special.

Over a five year period, how much do you think you would pay in performance fees? Our analysis is too path-dependent for a closed-form solution, so let’s play it out 100,000 times for various levels of portfolio volatility. We are examining the realized fees that would be paid annually as a percentage of assets, making certain (pretty realistic) assumptions about when we would probably fire the manager. Each point on the below chart is the average from those 100,000 simulations for each level of volatility.

The gray line shows across each of those simulations how much, on average, you should expect to pay in performance fees per annum during years in which you are invested. Remember, this manager has zero skill. You have no expectation of long-term alpha.

In other words, for any realistic expectation of the life-cycle of an invested relationship with a manager that charges performance-based fees, you might expect to pay roughly 80% of the manager’s annualized volatility (multiplied by whatever the performance fee rate is) in performance-based fees every year FROM SHEER RANDOMNESS WITH ZERO EXPECTATION OF REAL ALPHA.

That is the power of the asymmetry of paying performance-based fees when they are earned, but almost never recouping them when that performance is lost. Now, it may be hard to visualize some of the most egregious scenarios that roll up into these aggregates, so let us now take a look at the distribution of fees paid against gross returns generated at a particular volatility level. Let us consider a hypothetical skill-less manager with 8% volatility.

Again, what we’re doing here is randomly generating returns for an 8% volatility manager for each of 5 years. We pay fees at 20% of alpha at the end of each year above the high-water mark, and we terminate the manager if they have lost more than 10% absolute since inception or if they have experienced a drawdown of 20% from their high-water mark. Each dot below shows one of the simulation outcomes over that five year period, where the X-Axis represents the cumulative (non-annualized) gross return and the Y-Axis represents the percentage of assets that have been paid in fees over the corresponding period.

It should be intuitive that the slope of the diagonal line reaching upward to the right at the edge of the dots is 0.2, or 20%, the performance fee rate. Perhaps less intuitive for those of us who haven’t accustomed ourselves to thinking about performance-based fees in a path-dependent way is that a huge share of the outcomes end up with us paying way, way more than 20%, at times with seemingly no real relationship to the amount of value added. Remember, these are simulations of the outcomes for a pretty normal investment manager with ZERO SKILL.

See everything to the left of the blue edge sloping at 0.2x, or the 20% performance fee rate you sold to your board? Those are cases where you paid more than 20% in the aggregate over a five-year period. See everything to the left of the sloped black line? Those are cases where you paid this no-talent clown more in performance fees than the total gross performance they generated. In around 57-58% of these cases, your manager produced negative cumulative returns by the time you canned them. In about 47% of those cases, you still paid them a performance fee. In about 60% of those cases, that fee was more than 1%.

Friends, this is the water in which your incentive alignment structure swims. This is the bogey, the noise against whatever signal exists in your manager’s alpha/performance fee relationship must compete for us to consider it true alignment.

In any realistic path-dependent analysis, performance-based fees are far too noisy to align you with your managers.

So why do these fees exist?

Maybe because they can occasionally be structured to truly reflect a shared set of interests. Truly. It does happen.

Maybe because for some rare sources of alpha, even the likely elevated realized performance fee experience will be worth it.

But really? They exist because people who can charge these fees know that asset owners have boards that feel better and are less concerned about paying fees in particular periods where the returns are very good. They know that when we present funds for approval, we all show the linear scenarios of fees paid in different return scenarios, and that we heavily sell the downside scenarios where we don’t pay as much as we would under a management fee heavy structure. They know that we never, ever show the path dependent scenarios in which we pay fees early, hit a drawdown and terminate, and they know that no one ever, ever asks to see that illustration – even though it may be among the most inevitable outcomes in all of finance.

There is bigger game afoot here, too. In a very real way, by embracing the Yay, alignment! meme so wholeheartedly, we have institutionalized the ability of a class of individuals to extract mathematically inevitable rents from the act of doing nothing other than taking risk with our money and the money of our fiduciary charges.


So what do we do? If most of what we call alignment are right-sounding cartoons which enable massive compensation schemes, how do we achieve real alignment with our financial advisers, fund managers and consultants?

Simple. We don’t.

Sorry, were you expecting a panacea? There isn’t one. You cannot structure away principal-agent problems. And that’s the point. The manipulation of the meme of Yay, alignment! is designed to make you believe that it is possible to do so in order to agree to compensation schemes and arguments for ‘alignment’ of incentives which do absolutely nothing of the sort.

But here’s what we can do:

  1. We can demand beta hurdles: Guys. It’s 2019. Friends don’t let friends pay fees for beta. Stop doing it and stop explaining it away. When they tell you their consistent 40-60% net long exposure is an outcome of their alpha process and not really a beta, tell them they are full of it, and move on if you can’t move them off it. Seriously. You should already be skeptical about alpha. If you are paying 15-20% on a static 0.4-0.6 beta AND paying the volatility tax, the hurdle on your alpha expectations will be insurmountably high for just about any fund manager in the world.
  2. We can look more favorably on multi-year crystallization fee structures: These were all the rage a few years back, especially among more long-biased equity funds. Still, some liquid markets managers have and continue to offer multi-year crystallization on incentive fees in exchange for lockups on capital. My view is that the price you should demand for illiquidity is nearly always dwarfed by the benefit you gain from functional clawbacks on performance fees that would have been moot with shorter horizon fee crystallization.
  3. We can more eagerly pursue cross-fund netting: As allocators, we feel inclined to spread capital around to specialists. It feels right. It feels sophisticated. It feels like we’re doing the work we are paid to do. But the path-dependent power of getting to net the performance-based fees of multiple funds from a single investment partner with multiple investment capabilities often exceeds whatever “uniqueness” benefit we typically get from spreading assets around to smaller, less capacity-constrained, more ‘hungry’ boutiques. Sorry. I know that’s going to be an unpopular view. But asymmetry is a curse. Not nearly enough large, influential allocators take advantage of this.
  4. We can start paying more attention to our advisers/managers’ incentives to sell their firms: There is little more destabilizing to our simple point-in-time estimates of incentive alignment than the hidden calculus of how much an investment firm is worth. We can spend less time thinking about how much someone’s name on the door will make them act honorably, and more time thinking about how much a 10x multiple slapped on our account will make them act irresponsibly with our money.
  5. We can be very careful about the volatility tax we pay on our own behavior when hiring higher volatility managers with incentive fees: As we start to become more selective in our use of alternatives, we will often – appropriately – drift toward higher volatility, higher leverage or higher tracking error strategies to make better use of our various budgets. But take care: the bogey that we are charged in practice on the asymmetry of performance-based fees becomes particularly egregious on higher volatility strategies. If we must go this direction, relying more heavily on systematic managers who more explicitly track, target and limit risk seems prudent.

But most importantly, we can stop thinking that we can and will ever be aligned with our agents. We can’t. We won’t. And the sooner we realize that, the sooner we will also realize that anything being sold to us under the meme of Yay, alignment! ought to be seen with Clear Eyes. Not dismissed. Not rejected. But understood for what it is, lest those we hire to represent our interests hoist us by our own petard of ‘alignment.’


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Yeah, It’s Still Water


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Back in April, I wrote This Is Water.

There are these two young fish swimming along and they happen to meet an older fish swimming the other way, who nods at them and says “Morning, boys. How’s the water?” And the two young fish swim on for a bit, and then eventually one of them looks over at the other and goes “What the hell is water?”

David Foster Wallace (2005)

It’s a note about financialization … the zombiefication of our economy and the oligarchification of our society.

Financialization is profit margin growth without labor productivity growth.

Financialization is the zero-sum game aspect of capitalism, where profit margin growth is both pulled forward from future real growth and pulled away from current economic risk-taking.

Financialization is the smiley-face perversion of Smith’s invisible hand and Schumpeter’s creative destruction. It is a profoundly repressive political equilibrium that masks itself in the common knowledge of “Yay, capitalism!”.

What does Wall Street get out of financialization? A valuation story to sell.

What does management get out of financialization? Stock-based compensation.

What does the Fed get out of financialization? A (very) grateful Wall Street.

What does the White House get out of financialization? Re-election.

What do YOU get out of financialization?

You get to hold up a card that says “Yay, capitalism!”.


So anyway, there I was yesterday, minding my own business, and I saw a tweet about Texas Instruments (TXN) and how they were getting slammed after a difficult earnings call. Sometimes I can’t help myself, so I wrote this:

It’s a popular tweet. An excellent ratio, if you’re into that sort of inside-baseball social media stuff, but a couple of replies thought I was full of it. And there were the de rigueur “stock buybacks mean NOTHING” blog posts and tweets the following day.

So I decided to spend a day and dig into TXN a bit. Maybe I was wrong. Maybe there’s more to the story of Texas Instrument’s stellar stock performance over the past 10 years than mortgaging the future OVER and OVER and OVER again for the primary benefit of management shareholders and the secondary benefit of non-management shareholders.

Nah.

Texas Instruments is, in fact, a poster child for financialization.

There’s nothing illegal or incompetent or even unethical about it. It’s the smart play! Hats off to the TXN management team! I’d have done exactly the same thing in their shoes!

But yeah, this is, in fact, why the world is burning.

I’m going to focus on a 5-year stretch of TXN’s financials, 2014 through 2018. This is where the truly meteoric stock price appreciation took place over the past 10 years, even with the Q4 2018 market swoon, and comparing full year financials makes for a more apples-to-apples comparison.

But before I get into the numbers, let me tell you the story.

The Texas Instruments story is free cash flow and earnings growth that management “returns to shareholders”. EPS on a fully diluted weighted basis has more than doubled from 2014 through 2018, net income available to shareholders on a GAAP basis has doubled, and cash from operations has almost doubled.

The Texas Instruments story is NOT a Salesforce.com story. This is NOT a non-GAAP-this or pro forma-that story. There are real earnings and real operations and straightforward financial statements here.

What makes this a story of financialization is the WHY of the very real free cash flows and earnings growth. What makes this a story of financialization is the HOW of the allocation of those cash flows and earnings.

The WHY is pretty simple.

TXN management has cut their cost structure to the everlovin’ bone.

At the end of 2013, TXN cost of goods sold (COGS) was 48% of revenues. By the end of 2018, COGS was 35%. Gross margins went from 52% to 65%!

At the end of 2013, TXN sales, general and administrative costs (SG&A) was 15.2% of revenues. By the end of 2018, SG&A was 10.7%.

At the end of 2013, TXN research and development expenses (R&D) was 12.5% of revenues. By the end of 2018, R&D was 9.9%.

And while it’s not part of the fixed cost structure per se, Texas Instruments was a keen beneficiary of the Tax Cuts and Jobs Act of 2017, seeing their 2017 tax rate of 16% cut to 7% in 2018, reducing their tax bill by $1.2 billion.

Good thing they’re using that tax cut windfall to hire new workers and invest in new facilities!

Hahahahaha! I’m just joshing with you. Of course that’s not what the tax cut windfall went for.

But hang on … let me finish with the WHY of cash flow growth.

See, there was zero revenue growth at TXN from 2014 to 2015 ($13 billion flat in both years), and tiny growth from 2015 to 2016 (less than 3%). But there was healthy revenue growth from 2016 to 2017 (11% or so) and so-so growth from 2017 to 2018 (6% or so). And when you’re cutting costs like TXN was doing over a multiyear period, even mediocre top-line increases can lead to dramatic profit increases.

How dramatic? Cash from operations was $3.9 billion in 2014, but by 2018 was $7.2 billion. Nice!

Over this 5-year period, Texas Instruments generated $25.5 billion in cash from operations and $32.5 billion in earnings before interest, taxes, depreciation and amortization (EBITDA).

From a cash perspective, of course you’ve got to pay taxes out of all that (again, thank you for the extra $1.2 billion, GOP!), which comes to about $7 billion over the five years, but you can defer some of this to minimize the cash hit. And you’ve got to pay interest on the $5.1 billion in debt you’ve taken out, which comes to … oh yeah, basically nothing … thank you, Fed! And you’ve got to account for depreciation and amortization, which comes to $5.2 billion over the five years … but this is a non-cash expense, so it’s not going to dig into that cash hoard. And you’ve got some cash puts and takes from working capital and inventory and what not, but nothing dramatic. And you’ve got $1.3 billion in stock-based comp, but again that’s a non-cash expense … whew! And – oh, here’s an interesting cash windfall – TXN raised about $2.5 billion by selling stock over these five years. Wait, what? Selling stock, not buying stock? Selling stock to whom? Hold that thought …

Put it all together and I figure the company generated about $25 billion in truly free cash flow over this 5-year span (everyone calculates FCF a bit differently, so don’t @ me on this … I’m in the right ballpark). What are you going to spend this treasure chest on, Texas Instruments? HOW are you going to allocate this capital?

Well, surely you’re going to spend a healthy amount on capex, right? I mean, you took a $5.2 billion depreciation and amortization charge over this time span, and we all know that semiconductor manufacturers need to stay on that bleeding edge of technological innovation, right? Because we all know that technology and the productivity it brings are how we grow earnings, right?

Nope. Texas Instruments spent $3.3 billion on fixed assets from 2014 through 2018, one-third of that total in 2018. Some significant proportion of that was maintenance capex as opposed to growth capex. Significant like in approaching 100% (my guess). LOL. And don’t call me Shirley.

Well, if you didn’t spend your money on property, plant and equipment, then surely you spent a healthy sum in M&A, right?

Nope. $1.6 billion over five years. Tuck-in stuff. Again LOL. Again Shirley.

I guess you were paying down debt, then. Deleveraging up a storm, right?

Nope. Paid down debt by $500 million per year in 2014, 2015 and 2016, but got smart and increased debt by $500 million in 2017 and $1 billion in 2018. Wait, what? MOAR debt, on top of all that cash generation? Huh. Weird.

So it’s dividends, right? This is where all the cash went, yes?

Yes, now we’re getting there. $9.1 billion in dividends over five years. A healthy direct return of capital to shareholders. But it’s just a warm-up to the main event.

Texas Instruments spent $15.4 billion buying back its stock from 2014 through 2018.

Between stock buybacks and dividends, that’s $24.5 billion in cash “returned to shareholders”, essentially 100% of the free cash flow generated by the company over the past FIVE YEARS.

Now here’s the kicker.

What sort of share count reduction would you think that this $15.4 billion in buybacks gets you?

I mean, that IS the logic here, that we’re leveraging earnings growth through the share buybacks. I mean, this IS the judgment call that management is making on behalf of shareholders, that investing $15.4 billion in the company’s own stock is the best possible capital allocation that the company can make.

I would have guessed that surely $15.4 billion would retire anywhere from 20-25% of the outstanding shares over this time frame, with the stock price ranging from $40 to $100.

In truth, Texas Instruments retired only 10% of its outstanding diluted shares with its $15.4 billion investment, going from 1.1 billion shares to 990 million shares.

Remember all that stock and all those warrants sold to management with one hand while the other hand buys it back? Remember all that stock-based compensation?

Again LOL. Again Shirley.

But wait, there’s more.

We can measure the windfall compensation paid to TXN management here.

From 2014 through 2018, Texas Instruments bought back 228.6 million shares for $15.4 billion. That works out to an average purchase price of $67.37.

Over that same time span, Texas Instruments sold 90.8 million shares to management and board members as they exercised options and restricted stock grants, for a total of $2.5 billion. That works out to an average sale price of $27.51.

The difference in average purchase price and average sale price, multiplied by the number of shares so affected, is the direct monetary benefit for management. This is true whether or not management sells their new shares into the buyback or holds them. That amount works out to be $3.6 billion.

In other words, 40% of TXN’s stock buybacks over this five year period were used to sterilize stock issuance to senior management and the board of directors.

In other words, senior management and the board of directors received $3.6 BILLION in direct value from these stock buybacks.

But wait, there’s more …

As of December 31, 2018 there were still 40 million shares outstanding in the form of options and restricted stock grants to management and directors, at an average weighted exercise price of $55.

At today’s stock price, that means there is an additional $2.6 BILLION in stock-based compensation already awarded to TXN’s executives and directors.

Well golly, Ben, these surely must have been amazing managers and directors to warrant that sort of stock-based compensation in addition to their cash compensation!

Again LOL. Again … oh, you get the point.

That’s TXN stock performance in white and SOXX performance in gold over the 5-year period 2014 – 2018.

SOXX is an ETF that tracks the Philly Semiconductor Index. Texas Instruments is the fifth largest position in that ETF and that underlying index, with a 7.1% weight.

Oh yeah, one more thing … the expense ratio of the SOXX ETF is 47 basis points.

For the past five years, Texas Instruments has been nothing more than a tracking stock for a passive semiconductor index.

For this privilege, shareholders have rewarded management and directors with $6.2 BILLION in stock, plus a couple of BILLION in cash compensation.

I’d say LOL, but I’m not laughing anymore. Are you?

It’s never been a better time in the history of the world to be a senior manager of a publicly traded company.

Under the narrative cover of “returning capital to shareholders” and the common knowledge of “aligned interests” and the cash windfall of “job-creating tax cuts” and the equity valuations driven by “extraordinary monetary policy” … management teams like that at Texas Instruments have sucked the FUTURE of their company dry for the NOW of their personal enrichment.

What’s the real story of Texas Instruments?

It’s the real story of pretty much every public company over the past decade.

Public companies are managed today to mortgage the future OVER and OVER and OVER again, for the primary benefit of management shareholders and the secondary benefit of non-management shareholders.

And their main tool for this is the stock buyback.

It’s a crying shame, because here’s the thing … the total return on owning TXN is, in fact, 15% higher than the SOXX ETF over this five year span 2014 – 2018.

Not because of the stock buybacks.

Because of the dividend.

Do you want to run your company for cash generation? Do you want to return that cash to shareholders? GREAT!

Use a special dividend, not buybacks.

There, fixed it for you.

Do stock buybacks lift the stock market “artificially”? I guess. Kinda sorta. On the margins. Then again, markets happen on the margins.

IT’S THE WRONG QUESTION.

The right question is not whether or not stock buybacks prop up the overall market.

The right question is not the macro.

The right question is the micro.

The right question is whether or not stock buybacks are the best use of capital if you take a steward’s perspective rather than a manager’s perspective.

Which no one does today.

Not even the boards of these companies. Especially not the boards of these companies.


You know, everyone is all in a tizzy about Softbank paying Adam Neumann $1.7 billion just to go away.

My unpopular opinion: the Adam Neumann story is repeated in a non-infuriating and non-obvious way every day in every S&P 500 company. And it’s been going on for a DECADE.

Dimon, Iger, Cook, Nadella, Pichai, Fink … they’re not founders like Gates or Bezos. They’re not investors like Buffett or Dalio. They’re management. And now they’re billionaires. And all their captains and lesser brethren are centimillionaires. And all their lieutenants and subalterns are decamillionaires.

And everyone is perfectly fine with this. No one even notices that this is happening or that it’s different or that it’s a sea change in how we organize wealth in our society. It’s not good or bad or deserved or undeserved. It just IS. This is our Zeitgeist.

This Is Water

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

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

Welcome to the Long Now.


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The Long Now, Pt. 3 – Is This Normal? Asking for a Friend


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The Long Now is personal.

Tick-Tock

The Long Now is political.

Make – Protect – Teach

The Long Now is systemic, both in a micro sense of the body politic riddled through and through with this cancer, and in a macro sense of the tectonic plates of social organization shifting wildly without foundation or tether.

Today’s note is about the micro.

Today’s note is about getting back to the Real.


That’s me on the left, giving Luca a pat on the head. That’s Neb Tnuh on the right, giving you a pat on the head.

If you’re not familiar with Neb, here’s how I introduced him last year:

“Neb has a hard time talking with real people these days. Neb just doesn’t … connect … the way he used to. He doesn’t have much to say. He mumbles a lot. He imagines long and involved conversations with people in his head, but that’s where they stay. In his head.

Sartre famously said that hell is other people. For Neb, hell is other people who want to talk about markets or politics. Neb is just so WEARY of being lectured for the umpteenth time on why Trump is so awful or why Trump is so great, why Bitcoin is going to $100,000 or why Bitcoin is going to zero, why the “fundamentals are sound” or why the fundamentals are sound EXCEPT for this one thing which will bring the whole house of cards tumbling down ANY DAY NOW, why the Fed is the source of all evil in the world or why the NRA is the source of all evil in the world or why the Democrats / Republicans are the source of all evil in the world.

So obviously Neb is a real barrel of laughs at parties, which he shuns today even though he remembers that he used to like parties. The circle of real people that he actively feels comfortable being around has shrunk and shrunk and shrunk until he can count them on his fingers, and even here Neb increasingly has a hard time connecting with these non-rhinoceros friends. He increasingly talks past and through the people who are the most important to him, like his wife and daughters. And that makes Neb saddest of all.

He’s lost friends over the widening gyre, lost over the event horizon of black hole Trumpdom or lost in the blare of doubleplusgood DemSoctalk. He’s lost family, too.

On the flip side of that coin, it’s easier and easier for Neb to talk with complete strangers on social media platforms. It’s all so easy for Neb to lose himself in this ocean of social abstraction and Turing tests, because he’s fluent in the symbolic languages of mathematics, history and pop culture. And so he swims in that ocean, compulsively even, until he’s forgotten whether or not there was ever a shore.

That’s the defining characteristic of life in the Long Now … you swim in an ocean of stimulus and fear so long that you forget whether or not there was ever a shore. You forget yourself. You forget your identity as an autonomous human-in-full, connected with other humans that you work and play with in a non-instrumental sense. You forget your Pack.

You become a cartoon.

You become a believer in the “Yay, capitalism!” and “Yay, military!” and “Yay, college!” narratives used by the Nudging State and the Nudging Oligarchy to their advantage and your detriment.

And on and on we swim in the ocean of social abstraction.

This is Water.

It’s intentional. It’s done TO us.

It’s a system of belief and forgetfulness designed to objectify us … to turn us into predictable and thus manipulable objects. Not objects like a shoe or a rake, but “objects” as the term is used in computer code, as digitized receptacles for if/then functions to act upon.

Our contradictions become attributes. Our vectors become bitmaps. We are smoothed through a psychological Gaussian blur. We are digitized and depixellated. Our autonomous human IDENTITY becomes a programmable human ENTITY.

When I say that we are transformed into cartoons, I mean that quite literally.

Sound familiar, Neb? It should.

You see, Neb loves to play cards and games. He loves to gamble. And when he was in college in the mid-80s, he was in a fraternity that had a very infrequent poker game, maybe once a month or so. It was a wonderful game … low stakes, friendly camaraderie, really a lot of fun. But over a period of about 18 months over his junior and senior years, Neb corrupted that monthly low-stakes game of Community into a weekly high-stakes game of Alienation and Cartoon … into a system of belief and forgetfulness.

First, Neb introduced wild cards into the game.

Neb would always laugh to himself when someone bristled at poker games with wild cards, when he heard someone say “that’s not REAL poker”, as if there’s anything real about any of this. Neb knew that he would be able to run circles around that guy in calculating the revised odds of winning poker once he introduced greater volatility into the game. Neb also knew that greater volatility would result in more players hanging around in a hand longer than they should, given those revised odds. Neb also knew that greater volatility would result in players getting lucky more often, getting memorable hands more often … having more fun in the the game. Pretty soon everyone forgot what it was like to play games without wild cards.

Then Neb introduced credit into the game.

The original poker game was cash-only. Sometimes we wouldn’t even play with chips, just with dimes and quarters and dollar bills. There was no “bank”; you played with the cash you brought to the game, and that was it. But then Neb offered to hold the money and dispense the chips, so that in case there was some disparity when people cashed their chips in (which occasionally happened in a banker-less game), Neb would make up the shortfall out of his own pocket. From there it was an easy step for Neb to take IOUs written down on a little slip of paper rather than cash. Pretty soon Neb had a wallet full of IOUs. Pretty soon a game where losing $20 in cash felt awful became a game where losing $80 in little slips of paper felt like nothing. Pretty soon everyone forgot what it was like to play games without credit.

Then Neb raised the stakes.

This one was easy. Once you were no longer limited to the cash you brought to the table and once you no longer had to settle up your debts at the end of the game, it just made sense to raise the stakes. In truth it made no sense, of course, but Neb drove this with a narrative … that players were afraid if they didn’t jump in at the new betting levels. Amazing how college-age males don’t want to show that they’re scared or that the game is too big for them. Amazing how non-college-age males do the same. Pretty soon everyone forgot what it was like to play games without high stakes.

Then Neb introduced derivatives.

Derivative games are different than just adding wild cards to standard games. Derivative games are different rule sets, with additional zero-sum outcomes that allow for more ways for the better player to win with the same distribution of cards. Keep in mind that Neb played poker before Texas Hold-em and Omaha took over the world. This was dealer’s choice, and a derivative game with the right stimulus/response pattern could spread around the table like a virus. Side-pot games are a derivative rule set, as are hi-lo games, as are match-the-pot games. Neb introduced a game with SIX betting rounds, plus hi-lo, plus match the pot if you lost.  Tons of action, everyone felt like they were in the game all the way to the end, and then there was that wonderful frisson … that thrill of anticipation and ENORMOUS pot-matching potential loss … if you stayed in for that final, central card. Pretty soon everyone forgot what it was like to play games without derivatives.

And then Neb stole their tells.

This was the big one.

All of the regulars had different tells, but they all had one. Here was the one that made the most money for Neb. This was Kurt’s tell.

The final action of a hi-lo game, where both the best hand and the worst hand split the pot, is to declare whether you are going high (best hand) or low (worst hand) or both ways (must win both the high contest and the low contest with different 5-card combinations from your set of cards). To declare for high you put one chip in your clenched fist, to declare for low you put zero chips in your fist, and to declare for both you put two chips in your fist. You do all this underneath the table, you wait until everyone shows their fists publicly, and then everyone reveals the number of chips in their hands at the count of three.

When Kurt was declaring high (or both ways, I guess), his clenched fist looked like this:

And when Kurt was declaring for low, his fist looked like this:

That little crook of the thumb (and the ability to quickly calculate the right play as soon as Kurt’s hand came up above the table) was by itself worth a couple of thousand dollars to Neb, playing low stakes poker over a period of months. I won’t get into the math, except to say that knowing Kurt’s tell – and so always having the option of going the other way in a hi-lo game – gave Neb a +$2.00 to +$3.00 expected value for every hand dealt once the game was geared up to maximum loss levels. And they dealt a lot of hands. This was the secret to the system that Neb set up … he had a consistent positive expected return on every hand that was dealt, while the other players had a consistent negative expected return. And you may think that would make for a short-lived game where everyone quickly tired of playing with Neb, BUT:

  • The gameplay was thrilling, both on each hand and over the course of the night. When you won, you won big and you believed that you had played brilliantly. Neb would tell you so. When you lost, you believed it was because you were “unlucky”. You believed that it wasn’t your “fault”. Neb would tell you that, too.
  • On any given hand, Neb was subject to apparent volatility, which he played to the hilt. Neb loved to lose the occasional hand on a bad beat!
  • While there was very little true volatility for Neb, there was a ton of volatility for the other players. Meaning that everyone would have the occasional big win, and that was all that was needed to keep them coming back and believing in the game. And forgetting that the game had ever been anything different.
  • While Neb had a consistent positive expected return on every hand dealt, the player from whom Neb stole his tell typically had a positive expected return on that hand. A small positive return, to be sure, but enough to condition players over time to persist in their tells and believe that they were particularly good players in Neb’s game. I can’t emphasize this point strongly enough … everyone who sat at Neb’s table long enough came to believe that they were a great poker player. LOL.

And so did Neb. Also LOL.

It wasn’t playing poker really well that made Neb a lot of money in that college game. It was building a fear and stimulus machine that made Neb a lot of money. It was building a system of play that predictably zapped and rewarded the other players, so that they believed that a negative expected value system was a positive expected value system, and they forgot that an alternative system of play was even possible. It was turning his fraternity “brothers” into stimulus/response objects, turning them into abstracted versions of themselves. It was turning them into cartoons.

And in doing so, Neb became a cartoon himself. Not an objectified and manipulated cartoon (yet), but a cartoon nonetheless. Neb is neither clear-eyed nor full-hearted.

See, Neb didn’t really PLAN to objectify his fraternity buds. It just came naturally to him. That is, in fact, the scariest thing about Neb … he really does swim effortlessly in this ocean of social abstraction and manipulation. It’s something I have to talk to him about pretty much every day, especially when he steals the password to my Twitter account.

Looking back on it now, I am grateful beyond measure that online poker and poker-as-a-business did not exist for Neb in the mid-80s. Because if they had, Neb’s life would have gone down a VERY different path. A bad path. And of course, so would have mine.

Because Neb was not wise enough to understand the WHY of his poker winnings. Because Neb, like Matt Damon’s character in Rounders, would have thought he was talented enough to “compete” at a higher level. As if talent is enough to succeed in a fear and stimulus system geared against you. As if talent is enough to succeed in a rigged game. Because that’s what a fear and stimulus system IS … a rigged game.

Ah, youth.

For every too-clever-by-half coyote like Neb Tnuh who confuses talent for being on the right side of a fear and stimulus system, there is a scaled version of that same system that exists to objectify and stimulus/response Neb like he objectified and stimulus/responsed his frat brothers, and there is a scaled version of THAT system on top of that, and a scaled version of THAT system on top of that.

There are at least four nested systems of believing and forgetting in our modern social lives. Sooner or later, we all become objectified cartoons. We all get bitmapped. We all start to believe that our negative expected value game is a positive expected value game, and we all forget that an alternative game is even possible. Some part of us, anyway. The Neb part of us.

Few people today remember The Peter Principle, pretty much the first wildly successful pop psychology business management book, published in 1969. It’s a great book, with a simple one-line lesson: In a hierarchy, every employee tends to rise to his level of incompetence.

So here’s the Epsilon Theory variation, call it The Neb Principle:

In mass society, every citizen tends to rise to his level of cartoonification.

At every level of this nested and fractal system of believing and forgetting, the micro-structure time-line is the same. This is the exhaustive set of steps to establish a system of believing and forgetting, at any level of organization. It succeeds without fail, always and in all ways.

1. Introduce wildcards

2. Introduce credit

3. Raise the stakes

4. Introduce derivatives

5. Steal the tells

In every field of economic endeavor … in every manifestation of political competition … in every nook and cranny of our modern social lives … a system of believing and forgetting is being established following exactly these steps. It wasn’t necessarily planned that way. But with enough coyotes and enough time, it emerges. It IS. And it is a VERY stable system.

I believe that we are at a tipping point today. I believe that we are on the cusp of these systems becoming irreversible. Or at least irreversible without a cataclysmic Fall. I believe that the process of the Long Now is now being ensconced at a global scale … at the scale of an oligarchic economic system of believing and forgetting and a statist political system of believing and forgetting.

How? Through mastery of the fifth stage of the Long Now micro-structure.

By stealing our tells.

That’s what Facebook does. That’s what Google does. That’s what the Democratic Party and the Republican Party do. That’s what Wall Street does. That’s what every S&P 500 company does. That’s what every central bank does. That’s what every powerful economic and political organization in the world does today.

They steal our tells. At scale. At global scale.

You know the word for what they do with our stolen tells, don’t you? It’s Nudge.

And you know the true superpower of a Nudge, right? We believe we’re making a real choice. We believe we’re playing a positive expected value game by making that choice. We forget that making a choice on their terms and using their language is itself a choice.

I’ve written a lot about Nudging States and Nudging Oligarchs, and I won’t repeat all that here. If you want to know where I’m coming from, start with this note from two years ago: Clever Hans.

I will repeat this, though.

What do we DO about our Hollow Markets and our Broken Politics?

Actively engage with yourself to recognize how many of your behavioral choices in the world of investing and politics aren’t a free choice at all, but are instead derived from a clever “choice architecture” imposed by others. You probably won’t change your behavior. That’s kinda the point of these pleasantly skinned Hobson’s Choices — they’re offers you can’t refuse. But the day you recognize the choice architectures that enmesh us is the day you start making true choices. It’s the day you start thinking and reading differently. It’s the day that everything starts to change for yourself, your family, and your clients.

Actively engage with yourself to create a critical thinking curriculum that adds to your reservoir of free-thinking autonomy. Read more history. Read more biography. Read more science fiction. Every day. Watch a lot less CNBC and CNN and Fox and all the rest. I know we can’t wean ourselves from Facebook and Twitter. It’s our bottle and we’re addicted. I am, too. But take the time to listen to someone whose political or market views you emotionally dislike and force yourself to see the world through those views, not as an adversary but as another thinking, feeling human being. Every day. Educate yourself, don’t train yourself.

Actively engage with others to spread the word. To educate, not to train. We treat others as free-thinking autonomous human beings, not as manipulable objects. Never as objects, even if it means losing the client or losing the election. This is how we fix things. Bird by bird. Voice by voice. From below, not from above. As wise as serpents and as harmless as doves.

So I stand by all that. I think it’s all more important than ever. It’s a really good start on a personal regimen to resist the micro-structure of the Long Now, to keep your personal Neb in check.

But it’s not enough. There’s not enough time.

We have to confound the stolen tells. At scale. At global scale.

So I’ve got two new ideas … two forms of public resistance to share with you … two forms of hiding your tell that I think can scale … two forms of bypassing the fear and stimulus systems that make cartoons of us at every turn. One for politics and one for economics.

In politics, I want to start a movement to encourage write-in candidates. I want to give everyone the tools and the information they need to bypass the political party system. We organize to do this, using the Epsilon Theory megaphone as our springboard. Maybe we write in joke candidates. Maybe we don’t. Maybe we write in ourselves. It won’t be noticeable at first. And then it will. And then it becomes a self-sustaining narrative. And then … who knows?

In economics, I want Epsilon Theory pack members to know who the other Epsilon Theory pack members are, so that they can do business with and share information with like-minded people directly. I want to give Epsilon Theory pack members the tools and the information they need to bypass the information system of the tech giants and Wall Street. Obviously this is a voluntary thing. Don’t worry, pack-members-who-work-at-the-Fed, I’m not going to out you (and there are a lot of you). But we have a LOT of people actively engaged with Epsilon Theory. Tens of thousands of people, all over the world, in every financial institution of any significance you can name. Our active cooperation in a mutual game without fear, without stimulus, without cartoons … a mutual game of full-hearted engagement … it won’t be noticeable at first. And then it will. And then it becomes a self-sustaining narrative. And then … who knows?

Imagine that.


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Rust and Blight


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Suddenly, over the slope, as if tethered to a cord of air drawing quickly upward, came a Northern Harrier, motionless but for its rising. So still was the bird – wings, tail, head – it might have been a museum specimen. Then, as if atop the wind, it slid down the ridge, tilted a few times, veered, tacked up the hill, its wings hardly shifting. I thought, if I could be that hawk for one hour I’d never again be just a man.

PrairyErth: A Deep Map, by William Least Heat-Moon

This is cedar rust.

It is the effect of the fungus gymnosporangium juniperi-virginianae on an apple tree leaf in my orchard. This fungus has infected a particularly lovely Yarlington Mill tree that would otherwise make a rich English-style single-varietal cider.

I can slow cedar rust down.

I can spray the tree with copper or sulfur, and it’ll kill some spores. I can spray the tree with something ‘organic’, and it’ll make the spores smell like whatever ‘organic’ goop I sprayed them with. Neither strategy will stop them. They’re in the air, on the bark and on the ground. Any leaf on this tree that has been infected with cedar rust this season will eventually curl, yellow and die. Any new leaf on the same branch will still almost certainly become infected. Even on new growth on a different branch, the prognosis isn’t very good. I’ll lose every leaf on this tree this season before its time.

The tree will live. But as long as the eponymous hosts for the fungus exist in the vicinity, it will be my orchard’s constant companion.

I have a few choices.

I can find, uproot and burn every cedar, juniper, cypress, sugi, sequoia and redwood tree within a half-mile radius. Having seen what juniper did to turn the Central Texas plains into a desert over the last 100 years or so, I am inclined toward this idea. Regretfully, my neighbors disagree, even though the destruction of all cedar and juniper trees is both a righteous and holy crusade – and the only permanent solution to my little problem with cedar rust.

Alternatively, I can religiously apply sulfur to each and every apple tree before and following bud-break, and then follow up with copper in the late season.

But tearing up the tree and replanting a new one? Wouldn’t do a thing. Cedar rust isn’t a problem with the tree. It’s a problem with the tree’s environment.


This is fire blight.

Fire blight is, well, a blight. It isn’t caused by a fungus, but by a little bacterium called Erwinia amylovora. Thankfully, this picture isn’t from my orchard.

Fire blight is different from cedar rust. It can be controlled and prevented at some stages with many of the same chemical applications, but once you’ve got a canker in your wood, that wood must be removed and burned. If it emerges during the Goldilocks temperature and humidity environment of a North American summer, you’ll have to cut it a foot or more inside the canker to be sure.

And if the canker is in the main leader?

Pull the trees up, root and stem. Burn them in the hottest fire you can find and use the ashes to curse your enemies. Nuke ’em from orbit. And with whatever you plant the next time, be sure to pay your weregild to Cornell University, which curiously owns the patents on nearly every fire blight-resistant rootstock and makes a few bucks on just about every apple tree you’re likely to find at a modern orchard.

When it comes to blight, the problem is with the tree and with its roots.

How does the orchard hobbyist discern between rust and blight?

It is never easy. Sometimes a canker or growth gives you a strong hint, but the effects can otherwise be pretty similar. Browning, curling, drying of leaves. Yellow spots. These same symptoms may describe a dozen different maladies, some of which warrant patience and pruning shears, and some of which demand nothing short of fire and blood.

How does the investor and citizen discern between rust and blight?

It is never easy.


I remember the exact moment I decided to make orcharding part of my life’s work.

When my wife and I were first planning to be the only poor saps moving to Connecticut from Texas, we found a few houses we liked. We liked this one a little more than most. We thought the yard and woodlands were nice – a great place to free range our kids. But when we took a look inside the old red barn, we found two things: a gnarled old apple tree stump, four 19th century cider barrels and this old apple mill.

That was it. That was when we fell in love.

That was also when we decided we would plant apple trees.

It isn’t that I have some long-standing thing for apples. I mean, Jesus, I know I’m odd, but I’m not “apples are my passion” odd. My favorite fruit is the blackberry. I think most American cider is insipid. But I don’t understand how you can see and touch the value that generations saw in a piece of earth and come away unmoved. Unchanged.

If I could be that hawk for one hour I’d never again be just a man.

There is a contradiction here; surely you see it. It is the wellspring of American exceptionalism – an idea manufactured into a meme by the right and an ironic joke by the left. We are an exception, but not because we are uniquely free or uniquely smart or uniquely strong. We are an exception because for most of our history we have been a frontier. We are ever torn between a cultural and personal predisposition for adventure and a yearning for deeper connection. I moved my family half-way across the country, away from every root we’d ever sunk into that deep red clay, only to find a 150-year old barrel with a painted-on family name I felt obliged to honor. And for Americans, that story is decidedly unexceptional. It is the kind of story a hundred million families could tell.

What is the thread which ties those stories together? The escape to and civilization of a frontier.

If you, like my 7th or 8th (or whatever) great-grandfather, arrived in the early-to-mid 18th Century from an Irish port, you probably landed in Philadelphia or Wilmington. You were probably poor and probably indentured for some period to pay for the voyage. Once you were able, you found the lands around Philadelphia full and far too expensive. And so you took to the road west toward what is now Harrisburg or Lancaster, where Swiss Anabaptists fleeing an unfriendly religious environment and Palatines fleeing nearly constant French incursions into the Rheinland had already settled. And so, by wagon or horse, you followed the curve of the Shenandoah Valley into the James River Valley and all down the spine of the Appalachians.

No matter when you came, you kept going until you found the frontier.

It was always moving. Before 1750, the frontier was the backwoods of Virginia. In the 1760s or 1770s it was probably in North Carolina (my dear wife thinks I should make an Outlander reference here, but I have informed her that would be very off-brand). In the 1780s and 1790s, that frontier shifted to what is now Northeast Tennessee, where the Tennessee River and the lands lying before the Cumberland Gap opened entirely new worlds to most European settlers. Alabama, Mississippi. Kentucky. Indiana. Missouri. In the coming decades, the breach of the Appalachians meant that the frontier’s race westward would accelerate.

The most popular and enduring myth about these early pioneers – especially among my fellow Tocqueville-loving conservatives – is that they were an especially pious people, bringing civilization, godliness and order to the untamed country. What a laugh. As Lyman Stone correctly points out, they were drunks and heathens all, by which I hope you understand that I mean no criticism. These were my kind of people. The settling of the frontier was a demonstrable rejection of established cultural norms, established social structures and entrenched power. Of course it was. Y’all, that was sort of the point of the whole affair.

Image
Source: Lyman Stone

And yet.

Despite the fundamental small-l liberalism of frontier expansion, in each of these new communities, duty to fellow-laborers quickly became sacred and indispensable. Naturally, this took different forms in different places and with different people. But the pattern is recognizable in nearly every frontier town. Citizens realize that they needed someone who could marry them. Someone to share the burden of teaching children. Someone to shoe a horse. Someone to judge a dispute between two neighbors. Someone who could be trusted to lock up citizens who’d been hitting the cider too hard. They also needed to know that the people around them could be roused to selfless, communal action if their community was under threat.

Civilization emerges. Conservatism follows when people conclude that they’d like to keep the things they’ve found.

Of course, not every American had the luxury of simply working off an indenture to make whatever they could of the world. Nearly 4 million Americans whose mothers and fathers lived for centuries under the vile institution of chattel slavery were forced to wait until its abolition. And yet theirs is perhaps the most powerful frontier story of all – navigating at once a new, unfriendly and unfamiliar country, and in conquering it discovering and creating one of the most culturally cohesive – and yes, in its own way, conservative – communities in the world.

And that’s a good thing. No, that’s an exceptional thing – and essentially human.

Every great achievement, every great leap, every great advance we have made as a species is the result of small-l forces of liberalism and heterodoxy braving new ideas and new shores. AND it is the result of small-c conservatism and the successful institutionalization of orthodoxy around those new ideas alongside those that came before that worked.

The Long Now, well, it usurps and perverts them both. In the Long Now, we are helicopter parents and helicopter policymakers. In the Long Now, we create memes of liberalism! out of whole cloth in place of real frontiers, and memes of values! and conservatism! to defend not Lindy-proven ideas, but sources of existing power and influence. Want to know why we have a world that looks fair but feels foul? A world where present valuations of the future look great, but true expectations of the future feel lousy?

Tell me, where today is small-l liberalism and heterodoxy permitted from within? Do you think that you will find it in financial markets, where the very act of positing that maybe – just maybe – the job of a professional investor might involve judging the value of an asset being purchased in comparison to another has become a kind of heresy? Do you think you will find small-l liberalism among American progressives, where wholesale embrace of deplatforming and cancel culture will damn you and your ideas for all time because you were an ignorant dumbass when you were 16? Do you think you’ll find small-l liberalism among American conservatives, where opposition to Dear Leader will lead to your banishment and excommunication, regardless of the consistency of your political views?

Tell me, where today is good-faith orthodoxy not under assault from without? Is there a view about the public sphere it is possible to hold which has not made the transition in some group’s common knowledge from disagreement to dangerous? As utterly unacceptable, worthy of our derision, our strongest rhetoric and treatment as an existential threat to everything we love? Within these tribes of little meaning we have allowed to consume us, we handle every disease like rust, something to be pruned and treated, but gently. Kindly. Outside these tribes of little meaning we treat every disease like blight, burning and ripping indiscriminately.

There is but one end-game: a sparse field of dying trees, lovingly tended and violently defended.


Thankfully, in our own lives, careers and communities, we get to choose what we labor to heal and prune, and what we throw on the bonfire so that we may plant anew.

I’m with Ben. Even though we disagree on health care and health insurance. On abortion. On tax policy and the justifiable role and interest of the state in managing wealth inequality. On a great many things. We are not ‘political allies’ in any recognizable American sense. But national politics and national parties are a blight, and they will be a blight so long as they perpetuate their control through manipulation of existential narratives. I’ve ripped them from my orchard. Will I vote? Probably. Do I care who wins? Probably. I like Gorsuch. I’d like more Gorsuches. But my energy, my time, my wealth – such as they are – cannot belong to this painstakingly designed foreverwar of Flight 93 Elections.

News media is a blight, too. That doesn’t mean that there aren’t earnest, good people working to inform us. There are thousands – tens of thousands! A free press is, properly arranged, among the single most important institutions to the defense of liberty! However, the decision of the major outlets and their owners to fuse and gray the lines between news, analysis, feature and opinion journalism has made them vessels for fiat news and agents of the widening gyre. So yes, I think we should demand that legitimate news organizations, both left and right, exit the opinion and analysis business. Full stop. They won’t. Fostering the widening gyre via social media was the discovery that finally made this terrible business model modestly profitable for some outlets. And so it falls to us to determine the role they will play in how we inform ourselves, in our orchard. My vote, again, is for the bonfire.

What about other institutions, like our universities, our churches, temples, mosques and synagogues? Our system of laws, our intangible institutions and collective social values like home ownership, families, volunteerism, charity, patriotism and social mobility? There’s some pruning that needs to be done. Some branches in need of culling. But as marvelous as the really thoughtful Derek Thompson’s piece in The Atlantic was, I’m among those not yet willing to consign any of these things to flames of woe in hopes of some new stabilizing cultural institution taking their place.

Yet in all these things, what matters most is what we lose if we embrace the Long Now and the widening gyre.

What we lose is the ability and appetite to take risk.

Adrianus (Hadrian) was passing on his way to Tiberias when he saw a very old man digging holes preparatory to planting trees. Addressing the old man, he said: ‘I can understand you having worked in your younger days to provide food for yourself, but you seem to labour in vain at this work. You can surely not expect to eat of the fruits which the trees, that you intend planting, will bring forth?’

‘I’ said the old man, ‘must nevertheless do my duty as long as I am able to do it.’

‘How old are you?’ asked Adrianus.

‘I am a hundred years old,’ replied the planter, ‘and the God who granted me these long years may even vouchsafe me to eat of the fruit of these trees. But in any case I do not grudge the labour on them, and as it pleases the Lord so He may do with me.’

Leviticus Rabbah (5th to 7th Century)

Common knowledge will tell you that the real question is which national party and candidate you will support with your whole heart to stave off the coming existential threat, whatever that might be. I tell you that the real question is this: Who are you willing to take risk for, and who are you willing to protect – emotionally, morally and financially – when they take risk?

Maybe it’s just your immediate family.

Maybe it’s three or four neighbors. Or a couple very close friends.

Maybe it’s fellow laborers in local union.

Maybe it’s a small group from your place of worship.

Maybe it’s a small group of business partners, people with whom you’ve shared both wins and losses, successes and failures.

Maybe it’s a community separated by distance and united by technology, a collection of like-minded people willing to call themselves something.

Whatever that thing is for you, that’s your pack. Or at least it can be. We can Make. Every ounce of effort we would otherwise devote to defending blight can be devoted to taking new risks on new ideas, new investments and new creations. We can Protect. Every ounce of energy and time we muster to defend memes of our beliefs against all comers can be devoted to supporting our fellow-laborers when they fail. We can Teach. Every ounce of exhaustion that is poured into trying to signal our adherence to the Right Ideas can instead be poured into growing together intellectually, physically, emotionally, technologically, socially and culturally with our pack.

We may not succeed. But we will not grudge the labor.


PDF Download (Paid Subscription Required): Rust and Blight


The Long Now, Pt. 2 – Make, Protect, Teach


PDF Download (Paid Subscription Required): The Long Now, Pt. 2 – Make, Protect, Teach


Peter Paul Rubens, Saturn Devouring His Son (1636)

Every three or four generations, humanity consumes itself with the fang and claw of fascism and collectivism. Every three or four generations, we eat our own.

This is that time. This is the Long Now.

In politics it takes the form of a widening gyre, where the center cannot hold against the onslaught of polarizing political entrepreneurs who eliminate the political promise of the future, replacing it with the Long Now of constant political fear. In economics it takes the form of a market utility, where those same illiberal political entrepreneurs eliminate the economic risk of the future, replacing it with the Long Now of constant economic stimulus.

The first note in this series was about my personal response to the Long Now. Tick-tock.

Today’s note is about my political response to the Long Now. Make – Protect – Teach.

My question is not how we prevent or avoid the Long Now. Sorry, but that ship has sailed.

No, my question is how we keep the flame of small-l liberal thought and small-c conservative thought alive through the Long Now, so that it can light the world again when this, too, shall pass.

My question is … must we ALL become rhinoceroses?

Eugène Ionesco’s masterpiece, Rhinoceros, is about a central European town where the citizens turn, one by one, into rhinoceroses. Once changed, they do what rhinoceroses do, which is rampage through the town, destroying everything in their path. People are a little puzzled at first, what with their fellow citizens just turning into rampaging rhinos out of the blue, but even that slight puzzlement fades quickly enough. Soon it’s just the New Normal. Soon it’s just the way things are … a good thing, even. Only one man resists the siren call of rhinocerosness, and that choice brings nothing but pain and existential doubt, as he is utterly … profoundly … alone.

Yay, rhinoceroses!

Ionesco was born in Romania in 1909, spent most of childhood in France, and returned to Romania when he was 16. He got married and had a kid, pursued a career as a poet and playwright, but ended up fleeing Romania in 1942 for Marseilles. He wrote Rhinoceros in 1959 to describe the rise of the fascists in his homeland, a particularly nasty crew of Eastern Orthodox ultranationalists who went by names like the Iron Guard, the Legion of the Archangel Michael, the Greenshirts, and the National Legionary State.

The Iron Guard didn’t seize power in some bloody putsch, and they didn’t rise to ascendancy overnight. No, it took 13 years for them to come to power, contesting parliamentary elections all the way along. They got 0.4% of the vote in 1927, 1.1% of the vote in 1931, 2.4% of the vote in 1932, got themselves banned in 1933, returned with a new name in 1936, and won 15.8% of the vote in 1937. They were banned again in 1939 following the dissolution of parliament, but struck a deal with strongman-general-turned-politician Ion Antonescu and became the only legal political party in 1940.

And then the pogroms began.

Like the Bucharest pogrom of 1941, where – per the US attaché report to Washington after visiting one of the many massacre sites – “sixty Jewish corpses were discovered [in the meat-packing plant] on the hooks used for carcasses. They were all skinned … and the quantity of blood about was evidence that they had been skinned alive.” Their guts were hung around their necks and they were labeled “kosher meat”. Yes, some were children. A five-year-old girl is mentioned, flayed alive.

You know, I almost didn’t keep that last paragraph. Too harsh, I thought. Takes away from the flow of the larger argument I’m trying to make here, I thought. Some readers will get distracted, I thought, and some will get angry. Some will not recover or read beyond that paragraph, I thought.

I mean … there are no massacres in Ionesco’s play. There’s a lot of property damage. A few people trampled to death by the rampaging rhinoceroses. But there are no ritualistic mass murders. No butchery of five-year-old girls. Ionesco’s play is kinda cool, by which I mean it is not hot. Not emotional. It’s one long allegory. And yet he lived within 50 miles of Bucharest. He saw the 1941 pogroms with his own eyes!

Ionesco wrote about the PROCESS of the widening gyre and the Long Now, not the OUTCOME.

Why? Because he didn’t have to write about the outcome. Hell, his audience had LIVED the outcome.

I don’t have that luxury. All we know of mass murder is what we see on Criminal Minds.

So I’m keeping that paragraph. Because Central Europe. Because Biafra. Because Cambodia. Because Rwanda. Because (I suspect) Xinjiang. This is what it looks like when Things Fall Apart. I need you to be aware of the stakes.

I need you to be aware of what can happen – of what ALWAYS happens – when we become rhinoceroses.

But now I need to pull you back from the emotion and horror of the OUTCOME of the widening gyre that was Romania in the 1930s, just like I need to pull you back from the OUTCOME of the widening gyre that was Nigeria in the 1960s or Cambodia in the 1970s or Rwanda in the 1990s. Because otherwise I can’t bring home the Big Point that Ionesco was making about the PROCESS of the widening gyre and the Long Now. Which is this:

It wasn’t just the bad guys who became rhinoceroses.

Sure, the local brutes and rightwing martinets are some of the first to become rhinoceroses. But soon enough it’s the scientists and the academics and the logicians who turn. They are the worst of the lot. Not because they’re the biggest and baddest rhinos. But because they know better. Because they make a conscious and deliberate choice IN THEIR HEADS to lie to themselves and embrace a real and palpable evil IN THEIR HEARTS.

“All cats die. Socrates is dead. Therefore, Socrates is a cat.”

THIS is the syllogism of the logician turned rhinoceros. It’s nonsense. It’s logically wrong. But THIS is the lie that a rhinoceros scientist can convince himself is truth. THIS is how an intelligent, educated academic who loves his family and his dog can witness a pogrom. And look away. Ehh … gotta break a few eggs.

Romanian politics in the 1930s was a classic widening gyre, spread out over a decade, and policy followed the classic Long Now formula – more and more economic stimulus, more and more political fear-mongering. This was true of the fascists, for sure. IT WAS ALSO TRUE OF THE LIBERALS.

By February 1938, when King Carol II dissolved the parliament, nothing mattered anymore in Romanian politics. There was no “truth”. There was only narrative. There was only spectacle. There was only the naked exercise of power and the celebration of that naked exercise of power. You didn’t just seize control. You seized control, and then you threw yourself a big parade for doing it. This was true of the fascists, for sure. IT WAS ALSO TRUE OF THE LIBERALS.

That’s the kicker of Rhinoceros. It wasn’t just the bad guys who turned. It was everyone.

Just like it’s not just the bad guys who are becoming rhinoceroses in America today. It’s everyone.

How does THAT happen?

Through the embrace by ALL political actors of the idea that NOTHING MATTERS beyond that which accretes power, that power is to be sought for power’s sake and that once attained, power must be USED. Used for draining the swamp. Used for unmasking the corruption of the Trumps or the Clintons or (and here’s where I make a clever connection with 1930s Romania) the Hohenzollerns or the Bratianus. Used for undoing the obscene legislative influence of the Democrats under Nancy Pelosi or the Republicans under Mitch McConnell or (and here I go again) the National Peasant Party under Armand Calinescu or the Everything for the Country Party under Corneliu Codreanu.

It has all happened before. Many times. It is all happening again.  

You will hear that the danger at hand is so great, so existential, that NOTHING MATTERS other than combating that danger, that you must sacrifice your most precious possession – your autonomy of mind – to believe in the necessity of these political actions. You must not only think that it is possible for 2 + 2 = 5 if the political exigency is urgent enough, you must believe that it is necessary for 2 + 2 = 5. Orwell called this “collective solipsism”. I call it political nihilism. Either way, THIS is the politics of the Long Now.  

And once you believe that NOTHING MATTERS … poof! you have chosen to become a rhinoceros.

So you vote for Bob Menendez. You vote for Roy Moore. You excuse your party’s lies and your politician’s thuggery and moral corruption as necessary to prevent some greater evil.

Here’s the kicker.

There’s not a damn thing that you or I can do to stop this.

There’s only one thing that you or I can do. Luckily, it’s the most important thing.

We can refuse to become rhinoceroses ourselves.

Am I saying that we don’t fight against iniquity and evil? Am I saying that we just cede the field to the rhinos who are already running amuck?

So here’s where I’m going to lose a lot of you …

Yes, there will be a time to step boldly into the public political arena and help write a new set of rules, help re-establish political institutions that allow for cooperative gameplay and shared notions of the good life, and help instantiate small-l liberal and small-c conservative principles in a top-down manner.

But that time is not now.

Now is the time when the political institutions that allow for cooperative gameplay and shared notions of the good life are being shattered, and now is the time when they will continue to be shattered. Now is the time of the widening gyre, and you can no more command it to stop from the top-down than King Canute could command the tides. No, it’s precisely the opposite, where everything from the top-down will be devoted to rewriting the history and the narrative of the tides, intentionally moving us farther and farther into the Sea of Nudge.

Once you start looking for sharpies, you will see them everywhere.

That’s true for Trump today, and it will be true for whoever is in the White House in 2020. That’s political nihilism. That’s the way this ALWAYS plays out.

The Long Now is going to get worse before it gets better. A lot worse. Yes, that means more and more economic “stimulus”, more and more financialization and propping up of financial asset prices. You think there is a snowball’s chance in hell of a recession before the November 2020 election? LOL.

It also means more and more political fear-mongering and gyre-widening and nihilism-embracing. You think there’s a snowball’s chance in hell that either the Democrat or Republican party will ever again represent anything other than the accretion of power for power’s sake? Also, LOL. The Republican party is already all MAGA all the time. It is already 100% rhinoceros. By the time the primary season is over, the Democrats will be the same. Look at our Election Index analysis … the narrative center of this election is almost entirely race and gender identity memes. It’s like a pure SJW rhinoceros-inducing potion.

Should you vote in 2020? Sure. But as a statement of your personal identity, not out of some misplaced notion of efficacy or consequentialism.

Should you engage in national politics with more than your vote at this stage in the widening gyre? I mean … if you must. But when you give your heart to the rhinos, you become one yourself. Or you get trampled.

My advice? Abandon the party as your vehicle for political participation.

My alternative? The Epsilon Theory Pack.

My platform? Make – Protect – Teach.

We had our first “Pack Meet-up” last Saturday at Rusty’s house … about 30 Premium and Professional subscribers from all over the East Coast.

The barbeque was Rusty’s labor of love. Four beef briskets, three pork collars, three slabs of pork ribs. There was no vegan option. Sorry, not sorry. Enough food to feed an army, but somehow it was inhaled. Everyone brought a bottle of something to share with the group. That – and a commitment to an evening of full-hearted conversation – was the only admittance fee. Age range was 23 years-old to 75 years-young. Was there a lot of money around that table? I guess. You’d never know it from the utter lack of conversational alpha-dog-sniffing … unique for any Fairfield County dinner I’ve ever been to.

Know what we talked about? The political.

Know what we didn’t talk about? NOT AT ALL? Politics.

What is the political if not politics? It’s how we lead our lives as social animals. It’s how we understand small-l liberal and small-c conservative virtues as they play out in our lives. It’s what we want to SAY to the world through our efforts to Make, Protect and Teach.

THIS is where we stand our ground. Not on some national political scale where we are either turned into rhinos ourselves or trampled into the mud. But on the personal scale. On the scale of our families and our communities. A scale where we can recognize ourselves once again, not as a means to some grand Statist end, but as members of a clear-eyed and full-hearted Pack.

The way through the Long Now is a social movement, not a political party.

A social movement based on resistance and refusal. A refusal to vote for ridiculous candidates. A refusal to buy ridiculous securities. A refusal to take on ridiculous debts. A refusal to abdicate our identity and autonomy of mind.

And it’s more than refusal. It’s more than just saying “Homey don’t play that”, more than just turning the other cheek. There is also action. But it is action in service to our Pack, not action in self-aggrandizement and the celebration of power itself.

I believe that a decentralized and service-oriented social movement at scale can thrive in the age of social media technology. I believe that a decentralized and service-oriented social movement can both inoculate our hearts from the top-down Nudges that push us into rhinocerosness, as well as fill us with a positive energy that reverses the pervasive alienation that creates the Neb Tnuhs of the world.

It’s a social movement for a revitalized foundation of citizenship. It’s Make – Protect – Teach.

There’s no primacy to these three rightful objects of political power and the citizenship which drives them. Put Teach at the top of the triangle. Spin everything 90 degrees. Marry two of them. Take them independently. Change the colors and the font size. I’m not trying to be symbolic here.

I’m trying to be Real.

I’m trying to provide an alternative to the abstracted world of narrative and cartoon that rules our mindfulness from the top down, in favor of a concreted world of actual human beings making things and protecting each other and teaching each other, where we act as Stewards of our children’s future rather than as Managers of our personal now.

What does it mean to Make?

It means you are an inventor. A manufacturer. An artist. A craftsman. A kid at a Maker Fair. A farmer. An engineer. A home builder. A coder. It’s the creation of some THING through the application of some creative IDEA.

What does it mean to Protect?

It means you are a soldier. A policeman. A fireman. An EMT. A nurse. A doctor. It’s a Neighborhood Watch. It’s a mechanic fixing a car. It’s also a unionization drive. It’s also a fiduciary managing a portfolio.

What does it mean to Teach?

It means you are a teacher, of course. Or a writer. Or a researcher. Or a priest. Or a home-schooling mom. It means you’ve got something to say to your Pack, and you’ve got the guts to say it.

What is NOT some form of Make – Protect – Teach?

Basically, if you are in the business of money (and that includes you, Crypto Bro) or in the business of business, then you are neither a Maker nor a Protector nor a Teacher. The sole exception to this – and it’s why this job is my universal suggestion to people who say they want to work in finance but in an authentic, socially-supportive way – is the fiduciary financial advisor. A fiduciary is a Steward. A fiduciary is a Protector. It is unlike any other role in financial services, and it’s the only role I’d want to have.

Management, both in the private and public sphere, is out. Banking is out, both investment and commercial. Corporate lawyering. Consulting. Trading. Sales and Marketing. Out. Out. Out. Out.

If you are using your time and brains to make more money for a profit-seeking organization, or if you are using your time and brains to manage the time and money of a non-making, non-protecting, non-teaching government organization … then you’re outside the Make – Protect – Teach framework. There are no hard and fast rules here, and I mean to be more inclusive than not. But I think you understand the distinction.

Let’s just say that zero of the Forbes 100 Innovative Leaders list (LOL!) would make my list of Make – Protect – Teach. Neither would our professional political “leaders”, including 99% of current Senators and Representatives. As for current and recent residents of the White House … don’t make me laugh.

And yes, I realize that the vast majority of people reading this note would not be practitioners of Make – Protect – Teach, at least not in their day job.

But it doesn’t have to be your day job. It just has to be your Identity.

This is a social movement for people who are IN the world-as-it-is but not OF the world-as-it-is. I’m not saying that your success IN the world, financial or otherwise, is either laudable or damning. I’m just recognizing that it is. I’m saying that your success IN the world, financial or otherwise, does not DEFINE you. Unless you let it.

Everyone can Make – Protect – Teach.

Even Jeff Bezos. I guess.

Today our system of social rewards and political power is based entirely on MONEY, not just in our laws and in our practices – which is bad enough – but even more so IN OUR HEARTS.

Yes, there’s a town full of rhinoceroses there, too.

It was not always so. It is not ordained that it must always be.

What’s at stake with the Make – Protect – Teach movement? Well, in some distant day, when we do in fact remake the rules and institutions of society, you’ll need to be a Maker, Protector or Teacher to be a full citizen. You’ll need to be a Maker, Protector or Teacher to vote. It will never be the route to making the most money, but that’s a feature, not a bug. I think the answer to teachers’ pay scales isn’t to pay them like a corporate lawyer or an investment banker, but to reward their superior social participation through superior political representation.

The American revolution was founded on the slogan “No taxation without representation”. That direct link between taxation and representation was severed long ago, and NOT to the advantage of the people who deserve it the most – the middle class and the working poor. I mean, if you think the middle class and the working poor are represented AT ALL in Washington … once again, LOL. It’s time for a new American revolution, and my slogan is “No representation without making, protecting or teaching.” Okay, maybe that doesn’t sing. How’s this: “No representation without real participation.” Yeah, I like that.

It used to be commonplace to think of military service as a prerequisite for citizenship, and by commonplace I mean universal in the societies where the small-l liberal virtues of democracy and the small-c conservative virtues of citizenship were actually invented. Today we get an occasional watered-down version of this floated in a half-hearted way by Grumpy Grandpas who want those darn kids to spend two years in some national service program. Well, it’s not two years, it’s a lifetime. And it’s not those darn kids, it’s all of us. And it’s not public service to the national government, for god’s sake, but private service of Making and Protecting and Teaching to whatever level of community sustains us … and we them. That’s how a pack works.

It will start small. It will start with your family. And over time it will grow to include your community, especially your physical community. Over time it will spread fractal-like everywhere.

As Below, So Above.

One day.

In the meantime, we evaluate our current crop of gyre-widening political candidates and policies on the basis of how little damage they do to a society based on Make – Protect – Teach. I’m not expecting any of them to get this. And I’m keeping my emotional distance from all of them. But I’ll talk with anyone.

Also in the meantime, this is how we change the structure of OUR social conversation, from “politics” to the political. Here’s my offer:

Put together a group of 20+ people who want to have a full-hearted conversation about Make – Protect – Teach, who want to think and act differently in their political lives. Let me know when you’re getting together with some advance notice, and I’ll be there.

I can help publicize and organize. We are 100,000 strong, all over the world. If you can find a sponsor to pay direct expenses of the meet-up, great. If you can’t, we’ll make it work anyway.

Dinner by dinner. Handshake by handshake. Conversation by conversation. That’s how we do it.

To paraphrase Margaret Mead, never doubt that a small group of thoughtful, committed Makers, Protectors and Teachers can change the world. Indeed, it is the only thing that ever has!


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Notes from the Diamond #8: Room For Doubt

David A. Salem
Email: david.salem@epsilontheory.com
Twitter: @dsaleminvestor

Log of notes in series available here
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Trivia Question #8 of 108. By how many pounds does the American League (AL) MVP for 2014 and 2016 outweigh the same award’s winner in 2017? Hint: both players remain active — at the top of their games, in fact — with the larger man weighing 42% more than his more diminutive counterpart.  Answer below.

Narrowing Gyre.  Let’s be honest.  While the topics on which these Notes focus — baseball and investing — are endlessly interesting to some of us, they’re inconsequential relative to some topics on which Ben and Rusty comment frequently and incisively, including the “widening gyre” in American politics and culture.  Depressingly, that gyre has grown wider since the prior note in this series was published, with multiple mass shootings, the jailhouse death of a monstrous criminal, and heated controversies spawned by such events having unfolded in the meantime.  Happily, there’s at least one aspect of life in these increasingly Dis-United States in which an angst-inducing gyre has been narrowing of late: the baseball’s world unending debate over an all-purpose test of on-field excellence.  This note examines the whys and wherefores of that narrowing — and explores an old but by no means outdated standard for gauging investment excellence that independent-minded stewards of long-term portfolios might find useful in an era of generally inflated asset prices and correspondingly low yields.

The author’s daughter (right foreground) overseeing Mike Trout’s BP at Fenway Pahk 8/9/19. Trout is in red and gray, mid-cage, bat in hand. Daughter and father enjoyed the game; Trout surely did not, his Angels losing 16-4 with Trout going 1 for 3 in four plate appearances (double, walk, strikeout, groundout).

Myriad Duties.  As was true of the factors animating baseball analysts’ angrily divergent views of optimal performance metrics earlier this decade, the more recent convergence of such views is rooted in large measure in the impressively mounting achievements of a player also featured in my last note: 28 year-old Angels outfielder and “WAR machine” Mike Trout.  Despite his uncharacteristically pedestrian performance for my baseball-loving 10 year-old at Fenway earlier this month, Trout is on track to become this year’s AL if not MLB champ in at least two widely followed statistical categories: home runs and runs batted in (RBIs). 

Why does this matter, and how has Trout’s evolving performance de-escalated the war among baseball cognoscenti respecting WAR?  Both questions are answered with characteristic elan by baseball pundit par excellence Ben Lindbergh in a recent Ringer post available here.  As noted therein, Trout’s uniformly solid discharging of the myriad duties shouldered by a position player has kept him at or close to the top of most baseball experts’ subjective rankings of the sport’s most valuable players since his MLB debut in 2011.  Including 2019-to-date, Trout has also ranked #1 five times, #2 twice, and #6 in annual rankings of the American League’s roughly 400 players sorted by the least-worst objective metric for assessing on-field excellence: Wins Above Replacement or WAR, more on which follows. 

Importantly, one of Trout’s five #1 WAR seasons came in 2012, when he notched the 31st highest single season WAR in baseball history (of more than 40,000 observations) while finishing #2 to the Tigers’ Miguel “Miggy” Cabrera in the essentially subjective process by which the Baseball Writers’ Association of America (BBWAA) picks a Most Valuable Player for each of MLB’s two leagues (American and National) each year. 

How could an impartial judge of on-field output possibly have deemed Cabrera’s more valuable than Trout’s in 2012 when Trout produced 41% more WAR that season (10.5 vs. 7.1)?  Beats me — but, much as I wish things were otherwise, I don’t make a living following baseball, as do the beat writers comprising BBWAA’s MVP juries.  In 2012, 22 of 28 such writers comprising that year’s jury voted for Cabrera, causing the six dissenters (all of whom voted for Trout) plus a large and vocal phalanx of “statheads” to complain that the 22 ascribed undue weight to Cabrera’s #1 rank in the trio of “traditional” batting stats comprising baseball’s hallowed Triple Crown (see box).[1]


Impressive as the stats for Cabrera just cited were — absolute and relative to Trout’s — when combined with other objective measures of offensive output to produce a broader metric of same known as Offensive War (OW), Cabrera contributed 13% less value-added to his Tigers on offense (measured by estimated team wins) than Trout did to his Angels in 2012: 7.7 OW for Miggy vs. 8.7 OW for Mike.

Value Added.  If you’re following along as carefully as my daughter did when reading this note (approvingly) in draft form, you’ve already caught a curious twist in our tale of baseball’s decreasingly fierce war over WAR: Miggy’s overall WAR in 2012 (combining Offensive War or OW with its defensive analogue) was 8% lower than his OW alone — 7.1 vs. 7.7.  In contrast, in finance-speak terms, Trout “added value” on defense as well as offense, performing certain deeds as an outfielder (i.e., improbable catches and the like) while avoiding others (i.e., errors) and in the process boosting his overall WAR to the aforementioned 10.5 from his offense-only WAR (OW) of 8.7. 


These WAR differentials may seem trivial to some readers, and inconsequential to most given weightier money and other matters confronting them, but bear with me, please: I’m using WAR to frame a consequential and conspicuously current concern respecting capital deployment — one entailing far bigger stakes for some readers than the estimated $8 million that a single WAR is worth in MLB these days.  Don’t find that $8 million estimate credible? Check out the nifty blog post from which it plus the nearby graph was lifted.  FWIW, the ten retired players to whom Trout’s evolving output is compared in the graph include eight Hall of Famers; the graph was prepared in March 2019, and thus excludes the roughly 8 WAR Trout has racked up during the MLB season now underway.

Something Big.  Crucially for our purposes here, Trout’s play this year makes him the odds-on favorite to achieve the AL’s #1 rank in the only “traditional” baseball stat (as defined in footnote 1) in which he’s not already achieved a league-leading single season rank at least once: home runs.  In short, the large and loud cadre of baseball analysts who deemed Trout’s stellar all-around play in 2012 sufficient grounds for an AL MVP crown despite Trout’s sub-#1 rank in all traditional batting stats except Runs Scored (129 vs. Cabrera’s 109) were on to something.

Something big, it turned out, with 2012 and Trout’s near-but-not-top rank in a host of statistical categories that year presaging truly extraordinary performance in the 6+ seasons Trout has played since his official rookie year.  (Trout played in some big league games in 2011 but not enough to disqualify him for the AL Rookie of the Year award he ultimately notched in 2012.)  At this writing, Trout’s career WAR (per BP) of 72.3 puts him 87th on the all-time list of big leaguers ranked by that stat — a mounting tally exceeding that of roughly 70% of the 267 players enshrined in Cooperstown.

The Fog of WAR.  What exactly is WAR?  Truth be told, my youngest daughter’s baseball precocity notwithstanding, neither she nor her dad nor indeed the “God of WAR” himself could furnish more than a Trump-like simpleton’s answer to the foregoing query without consulting cheat sheets like those furnished herein.  In fact, when asked near the start of what’s become the largest accumulation of WAR by a 20-something in MLB history what he knew about WAR, the young deity just referenced (Trout) replied, “That’s a good question.  Not a lot.”

A Brief Primer on Wins Above Replacement (WAR)

•  WAR is a stat that seeks to capture in a single number a player’s total contributions to his team.  For reasons discussed in the main text, WAR is an imperfect metric that’s best viewed as an approximation of player value rather than a precise measure of it.

•    Despite or perhaps due to WAR’s growing importance to allocators of human and financial capital in baseball, multiple methods for computing WAR have been devised, spawning endless discussion over the pros and cons of each.  Among publicly available WAR tallies, the three most widely followed are arguably those of Baseball Prospectus (WARP), Baseball Reference (bWAR) and Fangraphs (fWAR). 

•    Over any given season, WARs for the 1,000 or so men snagging more than trivial playing time in MLB typically shape up very roughly as follows:

•    Over any given MLB career, a player’s WAR will reflect longevity as well as effectiveness, as suggested by these career bWAR tallies for selected superstars:

•  For position players, WAR typically comprises a weighted average of stats for batting, baserunning and fielding, with adjustments for a player’s position and playing venues (stadia) plus multiple other factors of lesser import.  For the benefit of readers combatting insomnia, here’s how Fangraphs computes a position player’s WAR:

Position Player WAR = (Batting Runs + Base Running Runs + Fielding Runs + Positional Adjustment + League Adjustments + Replacement Runs) / Runs Per Win

•  For pitchers, WAR typically reflects runs allowed, with material adjustments to actual runs allowed to pinpoint a pitcher’s effectiveness independent of his teammates’ performance on defense.  As a further aid to readers seeking to nod off — or to ponder formulas even more complex than those needed to compute internal rates of returns (IRR) in a finance context — here’s how Fangraphs computes a pitcher’s WAR:

Pitcher WAR = [[(League Fielding Independent Pitching (FIP) – Player’s FIP) / Pitcher Specific Runs Per Win] + Replacement Level Wins) * Innings Pitched/9)] * Leverage Multiplier for Relievers] + League Correction

•  Over any given interval, a player can mess up enough to produce negative WAR, as has Albert Pujols of late (#31 in all-time career WAR despite -1.1 cumulative WAR over the last three seasons).  Pete Rose backslid similarly toward the end of his 24-year career, producing -2.5 cumulative WAR in his last five seasons.

End of Brief Primer on WAR

Here’s another good question — one that’s central to this note’s exploration of optimal metrics for gauging excellence in baseball or investing: must such metrics be as simple and straightforward as the Triple Crown stats that enabled Cabrera to trump Trout in AL MVP balloting in 2012?  To be sure, the ease with which anyone who’s crossed the threshold of baseball consciousness can not merely grasp but compute a player’s Triple Crown stats suggests that my kids’ kids will cite such metrics in assessing batters’ prowess — assuming such progeny emerge and their DNA causes them to ape their granddad’s avocational interests.

But the simplicity of MLB’s hallowed Triple Crown stats, like the simplicity of total return as one’s chief metric for gauging investment success, is not an unqualified virtue. In fact, such simplicity in gauging professionals’ performance can be hazardous to a ballclub’s health, or an investor’s wealth, for reasons described memorably by two of my favorite thinkers in my favorite fields of human endeavor.

Not Obvious.  “It is dangerous to spring to obvious conclusions about baseball,” sportswriter Roger Kahn has observed, “or, for that matter, ball players.  Baseball is not an obvious game.”  Nor is investing, defined for purposes of these notes as the deployment of capital over long time horizons with the aim of preserving and ideally enhancing its inflation-adjusted value net of planned withdrawals.  As investment pro Jim Garland has argued in musings that merit much closer attention than they’ve received by institutional investors as a group, “[I]nvestment risk isn’t a function of betas or Sharpe ratios or Value at Risk.  Instead, the primary risk facing [long-term investors] is …  the risk of a decline in the earnings and dividends from the corporations in which they’re invested.” 

Borrowing a term from farming, Garland refers to the hazard just described as “fecundity risk” — the risk that a portfolio will produce insufficient cash for its owner “to buy something important”.

A Brief Primer on Fecundity

Fecundity [writes Garland] is a “portfolio’s long-term ability to generate spendable cash for its owner”.

• Since most portfolios’ owners are legally empowered to withdraw principal as well income, the near-universal practice is to set withdrawals at levels commensurate with long-term expected real returns, with the latter typically guesstimated as follows:

Long-Term Expected Real Return = Income Per Se (Dividends, Interest and Rent) + Anticipated Capital Gains – Investment-Related Expenses – Applicable Taxes on Net Nominal Total Returns – Projected Inflation.

• Most investors excluding Softbank devotees recognize the perils of extrapolating capital gains (especially unrealized ones) into the indefinite future. But too few investors heed a corollary principle: that market values and the total returns they underpin often constitute “false positives” respecting a portfolio’s evolving soundness.

• Quoting Garland, “Jane Austen … and her character Mr. Darcy knew that long-term wealth should be measured by sustainable cash flows rather than by ephemeral market values. But what Jane Austen knew has been lost in the thundering dissonance of modern finance.”

• Computing with even approximate accuracy a portfolio’s sustainable cash flows is difficult at best, requiring as do most mission-critical tasks in money management — or baseball — a combo of art, science and craftsmanship. 

End of Brief Primer on Fecundity

I gave Garland’s seminal work on investment metrics a shout-out by featuring him in a TIFF workshop conducted shortly after the 2004 publication of a note Jim guest-authored for Peter Bernstein’s strategy service.  By happy coincidence, 2004 was also the year my beloved Red Sox used seminal analytics devised by baseball sage Bill James to win their first World Series in 86 years — a feat they’d repeat thrice more (so far) this century, including 2013, the year Jim delivered one of the best talks on investing I’ve yet encountered.

That talk — Memo to the Darcy Family: To Thine Own Self Be True — does a better job than I ever could propounding fecundity as the soundest metricfor gauging the evolving performance of so-called permanent portfolios: pots of money created and managed to enable their ultimate owners, taxable or tax-exempt, to buy important things — including but not limited to necessities — on an essentially indefinite basis.

Self-Awareness.  Given fecundity’s intuitive appeal as a metric for gauging permanent portfolios’ evolving health, one wonders when if ever during the century now unfolding a critical mass of such portfolios’ ultimate owners will become true to their own selves in the manner Garland commends.  How might such enhanced self-awareness cause principal-agent relations to change in the money management biz, and what events might catalyze such change?


Mr. Fitzwilliam Darcy (played by Colin Firth) and Miss Elizabeth Bennet (played by Jennifer Ehle).  This scene from a BBC adaptation of Jane Austen’s 1813 novel Pride and Prejudice ranked #1 in a 1995 UK-wide poll of the most memorable scenes in British TV drama.  Famously, Austen’s omniscient narrator describes Darcy’s prodigious wealth in income rather than net worth or market value terms, citing a “report which was in general circulation within five minutes [of Darcy’s entrance into the initial gathering of the novel’s protagonists] of his having ten thousand [pounds] a year”.

Answering the second question first (if not also stating the obvious), sustainable cash flow yields as distinct from recent returns and the market values underpinning them will reassume Darcy-like importance in wealth management when but perhaps ONLY when investors in WeWorks paying scant heed to such yields start losing far more than they win. 

As a true believer in Ben’s gospel that no one can foretell accurately when global capital markets will morph from the political utilities they’ve become back into “Two-Body Markets” (to quote Rusty) susceptible of effective analysis by thoughtful allocators, I won’t hazard a guess respecting when the losses just prophesied will materialize.   What I can foretell with confidence is that the forward-looking and hence unavoidably pliable character of Garland’s preferred method of gauging long-term portfolios’ evolving health will remain offputting to many fiduciaries, even after the tide turns and market values that such folks currently deem sound become fishy at best. 

I’m confident making this prediction because I’ve encountered such obstinacy multiple times in my career, most memorably when trustee groups for whom TIFF was managing money nixed portfolio moves animated by my team’s carefully considered judgment that technology stocks as a group couldn’t possibly generate sustainable cash flows commensurate with their fin de siècle valuations. 

Of course, I’ve also witnessed such obstinacy in an avocational as distinct from vocational setting, as noted in the above account of supposed experts making the silly but unsurprising choice to pick Miggy Cabrera over Mike Trout as AL MVP for 2012 despite Trout’s superior overall play as measured by WAR.  To be sure, Cabrera’s votaries rejected WAR-based arguments in Trout’s favor not because WAR is unduly speculative or forward-looking in a way that Cabrera’s Triple Crown-winning stats self-evidently were not; rather, Cabrera got the nod because three backward-looking stats he compiled more robustly than anyone else in his league including Trout (BA, HRs and RBIs) were more hallowed by MVP balloteers than the broader and better but equally retrospective valuation metric that Trout conquered in 2012 (plus five of the seven full or partial seasons since then!): WAR. 

Ardor for Ambiguity.  Its enhanced clout in player appraisals since Trout entered The Show notwithstanding, WAR continues to challenge even the brainiest baseball aficionados.  As anyone who’s consumed his analyses for ESPN or Fangraphs can attest, Sam Miller is among the brainiest (and wittiest) of such folks.  In an essay I enjoyed lots upon its initial publication in 2013 and re-read when assembling this note on the pursuit of excellence when gauging excellence in baseball or investing, Miller writes:

WAR is a crisscrossed mess of routes leading toward something that, basically, I have to take on faith.  And faith is irrational and anti-intellectual, right?  Faith is for rain dances and sun gods, for spirituality but not science.  Actually, no.  Faith is how we organize a complicated modern world … The complicated nature of WAR … isn’t an argument against it.  That’s just what human advancement looks like in the 21st century … I trust the recipes of FanGraphs, Baseball-Reference and Baseball Prospectus [BP] because these sites incorporate decades of research, the scope of which I could never match on my own.  These recipes will get even better because they get smarter with more data.  [BP] will soon incorporate into its WAR catchers’ ability to frame pitches.  The numbers next to each player’s name on that site will change.  Does that mean the numbers we have now are wrong?  Of course they’re wrong.  Everybody is wrong about everything all the time, and WAR leaves room for this doubt.  Doubt has driven us toward better answers for millenia, from Socrates’ “I only know that I know nothing” to the guys who made billions betting against a seemingly invicible housing market.  Don’t accept any number that doesn’t leave you room for doubt.” [Emphasis added]

“WAR Is the Answer” by Sam Miller (2013)

Dunno ‘bout you, but if I chaired an investment committee (IC) and were tasked with finding a new member for it, Miller might plausibly get my nod.  He’d get it because the tolerance and indeed ardor for ambiguity he displays is a vitally important  condition for investment success. 

Cognitive Errors.  More to the point, having a kindred soul like Miller at hand could boost the odds of getting the IC as a whole to practice what Garland preaches so persuasively in his Memo to the Darcy Family — teachings evocative of those Jane Austen illumines so artfully in her majestic novel about the Darcys’ evolving fortunes, Pride and Prejudice.  That novel’s central teaching  — that one should weigh all relevant info before acting or choosing consciously not to act — has obvious relevance to investing, even if its practical utility to conscientious investment pros is diminished episodically by tidal waves of cheap money that temporarily lift all boats, including those with skippers named Musk spiffy topsides but irreparably leaky hulls. 

The Austenian precept just flagged is germane to baseball too, of course, though typically tougher for ballplayers than investors to follow due to the high speeds at which baseballs and baseballers often move.  That said, clear eyes and a concomitant commitment to weighing all relevant facts before acting are undeniably vital for people who make their livings in baseball, including especially those who get paid not to play the game but to evaluate those who do. 

As we’ve seen, some of these folks messed up big time in 2012, weighing Miggy Cabrera’s dominance of three hallowed but batting-specific metrics against Mike Trout’s overall body of work and somehow judging Cabrera’s play in 2012 to have been more valuable than Trout’s.  It’d be unfair to Cabrera, and overstating my chief argument here, to label Miggy’s Triple Crown-winning stats in 2012 the baseball equivalent of Garland’s “ephemeral market values” — “noise” meriting scant attention as opposed to “signals” meriting the converse.  But, c’mon: given Trout’s extraordinary overall play since and including 2012, both absolute and relative to Cabrera’s, how can any competent judge of such matters deem Cabrera’s MVP award for Trout’s first full season as a big leaguer in 2012 to have been anything other than a cognitive error by those who conferred or applauded it?

Open Questions.  Which big money allocators (if any) are committing comparable cognitive errors at present?  As argued repeatedly in these notes, fielding such a blatantly censorious question presupposes a clear articulation of the metrics used to gauge investment success and the time horizon over which such metrics are optimally applied.  By my lights, the longer one extends the horizon over which investment success is judged, the more relevant Garland’s preferred metric of fecundity becomes — less as a precise gauge of the evolving utility of a portfolio than as a test of what the persons managing a portfolio truly know and think about each of its parts.

I know what you’re thinking as you ponder the words just written:

• Wouldn’t the ongoing fulfillment of these Garlandian expectations require the hired guns involved to know MUCH more about each holding they’ve selected than they typically do at present — to know each holding well enough to fashion the credible bottom-up assessment of its fecundity needed to compile top-down or fund-level estimates of what funds’ owners can withdraw and spend on a sustainable basis? 

• Wouldn’t principal- or owner-imposed requirements that money managers furnish such assessments trigger big changes in managers’ methods (i.e., asset selection, sizing, timing and reporting)?         

• Wouldn’t the widespread adoption of Garlandian metrics for assessing long-term funds’ evolving performance catalyze changes in institutional funds management as material as those MLB has undergone through the widespread adoption of advanced statistics like WAR and the complex array of task-specific stats that the WAR formula requires?

• Wouldn’t changes like those just conjectured enhance some investment pros’ value-added and in turn incomes, reduce others’ incomes, and likely force some if not many raccoons players out of the game of managing OPM for a living?       

You know how I’d answer the bulleted questions above — with enthusiastic yesses to all of them, mindful that the sabermetric revolution in baseball from which big money asset owners might usefully borrow certain tricks has spawned harmful as well as healthy changes in how MLB gets played, who gets to play it, and how much they get paid to do so. 

Certainly the enhanced stature and incomes of multi-talented stars like Trout or Jose Altuve — a player whose stellar advanced stats negate timeworn arguments that big leaguers must be big to be great — are welcome by-products of the cardinal importance ascribed to sabermetrics in modern baseball.  Certainly, too, the silver linings just flagged adorn menacingly large clouds: changes in MLB games’ length and character that have made them less fun for many fans and prevented countless others from becoming baseball fans in the first place. 

Two of MLB’s biggest stars: 6’2”, 235 pound Mike Trout (AL MVP in 2014 and 2016) and 5’6”, 165 pound Jose Altuve (AL MVP in 2017

On Deck.  I owe it to my youngest daughter if not also others with budding addictions to baseball to weigh in on MLB’s sagging “production values” (TV-speak for fan appeal) and will do so in a future NftD, though not the next one. That Note (#9) will focus on the inevitable and laudable extension of rigorous analytics to a hitherto unquantified and perhaps unquantifiable aspect of big league baseball (and big money investing): the impact of players’ character and temperaments on their and their teammates’ performance.  Consistent with the age-old principle that “you get what you measure”, MLB front offices are paying both closer attention to and more money for players’ invisible as distinct from visible gifts, with the former dowry defined broadly to include mindsets conducive to continuous improvement (“player development” in MLB-speak) plus interpersonal skills conducive to healthy team karmas and the winning records often spawned by same. 

Tellingly but perhaps unsurprisingly, the best player in MLB now and perhaps ever proved recently that he possesses interpersonal skills worthy of pro sports’ largest pay package ($432 million over 12 years), displaying acute empathy and grace in response to the sudden death of his Angels teammate Tyler Skaggs. 

Would exhaustive analysis of Mike Trout’s potential as a pro baseballer just before he became one as an 18-year old have foretold with actionable certainty the bounties he’d produce as a pro — analysis as thorough as the fecundity-focused probes that Garland commends to folks putting long-term capital to work?  Given the unavoidable uncertainties surrounding the future paths of young baseballers — or companies of any age or size — I doubt it.  But just because there’s room for doubt with any such analysis doesn’t mean it shouldn’t be undertaken.  It should — especially by allocators seeking to gain an edge under market conditions inimical to the profitable use of methods that served disciplined investors well in the past but have produced as many whiffs as homers since capital markets became political utilities Mike Trout signed his first pro contract in 2009. 

End

Mike Trout consoling Tyler Skaggs’s mother Debbie before the team’s first home game following Tyler’s death.  A longtime softball coach, Mrs. Skaggs delivered what the AP labeled a “heartbreakingly perfect strike” on the game’s ceremonial first pitch. Trout drove in six runs in the Angels’ 13-0 win, including a towering 454-foot two run homer off the first pitch he saw from Seattle starter Mike Leake.
Summer “school” for the author’s youngest daughter (2019). 
Nail colors are no accident.

Up next: the importance of character and temperament in “weak link” endeavors like pro baseball and institutional investing


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[1] I’ve put traditional in quotes because there’s no universally accepted rule for distinguishing baseball’s so-called advanced stats from all others, excepting perhaps a calendar-based rule rooted in the 1985 publication of stathead Bill James’s Historical Baseball Abstract, i.e., stats devised before 1985 can’t be “advanced” so they’re “traditional” by defaultThat transparently suspect point having been made, we’ll note that with the possible exceptions of On Base Percentage (OBP, which became an official MLB stat in 1984) and OPS (OBP plus Slugging Average), most statheads would agree that “traditional” batting stats comprise the two just mentioned (OBP and OPS) plus Batting Average, Hits, Homes Runs, Runs Batted In, Runs Scored and Slugging.  As my 10-year old daughter would be pleased to tell you if asked, Slugging = Total Bases/At Bats.  

License to Kill Gophers

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License to kill gophers by the government of the United Nations. Man, free to kill gophers at will. To kill, you must know your enemy, and in this case my enemy is a varmint. And a varmint will never quit – ever. They’re like the Viet Cong – Varmint Cong. So you have to fall back on superior intelligence and superior firepower. And that’s all she wrote.

-Bill Murray as Carl Spackler in Caddyshack

The Gopher.

Recessions. Policy makers loathe them. The human costs are real and obvious, but they also lose elections. The desire of central banks to forestall recession at all costs reminds us a bit of the war that groundskeeper Carl Spackler had with the gopher in the 1980 movie Caddyshack. [1]For those of us old enough to remember that classic movie, Spackler won a final pyrrhic victory against the gopher by planting explosives throughout the golf course – eventually destroying the very course he’d sworn to protect.

Today, it seems to us that the allegory for the golf course applies to central bank policy as it relates to financial markets. Initially, Spackler tried to use less dramatic methods to find and kill the gopher, but none of them worked. Those methods are akin to traditional rates policy. It is our view that the concept of a natural or neutral rate is anachronistic in a world where QE is global and in which capital can flow relatively freely based on national comparative advantages. Moreover, monetary policy is reflexive in that lower rates (whether through temporary or permanent open market operations) beget lower rates. The neutral rate is dynamically impacted not just by the real economy but also by policy itself.

Indeed, prolonged application of policy will result in an eventual neutral rate of zero in the United States, just as it has in much of the rest of the developed world. Extraordinary measures in monetary policy, like buying equities (à la the BoJ) are akin to the dynamite that Murray’s Spackler eventually deployed. After all, he had “a license to kill gophers by the government of the United Nations.” Indeed, it a united front of central banks that possess the license, as negatively yielding debt globally has topped $15.6 trillion (up from below $6 trillion in the third quarter of 2018). It’s only a matter of time before the course is left unplayable.

The Groundskeeper.

The Fed’s 25 bps ‘insurance cut’ will do little to prevent the eventual necessity of QE – that is, if the Fed’s goal is to prevent a recession at all costs, it will require dynamite.[2]In my view, a 25 bps ‘insurance cut’ now and another 25 bps in September will do little to prevent the U.S. from succumbing to the global economic malaise (all developed market PMIs we track are now in contraction or neutral with the U.S. stagnant at a reading of 50.4). [3] We’re not alone in our assessment that, short of renewed QE, the Fed has little policy room.  MNI reported just prior to the most recent cut that former Fed director of the division of research, David Wilcox, said: “We’re currently at or near a cyclical peak, and yet the policy rate is still only 2.25% to 2.5%. That’s uncomfortably limited. I hope they will take steps to create more policy space for themselves.” In that same interview, Wilcox estimated the Fed was roughly 250 basis points short of policy space to fight the next recession. He noted that the central bank cut its policy rate by at least 500 bps in each of the past three downturns. Cantor’s global market Outlook expressed this very view in January of 2019. Again, it will be difficult for the Fed to forestall a recession without the use of dynamite.

We’ve already written in Epsilon Theory that ‘late cycle’ cuts are usually followed by recessions in the United States. We debunked analogies to 1995 and 1998 in our previous note Cake. It’s no coincidence that Chairman Powell introduced the concept of mid-cycle cut in his latest statement to avoid the perception that the Fed felt an economic downturn was imminent. Market participants cared little about his characterization. They simply wanted more. Just because Chairman Powell called it a mid-cycle cut doesn’t mean it is one. We now face a policy lull in August through September when many things can happen with the U.S. data. Services ISM recently missed expectations and appears to be following its historical course – tracking manufacturing ISM lower but with a lag. The rates markets have most recently been screaming loudly that the slowdown is about to occur here in the U.S., and they have been doing so globally (in Europe and Japan) for much longer.

We expect the PMI data over the next several days to continue to weaken, and we don’t think Chairman Powell will deliver what the markets want to hear at Jackson Hole. Last week, the spread from 3-month to 10-year treasuries inverted to over -40 bps and the 2-10 spread inverted, as I’ve been suggesting it would since January. As they always do, equity markets in the U.S. will eventually ‘get the joke.’ For those waiting for the real economic data to hit them over the head, it will already be too late. The sole bright spot is the U.S. consumer… but it always plays out this way. The consumer spends until s/he hits the credit wall. Lending standards are already beginning to tighten and labor markets are as good as they will get. That means they will only get worse. While lower rates are cushioning the blow from worsening fundamentals, they have never alone forestalled recession. [4] We believe the recent selloff is the beginning of a deeper correction as there is little to prevent the slide that has already begun


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[1] We’d also characterized central banks inability to spur inflation in the same way. We often written that the inability to catalyze inflation is a function of two principal factors: 1) globalization and 2) supply side effects. Globalization allows for the importation of deflation as capital and labor migrate to lower cost geographies, as the theory of comparative advantage suggests.  Monetary policy, which sets the cost of capital, sets the stage for a world in perpetual productive asset overcapacity – mostly in the developing world.

[2] Of course, the other groundskeeper ahead of the presidential election might be fiscal policy makers. However, with a divided House there is little that the president can do from a policy perspective (like a payroll tax deduction) that would forestall the slowdown. Even a ‘resolution’ of the trade war won’t do the trick as the root causes of the global slowdown are structural issues in places like Europe, Japan and China.

[3] Don’t be fooled; the U.S. economy is reliant on the global economy through a more complex global supply chain than ever before. About 39% of S&P revenues come from outside the United States and the global financial markets are inextricably intertwined.

[4] My one caveat to this assessment would be an immediate renewal of QE in the United States that drove long rates to close to zero. A renewal of QE in Europe is important, but until it includes high yield bonds and equity, it won’t have an efficacy. In the meantime, U.S. high yield has been a massive beneficiary of low global rates.

The World ‘Twixt Ought To and Is


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I don’t like the word ‘abstractions’ very much because most people don’t think in abstractions. That is too difficult for them. They think in stories. And the best stories are not abstract; they are concrete.

– Sapiens, by Yuval Noah Harari

I remember that there was always a street preacher on the college green at Penn. Like all prophets in his own town, he was never well-received.

Now, this was back in the days before veganism and keto were really things, and I think Crossfit had only just been invented. So the only means available to students to scream into the void “I am myself!” and “I am very intellectual!” and “Somebody please notice me!” all at once without expending any real effort were smoking and militant atheism.

My God, did this man take some abuse. And by God did he earn it.

Not because he was the giant-offensive-placards kind of street preacher (he wasn’t). Not because he was the hell-and-damnation kind, either (he wasn’t). Because he had a knack for getting himself into debates with college students. Not only that – because he allowed the students to badger him into taking ridiculous and strident positions on irrelevant topics that irrevocably damaged whatever true purpose he sought to achieve.

I was there on the periphery of a small crowd of eager, dickish young minds one day when our preacher passionately described how dinosaur bones were put into the earth by God to confound the wisdom of man and test his faith. Some mustachioed tankie was really feeling his oats (again, avocado toast being some years away at this point) and engaged him on the specific mechanics of God’s intervention. How, exactly, do you think that God worked this miracle, minister? Does he intervene in real time with the instruments which measure the quantity of carbon-14? If so, are you specifically making the argument that God adjusts how both beta radiation measurement tools and spectrometers counting carbon-14 atoms function? Or is the composition of the bone itself changed?

Within any religious community, there are legalistic subcultures which find positively nonsensical hills like this to die on. Around those hills, all sorts of uncomfortably specific explanations to tie everything together are built as hedges, take root and flourish. Want a nonsensical pseudo-scientific analysis of ancient Greek vernacular to argue that the wine Jesus miraculously created was just non-alcoholic grape juice (lamest miracle ever, by the way) to justify prohibition-as-doctrine? Somebody will be your huckleberry. Want a church-run webpage which takes serious intellectual issue with a famous musical’s farcical contention that God would punish a five-year old for stealing a maple-glazed donut since God would clearly only punish the child if he were eight? Huckleberry.

For most people of faith, these behaviors are powerfully cringeworthy. For all the secular protestations of their acolytes, the communities built around financial markets and economics are no less religious. They are no less prone to building edifices of oddly confident and hyper-specific speculation around their pre-existing models for predicting behaviors. And for most professional investors, they ought to be no less cringeworthy.


Please be seated. Let us begin our sermon today with some soggy, religious garbage from Nobel Laureate Paul Krugman.

There’s been a lot of speculation about why the stock market reacts so strongly to trade policy news — way out of proportion to the direct economic impacts of Trump tariffs. Today’s surge after Trump’s decision to delay some tariffs deepens the mystery. The best going explanation of the tariffs/market link was that markets took tariff announcements as indications of broader decision process; to be blunt, how crazy Trump is. Hard-line announcements suggested more radicalism to come, softer announcements more rationality. But this was obviously a defensive move to avoid price hikes before Christmas, not a change in Trump’s world view or improvement in his decision-making. So why respond so strongly?

– Nobel Laureate Paul “Nobel Laureate” Krugman – who has a Nobel Prize btw – via Twitter (8.13.2019)

Now, this is extremely stupid.

I don’t mean to be mean to Dr. K, who is not stupid. The unfortunate reality, however, is that most very smart people tend to have deeply stupid opinions and ideas about a great many things. Sadly, many of those same opinions and ideas often become articles of faith over which that person drapes his reputation, intellect and mental models which successfully supported earlier ideas and opinions.

It is pretty easy to unpack the three articles of faith at play here. Krugman has in his head a model for which each of the following is true:

  • Daily marginal price-setting behaviors are predictable as the output of mostly-rational optimizers;
  • Trump is objectively crazy; and
  • Trump’s craziness is so profound (and market participants are so ill-disposed to care about anything else) that changes in Paul’s perception of that craziness can explain functionally all of the daily variance in asset prices.

Let no one tell you that living in 2019 is not a joy.

Consider: you, dear reader, can watch in real-time as a Nobel Laureate publicly grapples with confusion that a multi-trillion dollar market might deviate for a single day from his single variable, Perception-Of-Trump’s-Craziness-based model. Consider further that you may watch him work out – again, in full view of the public – that the market must clearly have overestimated the extent to which a simple Christmas reprieve on tariffs ought to have reduced the value of their Perception-Of-Trump’s-Craziness variable.

This is God-burying-dinosaur-bones-to-piss-off-Neil-deGrasse-Tyson level crazy. This is Jesus-becoming-the-hero-of-the-party with-grape-juice level nuts. This is God-punishes-eight-year-old-donut-thieves-but-not-five-year-olds level insane.

And yet this kind of bizarre model-clutching lunacy is not just a possibility. It is an inevitability when you live in a world of prediction, in which your aim is to find The Answer to questions for which even a shred of epistemic humility would tell you that your model is shit.

It doesn’t really help that we’ve created academic and professional environments in which we respond to models that don’t produce The Answer by making adjustments to reflect what they missed most recently, calling it Bayesian Updating, finding a time horizon, data set and parameters for which we can get an acceptable p-value, and publishing a new paper.

Or y’know, launching a new fund.


The prelates of the preposterous aren’t the only characters in our world, however. We also have to contend with the agnostic – the person whose response to the difficulty of knowing everything is to believe that we cannot possibly know anything. Epsilon Theory was founded to ceaselessly harass and make fun of the religious pole (which we hope you understand we mean in an entirely secular sense) but to offer hope to those drawn to the desperation of the agnostic pole.

We respect the difficulty of active management. In our own portfolios, we happily use index instruments in many markets. But we don’t believe that it is possible to be a passive investor any more than it is possible to be a passive citizen or a passive friend or a passive partner or passive father. We will make decisions, and those decisions will explicitly or implicitly express views about the world and the way that it works and is working.

We reject the learned helplessness of the Long Now.

By rejecting that learned helplessness and embracing that we are all active investors, however, we will inevitably discover that there is an embedded layer of belief at work in nearly every investment strategy – a phantom model which exists between the ought to of our investment philosophy and the is of its results. That layer is, very simply, what we believe will cause an actual person (or computer programmed by a person) participating in the price-setting process for a security to change what price they are willing to pay or accept for that security.

The fundamental investor has in their head a model of the world in which they may predict how prices will change based on some assessment of the business today and in the future. Even beyond any fallibility in their own assessments and predictions, the phantom model between ought to and is – for them – is a set of assumptions about what other investors care about, what kind of information they will respond to, and over what time horizon.

Many of those strategies systematic and discretionary alike can be shown to work over many markets and many horizons. And yet, every investor with a shred of intellectual honesty will admit their concerns when going live with some new approach:

I am worried that the conditions under which I built the case for my strategy, whether the mental models and discretionary heuristics built over a long, successful career, or the systematic backtests I similarly produced, are a reflection of some state of the world that will not be the future state of the world.

Our skepticism about backtests, simulations and historical results is our acknowledgment of the phantom model in an emotional sense, to be sure. But it must also be an intellectual acceptance of the massive mathematical erosion in true explanatory power when our partially correlated models pass through an additional layer of partial correlation. We can’t always explain it away with “over a long enough time horizon” hand-waving in defense of our management fee annuity stream.

(Apologies if you did not know before now that the people who run money for you refer to you as an annuity stream. They do. Not figuratively. They literally say that in meetings.)

The problem for active investors (i.e. all investors), the problem I grappled with for so much of my career, and the problem I still grapple with at times in my own mind, is how to demonstrate epistemic humility about this loss in explanatory power without descending into agnostic nihilism. I have come to believe that there are three – and only three – ways:

  1. Parsimony – Adopting extraordinarily high standards and requirements for the addition of a model or framework for making predictions. This is the contribution of the AQRs and Bridgewaters of the world.
  2. Ensembles – Incorporating ensembles of models to composite concepts without excessive reliance on any one framework. This is the contribution of Two Sigma, our friends at Newfound and the discretionary work products of a small number of especially process-oriented minds.
  3. Concretion – Reducing the number of layers of abstraction between process and models on the one hand, and the Thing for which they are a representation, on the other.

Why do we study common knowledge – narratives? Because we think that studying, identifying and measuring the existence and effects of narratives can be a force for concretion of our investment theses. Can broader adoption of narrative analysis techniques, in fact, deliver on the promise of concretion? Can we better understand how, when and why different facts and events will matter to the marginal market participant in the price-setting process?

I don’t know. I think so. Our historical examinations of the question have produced promising results, but I fear that I am still an agnostic nihilist at heart.


Now, if you are thinking that narrative-as-force-for-concretion is a contradiction, then very well, it is a contradiction. Narrative is an abstraction from the real world, from cash flows, and from the long-term value creation potential of assets and intellectual property. But Narrative is also a concretion of the observable evidence of what the crowd believes that the crowd believes, what they care about and what they are paying attention to.

We are large, we contain multitudes, et cetera et cetera.

Soros’s quip about observing instead of predicting – that is concretion. It is a kind of process which permits decision-making based on observation, with fewer phantom models ‘twixt ought to and is. Taleb’s famous observation “don’t tell me what you think – show me your portfolio” is concretion, too, albeit a concretion of the phantom model of the language we use to describe why we own something. It is an indictment of manager surveys and the like, which are reflections of first level thinking rather than the thinking that drives actual asset price-determining decisions at the margin.

But while the Taleb heuristic is effective as a thought experiment into the importance of skin in the game, it is less useful (and was never intended) as a specific model for understanding the spread-crossing tendencies and response profiles of various investors to new information. For one, as anyone who has examined the positions of fund managers very often will tell you, someone’s positioning will often tell you a great deal about their constraints, their obligations and their boss’s predispositions, and often very little about why their view of price would change in the presence of new information. For another, because a portfolio is a complex thing, two sensible investors may be equally long or short a position for different reasons that would precipitate massively different responses to new information. Knowing what someone’s portfolio looks like is concretive in terms of language, but not at all in terms of a model for predicting future asset prices.

So why the focus on defining narratives through financial media, which we all know to be riddled with Fiat News, often conflicted and frequently produced in service to its purported subject matter? Because it is the only world in which we learn what everyone wishes everyone else to believe. Because it is the only world in which we know what everyone else knows, because we know that they have seen the top-fold of the WSJ and the Dear Sirs of the Financial Times.

Because it is our best chance to map the world ‘twixt ought to and is.


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I’m a Superstitious Man


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I’m a superstitious man, and if some unlucky accident should befall him — if he should get shot in the head by a police officer, or if he should hang himself in his jail cell, or if he’s struck by a bolt of lightning — then I’m going to blame some of the people in this room.

Vito Corleone, “The Godfather” (1972)

Same.

Vito Corleone was speaking of his son, Michael, and these were some of the people he intended to blame for an “unlucky accident”.

I’m speaking of a monster, Jeffrey Epstein, and these are some of the people I intend to blame for this “unlucky accident”.

So … I want to be careful with what I am saying and what I am not saying.

I am NOT saying that Epstein was murdered, and I am certainly not saying that he was murdered on the orders of anyone in this picture.

Well, certainly not by Melania or whatever Playboy model Bill was boffing at the time.

JK! JK! I really and truly am not accusing Trump or Clinton of having anything to do with Epstein’s untimely demise, not even in a “who will rid me of this troublesome priest” sort of way.

What I am saying is that sociopathic oligarchs – of which club I consider Donald Trump, Bill Clinton and Prince Andrew to be charter members – are the necessary and sufficient conditions of the specific evil that was Jeffrey Epstein as well as the more general evil of sexual predation of children.

What I am saying is that Epstein’s direct testimony – AND ONLY EPSTEIN’S DIRECT TESTIMONY – had the potential to create a Common Knowledge moment like the one that destroyed Harvey Weinstein through the direct testimony of Rose McGowan.

What I am saying is that Epstein’s direct testimony – AND ONLY EPSTEIN’S DIRECT TESTIMONY – had the potential to create a Common Knowledge moment that could bring down – not just specific sociopathic oligarchs like Mob Boss Donald or Mob Boss Bill or Mob Boss Andrew if they were the specific targets of that testimony – but the entire Mob system of sociopathic oligarchy.

Jeffrey Epstein was the Missionary to bring down the monsters behind the monster, to bring down the SYSTEM of monsters.

Jeffrey Epstein’s books and records are not.

The individual voices of Jeffrey Epstein’s victims are not.

And that’s what makes me angriest of all.

That while the individual victims of Jeffrey Epstein’s crimes will maybe (maybe!) get some smattering of “justice” and recompense from the show trial of a monster’s estate, there will be no Justice served against the monsters behind the monster, that the Mob system of sociopathic oligarchy that CREATED this Jeffrey Epstein and the next Jeffrey Epstein and the next and the next will continue unabated. Untouched. Golden.

“Yay, justice!”

What I am saying is that there are enormous vested interests spread across multiple avenues of violence and power that will not allow that Mob system of sociopathic oligarchy to collapse on a single point of failure like Epstein’s direct testimony.

And so it didn’t.

And so Jeffrey Epstein is dead, victim of an “unlucky accident”.

Was it murder? Was it suicide?

I’m a superstitious man. I don’t care.

Is a murder committed more heinous than a suicide allowed? In its act, sure. In this context? NO.

An “unlucky accident” like this is the ONE THING that a non-corrupt State must prevent. It’s the non-corrupt State’s ONE JOB to keep Epstein alive for trial, and everyone knows that everyone knows this is their ONE JOB.

It is impossible to violate this common knowledge without premeditation and malice, without conspiracy and criminality aforethought. It is impossible to have an “unlucky accident” like this in a non-corrupt State.

I’m a superstitious man. I’m blaming the people in the room.

What room?

The room of violence and power and wealth.

The room of the corrupt State.

The room that is swarmed by the Nudging Oligarchy. The room that is supported and propped up by the apparatchiks and hangers-on and wannabes and “journalists” of District One.

I DON’T CARE how deeply Mob Boss Donald or Mob Boss Bill or Mob Boss Andrew was part of this specific criminal conspiracy, either in its operation or its cover-up.

They are mob bosses all the same, and I blame them all the same, and they are guilty all the same, regardless of their specific interest in this specific crime and regardless of whether this was murder or suicide.

Many readers will think I’m naive when I tell you that I was genuinely shocked that Jeffrey Epstein suffered this “unlucky accident.” As the kids would say, I was shook.

I haven’t felt this way since October 2008 when the US Treasury put the full faith and credit of the United States behind the unsecured debt of Goldman Sachs and Morgan Stanley and JP Morgan and Bank of America.

Then as now, the pleasant skin of “Yay, democracy!” has been sloughed off to reveal the naked sinews of power and wealth and violence beneath. There’s no crisis like there was in 2008. The world isn’t ending like it was in 2008. But I’m telling you that it feels the same to me.

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

The Nudging State and the Nudging Oligarchy cannot be defeated on a single point of failure like Jeffrey Epstein’s testimony at trial. Or like the bankruptcy of AIG.

The sociopathic oligarchs will win every direct confrontation. That’s what sociopathic oligarchs DO.

But a million effin’ points of failure? A rejection of the ATTENTION that sociopathic oligarchs require, in both markets and politics? A refusal to vote for ridiculous candidates and buy ridiculous securities? A refusal AT SCALE? A modern movement of disengagement from a market casino and an election sideshow in favor of what is REAL?

Yeah.

Yeah, that can work.

What does a movement of refusal and disengagement look like? Start here

And then go here …

The Second Foundation hides in plain sight.


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The Long Now, Pt. 1 – Tick-Tock


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Last year I wrote a series of notes called Things Fall Apart, focused on the transformation of our most important social institutions – small-l liberal institutions like free markets and free elections – from cooperation-allowing games to competition-requiring games. That sounds bloodless and small, but it’s not. It’s literally how society self-destructs in a widening gyre of mistrust and defection.

Today I’m starting a new series of notes called The Long Now, focused on the further transformation of our social institutions into political utilities … into smiley-face Panopticons of self-censorship where our marrow of autonomy and free will is sucked dry by the Nudging State and the Nudging Oligarchy.

Our money, too. Yes, this will be “actionable”, just maybe not in the way you’re used to.

The Long Now is everything we pull into the present from our future selves and our children.

The Long Now is the constant stimulus that Management applies to our economy and the constant fear that Management applies to our politics.

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

It’s all happened before.

Here’s a SJW journalist who saw it clearly in the 1930s and 1940s.

History has stopped.

Nothing exists except an endless present in which the Party is always right.

George Orwell, “1984” (1949)

What Orwell called the Party, I call the Nudging State and the Nudging Oligarchy. I call it Management. Why? Because the future is not – as Orwell had it – a boot stomping on the face of humanity forever. Please. So messy. So … inefficient.

No, the future is a smiley-face authoritarianism, an authoritarianism that is not imposed on us, but an authoritarianism that we embrace.

 It’s not “Yay, Big Brother!”.

It’s “Yay, Capitalism!”, “Yay, Military!”, “Yay, Diversity!”, “Yay, College!” and “Yay, Stock Market!”.

You’re not, ummm, against any of those things, are you? Because that would be … unfortunate. I mean, you helping the terrorists and all.

Things Fall Apart started with the political and ended with the personal. Let’s flip that on its head with The Long Now. Let’s flip it ALL on its head. Because I know a few things about Time.


Tick-tock.

Tyler Durden, meet Neb Tnuh.


When did the future switch from being a promise to being a threat?

Chuck Palahniuk, “Invisible Monsters” (1999)

I remember exactly when MY future switched from being a promise to being a threat.

It was when my father died suddenly of heart failure in the summer of 1996. He was 62 and I was 32.

There’s something about the dynamic of your father dying suddenly that changes your relationship with the future and with time. Or at least it did for me. Now I was on a trapeze without a net. Now it was All. On. Me. With a baby on the way. Now, to use Palahniuk’s words, the future seemed like a threat, not a promise, where MY death was next in line. For the first time in my life, I felt the pressure of time and mortality, not as some philosophical musing, but for what it IS – an omnipresent pang, a constant bzzt-bzzt-bzzt of that feeling where you wake up with a start and you’re sure that the alarm clock is about to ring but it’s only 3am so you go back to sleep but you wake up again with a start and it’s 3:45 am.

Death inspires me like a dog inspires a rabbit.

Twenty One Pilots, “Heavydirtysoul” (2015)

So right.

See, the threat of the future isn’t a bad thing.

The threat of the future INSPIRES me. The threat of the future DRIVES me.

I’m not moping around waiting to die. I’m not lazing around eating bonbons. The present is for DOING. The present is FLEETING. I’ve got something to SAY before I go. I’ve got a future to SECURE for my children, because in them I can still see future’s promise and not just future’s threat.

This is your life and it’s ending one moment at a time.

Warning: If you are reading this then this warning is for you. Every word you read of this useless fine print is another second off your life. Don’t you have other things to do? Is your life so empty that you honestly can’t think of a better way to spend these moments? Or are you so impressed with authority that you give respect and credence to all that claim it? Do you read everything you’re supposed to read? Do you think everything you’re supposed to think? Buy what you’re told to want? Get out of your apartment. Meet a member of the opposite sex. Stop the excessive shopping and masturbation. Quit your job. Start a fight. Prove you’re alive. If you don’t claim your humanity you will become a statistic. You have been warned.

Chuck Palahniuk, “Fight Club” (1996)

The threat of the future revealed itself to me in 1996 with the death of my father and the birth of my child. One day the threat of the future will reveal itself to you, if it hasn’t already. When it does, you will be CONSUMED by thoughts of the future. You will FEEL the pressure of time more keenly than the younger you could ever imagine.

Tick-tock.

Time is the fire in which we burn.

Delmore Schwartz, “Calmly We Walk through This April’s Day” (1938)

You’ve never heard of Delmore Schwartz. In 1938 he set the New York literary scene on fire at the ripe old age of 25 with the publication of In Dreams Begin Responsibilities, a brilliant collection of short stories and poems about his parents’ marriage and divorce, and Delmore’s estrangement from them. From their “death”, so to speak. His work is imbued with the failure of the American dream for his generation, with the way in which the Team Elite of prior generations sucked the economic marrow out of the Gilded Age and dominated politics with false narratives. Sound familiar?

Delmore Schwartz wrestled with the threat of the future alone and unloved, and he succumbed to alcoholism and madness. He died in 1966 at the Chelsea Hotel – penniless, childless, friendless – dead for two days before a cleaning lady found his body. He was 52. Time is the fire in which we burn. Or rot.

The threat of the future washed over Delmore Schwartz in 1938 as surely as it washed over me in 1996. As surely as one day it will wash over you. But he never found his Pack.

If you would wrestle with future’s threat … if you would stare back at the abyss, as Nietzsche would have it, or if you would yell at the clouds, as The Simpsons would have it … find your Pack.

But see, that’s only one of the things I know about Time.

Tick-tock.

As Paul Harvey used to say, here’s the rest of the story.

It was the summer of 1996, early June, and I was teaching a course at Simmons College in Boston to make some extra dough. Jennifer was clerking for a lawfirm down in Dallas, pregnant with our first child. My dad called. He and my mom were in London, where they had rented a small flat for a month. Did I want to come over and stay for a few days? As it happened, I had five days free, perfect for a long weekend trip. I walked down to a cheapo travel agency on Boylston (yes, a physical travel agency), and found a ticket for $600 or thereabouts. Seemed like a lot. I could have afforded it, by which I mean there was room on my credit card to buy it, not that I could really afford it. $600 was a lot of money to me. That said, I hadn’t seen my parents since Christmas, and my dad sounded so … happy. This was a special trip for them, a chance to LIVE in a city that my father LOVED, and this was my chance to share it with them. But $600. I dunno. I called my father and told him that I just couldn’t swing it. He understood. He was a very practical guy. The call lasted all of 20 seconds. You know, international long distance being so expensive and all.

I never saw my father again. He died a few weeks after he and my mother got home.

Tick-tock.

Yeah, I know a few things about Time.

I know that the moving finger writes, and having writ, moves on.

I know that I would give anything to go back to that week in June 1996 and buy that stupid ticket that I couldn’t “afford” but really I could afford and spend five more days with my father and not do anything special but just BE with him and share a beer at that pub that he mentioned on the phone but that I just can’t remember the name of no matter how hard I try and it’s weird but that’s what bugs me most of all.

Tick-tock.

What do I know about Time?

I know that there is no Long Now.

The Now is short. That is exactly what makes it precious beyond price.

The Now is for LIVING.

I know that there is no Safe Future.

The Future is risky. That is exactly what makes it precious beyond price.

The Future is for INVESTING.

Yet instead of living in the Now and investing for the Future, we are nudged into “investing” for the Now and “living” in the Future.

HOW DOES THIS HAPPEN?

Economic stimulus

The threat of the economic future is removed by fiat and narrative, replaced by the Long Now of constant economic stimulus.

Political fear

The promise of the political future is removed by fiat and narrative, replaced by the Long Now of constant political fear.

We are told that the economic stimulus and the political fear of the Long Now are costless, when in fact they cost us … everything.

The Nudging State and Nudging Oligarchy will tell you “TINA!”. They will tell you that There Is No Alternative.

I tell you this is a Lie.

I tell you this is Sheep Logic, the intentional training of human intelligences to pursue myopic, other-regarding behaviors even unto death, through the vehicle of the Long Now.

What is the alternative to the Long Now?

Personal courage

Leaders who act as stewards of the future, not managers of the Now.

Professional courage

Investors who take more risk with what’s Real, and less with what’s not.

Social courage

Citizens who take back their vote, and who refuse to play the Fool.

Tick-tock.


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The Spanish Prisoner

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It’s an interesting setup, Mr. Ross. It is the oldest confidence game on the books. The Spanish Prisoner. Fellow says him and his sister, wealthy refugees, left a fortune in the home country. He got out, girl and the money stuck in Spain. Here is her most beautiful portrait. And he needs money to get her and the fortune out. Man who supplies the money gets the fortune and the girl. Oldest con in the world.

– David Mamet “The Spanish Prisoner” (1997)

Mark Zuckerberg is not The Spanish Prisoner. He’s the guy running the con.


Seven or eight years ago, I was on a commuter flight, sitting in an aisle seat. Two rows ahead of me, across the aisle on my right, a guy was arguing with his wife/girlfriend. It wasn’t a ferocious argument, but any sort of personal disagreement is noticeable in these circumstances, and it had been simmering since I noticed them boarding the plane.

There were two other things I noticed when they sat down. The wife/girlfriend had the husband/boyfriend’s name – Randy – tattooed on the back of her neck, and Randy had the letters T – R – U – S – T tattooed on the fingers of his left hand. I remember smiling to myself when I saw this. Obviously these two were from a very different background than me, but I really appreciated the public display of commitment they had made by getting these tattoos. I remember thinking to myself that I bet their relationship was a strong one, even though the disagreement seemed to simmer throughout the flight.

The plane landed and we all stood up. And then I saw the letters tattooed on Randy’s right hand.

N – O – O – N – E

All of a sudden, I was pretty sure this guy’s name wasn’t Randy. All of a sudden, I was pretty sure this relationship wasn’t likely to last.

I feel like I have TRUST NO ONE tattooed on my hands today, and if you’ve been working in finance for more than 10 years, I bet you feel exactly the same way.

Used to work for Bear? I know you feel this way.

Used to work for Lehman? I know you feel this way.

Used to work for Citi? I know you feel this way.

Used to work for Merrill? I know you feel this way.

Used to work for Deutsche Bank? I know you feel this way.

Yeah, we’ve all got these tattoos today. We have them as a reminder, as a figurative reminder (or literal in the case of “Randy”), that we really really really shouldn’t trust anyone AGAIN.

Because we need a reminder. Because we want to trust again.

Jimmy Dell: I think you’ll find that if what you’ve done for them is as valuable as you say it is, if they are indebted to you morally but not legally, my experience is they will give you nothing, and they will begin to act cruelly toward you.

Joe Ross: Why?

Jimmy Dell: To suppress their guilt.

– David Mamet “The Spanish Prisoner” (1997)

Jimmy Dell is the con man in the 1997 David Mamet movie, played by Steve Martin in his finest dramatic role. In lines like above and below, Jimmy builds a personal trust with the mark by calling his attention to the lack of trust in business relationships. Effective consultants do this a lot, speaking of confidence games.

Jimmy Dell: Always do business as if the person you’re doing business with is trying to screw you, because he probably is. And if he’s not, you can be pleasantly surprised.

That’s the thing about the Spanish Prisoner con. It doesn’t work on saints. It doesn’t work on people who forgive and forget, who turn the other cheek and have an unending reservoir of faith in their fellow humans. It also doesn’t work on sociopaths. It doesn’t work on people who truly trust no one, who can lie to themselves and others without consequence or remorse.

The Spanish Prisoner con works best on smart and accomplished people who think they have TRUST NO ONE figuratively tattooed on their hands, who think they’re too clever to be fooled again, but end up only being too clever by half.

The Spanish Prisoner con works best on coyotes.

Who is a coyote? A coyote is a clever puzzle-solver who really has the best of intentions. Who really wants to be successful for the right reasons. Who really wants to accomplish something of meaning in the world. Who is smart and aware and nobody’s fool. Who has been beaten up professionally a bit and has a healthy skepticism about the business and political world.

And who is just a little bit on the make. 

The defining characteristic of the Spanish Prisoner con is that the mark believes he is doing well while doing good. The mark believes that he is doing the right thing, that he’s the good guy in this story. And if the liberated Prisoner is financially grateful, or if the Prisoner’s sister is grateful in her own way if you know what I mean and I think you do … well, that seems only fair, right?

Now the Spanish Prisoner doesn’t have to be an actual person that needs rescuing. That’s a con for the rubes. The Spanish Prisoner is what Alfred Hitchcock called a MacGuffin – anything that serves as an Object of Desire for the mark, anything that motivates the mark and furthers the narrative arc of the con.

In fact, the most effective MacGuffins are rarely simple signifiers of wealth like an rich Spanish dude. No, the most compelling Spanish Prisoners are Big Ideas like social justice or making America great again or resisting the Man. That’s what gets a coyote’s juices going. Especially if there’s also a pot of gold associated with being on the right side of that Big Idea.

The most successful con operators are the Nudging State and the Nudging Oligarchy. Why? Well, partially because you’ve gotta have some heft to credibly commit to rescuing a Big Idea from the clutches of whatever Big Baddie has it now. But mostly because running the con for money is just thinking waaaay too small.

The Nudging State and the Nudging Oligarchy don’t need your money. They already have it!

The con here is to gain your trust – again – so that you willingly hand over your autonomy of mind. So that you accept without thought or reflection the naturalness of your current relationship to the State and the Oligarchy.

You’d never fall for this con if it were part of a straightforward commercial arrangement like a job or a purchase. Please! You’re much too savvy for that. You have TRUST NO ONE tattooed on your hands, remember?

But for the chance to help rescue a Big Idea …

But for the chance to make a few bucks or enjoy yourself a bit more as part of doing the right thing …

There’s not a coyote in the world that can resist that bait. And that’s why once you start looking for the Spanish Prisoner con, you will see it everywhere.

Libra, the cryptocoin promoted by Facebook, is a Spanish Prisoner con.

What’s the Big Idea? Why it’s banking the unbanked. It’s facilitating cross-border remittances. It’s bringing the benefits of crypto to the global masses. ALL OF THIS IS TRUE. So far as it goes.

And if it facilitates e-commerce along the way? if it’s possible to make a few bucks or enjoy some greater conveniences as part of Facebook and its partners executing on this Big Idea? Well, what’s wrong with that?

What’s wrong is that this is how Bitcoin dies.

This is how a censorship-embracing coin replaces a censorship-resistant coin. This is how the State and the Oligarchy co-opt crypto. Not with the heel of a jackboot. But with the glamour of convenience and narrative.

And in a few years it will all seem so natural to you.

Using government-approved electronic money will be the water in which you and your children swim. You will not be able to imagine a world where a censorship-embracing coin is not everywhere.

Yay, capitalism!

Libra was designed to co-opt Bitcoin.

Libra was designed to allow government oversight over your economic transactions.

Libra was designed to provide a transparent regulatory window and control mechanism over your money.

Libra was designed for Caesar.

From the Libra consortium:

This is why we believe in and are committed to a collaborative process with regulators, central banks, and lawmakers to ensure that Libra helps with the kind of issues that the existing financial system has been fighting, notably around money laundering, terrorism financing, and more. At the core, we believe that a network that helps move more cash transactions – where a lot of illicit activities happen – to a digital network that features regulated on and off ramps with proper know-your-customer (KYC) practices, combined with the ability for law enforcement and regulators to conduct their own analysis of on-chain activity, will be a big opportunity to increase the efficacy of financial crimes monitoring and enforcement.

“Boo, terrorists!”

A year from now, the narrative story arc regarding “criminal activity” through cash transaction networks AND censorship-resistant transaction networks like Bitcoin will be louder, not softer. In three years, it will be deafening.

Libra and its e-commerce convenience, together with its Big Idea skin of helping The Poors … that’s the carrot.

The “Boo, terrorists! narrative … that’s the stick.

Will Bitcoin itself be outlawed? Maybe. But I really doubt it. It’s too useful as a societal steam valve, now that we’ve got Libra and (soon) other Oligarchy-sponsored and State-supported cryptos in circulation.

What does Bitcoin become in a world where state-approved e-money is in wide circulation?

It becomes an act of effete rebellion, like a non-threatening tattoo on your upper arm that you can cover up with a shirt if you like.

Bitcoin becomes a signifier of Resistance rather than a tool of Resistance.

Owning Bitcoin will make you a Bad Boy! or a Bad Girl! … a safe malcontent that the Nudging State and Nudging Oligarchy are delighted to preserve.

What’s my message to the true-believers who continue to see Bitcoin as a tool for Resistance?

For the next fifty years, you get to play the role of the grumpy old man yelling at clouds.

You know, the role that gold true-believers got to play for the past fifty years.

It’s a miserable way to live.

It’s a miserable way to live for two reasons.

First, and most crucially, this role that the Nudging State is laying out for you is steeped in negative energy. You will find yourself rooting for catastrophe. You will find yourself hoping for decline and collapse. You will find yourself conflating justice with loss and comeuppance. You will take on sadness and schadenfreude as your resting psychic state. Trust me when I say that I know of which I speak. Negative energy is deadly. That is not a figurative statement. It will literally kill you.

Second, you’ll be infested by raccoons, which will be tolerated if not encouraged by regulators, in exactly the same way they are tolerated if not encouraged by regulators in gold-world. Sure, you’ll have the occasional show trial of egregiously aggressive security frauds and Crypto-Funded Criminals ™, but the run of the mill hucksters and con men will walk with impunity.

Because this is what ALWAYS happens.

The money quote from Too Clever By Half:

And that brings me to what is personally the most frustrating aspect of all this. The inevitable result of financial innovation gone awry, which it ALWAYS does, is that it ALWAYS ends up empowering the State. And not just empowering the State, but empowering the State in a specific way, where it becomes harder and harder to be a non-domesticated, clever coyote, even as the non-clever, criminal raccoons flourish.

That’s not an accident. The State doesn’t really care about the raccoons, precisely because they’re NOT clever. The State — particularly the Nudging State — cares very much about co-opting an Idea That Changes Things, whether it changes things in a modest way or massively. It cares very much about coyote population control.

It’s all about coyote population control. It always is.

Is there a way out of this for Bitcoin? No. Co-option by the State and Oligarchy was the Doom of Bitcoin from the beginning.

I mean … I say “Doom” like it’s going to be hurled into the fires of Mordor, but that’s not it at all. There will still be true-believers and raccoons alike generating tradable narratives. You’ll still be able to make money by trading Bitcoin on these narratives (and altcoins, too, I’d expect, although I have no idea how you generate a compelling altcoin narrative these days).

It’s not like Bitcoin is going to go away.

But Bitcoin is going to be permanently diminished in its social importance by the adoption of Libra and other Oligarchy-sponsored and State-embracing crypto currencies. Bitcoin will never again mean what it used to mean.

You know … just like gold was permanently diminished in its social importance by the adoption of Oligarchy-sponsored and State-embracing fiat currencies. Just like gold will never again mean what it used to mean.

I wrote this note six years ago. It was the first Epsilon Theory note to get widespread recognition. You’ll see hints – more than hints, actually – of all the big ET themes over the past few years, particularly The Three-Body Problem.

The core of this note is a quote by Bob Prince, Bridgewater’s co-CIO and an actual prince of a guy. I just think he’s wrong when he says this:

The relationships of asset performance to growth and inflation are reliable – indeed, timeless and universal – and knowable, rooted in the durations and sources of variability of the assets’ cash flows.

I think Bob Prince is wrong in exactly the same way that JP “Jupiter” Morgan was wrong when he said this:

Gold is money. Everything else is credit.

If you get nothing else from Epsilon Theory, get this:

There are no timeless and universal relationships between asset performance and ANYTHING.

The only determinant of price for a non-cash-flowing thing is Narrative. Actually, the only determinant of price for a cash-flowing thing is Narrative, too, but we can save that argument for another day. And what I am saying about these non-cash-flowing things is this:

The introduction of Libra changes the Bitcoin narrative in exactly the same way that the introduction of fiat currency changed the gold narrative. And by change I mean crush.

That makes me sad. That makes me angry. I am convinced that it is part and parcel of a Spanish Prisoner con game. But I refuse to give into the negative energy of that realization AND I refuse to give up on the Big Ideas that I believe in.

So what do I do?

I con the con man.

I know what Mark and Sheryl and all the other Davos-going Team Elite sociopaths are about.

I see what they are offering me and I TAKE it. Without hesitation. Without remorse. I take it just as they are trying to take from me … in full sociopathic bloom.

And what do I give them in return?

NOTHING.

Do I care about banking the unbanked and cross-border remittances? Yes, I do. Very much. So I will TAKE the protocols and the KYC procedures and everything else Libra offers, and I will USE all of that to further the social justice goals that I maintain. And they will get NOTHING from me in return. I will keep my autonomy of mind. I do NOT forget what they are trying to steal from me. I do not ALLOW them to steal that from me.

I refuse to give them my trust.

And I will look for every opportunity to destroy their Little Kingdom.

Seriously.

Do I really have TRUST NO ONE tattooed on my hands? No.

I trust lots of people. I trust my pack.

But Mark and Sheryl and Christine and Jay and Donald and Barack are not in my pack. And they never will be.

Trust no one? No.

I just don’t trust THEM.

Take back your vote.

Take back your distance.

Take back your data.

It’s that simple. And that difficult.

As wise as serpents. As harmless as doves.


  PDF Download (Paid Subscription Required):  The Spanish Prisoner


Life in the Gyre

I been watchin’ you watchin’ her watchin’ herself in the mirror.

High Tone Woman, from Somewhere Down in Texas by George Strait (2005)

I wanted to write something about Andy Ngo.

Andy is an independent journalist who was badly beaten by members of Antifa last weekend. He writes for Quillette, a provocative, liberal centrist publication that you will probably see (oddly) described as conservative. His public actions haven’t made him a saint in the eyes of everyone, but he didn’t deserve to be physically assaulted.

I wanted to write about how most media outlets weren’t talking about the attack in the way they would if Ngo’s politics were different. Because that’s how it felt to me. So I looked at our database of media coverage of other attacks on journalists that have taken place in the last year or so.

What I felt to be true, well, wasn’t.

Clear eyes. The attack on Andy – in no small part because of the graphic video capturing it – has gotten more coverage in the first three days of its aftermath than almost any attack on a journalist in the United States in 2019. More than coverage of journalists in D.C. being knocked down by Capitol Police, or a longtime Sacramento Bee cameraman receiving similar treatment. More than a journalist who took similar injuries from objects flying out of a car (hurled with epithets) when covering dueling pro-choice / pro-life rallies. More than the recent injuries to journalists covering the Memphis police protests. In fact, the only event in 2019 with comparable coverage was the attack on the press pool – and a BBC cameraman in particular – at a Trump rally in February.

We will be the first to say that quantity of coverage isn’t necessarily what is most important. Is there a cohesive narrative indicative of a collaborative desire of missionaries to tell readers how to think about this event? Can we spot the affected language we call Fiat News – opinions parading as fact – in news stories about it? Is there a detectable bias embedded in the qualities of the language used to discuss this event relative to similar ones? Yes. Yes. And yes.

And while demonstrating each of those things is what drew me to the topic, when I saw the narrative structure, it wasn’t what struck me. What jumped out at me was just how much of the coverage of this issue was about others’ response to coverage of the issue. In other words, more than just about any topic we have researched, somebody looking for news about these events was just as likely to instead find ‘news’ that would tell them how the curious case of Andy Ngo was really a symbol of virulent right-wing whataboutism equating childish antics to Nazism, or how it was really an example of mainstream left-wing hypocrisy and indifference to violence and bad behavior if perpetrated against the ‘right kind’ of people. And then it was media outlets trumpeting the content of media outlets making the opposite claim. In other words, if you felt what I felt and wanted to have a mirror engagement with the confirmatory story, or a rage engagement with the people getting it wrong, you had a host of articles to choose from.

How many?

By our estimate, roughly 40% of the 273 articles in our data set written about Andy Ngo between June 29th and July 1st have principally been about the coverage of the event and responses to that coverage by other outlets and people.

Source: Quid, Epsilon Theory

Missionaries have been shaking their fingers at us to tell us how to think about issues for a long time now. That is not new. But increasingly, what we are being told isn’t just how to think about issues. We are being told what other people think, how others are covering the events and how everyone else is all wrong. We aren’t even allowed to figure how we’re going to start fighting about some dumb thing. By the time we’ve read a single fact about a story, the ring is built, our gloves on, Michael Buffer already halfway to his car, and the bell still ringing.

It isn’t that there isn’t truth in these claims. I still believe personally that most large outlets were aggressively dismissive of Ngo’s victimhood for political reasons, and I think there’s substantial evidence in language of their coverage to indicate it. I think a lot of people of a different political persuasion would still think – in good faith – that it is ridiculous that we are even talking about this when psychotic, racist white nationalists are out there running people over.

The problem is that when the information we consume ceases to be information about things that happened, and is transformed into information about how important people perceived those things or how the other side is being hypocritical about their coverage or opinions of those things, we descend another layer into the Panopticon – watching the crowd, watching the crowd watch itself. The more of this kind of information we unwittingly consume, the more we unwittingly live our lives in a world in which our reality is defined by the second and third levels of the Common Knowledge Game. Even when we think – even when we know that we are right.

We can’t avoid being in the Widening Gyre. But we can avoid being of it.


It’s not all political theatre.

Let me give you an example. When I was preparing this essay, the New York Times was so sure that I needed to see this article that they paid for the pleasure of putting it on my screen:

What is it?

Well, it’s a promoted tweet from last year, which probably means that the New York Times has a marketing and social media department that has determined that paying for 30-something dads who search for “real metal Tonka trucks” and “foam airplanes with long wings” on Amazon and post dad jokes on Twitter to see this article has a positive ROI.

The article itself, of course, includes zero descriptions of how parenting is any different from what it used to be. The descriptions are of how specific parents have said that they feel they have to do different things for one reason or another. This isn’t the kind of Fiat News we’d usually see in your classic feature piece, trying to guide in a newsesque way in how you think about some Big Social Issue. Instead, it’s news that provides you with reminders that this is how other people are thinking correctly about this.

It sounds melodramatic, but under any reasonable interpretation, the New York Times is literally trying to sell subscriptions to parents by preying on their fear that they will miss an article that will tell them how other parents are defining what parents are supposed to do. It’s a less obtrusive version of Black Mirror’s Fifteen Million Merits, with more nudges and less Big Brother. Click-bait, sure, but more subtle and far more powerful. Don’t mute your audio, or else you’ll be subject to a penalty.

Image result for fifteen million merits don't look away

But no, it also isn’t always gentle nudges. The media-as-principal has determined that vanilla Fiat News isn’t enough, that guiding how you think will be most effective by telling you how other people are thinking about things, how they are getting it wrong, etc. The pattern is everywhere.

It is evident in the editorial selection of news articles and how they are written. Here, for 2015-2018, are the percentages of articles in the New York Times, Washington Post, CNN and Huffington Post – the most socially important left-leaning news publications in the US – which specifically reference Fox News.

Source: Quid, Epsilon Theory

Fox itself, probably as influential and powerful in right-leaning circles as each of those outlets combined in their own milieu, is selling the same thing. The growth is not so dramatic, but part of that is – I think – because the narrative of a general left-wing bias in media was already well-established as the network’s raison d’etre.

Source: Quid, Epsilon Theory

What does this mean? It means that, relative to only four years ago, you are twice (or more) as likely to encounter a ‘news’ article telling you what tragedy the opposing political side isn’t treating the same as they did a different one, a response ‘news article’ which snidely references the first with as many scare quotes as possible, and then a set of third articles which just cover all of the most virulent social media posts the dueling articles spawned.

Oh, think that last one was a throwaway joke?

Yeah, that’s happening, too.

If your response to this is, “Yeah, but that’s just reflective of growth in Twitter and social media in general – it’s just an indication that it is being embraced more broadly by public figures,” well, yeah, no kidding. Y’all, the point isn’t necessarily to convince you that people are doing something wrong here. It’s to show that this is happening. To argue that we can stop predicting and start observing. Some statement or dispute on social media is now newsworthy. A public figure condemning X on Twitter but not condemning Y is now a news event. A random jackass replying to AOC with a racist remark is now a fully fleshed-out feature piece about the New Right Wing, and a search that yields a community college professor who liked a post about punching Nazis is now a wholesale indictment in print of the Lunatic Left.

The peril of this new Panopticon? Fewer of the facts we are provided are divorced from opinions, sure. But fewer still are untarnished by the light shining back on all of us, telling us what the crowd thinks and what it ought to think. Missionaries are taking our Common Knowledge into their own hands.


And it’s working.

Think for a moment about the coverage of the events on America’s southern border. When is the last time you read such a story that was not at least partly meta-commentary about contrasting media treatment of the events? OK, give yourself a little test. How many asylum-seekers have been detained so far in 2018? Just an estimate. Roughly what percentage have come from Guatemala? What about other countries? What are most of them fleeing? How do the conditions and US border policies as currently enforced compare to those of other developed countries?

Cool, cool. OK, now who tweeted out a border photo-shoot in a white outfit? What did some political leaders compare the detention camps to? Who took issue with those characterizations? What biased newspapers and networks have been ignoring and downplaying the current situation in the detention centers? Which biased outlets ignored it during the Obama Administration?

I think I know which set of questions the average news-following American would be able to answer and which they wouldn’t. There’s a reason: because the latter, increasingly, is what is produced and consumed. And whether that tendency plays the role of the chicken or the egg in all this, this is happening because it’s increasingly the content that gets shared. In our query of detention facility-related news this year, here are 5 articles from the top one-half of 1% in shares across social media:

Bank of America will no longer do business with companies that run detention centers [CNN]

Wayfair employees plan walkout to oppose furniture sales to migrant detention facilities [Boston Globe]

Alyssa Milano Promotes Fundraiser for Illegal Alien After Mocking Veteran’s Border Wall Crowdfund [Breitbart]

Ocasio-Cortez presses case that U.S. is running ‘concentration camps’ at border amid Republican outcry [Washington Post]

Many in media changing their tune on border ‘crisis’ after claiming it was ‘manufactured’ [Fox News]

I’m not saying that these topics aren’t newsworthy.

But the fact that the ‘what everyone else is thinking/saying/doing’ articles spread like viruses – when reporting of simple facts does not – matters. It is changing the kind of information we get through incentives alone. There is nothing – nothing – a media outlet can do to better position its franchise than to frame every story as being about the hypocrisy or bad behavior of some opposing group. It is squelching the already short supply of pure, unadulterated, fact-based news we have available to us.


Second- and third-degree Common Knowledge posing as news is doing something else, too:

It is killing good faith. It is killing our collective willingness to believe the benevolent / benign intentions of our fellow-citizens.

Some of that is happening through the subtler – if we can even call it that – Fiat News-like stories above. Some of it is happening through much more transparent means. Consider, for example, the below image, which began to make the rounds yesterday (collected by Heather Heying) about the Andy Ngo affair.

It would be an extremely, er, powerful assertion from the American Spectator – except it was never made. The American Spectator never published this article. You could say it was fake news of the type meant to mislead some number of people on simple facts, but I don’t think so. This image exists to break down any lingering belief that the information being circulated outside of our curated on-narrative sources comes from a place of good faith. Here’s the real one below.


I am not ignorant to the fact that much of what we do on this website is the identification of what we see as common knowledge and active narratives. But the danger isn’t in thinking about the second- or third-degrees of the Common Knowledge Game. We should do that. We must do that. The danger lies in treating the second- and third-degree information that we receive as first-degree fact, rather than how we or someone else would like us to interpret the import of those facts.

And the more we allow others to do that interpretation for us, even when it seems sensible – no, especially when it seems sensible – the less sovereignty we retain over our own thoughts, and the further the gyre of our divided politics widens.

The Half-Happy Horror


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The Judgment of Solomon, Gaspar de Crayer (c.1620)

Optimization is a scourge.

I say this as someone who is as addicted to efficiency as anyone I know. I have a chart – not a mental chart, but an actual on-paper chart – of which of the three specific routes I should take to my office by day and time. I almost never schedule same-day meetings because I find it disruptive to planned periods of work on certain projects. I set up a mise en place for making Kraft Mac & Cheese for my kids, for God’s sake. My biggest average allocation to public markets in non-taxable accounts for several years has been to risk parity. Much of the rest has sat in systematic trend-following and behavioral premia strategies. I am an optimizer, y’all.

Yet I have also spent my career as an allocator to investment strategies observing what both explicit and implicit goal-seeking does to investors and their processes.

I’m not really talking about the robustness of objective-function optimized portfolios to changes in key variables or estimation methodologies, although just a shred of epistemic humility in portfolio construction would go a long way with some quants. I’m also not really talking about the mean-variance frontier-plotting and JP Morgan GTTM-driven Monte Carlo slides I see being put in front of clients (and which I have, from time to time, put in front of them myself). Feel seen? Throw a rock in the air and you’ll hit someone guilty.

But what I really mean is this:

Our need to manage common knowledge about multiple competing objectives in an optimization-centric framework makes us into professional cartoonists.

The Lip-Service Cartoon

I’m not saying anything outlandish here. If you’re a professional investor, you’ll be familiar with this – especially the lip-service cartoon. This is the one where we pretend – and ask everyone else to pretend – that our secondary and tertiary objectives or constraints are conveniently totally achievable without impacting our primary pursuit, even when they’re not.

I have written about this recently in context of post-secondary education, where optimization’s effects are obvious. The stories we tell about college are that it ought to serve three objectives, usually all at once:

  • College should broaden horizons, providing a foundation of historical, philosophical, aesthetic and scientific knowledge and the critical thinking needed to process problems raised by or answerable using that knowledge;
  • College should prepare students to enter and be successful in a profession; and
  • College should provide an environment for the socialization, personal growth and independence of young adults.

In practice, by any realistic measure of revealed preferences American universities don’t really optimize for any of these things. As we have argued, we think they mostly target maximizing the signal sent about the underlying intellectual, temperamental and socioeconomic and demographic traits of their degree-holders, because, well, that’s what our culture has permitted and what alumni donors demand.

Is it true that critical study of history, philosophy and language can improve the quality of thinking? Of course it is! If you’ve been reading Epsilon Theory very long, you will know that we believe the same Big Ideas tend to permeate almost every area of human activity, and that identifying those variants and their memetic attachments in the wild can be a meaningful advantage to our thinking. You’ll also know that we are passionate about the human importance of art and creation. The cartoon isn’t in recognizing the importance of these things. It isn’t even in recognizing that they may have some value for multiple objectives. The cartoon is in our pretense that coursework in music theory and the emergence of proto-Celtic language and cultures from other Beaker societies will be just as important to professional pursuits or personal growth of young adults as it is to living an enriched life. By corollary, however many hours you spend studying Kant, it won’t make you as good at your job as spending the same amount of time doing that job or preparing more directly for it.

To maintain the cartoon, we must pretend that it will.

Our pressure to create these cartoons can be traced to our sensitivity to common knowledge about those secondary and tertiary objectives that we are ‘balancing’. It is untenable – unacceptable – to be seen as not seeking out those objectives, and it is desirable under almost every governing narrative of the Zeitgeist to be seen as pursuing them. The inevitable result is that they get only as much of our energy and attention as is necessary to maintain the cartoon.

If you want to see this in financial markets, look no further than the methods your value managers provide for avoiding value traps (which will, I assure you, be disregarded as not being relevant in this particular case when it suits them), most ESG overlays, and almost every risk report provided by a non-integrated risk team to the portfolio management team. Pro-tip: the more a PM you are interviewing goes on about how much having daily access to these risk statistics has really changed their thinking, the more full of shit they are.

In fairness, it isn’t that they’re lying – it’s that the cartoon permits them to act as if the balancing of multiple objectives is serendipitously bereft of any tradeoffs. Their process is just that good.

The Measurement Cartoon

Sometimes our cartoon isn’t that we wave our hands at potential tradeoffs between our objectives, pretending that some magical alignment of our ideas permits the kind of synergy never found in nature. Instead, the cartoon is the pretense that we have the capacity to measure what those trade-offs are, even when we don’t.

The most inevitable cartoons of this variety, I think, are those built around liquidity. Our industry gets the occasional reminder that liquidity matters, such as with the recent Woodford business in the UK, or the Third Ave blow-up a few years back. After those events, there’s usually a 12-18 month cycle in which people Really Care about it. They add a few more questions to their DD questionnaires, and once the answers from fund managers congeal around some standardized answer, the questions largely stop, other than in the most perfunctory way. That is, until the SEC passed 22e-4, a rule establishing the requirement for a liquidity risk management program for open-end investment companies. It requires the mapping and publishing of position liquidity in four different categories.

In this case, we have a rule requiring the creation of a cartoon, and lest anyone is laboring under any delusions here, that’s exactly what investors will get. I’ve provided below a helpful example of the rule, its standards, the cartoon responses investors will receive and the real response investors would get if the industry were concerned about telling them the truth:

The point, of course, is not that liquidity isn’t important. When it matters, it matters a lot. And when it matters a lot, things are happening that are often not quantifiable in ways that will make sense under any objective quantification scheme in a normal environment. Asset class flows, manager-specific flows, market direction and available position-level liquidity are all pro-cyclical. As has almost always been the case, these cartoons will tell a happy story about liquidity to investors…until it’s too late. In other words, the value ascribed to a liquidity bucket is an ephemeral, practically useless figure that gives false comfort and context to manager and investor alike.

There are other examples of how we optimize for multiple objectives by turning a complicated secondary objective that deserves our respect into a cartoon we hand over to ALPS, BNY or our internal risk management team. Highly leveraged funds whose managers have ever uttered the words ‘Cornish-Fisher expansion’ to a client, you are correctly detecting side-eye. In all such cases, there’s nothing disqualifying or wrong about using guideposts or systematic measures, but when we optimize for some key objective (return or volatility-adjusted return) and explain away others (maintaining adequate liquidity) by constructing a cartoon to ‘measure’ them away, we’re gonna have a bad time.

The Mitigant Cartoon

In still other circumstances, we know that we can’t measure a secondary thing we care about, so the hand-waving takes a different form. We don’t have measurements. We have mitigants.

To be fair, mitigants are real things. AND they are often the basis of cartoonish abstractions that allow us to dismiss important things we ought to honestly, fully consider. We know that excessive leverage and concentration in this strategy creates potentially outsized risks to the portfolio, but worry not: in portfolio transparency we have a powerful mitigant. We know that there’s an unusual capital structure which could permit the intentional impairment of our class of interest, but the principal is a public personality with long-term clients in the same class. These are strong mitigants, you see.

The problem with mitigant cartoons – and what distinguishes them from actual mitigants, is that they are among the most basic tools of confirmation bias. They provide ready answers to our concerns which, like our other cartoons, miraculously seem to support the unbridled pursuit of whatever our primary objective was in the first place.

When we build too much of our thinking around optimization instead of good-faith, knowingly messy, honest evaluation of conflicting facts and circumstances, we will inevitably find that all of our problems become just-so stories. They will perfectly explain, measure or mitigate away the things we have to be seen to care about but don’t. They will perfectly support our single-minded pursuit of the things we do care about.

The Half-Happy Horror

Look, the idea here isn’t that we can’t walk and chew gum at the same time. An incredible share of life is obviously about finding balance between conflicting things, priorities and ideas – whenever it’s possible to do that, that is. The idea also isn’t that we shouldn’t adopt systematic methodologies -quite the opposite, as I frankly think these tendencies to optimize are stronger for those who don’t constrain their processes to rules (yes, it is clearly quite possible to systematize predispositions in such rules, too).

The idea is simply that optimization of decisions involving multiple objectives and constraints – whether fully systematic, rules-based or discretionary – is the kind of thing that should always cause the responsible investor and citizen to step back. Especially when the alternative is often a solution that will make everyone half-happy, which in a zero-sum game is no solution at all.

What can that person do?

  • We can (try to) be honest with ourselves. If we have a constraint, a risk, or a secondary objective in our strategy we’re trying to balance with another, are we giving them lip service? Are we draping them in unwarranted quantification so that we can consider them ‘solved’? Are we clothing them in ‘mitigants’ so that we can check the box and move on?
  • We can focus on ANDs. The language we use to talk about multiple objectives often betrays our attention and the considerations we would just as soon wave our hands at. In my experience, it is critically important to start from a place that considers all facts as ANDs, rather than presuming their relationship to one another.
  • We can try to simplify our decisions. Where possible, simplifying decisions and our responses to them so that we truly can focus on a narrower set of objectives – not through abstraction, but in truth – can help a great deal. With portfolios, maintaining a lens to conceptualizing pools of capital as serving discrete objectives can be an effective management tool.

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In the Trenches: Cake


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What’s next for U.S. equity markets, and what historical analogs might provide some insight? There are plenty of bullish pundits citing renewed monetary policy easing as a catalyst for higher equities – some even suggesting a melt-up could yet occur. While a surprise (at least to us) cut this week could propel equities higher for one last gasp, I’d not chase. Since my 2019 Outlook, I’ve been suggesting a ‘tale of two halves’ narrative for risk assets.[1] In it, my team and I described a first half characterized by a correlated risk-on resulting from improved central bank communication, more reasonable valuation, and more favorable optics around China trade. This has largely occurred. In particular, our mid-year target for the S&P 500 was and remains 2,800, while our year-end target remains well below street consensus at 2,500.

The recent rally in U.S. equities is largely a result of market participants believing they can have their rate-cut cake and eat it, too.

Market participants’ Pavlovian response to a cut of any kind – regardless of context – has been well reinforced over the past ten years. As my team and I have pointed out, and as Figure 1 illustrates, a cut now would bode ill (as a signal rather than a cause) for the U.S. economy over at least the next year. Will the Fed cut in June? While in play, we don’t think the Fed will cut, as it would amount to preemptive action.[2] There are three relevant precedents upon which market participants have relied to justify such preemptive Fed action.

Some argue that market conditions are analogous to 1995, when the Fed cut preemptively. I disagree. In our BIG Picture piece entitled Fed Reaction Function (dated April 20, 2019), my team and I presented our view that current conditions did not resemble 1995, and we continue to hold that view. As Figure 2 shows, when the Fed decided to cut in 1995, economic conditions were significantly worse than they are today. ISM manufacturing was deep in contraction, and at 5.6%, the unemployment rate was significantly higher than it is today. That said, the view has consistently been that the Fed will cut if equity markets risk-off by more than 15% or if there is a hard turn in the economic data, neither of which have occurred quite yet. Such conditions will likely manifest later in the year, especially if rates markets are as predictive as we think they are. It’s a matter of when – not if.

Eurodollar futures markets (ED1 – ED3 = 40bps) are implying an 80% chance of two cuts between June and December. This suggests the Fed is too tight relative to economic conditions (Figure 3). The correlation between 10-year rates and ISM manufacturing show that ISM will move into contraction in the near future (Figure 4). Nonetheless, we don’t believe that the Fed will move before that happens – nor should it. The equity markets and rates markets are severely disconnected, and that disconnect is the result of expectations for market intervention from the Fed, upon which markets have become far too reliant. My expectation is that equity market volatility will precede the Fed’s next move. Certainly, with the S&P 500 at ~2,900 amidst a global slowdown and flat U.S. earnings, the risk-reward appears poor to owning U.S. equities.

Looking at another potential historical precedent, I also do not believe that the current situation is analogous to the early 1970s when President Nixon appointed Arthur Burns as the Chairman of the Federal Reserve. While we will leave the reader to his or her own conclusions about the similarities between Donald Trump and Richard Nixon, it would appear that Chairman Powell is far less naïve than the academic, Burns. On February 1, 1970, Burns, known as a Republican loyalist, took office. Preceding the 1972 election, Nixon is alleged to have instructed Burns to cut rates.  Burns lowered funds starting in mid-1971 from 5.75% to 3.5% into March of 1972; GDP growth picked up to 5.6 % in 1972 from 3.3% the year prior. Inflation rates rose to 5.3% from 3.6%. This may have helped exacerbate the impact of the oil shock, which occurred as a result of an OAPEC oil embargo, which was retaliation for U.S. aid to Israel during the Yom Kippur War. While clearly there was a complex brew of potential causes, this policy period was followed by a considerable amount of asset volatility.

Lastly, the kind of central bank coordination that occurred in February 2016 at G20 is unlikely. Recall the backdrop from 2015 into 2016. A burgeoning China slowdown and fears of an aggressive devaluation of the yuan catalyzed two selloffs – one in late summer of 2015 and the other in early 2016. Complicating the U.S. backdrop was a U.S. earnings recession and a rise in default rates amongst energy companies that risked sparking a broader U.S. default cycle.  The G20 meeting that year was in February in Shanghai. At the time, my team and I failed to appreciate just how aggressive and coordinated the global central bank policy response would be. After a largely correct markets call for 2015, we failed to pivot bullishly enough on this stimulus. Could we be making the same mistake here? We don’t think so.

For one thing, global central bank balance sheets are no longer expanding in aggregate. Figure 5 shows that 2015 equity market volatility (green lower panel) was quickly suppressed by an expansion of global central bank balance sheets (on a stable Fed balance sheet). Now conditions are quite different with the ECB no longer buying new bonds and the Fed selling its holdings. While rates volatility caused by higher rates has abated this year, rates are considerably higher here in the U.S. than in the rest-of-the-world and most developed market central banks remain on hold after only recently being in normalization mode.[3] Lastly, there is no longer a post-crisis chorus of Kumbayah coming from world leaders. Instead, the world’s largest economies are embroiled in what appears to be a prolonged trade war. This makes coordination more difficult especially because many central banks are not independent of the governments engaged in the trade dispute. Lastly, we do not think the Fed wants to hand President Trump a rate cut into the G20 meeting simply because he asked for it. There must be an objective basis for Fed action.

Conclusion

Will we see a change in Fed’s modus operandi in June that results in a cut? We believe a cut in June would require a philosophical change in approach, as we would take it to be a preemptive move influenced by the executive branch. This is why June is such an important meeting. Were it to cut, policy would begin the slide down a slippery slope – a slide back to ZIRP and back to QE (quantitative easing). While we hold the unfortunate belief that all central banks will be at zero interest rates and aggressive QE (including the Fed) in the not-so-distant future, we also think the Fed wants to resist moving in that direction too quickly. Why? For one, the Fed understands the inadvertent redistributive effects of its policy decisions.

Wages compensate labor. Interest compensates owners of capital – credit investors, in particular. As a result, rate cuts, which set the cost of capital, implicitly make a wealth redistribution decision from credit investors to labor (in the form of lower unemployment). Moreover, not only do central bank decisions lead to wealth redistribution from creditors to labor, but low rates typically also discriminate against credit investors in favor of equity capital providers (as the ‘Fed model’ implicitly acknowledges). Moreover, a central bank decision to maintain low rates effectively discriminates against retirees in need of income; thus, there is an additional, unintended demographic consequence. Overall, current workers and equity investors tend to be favored over retirees and credit investors.

The unintended redistributive impact of Fed (and all central bank rate policy) comes largely without explicit legislative authority outside the Federal Reserve Act. Thus, in our view, the Fed still recognizes that the bar for central bank action in a capitalist economy should be relatively high. Historically, the Fed has generally viewed it as such through its data dependent approach and through its mandate to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”[4] We would also note that “moderate long-term rates” seems to exclude both extremely high rates as well as extremely low rates. With the current condition of policy (as shown by Figure 6), the Fed would appear not to have cause to act just yet. Indeed, it’s our view that the Fed will eventually be compelled to move back to ZIRP (zero interest rate policy) over the course of the next couple of years as yet lower rates are required to maintain even the most meager of growth rates. Because we believe the Fed wishes to maintain precedent as well as its independence, it will remain reactive to the data – at least for June – but the data continues to evolve as we foresaw it in the beginning of the year.


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[1] The 2019 Outlook was published on January 4th, 2019.

[2] To be clear: I do think U.S. economic conditions will warrant a Fed cut in late summer and another in fall. My team and I have been arguing strenuously since mid-year 2019 that global economic conditions were beginning to deteriorate and the U.S. economy would follow late this year.

[3] While true, the lean is clearly much more dovish than just a month ago, and emerging market central banks have already started to move with Russia, for example, cutting for the first time in 2-years.

[4]  Statement on Longer-Run Goals and Monetary Policy Strategy, adopted effective January 24, 2012; as amended effective January 29, 2019.


After All, We Are Not Communists


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If Don Corleone had all the judges and the politicians in New York, then he must share them, or let us others use them. He must let us draw the water from the well. Certainly he can present a bill for such services; after all… we are not Communists.

– Don Barzini, “The Godfather” (1972)

I catch a lot of grief for all of the Godfather references I make, but for men of a certain age it remains the most powerful cinematic if not cultural touchstone we’ve got. It’s also just really good narrative art.

This dinner of the Five Families is the heart of the Godfather story arc. It’s where Vito realizes the scope and power of the plot against him (“It was Barzini all along!”), and where he sets in motion a strategy of revenge and redemption that plays out over a decade through his son, Michael.

Vito Corleone played a mean metagame, the big picture game-of-games that can define a life. Vito was a clever coyote who, unlike most clever coyotes, didn’t allow himself to be blinded by the passion of whatever immediate game was thrust upon him, but was able to excel in the long game. In this case, the really long game.

What drove Vito in his metagame play?

What was his motivation?

“I worked my whole life, I don’t apologize, to take care of my family. And I refused to be a fool dancing on a string held by all of those big shots.”

Same.

I was at a dinner of about 20 Epsilon Theory pack members down in Houston last month. I’ve been doing a couple of these meet-up dinners of late, and I intend to do a lot more over the next 12 months. I got a question at this dinner that I had never been asked before, a question that – like Vito’s dinner with the other Dons – forced me to crystallize my metagame.

Hey, Ben, I think what you’re saying about society and politics and finding your pack is really important, and you say it really well. Why are you wasting your time talking so much about markets and investing? Why aren’t you writing full-time about what’s truly important?

It’s a question that I’ve thought about a ton, but never talked about publicly. So here goes.

My goal in all things, but especially my metagame, is to act non-myopically and in a way that treats others as autonomous ends in themselves. It should be your goal in all things, too. You know the drill … Clear Eyes, Full Hearts, Can’t Lose.

Acting with a full heart means two things: acting for Identity and acting for Cooperation.

Or as Socrates would have said, Know Thyself, and as Jesus would have said, Do Unto Others As You Would Have Them Do Unto You.

See, there’s really nothing new under the sun. Everything we write in Epsilon Theory has been written before – and better – by teachers who lived hundreds or even thousands of years ago. All you’re getting here is old wine in a new bottle. It’s just really, really great wine. And a half-decent bottle with Godfather quotes or farm animal stories on the label. You could do worse.

What’s my Identity?

I am a solver of puzzles and a player of games. This is who I have always been, from my first childhood memories. This is my motivation. This is my intrinsic spark and reward. This is my Aristotelian entelechy, to use a ten-dollar phrase. This is my I AM, to use the Epsilon Theory lingo.

The market is the biggest puzzle there ever was. That’s why I can’t stay away.

So in keeping with my Identity and our metagame at Epsilon Theory, today I want to share with you a puzzle that I think Rusty and I are solving. Not solved, because a) that’s impossible in a three-body problem like the market, and b) it’s still early days in the Narrative Machine research program. But we’ve completed enough testing and research to have convinced ourselves at least that we are onto something cool and important.

This is the market puzzle that we introduced in March with this note:

It’s our effort to apply our narrative research to an actual, honest-to-god practical investment question – can you measure the structure of financial media narratives in a way that gives a useful signal for underweighting or overweighting big market structures like S&P 500 sector ETFs?

At the conclusion of that note, after laying out our research thesis and the way we were operationalizing our tests, I wrote this:

So I’m not going to talk about results until I can do it without telling a story, until I can show you results that speak for themselves. It’s like the difference between qualitatively interpreted narrative maps and algebraic calculations on the underlying data matrix … the difference between what we THINK and what we can MEASURE.

I know, I know … kind of a tease. But today I think we have results that DO speak for themselves, so that’s what I’m going to let them do.

First a recap on our test procedures, although I’m going to keep this really brief because you can read more in “The Epsilon Strategy”.

In addition to measuring the Sentiment of each article within a batch of financial news articles (something everyone does and we think is better thought of as a conditioner of narrative than as a structural component of narrative), we also measure the “weight” of one narrative structure relative to all the other narratives within a universe of media – what we call Attention – and the “center of gravity” of a narrative structure relative to itself over time – what we call Cohesion.

These are massive data matrices that we are evaluating, so the narrative map visualizations that we often publish in Epsilon Theory notes should be thought of as tremendous simplifications (2-D flattenings of many-D matrices) of the measurements we’re taking here. Still, I’ll incorporate some visualizations where I can.

For example, on the left is a 2-D visualization of the Attention score of the Utilities sector in December 2014. Every faint dot (also called a node) in the graph is a financial media article talking about the S&P 500 in some way, shape or form. There are thousands of these nodes, of course, clustered by all the different topics that drove stock market narrative that month. The dark nodes, few and far between, scattered among several different clusters, are the articles that are about the Utilities sector.

On the right is a 2-D visualization of the same data query and the same data sources for January 2015. What’s pretty clear even in this inherently truncated visualization is that the narrative Attention paid to the Utilities sector – the amount of media drum-beating about the Utilities sector – is much higher in January than in December.

We think this is a short signal for February 2015, by the way.

To be clear, we have ZERO insight into the fundamentals of the Utilities sector going into February 2015. We are NOT actually reading any of these media articles, and we really DON’T CARE what everyone’s opinion about the Utilities sector might be. All we know is that the financial media is shouting at investors to focus their attention on the Utilities sector in January 2015 … or at least shouting in a relative sense to how they were talking about Utilities in the prior month … and we believe that all this shouting has an effect on investor behavior. We believe that investors probably plowed into the Utilities sector in January 2015, so we want to be short (or underweight) this overbought sector in February 2015.

We came up with eight testable hypotheses like this, based on states of the narrative-world as measured by Attention, Cohesion, and Sentiment, and we ran a five year backtest on each hypothesized strategy for its signals in overweighting or underweighting S&P 500 sectors on a monthly basis. Importantly, we came up with the hypotheses before we did any backtesting or simulations, and we did zero tweaking or retesting after we did any backtesting or simulations. These sector rotation strategies are deductively derived, based on our professional intuition of investor behavior and our professional knowledge of how the Common Knowledge Game works.

Also importantly, these are slow-twitch strategies, where we take our measurements at the end of each tested month to generate a signal for the following month. All of the financial media articles are publicly available. There’s no massaging of the data or change in the search queries over time. There’s no discretionary input. We are testing on the Select Sector SPDR ETFs, each of which have no appreciable liquidity constraints, and we take into account ETF fees in our performance simulations. We do not take into account trading costs, although we would expect these to be minimal.

Of the eight hypothesized narrative-driven sector rotation strategies, we found that six of them “worked”, meaning that in our backtest simulations they generated excess returns over the S&P 500 and had an information ratio > 0.6 (again, I’m going to let our findings speak for themselves, so if you need a primer on “information ratio” and some of the other terminology here, that’s on you). We then took a simple, non-optimized equal weighting of each of the six working strategies to create an unconstrained “Beta-1” portfolio strategy, meaning that we let the individual strategies do whatever they signaled as far as underweighting or overweighting the individual sectors relative to their baseline S&P 500 sector weights, and then we added whatever vanilla S&P 500 index long or short exposure was required to make a fixed portfolio net exposure of 100% long. So if you’re keeping track of these things, the unconstrained Beta-1 portfolio of strategies averaged about 12 separate sector signals per month, an average gross exposure of around 200%, and is the rough equivalent of a 150/50 strategy. 

Now before I show you the results of the portfolio simulation, I want to say the following really clearly. I’m not saying this as boilerplate, and I’m not saying this in tiny text or in ALL CAPS, both of which are signals for you to stop paying attention. These are simulated, backtested returns. You could not have invested in these strategies. You cannot today invest in these strategies. Even if you did, there is no guarantee your results would reflect those of the backtests I’m going to show you. We have treated all of this as a research puzzle we are trying to solve, and so should you.

We understand that many investors are not allowed to be short anything, even an S&P sector ETF, so we also modeled a constrained long-only portfolio of strategies, where we cap all underweights at zero exposure, creating a 100% gross exposure, 100% net exposure portfolio strategy, with no shorting of any sector ETF. As you would expect, the performance statistics are muted compared to the unconstrained version, but still quite powerful.

Crucially, these excess returns are uncorrelated to all major factor categories – Momentum, Value, Low Vol, and Quality.

So there you have it.

We think we are identifying a novel and predictive signal of investor behavior from our systematic measurement of narrative structure in publicly available financial media.

Now, savvy readers will note that I started this note by talking about metagames and Identity, but cut that discussion short to get into the meat of this investment research puzzle that I think we are solving. Savvy reader will ask themselves if there’s another shoe to drop here. Savvy readers would be right.

What’s my metagame?

Let’s start with this blanket statement: I will do anything for my pack. I’ll be the patsy. I’ll make unreasonable sacrifices. I’ll give away the store if that’s what’s required. But here’s the thing – my pack would never require this of me. At every level of my pack, from nuclear family to the ET epistemic community, we do unto each other as we would have each other do unto us.

To put it in Kipling’s poetic terms about the pack, we drink deeply, but never too deep.

To put it in Dungeons & Dragons terms, we are lawful good but not lawful stupid.

So hell yes, we’re going to charge money for access to and information about our investment research. Second Foundation Partners is a completely independent company. It’s me and Rusty doing a high-wire act with no net. Our research and puzzle-solving is not only an expression of our Identity … it’s also how we preserve our independence so we CAN write about more than markets and investing.   

If you’d like to draw water from this research well, you’ll need an ET Professional subscription. It’s the only place we will be sharing our insights and plans for developing the Narrative Machine for investment applications.

Because after all, we are not Communists.  


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In the Flow – Chef’s Knives


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Two weeks ago, in both the weekly ET Professional email and the ET Live! webcast, I mentioned European Senior Financial Index Credit Default Swaps (CDS) as my favorite way to set up a trade against what we see as a very complacent market narrative regarding US-China trade conflict. In this email I want to dig into that trade a little deeper.

Credit default swaps are like chef knives. They are precision instruments and a necessary tool for so many tasks in the professional kitchen. Sure, they are also sharp as hell and will give you a nasty cut if you don’t know what you’re doing, but the truth in the kitchen and the market is that a sharp knife is actually safer than a dull knife. Even if you don’t cook or trade a portfolio professionally, you’ll want to own a good knife and you’ll want to know the mechanics and the rationale of a CDS trade.

What we’re talking about today is buying protection through CDS. To use the insurance analogy that is typically used in explaining how CDS works, we are buying a “policy” that pays off in full if the referent credit issuance defaults over the term of the swap, typically 5 years.

But hold on, you say. I thought this was a Senior Financial Index CDS. How can an entire index default? Answer: it can’t. This index is composed of 25 individual financial issuers, and if all of them default, then the world has ended and you should be worried about stockpiling ammo and seeds, not managing an investment portfolio. Even if one or two of these individual issuers default, they will be replaced by other issuers and you will never get a full default pay-out. Index CDS is a very different animal than single-name CDS … it’s a synthetic creature with no direct “insurance policy” usefulness.

You are not buying index CDS protection as an actual insurance policy against an actual default. You are buying index CDS protection for the change in value of that aggregated insurance policy as the component values of the component insurance policies change over time. As such, index CDS protection is a trading instrument, pure and simple. It is NOT a buy-and-hold investment or insurance policy or anything of the sort. In fact, the worst thing you can do with an index CDS is buy it, stick it in a drawer somewhere and forget about it, as you might do with an insurance policy.

But if you have an edge on the timing of an event that you believe is systemic … ie, an event that will impact the entire financial system rather than just an idiosyncratic company or sector … then there is no more powerful or asymmetric trade you can put on than with index credit default swaps, precisely because it ONLY reacts to systemic stress. Your counterparties selling you the swap don’t have to worry much about idiosyncratic corporate credit risk, and so the price of the derivative security is typically very cheap, particularly on investment grade or senior debt insurance policies. And because it’s going to be a 5-year contract, there’s a tremendous amount of leverage embedded within the term structure itself … again, if you have an edge on the timing here.

Back in the day, CDS trades were the Wild West. There was no standardization on these contracts, and certainly nothing traded on an exchange. Everything was bespoke, and counterparty risk was a very real worry. Maybe my greatest moment as a PM was novating my CDS away from Lehman, eliminating rehypothecation in the portfolio, and switching my prime brokerage away from Bear Stearns in late 2007 and early 2008. Three big bullets dodged!

Today the CDS world is a lot safer. Starting in 2011, ISDA standardized all CDS trades on two common templates (one for Investment Grade pricing and one for High Yield pricing) and set up a clearinghouse to backstop all member banks’ trades and reduce counterparty risk. Once the clearinghouse was established, it was just a matter of time before the more liquid trades could be moved over to an exchange and eliminate the need for ISDAs altogether, and that’s exactly what happened with the major credit indices. If you can buy and sell commodity contracts on ICE, you can buy and sell index CDS.

Anyone can own a chef’s knife today.

Here’s the core Bloomberg screen (CDSW) for any standardized CDS contract today, with the major pricing elements marked by the yellow boxes, cash settlement marked by the blue box, and P&L marked by the red box:

The top yellow box is what you’re buying – in this case 5 years of protection against default in $10 million worth of the Itraxx European Senior Financial Index. The left-hand yellow box just below is the market price (the “spread”) to take on this contract – in this case 81.5 basis points on the $10 million notional exposure, or $81,500. That right-hand yellow box is the obligation you are agreeing to in this contract – in this case paying 100 basis points per year on a quarterly schedule, so $25,000 to the protection seller every 3 months for the 5-year term.

With a market price of 81.5 basis points, the market is saying that an “insurance premium” of 100 basis points per year is too expensive. In other words, if this contract were not standardized, the market clearing premium would be 81.5 basis points per year. So when this contract is settled, your counterparty pays YOU that difference in premium (18.5 bps) over the course of the remainin term of the contract (4.8 years or thereabouts), plus the accrued premium so far in this quarter. So what you see in the blue box is that you are receiving $104,000 today for the obligation to pay the seller $25,000 at the end of this quarter and every other quarter for which you hold the contract.

Finally, the red box shows you the change in value for this contract for every single basis point that the market price (the spread) moves up or down. So if tomorrow the spread widens from 81.5 bps to 82.5 bps, the value of the contract would increase by $4,742 in your favor. Vice versa if the spread narrows by a basis point.

Since I took this snapshot last week, the spread has widened 8 basis points … call it $38,000 in value … to a market priced spread of 89.5 bps. If I wanted to sell this contract and realize my gains, then, I would pay the new owner of protection $49,000 in principal (10.5 bps x 4.7 yrs) plus $18,500 in accrued premium (the $16,900 accrued when I bought the contract plus $1,600 for the week I’ve held the contract), for a total of $67,500. Since I received $104,000 from the seller I bought the contract from, that’s $36,500 remaining for me.

It’s a weird instrument, right? You have to post some margin to cover your potential P&L losses, but it’s a very small margin requirement if you’re buying protection (significantly more if you’re selling protection) because the asymmetry of how much the spread can narrow versus how much it can widen is so pronounced. I mean, at one point you could buy protection from GS with a 2% margin on notional, so potentially a 50x leverage on a cash account. That would be nuts, of course, but it’s indicative of how easy it is to buy a lot more insurance than you have assets to “insure”.

Here’s the price history of the spread since these contracts were standardized in 2011. I’ve circled in red the last two times we had a sharply strengthening dollar and a sharply weakening yuan, because that’s what I think is highly likely here … not a blowing out of spreads to 300 bps wide like in the full-blown Euro crisis of 2001 and 2012, but a spiking of spreads to 120 – 140 bps wide as systemic concerns of a yuan devaluation and/or a credit freeze around trade finance take hold.

Here’s the first of those red circle periods (Q1 2016), showing how the blue yuan spikes (weakens) before the yellow iTraxx Senior Fin’l CDS spikes.

And here’s the second of those red circle periods (Q4 2018), showing the same thing … and how the yuan has spiked (weakened) again here in May. I think the SnrFin CDS will follow suit. Again.

As always, happy to discuss this instrument and this trade in more detail if you like. I realize this discussion is old hat for some and way in the weeds for others, but I hope you found this primer useful!


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A Song of Ice and Fire


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Every winter, we lose something here on Little River Farm. It’s like a tithe that nature takes, year after year after year. This winter was particularly tough. Polar vortex and all that, I suppose.

None of the bees made it.

Sigh. I’ve lost hives before. It happens. But it’s never easy. Never anything but sad. They work SO HARD at staying alive through a New England winter and they’re all boxed away for months and you can’t open the hive to check on them because that would weaken them for sure and it wouldn’t do any good anyway and so you wait and you worry and you do all you can to set up windbreaks and you don’t know if they’re hanging in there and it finally gets warm enough to crack open the hive and get them some help and … death. Nothing but death.

Always go to the funeral.

We respect our animals in life and in death. Especially in death. So I remove the bee husks and the old comb and I make a small fire and I give them to the flames. Because it doesn’t seem right to put bees into the ground. They are of the air in life, and they should be of the air in death.

And we begin again. Always.

But this isn’t a note about beginning anew after a polar vortex of a winter. Well, it kinda is, so hold that thought in the back of your head. But the narrative structure for this note isn’t about winter and ice and the tithe of death. It’s about winter and ice and the miracle of life.

There were two animals I was certain the winter would take from us, and those are the goldfish that live in the horses’ outdoor water trough. Yes, we put goldfish in the water trough last spring. The horses are careful not to eat them or drink them in, and the goldfish are great at keeping the trough clean. Not industrially clean, of course, but fingernail clean. The way a real, living farm should be.

I figured this was a brick of ice in the dead of winter. I figured there was no way on god’s green earth that two little fish could sit outside in what amounts to a big pail of water through a Connecticut winter. Good lord, we had DAYS and DAYS of sub-zero temperatures this January. And yet … there they were, glints of orange-red swimming around in the trough here in late March.

A miracle? Yes. But not the kind of miracle you’re thinking of. Not the miracle of some sort of cryogenic suspension, where the goldfish are like Captain America, thawed out from a giant block of ice after 40 years, ready to pick right back up fighting supervillains or eating algae or whatever it is one does after resurrection.

No, the miracle here is the non-linear nature of water.

See, we all know that when gases or liquids get colder, they get denser. They get heavier. The molecules in the gas and the liquid are less energetic as they cool off. They bounce around less. They sink. This is why pool water and lake water and ocean water gets colder the deeper you go. It’s a perfectly linear relationship … the colder the water, the heavier the water … the colder the water, the more it sinks.

But when water gets to 4 degrees centigrade, this nicely linear relationship between temperature and density stops happening. In fact, it REVERSES. It’s not only non-linear, it’s non-monotonic (a ten-dollar word that means reversal). As water gets colder than 4 degrees centigrade, it no longer gets heavier. It no longer gets denser. It no longer sinks.

Instead, this miraculous substance called water gets lighter as it nears its freezing point. It’s still a liquid. There are no solid ice crystals forming here that have a different density than liquid water. It’s still exactly the same substance in form and chemistry and everything else at 3 degrees centigrade as it was at 4 degrees centigrade, but somehow it is now lighter than it was before. And so it rises. And it rises still more at 2 degrees centrigrade. And still more at 1 degree centigrade. And so ice does not form at the bottom of a Connecticut pond or lake or water trough, but instead forms at the top of a Connecticut pond or lake or water trough, where it forms an insulating barrier against the cold air reducing the liquid water temperature still further. That’s how the goldfish survived. There was liquid water at the bottom of that deep horse trough, even as the polar vortex raged above.

Without this non-linear, non-monotonic property of water, life as we know it would hardly exist.

Every Ice Age would be every bit as much an extinction event as a giant meteor of death. Every lake or pond above or below a certain latitude would be as lifeless as the moon.

It’s a miracle of life that liquid water – the foundation of life on our planet – gets lighter instead of heavier right before it changes state into solid ice.

There’s no reason why this non-linear property of water should exist.

And yet it does.

If you were predicting the behavior of water from a theory of thermodynamics, there is no way you would predict 3-degrees cold water would be lighter than 4-degrees cold water.

And yet it is.

Facts don’t care about your feelings? Yeah, yeah … cute. Here’s the far more serious truth:

Facts don’t care about your theories.

The only way to learn the non-linear nature of water is through empirical observation, through actually living with water and ice rather than simply theorizing about water and ice. Because once you SEE that very cold water becomes lighter rather than heavier, then you KNOW that there must be something WRONG with your theory of thermodynamics, because this behavior is IMPOSSIBLE within a theory of thermodynamics. There must be something ELSE acting on the behavior of water than thermodynamics, something BIGGER and more FUNDAMENTAL than thermodynamics.

In the case of H2O, it’s the asymmetric positioning of the two hydrogen atoms connected to the single oxygen atom. It’s the atomic structure of the water molecule that creates the miracle of life.  

Same thing with economics.

Because money, like water, is non-linear.

Because you think you can explain and predict human behaviors around money based on a macro theory of monetarism (the supply and price of money), and usually that’s true, but sometimes it’s not.

Because there is a more fundamental theory of money – an atomic structure theory of money based on human risk-taking and human social narratives – that subsumes and improves on your macro theory of monetarism.

Does lowering the price of money from 8% to 7.5% create more risk-taking? Does it increase the velocity of money through the real economy as corporate and household risk-takers are willing to borrow and spend and invest MORE at 7.5% than they were at 8%? Yes.

How about lowering the price of money from 7.5% to 7%? Yes.

7% to 6.5%? to 6%? to 5.5%? to 4%? Yes, yes, yes, and yes.

It’s a nicely linear relationship.

It’s exactly as one would predict from a theory of molecules and thermodynamics monetarism and macroeconomics.

So I understand why central bankers believe that lowering the price of money from 1% to 0.5% would act on risk-taking in the same linear fashion. And from 0.5% to 0%. And in the case of Europe, from 0% to negative interest rates, and from slightly negative interest rates to really negative interest rates. They have a linear theory of monetarism and macroeconomics. Lower interest rates have a specific and direct relationship with risk-taking economic behavior and expectations. The lower the interest rate, the greater the spur to “inflation”, by which central bankers mean risk-taking economic behavior.

Inflation not being spurred? Lower the price of money more.

Inflation still not being spurred? Lower the price of money still more.

Inflation STILL not being spurred? Lower the price of money MOAR.

But it’s not working, people. Lower and lower interest rates are demonstrably not spurring risk-taking economic behavior in the real economy. Lower and lower interest rates are empirically not spurring inflation.

When the price of money gets really cold low, like close to zero degrees percent low, risk-taking behavior changes. The rational risk-taker in a zero interest rate world does NOT invest in property, plant and equipment. The rational risk-taker does NOT borrow more and spend more to invest in the future. No, the rational risk-taker believes the central bankers who say that interest rates will be ultra-low forever and ever amen, that future growth rates are moribund and miserable, that our world persists in a long gray slog of deflation just as far as the eye can see.

What do rational risk-takers do in a zero interest rate world? They buy back stock. They buy profitless revenue. They engage in financialization.

They minimize risk and maximize return. They are greedy AND they are fearful. They demonstrate the atomic behavior of rational greedy/fearful human beings since the dawn of freakin’ time.

THIS is water.

This is profit margin without labor productivity growth.

This is the zombiefication and the oligarchification of the US economy.

This is the smiley-face perversion of Smith’s invisible hand and Schumpeter’s creative destruction.

This is the profoundly repressive political equilibrium of an entrenched State and entrenched Oligarchy that masks itself in the common knowledge of “Yay, capitalism!” and “Yay, military!” and “Yay, college!“.

That’s a thick layer of ice above us, growing thicker by the day. But we are still the goldfish on Little River Farm, still swimming in a small pocket of water, not yet encased in a solid block of ice. We aren’t yet the bees. Not yet. What must we DO to avoid the bees’ fate? What must we DO to end this winter that is imposed on us?

We have to Break the Wheel.

We have to break the tyranny of ideas that nudge us into service to the entrenched State and the entrenched Oligarchy, without replacing those ideas with a tyranny of our own.

How do we do THAT?

Well … I know it’s all the rage to rip the Benioff/Weiss screenplay in the post-George RR Martin seasons. I’m pretty bummed myself. But this line by Tyrion in the finale shows the way.

What unites a people? Armies? Gold? Flags?

Stories.

There’s nothing more powerful in the world than a good story. Nothing can stop it. No enemy can defeat it.

How do we Break the Wheel?

Not by revolution. Not by dragon fire. It didn’t work for Daenarys, and it won’t work for us.

We break the wheel with a better story, with a better theory.

Because that’s what a theory is … a story about how the world works.

By the way, this is how science works. By the way, it’s always science that breaks the wheel.

The story of the Masters is that the market is a macro clockwork machine, governed by linear, mechanistic “laws”. I have a better story.

I tell you that the market is a BONFIRE.

From We’re Doing It Wrong:

Fire is not magic. Fire is not somehow separate from science or rigorous human examination. We know how to start fires. We know how to grow and diminish fires. We know how to put fires out. In a technical sense, Ray Dalio, you can classify fire as a machine.

But you’d never think that you could possess an algorithm that predicts the shape and form of a bonfire.

You’d never think that if only you stared at the fire long enough, and god knows humans have been staring at fires for tens of thousands of years, that somehow you’d divine some formula for predicting the shape of this or that lick of flame or the timing of this or that log collapsing in a burst of sparks.

No human can algorithmically PREDICT how a fire will burn. Neither can a computer. No matter how much computing power you throw at a bonfire, a general closed-end solution for a macro system like this simply does not exist.

But a really powerful computer can CALCULATE how a fire will burn. A really powerful computer can SIMULATE how a fire will burn. Not by looking for historical patterns in fire. Not by running econometric regressions. Not by figuring out the “secret formula” that “explains” a macro phenomenon like a bonfire. That’s the human way of seeing the world, and if you use your computing power to do more of that, you are wasting your time and your money. No, a really powerful computer can perceive the world differently. It can “see” every tiny piece of wood and every tiny volume of oxygen and every tiny erg of energy. It “knows” the rules for how wood and oxygen and heat interact. Most importantly – and most differently from humans – this really powerful computer can “see” all of these tiny pieces and “know” all of these tiny interactions at the same time. It can take a snapshot of ALL of this at time T and calculate what ALL of this looks like at time T+1, and then do that calculation again to figure out what ALL of this looks like at time T+2.

This is an atomic theory of markets. This is the intuition and the technology roadmap to provide a better theory. It’s not that macroeconomics and monetarism are wrong … there’s no such thing as right or wrong when it comes to theory. It’s that macroeconomics and monetarism are not as USEFUL a theory as one formed organically from the risk-taking economic behaviors of actual economic actors.

Look, central bank cultists will never change their beliefs that they are the thin blue line between order and chaos, or that academic economics is the One True Path for enlightenment and the maintenance of that thin blue line. Change isn’t going to come from attacking the Fed or from a snarky blogger. I mean, I did just call them cultists.

No, no …  change will come from a Fed economist reading this note (on her gmail account, of course) and dropping the assumption – because it IS an assumption – that, for all prices of money, there is a monotonic relationship between change in the price of money and change in the velocity of money employed for productive economic purposes. Change will come from this economist allowing for the possibility of a non-linear and non-monotonic relationship between interest rates and inflationary behaviors at very low interest rates, loosening her stochastic assumptions accordingly, and then TESTING this possibility against the actual empirical evidence of the past ten years. Change will come from this economist presenting her findings from within the proper academic forms as an extension and progression of what came before, so that the institutional imperative to self-servingly mansplain our place in the world (you’re welcome!) can be maintained.

Daenarys and her city-destroying dragons couldn’t break the wheel. Moana and her Maui-tolerating wayfinding could.

In a thousand small steps … this is how theory changes. This is how science advances. This is how progress is made. This is how the story that we tell ourselves about who we are evolves into something that subverts institutions from within, not something that attacks institutions from without.

As below, so above.

To be honest, it’s a longshot that we’ll be able to pull this off. After all, we’re not characters in a Disney movie. Or even an HBO show.

One of my favorite authors, Kurt Vonnegut, wrote a lot about theory and non-linear systems and humanity’s place in all that. You wouldn’t know it from a cursory read, because he could spin a yarn, but that’s what most of his books are about. Cat’s Cradle is the novel most obviously connected to my particular theme, as the plot is driven by the invention of a substance called ice-nine, an isotope of water that freezes at room temperature and replicates itself in any ordinary water it touches, thus spreading ice throughout all the liquid water in the world. You know, kinda like negative interest rates.

Along the way to the end of the world, there’s a nihilist religion called Bokononism to explore, with this wonderful quote:

The Fourteenth Book is entitled, “What can a Thoughtful Man Hope for Mankind on Earth, Given the Experience of the Past Million Years?”

It doesn’t take long to read The Fourteenth Book. It consists of one word and a period.

This is it: “Nothing.”

Vonnegut would probably say we don’t stand a chance against the Nudging State and the Nudging Oligarchy, armed to the teeth with narrative-controlling instruments that promote their Wheel-preserving ideas, convincing us to sign away our autonomy of mind.

Like how the narrative of Yay, capitalism! subverts our liberty (and responsibility) to Make.

Like how the narrative of Yay, military! subverts our liberty (and responsibility) to Protect.

Like how the narrative of Yay, college! subverts our liberty (and responsibility) to Teach.

Yeah, he’s probably right.

But then again, Kurt, why did you write?

It’s why I write, too.

I’m publishing this note on Memorial Day for a reason. You get it. I know you do.

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.

The Pack remembers.

Yours in service to the pack, – Ben


PDF Download (Paid Subscription Required):  A Song of Ice and Fire


In the Flow – You Are Here, May 2019


PDF Download (Paid Subscription Required):  In the Flow – You Are Here, May 2019


We updated our five narrative Monitors last week with financial media tracking through April 30, so I wanted to focus today on our findings from that update, particularly as it relates to the recent re-escalation of trade tensions. The data can be accessed as a PDF file here, a Powerpoint file here and as an Excel file here.

For each of the five Monitors I’ve highlighted the finding that I think is most interesting. Put it all together and here’s the skinny – there’s a tremendous amount of narrative complacency out there, particularly on Trade and Tariffs, which means this market has a long way down if the narrative focuses on negotiation failure. It’s not focusing there yet, but that’s what you want to watch for. We’ll keep watching for any changes of that sort in narrative-world, and in market-world you should keep your eye on USDCNY and iTraxx European senior financial CDS spreads. A quick move over 7.0 in the former or 100 bps wide in the latter is a sign that China is considering a currency float/devaluation. That’s how China will declare these negotiations have failed.


Inflation

  • Inflation language remains at a low-to-moderate level, but outside of central bank policy discussions and discussions of health care and education (esp. student loans), attention – its influence on broader narratives – is limited.
  • Consistent with prior updates – and despite our belief in the long-term shift in Zeitgeist toward inflation – we do not think there is a coherent short-term inflation narrative at this time.
  • Inflation discussions persist with somewhat higher intensity than usual in the usual pockets in emerging markets. Latin America and Middle East have become more central to EM inflationary narratives.
  • We found it noteworthy in April that the language used in media to describe US inflation and central banking is most similar to language used to describe BOJ (relative to BOE/ECB/EM banks).

Central Bank Omnipotence

  • Our measures of both attention and cohesion of central bank omnipotence narratives flagged slightly in April.
  • We think this is generally the result of (1) increasing separation in policy imperatives within the narratives surrounding the major central banks and (2) the brief emergence of a new (and separate) view on a potential rate cut in the US.
  • Regardless, we continue to think that Central Bank Omnipotence is the primary governing narrative of risky asset markets in the US – with Trade and Tariffs emerging from complacency much more recently.
  • We also note the recent emergence of a central cluster relating to inequality, ‘failures of capitalism’, student loan debt and other issues making the rounds in US election politics. These are surprisingly well connected across articles in the CBO dataset. We think shifting political pressures on central bank narratives are worthy of long-term monitoring.

Trade and Tariffs

  • For much of April, cohesion continued to drift downward, as trade and tariffs discussions splintered further into distinct Europe, North America, China and now US/Japan trade clusters.
  • Meanwhile, sentiment remained noticeably more positive than in the recent past, leading us to believe that the narrative structure is still highly complacent.
  • In early May, a couple well-placed tweets from President Trump very briefly showed some measure of the volatility-inducing potential of negative surprises on this complacent narrative structure.
  • We suspect that focus will return to China/US trade discussions in May, and we would not be surprised to see sentiment retreat somewhat.
  • Will the complacency about a positive outcome stick around? We think it will be heavily influenced by whether the additional tariff threat is a true negative surprise or a manufactured “wall of worry.” We lean toward the latter, but that is opinion and not something we necessarily see in the narrative data.

US Fiscal Policy

  • Rising sentiment and cratering cohesion in US Fiscal Policy narratives appear to be the result of electoral politics: wide-ranging, optimistic plans in popular areas (e.g. student loan debt retirement, medicare-for-all, infrastructure)
  • There is, however, no central governing narrative, and financial market attention on fiscal policy narratives remains below historical levels. We don’t think it’s an overstatement to say that financial markets simply do not care about US fiscal policy at this time.
  • Of interest: as covered elsewhere on Epsilon Theory, language used in articles about student loan debt continues to be among the most well-connected in the US Fiscal Policy dataset.
  • While you may note a cluster of articles focused on the ‘US Federal Debt Crisis’ topic, we note that most refer to it as a non-existent crisis. It includes many pro-MMT style opinion and analysis pieces.

Credit Cycle

  • We are now comfortable characterizing the credit market narrative structure as complacent.
  • There is very little overall structure to any one narrative about risks to credit markets, defaults or liquidity, and general coverage continues to be quite positive in sentiment about lending.
  • In addition, each of the notable credit events large enough to merit a cluster of articles is visibly separate from the core of financial journalism.
  • In other words, the only people talking about Canadian Banks, China Debt Traps in the Philippines, or HNA’s CWT International are people talking about those specific issues; they are NOT being pulled into broader discussions of fixed income and credit markets.
  • As noted elsewhere, the student debt market continues to be central to most coverage of credit markets.

PDF Download (Paid Subscription Required):  In the Flow – You Are Here, May 2019


Wage Growth, Groucho Marx Edition


This is an ET Professional note, and for the next few days we’re making it available to everyone to review.

Every week, ET Pro subscribers get something like this – an original piece of research and analysis with a perspective that you can’t find anywhere else.

Every month, ET Pro subscribers get updated narrative data and analysis on five core market risk monitors – Inflation, Central Bank Omnipotence, Trade & Tariffs, US Fiscal Policy, and Credit Cycle.

We’ve had what I think are some important breakthroughs on how to apply natural language processing (NLP) to investment research, and we think it’s something that every portfolio allocation, wealth management and active investment team can find useful, particularly for risk management.

ET Pro is the only place we provide direct access to our research.

The ET Pro service is $2,950/yr, with a 30-day full refund trial period, and we’re happy to work through a soft dollar provider. Any remaining time on an ET Premium subscription will be applied as an upgrade. We’ve designed ET Pro to be used by investment teams, allowing up to three simultaneous log-ins with the same credentials, and of course we’re happy to discuss more specific research applications and how you might incorporate them into your current investment or allocation processes.

You can see the ET Pro homepage here, and you can find more information on an ET Pro subscription here. Questions? Email us at info@epsilontheory.com.


Wage Growth, Groucho Marx Edition

The Secret of life is honesty and fair dealing. If you can fake that you’ve got it made.

These are my principles, and if you don’t like them … well, I’ve got others.

I’m not crazy about reality, but it’s still the only place to get a decent meal.

A child of five could understand this. Send me someone to fetch a child of five.

Last March, I wrote a long note on the cartoon that labor statistics present, called The Icarus Moment. To set the scene:

Once you start looking for these cartoons, you will see them EVERYWHERE.

It’s not a Karl Marx world of alienation. It’s a Groucho Marx world of alienation.

The cartoon of our monthly theater regarding labor statistics, particularly wage growth, rests in the fact that they are reported as hourly wages. Even though the majority of wages in 2019 America are paid biweekly against an annual salary, the Bureau of Labor Statistics (BLS) reports ALL of our wages as if they were paid hourly. Why? Because in 1915 America, when the theater of labor statistics began, this was how most people got paid. Even today, the abstracted idea of hourly wages connects with people more effectively than the abstracted idea of weekly wages. Put that together with bureaucratic inertia, and that’s why this cartoon exists.

But here’s the problem with the hourly wage abstraction. It requires introducing a new data estimation into the mix, one that has nothing (or at least very little) to do with the real-world concept we’re trying to represent, which is whether you’re taking home more money today than you did this time last year. That additional layer of abstraction is the average length of the work week.

The root data collected by the BLS consists of the weekly wages paid by US businesses to their employees. That number is then divided by the total number of people being paid, and the result is the average weekly wage for Americans. Here is that abstracted data for the past 7+ years.

source: Bureau of Labor Statistics

But instead of reporting the annual percentage change on a month-to-month basis, the BLS also calculates the “average work week” so that they can maintain the cartoon of hourly rather than weekly wage reporting. Here is that abstracted data.

source: Bureau of Labor Statistics

For the past 7+ years, the average work week has averaged 34.45 hours, with a range from 34.3 hours to 34.6 hours. That’s 2,067 minutes, ranging from 2,058 minutes to 2,076 minutes. Here’s a graph of that.

source: Bureau of Labor Statistics, Epsilon Theory

This is not a variable. This is a constant.

From a statistical perspective, given the inherent errors of measurement, any month-to-month difference of 6 minutes here or 6 minutes there is a totally random event.

Measured changes in the average work week are not real.

And yet they have very real effects on the narrative.

Here’s the year-over-year wage growth data from the singly-abstracted measure of weekly wages:

source: Bureau of Labor Statistics

These are the “true” results, or at least the most basic abstraction of what we’re after.

And now here’s the year-over-year wage growth data from the doubly-abstracted measure of hourly wages:

source: Bureau of Labor Statistics

These are the results that are reported to us and create the political and investment narrative.

And now here’s the difference in the two data series, with weekly wage increases subtracted from hourly wage increases. The numbers here are how much the reported wage growth result overstates or understates the actual wage growth result.

source: Bureau of Labor Statistics, Epsilon Theory

In 2016, reported wage growth massively overstated actual wage growth. Wage stagnation going into the 2016 election was actually much worse than you were told. Did this make a difference in the Midwestern states that swung the election, in that actual labor conditions were worse than everyone thought they were? I think yes.

In 2018, reported wage growth massively understated actual wage growth. Wage growth all last year was actually much better than you were told. Did this make a difference in the current Fed/Wall Street/White House narrative that inflation is dead and the easy money punchbowl can be maintained without consequence? I think yes.

What does all this mean for our investments? Here’s the money quote from The Icarus Moment:

Honestly, I still don’t have a good answer to this question.

Do I invest on the basis of what I can see happening in real-world or do I invest on the basis of what I can see happening in narrative-world?

Ultimately, I STILL think that real-world wins out.

But the path for that … the timing of that … it’s utterly narrative dependent.

Groucho would understand.