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


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This Is Why We Can’t Have Nice Things

Here’s the most powerful animal on our farm — a deer tick, well embedded, gorging itself on human blood.

Of course, it’s not the tick itself that is so powerful, but the Lyme disease it can transmit, caused by a spirochete bacterium named Borrellia burgdorferi, pictured below. As you probably know, Lyme is a terrible disease, difficult to diagnose and difficult to treat once established. Once transferred via tick saliva, the wormlike burgdorferi bacteria quickly spread throughout the human host, particularly into joints, the heart and the brain. From there, the bacteria cause symptoms including intense arthritic pain, palsy and paralysis, loss of memory and extreme fatigue. Our immune systems typically fail to create the necessary antibodies to fight the infection, due to both the antibody-suppressing qualities of tick saliva and the antibody-hiding qualities of burgdorferi. And in a process still not entirely clear but suspected to be connected to an autoimmune failure spurred by burgdorferi, these crippling symptoms can persist for years, even after all of the bacteria have been killed through aggressive therapy. This is a potent parasite, and if you’ve lived for any length of time in Connecticut, you surely know at least one family that has been hit hard by a tick-borne disease.

But Lyme disease isn’t the reason that the deer tick is the most powerful animal on our farm.

No, it’s not Lyme disease. It’s Lyme disease!.

Huh?

Lyme disease is a physiological ailment caused by bacteria and injected into your body by ticks.

Lyme disease! is a mental ailment caused by words and injected into your mind by humans.

Lyme disease! is the IDEA of Lyme disease. It’s the mental construction of a world where Lyme disease and the bloodthirsty deer ticks and the grotesque burgdorferi bacteria are EVERYWHERE, an omnipresent threat to you and your children. Lyme disease! is an infectious meme, in the true and powerful meaning of the word, not the ha-ha cartoonized meaning that we see every day on social media. Memes are self-sustaining ideas that live in the human brain. They are as alive as any bacteria or virus, and they infect every aspect of our social lives.

What do I mean? I mean that families infected with the meme of Lyme disease! don’t allow their children to hike or play in our woods. I mean that the meme-infected next door neighbors have spent hundreds of thousands of dollars to wall off — literally wall off, including river barriers — their 20+ acres from all animal life that can’t fly. I mean that we have been sued — literally sued — by meme-infected parents who thought their child might have “caught rabies” (not Lyme, but close enough) from petting our dog some hours after the dog found a dead raccoon. No, I’m not making this up. And just wait. I can promise you that I’ll get “well, actually” emails from meme-infected readers of this note.

What we have in the wilds of Fairfield County, Connecticut (and I suspect in every exurb in the country), is a large population of wealthy people who for a variety of reasons want to live closer to nature, but are scared to death of nature! … the memes that infect our brains about the risky parts of nature, memes like Lyme disease! or rabies! or coyotes!. It’s not that these aren’t actual dangers. Lyme disease is a real thing and a real risk. So is rabies. So are coyotes. But our social lives aren’t governed by the actual risks of the real-life things. They’re governed by the memes. They’re governed by the metagames.

I wrote about this from the perspective of the real-life thing in Too Clever By Half, where I described why the coyotes in our woods always lose the metagame. They win every direct interaction with us tame humans because they’re smarter and braver than we are. But they lose in the larger metagame because the townfolk have access to armed animal control officers who are required — begrudgingly and remorsefully — to kill the real-life coyotes when the coyote! meme infects enough civilians. The lesson for all coyotes, four-legged and two-legged alike, is pretty simple. Don’t trigger the townfolk. Yes, you’re smarter and braver than they are. You can win the immediate game. But you will always lose the metagame if you’re too visible in your “winning”. Always.

There’s a larger perspective here, too, and a larger lesson. It’s the perspective of all of us. The meme-infected. Like me. Like you.

In my eight years on the farm, where I spend a lot of time clearing brush and cavorting around tick-rich environments, I’ve been treated for Lyme disease twice. Both times I had an attached tick, so I pulled it off and went to the doctor. Both times the doctor didn’t even bother testing me for Lyme, but just started me on antibiotics, because you can knock Lyme out if you treat it early enough. Maybe I had Lyme and maybe I didn’t. We’ll never know.

In the immortal words of Remo Gaggi when he and his fellow mob bosses of Casino decided to whack a loyal lieutenant who had the misfortune to have a slight opportunity to rat them out, “Why take a chance?”

Look, I get it. There is zero upside for the doctor to make a measured calculation of the actual risk of Lyme disease. There’s zero upside because the doctor knows that as bad and prevalent as Lyme disease might be, Lyme disease! is even worse and more prevalent. THAT’S the disease that the doctor was treating when she prescribed the antibiotics — Lyme disease!, not Lyme disease. Because she knew that even if the correct and rational treatment for Lyme disease was to do nothing or carry out some more tests, the absolutely correct and rational treatment for Lyme disease! was an immediate course of broad-spectrum antibiotics. It’s a no-brainer. There’s no doctor in the world who can stay in business for long if she doesn’t recognize the memes that infect her patients, who doesn’t nod understandingly and overprescribe when a mother wrings her hands over her child’s “exposure” to this dread disease! or that dread disease!, regardless of the disease truth. This is the metagame of modern health care.

Ditto with financial advisors.

You’re not going to stay in business for long if you don’t recognize the memes that infect your clients, memes like the fundamentals are sound! and we’re cautiously optimistic! and stocks for the long haul! and value! and bet on America!, all of which are most effectively treated with a profound over-allocation to U.S. equities under any and all circumstances. It’s not that these aren’t true and real things. They are absolutely true and real, just like Lyme disease is absolutely a true and real thing. But the true and real thing isn’t what drives our behavior. It’s the meme! that does that. There is zero upside for a financial advisor to make a measured calculation of the actual portfolio risk of a client’s under-exposure to U.S. large-cap stocks, because the actual portfolio risk isn’t the driving risk! that the client is infected with. So all financial advisors overprescribe U.S. large-cap stocks for their clients. We all know it’s true. We don’t like it, just like no doctor likes overprescribing antibiotics, but we do it anyway.

As Hyman Roth said to Michael Corleone, this is the business we have chosen. This is the metagame of modern investment management.

But like I say, it’s bigger than that.

Five years ago, I started Epsilon Theory to talk about capital markets, and it will always be a core part of what makes me tick and what I choose to write about. But as important as it is to recognize and call out the memes that infect our markets, it’s even more important to recognize and call out the memes that infect our politics. And the human ticks who spread them. That effort starts today.

A preliminary observation before we get to the stuff that will annoy a lot of readers … everyone I’ve ever known, including me, comes at the question of memes and their influence on our decision-making from a very simple starting point — yes, they’re effective on other people, but not on me. I am smart enough and independent enough to be effectively immune from a meme infection.

No, you’re not.

If you get nothing else from Epsilon Theory, get this: we are ALL hard-wired — literally hard-wired through millions of years of neurological evolution — to respond positively to effective meme introduction. We are ALL programmed — literally programmed through tens of thousands of years of cultural evolution — to respond positively to effective meme introduction. It’s no exaggeration to say that our biological and cultural symbiosis with memes defines the modern human species. This is a feature, not a bug.

Eusocial animals (the “pure” form of what it means to be a social animal) swim in an ocean of constant intra-species communications. It’s why these species — the ant, the termite, the bee, and the human — are the most successful multicellular animal species on the planet. Eusocial animals have the ability to store, retrieve and broadcast information (yes, eusocial insects communally “remember” incredibly complex informational structures) in a way that non-eusocial animals simply can’t, and it allows the eusocial animal not only to survive its environment, but to master its environment. Any environment. Humans are essentially giant termites with opposable thumbs and fire, and that combination is particularly unstoppable. But it’s the termite-ness … it’s the swimming in an ocean of constant intra-species communication … that’s the most important of these qualities.

The downside, of course, is that we can no more resist the language of Hero! and Wizard! and Enemy! than an ant can resist the pheromones of its queen. These are the Old Stories and the New Stories alike. Memes are our greatest strength as a species. And our greatest weakness as individuals.

Memes are the stuff that Narratives are made of.

Fortunately, the human animal is a self-aware animal. For the most part. Kinda sorta. At least we have the ability to perceive our infection. Through a glass darkly, as the Old Stories would put it.

Self-awareness doesn’t mean some magical immunity to being influenced and played by the other players. On the contrary, if you think that you are immune to all this, well that’s prima facie evidence that you are not self-aware at all. That’s prima facie evidence that you are, in fact, the sucker in this big poker game of citizenship. No, self-awareness means a recognition that you ARE being influenced and played by the other players, so that you can use that knowledge of HOW you are being influenced and played to maintain YOUR personal liberty of mind and play YOUR best game.

We can’t change our nature as meme-susceptible human animals, but we can absolutely become better human animals, both instrumentally as game players and ultimately as citizens. We can absolutely NOT be suckers. We can absolutely NOT lose our liberty of mind — which is the only liberty that really matters — to the incessant meme-generation of the Nudging State and the Nudging Oligarchy.

So how do we avoid being the sucker within this largely invisible poker game of memes and narratives that we are immersed in from birth, a poker game that we are biologically and culturally evolved to play rather poorly?

First and most importantly, we can simply recognize that there is a logic and a process to meme introduction and contagion in the human animal. Here in Epsilon Theory I like to focus on one powerful contagion vector — the Common Knowledge Game — but there are many others. Like all of the invisible forces that drive our lives, once you start looking for embedded memes and the logic that drives them, you will see them EVERYWHERE.

Second, we can use the new tools of AI and Natural Language Processing (NLP) to visualize the meme introduction and contagion process. This is what I’ve called the Narrative Machine, and it’s as useful for understanding the behavioral drivers of politics as it is for understanding the behavioral drivers of markets. Why is visualization so important? Because it taps directly into the way our brains are hard-wired. Seeing is, in fact, believing, and by showing you visual evidence of political meme introduction and contagion, you will be far more likely to accept the worth of my broader argument. It’s why data visualization is such an important topic, and it’s why Ed Tufte is a personal hero of mine. [Optical Illusion / Optical Truth]

More generally, NLP can help visualize what I described as the “cartoonification” of political candidates and political issues. From The Icarus Moment:

Cartoons aren’t just created to mobilize positive sentiment and supportive social behaviors (although that’s pretty much all we see in capital markets, because it’s a positive-sum game, not zero-sum like politics). The negative cartoonification of Hillary Clinton was both the most vicious and the most effective gambit in the last 100 years of American politics. To be sure, The Clintons™ brought soooo much of this on themselves. If there’s ever been a political candidate more ripe to be transformed into a negative cartoon than Hillary Clinton, I am unaware of who that might be. But where Donald Trump embraces and actively creates his obvious cartoonishness, Hillary Clinton had her cartoon imposed on her unwillingly, to disastrous result. Today’s key to political and economic success is controlling your own cartoon. Yes, this is why Trump won.

So what does the Narrative Machine show us about meme construction and contagion in the last U.S. presidential election campaign?

Here’s an NLP analysis of 124,000 articles on Hillary Clinton published in non-paywalled top-tier U.S. media over the year prior to the presidential election — where linguistic similarities create clusters of articles with similar meaning, essentially a linguistic “gravity model” (for methodology background on all this, see The Narrative Machine).

Source: Quid, Inc. For illustrative purposes only. Past performance is no guarantee of future results. Quid, Inc. is not an affiliate of Salient. Software used under license.

It’s a dense narrative map because of the quantity of articles, but we can simplify the analysis by re-coloring the clusters by sentiment, and then isolating the negative attack memes.

Here’s the sentiment map. 20% of the articles are negative, including lots of negative articles in non-attack memes like Primaries! and Supreme Court!, 45% are neutral, and 34% are positive. Hold that thought.

Source: Quid, Inc. For illustrative purposes only. Past performance is no guarantee of future results. Quid, Inc. is not an affiliate of Salient. Software used under license.

And here’s the re-spun narrative map after isolating the negative attack memes:

Source: Quid, Inc. For illustrative purposes only. Past performance is no guarantee of future results. Quid, Inc. is not an affiliate of Salient. Software used under license.

Beyond the frequency of articles associated with this or that meme (Emails! clearly dominating on that dimension, with 42% of all negative meme articles published), there are three critical dimensions in an interpretation of a narrative network: geometry, time dynamics, and affect. The map above gives us our geometry, and I’ve found a scatterplot (below) to be the best visual representation of time dynamics and affect. Between the two graphs a fascinating meme contagion pattern emerges.

Source: Quid, Inc. For illustrative purposes only. Past performance is no guarantee of future results. Quid, Inc. is not an affiliate of Salient. Software used under license.

First, geometry. There’s no real information in the north/east/south/west orientation of a narrative map, but there is significant information in distance, center/periphery orientation, and inter-cluster links, all of which can be understood with a simple gravity metaphor. The greater the distance between meme clusters, the less similarity in vocabulary and grammar employed in the individual articles that comprise the clusters (less gravitational attraction between the clusters). The more central the meme cluster to the overall network, the more coherence it provides to the overall narrative (a gravitational pull exerted in all directions). The more inter-cluster links (the long strands that connect one cluster to another), the more articles that explicitly have one foot in each camp, visualizing the gravitational tethers.

What we have in the Hillary meme network is a clear outlier in the Benghazi! cluster, as well as a clear super-cluster comprised of Wall Street!, Clinton Foundation! and Emails!, with Wall Street! and Clinton Foundation! being more central to the overall Hillary cartoon-ification, despite the far greater frequency of Emails! articles. The way to think about the peripheral nature of Benghazi! and Emails!, I think, is that these memes didn’t “take” in the same immediate and easy way that Wall Street! and Clinton Foundation! “took”. To use the deer tick metaphor, whatever ticks were trying to inject the Benghazi! meme never really got fully embedded in the body politic, while the Wall Street! and Clinton Foundation! ticks gorged easily to their little tick-hearts’ content. What’s really interesting, though, is the Emails! meme. Whatever the Emails! delivery ticks lacked in embeddedness, they more than made up for it in effort.

That’s my takeaway from the scatterplot representation of time dynamics and affect, where the green dots (sub-clusters of Emails! articles) are high in affect (the x-axis, representing the strength of “emotion” in article word choice, mostly negative, but some positive, too) and almost constant in duration (the y-axis, representing time). That second phenomenon — the degree to which there was an almost constant drumbeat of Emails! articles over the course of the campaign — is particularly rare and unusual.

Here’s what a typical meme infection looks like, as shown in a histogram for Clinton Foundation!. The meme percolates in the background for a while, explodes in an outbreak of virulence and Sunday talk show segments, and then dies back down again just as quickly.

Source: Quid, Inc. For illustrative purposes only. Past performance is no guarantee of future results. Quid, Inc. is not an affiliate of Salient. Software used under license.

Source: Quid, Inc. For illustrative purposes only. Past performance is no guarantee of future results. Quid, Inc. is not an affiliate of Salient. Software used under license.

Emails!, on the other hand, had multiple outbreaks and never died down. Sure, it got crowded out by other memes here and there, as the sum-to-100% histogram above shows, but I can’t tell you how unusual it is that a meme like Emails! persisted in such a virulent form for an entire year.

In the overall narrative network, not just the negative meme creation stuff, but the entire universe of media coverage, 6% of EVERYTHING written about Hillary Clinton for a YEAR was about Emails!.

This is nuts. It’s not an accident.

And please, I’m begging you, don’t send me a “Well, actually” note yelling at me about how Hillary Clinton’s handling of her email servers was a ridiculous, mendacious and probably illegal thing, that it was, in fact, a big deal.

I AGREE.

The Emails issue was a real and true thing, just like Lyme Disease is a real and true thing.

But you are the sucker at the poker table if you don’t recognize the incommensurability between the real and true Emails issue and the Emails! meme, if you don’t recognize how YOUR political behavior and YOUR liberty of mind was impacted by Emails! in a way that Emails could never achieve.

Mine certainly was. I was so righteously aggrieved by Emails!, thinking all along it was Emails. Emails! angered me for months. It made a difference to me. And then I did this analysis and saw how the meme was constructed and promoted. I saw how I had been played. If I knew then what I know now, would it have made a difference in my NeverTrump + NeverHillary position? No. But I’m not going to let it happen again. I’m going to do everything I can to protect my liberty of mind.

And in the spirit of in-for-a-penny-in-for-a-pound, here’s another sure-fire aggravating observation on the meme construction process around the most recent U.S. presidential election, this time from the Trump narrative map.

Source: Quid, Inc. For illustrative purposes only. Past performance is no guarantee of future results. Quid, Inc. is not an affiliate of Salient. Software used under license.

Above are all the different meme clusters associated with Trump for the year prior to the election, all from top-tier U.S. media, colored by sentiment. Lots of incendiary memes in there, right? But here’s the thing. First, the overall narrative network is comprised of 167,000 articles, about 35% more coverage than Clinton received. Second, of that coverage, only 15% of the articles are negative, with 50% neutral and 34% positive. Third, of the negative memes, none had a persistence pattern like Emails!. They all spiked and faded like Clinton Foundation!.

Trump got significantly more coverage than Clinton in major media outlets.

Trump got significantly more positive coverage than Clinton in major media outlets.

Trump suffered from no infectious meme like Clinton suffered from Emails! in major media outlets.

I’m not saying whether all this is good or bad. I’m just saying that it IS. And what it isn’t.

This isn’t a Russia thing.

This isn’t a Facebook thing.

This is a mainstream media thing. A mainstream media thing comprised of people who, for the most part, would rather rip out one of their own fingernails with red-hot pincers than help Trump, but who, driven by the systemic pressures of their business and its utter reliance on Fiat News, did just that.

So what do we do about this?

Well … nothing. Or at least nothing to “fix” mainstream media directly. I say that because I don’t think it CAN be fixed, just like I don’t think mainstream political parties CAN be fixed. They can’t be fixed because both of these social institutions — media and political parties — are not broken from an  internal perspective of institutional profits and personal agency. On the contrary, they’re thriving.

Media and political parties are institutionalized ticks, and the tick business has never been better.

Look again at that Trump narrative map. Look at all the obvious negative attack memes — SNL, Late Night TV, Meryl Streep, JK Rowling, KKK, Megyn Kelly, Russia, Funny or Die, Judge Gonzalo — they’re not red! I mean, there’s some red in there, particularly for Megyn Kelly because it linked into the highly negative (and politically effective) Sexism meme, but for the most part the sentiment of the articles themselves is neutral to positive, even though they’re part of an obviously negative meme. How can this be? Sure, Fox and its ilk are going to be neutral to positive on all this, but they’re a small fraction of the universe here. Why is the “Failing New York Times” using neutral language to talk about Trump and the Ku Klux Klan? Why would they use language like “Trump’s ‘very fine people’ remark was taken by many as an endorsement of the KKK and other white supremacist groups”? There’s nothing inherently negative in those words. Why aren’t they hitting Trump harder?

Because metagame. Because the long-term evolutionary stable strategy for a tick species is not to maximize blood-sucking and egg-laying, but to balance resource gathering and reproductive success against the minimal requirements to keep the host species alive.

There’s that word. Balance. Like in “balanced” media coverage that of course is not balanced at all, but observes the forms of the free and fair press! meme that thoroughly infects all of us, not least the media participants themselves. Like in the balance of an equilibrium.

The current state of intense political fragmentation and conflict is a very stable evolutionary equilibrium for all of these professional meme-generation entities. Ratings are up. Subscribers are up. Engagement and participation are up. The host species is showing signs of exhaustion and stress, but nothing potentially fatal. If Trump did not exist, professional meme-generation entities would have to invent him.

So they did.

And once the miracle of Trump does exist, professional meme-generation entities must be careful not to kill him.

So they won’t.

Successful ticks have the same secret as successful coyotes — they play the metagame really well — and there is no more effective metagame player than giant corporate media.

They’ve been manipulating memes for a really long time. It works really well for them.

It just doesn’t work very well for us.

We are infested by ticks.

And yes, I understand that this is a horrifying photograph. I’ve used it because I want everyone to be equally horrified by the degree to which OUR ears are stoppered up by these monsters. Because as revolting as this picture may be, all of those ticks won’t kill the dog. They just destroy his hearing and ruin his brain.

Seeing is believing. Once you see the meme introduction and contagion process, you WILL take every step necessary to rid yourself of them. You WILL become more self-aware. You WILL achieve a greater liberty of mind, which is the only effective treatment for a meme infection.

And that’s what we can do. That’s what Epsilon Theory can do. Not try to be a “fact checker”, because that’s a fool’s gig in a world of Fiat News, where everything you hear is in service to this Narrative or that, a self-serving political or economic view served up with some veneer of “fact”. No, what we can do is measure what IS, without attaching any affect or opinion as to whether it is RIGHT. What we can do is visualize what has heretofore been HIDDEN, so that we can go beyond the immediate communication game and SEE the metagame.

Because you’re smart enough to make up your own damn mind.

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The Icarus Moment

A juvenile red-tailed hawk took up residence near our farmhouse soon after we moved onto the property, now eight years ago. The girls named him Indiana Jones, which is a wonderful name for a hawk, and his daily kreeeeeees thrill me every time I hear them. Red-tailed hawks are also known as chickenhawks, but we’ve never had a problem with Indiana in that regard, as he seems more than content to pillage our fields for ground squirrels, voles and the occasional snake. I am particularly happy for his attacks on the local vole population, as we lost a young apple tree to voles a few years back (they will eat the tender bark all the way around the thin trunk, “ringing” the tree and killing it). We don’t know if Indiana has been successful in finding a mate in one of the past few breeding seasons. We hope so. It’s a solitary life being a red-tailed hawk, all alone in your instinctive mastery of flight and field.

Tyger Tyger, burning bright,
In the forests of the night;
What immortal hand or eye,
Could frame thy fearful symmetry?

[Four stanzas later …]

Tyger Tyger burning bright,
In the forests of the night:
What immortal hand or eye,
Dare frame thy fearful symmetry?
William Blake (1757 – 1827)

It’s the single word change in the first and last stanza of Blake’s most famous poem, the shift from Could to Dare, that moves me as much as Indiana’s kreeeeeees. It’s at the heart of all of Blake’s work, this notion that not only is it a difficult thing to frame/model the symmetry/pattern of Nature as found in a raptor’s swooping flight or a tiger’s slouchy walk, but that it is a dangerous thing, too!

Of course, that’s exactly what we humans do all the freakin’ time.

Here are some amazing William Blake paintings on this theme.

Blake’s famous quote was “Art is the Tree of Life. Science is the Tree of Death.”, so I suppose it’s no great surprise that Isaac Newton was one of the main villains in Blake’s philosophy, which saw science — particularly fundamental science focused on divining the “laws” of nature — as part and parcel of an inherently repressive political regime hell-bent (literally) on imposing a stultifying order and uniformity on mankind. The old man in “The Ancient of Days” isn’t the God of Genesis bringing form to the Void, but a god of mostly evil — Urizen by name — using that same compass of Newton’s to measure the Void and begin the repressive march of Science with a capital S. And then there’s my personal fave … Blake’s doltish Adam, hypnotized by the Snake as he asserts our most potent means of control — the power of names, aka the power of abstraction, aka the power of symbolic representation, aka the power of Narrative.

William Blake is the OG Epsilon Theory

Okay, Ben, thanks for the art history lesson. But what’s the point? These ETFs aren’t going to trade themselves, you know.

Yeah, I know. And that’s actually pretty close to the point I’m going to make. But it’s bigger than that, too, and to get there I need to make one more observation about red-tailed hawks, science and social history.

There is nothing abstract about a red-tailed hawk and its mastery of flight. There is no active contemplation and scenario modeling required for Indiana to glide on a thermal, spot a chipmunk sliding through the tall grass, and dive Stuka-like to rend his breakfast with beak and talon. It’s beautiful, sure, in a deadly sort of way familiar to anyone who observes markets or politics for a living. It’s a mystery that a part of my brain would desperately like to solve, double sure. But most of all … it’s REAL. It’s utterly authentic and true. Not only to Indiana and the chipmunk, but to me the Observer, too.

There is no separation from what Indiana IS and what Indiana DOES.

Marx called the separation from what one is and what one does “alienation”, and he applied it (of course) to his notion of class identity and class struggle, such that in capitalist societies a worker was separated from the meaning of his labor. When you’re a cog in a machine, moving widgets around on an assembly line, there’s no connection to the finished product. You ARE a human but you DO as a machine. That’s alienation, and it’s a heartbreaker.

Now Marx being Marx, naturally he thought of this notion of alienation as it applied to the terrible but inevitable seizure of the means of production by the capitalist class from the working class (to be followed by the capitalist class eating itself, but that’s another story). And that’s fine. But the concept of alienation goes much farther than that. Alienation applies just as much to Team Elite and us awful capitalists as it does to the “working class”. More so.

Meaning what? Meaning that I’ll tell you the story of Neb Tnuh, investor and citizen, and you tell me if it sounds familiar.

Neb has a hard time talking with real people these days. Neb just doesn’t … connect … with people 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. He gets lost in his own thoughts. Hmm, “lost” isn’t quite right. Trapped is more like it. Trapped in a maze of social abstractions, both in markets and in politics, blared at him from all sides, without pause or relief.

Sartre famously said that hell is other people. For Neb, hell is other people who want to talk about markets or politics. It’s not that Neb is so certain that he has the answer for what’s going on, for why his Twitter feed is a dumpster fire, for why the markets seem like a bad joke and why politics seem like “Black Mirror” re-runs. No, Neb is positive that he doesn’t have an answer, that he’s definitely not in on the joke. But he would rather carve out an eye with a rusty spoon than wrestle with civilians who want to tell him 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 issue 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, why Amazon is going to take over the world or why Amazon … actually, no one ever takes the other side of that argument, which is kinda interesting to Neb.

So obviously Neb is a real barrel of laughs at parties, which he shuns like the plague 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 unless they are in the trenches of this mental war of abstracted social constructs, Neb increasingly has a hard time connecting even with them. He increasingly talks past and through the people who are the most important to him, like his wife and daughters. They’re not on this abstracted battleground (thank god!), but as the war takes up more and more mental space there’s just not enough room for much else.

On the flip side of that coin, it’s easier and easier for Neb to talk with complete strangers on social media platforms, precisely because these entities (some human, some not) are entirely abstracted. He doesn’t even have to work very hard at “naming” the strangers as Adam named the beasts, because they depict themselves as symbolic representations of this tribe or that. 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.

Neb Tnuh is profoundly alienated.

Who Neb Tnuh IS — a free man in a real world — is almost totally separated from what Neb Tnuh DOES — abstracted other-regarding behaviors for abstracted others — both as an investor and as a citizen.

What’s driving Neb’s alienation? It’s what William Blake warned about. It’s the abstraction of the real world and real human activities into mental constructs, which are then established as “the real things” that we must interact with in order to succeed. It’s Magical Thinking, which is ALWAYS used in service to a political structure of social control.

But it’s worse than Blake imagined. Driven by a global policy response to the Great Financial Crisis and by the universal spread of new media technologies, the scope and scale of abstraction in service to political ends has evolved to levels unparalleled in human history. Yeah, this time is different.

The simple abstraction of nature is something that’s been alienating the Neb Tnuhs of the world since Archimedes was drawing figures in the sand and got a Roman sword in the gut for his troubles. What’s different today is that the abstractions themselves have become abstracted farther and farther away from their ostensible real-world source, such that the abstractions have become — and I’m using this word in its technical sense — cartoons. We’ve “progressed” from abstracting the principles of flight from red-tailed hawks to abstracting the principles of social influence from the abstracted principles of red-tailed hawks. We model the model in order to instill fear or greed or pleasure or patriotism. Constantly. Everywhere.

Today we abstract social behaviors, not Newtonian physics.

Today we abstract at scale through digitization.

THIS is the true Triumph of Abstraction. It’s the Triumph of the Cartoon.

I’ll give you two examples. These cartoons will seem like small examples, tiny things. But they’re not. Hundreds of billions of dollars of wealth has been created (and lost) because of the first of these cartoons, as recently as the other Friday. A Presidential election was impacted by the second cartoon. And it’s not the Presidential election you’re thinking of. Although that one, too.

Example 1 — In the beginning, there was a desire to model the employment patterns of the U.S. economy to help policymakers figure out what was actually going on. So in 1884 (!) Congress established the Bureau of Labor Statistics (BLS) to do some counting and abstracting, and since 1915 (!) the BLS has been surveying employers to estimate how many Americans are working and how much they’re being paid. On the first Friday of every month, the BLS releases its report on the real-world employment patterns in the U.S. for the prior month. This data is an abstraction, to be sure, full of seasonal adjustments and model estimations, but it is a first level abstraction. This is not the cartoon.

One of the standard calculations that the BLS reports is the percentage change on a year-over-year basis in how much workers are being paid. Usually this wage growth report takes a backseat to the more famous “jobs report” of how many jobs were added or subtracted from the U.S. economy in the prior month and the even more famous “unemployment report” (which is actually based on an entirely different survey) of the percentage of Americans who were actively looking for work but were unable to find jobs. But when everyone and his cousin is either worried about wage inflation or hoping for wage increases, then the wage growth “number” takes on enormous importance. It’s the depiction and the narrative around the BLS wage growth calculation that is the cartoon. And that cartoon is everything for markets today.

On Friday, February 2, the BLS reported a January wage growth number of 2.9%, far “hotter” than consensus estimates and widely taken as evidence that (finally) inflationary pressures were showing up in wages. The following week markets sold off as hard as they have in years, in large part because it seemed that central bankers were now terribly “behind the curve” when it comes to inflation, and that they would be forced to tighten faster and more dramatically than “promised” via prior forward guidance.

On Friday, March 9, the BLS reported a February wage growth number of 2.6%, well below consensus estimates and widely taken as evidence that — together with the massive increase in jobs — we were actually in a “Goldilocks” investment world that was neither running too hot to force the Fed’s hand nor too cold to slow down expectations of real-world growth and expansion. What a difference a month makes! All major market indices had glorious days, with the NASDAQ setting a new all-time high.

What if I told you that both of these wage growth numbers were misleading abstractions of what they claimed to be?

What if I told you that you’ve been whipsawed by a cartoon, and you’re going to be whipsawed again?

Here’s what I’m talking about, and if you want to double-check the math or the numbers it’s all available on the BLS website. For historical data, this is a good place to start.

The most basic way to look at wages for a monthly report would be to count up how much all workers got paid in that prior month. But that doesn’t work for a month-to-month comparison because different months have meaningfully different numbers of days. Unless you’re getting paid on a monthly or twice-monthly basis, then you’re going to be making less in February than you are in January. So the BLS uses the work week as their basic apples-to-apples comparison basis.

On this most basic abstraction of wages, annual wage growth for January (the Feb. 2 announcement) was 2.8% and annual wage growth for February (the Mar. 9 announcement) was 2.9%.

Wait, what? That’s not at all what we were told. It’s not quite as hot for January, and it’s clearly not Goldilocks for February. What’s going on here?

As far back as I can trace the theater of BLS reports — and that’s how one should think about these market data reports, as theatrical productions consciously designed to impact behavior — the “number” that’s reported isn’t the apples-to-apples comparison of weekly wages. Instead, it’s hourly wages. Why? Because back in 1915 this is how most people got paid. The abstracted idea of hourly wages connects with people more than the abstracted idea of weekly wages. It’s a more effective tool for eliciting a behavioral response, so that’s why our theatrical effort focuses on it every month.

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 last year. That additional layer of abstraction is the average length of the work week.

Now this data estimation changes very little from month to month. Unlike the difference in work days from month to month, which can be meaningful and is incredibly easy to measure, the difference in work hours from week to week is an immaterial and almost certainly statistically spurious estimation. Here are the average number of hours in the work week since 2012.

Since 2012, the average length of the work week has been as low as 34.3 hours and as high as 34.6 hours. For more than SIX YEARS, the maximum deviation from the mean has been less than NINE MINUTES, less than ONE-HALF OF ONE PERCENT of the total work week. This is the flattest line you will ever see in any time series, and any month-to-month deviation from the mean is almost certainly a spurious statistical estimation. Meaning that the month-to-month differences in the average work week are so far inside your margin of error for this sampling and estimation process that you can have ZERO confidence that you are abstracting anything real. This is as bogus of an abstraction as you will ever see.

And yet it makes all the difference in the world for hourly wage calculations!

Why was the February wage growth number reported on March 9th as 2.6% rather than 2.9%?

Because the average work week in February 2018 was randomly estimated as being six minutes longer than it was a year ago.

Everything you read about what the March 9th wage growth number meant for your portfolio — the entire Goldilocks narrative of a “contained” wage inflation number combined with strong job growth — is based on a statistically spurious result. Everything. It’s all made up. None of it is real.

And yet, on the basis of the Goldilocks narrative, which was the all-day headline of the Wall Street Journal and the talking point of every Missionary on CNBC that Friday, the S&P 500 was up more than 1.7% on the day. That’s $415 BILLION of market wealth created in the S&P 500 alone, in one day, from a cartoon representation of annualized wage growth in the U.S. economy.

Now here’s the kicker. Unless the average work week in March randomly declines 12 minutes versus the February average work week, it’s all going to happen again on April 6th. Why? Because the March 2017 work week was 34.3 hours long. So even if weekly pay increases by more than 3% in March, which is like the Maginot Line of wage inflation numbers, when the curtain rises at 8:30 AM ET on April 6th, we will be told by the theater performers that the wage inflation “number” is still a very manageable 2.6% or something like that. And in the immortal words of Monty Python, there will be much rejoicing.

But by the same token, at some point this year we will have a perfectly random 12 or 18 minute estimated decline in the average work week, and the 2017 comp will be a month with a randomly high average work week. On that first Friday of that fateful month, we will have a “shockingly” high wage inflation number, “proving” that the Fed is way behind the curve, with breathless coverage of swooning markets on CNBC. In the immortal words of Monty Python, there will much gnashing of teeth as the Killer Bunny emerges from its cave.

It’s the Triumph of the Cartoon, and as an investor it puts me at war with myself. Do I invest on the basis of reality, meaning the fact that wage inflation is, in fact, picking up in a remarkably steady fashion in the real economy? Or do I invest on the basis of Narrative abstractions that I can anticipate being presented and represented to markets at regularly scheduled moments of theater? Because the investment strategy for the one is almost diametrically opposed to the investment strategy for the other.

I’ll probably do the latter. I’ll probably act on the basis of abstracted and doubly abstracted cartoons of reality because that’s what I think everyone else is going to react to (the Common Knowledge Game), rather than act on the basis of what I truly believe is happening in the real world.

And that’s where the alienation comes from.

But that’s just my alienation as an investor. I am equally if not more alienated as a citizen.

Example 2 — Sticking with the labor statistics genre of abstraction in the service of Narrative creation, let’s turn to the weekly theater of new unemployment claims, presented every Thursday morning at 8:30 AM. This is, historically speaking, a decidedly uninteresting and low prestige data series, to the degree that the Bureau of Labor Statistics does not compile the data and abstracted reports themselves, but have handed it off to a lonely backwater the Employment and Training Administration of the Labor Department.

Starting with the Great Recession, however, interest in all macro data reports soared to new heights, and as the only weekly U.S. government report of any note whatsoever, CNBC began to build a regular feature around the new unemployment claims report in mid-2009. Over the next three or four years, anyone who was actively involved in markets would know whether or not the weekly initial unemployment data had surprised to the upside (bad news, as that meant that more people than expected had filed for unemployment claims for the first time) or surprised to the downside (good news, as fewer people than expected had filed). These reports were presented as a Big Deal, and markets moved markedly up and markedly down on the news. Not for more than a day or a half day, typically, but they moved.

Almost always, the number surprised to the downside (good news) as “green shoots” of recovery spread across our great nation from 2009 through November 2012, when — oh wait! — we had a Presidential election. In truth, these abstracted reports, purporting to give an accurate snapshot of weekly developments in the real-world employment situation in the U.S., were a joke over this time period. They were a constructed cartoon.

The chart below is a frequency distribution (also called a histogram) of the errors made in the reporting of weekly unemployment claims from September 30, 2009 through the November 2012 election.

Frequency Distribution of Weekly Unemployment Data Reporting Errors
September 30, 2009 – November 2012 Election (n=162)

Source: Employment and Training Administration. For illustrative purposes only.

What you’re seeing here is the percentage of weekly reports that showed an error in the original reporting versus the initial revisions posted one week later (there are then final revisions posted two or more weeks later). The bars to the right of the red line are positive revisions, meaning that the revised reports showed more people than originally reported filing for unemployment. In other words, the original report made a “good news!” mistake by under-reporting the true number of first-time unemployment claimants.

In a bias-free world, you would have errors equally on one the left side of the red line as on the right side of the red line, and they would form some sort of normal distribution (a bell curve) centered on that red line of zero revisions. Obviously enough, these revisions are anything but normally distributed. They are bizarrely and incontrovertibly skewed enormously to the “good news!” bias side of all this. I mean … I could give you p-tests and other calculations of statistical significance, but this picture is worth a thousand words. There is a greater chance that the sun will go nova tonight and destroy the Earth in a paroxysm of incinerating plasma than for these errors in initial jobless claims to be the work of chance alone.

And I know what you’re thinking, because I thought the same thing when I first compiled this data for a 2013 Epsilon Theory note (“Heeeere Comes Lucky!”). Maybe these reports have always been so jaded, so wrong, so cartoonish in their bias. But no.

Here’s the histogram of the errors made in the reporting of weekly unemployment claims during the Bush Administration from September 30, 2005 through the November 2008 election. Same time frame, same number of observations. Totally different pattern.

Frequency Distribution of Weekly Unemployment Data Reporting Errors
September 30, 2005 – November 2008 Election (n=163)

Source: Employment and Training Administration. For illustrative purposes only.

There are a few weeks with slight over-reporting of unemployment claims and a few more weeks of more pronounced under-reporting of unemployment claims, but by and large this is a picture of a reasonably accurate and only slightly biased data report. Compared to the same time period in the first Obama term, there is no comparison.

Here are the aggregate numbers that underpin these graphs.

In the first Obama term, original Labor Department reports understated initial jobless claims by 858,000 people relative to initial revisions. Compared to final revisions, the original estimates look even worse, understating jobless claims by 884,000.

In the second Bush term, original Labor Department reports understated jobless claims by 292,000 relative to initial revisions. Compared to final revisions, the original Bush-era reports understated jobless claims by only 5,000 people.

Were there more initial jobless claims in the Obama time period than in the Bush time period? Yes, but only approximately 25% more. The total errors versus initial revisions, on the other hand, increased almost 300% over the comparable time periods, the total errors versus final revisions increased more than 18,000% over the comparable time periods, and the skew towards under-reporting actual claims (not just the number of wrongly reported claims but the degree of wrongness) is even more pronounced.

These are the facts.

So I want to be very careful in what I say next.

What I am NOT saying is that there was a conscious conspiracy to skew the employment Narrative of the real economy in a good news direction. The reported abstraction of initial unemployment claims is constructed from a compilation of abstractions from each individual state, and in the disarray of state government post-Great Financial Crisis, no doubt these first level abstractions were chronically late and poorly estimated, requiring significant revisions in subsequent weeks.

What I AM saying is that this systematic error was clearly visible and known to the BLS, which is staffed with very smart people, and they could have fixed it if they had wanted to. The BLS adjusts raw data all the time, and there are obvious statistical adjustments that could be applied to this obvious systematic error. But the BLS chose not to fix it, or rather they chose to allow the Employment and Training Adminstration to continue making these egregious errors.

Until after the election.

On September 12, 2013, reported weekly unemployment claims were shockingly low — only 292,000 Americans had filed for initial unemployment benefits in the prior week, the lowest number in more than seven years and a decline of more than 30,000 applicants from the prior week. Huzzah! This economy is finally starting to hum! As it turns out, however, the low number was because neither Nevada nor California had filed their data with the Labor Department on time. As it further turns out, the Employment and Training Administration knew that the number was way off for this reason, but published it anyway without explanation. As it further turns out, the Labor Department informed a few reporters of the mistake in an embargoed fashion, which meant that the “news” of the embedded error in the filing was dribbled out by private news agencies after the official release.

The problem with all this for the Labor Department wasn’t the ridiculous process that drove a ridiculous error. After all, this had been the practice for years. The problem for the Labor Department was that their act of theater was now publicly revealed as an act of theater. The multi-level data abstraction was revealed as a constructed cartoon. So the Labor Department asked Keith Hall, a former BLS commissioner, and “several” unnamed economists (i.e., current BLS commissioners) to tell the Wall Street Journal that the methodology and bureaucratic oversight of the Employment and Training Adminstration had to be improved. And it was. I guess.

The kicker, of course, is that this cartoon Narrative regarding real-world employment patterns had a significant impact on the 2012 election. That’s not my view. That’s the view of Obama’s Chief Strategist for both Presidential campaigns, David Axelrod. Take a look at what he says about the unemployment rate in a panel discussion organized by his Institute of Politics: Campaign Strategists: 2012 Explained. It’s a long video, but for anyone interested in U.S. politics it’s a must-see. Why did Obama win in November? Because the unemployment rate went down in the months leading up to the election. The economy got better, as evidenced and interpreted by the unemployment rate, and that swung a lot of undecided voters. Per David Axelrod, that’s what won the election.

Now did the weekly initial claims data play a big role in shaping that cartoon interpretation of the U.S. economy going into the November 2012 elections? I dunno. This particular act of theater was more widely distributed on CNBC than on CNN, so it didn’t get the sort of audience of, say, the unemployment “number” itself. But it wasn’t useless, either.

Let’s just say that I think a lot of people owe Jack Welch an apology.

To be clear, this is neither a Democrat nor Republican thing. It’s an us thing.

I mean … “emails”? Are you freakin’ kidding me? Cartoons aren’t just created to mobilize positive sentiment and supportive social behaviors (although that’s pretty much all we see in capital markets, because it’s a positive-sum game, not zero-sum like politics). The negative cartoon-ification of Hillary Clinton was both the most vicious and the most effective gambit in the last 100 years of American politics. To be sure, The Clintons™ brought soooo much of this on themselves. If there’s ever been a political candidate more ripe to be transformed into a negative cartoon than Hillary Clinton, I am unaware of who that might be. But where Donald Trump embraces and actively creates his obvious cartoonishness, Hillary Clinton had her cartoon imposed on her unwillingly, to disastrous result. Today’s key to political and economic success is controlling your own cartoon. Yes, this is why Trump won.

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.

So where does this end?

You hear a lot of people talk about an inevitable Minsky Moment, where financial system instability is revealed in an Emperor’s New Clothes instant, and the whole central bank-led house of cards comes tumbling down. I’m a big fan of Hyman Minsky, but I don’t believe that a Minsky Moment is nigh, for the most part because Minsky saw central banks as the solution to financial instability, not the cause. I wrote about my views on the Minsky Moment here, back in 2014.

But I do think we are close to what I want to call an Icarus Moment.

The myth of Icarus is one of the Old Stories, meaning that its narrative power spans geography, culture and time. The Greeks alone had at least two Icarus narratives, both the younger myth that we all know and the older myth of Phaeton driving the chariot of the sun to his death.

What is an Icarus Moment?

It’s the price we pay for our hubris in modeling Nature past the point where our human brains and human bodies can handle the strain of our application of those models. It’s our forfeit for daring to frame the fearful symmetry of a jungle cat. It’s flying too close to the sun. It’s the destructive consequences of overweening pride in our pursuit of greater and greater abstraction that drives greater and greater alienation at greater and greater scale.

An Icarus Moment is a Fall.

It’s the Fall of Rome and the Fall of Troy. It’s the Fall of Man. It’s the Fall of the Mississippi Company and the South Sea Company. It’s the Fall of Enron and the Fall of Corzine. It’s the Fall of Residential Mortgage-Backed Securities. It’s the Fall of every too-clever-by-half coyote in the history of man, both in politics and in markets.

It’s the Fall of Donald Trump. It’s the Fall of Bitcoin. It’s the Fall of the Euro. It’s the Fall of Pax Americana. It’s the Fall of Central Bank Omnipotence. Hubristic conceits one and all, now operating as cartoons of their former selves.

Why do I think we’re near an Icarus Moment?

Three reasons.

First, it’s the overwhelming dominance of abstraction and symbolic representation in our social lives, in turn leading to bewildered and profound alienation.

Our politics are now completely consumed by trope and fiat news, such that our identities as Democrats or Republicans no longer have recognizable meaning. The Donald Trump cartoon of the Mad King? The Russia/China cartoon of the Foreign Peril? The Bezos/Gates/Buffett cartoon of the Oligarch? The Bitcoin/Silicon Valley cartoon of the New? The CNN/Fox/CNBC cartoon of the Circus? Tropes all, combined and recombined in engaging fashion as if written for a Hollywood script (which is itself a trope). Who we ARE as citizens and voters is no longer reflected in what we DO as citizens and voters, and that’s the very essence of alienation.

Our markets are now completely consumed by factors and narratives, such that our identities as value investors or growth investors no longer have recognizable meaning. Value investing and growth investing, which have been the dominant ideologies of markets for the past 70 years or so, are no longer meaningful processes where research into individual real-world companies has any usefulness whatsoever. Instead, they have been abstracted into “factors”, into a modeled quality of a modeled quality of a real-world company. We no longer invest to own a fractional share of a corporation’s cash flows and opportunities (an individual stock). We no longer invest to own an abstraction of that fractional ownership share across multiple companies (an index). Today we invest to own an abstraction of a quality of the abstraction of fractional ownership shares across multiple companies (a factor). And even these factors are muted to the point of triviality by the algorithmically unpredictable shifts of the Three-Body Problem. My guess is that 80% of investment research and management jobs in the financial services sector add zero value today and will be gone in less than 20 years.

Second, it’s the return of hubris as the ancient Greeks conceived it, an aggressive pride where the strong delight in attempts to shame the weak. You see it constantly from our White House. You see it constantly on Twitter and throughout social media. You see it whenever rapacious, know-nothing narcissism is celebrated as leadership even as civility, expertise and service are mocked as cuckery. Which is to say you see it everywhere.

Pride goeth before destruction, and a haughty spirit before a Fall.

Yeah, I know I sound like a grumpy grandpa when I write something like this. Yeah, I know that this is a Bible quote. It’s also THE plot of every Greek tragedy. You think we’re wiser than Aeschylus, than Sophocles, than Euripides? You think we’re smarter than Socrates, than Plato, than Aristotle? You think our politicians have got anything on Cleon, on Alcibiades? Bollocks. This is the human condition, people! There is NOTHING new under the sun when it comes to human behavior, and this is how the story of aggressive pride ALWAYS ends. We’ve transformed Pride from the deadliest of the Seven Deadly Sins into the foremost of Virtues, particularly in our children and our celebrities, and that’s the biggest tragedy of any age.

Third, from a game theoretic perspective, we are transforming all of our cooperative games into competitive games. I’ve written about this in two Epsilon Theory notes — “The Silver Age of the Central Banker” and “Virtue Signaling, or … Why Clinton is in Trouble” — so I won’t repeat all that here. The basic idea, though, is that most games we play as a nation in the international arena or as political parties in the domestic arena have multiple equilibria, multiple balancing points that are as good as it gets for the players and where it is irrational to take actions that would break away from those balancing points. On two occasions — after the Revolutionary War for domestic games and after World War II for international games — political leaders in the United States established/enforced an equilibrium that is largely cooperative at the meta-game level (I’m using cooperative in the non-technical sense of the word), to the benefit of ALL players. What we are doing now is unilaterally and intentionally breaking those equilibrium positions — in both international and domestic games — to “drop down” to competitive equilibria where ALL players are worse off. Why? Because it makes for an effective political cartoon. We’re tough! We’re fighters! We’re winners! Again, bollocks.

But because these competitive equilibria are, in fact, equilibria, they stick. They stick until you have an enormously destructive event — an Icarus Moment — that breaks this equilibrium and creates “room” for a dominant player to reestablish the cooperative “regime”. Or not. Sometimes, as it was for Groucho, the Icarus Moment is an all-encompassing war. Sometimes, as it was for Karl, the Icarus Moment is a lot of medium-sized wars and domestic conflicts. Sometimes, as it was for Augustine, the Icarus Moment is a slow-motion dissipation of the City of Man, where the Oligarchs and the Generals hollowed out the greatest country in the world for a century in a long series of little Icarus Moments until some second-rate foreign power finally put out the lights in the West for a millennium.

So what do we do about all this?

As investors, I think we must take a profoundly agnostic perspective on capital markets. That means that we don’t trust anything we hear or read. That means we ask WHY we are being told something with as much or more attention as we ask WHAT we are being told. That means that we don’t trust our own biases. That means that we recognize our long-standing investment processes to identify value or growth as a bias, not as some eternal investment truth.

The bottom line here is that we all have to make the same alienated decision as Neb Tnuh. Recognizing that we are being played, do we embrace the game-playing and focus on the Narrative ebbs and flows for our investment decisions? Or do we push away from the casino table that our doubly and triply abstracted markets have become, in favor of securities that are at least closer to real-world economic activities? We can’t isolate ourselves from abstracted markets and an Icarus Moment. But we can insulate ourselves. Exactly two years ago I wrote a long note on exactly this, called “Hobson’s Choice”. It’s held up pretty well, I think.

Oh yeah, one more thing. When an Icarus Moment happens, you want to be long volatility.

As citizens, I think our actions depend on where we are in life. For me, now in the autumn of life (early autumn, one hopes!), it’s a matter of reconnecting to the real world of real people and real animals. It’s a matter of repairing the damage — and it IS damage — that alienation creates. That’s why I have a farm. That’s why I write Epsilon Theory. It’s therapy.

More broadly, though, here’s the principle I want to live by: don’t be Daedalus.

Don’t become so consumed with your own powers of abstraction and ability to create weapons and labyrinths that you end up in a prison yourself. Don’t be the guy who straps those wings onto Icarus and sees his son fall to his death. The game ain’t worth the candle.

Or in terms of a recent note: don’t be a coyote who ignores the meta-game.

For my children, for anyone in the spring and summer of life, it’s a different principle: don’t be Icarus.

Don’t confuse a knowledge of Science and its languages of abstraction for wisdom. Wisdom comes from an ability to think critically about abstraction and its uses and misuses for political and economic power. Anyone can learn a language, like mathematics. Anyone can apply that language to abstracted questions of social behavior, like economics. Everyone is so focused on STEM. Everyone is tripping over themselves to hire physicists or math majors. Not me. I want to hire comparative literature majors. I want to hire history majors. Why? Because it’s training in how to think about the WHY and not just the WHAT; because it’s training in the universal language of symbolic representation, which is words and story, not math.

Or in terms of a recent note: don’t believe the coyote-math.

Long volatility and short abstraction

That’s my algorithm for living in the Cartoon Age, both as an investor and as a citizen.

It’s a lonely perch, because it doesn’t scale. You’ll never get rich and you’ll never get elected President being long volatility and short abstraction. But it’s real. It’s my personal equilibrium.

Everyone sees a hawk and wishes they could fly. But that’s not the hawk’s great secret.

The great secret is living such that Being and Doing are as one.

And we can all do that.

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Good Job!

Every dog needs a job. It’s how they make sense of their place in the pack. It’s the key to a Good Dog.

You don’t have to tell dogs what their job is. They tell you. Maggie the German Shepherd? Her job is to protect. Sam the Sheltie? His job is to herd. Not sheep, of course, because that would be too useful. Nope, just squirrels. Turns out it’s not easy to herd squirrels, but that doesn’t stop our “special” dog from giving it his all, every day, rain or shine. Eco the Golden Retriever, pictured above? His job was to love, which he did with grace and abandon for 12 years. Rest in peace, old friend. You were a Good Dog, and I miss you.

A dog knows perfectly well when she’s done a Good Job. You can see it in her gait, in her tail, in her ears … everything about the way she carries herself says, “yep, I done good. did you see how good I done? ‘cause I done good.” Conversely, a dog also knows when she hasn’t performed up to snuff. The hangdog look is a real thing. A dog knows honor and a dog knows shame, and there is no more important example that any animal can set for us poor benighted humans.

Why? Well, this is the money quote from Sheep Logic:

Because with no sense of shame there is no sense of honor. There is no mercy. There is no charity. There is no forgiveness. There is no loyalty. There is no courage. There is no service. There are no ties that bind us as citizens, as fellow pack members seeking to achieve something bigger and more important than our ability to graze on as much grass as we can. Something bigger like, you know, liberty and justice for all.

Unlike dogs, humans have a hard time knowing whether or not they’ve done a Good Job. We consistently overestimate our competence at tasks, and when we fail, we evince befuddlement — as if we’re looking for the Restore Saved Game function — rather than remorse or apology. We humans are more Yogi Bear than Lassie.

It’s a widespread behavioral phenomenon at every age and demographic category. But it’s endemic in the young.

I think our notions of what it means to do a Good Job are so stunted for three reasons.

We’ve trivialized honor.

We’ve personalized shame.

We’ve redefined pride.

We trivialize honor through our constant celebration of mere engagement as some sort of actual achievement. We give ourselves and our children these faux “Certificates of Achievement” in one form or another all the time, and once you start looking for them you will see them everywhere.

This is how the Nudging State and the Nudging Oligarchy bring us into the fold. This is how they neg us.

This is how our children become Industrially Necessary Eggs.

We personalize shame by attaching it to identity rather than to behavior. Shame over behavior is ephemeral and corrective. Shame over identity is existential and utterly self-destructive.

The personalization of shame is a merciless goal of the Nudging Oligarchy because we will pay any price to “fix” ourselves. And our children are their primary targets.

Wait, your body isn’t “perfect” like a Victoria’s Secret model? What a shame. But don’t worry, we can help you with that.

We redefine pride when we confuse it for participation and belonging, when we treat it as the opposite of shame rather than what it really is — the foremost of the Seven Deadly Sins.

Like honor and shame, pride has been reattached from behavior to identity by the Nudging State and the Nudging Oligarchy. Like honor and shame, our children are their primary targets.

As Hieronymus Bosch knew well, the demon holding up the mirror of Pride isn’t a fable. The demon is us.

We’ve turned honor into a cheap candy, shame into an existential identity crisis, and pride into a virtue.

  • No wonder hospital admissions for suicidal teenagers have doubled over the past ten years.
  • No wonder our girls cut themselves and our boys shoot themselves.
  • No wonder my Twitter timeline is, day in and day out, a dumpster fire.
  • No wonder our 2016 election was a Sophie’s Choice.

By the way, the right answer to a Sophie’s Choice is NO. The right answer to an impossible dilemma is simply this: Homey don’t play that game.

Whee! I bet you’re a real hoot at cocktail parties, Ben. But can we come back to Planet Earth now?

Yeah, sorry about that. Actually, sorry not sorry. But in any event we’ve got to answer this question:

So what DOES it mean to do a Good Job?

Here’s what it means to any self-respecting dog. Which is to say, here’s what it means to all dogs:

You know what your job is.

The job is in service to the pack.

You do the job better than the average dog.

That’s it. That’s the Good Dog’s definition of a Good Job. Like all old wisdom, it’s deceptively simple. Like all old wisdom, it’s applicable across time and endeavor. This is an algorithm, by the way.

I’ll discuss two applications of the Good Dog’s definition of a Good Job in this essay: professional sports and professional investing. In both fields, there’s a LOT of money at stake with answering our question du jour — what does it mean to do a good job? — and in both fields there’s a clear notion of what “the pack” represents — the team in professional sports and the portfolio in professional investing. Given these similarities, it surprises me that there’s not a commonly held language to address the issue.

I think that professional sports is actually more advanced in their language on this than professional investing, or at least more cohesive, so I’ll start there. This is particularly true in the major professional sport most similar to professional investing in terms of its research methodology and sheer number of observable score/price events — baseball.

The modern methodology of baseball analysis goes by the name sabermetrics, coined by the Godfather of modern baseball statistics, Bill James, and named after the Society for American Baseball Research. I’m not sure if my dad started getting the Bill James Abstract in 1980 or 1981, but it was definitely before James hit the (well-deserved) big time in the mid-80s. In his own way, I’d say that Bill James has been the most influential data scientist in the world over the past 40 years. Certainly he’s had a huge impact on my career. Many others who work with data for a living, like Nate Silver, say the same thing.

The central question that Bill James set out to answer in the late 1970s is the Good Job question: You say that Ted Williams was a great baseball player. How do you know? Compared to who? What does that statement even mean? What’s the relationship between the greatness of Ted Williams and the performance of the Boston Red Sox?

These are exactly the questions that investors should be asking about active asset management, too.

There’s an enormous body of work developed in the sabermetric community to answer the Good Job question, but here I want to focus on one specific thread — the idea of Wins Above Replacement (WAR). It’s an approach largely credited to Keith Woolner (he calls it Value Over Replacement Player, or VORP), although as with all great concepts there are plenty of parents and plenty of variations on this theme.

Here’s what WAR seeks to measure: if you were replaced with an average player for your specific position, how many fewer games would your team win?

This is a perfect application of the Good Dog’s definition of a Good Job, all in convenient algorithm form!

  1. You know what your job is. We compare shortstops to shortstops, left fielders to left fielders, relief pitchers to relief pitchers. We take into account all aspects of the job, including defense.
  2. The job is in service to the pack. We measure players in terms of how they contribute to winning games for the team. We care about individual statistics only as they relate to team outcomes, not as ends in themselves.
  3. You do the job better than the average dog. You and your major league peers are, by definition, above average. We have the performance data for easily available replacement players (minor league call-ups, mostly), and we’re going to use that as your performance benchmark.

WAR is the Good Job algorithm for baseball. Today, WAR and its variants are the foundation for almost every economic decision that general managers make, from drafts to trades to contracts, in how they structure their team. Not just in baseball, but in every professional team sport.

So what’s the equivalent of WAR for investing?

Well, there’s no snappy acronym in investing, so I’m going to make one up.

Let’s call it PAR — Performance Above Replacement.

In WAR we want to compare the offensive and defensive stats of a professional position player, like a left fielder, to a readily available replacement position player, like a AAA call-up.

In PAR we want to compare the offensive and defensive stats of a professional active manager, like a long/short equity hedge fund manager, to a readily available replacement manager, like an ETF.

What do I mean by offensive and defensive stats? I mean making a distinction between the investment manager’s performance when the market is up and when the market is down. Makes sense, right? There are bull market managers and there are bear market managers and there’s a lot of muddy area in-between. Let’s measure how active managers perform across this crucial dimension for your portfolio so that we don’t miss some skill that might otherwise get lost in the shuffle. This is particularly important for long/short equity and global macro investors because they’re constantly changing their gross and net exposures, and it is the driving force behind the most commonly uttered phrase of active managers trying to explain how they do a Good Job: “We capture x% of the upside in our market but only y% of the downside!” where, of course, x is greater than y. If you haven’t heard (or used) that line 5 bazillion times in your investing career, then … lucky you. In more technical terms (and I’m sorry to do this, but I promise you there will be a payoff), these active managers are saying: “I am doing a Good Job because my performance demonstrates convexity.”

The concept of convexity is at the heart of Performance Above Replacement.

Convexity? Woof … that’s a ten-dollar word if there ever was one.

Let’s say you’ve got an area of your portfolio — call it your “tactical overlay” portion of the portfolio — where you’d like to give active management a shot. You’ve identified an active manager who runs a long/short global macro fund, you’ve decided that this is potentially a “real” diversifying strategy, and now you want to look at the manager’s PAR. Since this manager plays in the Everything sandbox, you’re going to use a global 60/40 investable index (or better yet a global risk parity strategy … yes, I went there) as the “replacement player”, and you’re going to separate out how the manager performs in up markets versus down markets, using the S&P 500 for that distinction because that’s your benchmark.

Here are some stylized absolute return profiles on the left, and the corresponding relative return profile on the right. I’m simplifying things here by drawing straight lines instead of what would be a smattering of point observations (monthly performance numbers, for example), but you can use a linear regression to create the lines. Actually you’re running two linear regressions, one for the manager’s offensive stats (performance when the S&P 500 is up, in green) and one for the manager’s defensive stats (performance when the S&P 500 is down, in red). The blue line is the performance of the replacement strategy (a global 60/40 or risk parity fund). Both funds cross the y-axis slightly below zero (more so for the active manager) to reflect the management fees and expenses associated with the funds.

When you “normalize” the active manager’s performance versus the replacement strategy and the S&P 500, which is what the right-hand graph is doing, you see that this manager nicely outperforms the replacement strategy in difficult markets without underperforming nearly so much when markets are rocking, creating a shallow V-shape or upward bend to the performance line. THIS is convexity.

This manager clearly has positive PAR, meaning that she improves the performance of your portfolio versus what you would have done with a passive replacement strategy, once you take into account both offensive and defensive stats. This manager is like a talented defensive catcher (i.e., a position where it’s important to play good defense) who is a so-so offensive player. That’s a classic player type, and there are plenty of teams who would find a spot on their roster for that.

There are dozens of different tools and well-known performance analytic statistics (Sortino ratio, Jensen’s alpha, upside/downside capture) that will do some variant of this PAR calculation for you, and they’re all designed to capture different aspects of convexity. This sort of exercise is the mother’s milk of consulting gigs, and every consultant in the world would look at this data and tell you that this manager is doing a Good Job.

Pretty exciting, right? Here’s a methodology that clearly works in professional sports and can be directly brought over to professional investing. It’s empirically driven and mathematically sound.

But it doesn’t work.

Or at least it doesn’t work anymore. Like so many other aspects of our investing lives, these mathematically sound and empirically driven efforts to answer the Good Job question for active management have collapsed under the chaotic gravitational pull of The Three-Body Problem.

In exactly the same way that Quality has been absolutely useless as an investment factor for the past eight and a half years, so have our traditional measurements of active manager skill.

The orange line in the chart below is the S&P 500 Index from 1998 to today. The white line and blue-shaded area is the HFRX Global Hedge Fund Index divided by the S&P 500 Index. It represents the relative underperformance or outperformance of hedge funds versus the S&P 500, and today we are at all-time underperformance lows. There is no convexity here! At least not in the aggregate. It skipped town in March 2009, just as the Central Bank Brigade rode in to save the day.

Managers who used to “capture” more upside than downside don’t. Managers who used to demonstrate convexity in their results don’t. They still have lots of stories to tell you about how they manage gross and net exposure, lots of stories to tell you about volatility and risk management, and lots of stories to tell you about thematic opportunities. Most still express a great deal of pride in their investment process.

I’m not saying that these “proprietary processes” will never work again. I’m not saying that they’re not working now. I’m saying that if they’re working, they’re working very very faintly. So faintly that you have to believe in the story to stay the course, because it’s sure not in the aggregate results. I’m saying that the processes and the skills and the performance convexity of professional active investors are swamped by the gravitational pull of $20 TRILLION of central bank balance sheets, as are the traditional tools we’ve used to measure all that. Because that’s the point of the Three-Body Problem – any algorithmic understanding of the system will fail to predict what’s next.

So what’s to be done? Do we just give up trying to answer the Good Job question? If our evaluative tools for active managers are non-predictive, do we just throw ourselves onto the waves of the S&P 500 and hope for the best? Because that’s what a lot of investors are doing, including giant pension funds who should know better, even though doing so is an active management decision of the first order!

Here’s the thing. Yes, It’s more difficult than ever to answer the Good Job question regarding active investment management. It’s also never been more important.

Because while I have no way to predict what’s next in the Three-Body System, I can tell you with absolute certainty that there IS a next, and it will NOT look like now.

Because you ARE the active manager when you select this passively managed fund over that passively managed fund, and you are not as good of an active manager as you think you are.

As wonderful as it would be for investors to style themselves as baseball general managers, poring over advanced performance statistics to pick this or that great fund manager in some sabermetric nirvana, that’s just not in the cards. We have to find a better way, a way to answer the Good Job question in a Three-Body system. Because we’re not getting away from active management even if we wanted to.

Our answer, I think, is to go back to first principles, to go back to the code of the Good Dog. The answer, I think, is in convexity, but not in the mathematical over-scientificized cartoon of the word.

The answer, I think, is in convexity as a philosophy.

Convexity as a philosophy is about identifying what you are particularly good at, and then executing on THAT. It’s the key to unlocking a much more stable notion of identity — a Good Dog’s notion of identity. Good Dogs know what they’re good at, and I don’t need to calculate a Sortino ratio to know if they’re doing a Good Job.

We can do the same with our evaluation of active managers. We can tell when an active manager is doing a Good Job. We can see it in her demeanor, we can see it in her temperament, we can see it in her bravery, both personally and professionally. Every Good Dog is a Brave Dog. It’s the same with investment managers. We can see it in her humility — the virtuous opposite of sinful pride. We can see it in her sense of shame when a behavior is not up to snuff. Not identity, behavior. There’s no shame in identity. Ever.

There’s a sine qua non for adopting convexity as a philosophy in evaluating active managers, and it’s as simple as it is difficult: courage, both personally and professionally. We’ve got to be Brave Dogs, too.

To be clear, the behavioral attributes associated with a Good Dog’s notion of a Good Job are a necessary condition for approving an active manager, not a sufficient condition. Sam the Sheltie does a Good Job, too, but I wouldn’t exactly recommend an accomplished squirrel herder as a must-have addition to your farm. Even Maggie the German Shepherd, who does a Good Job of protecting the farm and is a player everyone would want on their team, has “regimes” where her above-replacement performance vanishes. I’ll put it this way … she apparently dislikes chickens almost as much as I do, such that if you’re a fox and you want to chow down on a free range hen or two, picnic-style in the middle of a grassy field while Maggie sits there and watches you eat … well, come on over. And that gets me to the second sine qua non of adopting convexity as a philosophy in our manager selection — we must have the process and the fortitude to scale our active risk allocations up and down based on what is working, including the ability to take risk completely away from our managers. Maggie is a VERY Good Dog. But when the chickens are loose her risk allocation here at the farm goes to zero. We find protection somewhere else.

Convexity as a philosophy is also at the heart of how we improve ourselves and our children as citizens.

Always be yourself. Unless you can be Batman. Then always be Batman.

It’s maybe the funniest movie line I know. Why is this funny? Because we have made a political and social fetish out of identity, out of the New Commandment to ALWAYS BE YOURSELF. Unless you can be Batman.

At the same time, we’ve attached pride and shame to identity, rather than to behavior where they belong, training ourselves and our children to be absurdly self-assured and prideful, and yet existentially ashamed all at the same time. ALWAYS BE YOURSELF is the most powerful story we tell ourselves. And the most dangerous if attached to pride and shame wrongly understood.

We can tell ourselves a new story. A story, dear Brutus, where the fault is not in our stars, but in ourselves. As is the achievement. As is the honor.

Find your pack. Here and here and here are some ideas on how to do that. And then do a Good Job with your service to the pack, no matter how big, no matter how small. You’ll figure it out.

Every dog needs a job to make sense of its place in the world. So does every human.

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Too Clever By Half


The smartest animals on my farm aren’t my bees (although they possess the genius of the algorithm). It’s not the horses or the goats or even the dogs. The barn cat is pretty smart, but only in fairly limited circumstances, and the house cats are useless. Obviously it’s not the sheep or the chickens. Nope, the smartest animals on my farm aren’t really on my farm at all. They’re the coyotes who live in the woods.

My favorite example? We have a really big invisible fence for the dogs … covers about five acres. Yes, my farm is a great place to be a dog. For those of you who aren’t familiar with the technology of the invisible fence, it’s a buried wire that transmits a signal to a receiver placed on your dog’s collar. When the dog gets close to the wire, the receiver starts to beep, and when the dog gets all the way to the “fence” boundary, the receiver generates a small electric zap. I know, I know … it’s negative reinforcement and it’s a shock collar and all that. Don’t care. It’s fantastic for us and our dogs. But whether it’s a smart dog like Maggie the German Shepherd or a … shall we say … “special” dog like Sam the Sheltie, after a few weeks (Maggie) or a few hours (Sam) they will forget where the fence exists if they stop wearing the collar.

Not so the coyotes.

The coyotes know *exactly* where the invisible fence begins and ends, without the benefit of *ever* wearing a shock collar. How do I know? Because they intentionally leave their scat on their side of the invisible fence, creating a demilitarized zone as precise and as well-observed as anything on the Korean peninsula. Occasionally a coyote will try to test our dogs by leaving its scat juuusst over the line on our side of the DMZ. Our dogs, of course, just blithely ignore the provocation, not even knowing that they’re being challenged. My dogs are the Roadrunner in some real-life Looney Tunes competition with Wile E. Coyote, super-genius. The coyotes are scheming; my dogs have no idea what scheming is.

I feel bad for the real-life coyotes in exactly the same way that 7-year-old me felt bad for Wile E. Coyote and 30-year-old me felt bad for The Brain (not a coyote, of course, but still). They put SO MUCH EFFORT into their plans and machinations for taking over the world, and it all comes to naught in a world of Roadrunners, Pinkys, and dogs like my Sam the Sheltie.
I see myself in the coyotes. So do most people reading this note, I bet.

For the canonical compilation of all Pinky and the Brain “pondering” quotes, see Richard Watanabe’s magisterial site.

The truth is that domestication makes any animal dumb. You name the species — dogs, cats, cows, horses, sheep, pigs — human selection on “tameness” for thousands of years accumulates a wide array of traits, including floppier ears, shorter snouts, hair color variability and the like, most likely based on more basic inherited alterations in certain stem cell and stress hormone production patterns (see Domesticated: Evolution in a Man-Made World, by Richard Francis, for a great read on all this). Different species show these external traits to different degrees. But the trait that ALL domesticated species demonstrate relative to their wild species is a smaller brain. I’d bet it’s happening with humans, too, but that’s just an observation for another day.

Unfortunately, coyotes are too smart for their own good. They are, to use the wonderful Brit phrase, too clever by half. They are, to use a post-modern, TV reality show lingo, not good in the meta-game. And the meta-game has turned against the coyotes with a vengeance.

Case in point — in our pre-farm life, where we had a yard like any other yard and were part of a neighborhood like any other neighborhood, we still had run-ins with coyotes. There were three or four of them roaming around one fall, coming in from the local nature preserve, and it became something of an issue in our small town. Warnings went out on mom chat groups not to let your small children play outside alone, much less your small dog or cat (yes, this was back in the day when it was not a blatant act of animal cruelty in Fairfield County, Connecticut to let your house cat go outside when it wished). Fortunately, clear instructions were provided through various channels as to how to protect your family.

Don’t yell at the coyotes. Half fill an empty coffee can with loose change and shake it at them. This will frighten them and they will run off.

Again, this is Fairfield County, Connecticut, where even owning a BB gun is enough to earn a lifetime ban from any play dates for your kids. It’s a far cry from growing up in Alabama like me or Texas like my wife, but when in Rome …

A few afternoons later the coyotes came wandering around our yard. We had (very) small kids at the time. So my wife dutifully brought out the coffee can she had prepared, and rushed out into the yard to confront the coyotes, shaking the coffee can like a madwoman. At which point the lead coyote, a female we think, sloooowly looked up and just stared at my wife. It wasn’t scared. It wasn’t frightened. It recognized immediately that there was absolutely zero danger posed by this human female gesticulating wildly and making a bizarre clanking sound with her hands. The message from that coyote’s stare was clear — is that all you got? Really? Almost derisively, the lead coyote sloooowly turned around and sauntered back towards the woods, leading the others away.

It was an alpha move. Smart, cool, totally in command. I’m leaving because I want to, at my own speed, and only because you’re annoying me with that ridiculous noise, not because I’m scared.

It was also a really dumb move for the meta-game.

What’s the meta-game? It’s the game of games. It’s the larger social game where this little game of aggression and dominance with my wife played out. The meta-game for coyotes is how to stay alive in pockets of dense woods while surrounded by increasingly domesticated humans who are increasingly fearful of anything and everything that is actually untamed and natural. A strategy of Skirmish and scheming feints and counter-feints is something that coyotes are really good at. They will “win” every time they play this individual mini-game with domesticated dogs and domesticated humans shaking coffee cans half-filled with coins. But it is a suicidal strategy for the meta-game. As in literally suicidal. As in you will be killed by the animal control officer who HATES the idea of taking you out but is REQUIRED to do it because there’s an angry posse of families who just moved into town from the city and are AGHAST at the notion that they share these woods with creatures that actually have fangs and claws.

The smartest play for coyotes in the meta-game is never to Skirmish with humans. Never. And if you find yourself in a Skirmish-with-Humans game, then the smart play is to act scared, to run away at top speed from a jangling coffee can. But no, coyotes are too clever by half, plenty smart enough to understand and master the reality of their immediate situation, but nowhere near smart enough to understand or withstand the reality of their larger situation. It’s their nature to play the scheming mini-game. They can’t help themselves. And that’s why the coyotes always lose. It’s always the meta-game that gets you.

Okay, Ben, entertaining as ever, but where are you going with all this?

Almost there. Before I pull this charming discussion of too clever by half coyotes back into the real world of markets, there’s one other (supposedly) clever, non-domesticated animal I need to introduce into this story. That’s the raccoon.

Coyotes have a roguish charm and bring something interesting to the world with their independence and scheming. Raccoons are simply criminals. And they’re not that smart. I’d put our barn cat up against a raccoon any day on any sort of cognitive test. We think raccoons are clever because they have those anthropomorphic paws and those cute little masks and even a Marvel superhero with its own toy line, but please. Raccoons are takers, not schemers. They’re killers, often for the sheer hell of it. Raccoons steal and kill way beyond what they need, and they do so in a totally wanton, non-clever way. I hate raccoons.

When they push their scheming and stealing too far, coyotes and raccoons ALWAYS end up getting killed by the farmer — regretfully in the case of coyotes, remorselessly in the case of raccoons. It’s not a cute Looney Tunes death, either. There’s no little puff of smoke and immediate reincarnation for these Wile E. Coyotes and Rocket Raccoons. Just blood and sadness.

That’s true on the farm and it’s true in the real world, too. And that’s how we pull this allegory together.

Every truly disruptive discovery or innovation in history is the work of coyotes. It’s always the non-domesticated schemers who come up with the Idea That Changes Things. We all know the type. Many of the readers of this note ARE the type.

Financial innovation is no exception. And this is Reason #1 why financial innovation ALWAYS ends in tears, because coyotes are too clever by half. They figure out a brilliant way to win at the mini-game that they’re immersed in, and they ignore the meta-game. Eventually the meta-game blows up on them, and they’re toast.

Reason #2? Financial innovation, more than any other sort of innovation, attracts the raccoons — con men and hucksters at best, outright thieves at worst. They infest financial innovation. And they can’t control themselves, so they always push it too far. They’re never content with stealing a little. Or even a lot. No, raccoons want it ALL.

Example, please.

Financial innovation is always and in all ways one of two things — a new way of securitizing something or a new way of leveraging something.

Securitization is a ten-dollar word that means associating something in the real world (a cash flow from a debt, an ownership interest in a company, a deed on a property, a distributed ledger mathematical calculation, etc.) with a piece of paper that can be bought and sold separately from that real world thing.

Leverage is a ten-dollar word that means borrowed money.

That’s it. There’s nothing new under the sun. Finding new ways to trade things (securitization) or new ways to borrow money on things (leverage) is what financial innovation is all about, and there are vast riches awaiting the clever coyotes who can come up with a useful scheme on either.

The biggest market disasters happen when both leverage and securitization get mixed up with the same clever scheme, as when new ways of leveraging and securitizing U.S. residential mortgages were developed in 2001, resulting in the creation of a $10 trillion asset class that utterly collapsed during the Great Financial Crisis. There were a lot of coyotes involved in so gargantuan an Idea That Changes Things, but most illustrative for these purposes is the Gaussian Copula formula published by David Li in 2000, the “technology” which allowed the securitization of pretty much any mortgage portfolio (prior to this most securitization was limited to “conforming” mortgages securitized by Fannie Mae and other government-sponsored mortgage agencies) and also the leveraging of those securities through tranching (splitting up the security into still more securities, each of which can be used as collateral for more borrowing, particularly those tranches with higher credit ratings). I wrote a bit about the Gaussian Copula in “Magical Thinking”, and if you want to learn more you can’t do better than  Felix Salmon’s 2009 Wired magazine article — “The Formula That Broke Wall Street” — still my all-time favorite piece of financial market journalism.

The formula doesn’t look like much, does it? But this little equation made billions of dollars in profits for Wall Street through hundreds of clever coyote schemes. More than a few raccoons got involved along the way. And then it broke the world in 2008.

It’s what I’ll call “coyote-math”. The math behind blockchain and Bitcoin the Gaussian Copula and non-agency residential mortgage-backed securities (RMBS) is undeniable. It is a mathematical certainty that these securities “work”. Unless, of course, you have a government-led chilling effect on exchanges and network transactions a nationwide decline in U.S. home prices, in which case Bitcoin non-agency RMBS doesn’t work at all.

So what will does the aftermath of this classic example of financial innovation gone awry look like?

Blockchain The Gaussian Copula is still around. These things don’t get un-invented, and it’s still a very useful piece of code for certain applications. The truth about blockchain the Gaussian Copula is that it’s an Idea That Changes Things In a Modest Way, not an Idea That Changes Everything. It’s a modern algorithmic twist on letters of credit portfolio risk, and there are a few interesting uses for that. Just a few, but that’s okay. That’s still important. Just not as important as HODLers Wall Street thought it was.

As for the primary financial application that blockchain the Gaussian Copula spawned, Bitcoin non-agency RMBS is still around, too. The securitization of distributed ledger calculations non-conforming mortgages is something that market participants still want and still trade. It will NEVER be a $10 trillion asset class again, because the inherent flaws of this security have been well revealed. Turns out that Bitcoin a AAA-rated tranche of Alt-A mortgages wasn’t the store of value that coyote-math “proved” it was, to the detriment of individual institutional investors who put a significant portion of their portfolio into these securities, and to the ruin of those who used leverage to acquire these securities.

Many of the coyotes involved with this classic example of financial innovation gone awry are (professionally) dead. At the very least careers were permanently derailed, and entire coyote institutions, like Bear Stearns, were taken out into the street and shot in the head by animal control officers were merged into healthier financial institutions by government regulators as an example to other coyote institutions as a necessary measure for systemic stability. I miss Bear Stearns. The world is a poorer place for Bear Stearns not being in it.

Surprisingly few of the raccoons involved are (professionally) dead. In fact, more than a few of the financial hucksters involved with the run-up to the Great Financial Crisis are back to their old tricks with cryptocurrencies whatever the latest coyote innovation might be. This makes me VERY angry, and probably colors my view on blockchain financial innovation more generally. I wouldn’t miss the raccoons for a second if the animal control officers took them out, but somehow they never do.

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.

When coyotes play the Skirmish game, that’s all the excuse the State needs to come swooping in. And that’s exactly what is happening with Bitcoin what happened with non-agency RMBS.

What’s the alternative to playing Skirmish in the meta-game?

It’s this: to be an arborist.

It’s this: to be as wise as serpents and as harmless as doves.

Coyotes can change the world. Coyotes WILL change the world. But not if they misplay the meta-game. Not if they hang out with raccoons. Not if they fetishize ANY financial instrument as an intrinsic aspect of a commitment to liberty and justice for all. Because it’s not.

Render unto Caesar the things that are Caesar’s. Wise words 2,000 years ago. Wise words today.

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The Three-Body Problem

As much as I dislike the chickens on our farm, I love my bees. Do they sting? Of course they sting. The swarm is a wild animal. But after a few painful years I’m no longer a ham-handed goofball with my hives, and a morning spent in sync with this amazing animal is never a bad morning. Not only are bees low maintenance, not only do they pay a wonderful rent, but they demonstrate a genius and an optimism — there’s just no other word for it — that makes me feel more creative and alive.

The Connecticut winters are tough, though. I do what I can to support the bees, which is mostly just building a wind break with bales of straw, making sure that the hive stays ventilated enough to prevent water vapor condensation, and preventing mice from taking up residence. That and avoiding original sins like poor hive placement or collecting too much rent. But ultimately it’s a battle between the animal and Mother Nature. It’s up to them to survive. Or not.

Honeybees don’t hibernate (bumblebees do, but hive colony bees don’t), and they can’t fly south for the winter. To survive a Northern winter, bees change the composition of the swarm by shrinking the overall population, caulking the hive, getting rid of the deadweight males (i.e., ALL of the males), and laying just enough eggs to preserve a minimal survivable population through the winter and into spring. They cluster together in the center of the hive, keeping the queen in the center, shivering their wings to create kinetic energy, occasionally sending out suicide squads to retrieve honey stores from the outer combs. They lower their metabolism by creating a cloud of carbon dioxide in the hive. Yes, a carbon dioxide cloud.

All of this preparation takes time. To survive winter, the swarm starts to change its behaviors — from brood patterns to pollen collection to comb creation — not when the weather starts getting cold, but in the middle of summer when the dog days of August are still in front of us. And not just on some random date, but on a completely predictable day.

In 2018 my bees will begin to prepare for winter on Friday, June 22nd.

Why? Because bees can measure the angle of the sun’s rays. They can remember this from one day to the next. When today’s midday sun is ever so slightly lower in the sky than yesterday’s midday sun, a bee will know it. And the entire colony will begin to change.

Bees recognize the freakin’ summer solstice with as much accuracy as any human civilization ever did.

See? Genius. But we’re just getting started.

When bees act on their awareness of the summer solstice, they are trading a derivative. And they expertly manage the basis risk of that trade.

Huh? Time out, Ben. What are you talking about?

A derivative, in the broadest sense of the word, is something that’s related to something else you care about (the “underlying”), but for whatever reason you choose to interact with the derivative-something rather than the underlying-something. For humans, you might care about the stock price of company XYZ, so that’s the underlying, but you think something momentous is going to happen to the company three months from now, so you interact with a derivative on the stock, in this case a three-month option contract. For bees, the thing they truly care about is how cold it gets, so from their perspective the temperature is the underlying and the sunlight angles are the derivative thing that they analyze and interact with. In truth, of course, it’s the tilt of the Earth’s axis and the resultant sunlight angles that cause seasonality and temperature changes, so a curmudgeonly reader might accurately say that actually, it’s the temperature that’s the derivative here, but I trust we’re all open-minded enough to take a bee’s eye view of the world for the duration of this note.

Why do bees take their behavioral cues from sunlight angles rather than temperature change directly? Because the algorithm for predicting seasonality:

IF (maximum incident angle of sunlight today is less than the maximum incident angle of sunlight yesterday)

THEN (prepare for winter)

is enormously simpler, more predictive, more timely, and less volatile than any sort of temperature time-series analysis, or at least any temperature time-series analysis available to bees and pre-weather satellite humans. The genius (and fatal flaw) of bees and humans is their ability to create complex social systems on the basis of simple algorithms like this. Modern computing systems of the Big Data sort have a very different type of genius.

Hold that thought.

But first let’s make sure we understand what basis risk means, and why it’s The Most Important Thing to understand when you’re dealing with derivatives. “Basis” is the relationship between the derivative and the underlying, and so basis risk is how bad things could get if the relationship between derivative and underlying isn’t as tight as you thought it was. For bees, basis risk takes the form of cold weather coming sooner or later than normal. Shrinking the colony like clockwork based on the summer solstice works great if the first big freeze comes in November, not so well if you get a big snow in mid-October.

The key to managing basis risk is to keep your risk antennae (literally antennae when it comes to bees) focused on how well the derivative thing is tracking with the underlying thing. You need to watch the correlation. So to manage their basis risk, bees are also sensitive to temperature (the underlying) and all of the other derivative things related to changing temperature, like flower bloom patterns or prevailing winds. Nothing will totally override the summer solstice trade (even tropical bees make some small colony adjustments based on seasonality), but bees are adaptive investors, able to accelerate their winter preparation if cold weather comes early or delay it if cold weather comes late. Efficient management of basis risk is a balancing act between sticking with the original trade and adapting your behavior to changing correlations (you don’t want to mistake an Indian Summer for spring!), but that’s the beauty of evolution — billions of bee colonies over millions of years have lived and died and reproduced to naturally select the combination of hard-wired nervous system algorithms that allows honeybee species to thrive across a wide range of ecosystems and a wide range of seasonal weather variations.

But it’s only a range. Bees can’t live in as wide a range of ecosystems and weather variations as, say, ants. I doubt there’s a bee colony on Earth that can survive six months straight of sub-50 degree weather. If you’re a bee colony and you’ve moved that far north and that’s the magnitude of your downside basis risk, it really doesn’t matter how amazing you are in your solar declination calculations … you’re not going to make it. Maybe you get lucky for a couple of years, but if it’s possible that you could have four or five months of harshly cold weather, then sooner or later that severe basis risk catches up with you. This is a basis risk that you can’t insure against, that you can’t hedge against with extra preparation or precaution. It’s an unmanageable basis risk. For most of North America, though, even pretty far up into Canada, cold weather is a manageable basis risk, particularly if you’ve got a beekeeper able to lend a helping hand. Sometimes the bees will get a bad roll of the weather dice and you’ll lose a hive to basis risk, but it doesn’t threaten the species.

Species risk comes into play when you get a major climactic event that lasts for a long time in terms of a colony’s lifespan but not long at all in terms of evolution, genetic mutation, and natural selection. Like, say, what if spring no longer followed winter? What if it snowed in August and flowers bloomed in January? What if winter disappeared for a decade? What if it lasted that long? What if your weather basis risk was unknowable, as in Game of Thrones? Even a short Westerosi winter of a couple of years would kill every bee colony on the continent, which is why I don’t think I’ve ever seen a bee hive on Game of Thrones. [Hmm … I’ve just been informed by Grand Maester Guinn that “one of the Baratheon vassal houses of the Reach is House Beesbury, with a family seat of Honeyholt and a family motto of Beware Our Sting.” Sigh. You see what I have to put up with? Okay, we’ll stipulate that Dornish latitudes are safe. But The North is no place for bees when winter comes!]

This is basis uncertainty, where you’re not even sure that any basis exists at all, as opposed to mere basis risk. Basis uncertainty is an unknowable basis risk, which is much more damaging to species development than the occasional bout of severe basis risk.

[Long parenthetical: understanding the distinction between risk and uncertainty is crucial in every aspect of life. A risky decision is when you have a pretty good sense of the odds and the pay-offs. It lends itself to statistical analysis and econometrics, particularly if it’s a decision you will have the opportunity to make multiple times. An uncertain decision is when you don’t have a good sense of odds and pay-offs. Here, statistical analysis may very well kill you, particularly if you’re not going to get many cracks at the game, or if you don’t know how many times you’ll get to make a choice. You need game theory to make sense of decisions made under uncertainty.]

Basis uncertainty is the core problem facing every investor today.

It’s not just that we endure large basis risks here in the Hollow Market, unmanageable for many. It’s not just that all of our old signposts and moorings for navigating markets aren’t working very well. It’s not just difficult to identify predictive/derivative patterns in today’s markets. There is a non-trivial chance that structural changes in our social worlds of politics and markets have made it impossible to identify predictive/derivative patterns. THIS is basis uncertainty, and it’s as problematic for humans facing markets that don’t make sense as it is for bees facing weather patterns that don’t make sense.

Well, that’s just crazy talk, Ben. What do you mean that it might be impossible to identify predictive/derivative patterns? What do you mean that basis might not exist at all? Of course there’s a pattern to markets and everything else. Of course spring follows winter.

Nope. This is the Three-Body Problem.

Or rather, the Three-Body Problem is a famous example of a system which has no derivative pattern with any predictive power, no applicable algorithm that a human (or a bee) could discover to adapt successfully and turn basis uncertainty into basis risk. In the lingo, there is no “general closed-form solution” to the Three-Body Problem. (It’s also the title of the best science fiction book I’ve read in the past 20 years, by Cixin Liu. Truly a masterpiece. Life and perspective-changing, in fact, both in its depiction of China and its depiction of the game theory of civilization.)

What is the “problem”? Imagine three massive objects in space … stars, planets, something like that. They’re in the same system, meaning that they can’t entirely escape each other’s gravitational pull. You know the position, mass, speed, and direction of travel for each of the objects. You know how gravity works, so you know precisely how each object is acting on the other two objects. Now predict for me, using a formula, where the objects will be at some point in the future.

Answer: you can’t. In 1887, Henri Poincaré proved that the motion of the three objects, with the exception of a few special starting cases, is non-repeating. This is a chaotic system, meaning that the historical pattern of object positions has ZERO predictive power in figuring out where these objects will be in the future. There is no algorithm that a human can possibly discover to solve this problem. It does not exist.

To visualize the Three-Body Problem, here’s a simulation of the orbits of green, blue, and red objects with random starting conditions, each exerting a gravitational pull on the others. What Poincaré proved is that there is no formula where you can plug in the initial information and get the right answer for where any of the objects will be at any future point in time. No human can predict the future of this system.

But a computer can. Not by using an algorithm, which is how biological brains — human and bee alike — evolved to make sense of the world, but by brute force calculations. Remember, you know everything about these three objects … none of the physics here is a mystery. If you can do the calculation quickly enough, you can compute where all three objects will be one second from now. And one second from then. And one second from then. And so on and so on. With enough processing power (and this can require a LOT of processing power) you can calculate where the three objects will be 100 years from now, even though it is impossible to solve for this outcome.

It’s a hard concept to wrap your head around, this difference between calculating the future and predicting the future, but it will change the way you see the world. And your place in it.  

Now here’s an observation that I can’t emphasize strongly enough, although I’ll try:

THIS IS NOT HOW WE USE COMPUTERS IN OUR INVESTING STRATEGIES TODAY

The way that computers can calculate an answer to the Three-Body Problem is straightforward — they can be programmed with the physics rules for how one object influences another object, so they can simulate where each object will go next. There is ZERO examination of where the objects have been in the past. This is entirely forward looking.

The way that computers can NOT calculate an answer to the Three-Body Problem is by examining the historical data of where the objects have been. In a chaotic system, it doesn’t matter how hard or how fast or how deeply you look at the historical data. There is NO predictive pattern, NO secret algorithm hiding in the data. And yet this is exactly what we all have our computers doing … examining historical data to look for patterns that will give us the magic algorithm for predicting what’s next! The only thing that the past gives you in a chaotic system is inertia, which can look like a pattern or an algorithm for some period of time, depending on how all the objects are aligned. But it’s a mirage. It will not last. Examining the past of a chaotic system can give you lots of little answers, like sparks off a bonfire, none lasting more than a few seconds. And certainly if you’re efficient with your inertia-identifying spark-capturing effort, you can make some money using computers this way. But this examination of the past through naïve induction will never give you The Answer. Because The Answer does not exist in the past. The Answer — which is another word for algorithm, which is another word for “general closed-end solution” — doesn’t exist at all in a chaotic Three-Body System.

But we can approximate The Answer. We can calculate the future in small computational chunks even if we can’t predict the future in one big algorithmic swoop, but only if we can program the computer with the “physics” of how “gravity” works in social systems like markets. What’s our financial world equivalent of a theory of gravity? I think it’s a theory of narrative. This, to me, is a more interesting research program than identifying small inertias or capturing brief sparks. But it’s not where our computing resources are being allocated, because there’s no money in it. Yet.

Exploring a theory of narrative, what I’ve called the Narrative Machine, is basic research. Like all basic research, it’s not immediately remunerative and thus is difficult to fund. But that’s not the biggest obstacle. No, the biggest obstacle to basic research in computational finance is that humans are hard-wired to look for algorithms and have a really hard time imagining that it’s even possible to pursue a non-anthropomorphic (how about that for a $10 word) research design that doesn’t pore through historical data looking for predictive algorithms at every turn. We can’t help ourselves!

What if I told you that algorithms and derivatives are as much at the heart of how humans prepare for their financial future as they are for bees preparing for their seasonal future? What if I told you that the dominant strategies for human discretionary investing are, without exception, algorithms and derivatives? And what if I told you that these algorithms and derivatives were perhaps “evolved” under a “benign” configuration of the Three-Body Problem that not only might never repeat, but in fact is certain to never repeat because it is a chaotic system?

I’ll give you two examples of influential investment algorithms/derivatives. There are many more.

GOOD COMPANIES => GOOD STOCKS

GOOD COUNTRIES => GOOD GOVERNMENT BONDS

These are the central tenets of stock-picking and sovereign bond-picking, respectively. In both cases, goodness (like beauty) is in the eye of the beholder, so I’m not saying that there is some single standard for what makes a “good” company or what makes a “good” set of macroeconomic policies. What I’m saying is that everyone reading this note (including me!) believes that there is a direct relationship between the quality of a company or an economy (however you define quality) and the future price of whatever stocks or bonds are connected to that company or economy. What I’m saying is that everyone reading this note believes that tracking the measurable quality of a company or an economy (the derivative) according to some standardized and repeatable process (the algorithm) will, over time, have a predictive correlation with the future price of the related stock and bond securities (the underlying).

What stocks do we want to own? Why, the stocks of high quality companies, of course … companies with stellar management teams, fortress balance sheets, and wonderful products or services that everyone wants to buy. Ditto for government bonds and currencies and broad market indices and the like. Maybe it will take some time for this faith in Quality to pay off, but we all believe that it WILL pay off. It’s only natural, right? As natural as spring following winter. As natural as flowers blooming in May and snow falling in December. Maybe the flowers will bloom a few weeks late and maybe the snows will fall a few weeks early, but that’s just basis risk, and we can manage for that.

But what if spring doesn’t follow winter anymore?

Look, I’m not asking us to abandon our faith in Quality. One of the key corrolaries of the Three-Body Problem is that we don’t have to reject our belief that Objects 1 and 2 exist. We don’t have to deny our faith that the Quality-of-Companies is an actual thing and that it has a big gravitational pull on the price of stocks. We don’t have to deny our faith that the Quality-of-Governments is an actual thing and that it has a big gravitational pull on the price of government bonds.

What we have to accept is that there is an Object 3 that has moved into a position such that its gravity absolutely swamps the impact of Objects 1 and 2. This Object 3, of course, is extraordinary monetary policy, specifically the purchase of $20 TRILLION worth of financial assets by the Big 4 central banks — the Fed, the ECB, the BOJ, and the PBOC.

$20 trillion is a lot of mass. $20 trillion is a lot of gravity.

Here’s the impact of all that gravity on the Quality-of-Companies derivative investment strategy.

The green line below is the S&P 500 index. The white line below is a Quality Index sponsored by Deutsche Bank. They look at 1,000 global large cap companies and evaluate them for return on equity, return on invested capital, and accounting accruals … quantifiable proxies for the most common ways that investors think about quality. Because the goal is to isolate the Quality factor, the index is long in equal amounts the top 20% of measured  companies and short the bottom 20% (so market neutral), and has equal amounts invested long and short in the component sectors of the market (so sector neutral). The chart begins on March 9, 2009, when the Fed launched its first QE program.

Over the past eight and a half years, Quality has been absolutely useless as an investment derivative. You’ve made a grand total of not quite 3% on your investment, while the S&P 500 is up almost 300%.

This is not a typo.

Have the Quality stocks in your portfolio gone up over the past eight and a half years? Sure, but it’s not because of the Quality-ness of the companies. It’s because ALL stocks have gone up ever since Object 3, the balance sheets of central banks, started exerting its massive gravity on everything BUT Quality. That’s not an accident, by the way. Central banks don’t care about rewarding “good” companies. In fact, if they care about anything on this dimension, they care about keeping “bad” companies from going under.

This is what it looks like when spring does not follow winter.

And here’s the impact of all that gravity on the Quality-of-Countries derivative investment strategy.

The gold line below is the spread (difference) between Portugal’s 10-year bond yield and the U.S. 10-year bond yield, and the blue line is the spread between Italy’s 10-year note yield and the U.S. equivalent. In “normal” times, a country with a weaker set of macroeconomic characteristics (high levels of national debt, say, or maybe low productivity) will have to offer investors a higher rate of interest to borrow their money than a country with a stronger set of macroeconomic characteristics. So in the summer of 2012, when Portugal and Italy were both looking like deadbeat countries, they had to pay investors a much higher rate of interest than the U.S. did to attract the investment … about 9% more (this is per year, mind you) for Portugal and 4% more for Italy. Those are enormous spreads in the world of sovereign debt!

This chart begins in the summer of 2012, when the ECB announced its intentions to prop up the European sovereign debt market directly. Since that announcement — even though both Portugal and Italy have higher debt-to-GDP ratios today than in 2012 — the spread versus U.S. interest rates has done nothing but decline. Driven by the commitment of the ECB to “do whatever it takes” and to be not only a last-resort buyer but also a first-in-line buyer of Portuguese and Italian debt, it now costs LESS for these countries to borrow money for 10 years than the U.S.

This is nuts. It’s an understandable nuts when you consider that the German 10-year bond yield is currently about 30 basis points, and was actually negative (meaning that you had to pay the German government for the privilege of lending them money for the next 10 years) for about six months in 2016. Meaning that at least with Italian and Portuguese debt you’re being paid something (a little less than 2% per year). It’s an understandable nuts when you consider that the Swiss 10-year bond still sports a negative interest rate and has been negative for the past two and a half years. There’s about $10 trillion worth of negative yielding sovereign bonds out there today, something that is IMPOSSIBLE under a [good country => good bond] derivative algorithm. No country is that good! But it’s entirely possible under the immense gravitational force of massive central bank asset purchases.

Here’s the kicker. Below is the spread between Greek 10-year sovereign bonds and U.S. 10-year notes. In 2012 you were paid 24% more to lend money to Greece. Per year! Today you are paid less than 2% more to lend money to Greece rather than the United States. For ten years. To Greece.

Again, I’m not saying that the Quality derivative doesn’t exist as a real thing or that it isn’t an important factor in the history of successful stock-picking or bond-picking. What I’m saying is that the Quality derivative hasn’t mattered for eight and a half years with stocks and five years with sovereign debt. What I’m saying is that it might not matter for another eighty years. Or it might matter again in eight months. A Three-Body System is a chaotic system. As the boilerplate says, past performance is not a guarantee of future results. In fact, the only thing I can promise you is that past performance will NEVER give you a predictive algorithm for future results in a chaotic system.

This is basis uncertainty. This is the biggest concern that every investor should have, that the signals (derivatives) and processes (algorithms) that we ALL use to make sense of the investing world are no longer connected to security prices.

… Okay, Ben, you’ve exhausted me. It’s a weird and strange way of looking at the world, but let’s go with it for a minute. What’s the pay-off here? What do we DO in a chaotic system? What does that even mean, to say that we are investors in a chaotic system?

Four suggestions.

First, I think we should adopt a philosophy of what I’ve called profound agnosticism when it comes to investing, where we don’t just embrace the notion that no one has a crystal ball in this system, but we actually get kinda annoyed with those who insist they do. I think that risk balancing strategies make a ton of sense in a chaotic system, so that we think first about budgeting our risk agnostically across geographies and asset classes and sectors, and secondarily think about budgeting our dollars.

Second, and relatedly, I think we should adopt a classic game theory strategy for dealing with uncertain systems — minimax regret. The idea is simple, but the implications profound: instead of seeking to maximize returns, we seek to minimize our maximum regret. Keep in mind that our maximum regret may not be ruinous loss! I know plenty of people whose maximum regret is not keeping up with the Joneses. In fact, from a business model perspective, that’s more common than not. Or if you’ve bought into Bitcoin north of $15,000 per coin, I think you know what I’m talking about, too. The point being that we need to be painfully honest with ourselves about our sources of regret and target our investments accordingly. If we can be this honest with ourselves, it’s a VERY powerful strategy.

Third, I think we should reconsider our approach to computer-directed investment strategies. Using computers in an anthropomorphic way, where we treat them like a smarter, faster human, set loose in a vast field of historical data to search for patterns and algorithms … it’s a snipe hunt. Or at least I think we’ve squeezed just about all the juice out of this inductive orange that we’re likely to get. With the massive processing power at our fingertips today, not to mention the orders-of-magnitude-greater processing power that quantum computing will bring to bear in the future, there’s much bigger game afoot with computational approaches that take a more deductive, forward-looking strategy.

Fourth, and perhaps most importantly, I think we need to accept that we’re never going to fully understand the reality of a chaotic system, but that it’s never been more important to try. The brains of both bees and humans are hard-wired for algorithms. Both species see patterns even when patterns don’t exist, and both species tend to do poorly in environments where derivative signals are plagued by basis uncertainty rather than mere basis risk. Every bee in the world will follow its hard-wired algorithms even unto death. And most humans will, too. But humans have the capacity to think beyond their biological and cultural programming … if they work at it.

Where do we lose good people? When they convince themselves that they’ve found The Answer — either in the form of a charismatic person or, more dangerously still, a charismatic idea — in a chaotic system where no Answer exists. A chaotic system like markets, yes, but also a chaotic system like politics.

The Answer is, by nature, totalitarian. Why? Because it’s a general closed-form solution. That’s the technical definition of The Answer, and that’s the practical definition of totalitarian thought. We’re hard-wired to want the all-encompassing algorithm, which is why it’s so difficult to resist. But if we care about liberty. If we care about justice. If we care about liberty and justice for all … we have to resist The Answer.

Because we’ve lost enough good people.

As wise as serpents, as harmless as doves …

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Pecking Order

Out of all the animals we keep on our “farm”, chickens are the only ones that bring me no joy. Chickens are, by nature, brutal and cruel. They will torture the weak to death with their pecks, not because they have to, but because they can. It’s the way their brains are hard-wired, and it works for them, as a species. So I pretend that chickens aren’t evil and I’m not complicit. Because I really like the eggs.

We are trained and told that the pecking order is not a real and brutal thing in the human species. This is a lie. It is an intentional lie, one that we pretend isn’t evil and where we are not complicit.

Because we really like the eggs.

And that’s the news from Lake Wobegon, where all the women are strong, all the men are good-looking, and all the children are above average.

― Garrison Keillor

We can’t all be rich.

We can’t all be famous.

We can’t all be Someone Who Matters to the World.

[Team Elite Narrator: OR CAN WE?]

Blake: Put. That coffee. Down. Coffee’s for closers only. You think I’m f**king with you? I am not f**king with you. I’m here from downtown. I’m here from Mitch and Murray. And I’m here on a mission of mercy. Your name’s Levine? You call yourself a salesman, you son of a bitch?
Moss: I don’t gotta sit here and listen to this s**t.
Blake: You certainly don’t, pal, ’cause the good news is — you’re fired. The bad news is — you’ve got, all of you’ve got just one week to regain your jobs starting with tonight. Starting with tonight’s sit. Oh? Have I got your attention now? Good. ‘Cause we’re adding a little something to this month’s sales contest. As you all know, first prize is a Cadillac Eldorado. Anyone wanna see second prize? Second prize is a set of steak knives. Third prize is you’re fired. Get the picture? You laughing now? You got leads. Mitch and Murray paid good money for their names. You can’t close the leads you’re given, you can’t close s**t. You ARE s**t! Hit the bricks, pal, and beat it ’cause you are going OUT!
Glengarry Glen Ross (1992)

The truth is that unless you are really rich, you work for Mitch & Murray. Yes, that includes you, Vox writer changing the world one smarter-than-thou opinion at a time. Yes, that includes you, tech start-up developer kicking back in your flair-bedecked WeWork cubicle.

We don’t feel the crushing power of the Mitch & Murray pecking order as palpably as the salesmen berated by Alec Baldwin feel it, because the language of David Mamet has been replaced by the language of Dick Thaler and Cass Sunstein. The modern Mitch & Murrays don’t browbeat us. They nudge us. They convince us that a set of steak knives is a darn good outcome, that it’s a promise kept rather than a threat delivered. Coffee’s not just for closers. No, no … coffee is for EVERYONE. In fact, let’s put some caffeine into everything you drink. Something nice and caffeinated to wash down that big slice of office birthday cake.

Most importantly, today’s Mitch & Murray writ large — the system of Mitch & Murrays — provides credit to the non-rich, essentially limitless credit for anything that’s intangible or depreciates quickly, anything that lets the non-rich FEEL rich. How about a nice dinner out? New smartphone? You deserve it! How about a couple of years of graduate school? More than a couple of years, shooting for a tenure track position? [Heh, heh] I mean … why certainly, even better!

Go on, try the eggs. They’re delicious.

And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

― Ben Bernanke (2010)

Step One in the Pecking Order Lie is to promote a narrative of trickle-down economics — that making the rich even richer is a good thing for the non-rich.

This is exactly what Ben Bernanke is saying here, that the Fed’s extraordinary efforts to prop up the stock market aren’t just good for the rich, but will be good for everyone once the “wealth effect” kicks in and the rich start spending their money.

Whenever someone uses the phrase “wealth effect”, they are promoting a trickle-down narrative.  

How does trickle-down monetary policy work? By spending TRILLIONS of dollars to buy financial assets, the world’s central banks have inflated the prices of ALL financial assets, EVERYWHERE in the world.

This is not a secret plan. This is not a hidden agenda. This is the avowed purpose of what central bankers call Large Scale Asset Purchases (LSAPs). The goal is to force us to “reach for yield”. The goal is to force us to buy more and more risky assets (stocks) at higher and higher prices. The Fed is trying to make the stock market go up. And they’re succeeding.

Here’s a great chart from TCW showing how this works. The orange line is the growth rate of the US economy. The blue line is the growth rate of how rich we are. By tripling the stock market, the Fed has made us much richer than our economy has grown … SOOO much richer than our economy has grown.

But the goodies of a trebled stock market aren’t evenly distributed. Who owns stocks? If we’re talking about households, leaving aside pension funds and endowments and other institutional investors, it’s the rich, mostly. And that household share of the Central Bankers’ Bubble doesn’t increase linearly with wealth, but exponentially, meaning that the really rich own a lot more stocks than the merely rich, so the really rich have gotten a lot richer than the merely rich.

Here’s a chart from Deutsche Bank showing the impact (it’s a year old, so the effect is even more pronounced today with the stock market 20% higher). Thirty years ago, the non-rich (the bottom 90% of American households by income) owned 35% of American household wealth. Today they own about 22%. Forty years ago, the really rich (the top 1/10th of 1% of American households by income) owned about 7% of American household wealth. Today they, too, own about 22%. Moreover, the gains of the really rich have mirrored the losses of the non-rich, which means that the well-off and merely rich (the remaining 9.9% of American households) haven’t seen much of a change one way or another.

Now this shift in relative wealth of the non-rich and the really rich didn’t start with the Central Bankers’ Bubble and its narrative of trickle-down wealth effects from monetary policy. It started roughly in 1980 with the Reagan narrative of trickle-down wealth effects from fiscal policy. And before we make overly facile comparisons with the 1920s and 1930s, this chart isn’t taking into account pensions and social security and other safety net features of the modern semi-sorta-welfare state. So I don’t know how historically abnormal today’s level of significant wealth inequality might be, whether it’s Louis XVI level inequality or simply robber baron level inequality.

But I know that it IS.

I know that inequality is growing. I know that the pecking order has been getting stronger for a couple of decades now, and that it’s been driven by the Central Bankers’ Bubble over the past decade. I suspect that this is probably a good thing for global egg production. I also suspect that this is a bad thing if you care about liberty and justice for all.

The narrative around trickle-down fiscal policy has become highly politicized, as the good Democrat soldiers at the usual Team Elite bastions never tire of telling us how those Republican tax policies will increase wealth inequality. And they’re right.

But these same tireless foes of trickle-down fiscal policy trip over themselves praising and promoting the narrative of trickle-down monetary policy under Bernanke and Yellen, which has been FAR more effective at delivering windfall gains to the really rich than Ronald Reagan or Paul Ryan could ever dream of achieving through tax “reform”.

Lenin called communist sympathizers in the West “useful idiots”. The Nudging State and the Nudging Oligarchy have their own willing crew of stooges, drawn primarily from children of privilege (well off or merely rich, not really rich) who want to “make a difference”, who want to be Someone Who Matters to the World.

[Team Elite Narrator: But you DESERVE to be Someone Who Matters to the World, my young friend. You’re good enough, you’re smart enough, and doggone it, people like you. Why, here as a WaPo staffer you’ll be making the world a more succulent host for Jeff Bezos better place for all!]

The picture on the left is Jeff Bezos, age 40, worth a billion dollars or so. The picture on the right is Jeff Bezos, age 52, worth 100 billion dollars or so. HGH looks good on you, Jeff.

I think that at some point in the next decade, it’s inevitable that oligarchs like Bezos will gain access to life extension technologies unavailable to ordinary mortals. At that point, the pecking order will take on an entirely new dimension. At that point, we have a war. Which the non-rich will lose.

You’ll be pleased to know that Janet Yellen, with a reported net worth of about $15 million, is “greatly concerned” about growing inequality, but regrets that the Fed has no purview on this terrible problem. Perhaps Congress should do something, she suggests, like “making college more affordable” — by which she means extending even more debt financing — or “supporting early childhood education” — by which she means publicly funded daycare so that both parents can work in support of the Nudging State and the Nudging Oligarchy.

This is Step Two of the Pecking Order Lie — the provision of massive debt financing to the non-rich, preferably for non-appreciating experiences like going to college or quickly depreciating things like cars and smartphones.

Why? So that the non-rich will FEEL RICH even as they BECOME POORER.

Student debt (and every other form of consumer debt) is the functional equivalent of an office birthday cake. Debt provision and a pleasant narrative to go with it is a highly cost-effective behavioral tool for maintaining worker morale in the face of objectively deteriorating labor conditions.

Milton:   The ratio of people to cake is too big!
 Office Space (1999)

Unless, like Milton, you don’t get your slice of cake. Then you burn the office down. Or vote for Trump. Same thing.


It is a sin to believe evil of others, but it is seldom a mistake.

― Garrison Keillor

The pecking order is real. It is beautifully masked in modern human society, but no less brutal and no less cruel than in the chicken coop.

How do you escape the pecking order? How do you quit Mitch & Murray? Well, you can make a lot of money. That’s the tried and true method. Enough money to build a walled garden around you and yours, expanding it as you can to take in others. F-you money. Somewhere between merely rich and really rich should do the trick, depending on how many generations you want to protect within those walls. Unfortunately, that’s a big gulf these days, that distance between merely rich and really rich, and it’s getting wider every day.

But there’s another way.

No matter how much money we have or don’t have, we can reject the idea that we can be Someone Who Matters to the World and instead embrace the idea that we must be Someone Who Matters to the Pack. Now maybe your pack IS the world. Probably not, but maybe. If it is, then be bold and matter to the world. But more likely it’s your family. More likely it’s your friends. More likely it’s your partners and employees. More likely it’s your church. More likely it’s your school. More likely it’s your country. It’s damn sure not your political party. It’s damn sure not an oligarch.

Why should we reject this notion of being Someone Who Matters to the World? Because that’s the shiny lure that the Nudging State and the Nudging Oligarchy dangle in front of bright young things. And bright not-so-young people, too. The shiny lure of mattering is how they set the hook — which is debt — and that’s how they reel you in. Because once you’ve got that hook in your mouth … once you’re up to your eyeballs in debt … it’s soooo hard to ever get free. I know of which I speak. So do a lot of people reading this note, I bet.

The simple truth is that we can’t escape the pecking order. We can’t escape economic inequality and the hard-wired impulses to brutality and cruelty used to support inequality. Not for long, anyway. Walled gardens never last.

But we can do better. We can reject the lies used to justify inequality even as we accept the reality of inequality. We can be IN the pecking order world without being OF the pecking order world.

There is an autonomy inherent in rejecting the lure of the Nudging State and the Nudging Oligarchy, an autonomy that can power a life well lived. It doesn’t mean rejecting the world as it is. It doesn’t mean leaving the grid for Alaska homesteading. No, that’s a prison of quite another sort. It doesn’t mean mattering to nothing. It means mattering to other humans who see YOU as an autonomous end-in-itself and not as a means to an end. THAT’S your pack. Make a difference for THEM.

In January 1941, eleven months before Pearl Harbor brought the United States into World War II, Franklin Roosevelt gave his Four Freedoms speech — Freedom of Speech, Freedom of Worship, Freedom from Want, Freedom from Fear — memorialized over the next few years by Norman Rockwell in these famous paintings.

What is autonomy? It’s freedom.

What freedoms? These.

If you get nothing else from Epsilon Theory, get this: these freedoms are not granted to us by the State or the Oligarchs. They are not theirs to give. They are not rewards for good behavior or allocations from a central pot. They are ours. They have always been ours. They cannot be taken away.

But we can give them away. We can sell our birthright for a mess of pottage in the form of student debt and a tasty slice of office birthday cake. We can allow ourselves to be beguiled by the glamour of mattering for a Mighty Cause, giving away our allegiance to those who would use us as fodder or feed. We can embrace the pecking order lie and exchange our True Freedoms for Hollow Freedoms, for a freedom of socially acceptable speech and a freedom of socially acceptable worship and a freedom from socially manufactured wants and a freedom from socially manufactured fears.

We can’t escape from a world dominated by the Hollow Freedoms any more than we can escape from a market dominated by Hollow Liquidity and Hollow Volatility. But in markets and in politics we can call things by their proper names. We can maintain our autonomy of mind. We can find our pack and matter to them. We can recognize that a politics without shame is a politics without honor, just as a market without risk is a market without reward. We can take a loss in the short term, knowing that we’re playing the long game. We can do this handshake by handshake, investment by investment, candidate by candidate, good deed by good deed.

And watch how our world starts to change. Watch how we Make America Good Again.

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Clever Hans

This is Bali, a three-year old mustang mare we adopted in 2016 from the Bureau of Land Management, trained by daughter #3, Haven.

Vast herds of wild horses still roam out West on federal land. Officially categorized as an invasive species, many of these herds suffer terrible depradation from overpopulation and limited resources. In response, the BLM has captured more than 40,000 mustangs and moved them to long-term holding pens back East. Check out the inspiring 2011 film “Wild Horse, Wild Ride” to learn more about the controversial BLM program and efforts to encourage adoption of these magnificent creatures.

Mustangs have to be “broken” to accept a human’s touch and control, a word that conjures up images of bucking broncos and the forcible crushing of an animal’s spirit. But that’s not how it works.

The most effective way to break a horse is “negging”, a word familiar to high schoolers but not to me. Negging is negative attention. In the YA social scene, it’s small insults to supposedly pique your target’s attention and interest, like “You’d be pretty if you cut your hair.” In the horse training scene, it’s sitting in the paddock and turning your back on the mustang, ignoring her entirely. The horse gets curious and comes to check out this strange creature sitting on her turf, albeit keeping a healthy distance. The trainer continues to studiously ignore the horse. This goes on for quite a while, maybe a couple of days, but each time the mustang approaches she gets a little closer, until ultimately she makes the first physical contact and allows the human to start controlling her.

It’s really pretty amazing. This highly intelligent animal is so desperate to have a social interaction, so frustrated at being ignored, that it willingly surrenders its autonomy. Sound familiar?

This is Dick Thaler, who won the Nobel Prize in Economics a few weeks ago. He’s best known for the ideas presented with Cass Sunstein in the book Nudge, where they describe a system of “libertarian paternalism” in which a State-directed “choice architecture” improves public policy outcomes by influencing our behavior through clever framing techniques.

So if you want more organ donors, you require an opt-out choice rather than an opt-in choice on your driver’s registration. If you want more diversified 401k allocations, you make a predetermined mutual fund the default choice for your employees. If you want to preserve a law forcing citizens to buy health insurance from a government-approved list, you characterize any restoration of the freedom to say no as a “heartless cut” in the number of insured, by counting as cuts your estimate of the people you will no longer be able to force into buying insurance.

By treating citizens as manipulable objects, the Nudging State can get them to give more, save more, and insure more, all on their own volition. What possible objection could anyone have to that?

This is Adrian Veidt, aka Ozymandias, aka The World’s Smartest Man, from the classic Alan Moore comic series Watchmen. The central plot of Watchmen is that the world’s smartest man saves humanity from itelf by tricking us into choosing a peaceful set of behaviors. This is the pure expression of Nudge. This is the pure expression of smiley-face authoritarianism. By the way, Adrian Veidt is also the world’s richest man.

In the end the Party would announce that two and two made five, and you would have to believe it. … The heresy of heresies was common sense. And what was terrifying was not that they would kill you for thinking otherwise, but that they might be right.

– George Orwell, 1984 (1949)

Jackbooted thugs are so passé. Unless you live in Barcelona, I suppose. Or Berkeley. It’s just so messy to stomp on someone’s face when you can cleanly accomplish the same ends with “choice architecture” and “libertarian paternalism”. If Orwell were writing today, a Ministry of Liberty would figure prominently, right alongside the Ministries of Peace, Love and Truth.

If you don’t like what’s being said, change the conversation.
― Don Draper

Ad men understand “choice architecture”.

It’s not called the Wheel.
It’s called the Carousel.

I’ll make him an offer he can’t refuse.
― Vito Corleone

Mob bosses understand “choice architecture”.

An offer you can’t refuse is what game theorists call a Hobson’s Choice, part of a more general class of games that includes ultimatums and dilemmas. 

Any customer can have a car painted any color that he wants so long as it is black.
― Henry Ford

Oligarchs understand “choice architecture”.

The secret to smiley-face authoritarianism is a choice architecture that presents a Hobson’s Choice as the most natural thing in the world.

Chief Bromden:  My pop was real big. He did like he pleased. That’s why everybody worked on him. The last time I seen my father, he was blind and diseased from drinking. And every time he put the bottle to his mouth, he didn’t suck out of it, it sucked out of him until he shrunk so wrinkled and yellow even the dogs didn’t know him.

McMurphy:  Killed him, huh?

Chief Bromden:  I’m not saying they killed him. They just worked on him. The way they’re working on you.

One Flew Over the Cuckoo’s Nest (1975)

We are being worked on, and our bottle is social media.

Nurse Ratched has two employers — the Nudging State and the Nudging Oligarchy. Tough enough to resist separately, and they’re merging today. We’re all in line for McMurphy’s final treatment.

John Keating:  We don’t read and write poetry because it’s cute. We read and write poetry because we are members of the human race. And the human race is filled with passion. And medicine, law, business, engineering, these are noble pursuits and necessary to sustain life. But poetry, beauty, romance, love, these are what we stay alive for. To quote from Whitman, “O me! O life! … of the questions of these recurring; of the endless trains of the faithless … of cities filled with the foolish; what good amid these, O me, O life?” Answer. That you are here — that life exists, and identity; that the powerful play goes on and you may contribute a verse. That the powerful play *goes on* and you may contribute a verse. What will your verse be? 
 Dead Poets Society (1989)

Oh captain, my captain! Writing your own verse — as a parent, as an investor, as a citizen — is the Resistance to smiley-face authoritarianism.

This is Clever Hans, a celebrity animal at the turn of the 20th century, a horse who could perform complex arithmetic calculations. For years, no one could figure out the trick, because there was no trick, at least not in the sense of intentional fraud.

Now of course Clever Hans had no idea how to do math. But his trainer did. And Clever Hans could absolutely recognize the subtle tells in his trainer’s expression as he approached the right answer. Clever Hans would have been a good sheep. Or a good investor here in the Hollow Market.


We homeschool our children.

I don’t talk about this very much in public, because most people assume that homeschoolers are either religious zealots or antisocial freaks, and we’re definitely not the former. Maybe a bit antisocial, but I wouldn’t call it “freakish” per se. We just don’t like seeing neighbors’ houses. Or neighbors. People, really … okay, maybe a little freakish after all. But that’s not why we homeschool.

We homeschool because we want to be more active participants in our children’s education. That’s not a knock on our local public schools, which are as good as they come. That’s not a knock on private schools in the area, many of which are world-renowned. We homeschool because most of the practices and structures of the modern school, public or private, exist for the benefit of the institution, not the child. There’s nothing evil or bad about this, it’s just inherent in the logistics and organization required for any effective institution responsible for hundreds or thousands of people. But it’s not just logistics. It’s not just the bus schedule. It’s also the curriculum. It’s also the homework and the testing. It’s also the social structures and social behaviors that are embedded in the modern school.

Modern education is a perfect example of the Industrially Necessary Egg — spotlessly clean and cool to the touch, not because that makes for a better tasting egg, but because the protein factories that supply mass society with mass quantities of eggs require chemical washes and refrigeration to turn a profit. That’s fine. I get it. We live in a big world where lots of people want eggs, and the protein factories satisfy that desire pretty effectively.

But what’s not fine is that we have all been nudged into believing that the Industrially Necessary Egg is the Best Egg, that a fresh egg, which isn’t scrubbed clean and never sees a refrigerator, is an Inferior Egg. We have all been nudged into believing that of course 13-year olds should be grouped with other 13-year olds during most waking hours, that of course there should be a clear delineation between home life and school life, that of course the school day should mirror the adult work day, that of course classroom lectures are the most effective pedagogy, that of course children can only be socialized by letting them roam free in a big flock from one semi-shepherded environment to another.

I don’t begrudge the practices and structures of modern schools. Necessary is as Necessary does.

I don’t begrudge the taxes that I pay to support these schools. Don’t tell anyone, but I’d pay even more to support public education and public safety.

What I begrudge is the question that I always get when I tell someone that we homeschool our kids: “Don’t you worry about their socialization?”

My response: “Don’t you?”

My god, hospital admissions for suicidal teenagers have doubled over the past 10 years. Tell me you don’t know a family touched by this tragedy. Tell me you don’t see how our children are sexualized and objectified at a younger and younger age, not by predators lurking outside some gender-neutral bathroom, but by themselves, adrift in the vast oceans of social media. Tell me you don’t see how drug and alcohol use by our children is changing in form, where instead of getting high to party they get wasted to obliterate themselves.

None of this is the fault of the Industrially Necessary School. But it’s not unconnected, either.

So yeah, we want to be active participants in our childrens’ lives, and that’s why we homeschool. Not to shield them or isolate them from reality, but to be there for them as counselors and teachers as they confront reality. And not just to be there for them when mass society allows us, when it’s our turn during the work week to take responsibility for our own kids, but to embrace that responsibility all of the time. Because it IS our responsibility all of the time, no matter how much mass society facilitates and nudges us into partially abdicating that responsibility so that we can work longer and longer hours in service to the Nudging State and the Nudging Oligarchy.

I know that homeschooling isn’t for everyone. I know that homeschooling is impossible for most. I know that when I say “we homeschool” it is entirely a royal we, where my wife shoulders 99% of the burden. But I also know that you don’t have to homeschool outright to be a truly active and engaged participant in your child’s education. Everyone can do that.

Engaging actively in our children’s education has given us two great gifts.

First, the stress level in our family evaporated the day we got off the industrially necessary schedule of the school and onto the organically beneficial schedule of the child. Imagine if you suddenly found three or four hours of new time every day. Imagine how that would reduce the stress in your life, and now think about giving that gift to your child. Even if you can’t escape entirely the scheduling clutches of the Industrially Necessary School, simply recognizing how much of your child’s schedule is institutionally nudged on you and them rather than educationally required of you and them will change everything.

Second, we were able to inject a program of critical thinking and critical speaking into our children’s curriculum, what a classical education would have called Rhetoric and modern education calls Debate. I dunno … I never did Debate in high school, and my prior was that this was impossibly nerdy and more than a little silly. I could not have been more wrong. Our girls can think on their feet. Our girls can stand their ground. Our girls can make a persuasive argument, and they can recognize how others try to persuade them. My favorite part of a critical thinking/writing/speaking education? Our girls have demolished hundreds of smarter-than-thou mansplaining-in-training boys in debate competitions around the country. What does a curriculum of critical thinking/writing/speaking look like? It looks like girls and boys of different ages and backgrounds, all practicing and competing on an equal footing in a battle of research and wits — now there’s a socialization we can all support!

And here’s the kicker. Our girls are now teaching these critical thinking and critical speaking skills to those who have a hard time raising their voice effectively in a Team Elite world, from middle schoolers in Bridgeport, Connecticut to high schoolers in Malelane, South Africa to prison inmates in California. What do I mean when I say we need a Movement to change the world? This.

What I’m describing is the difference between education and training.

Education — whether we’re talking about the education of a child, the education of an investor, or the education of a citizen ­— is always additive to the free-thinking autonomy of the child/investor/citizen. But that’s not what the Nudging State and the Nudging Oligarchy have in mind. They don’t want education. They want training. The Nudging State and and the Nudging Oligarchy want to train you like Haven trained her mustang. They want to turn you into Clever Hans, an intensely other-regarding animal who welcomes the saddle. Because once you’re trained to welcome the saddle, you’re going to take the bit.

The playbook of the Nudging State and the Nudging Oligarchy is always the same — put a compelling Narrative around some Industrially Necessary System and train humans who use that system into some version of Clever Hans.

It’s clearly the playbook for our modern markets, where we are trained by the Nudging Fed and the Nudging Street. We are Clever Hans, dutifully hanging on every word and signal from Janet or Mario or Goldman or Merrill as we stomp out our investment behavior.

It’s also the playbook for our modern politics, where we are trained by the Nudging Parties and the Nudging Media Oligarchs. We are Clever Hans, dutifully hanging on every word and signal from Donald or Bernie or Fox or WaPo as we stomp out our voting behavior.

In all of these Industrially Necessary Systems — schools, markets, and politics — recognition and critical thinking is the antidote to Clever Hans Syndrome, and active engagement is how you administer the medicine. 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.

What will your verse be?

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Sheep Logic

These are baby-doll Southdowns, and yes, they’re exactly as cute as they look in this picture. We only have four today on our “farm”, as sheep have a knack for killing themselves in what would almost be comical fashion if it weren’t so sad. We keep them for their so-so wool, which we clean and card and spin and knit. It’s so-so wool because the Southdowns were bred for their meat, not their fleece, and I can’t bring myself to raise an animal for its meat. Well, I could definitely raise birds for meat. Or fish. But not a charismatic mammal like a baby-doll Southdown.

Here’s the thing I’ve learned about sheep over the years. They are never out of sight of each other, and their decision making is entirely driven by what they see happening to others, not to themselves. They are extremely intelligent in this other-regarding way. My sheep roam freely on the farm, and I never worry about them so long as they stay together, which they always do. But if I only count three in the flock, then I immediately go see what’s wrong. Because something is definitely wrong.

That’s the difference between a flock and a pack. A flock is a social structure designed to promote other-awareness. It has no goals, no coordinating purpose other than communication. A flock simply IS. A pack, on the other hand, is a social structure designed to harness self-aware animals in service to some goal requiring joint action — the raising of cubs, the hunting of meat, etc. Both the flock and the pack are extremely effective social structures, but they operate by entirely different logics.

We think we are wolves, living by the logic of the pack.

In truth we are sheep, living by the logic of the flock.

Jealousy, turning saints into the sea
Swimming through sick lullabies
Choking on your alibis
But it’s just the price I pay
Destiny is calling me
Open up my eager eyes
Cause I’m Mr. Brightside
 The Killers, “Mr. Brightside”

It was only a kiss. Leave it to a Las Vegas band to write the best song ever about the most powerful other-regarding emotion — jealousy. That’s Laurence Fishburne as Othello on the left and Kenneth Branagh as Iago on the right, actors’ actors both.

Gary Coleman:Right now you are down and out and feeling really crappy
Nicky:I’ll say.
Gary Coleman:And when I see how sad you are
It sort of makes me…
Happy!
Nicky:Happy?!
Gary Coleman:Sorry, Nicky, human nature-
Nothing I can do!
It’s…
Schadenfreude!
Making me feel glad that I’m not you.
― Avenue Q (2003)

There’s no way that a grown-up musical with Sesame Street puppets should work, but Avenue Q does. “Schadenfreude” is my favorite tune from the show, as well as the second-most powerful other-regarding emotion that drives our world.

Jukeboxes made a nice comeback when the user interface started showing you what other people had chosen to play, both in the past and coming up.

Once you start looking for the Jukebox Effect — the intentional effort to force you into other-regarding flock behavior — you see it everywhere.

All the world will be your enemy, Prince with a Thousand Enemies, and whenever they catch you, they will kill you. But first they must catch you, digger, listener, runner, prince with the swift warning. Be cunning and full of tricks and your people shall never be destroyed.

Richard Adams, Watership Down (1972)

I’ve got an unexpurgated print of this card sitting on my desk. A prey animal like a rabbit would find Watership Down unrecognizable. Not because reality is any less dominated by fang and claw, but because the protagonists are protagonists, driven by independent will and self-regarding decision making. It’s a Hero’s Journey, which makes it a great read but poor rabbit socio-biology.

Roy:I’ve seen things you people wouldn’t believe. Attack ships on fire off the shoulder of Orion. I watched C-beams glitter in the dark near the Tannhäuser gate. All those moments will be lost in time… like tears in rain… Time to die.
― Bladerunner (1982)

The movie Bladerunner was based on the Philip K. Dick novella, Do Androids Dream of Electric Sheep?, and inherent in the question is the reason we root for the androids over the humans. It’s the same reason we root for Hazel and the other intrepid rabbits of Watership Down. They’re dreaming and striving for a better life. They’re fighters. They have gumption.

In reality, neither sheep nor rabbits nor androids have gumption.

Deckard:She’s a replicant, isn’t she?
Tyrell:I’m impressed. How many questions does it usually take to spot them?
Deckard:I don’t get it, Tyrell.
Tyrell:How many questions?
Deckard:Twenty, thirty, cross-referenced.
Tyrell:It took more than a hundred for Rachael, didn’t it?
Deckard:[realizing Rachael believes she’s human] She doesn’t know.
Tyrell:She’s beginning to suspect, I think.
Deckard:Suspect? How can it not know what it is?
― Bladerunner (1982)

That’s the Big Question. How can we not know what we are? it not know what it is?

Better to live a day as a lion than 100 years as a sheep.

Benito Mussolini (1883 – 1945)

Donald Trump retweet (Feb. 28, 2016)

Really? I’ll take the 100 years, thank you very much. Life is too precious, and this, too, shall pass.

Such a vainglorious statement by such a preening man. Mussolini, that is. Find a film clip and watch how he uses his hands.

Our compliance departments require us to say that retweets are not endorsements. But of course they are.

The copycat phenomenon is real. As more and more notable and tragic events occur, we think we’re seeing more compromised, marginalized individuals who are seeking inspiration from those past attacks.

Andre Simon, head of FBI Behavioral Analysis Unit 2 (Threat Assessment)

Mass shooters are not Lone Wolves. They are Lone Sheep.

Tom Junod at Esquire featured FBI agent Andre Simon in his must-read 2014 article, “A Radical New Look at Mass Shooters.” Three years later and we’re still having the wrong debate, focusing on gun control rather than mental health and intervention. Why? Because the gun control debate has enormous political efficacy for both the Left and the Right, where the mental health debate has none. Steve Bannon’s fondest dream is for Democrats to make Federal gun control a key issue in the 2020 electoral cycle. We are, YET AGAIN, being intentionally shepherded by political entrepreneurs into a pernicious Competitive Game of domestic identity politics.

Behold, I send you forth as sheep in the midst of wolves; be ye therefore wise as serpents, and harmless as doves.

Matthew 10:16

There’s no domesticated animal species that has had more of a reputational fall from grace than the sheep. To call someone a sheep today is just about the worst insult there is. To call someone a sheep is to call them stupid and — more pointedly — stupidly obedient and in thrall to some bad shepherd.

It wasn’t always this way. Jesus isn’t insulting you when He calls you a sheep. The point of all those Biblical allegories isn’t that sheep are stupidly obedient or easily led, but that the healthy life of a willful sheep requires a good shepherd.

Ask anyone who actually keeps sheep. Sheep are weird. Sheep are evolved to have a very different intelligence than humans. But sheep are not stupid. Sheep are not obedient. And sheep are definitely not easily led.

Of course, no one except a dilettante farmer like me keeps sheep today, so all of the Old Stories about sheep and shepherds have lost their punch. They’ve all been diminished through the modern lens of sheep-as-idiot-followers.

Today most people dismiss the notion that good shepherds — i.e., individuals with expertise and wise counsel in some difficult to navigate field like … I dunno … investing — exist at all. And they utterly reject the idea that it’s actually okay not to have a fully formed and forcefully held opinion on anything and everything, that it’s not a sign of personal failure to say “I don’t know” and follow another’s lead.

It’s not just the media careers and media business models that are built on the notion of the Constant Hot Take — an unending stream of contrarian opinions expressed in the most incendiary way possible, solely for the entertainment value of contrarian opinions expressed in the most incendiary way possible — it’s the millions of hours that so many non-media civilians will spend engaged on Twitter or Facebook or whatever to construct their own steady stream of Hot Takes and bon mot responses. All tossed out there like bottles into the vast social media ocean, never to wash up on any inhabited shore, lost in some great Sargasso Sea of impotent and forgotten texts.

Why? Why does @RandoBlueStateLawyer with 45 followers spend the better part of every afternoon thinking about his next brilliant riposte to the latest Republican Hot Take on Obamacare reform? Why does @RandoRedStateRetiree spend every evening working himself into a MAGA apoplexy that can only be sated by retweeting his 19,001st Hannity blurb?

To answer that question, I want to go back to the Old Stories. I want to share with you what sheep are really like.

Sheep are evolved to have a specific type of intelligence which has the following hallmarks.

  • Enormous capacity for other-regarding behaviors. Sheep are unbelievably sensitive to what other sheep are doing and their emotional states. If another sheep is happy — i.e., it’s found a good source of food, which is the only thing that makes a sheep happy — then every other sheep in the flock is filled with jealousy (there’s really no other word for it) and will move in on that good thing. If another sheep is alarmed — which can be from almost anything, as bravery is not exactly a trait that tends to be naturally selected in a prey species — then every other sheep in the flock is immediately aware of what’s going on. Sometimes that means that they get alarmed, too. As often, though, it’s just an opportunity to keep going with your own grazing without worrying about the alarmed sheep bumping into your happy place.
  • Zero altruism and overwhelming selfishness. The most popular misconception about sheep is that they are obedient followers. It’s true that they’re not leaders. It’s true that they are incredibly sensitive to other sheep. But it’s also true that they are the most selfish mammal I’ve ever encountered. They don’t lead other sheep or form leadership structures like a pack because they don’t care about other sheep. Every sheep lives in a universe of One, which makes them just about the most non-obedient creature around.
  • The determination to pursue any behavior that meets Hallmark #1 and #2 to absurd ends, even unto death. My worst sheep suicide story? The first year we kept sheep, we thought it would make sense to set up a hay net in their pen, which keeps the hay off the ground and lets the sheep feed themselves by pulling hay through the very loose loops of the net. Turned out, though, that the loops were so loose that a determined sheep could put her entire head inside the net, and if one sheep could do that, then two sheep could do that. And given how the hay net was hung and how these sheep were sensing each other, they started to move clockwise in unison, each trying to get an advantage over the other, still with their heads stuck in the net. At which point the net starts to tighten. And tighten. And tighten. My daughter found them the next morning, having strangled each other to death, unable to stop gorging themselves or seeking an advantage from the behavior of others. The other sheep were crowded around, stepping around the dead bodies, pulling hay for themselves out of the net. That was a bad day.

In both markets and in politics, our human intelligences are being trained to be sheep intelligences.

That doesn’t make us sheep in the modern vernacular. We are not becoming docile, stupid, and blindly obedient. On the contrary, we are becoming sheep as the Old Stories understood sheep … intensely selfish, intensely intelligent (but only in an other-regarding way) and intensely dogmatic, willing to pursue a myopic behavior even unto death.

Why are we being trained to think like sheep? Because sheep are wonderful prey animals. They pay the rent with their fleece, and when push comes to shove you can eat them, too. Plus they’re not helpless prey animals. Sheep are quite competent and rather self-sufficient prey animals, which from a smart owner’s perspective is really what you want. If sheep were truly docile and stupid, then they’d be way too much trouble to keep. Nope, with sheep you can let them wander around all day and do their thing. Just keep them from killing themselves in some really stupid accident and you can harvest them for years and years and years.

How are we trained to think like sheep? By the rewards we receive from our modern social institutions for other-regarding flock behaviors like jealousy (feeling sad when others are glad) and schadenfreude (feeling glad when others are sad), and by the penalties we receive for self-regarding pack behaviors like honor and shame. If you’ve ever kept a pack animal like a dog, you know how clearly they can experience a sense of shame, that feeling when you believe you’ve let the pack down through your personal failure. Sheep have no shame. Not a bit. Shame requires self-evaluation and self-judgment against some standard of obligation to the pack, concepts which would make sheep laugh if they could. Sheep are enormously other-aware, but never other-obliged. They’re high-functioning sociopaths, shameless creatures of jealousy and schadenfreude, which is exactly the type of human most purely designed to succeed in the modern age.

The mechanism for all this sheep training, particularly in our investment lives, is what game theory calls the Common Knowledge Game. Once you start noticing it, you will see it everywhere.

I’ve written about the Common Knowledge Game a lot in Epsilon Theory, starting in the original “Manifesto” and continuing with notes like “A Game of Sentiment” and “When Does the Story Break”. But let’s review this core game of sheep logic one more time, with feeling. So here’s the classic thought experiment of the Common Knowledge Game — The Island of the Green-Eyed Tribe.

On the Island of the Green-Eyed Tribe, blue eyes are taboo. If you have blue eyes you must get in your canoe and leave the island the next morning. But there are no mirrors or reflective surfaces on the island, so you don’t know the color of your own eyes. It is also taboo to talk with each other about eye color, so when you see a fellow tribesman with blue eyes, you say nothing. As a result, even though everyone knows there are blue-eyed tribesmen, no one has ever left the island for this taboo. A Missionary comes to the island and announces to everyone, “At least one of you has blue eyes.”

What happens?

Let’s take the trivial case of only one tribesman having blue eyes. He has seen everyone else’s eyes, and he knows that everyone else has green eyes. Immediately after the Missionary’s statement, this poor fellow realizes, “Oh, no! I must be the one with blue eyes.” So the next morning he gets in his canoe and leaves the island.

But now let’s take the case of two tribesmen having blue eyes. The two blue-eyed tribesmen have seen each other, so each thinks, “Whew! That guy has blue eyes, so he must be the one that the Missionary is talking about.” But because neither blue-eyed tribesman believes that he has blue eyes himself, neither gets in his canoe the next morning and leaves the island. The next day, then, each is very surprised to see the other fellow still on the island, at which point each thinks, “Wait a second … if he didn’t leave the island, it must mean that he saw someone else with blue eyes. And since I know that everyone else has green eyes, that means … oh, no! I must have blue eyes, too.” So on the morning of the second day, both blue-eyed tribesmen get in their canoes and leave the island.

The generalized answer to the question of “what happens?” is that for any n tribesmen with blue eyes, they all leave simultaneously on the nth morning after the Missionary’s statement. Note that no one forces the blue-eyed tribesmen to leave the island. They leave voluntarily once public knowledge is inserted into the informational structure of the tribal taboo system, which is the hallmark of an equilibrium shift in any game. Given the tribal taboo system (the rules of the game) and its pre-Missionary informational structure, new information from the Missionary causes the players to update their assessments of where they stand within the informational structure and choose to move to a new equilibrium outcome.

Before the Missionary arrives, the island is a pristine example of perfect private information. Everyone knows the eye color of everyone else, but that knowledge is locked up inside each tribesman’s own head, never to be made public. The Missionary does NOT turn private information into public information. He does not say, for example, that Tribesman Jones and Tribesman Smith have blue eyes. But he nonetheless transforms everyone’s private information into common knowledge. Common knowledge is not the same thing as public information. Common knowledge is information, public or private, that everyone believes is shared by everyone else. It’s the crowd of tribesmen looking around and seeing that the entire crowd heard the Missionary that unlocks the private information in their heads and turns it into common knowledge.

The important thing is not that everyone hears the Missionary’s words. The important thing is that everyone believes that everyone else heard the Missionary’s words, because that’s how you update your estimation of everyone else’s estimations (why didn’t that blue-eyed guy leave the island? I know he heard the news, too … hmm … but that must mean that he, too, saw a blue-eyed guy … hmm … oh, snap.). The power source of the Common Knowledge Game is the crowd seeing the crowd, and the dynamic structure of the Common Knowledge Game is the dynamic structure of the flock. There’s no purposeful objective that animates a flock the way it does a pack, which is why you famously have people describing the “madness of crowds.” But it’s not madness, and it’s not chaos, either. A crowd is the communication mechanism for the Common Knowledge Game, with clear rules and strategies for playing and winning.

Understanding the Common Knowledge Game has been the secret of successful shepherds since time immemorial, in business, politics, religion … any aspect of our lives as social animals. The only difference today is that technological innovation provides a media toolkit for modern shepherds that the shepherds of the Old Stories could only dream of.

This is why sitcom laugh tracks exist. This is why performances, whether it’s an NFL game or Dancing with the Stars, are filmed in front of a live audience. This is why the Chinese government still bans any internet pictures of the Tiananmen Square protests, with their massive crowds, more than 20 years after they occurred. This is what John Maynard Keynes called the Newspaper Beauty Contest, which he believed (and demonstrated) was the secret to successful investing through the 1930s. This is how Dick Clark built a massive fortune with American Bandstand. He didn’t tell Middle America what music to like; he got a crowd of attractive young people to announce what music they liked (“it’s got a good beat and you can dance to it, I give it a 94, Dick!”), and Middle America took its cues from that. Not only is that all you need to motivate sheep, it’s far more effective than any efforts at direct influence.

This is why executions used to be held in public and why inaugurations still are. This is why Donald Trump cared so much about the size of his inauguration crowd. This is why he’s always talking about the viewership and ratings of his televised appearances. Trump gets it. He understands what makes the Common Knowledge Game work. It’s not what the crowd believes. It’s what the crowd believes that the crowd believes. The power of a crowd seeing a crowd is one of the most awesome forces in human society. It topples governments. It launches Crusades. It builds cathedrals. And it darn sure moves markets.

How do we “see” a crowd in financial markets? Through the financial media outlets that are ubiquitous throughout every professional investment operation in the world — the Wall Street Journal, the Financial Times, CNBC, and Bloomberg. That’s it. These are the only four signal transmission and mediation channels that matter from a financial market Common Knowledge Game perspective because “everyone knows” that we all subscribe to these four channels. If a signal appears prominently in any one of these media outlets (and if it appears prominently in one, it becomes “news” and will appear in all), then every professional investor in the world automatically assumes that every other professional investor in the world heard the signal. So if Famous Investor X appears on CNBC and says that the latest Fed announcement is a great and wonderful thing for equity markets, then the market will go up. It won’t go up because investors agree with Famous Investor X’s assessment of the merits of the Fed announcement. The market will go up because every investor will believe that every other investor heard what Famous Investor X said, and every investor will be forced to update his or her estimation of what every other investor estimates the market will do. It doesn’t matter what the Truth with a capital T is about the Fed. It doesn’t matter what you think about the Fed. It doesn’t matter what everyone thinks about the Fed. What matters is what everyone thinks that everyone thinks about the Fed. That’s how sheep logic, aka the Common Knowledge Game, works in markets.

So who owns us market sheep? The controllers of any Common Knowledge Game are the Missionaries, and the eternal Missionaries are the political executive and the market sell-side. Politicians and brokers have understood the power of this game for thousands of years, which makes the Street and the White House the constants as you examine the history of American sheepification. But they’re not the most powerful Missionaries of the modern age. No, that honor goes to our central bankers, relative newcomers to the Game, but quick studies all the same.

In his last Jackson Hole address, Ben Bernanke extols the virtues of their “communication tools”, carefully constructed media messages designed to alter investor behavior, messages that he says have been their most effective policy tools to date. Interest rates may hit a lower bound of zero, and asset purchases may lose their punch, but investors can ALWAYS be “guided”. The architect of this new and powerful toolkit? Vice Chair Janet Yellen, natch. Forward guidance and what the Fed calls communication policy are the very definition of Missionary statements, and our utter absorption in what everyone believes that everyone believes about the Fed’s impact on markets IS sheep logic.

Think that the Fed will go back to their old taciturn ways, content to let their actions speak louder than their words? Think again. Here’s Ben Bernanke again, this time in his final speech as Fed Chair:

The crisis has passed, but I think the Fed’s need to educate and explain will only grow. When Paul Volcker first sat in the Chairman’s office in 1979, there were no financial news channel on cable TV, no Bloomberg screens, no blogs, no Twitter. Today, news, ideas, and rumors circulate almost instantaneously. The Fed must continue to find ways to navigate this changing environment while providing clear, objective, and reliable information to the public.

Active central bank Narrative construction in the service of their policy goals is a permanent change in our market dynamics. The introduction of such a powerful new weapon in the Fed’s policy arsenal can no more be removed than mustard gas or tanks could be removed from national arsenals after World War I. Market prices may be mean-reverting, but “innovation” in the service of social control never is.

What do the Missionaries get out of this? What’s our equivalent of wool and mutton? It’s low volatility. It’s the transformation of capital markets into a political utility, which is just about the greatest gift that status quo political interests can imagine. When Donald Trump and Steve Mnuchin talk about the stock market being their “report card”, they’re just saying out loud what every other Administration has known for years. Forget about markets, our entire political system relies on stocks going up. If stocks don’t go up, our public pension funds and social insurance programs are busted, driving our current levels of wealth inequality from ridiculously unbalanced to Louis XVI unbalanced. If stocks don’t go up, we don’t have new collateral for our new debt, and if we can’t keep borrowing and borrowing to fuel today’s consumption with tomorrow’s growth … well, that’s no fun, now is it?

The flip side to all this, of course, is that so long as stocks DO go up, nothing big is ever going to change, You say you want a revolution? You’re a MAGA guy and you want someone to drain the Swamp? You’re a Bernie Bro and you want the rich to “pay their fair share”? Well, good luck with any of that so long as stocks go up. It’s a very stable political equilibrium we have today, full of Sturm und Drang to provide a bit of amusement and distraction, but very stable for the Haves.

And that brings us back to @RandoBlueStateLawyer and @RandoRedStateRetiree, fighting the good fight on Twitter or Facebook or wherever, speaking their Truth to their audience of dozens. They’re smart guys. Politically engaged guys. They’re angry about the mendacity of the Other Side. In another day and age they’d slam the newspaper down on the table and tell the dog what a fool that darn Truman was. Maybe write a strongly worded letter to the editor. But today they are consumed by this modern equivalent of writing a letter to the editor. They are immersed in the world of the Constant Hot Take, morning, noon and night. Why? Because Common Knowledge Game. Because they see a crowd responding to a crowd, and they are hard-wired to join in. Because it makes them feel good about themselves. Because they’ve been turned into other-regarding sheep even as they think they’re being self-regarding wolves.

In the same way that the modern story of what it means to be a sheep — docile, obedient, stupid — is totally wrong, so is the modern story of what it means to be a wolf. We think of a wolf as the epitome of rapacious independence, but wolves, like all pack animals, are far less independent (and far less greedy) than your average sheep. Unlike sheep, wolves can act outside of their group because they’re not consumed by other-regarding behavior, but those actions are ultimately in service to the pack. A sheep always acts within its group, but it’s never in service to the flock, only to its own needs.

Look, I’ll admit that I’m talking to myself as I write these words. I spend WAY too much time on Twitter, justifying it to myself in any number of ways, when in truth it’s the functional equivalent of a meth habit. At least it’s not as tough on the teeth. My wife is hooked on Facebook, my kids on god knows what social media platforms …. I’m not so naïve as to think that the answer to our collective sheepification is just to put the devices down. No, we’ve got to shift the way we use this stuff, not quit it cold turkey.

So what do we do? We stop pretending to be fake wolves and we start acting like real ones. We stop acting like animals of the flock and we start acting like animals of the pack. We reject the other-regarding emotions of jealousy and schadenfreude. Yes, even in our tweets (gulp!). We embrace self-regarding emotions like honor and — here’s where I’m going to lose everyone — shame.

Yes, we need a lot more shame in the world. The loss of our sense of shame is, I think, the greatest loss of our modern world, where — to retweet myself scale and mass distribution are ends in themselves, where the supercilious State knows what’s best for you and your family, where communication policy and fiat news shout down authenticity, where rapacious, know-nothing narcissism is celebrated as leadership even as civility, expertise, and service are mocked as cuckery. Or to put it in sheep logic terms: the tragedy of the flock is that everything is instrumental, including our relationship to others. Including our relationship to ourselves.

Why do we need shame? Because with no sense of shame there is no sense of honor. There is no mercy. There is no charity. There is no forgiveness. There is no loyalty. There is no courage. There is no service. There is no Code. There are no ties that bind us as citizens, as fellow pack members seeking to achieve something bigger and more important than our ability to graze on as much grass as we can. Something like, you know, liberty and justice for all.

Any coin worth having has two sides. A shameless politics has no honor. A riskless market has no reward. Oh, the Missionaries will tell you that there’s honor in the shameless politics and reward in the riskless markets, and for all the high-functioning sociopaths out there I’m sure that’s true, But if you’re not totally sheepified yet, if your goal is still honorable service to your clients or your partners or your family or your nation or your species — whatever your pack may be — then you know that this is NOT true. You know that shame and risk can be deferred or displaced but never wiped clean, no matter how many Supreme Court Justices you appoint and no matter how many all-time highs the stock market hits. You know that a reputation is like a tea cup; once broken you can glue it back together, but it will always be a broken tea cup. You know that the only game worth playing is the long game.

This is the Age of the High-Functioning Sociopath. This is the Age of Sheep Logic. We have to survive it, but we don’t have to succumb to it. How do we Resist? Not by switching out blue Missionaries for red Missionaries or red Missionaries for blue Missionaries. Not by switching out one bad shepherd for another bad shepherd. We don’t have to play that game! We resist by changing the System from below, by carving out local spheres of action where we are relentlessly honorable and charitable, relentlessly un-sheeplike. We resist by Making America Good Again, one pack at a time, which is a hell of a lot harder than making America great ever was. We resist by doing right by our clients, even if that means getting slapped around by supposedly riskless markets and shameless politics. Even if that means losing clients. Even if that means losing our jobs.

A good shepherd once said that whoever shall smite thee on thy right cheek, turn to him the other also. Of course, I also knew a good Dungeonmaster who said that being lawful good didn’t mean being lawful stupid, and turning the other cheek always seemed to be kinda stupid to me. Kinda sheeplike. But then I started keeping sheep, and my perspective changed. Sheep would never turn the other cheek. But a wolf would. A wolf would take a hit for the pack. It’s the smart play for the long game. As wise as serpents, you might say.

It’s time to be wolves. Not as devourers, but as animals that know honor and shame. It’s time to be wise as serpents and harmless as doves. It’s time to remember the Old Stories. It’s time to find your pack.

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Always Go To the Funeral

But Brutus says he was ambitious;
And Brutus is an honorable man.
Julius Caesar, Act 3 Scene 2 (1599)

That’s Ray Fearon as Mark Antony on the left and Paterson Joseph as Brutus on the right, in the 2012 Royal Shakespeare Company production of Julius Caesar. You can see a video of Fearon’s funeral speech for the murdered Caesar here. It’s an insanely powerful performance of an insanely powerful scene, with the repetition of the famous Brutus lines twisting the crowd like a rope.

The Democrats, the longer they talk about identity politics, I got ‘em. I want them to talk about racism every day. If the left is focused on race and identity, and we go with economic nationalism, we can crush the Democrats.
Steve Bannon, from his August 16 exit interview with Robert Kuttner in The American Prospect.

A spirit of national masochism prevails, encouraged by an effete corps of impudent snobs who characterize themselves as intellectuals.
Vice President Spiro Agnew (1918 – 1996), Nixon’s Bannon, the voice of the “Silent Majority” (with an assist from speechwriters Bill Safire and Pat Buchanan). Resigned office in 1973, pleading no contest to bribery and tax evasion charges. History never repeats, but it sure does rhyme.

Death has a cruel way of giving regrets more attention than they deserve.
Elisabeth Kubler-Ross (1926 – 2004), author of On Death and Dying, developer of the five stages of grief: denial, anger, bargaining, depression, and acceptance.

I’ve gotten three irreplaceable pieces of advice over the years, two for business and one for life. The business advice: 1) Always live to fight another day. 2) It’s not about the money. It’s. About. The. Money. The life advice: Always go to the funeral. That’s courtesy of my partner Jeremy Radcliffe. I’m not sure who he heard it from. Now I’m passing it along to you.

It’s not easy to go to the funeral. Life closer to home has its demands. Travel on short notice is expensive. And god knows I’ve failed to live up to this advice as often as I’ve followed it. But every time I’ve made the effort, I’ve experienced a uniquely powerful and sustaining human connection that I really don’t have words to describe. Let me put it this way. Twenty years later, I remember who was at my father’s funeral, not in a sense of keeping score, but of abiding appreciation. There’s zero negative affect for those who weren’t there. Zero. I understand! But there’s a nuclear reactor of positive affect and energy for those who were.

Going to the funeral is part of the social contract we have with our families, our friends, and our tribe, both immediate and extended. It’s part of the social contract we have with ourselves. It’s part of the personal obligation that we have to others, obligation that doesn’t fit neatly or at all into our bizarro world of crystalized self-interest, where scale and mass distribution are ends in themselves, where the supercilious State knows what’s best for you and your family, where “communication policy” and fiat news shout down authenticity, where rapacious, know-nothing narcissism is celebrated as leadership even as civility, expertise, and service are mocked as cuckery.

Understanding the obligations we share in life and in death is the greatest lesson I’ve learned (and I hope passed on to my girls) from life on the farm. Because our obligations aren’t just to our human tribe, but to our animals, too.

I’m not a nut about this. The obligations we have to our animals aren’t the same as the obligations we have to our family. They aren’t the same as the obligations we have to other, more remote humans (hmm … sometimes I’m not too sure about that last bit, but let’s go with it anyway), but they’re obligations nonetheless. In life those obligations include water, food, shelter, and an environment that lets them express their sheepness or goatness or horseness or dogness or whateverness in a safe and healthy way. It’s all of those, especially fresh water. That’s a thing for me. In death, those obligations are a proper funeral, well attended. A grave plenty deep, well marked. A body positioned properly, well respected. Collars and bells and other instruments of control all come off, because there are no collars in death. That’s a thing for me, too.

I know this seems like a morbid topic, but it’s not for me, and I suspect it’s not for anyone who’s spent time on a farm. I’ve buried lots of animals. They’re born, they live, and they die. We give them a really good life. We respect our animals in life and we respect them in death. The care we give our animals when they die means nothing to the animals, obviously not to the dead but no more to the living. It means an enormous amount to us. It’s our personal obligation. We owe them, not the other way around, in life and in death.

Always go to the funeral.

Whew! Okay, Ben, let’s see you draw some lessons for investing and macroeconomics from that!

On the investing side, the lesson is that every discretionary investment needs a proper funeral at some point. Discretionary investments are born, they live, and they die. I’ve learned from a lot of great investors over the years, and one of the lessons that really stuck with me was that your portfolio should be one-third positions that hadn’t worked yet and you are getting into, one-third positions that are working now, and one-third positions that have worked and you are getting out of. It’s that last one-third that we all have the most trouble with. It’s not the positions that never work at all. We’ve all been trained to cut our losers, and so that’s what we do. In this business, you’re wrong about something every single day, and if you don’t learn early and well what to do when you’re wrong, then you won’t survive long. No, the much harder lesson is what to do when we’re right. We’ve all been trained to “let our winners run”, and there’s a lot of truth in that for a trader. Much less so for an investor. For an investor, it becomes an excuse to keep a discretionary position in the portfolio well past its natural lifespan, leading to a bloated portfolio, chock-full of merely good or used-to-be good positions. It’s the unforced error that I see more frequently than anything else out in financial advisor-land, because it’s really hard to say goodbye to an investment that’s served you well and faithfully.

I’ve buried lots of investments. You should, too.

That means a proper funeral, well attended. You communicate with your team and your clients. You tell them how and why the death occurred, and you invite them to learn more.

That means a grave plenty deep, well marked. It’s waaay too easy to resurrect a dead investment in a slightly new form, saying that there’s some new catalyst for the old stock when in truth you wouldn’t be there except for the prior history. The dead should stay buried.

That means a body positioned properly, well respected. You keep a record of the investment, and you describe why you were there, how it worked, and how it didn’t. Honestly.

None of this is as easy as it sounds. But it’s your obligation.

Now wait a second, Ben, it sounds like you’re preaching against buy-and-hold stock-picking, something that might get you stoned to death if you were making the hajj to Omaha along with the value investing faithful. Is that what you’re saying?

Nope. I’m an arborist. I love planting trees and investments that can last for decades. There’s nothing more powerful in the investment world than the power of compound returns. But spare me the forever stuff. Nothing lasts forever. Death and taxes … those are the only eternals.

Every highly successful stock-picking investor in the world, value oriented or not, has two things:

  1. A boneyard. You think the guys in Omaha haven’t buried a huge number of investments? Please. And they don’t just bury the dead. They cull the weak. Good for them.
  2. A duration match between assets and liabilities. To continue with the forest example, it’s all great and wonderful to plant some oak trees that you’re certain will be strong and majestic in 20 years, but not if you need the lumber in 5 years. If you’re pursuing long-lived investment returns, you better have similarly long-lived investment funding, or eventually you will fail as an investor. That’s not opinion, that’s math. So yeah, if you’ve got permanent capital, then you can make permanent investments. But no one has truly permanent capital.

These two qualities of successful investing — burying the dead and matching the lifespan of your assets with the lifespan of your liabilities — are part of the investment meta-game. They’re not the immediate game — picking this stock or picking that stock — but they’re the game behind the game. It’s more important to play the meta-game well than to play the immediate game well. It’s more important to see the forest than to see the trees.

Here’s another way to think about the meta-game. I was a fan of Shark Tank before it was cool to be a fan of Shark Tank, and I still am. I watch it with my girls, as it sparks all sorts of good conversations about entrepreneurialism and capitalism and the like. My favorite moments on Shark Tank, by an order of magnitude, are when Kevin O’Leary tells a presenter that their idea is dead and they need to bury it. He’s always right. The worst thing that can happen to you on Shark Tank is NOT that you fail to get an investment and go down in flames of embarassment. No, the worst thing that can happen is that you fail to get an investment but are encouraged to keep on pursuing a used-to-be-good idea that died a year ago. You will have another good idea! It’s far more important to play the meta-game well — to do nothing and wait for the next live opportunity — than to keep propping up the dead opportunity with extraordinary effort. Bury your dead. Have a proper funeral. Respect the dead. Never forget the dead. And move on without regret.

On the economics side, the lesson here is that central bankers today are grieving the death of the so-called Great Moderation, where productivity rocked, inflation was tamed, and the business cycle was muted. But they can’t move on. They can’t bring themselves to have a proper funeral. They are expressing their grief poorly — not through anything like the Kubler-Ross stages of denial, anger, bargaining, depression, or acceptance — but through magical thinking, through the pathological belief that if only the right words are said and the right thoughts are thought, then the dead will show up at the front door as if nothing had happened. To understand the human pathology, read Joan Didion’s wonderful book. To understand the policy pathology, you could do worse than to read the Epsilon Theory note.

I’m not going to spend a lot of time rehashing that Epsilon Theory argument, because there’s another death I want to talk about in this note, one connected with neither investing nor monetary policy. It’s the death of cooperative game-playing in American politics. I wrote a full note about this, too, titled “Virtue Signaling … or Why Clinton is in Trouble”, but after the events of the past two weeks, particularly Charlottesville and its political aftermath, I want to update those thoughts here.

I’ll start with what I wrote last September.

I’m thoroughly despondent about the calcification, mendacity, and venal corruption that I think four years of Clinton™ will impose. I think as a candidate she’s a bizarre combination of Michael Dukakis and Teddy Kennedy, and I think as a president she’ll be an equally bizarre combination of Ulysses Grant and Warren Harding, both of whom presided over a fin de siècle global economic collapse. Gag. But I don’t think she can break us, not as a society, anyway.

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

Blowing up our international trade and security games with Europe, Japan, and China for the sheer hell of it, turning them into full-blown Competition Games … that’s really stupid. But we have a nasty recession and maybe a nasty war. Maybe it would have happened anyway. We get over it. Blowing up our American political game with citizens, institutions, and identities for the sheer hell of it, turning it into a full-blown Competition Game … that’s a historic tragedy. We don’t get over that.

Case in point: the current “debate” about Confederate war memorials. In truth, there is no debate about Confederate war memorials. No one cares about Confederate war memorials. There is no “Southern identity” associated with Robert E. Lee statues. You know who thinks that Southerners care deeply about these statues? New York City real estate developers who know nothing about the South, but think that this is what motivates us dumb hicks, that’s who. A month ago, you could have taken down any of these statues and you’d get three wackos holding signs outside the city administration office and an angry letter from the local chapter of the Daughters of the Confederacy. I mean, it’s not like you’re canceling an SEC football game … there’s your Southern pride.

But frame the issue in terms of “THEY are coming to take your statues away from you”, show some pics of Antifa goons and campus goofballs, and absolutely people are going to care. Hell, these pictures make me care, and I’d get rid of the statues tomorrow if I could.

If getting rid of the statues is framed as capitulating to these idiots — and that’s exactly the narrative that’s been created — then every elected Republican in the South who wants to stay in office must now come out in favor of keeping the damn statues. They must be seen as opposing the idiot outsiders who are DEMANDING something that no one cared about a month ago, because that’s what it means to play a Competition Game.

Conversely, every elected Democrat in the South who wants to stay in office must now take action to dismantle the statues. Because otherwise you’re capitulating to these very fine people idiots.

Just like the incumbent Republicans, incumbent Democrats must be seen as opposing the idiot outsiders who are DEMANDING something that no one cared about a month ago, because that’s what it means to play a Competition Game.

You hear all the time about how these Trump tweets and the associated narrative construction are a “dog whistle” that motivates and calls forth the alt-right clowns. Okay. I guess. But what the tweets and the narrative really are — and this is what Steve Bannon understands perfectly — is a dog whistle for the Democrats and an obedience collar for the Republicans. It creates a Competition Game where none existed before, and it forces every elected politician, regardless of party, to play their appointed role, strutting and fretting upon the stage. Even though none of them like the script and none of them want to play the part.

It’s a political meta-game.

What’s happening today isn’t new in theory. It’s a tried and true strategy for political entrepreneurs throughout history, ancient and modern. It’s what Marc Antony did to reconfigure the narrative around Julius Caesar’s assassination in 44 BC. It’s what Richard Nixon and Spiro Agnew did with their “Silent Majority” narrative to win the 1968 and 1972 Presidential campaigns. It’s what George Wallace did in 1972 to win the Democratic primaries in Michigan and Florida. It’s what Pat Buchanan (who wrote a lot of the Silent Majority speeches) tried to do when he primaried George H.W. Bush in 1992.

But what’s happening today is very different in scale for two reasons, I think.

First, it’s different because of the unprecedented effectiveness of the technology and social media systems that drive what I call fiat news — highly political statements constructed and presented as apolitical fact. In exactly the same way that fiat currencies ultimately crowded out all hard currencies, so is fiat news now crowding out hard news. Political entrepreneurs today — a roster that includes Mark Zuckerberg and Jeff Bezos and Michael Bloomberg just as surely as it includes Steve Bannon — have a tool kit at their disposal for playing the political meta-game that Richard Nixon could only dream of.

Second, it’s different because of the goals of the political entrepreneurs themselves. Richard Nixon was a professional politician. Being president was his lifelong ambition, and he used the Silent Majority narrative as a means to that end. He didn’t want to blow up the System. He WAS the System. Whatever Donald Trump is, he’s not the System. My sense is that he really doesn’t care about the System one way or another, that so long as he and his family have the keys to the national car, he’s good with whatever happens. Steve Bannon, however, cares deeply about the System. Not to preserve it, but to reboot it. And not just to reboot it, but to reboot it with a new operating system.

So what’s the punch line? Why am I talking about all this in a cheery note about death and funerals?

Because once a Cooperation Game becomes a full-blown Competition Game, it never goes back to the way it was before. Once mustard gas is introduced into your trench warfare game, whether it was one of the other guys or one of your guys, it’s here to stay. Deterrence has failed. The cooperative Stag Hunt equilibrium is dead. I am, admittedly, still at Stage 4 of the Kubler-Ross scale on all this — depression — but we all need to get to acceptance ASAP. No regrets. No magical thinking. Just hard thoughts on how to design an operating system that can compete with and win against the billionaires’ operating system when the reboot happens. And who we want in our foxhole in the meantime. And how to build a gas mask.

Because it wasn’t that long ago when Southern identity was defined not by statues, but by civility, personal obligations, and service, particularly military service to … wait for it … the United States of America. That narrative is still out there. It’s still alive. We can get it back if we’re smart enough to play the political meta-game.

Because there’s a pose that very sick farm animals sometimes take when they’re near death, where they lie down and twist their head way back into their shoulder in a very unnatural way. It’s an odd sight if you don’t know what it signifies, a horrible sight if you do. Both the Republican Party and the Democratic Party are starting to twist their heads back into their shoulders. I don’t know if it’s too late to save them or not, but I’m increasingly thinking that it is. We need to start thinking about the funeral, who’s going to speak, and what they’re going to say.

But Brutus says he was ambitious;
And Brutus is an honorable man.

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The Arborist

Shape clay into a vessel;
It is the space within that makes it useful.
Cut doors and windows for a room;
It is the holes which make it useful.
Therefore benefit comes from what is there;
Usefulness from what is not there.
Lao Tzu (c. 530 BC)

This is the only quote I’ve used three times in Epsilon Theory notes, previously in The Tao of Portfolio Management and Who’s Being Naïve, Kay?, because it’s such a powerfully wise observation about the vessels we create when we put together a portfolio.

But its wisdom goes way beyond investing. Our days are spent shaping clay into vessels … our homes, our businesses, our friendships, our marriages, our children … our lives themselves.

Not every empty space needs filling.

“It is hard to find good explanations for the low-inflation era being experienced by the U.S.”
Jim Bullard: St. Louis Fed Governor, waver of hands, charter member of the Epsilon Theory Self-Parody Hall of Fame.

I actually feel bad for Bullard. The cognitive dissonance between what the job requires and what any thinking human being observes must be crippling.

QE and negative real rates are ice-nine. If you don’t know what ice-nine is, read “Cat’s Cradle”, preferably both the Vonnegut book and the Epsilon Theory note.

Spoiler alert: the world ends.


Lianas are woody vines that climb up trees to get to the light. They’re what Tarzan would swing on from tree to tree. They’re also the incarnation of evil in the natural world.

The particular bane of my existence is a liana called Oriental Bittersweet, now endemic in the Eastern U.S. and Canada. Like other creeping plagues such as privet and kudzu, the Oriental Bittersweet was originally introduced as an ornamental plant, but found easy pickings in North America once it escaped captivity.

How do you kill the Oriental Bittersweet? Per the latest intel from the U.S. Forest Service, you need to cut the stem and then immediately douse it with Garlon 4 herbicide mixed with diesel fuel or kerosene. Just be sure that you don’t get any of that Garlon 4 on anything that, you know, you don’t want to kill. Or on your skin. And for god’s sake please don’t use it in wetlands or anywhere it might get into a stream or pond. That would be … umm … not good.

This is what crowding-out looks like in the forest. It’s no prettier in the real economy.

I’m a reluctant gardener. I’ll work in the dirt because I like the outcome, but it’s just that to me — work. I don’t get any intrinsic pleasure from the act of gardening, from the growing of plants from seeds to maturity, because I don’t see the human art in it. I can appreciate the form and function of the plant itself. But that’s nature’s art, not mine.

On the other hand, I’m an enthusiastic arborist. Working with trees isn’t about the growing, it’s about the pruning. It’s about identifying the natural, healthy lines of a tree and shaping the tree to follow those lines over time. It’s about having a vision in your head of what Treeness means in this particular place and this particular plant, and then bending nature to fit that vision. It’s this imposition of human will that makes working with trees an art, whether you’re expressing it in miniaturized form through bonsai or massive form through four acres of maple trees. That’s why I’m an arborist.

At the heart of being a good arborist is recognizing that less is almost always more, that the absence of a branch or limb is as necessary in expressing Treeness as presence. Filling space is easy. That’s the default because that’s nature’s blind imperative, to grow and spread and get more light, regardless of the internal or external consequences. Nature will grow itself into structural ruin, and the arborist must be imaginative enough to see the alternative and brave enough to act. The courage is always in the cut. The imposition of human will and vision is always in the cut. The art is always in the cut.

I rarely use a chainsaw to cut a living tree, or at least a tree that I want to keep on living. For starters, I’m even more scared of my chainsaw than I am of my tractor, which really only goes to show that I’m not scared enough of my tractor. More importantly, if you’ve gotten to the point where a limb is so thick that you need to use a chainsaw on it, then either you’re doing some sort of medically necessary surgery or you’re making a terrible mistake in the imposition of your vision for this particular tree in this particular place. No, my instruments of choice are the handsaw and the lopper. Just because the courage is in the cut doesn’t mean that you need to cut with abandon and leverage.

So as per usual with these Notes From the Field, I’ve got two arborist-as-metaphors to relate, one for investing and one for the economy.

On the investing side, this is the math-free companion piece to Rusty Guinn’s You Still Have Made a Choice, where we’re both saying the same things about portfolio construction and healthy diversification thereof, just in different dialects.

Left to its own devices your portfolio will grow wildly — not to structural ruin, but to structural inefficiency. Of course, by its own devices I really mean by your own devices, and by growth I mean number of positions, not value. The human tendency to keep adding “good ideas” to a portfolio as they come available is at least as powerful and natural an imperative as a tree growing more leaves for more sunlight, and unchecked is just as destructive. A tree pays a price for each branch and limb and leaf it grows. So do you in your portfolio. Each of these investments may be, in and of itself, truly a good idea. But they are merely good ideas. Show me a portfolio chock-full of good ideas and I’ll show you a tree that is not growing to its full potential, and here I do mean value.

A portfolio doesn’t grow to its full potential by having lots of good ideas. It grows to its full potential by having a few great ideas. Okay, that seems obvious. Here’s one that’s not. A portfolio will reach a better outcome by having fewer branches and limbs and leaves that all work together to create a harmonious whole — even if those branches and limbs and leaves are merely good, not great — than by having more branches and limbs and leaves of the same good quality.

The ordinary investor is always looking for a good idea to put into the portfolio. The arborist investor is always looking for a merely good idea to take out of the portfolio.

Now, there IS a science (or at least a methodology) for calculating whether or not the addition or subtraction of a limb in your portfolio adds or subtracts value compared to the shape of your portfolio now, and that’s where Rusty’s note ends up. My message is that there is also an art to this assessment, and that we end up in the same place. How? By the marriage of art and science within the mathematics of harmony and aesthetics.

Above is a depiction of the 15 classic bonsai styles, shapes, and forms. There are more, but pretty much every bonsai tree you ever see will be a variation on one of these themes or archetypes. This is the art of bonsai, and an experienced bonsai artist like Mr. Miyagi (you didn’t think I could write this note without a movie reference, did you? “Remember, best block, not to be there” is pretty much the finest advice ever on risk management) can instantly look at an actual bonsai plant and tell you its underlying archetype and how to shape the actual plant to fit the archetype more perfectly. OR (and this is the cool part) a true bonsai artist can tell you how to differ from the archetype to take advantage of something special about either the plant or its environment or its owner.

Each of these 15 classic bonsai themes can ALSO be expressed in geometry and math. I mean, you can see it pretty clearly with even a cursory knowledge of tessellation (turning everything into triangles), fractals (repetitive forms at different levels of aggregation or magnification), and catenary curves (self-supported minimal surfaces). You have to wave your hands a bit at some of the basing objects (although mountains are also fractals), but you get the idea. This is the science of bonsai, and I have no doubt that a modern scanner plus a rudimentary AI could also measure a real bonsai plant and tell you which archetype it most closely matched and how to optimize it to match the archetype more closely. It can’t do the cool part, though, of accounting for uniqueness in the specific plant or its environment and intentionally diverging from an archetype to make something truly special, at least not yet.

Robo-advisors today are based on the scanner + math approach to portfolio construction. A good human financial advisor embodies the Mr. Miyagi artistic approach. Both are arborists. Both know that it’s as important to leave things out of a portfolio as to put things in. Both are effective counters to the all-too-human impulses to build a portfolio myopically and without consideration of the whole. Both get you much closer to a more useful and effective portfolio.

In my opinion the best human financial advisor still has an edge over the best robo-advisor, in the same way that human artists still have an edge over non-human artists. Humans are clearly NOT as good in the optimization exercise, which is why robo-advisors have such an advantage in the mass market for financial advice. And to be clear, the robo-advisor is giving high quality advice, definitely not one-size-fits-all. But it’s never extraordinary advice. To be fair, the vast majority of human financial advisors don’t provide extraordinary advice, either. But if you can find that exceptional arborist, someone who knows when to deviate from the archetypes rather than just optimize … well, that can create extraordinary value.

So that’s my investment arborist-as-metaphor. I’m afraid my economics arborist-as-metaphor won’t be as uplifting.

That’s because we have no arborists today in the public spheres of politics and economics. We are overrun with Oriental Bittersweet, privet, and kudzu — or as I like to call them, monetary policy, the regulatory state, and fiat news — invasive species that crowd out the small-l liberal virtues of free markets and free elections. Even our strongest trees are girdled by the lianas, choked of resources and at risk when the next Nor’easter hits.

This is what I’ve been writing about in the recent Epsilon Theory notes on the death of productivity. Why do we have low growth, low inflation, and low productivity, despite the most accommodative monetary policy in the history of man? BECAUSE of the most accommodative monetary policy in the history of man. Why does the economic ground feel so unsteady beneath our feet, despite the immense power of the regulatory state providing insurance against every ill? BECAUSE of the immense power of the regulatory state providing insurance against every ill. Why are we so profoundly divided and mistrustful as a political society, despite the unprecedented quantity of political news and analysis available to inform us? BECAUSE of the unprecedented quantity of political news and analysis available to inform us.

What’s the solution? I don’t think there is a top-down solution. It’s not Donald Trump. It’s not the human equivalent of aerial spraying Garlon 4 on anything and everything. It’s not the usual suspects from Team Elite, the Jim Bullards of the world who are so … lost … in their mind palaces and hand waving and cognitive dissonance and magical thinking that they are hardly recognizable as human beings. I mean that seriously and with sadness. How do you ever come back from a stint as a Fed Governor?

I’m pretty sure that there is no single person, no miraculous candidate for the Fed or the White House, no Moses to lead us out of our liana-infested wilderness. I’m pretty sure that the answer is a Fight Club-esque grassroots movement devoted to Making, Protecting, and Teaching, where really old school notions like feudal bonds of personal obligation and trust are reinvigorated through modern technology like blockchain, mitigating both the limits of geography and the unblinking stare of the State. I’m pretty sure that it’s a work of decades in school districts and local elections, that it’s bird by bird, to paraphrase the wonderful book by Anne Lamott. And that’s okay. That’s as it should be. A bonsai tree is the work of decades. So is a four-acre grove of maple trees. So is a family office portfolio. So is a local community built on liberty and justice.

You don’t need anyone’s permission to be an arborist. You just decide to be one. You just start cutting down the evil vines in your backyard. And you cut them down again when they grow back, because they always do. And you teach your children and neghbors how to cut. And that’s how the future changes.

The courage is in the cut.

To remix Margaret Mead, never doubt that a small group of thoughtful, committed arborists can change the world; indeed, it’s the only thing that ever has.

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Horsepower

There is no animal more important in the ascendancy of Western Civilization than the horse, and no invention more important than the horse collar. It has nothing to do with warfare, and everything to do with farming and transportation.

Horses can work 50% faster than oxen, and they can go all day, particularly the draft horses of Northern Europe. But if you put an ox harness on a horse, the horse will choke to death. Very different bone structures, particularly with the shoulders.

When the horse collar was introduced into Europe in the 10th century (invented by the Chinese, of course, just like everything else of note prior to the Industrial Revolution) agricultural productivity skyrocketed. The resulting food surpluses led to a population boom, labor specialization and diversification, and the development of a merchant class. The horse collar (plus the horse shoe and the heavy plow) sparked a productivity revolution that totally reshaped European civilization and the history of the world.

A farm should have a foreman, a foreman’s wife, ten laborers, one ox driver, one donkey driver, one man in charge of the willow grove, one swineherd, in all sixteen persons; two oxen, two donkeys for wagon work, one donkey for the mill work.

Cato the Elder (234 – 149 BC), Roman senator, farming aficianado. Also Carthago delenda est.

I get about the same amount of work done with my John Deere 4610 as Cato accomplished with his sixteen people and five animals, particularly when I’ve got a 460 loader up front and a shovel mounted in back.

The parable of the man who has fled from an elephant

This is the story of a man who, in fear of an enraged elephant, has escaped into a pit, into which he has let himself down, hanging down and holding on to two branches at its edge. He looks down and there is a dragon, its mouth open, waiting for him to fall so that it can devour him. Then he raises his eyes to the two branches and sees two rats at their root, a black one and a white one, that are gnawing at the two branches untiringly and without flagging.

While considering his situation and worrying about his fate, he notices near him a beehive containing honey. He tastes the honey, and its sweetness preoccupies him and the delight of it distracts him from thinking about his plight, or from seeking a means to escape. Thus he remains diverted, unaware, preoccupied with that sweetness, until he falls into the mouth of the dragon and perishes.
Abdullah Ibn al-Muqaffa, from “Kalilah wa-Dimnah” (c. 750).

An Iranian who wrote in Arabic, Ibn al-Muqaffa had a knack for telling Persian fables with a political bent. He was killed for that, of course.

In 1917, Pierre Cartier bought the townhouse at 653 Fifth Avenue in exchange for his most valuable two-strand pearl necklace, valued at $1 million. Today, you can get a two-strand pearl necklace of similar length and pearl size from Macy’s for about $2,000. As for what 653 Fifth Avenue is worth today … well, it’s a lot more than $1 million.

Some of my happiest hours are spent on a tractor. The John Deere 4610 engine has 42.8 horsepower, which means that it generates the raw energy to lift 23,540 pounds one foot into the air in one second. That’s 32 kilowatts for people who think of energy in those terms. The tractor uses this raw energy to power both a drivetrain with enormous torque and a top speed of 30+ miles per hour, as well as a hydraulic system to which you can attach loaders and shovels and the like. It’s a beast, and the ability to control a beast like this is an absolute rush. My girls get this rush by riding and controlling an actual horse. I get it through a tractor that aggregates 43 horses into one hunk of metal.

The tractor isn’t just a powerful beast, but — like an actual horse — is also an incredibly versatile beast. It makes me a one-man wrecking crew if that’s what needs doing around the farm (and occasionally when it doesn’t need doing … I’ve inflicted my share of unintentional damage over the years). But my favorite and best use of the tractor is to Repair and to Make. Need to grade the quarter-mile driveway? Tractor. Need to carry the lumber and lift the roof to build the mustang’s run-in? Tractor. Need to shovel out the boot-sucking ankle-deep “mud” from the sheep and goat pen? Tractor. Need to brush hog a field and clear some trash trees to keep it healthy? Tractor. I am productive with my tractor to a degree and in a manner that I had no idea was even possible in my pre-farm life.

I’ve got two tractor-as-metaphor points I want to cover in this Note From the Field, one on investing and one on macroeconomics.

The investing metaphor is a simple one — a tractor leverages my personal strength a hundred-fold (assuming that I could lift 235.4 pounds one foot into the air in one second, which sounds about right for my maximum ability … on a good day … once … followed by a week in traction). I can accomplish amazing things with that untiring, never flagging, hundred-fold leverage. I can also kill myself.

In 2015, more than 400 people died in farm accidents in the U.S., and tractors accounted for about half of those fatalities. Interestingly, tractors only accounted for 5-10% of non-fatal farm accidents. When you screw up with a tractor, the consequences are deadly.

The source of a tractor accident (or in my case, thankfully, near accidents) is always one of two things: overconfidence or distraction. The machines themselves are phenomenally robust and well-engineered, which means that it’s never equipment error that gets you into trouble. It’s driver error.

Not coincidentally, the most careful, measured people I’ve ever met are professionals who drive big pieces of powerful machinery. There’s no bravado with these guys, no “sure, I guess you can stand on that, why not?”, no “yeah, be right with you, just wanna check my Twitter feed real quick.” It’s always measure twice, cut once, and if there’s anything that’s out of place or out of sight … the answer is no. They are, without exception, the antithesis of Donald Trump (in behavior I mean, not politics), which I suppose is a third tractor-as-metaphor story, given that the White House is the biggest piece of powerful machinery on Earth.

I’ve tried to bring this same sense of non-bravado professionalism to my farming activities, particularly whenever I’m around the tractor. I have to admit that it’s a work in progress, particularly on the overconfidence side. After all, I grew up in Alabama, where invitations like, “Hey, come on over, we’ve got a box of fireworks and a shotgun, so we’re gonna blow stuff up!” were not unknown. But there’s nothing like a slight feeling of “tippiness” while you’re sitting in that tractor chair with 2,000 pounds of gravel in the loader that you’re carrying juuuust a bit too high on a sideways slope that’s juuuust a bit too steep to refocus the mind into a more appropriate frame.

As importantly, and I think with more success, I’ve tried to bring this same measured sensibility to my investing activities, particularly whenever I’m around leverage. As with the tractor, the two devils to battle are overconfidence and distraction. That’s not to say that underconfidence — i.e., irrationally taking too little risk — isn’t a chronic problem for investment performance (Rusty Guinn’s recent notes are a must read on this!). An underconfident investor will inevitably suffer the cuts and sprains of underperformance. It’s the leading cause of high frequency, low severity investment accidents, and it’s hard to make a living in this business if you’re always banged up. But it won’t kill you. Not directly, anyway.

The tractor-as-metaphor is about fatal investment accidents, not non-fatal accidents. It’s about low frequency, high severity market events, which are almost always caused by the use of leverage in an overconfident or distracted manner. It’s not equipment error. It’s not a risk parity fund or an LBO fund posing some sort of inherent crash risk to markets. It’s the overconfident or distracted driver of a levered portfolio that poses crash risk to himself and to others, and that’s what we need to guard against in ourselves and in others.

How do we guard against overconfidence and distraction? By not confusing luck for skill (overconfidence), and by not getting bored with the long slog of compounded market returns (distraction). Or as expressed in Epsilon Theory-speak, by understanding the stochastic sea in which we swim. It’s not easy! And the smarter you are, the more prone you will be to hearing both devils whisper in your ear. Because you DO have skill, and it IS boring to invest with measured professionalism. But that’s the job. That’s the responsibility to yourself, your family, and your partners when you drive a tractor.

My macroeconomic story with tractor-as-metaphor also hinges on overconfidence and distraction, but the sources and mode are very different. The macroeconomic story focuses on the manufactured overconfidence and distraction that are intentionally imposed on us, creating a stable political equilibrium even as productivity growth grinds lower and lower.

Probably the biggest economic question in the world today is why productivity has stopped advancing, why we are no longer making more stuff with the people we’ve got.

US Labor Productivity Growth (2-year moving average)

Source: Bureau of Labor Statistics as of 7/13/17. For illustrative purposes only.

As I wrote in “Gradually and Then Suddenly”, how is it possible — with the most accommodative monetary policy in the history of the world, with the easiest money to borrow that corporations have ever experienced, with all the amazing technological advancements that we read about day in and day out — that companies have not invested more in plant and equipment and technology to improve their labor productivity? How is it possible that we’re not buying more and bigger tractors — not in the literal sense (although maybe that, too) — but in the figurative sense of doing more of what I do with my tractor on my farm: Repairing and Making in the U.S. economy.

My view: The reason companies aren’t investing more aggressively in plant and equipment and technology is BECAUSE we have the most accommodative monetary policy in the history of the world, with the easiest money to borrow that corporations have ever seen.

Why in the world would management take the risk — and it’s definitely a risk — of investing for real growth when they are so awash in easy money that they can beat their earnings guidance with a risk-free stock buyback? Why in the world would management take the risk — and it’s definitely a risk — of investing for GAAP earnings when they are so awash in easy money that they can hit their pro forma narrative guidance by simply buying profitless revenue?

Math is a funny thing. You can increase a ratio by enlarging the numerator OR by shrinking the denominator. But we are well and truly trained to focus on the earnings numerator of our most cherished metric for valuing stocks — earnings-per-share — not the share denominator. We’ve been well and truly trained to believe that’s what companies are supposed to do — grow earnings. So we don’t pay nearly as much attention to the total number of outstanding shares, either for a particular company or an overall market. In fact, the traditional meaning we attach to capital markets is that the total number of outstanding shares should naturally increase, either by new companies going public (IPOs) or existing companies issuing new shares to raise capital in order to buy “tractors” that will grow earnings faster than the cost of that new capital. This traditional meaning attached to capital markets — a transmission belt by which shares are issued for growth capital that increases the productivity of the firm — is dead and gone. Instead we have had a decade of shrinking share counts, as more companies leave public markets through acquisition or going private than enter through IPOs and as more companies use cash flow and debt to buy back shares. This — plus the aforementioned purchase of profitless revenue to satisfy a narrative of growth — is financialization. And it works. It increases both earnings-per-share and the multiple assigned to earnings-per-share (or revenue-per-share or bookings-per-share or whatever your market narrative demands) in a less risky and more predictable fashion than making more stuff at a lower cost and trying to sell it to more people at a higher price.

That’s what I think is going on with corporations, or at least the publicly traded companies that can easily tap into the magical elixir of financialization. Smaller companies and individuals don’t have this access. So why aren’t private companies buying more “tractors” to increase their productivity and make more money? Why aren’t individuals buying “tractors” to start a productive business where they make stuff to sell at a profit?

There are two popular explanations for this lack of productivity growth in the vast real economy of private companies and private individuals, both of which are two sides of the same coin, I think, as understood through the tractor-as-metaphor.

The first explanation is that we are measuring productivity all wrong today, that the glories of modern technology have succeeded in improving our quality of life even if they are not directly benefitting our gross national product. Put satellite position-tracking technology together with mobile telephony devices and electronic payment networks and voila! … on-demand driving services like Uber magically appear, making transportation a breeze. We’re not buying more cars, but we’re able to consume more driving. It’s what I’ll call “experiential consumption”, and it’s at the heart of all of these on-demand business models that absolutely dominate the modern economy, from transportation to education to food to retail to entertainment to politics. Yes, politics. Think about how you consume the experience of politics today, how it’s served up to you on a plate in on-demand fashion without requiring you to go out and actually participate in a political activity. If you don’t recognize that this is a conscious business model, no different than how Domino’s serves up pizzas in on-demand fashion, then I don’t know what to tell you.

The second (and related) explanation for productivity loss is that job growth since the depths of 2009 has been robust in low value-added sectors like healthcare services or leisure & hospitality, but meager in high value-added sectors like IT or financial services. By value-added we mean how much revenue or profits a human being, driving whatever “tractors” are common in that sector, can add to the firm’s coffers. A new hire in a software company or a bank, armed with all the leverage-increasing technologies and processes available in those fields, can add north of $300,000 to that company’s revenues. Unfortunately, there are fewer people working in IT today than there were in 2007 (!), and essentially no growth in financial services. On the other hand, a new hire in the leisure & hospitality sector adds only $50,000 or so to the hiring company’s revenues, but there are 20% more employees in that sector today than there were in 2007 (value added data from U.S. Commerce Dept. and job change data from U.S. Labor Dept.). The same phenomenon holds true for small business creation over the past decade, which has been dominated by low value-added gigs and personal services. It’s what I’ll call “experiential production”, and it’s at the heart of all the personal training and personal shopping and personal tutoring and “lifestyle” businesses that have cropped up after the Great Recession like mushrooms after a spring rain.

Over the past eight years we have thrown our money into relatively unproductive activities (experiential consumption), and we have thrown our bodies into relatively unproductive jobs (experiential production).

It’s as if we’ve intentionally returned to the recommended farming practices of Cato the Elder in 200 BC, where instead of a tractor with a 43 horsepower engine to get the work done, we’ve got “a foreman, a foreman’s wife, ten laborers, one ox driver, one donkey driver, one man in charge of the willow grove, and one swineherd”. Because god forbid we miss out on the experience of being a swineherd. Hey, with modern technology, you can drive for Uber herd swine whenever you like. Just imagine the personal satisfaction, not to mention all that extra cash, that comes with “being your own boss” as an on-demand swineherd.

It’s as if we’ve intentionally returned to the recommended farming practices of Cato the Elder because it IS intentional.

There is a very stable political equilibrium to be found in convincing a citizenry to trade, in Biblical terms, their birthright for a mess of pottage, or, in early 20th century terms, their townhouse for a string of pearls, or, in early 21st century terms, their sense of self-worth and self-actualization for the meme of “being your own boss” as an on-demand swineherd. There is a very stable political equilibrium to be found in convincing a citizenry to value experience and identity over stuff.

And yeah, I know this is coming across as all materialistic and crass. I know it’s rank heresy to say that it’s better to buy a tractor than to take your family on “the vacation of a lifetime”, that it’s better to stay an extra hour at work crunching on a project than to “take a little me-time” at the yoga studio. I know that it’s social suicide in red states to say that fighting over gender identity and who can use what bathroom is stupidity incarnate, just as it’s social suicide in blue states to say that diversity isn’t even a top three goal of anything that matters, much less an end-all-and-be-all goal, and by the way you’re bonkers if you think the Russians altered the 2016 election by one iota. These are all intentionally manufactured diversions of the first order, combined with a preening overconfidence generated by the wealth effect of intentionally inflated financial assets, creating a politically stable Western society of division, diversion, and debt. Yeah, that’s my heresy.

Why is it stable? Because it takes governments off the hook. Taken a ride on BART recently? The NYC subway? I have, and they’re appalling. But there’s no public outcry for Repairing and Making these systems and hence no need to spend the money that doesn’t exist or raise the taxes that can’t be raised or make any of the hard choices that can’t be made without running the risk of upending the entire municipal political system. There’s no public outcry because you’ve got an army of on-demand swineherds cruising the streets of the city providing driving services for everyone who wants to consume that experience. It’s the same tacit social equilibrium with EVERY government function and service in the modern Western world. Including defense. Including banking. Especially banking.

So what’s to be done?

Well … you’re not going to change this from the inside or from the top down. You’re going to change it from the outside and from the bottom up. It’s going to be a movement. It’s going to be a Maker movement and a Protector movement and a Teacher movement.

It’s happening now, at least on the Making side of things (Protecting and Teaching are a little more enmeshed with government monopolies, so that may take a bit of time). It’s happening with every Maker Faire and every public library with a 3D printer and every kid who learns to solder.

And every old guy with a tractor.

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The Goldfinch in Winter

I’ve learned that people will forget what you said, people will forget what you did, but people will never forget how you made them feel.

Maya Angelou (1928 – 2014), author of I Know Why the Caged Bird Sings

And in our business, people will forget what price targets you set, people will forget what funds you managed, but people will never forget how you impacted their personal account.

Longer summer means longer winter.

traditional Westerosi saying

We’ve got a five acre field that I brush hog once a year if I’m feeling particularly industrious, and one day I suppose we may do something with it.

In late summer this fallow field of thistle and hay is one of my favorite spots, particularly in the early morning and late afternoon, because of the flocks of goldfinches that swoop in and around the field. The goldfinch is exactly as the name implies — a small bird with a bright yellow, almost tropical, plumage — and it looks out of place in the Northeast, like maybe it’s an escapee from a gilded cage in Greenwich. But they love these Connecticut summers, and it’s not uncommon for me to count 30 or more flying around in a swarm that at times seems to be the animal itself.

The flocks are never as big as the far more famous murmurations of starlings, which is a good thing, of course, but they generate that same sense of awe in that there is clearly some sort of order and method to the flowing chaos of all these birds moving together. Most unlike the starlings, however, is that the goldfinch flocks are absolutely beautiful. The glints of yellows and gold moving through the air like a living liquid, the morning sun piercing the flock … it’s a natural poetry that has no good reason to exist, but does all the same.

I’m as much a dilletante birdwatcher as I am a dilletante farmer, so when the beautiful yellow birds stopped making their appearances over the field every fall, I just assumed that they were like the robin, flown south for the winter. I assumed this was the case for years, And in fact some goldfinches do migrate south every year, particularly the ones who set their breeding nests up in southern Canada.

But not our goldfinches. No, our field and its thistles, together with the nearby woods and the river that runs through it, is just too good of a home base to leave even for a season (I agree!). So they don’t fly south. They don’t go anywhere at all. They stay the whole winter, there in the field and the scrub and the forest all along.

Why didn’t I see them in the winter? Because they change color, or at least the males do, exchanging their flashy yellow feathers for a quite pedestrian dull brown. Just an ordinary little bird, one you’d never give a second glance at, even if now you remember seeing so many at the bird feeders you set out when the snows come.

Yes, the goldfinches were there all along. I just didn’t know where to look.

What’s the investing lesson here?

Goldfinches are like Value investing. Or Growth investing or Momentum investing or whatever your investment style might be. They have a season where they seize the stage, blistering in their radiance. And then they recede. They don’t go away. They just fade into the background and become a pedestrian little bird, until their appointed season returns — it always does! — and they seize the stage once more, zipping around in a glorious flock with some sort of fractalish order-in-chaos.

Unfortunately for us investors, though, the seasonality of investment styles is more like Westeros on Game of Thrones than Connecticut here on Earth. “Winter is here” on Game of Thrones today, but it took a long time coming … summer lasted a good nine years this time around, and legends tell of a winter back in the day that lasted for an entire generation. The winter currently being experienced by Value investors only seems like it’s lasted for a generation.

Not surprisingly, then, investors are always asking the same question: is there a bird for all seasons? Is there an investment style or process that can be more than just a pedestrian performer come winter, spring, summer, or fall, and no matter how long or how deep those seasons might be?

The answer, I think, is yes. The answer, I think, is diversification. There’s your bird for all seasons.

But here’s the problem with diversification, and it’s a problem I’ve written about extensively in Epsilon Theory, most recently in “It’s Not About the Nail” and “It’s Still Not About the Nail”, and in an oldie but goodie titled “Don’t Fear the Reaper”.

Diversification isn’t a pretty bird. Diversification doesn’t make my heart skip a beat like a flock of goldfinches in July. Diversification, by design, is going to have winners and losers simultaneously. Diversification, by design, is never going to look pretty doing its job, because if your portfolio is all working in unison, swooping through the market in a beautiful glint of gold … well, you may be making money, but you sure aren’t diversified. Diversification is undeniably effective, but it’s effective like a rat is effective, wonderfully adapted to do pretty well in pretty much any possible environment without calling too much attention to itself. That’s actually one of the rat’s primary survival mechanisms. It’s not flashy. It’s not pretty. It’s a freakin’ rat.

Diversification doesn’t make us feel good like a winning value or growth investment makes us feel good, and as Maya Angelou so brilliantly said, how you make people feel is ALL they remember.

I don’t have an answer for the simple fact that diversification doesn’t sing. I can’t make a financial advisor’s client feel good about diversification. I wish I could, because I would be … umm … a very rich man. But what I do know is that it’s a mistake to gussie up diversification as something that it isn’t. You can’t sell diversification as a beautiful song bird. You have to be honest about what diversification can and can’t do, not just for a portfolio’s performance, but also for a portfolio’s experience. The more years I spend in this business, the more I am convinced that how one lives with a portfolio, how one experiences its ups and downs over time, is more important for business success and business staying power than that portfolio’s performance. And I’m not just talking about volatility, which is usually how we think about the path of a portfolio and its ups and downs. No, I’m talking about how a portfolio makes us feel. Most of us need those goldfinch moments of wonder and awe, even if they just last for a season, to feel good about our portfolios, and those are moments that diversification has a really hard time delivering.

To every thing there is a season, and a time to every purpose under heaven. That holds for portfolio construction, too.

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Notes From the Field

To make a prairie it takes a clover and one bee,
One clover, and a bee,
And revery.
The revery alone will do,
If bees are few.
― Emily Dickinson (1830 – 1886)


I’ve said it before, and I’ll say it again.
Emily Dickinson is a total badass.

When a livestock farmer is willing to “practice complexity”— to choreograph the symbiosis of several different animals, each of which has been allowed to behave and eat as it evolved to — he will find he has little need for machinery, fertilizer, and, most strikingly, chemicals. He finds he has no sanitation problem or any of the diseases that result from raising a single animal in a crowded monoculture and then feeding it things it wasn’t designed to eat.
Michael Pollan, The Omnivore’s Dilemma: A Natural History of Four Meals (2006)

In modern farming and in modern investing, we have become prisoners of the monoculture. It’s efficient. It’s necessary for a mass society of ever-increasing Desire. And yet …

Oh, and one more thing. In the investment monoculture, you’re not the farmer.

Up on the Ft. Peck Reservation
(Assiniboine and Sioux)
just as I passed two white crosses
in the ditch I hit a fledgling meadowlark,
the slightest thunk against the car’s grille.
A mean minded God
in a mean minded machine, offering
another ghost to the void to join the two
white crosses stabbing upward in the insufferable
air. Wherever we go we do harm, forgiving
ourselves as wheels do cement for wearing
each other out. We set this house
on fire forgetting that we live within.
 Jim Harrison, “To a Meadowlark” (2008)

One thing that has gone wrong in America is the general acceptance of bad ham.
Jim Harrison (1937 – 2016)

After gaining widespread fame as an explorer and “Indian fighter” during the Revolutionary War (yes, that used to be a profession, and a respected one), Daniel Boone earned his living in the Kentucky wilderness by producing what was known as bear bacon. It wasn’t “bacon” as we know it today, which typically comes from the sides and bellies of pork. Instead, Boone would take the whole bear and portion it into large hunks of meat that were brined and smoked. Living out of a lean-to shelter, he and his family hunted the bears with the help of tracking hounds. They soaked the meat in handmade barrels filled with a brine of water, salt, and sugar. They got the salt from mineral licks, and they got sugar by tapping the sweet sap from maple trees. Once the meat was brined, it was smoked and loaded onto keelboats headed up the Ohio River. Riding along with the meat were barrels of lard, rendered down from bear fat, as well as stretched and dried bear hides. All of it was sold in the eastern settlements. In one particularly productive season, Boone brought to market the meat and by-products of 155 black bears.
Steven Rinella, “First Catch Your Bear: Recipe for Smoked Black Bear Ham,” Cured v.1, Fall 2016

I had a coonskin cap when I was a wee lad, and I can still sing the Daniel Boone theme song. Not sure I can imagine Patricia Blair boiling down bear fat and living in a lean-to, any more than I can imagine Fess Parker being an “Indian fighter”. I mean … the bad Indians, sure, but Daniel Boone was a great friend to the good Indians like Mingo. Right?

Of all the occupations by which gain is secured, none is better than agriculture, … none more becoming to a free man.
Cicero (106 – 43 BC)

Men are not so much the keepers of herds as herds are the keepers of men.
Henry David Thoreau, Walden (1854)

The land is ours. We are the land’s.

Robert Frost wrote a similar line to lead off a patriotic anthem (“The Gift Outright”), most famously delivered at JFK’s inauguration when he was 87 years old. The poem rings poorly to the modern ear. Too jingoistic. Too rah-rah. But there’s a deeper meaning, I think, whether Frost intended it or not. The land is ours. There is a freedom that comes from working one’s own land, a groundedness — in the truest sense of the word — that was the foundation of Roman civilization and the republican virtues that inspired Jefferson, Madison, Hamilton, and the rest of the Founders gang.

But the land owns us, too. That encompasses nationalism and patriotic duty, for sure, which is how I think Frost meant it. It also encompasses civic and social duty, which is how I mean it. This is the price of civilization, that we allow ourselves to be the land’s. It’s a price worth paying.

Regular Epsilon Theory readers may know that I’m originally from Alabama but now live out in the wilds of Fairfield County, Connecticut. Politically this is a failed state, but it’s still a beautiful one, and we’ve had nothing but happiness raising our four daughters here on a “farm” of 44 acres. I put that word in quotations because although we have horses and sheep and goats and chickens and bees, my grandfather — who owned a pre-electrification, pre-refrigeration, pre-pasteurization dairy farm in Alabama during the 1920s and 1930s — would surely have a good belly laugh at the notion of calling this a “farm”. But it’s a farm to us, and it’s been the bedrock for how we’ve educated our girls, who along with their mother do every bit of the work required to keep these animals alive (except for the bees, which are my thing, and anything that requires using the tractor). There are lessons from training a mustang to take a saddle, from shearing a sheep, from watching how goats defend the weak and how chickens torture the weak … lessons that have made my daughters strong and wise way beyond their years … lessons that you can’t get anywhere else but a farm.

It’s been a learning experience for me, too, of course. The dilettante farmer has been a stock comedic character since Cicero’s day, and Eddie Albert on Green Acres is a farming savant compared to me. One of the nice things about the land, though, is that it doesn’t hold a grudge. It forgives. Stick with it long enough and you can start figuring out the rhythms, or at least injure yourself less frequently. Plus, in case I wasn’t clear earlier, this is freakin’ Fairfield County, Connecticut. I’ve installed a really excellent wifi router in my barn so I can download instructional videos on, say, replacing the oil filter on my tractor. I expect Amazon Prime drone delivery service for said filter to start up any day now. And if all else fails it’s a 10-minute drive to a couple of really good bars where I can nurse my wounded pride with some artisanal Mezcal and whatever locally-sourced amuse-bouche the chef has whipped up that day. I mean, this isn’t exactly Grapes of Wrath material.

By the way, the joke in that last paragraph for farming cognoscenti is how easy it is to change an oil filter on a modern tractor. It’s a four-inch canister that pokes out from the engine. You literally unscrew it by hand (“remember, lefty-loosey!” says the instructional video, clearly designed for dilettante Team Elite tractor owners like me) and screw the new one on tight. Maybe put a little fresh oil in the new filter before attaching if you wanna show off a bit. But, yeah, that’s all it is.

Still, I have learned a few things over the years from the farm and its animals, and they’ve helped me to become a better investor. Those are the notes from the field that I want to share in this Epsilon Theory letter.

#1: Fingernail Clean

Fresh eggs are, in fact, one of the best things in life, and they (almost) make up for the necessity of dealing with the evil reptilian brain of the modern-day chicken. A fresh egg is notable for both its yolk (an orange-yellow that seems to glow, not the flat yellow-yellow you get in a store-bought egg) and its white (the fresher the albumen, the greater its coherence, so that you can, for example, poach a very fresh egg without putting vinegar in the water). A fresh egg is also notable for the fact that, depending on where it was laid and when it was collected, it may have dried chicken poop on the shell.

Now an eggshell is semi-permeable, and a fresh eggshell has a thin anti-bacterial protective layer called the “bloom”, so you don’t want to soak it in soapy water, or really any water at all. You can use an enzymatic egg wash to loosen the “dirt”, but really all you need to do is moisten the spot and scrape it with your fingernail until it’s clean. Not scrubbed. Not pristinely clean. Just fingernail clean. That’s really the optimal outcome.

Here’s another truth about fresh eggs: you don’t need to refrigerate them. They’ll keep for a month just sitting out on your kitchen counter. They don’t rot. They don’t start to smell. They don’t serve as a Petri dish for salmonella or some other dread bacterium. Seriously.

So you don’t have to refrigerate your fresh eggs. But if you scrub your eggs all nice and perfectly clean, removing the anti-bacterial bloom layer in the process, then you have to refrigerate them. Similarly, if you start refrigerating an egg, then you have to keep refrigerating it. You can’t go back and forth.

Of course, you can’t scrape eggs fingernail clean on an industrial scale, and there really are dread diseases running rampant in every industrial protein monoculture facility, whether it’s for eggs or chickens or cows or pigs or whatever, which is why antibiotics are constantly fed to these animals. You can’t be certain that industrially produced eggs will get to a buyer within a month, and you certainly can’t be certain they’ll be kept at room temperature over that span. So you wash the hell out of the industrially produced egg, and you introduce it to refrigeration as soon as you can for storage and transport. That’s why the spotless, refrigerated egg is all we know. It’s necessary for effective and profitable industrial production.

But because the spotless, refrigerated egg is all we know, we believe anything to the contrary must be a defective and potentially diseased egg. Not a better egg, which is the truth, but a worse egg. A bad egg. You see this all the time when you give people fresh eggs. They’re disturbed if the eggs aren’t housed in an egg carton and cool to the touch. They get freaked out if the eggs aren’t perfectly, and I mean perfectly, clean.

We have been well and truly trained to accept the Industrially Necessary Egg as the Good Egg.

It’s the same with all dairy products. It’s the same with all industrially produced proteins. It’s the same with all industrially produced anything.

So many ideas that we take as immutable truths of safety or goodness, whether those truths concern the food we eat or the stocks we buy, are not truths at all. They are conveniences, and not conveniences for us, but for the sellers of the food we eat or the stocks we buy.

Do you really think that an ETF (and let’s recall what those letters stand for — an Exchange Traded Fund) was designed for your benefit? I wrote the following in September, 2015 in an Epsilon Theory note called “Season of the Glitch”. It bears repeating.

The key letter in an ETF is the F. It’s a Fund, with exactly the same meaning of the word as applied to a mutual fund. It’s an allocation to a basket of securities with some sort of common attribute or factor that you want represented in your overall portfolio, not a fractional piece of an asset that you want to directly own. Yes, unlike a mutual fund you CAN buy and sell an ETF just like a single name stock, but that doesn’t mean you SHOULD. Like so many things in our modern world, the exchange traded nature of the ETF is a benefit for the few (Market Makers and The Sell Side) that has been sold falsely as a benefit for the many (Investors). It’s not a benefit for Investors. On the contrary, it’s a detriment. Investors who would never in a million years consider trading in and out of a mutual fund do it all the time with an exchange traded fund, and as a result their thoughtful ETF allocation becomes just another chip in the stock market casino. This isn’t a feature. It’s a bug.

More recently, both Rusty Guinn and I have been hammering on this point in Epsilon Theory notes: ETFs are the epitome of active trading. They exist because we can’t help ourselves. We demand the ability to actively manage our portfolio on a minute-by-minute, second-by-second basis. We’re addicted to the “news” on CNBC and the rush we get from playing the hand and the false sense of security we derive from the immediate liquidity and the false satisfaction we derive from making the decision ourselves. We fancy ourself to be a macro investor — able to select this sector or that sector, this geography or that geography, this theme or that theme, this asset class or that asset class — and that’s why ETFs exist. We’ve been sold the idea that we’re excellent macro investors, just as smart and observant and on top of things as all those fat cats we read about. We’ve been sold the idea that it’s a Good Thing for us to “take control” of our portfolio and give the boot to all of those “so-called experts” with their “out of control fees”.

It’s a powerful idea because, like all powerful ideas, there’s more than a little truth to it. Fees are often too high. Experts and advisors are often just marketing shills. That’s all true. But what’s also true is that you are not an excellent macro investor. Sorry. And more to the point, there’s no need for you to be an excellent macro investor and still achieve your investment goals. But so long as we allow ourselves to be well and truly trained into believing that the Industrially Necessary Financial Innovation is the Good Financial Innovation, it’s harder to achieve those goals. Like a store-bought egg, ETFs are occasionally necessary, and always convenient. But they can’t hold a candle to a fingernail clean fresh egg.

#2: Structure Is a Cruel Master

I like animals that pay the rent. It’s why I put up with chickens and sheep, both of whom are just about the stupidest and most selfish animals on this green earth. And it’s why I’m particularly interested in bees, because honey is the best rent I collect. Honey is another food product where, like eggs, the necessities of industrial production have led to the general acceptance of bland honey as good honey. In truth, the best tasting and healthiest honey will have bits of raw pollen in it, maybe a bit of wax, maybe — brace yourself — other impurities. But that’s not my point in this note from the field. My point here is about the particular genius of bees, which is that they are hard-wired to create amazing structure out of complete chaos. Usually that genius results in a triumph of both social and physical engineering, but occasionally it goes awry. Ditto for humans.

I use a top-bar hive design for my bees, rather than the far more common Langstroth hive design. The top-bar hive essentially mimics a hollow log, providing nothing more than a flat ceiling and some holes in the “log” for the bees to fly in and out. It’s completely up to the bees how they build their combs within the “log”, and I’ve got a plastic window on one side of the structures so I can see their progress. Think of it like an ant farm for grownups. Alternatively, the Langstroth design forces the bees to build their combs in a deterministic manner, providing pre-waxed, precisely distanced slats within tight boxes that can easily be stacked and moved. The Langstroth hive is a wonderful design for transporting bees for commercial pollination services, and similarly effective for maximizing honey production and extraction. Neither of which I care about.

What I do care about, beyond collecting the occasional honey comb, is understanding, experiencing, and learning from the bees, and that’s what a top-bar hive allows me to do. The downside to a top-bar hive is that it doesn’t provide any “guardrails”, to use a management term du jour, for the bees. Plus, any honeycombs you collect are likely to have a few, or more than a few, larvae in the comb, making it more of a challenge to extract the honey without the yucky stuff. But both of these negatives are positives in my book. I’m not trying to get a ton of honey, and I want the responsibility of identifying and rectifying any structural wrongs that might develop in the hive. Or so I thought.

My first year with a top-bar hive, I thought it would be helpful if I gave my new colony a bit of a head start by placing some pre-waxed Langstroth hive sheets (basically a wax sheet held together with thin strands of wire) in the bottom of their “log”. Sure enough, the bees quickly harvested the wax and used it for their new combs, leaving the thin wires at the bottom of the hive. Mission accomplished!

One month later, though, and my hive was a mess. The bees didn’t physically harvest the thin metal wires like they had the pliable wax, but they had harvested the idea of the wires. You see, bees will use any structure as a template for their structure-building instincts. The reason a top-bar hive works is that it mimics a hollow log. Any structure within the log, any at all, even a few wires jumbled at the bottom, will be seized on as a structural framework. So instead of only getting the classic honeycomb built from the ceiling down in beautiful straight lines with exactly ¾ of an inch between combs, I also got a blob comb built from the floor of the hive up. To make matters worse, I had made the newbie mistake of not ensuring that my full hive, the “log” itself, was perfectly level when I set it up, and as a result the ceiling-built combs were listing downhill. Put it all together, and I got the disaster structure: cross-comb, where your hive becomes a maze of interlocked combs and lobes, impossible to interact with without destroying big chunks of the hive and killing large numbers of bees. If you’ve ever mistreated an engine to the point where it seized up, fusing into a solid block of metal, then you have a good notion of what I had done to this hive.

And here’s the kicker. I knew this was happening (remember the plastic window so I can see into the hive), and I still did nothing to stop it. Or rather, I suspected that something bad was happening, and rather than dig in and kill a few bees and wreck a small amount of comb in order to scrape out the wires and get the hive on the right track, I didn’t want to pay that price. There’s no way, I kept telling myself, that these bees would become so utterly focused on building around a few metal wires that obviously weren’t part of the master plan and obviously didn’t lead to a properly built hive. I was wrong.

So what are my lessons here?

Investors are like these bees, determined to find structure — i.e., meaning — in anything the beekeeper or nature gives them. They will find structure and meaning even if the beekeeper intended no such thing. They will find structure and meaning even if what they build is obviously flawed. They will keep building on this flawed foundation for as long as they are physically able to do so.

The architectural design for a beautiful end result — a productive hive or a productive portfolio or a productive market — is nowhere to be found in a bee’s brain or a human’s brain. What is in our brains is an algorithm — a process — where we take meaning from found structures and we build on them. And build and build and build. That’s what the bee and the human are biologically evolved to do, and that’s exactly why the bee and the human are two of the most successful species on the planet. Our algorithms work. For both bees and humans, our process is our genius. And it usually ends up as a grand success. Unless, of course, we’ve been given a flawed foundation. Unless, of course, we’re finding structure and meaning in a bunch of wires on the floor of the hive.

Central bankers are like me, the Hamlet-esque, dithering newbie beekeeper who left a destructive structure in the hive but can’t bring himself to accept that fact. Central bankers absolutely think of themselves as beekeepers. They absolutely believe that they, and only they, can keep the global economy from going off the rails. They absolutely believe that they provided the necessary materials to keep the hive alive in 2009 and 2012, albeit admittedly with a bit of detritus left behind in the form of massive balance sheet reserves. They absolutely do NOT believe that removing these reserves will be a big deal, so long as they keep saying the right words and go very very slowly. They are wrong.

To use another pastoral reference, what’s good for the goose is good for the gander. If Bernanke was right about the portfolio rebalance channel on the way up, he’s going to be right about the portfolio rebalance channel on the way down. What’s the portfolio rebalance channel? It’s the whole entire rationale for QE, the whole entire reason that central banks now own $14 TRILLION worth of stuff. By buying their fixed income stuff, central banks push down the yield on ALL fixed income stuff. They make ALL investors take on more risk than they otherwise would. The safe-as-houses U.S. Treasury buyer has to buy mortgages to get the same portfolio return as before. The cautious mortgage buyer has to buy corporate debt to get the same portfolio return as before. The corporate debt buyer has to buy equities to get the same portfolio return as before. It’s turtles all the way down. And it will be turtles all the way up as ALL investors are forced to take on less risk than they otherwise would.

This algorithm — what I’ve called in the past the Narrative of Central Bank Omnipotence, or the idea that Central Banks are responsible for all market outcomes — is now well and truly implanted in the human brain. Maybe it’s not in your brain. Good for you (although I don’t believe you). But would you deny that it’s implanted in enough human brains to make all the difference in market behaviors? I don’t know whether Bernanke was right about the portfolio rebalance channel. And I don’t care! What I care about is that enough people believe that the portfolio rebalance channel worked, just like enough people believe that Draghi’s Outright Monetary Transaction program worked, so that it DOES work. In either direction.

To make a prairie it takes a clover and a bee. Plus revery. Belief.

And belief alone will do.

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