Infrastructure Week!

Roy Lichtenstein (1961)

There’s a great Sherlock Holmes story called “Silver Blaze”, where a star racehorse is stolen the night before a big race and his trainer is murdered. Scotland Yard is baffled, of course, but the GOAT consulting detective figures it all out with typical panache. Here’s the big reveal:

Det. Gregory: Is there any other point to which you would wish to draw my attention?

Holmes: To the curious incident of the dog in the night-time.

Det. Gregory: The dog did nothing in the night-time.

Holmes: That was the curious incident.

I like to think of myself as a consulting detective. 

Not a real world detective, of course … too boring and too dangerous for my taste, at least as I understand the work. But a market detective? A narrative detective? That works.

I’ve found, though, that one of the occupational hazards of being a narrative detective (and I suppose this is an issue for real world detectives, too) is that I am always examining objects that exist. Hmm … Apple is going to announce earnings tomorrow; I wonder what the narrative around the new iPhone looks like? Hmm … that Khashoggi murder is all over the news; I wonder what the narrative around Saudi and Saudi-linked entities looks like?

I get so used to looking for the things that I know exist, that I forget to look for the things that don’t. And that’s a mistake for any detective, for anyone trying to figure out the Why of the world. Because as Holmes showed, the ABSENCE of a thing can tell us as much about the Why of the world as the presence of a thing. 

There’s a dog that didn’t bark in the midterm campaign. And its silence tells me a lot about where this country is going.

Anyone remember the Fiscal Cliff of January 2013, when markets swooned over a deficit-driven government shutdown? When U.S. debt was downgraded over the budget deficit? When the Sunday politics shows were awash in words like “sequestration” and “CBO projections” and “debt ceiling”? Ah yes, those were the days. That was a barking dog.

What a difference 6 years can make. Here’s the narrative map of all Bloomberg articles from October 2017 – October 2018 that have anything to do with the US budget deficit.

Budget Deficit Narrative October 2017 – October 2018
Source: Quid, Inc. For illustrative purposes only. Software used under license.

This is 25 measly articles over the course of a year. This is the ABSENCE of a narrative. This is a dog that is NOT barking.

And it’s not because the US budget deficit problem is getting better. On the contrary, the budget deficit is soaring. The difference between 2012 and 2018 isn’t in Reality-space, but in Narrative-space. The difference between 2012 and 2018 isn’t that the budget deficit has gone away. It’s that no one is talking about it. It’s that no one CARES. 

So what does it mean that no one is talking about US budget deficits? What does it mean that political entrepreneurs and Missionaries see no advantage in shaking their fingers at us about that god-awful deficit? What does it mean that Austerity!  has disappeared in Narrative-space?

For starters, it’s definitely an equity market positive. It’s the ABSENCE of a negative narrative, and it UNBLOCKS positive narratives like Infrastructure Spending! that Wall Street can promote. In the two days since the midterms, I’ve received five sell-side reports on companies poised to do well when Congress passes the inevitable Trump infrastructure spending bill.  I mean … who’s going to say no to this? 

How does this all end? The same way that the removal of any big countervailing narrative always ends. It ends in massive excess. It ends in tears.

Unless and until a Budget Restraint! narrative reappears, there will be no budget restraint. There will just be spending. There will just be fiscal stimulus. Now, it won’t be called spending. It won’t be called stimulus.  It will be called “investment”. You know, like “investment in our future” or “investment in our country” or “investment in our crumbling infrastructure”. Because who can be against “investment”? 

And people still ask me how it’s possible to have an inflationary world.

This is how Things Fall Apart. Not with a bang. Not with a whimper. But with the excess of an unrestrained government. 

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  1. As a long-time deficit scold - now cowed - I’ve learned this about deficits: they don’t matter until they do.

    The trigger / the catalyst / the tripwire / the moment seems unknowable in advance (at least in advanced countries). Pick a putative trigger - some percent of GDP, some ratio, something - and Japan shows it can be blown through without any consequences.

    QE, monetization, what have you - it works until it doesn’t, but if we have no guide as to when “it doesn’t” is, then it’s probably a three-body problem.

    Can we have an inflationary world - sure, but Japan has taken deficits to unfathomable heights while doing everything it can to generate inflation with almost no success.

    So, I close where I opened, I’ve learned this about deficits: they don’t matter until they do.

  2. A bearish steepener for the bond market, that’s what happens first. Haven’t seen that for many, many years.
    Will bonds be once again called “certificates of confiscation” as they were when I first entered the investment world?
    Maybe, but not until we see many years of a bond bear market.
    Anyway, clear drag on equities but only on a secondary basis.

  3. Ben, this echoes my own thinking as much as anything you have written. I was thinking the exact same thing as I watched the election postmortems. In all the analysis, the discussions of the issues that people cared about and the charts and graphs showing the relative importance of those issues----deficits and debts were nonexistent. Somehow a ragtag band of refugees wandering through Mexico was more important than a trillion dollar deficit.

    My father served in the Maryland state senate for 24 years and was involved in the efforts in the 80’s and 90’s to get a balanced budget amendment added to the US Constitution. His main emphasis was to get two thirds of the state legislatures to petition for a constitutional convention for the purpose of writing an amendment to the Constitution to mandate a balanced budget. They fell a few states short of two thirds and then the balanced budgets in Clinton’s final years put an end to the amendment movement.

    I’m not arguing that amending the Constitution is or isn’t the answer. What I am saying is that what was once a major issue 25 years ago is totally removed from the political and public discourse today. It amazes me that hardly anyone thinks it odd that an economy running at full speed could result in a federal deficit approaching a trillion dollars. But the day is coming when the dog will bark.

  4. it’s not a bear steepener. That implies bond holders would be shortening duration rather than outright selling if inflation expectations were to accelerate. Also would imply the FOMC (or ECB) would sit on their hands rather that move to subdue inflation with higher front end rates. Questions on central bank independence as we see in EM from time to time would indeed be the steepener trade.

    The story here diverges from Japan when you see employment, consumer spending, and credit all growing smartly and gov’t spending throwing fuel on the fire (C+I+G). Demographics and a lack of attractive domestic investment opportunities have scuttled that factor convergence in Japan, despite a spectacular degree of “G”. Tough to see what the right implications of this theme is for the bond market, other than to remain short relative to equities and commodities.

  5. I would expect “Austerity” to get the same reception in the US as it has in EC countries where preached. Benefits once received are very difficult to suspend. Therefore, after some longer period of time than we expect, the flash point will come.

    Besides looking for companies with sufficient “moats” (to ensure demand, at least), I am accepting that some or much of the recent paper wealth increase will be given back in the reset. Hopefully not, but maybe so. (Back to you, Ben.)

  6. Avatar for cazo97 cazo97 says:

    CNBC right on que - 11/12/18: “Rebuilding America”

  7. Well, maybe today’s WSJ article about interest/debt service as a percent of budget, revenue, and GDP will be among the voices to change the narrative. Tho not the boy who sees an naked emperor, just maybe heading in that direction.

    Haul-ass, bypass, and re-gas!

  8. Long bonds would be under the greatest threat in the environment Ben is describing.
    Both lose ( hence bear steepener ) but 30 year bonds at greatest risk from out of control deficits and inflation.
    Fed has no appetite for all out , damn the torpedo, inflation fighting.
    That requires support from the populace, like Volcker had when people wanted, needed relief from the raging inflation of the late 1970s.
    They will lag what is really needed until the people demand it. Long bonds will hate that.

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