Inflation Monitor – 12.31.2018

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Access this month’s monitor slides in Powerpoint and in PDF.

Access the monitor values in Excel.

  • For yet another month, stock market declines refocused investor narratives – especially concerning monetary policy – on the pace of rate hikes and the ’Powell Put’, putting inflation very clearly on the back burner.
  • As a result, it appears that the inflation narrative has largely eroded. There is little connectivity between inflation stories and markets stories, and what connectivity exists appears to be the vestiges of a resurgent Central Bank Omnipotence narrative.
  • Fiat news measures have fallen as well, probably (this is our view, not a fact) because there isn’t an active narrative being promoted.
  • We do take note of an especially interesting cluster of stories (in red, middle right of the map). It is a highly connected cluster of stories that boil down to inequality stories, from student debt feature pieces to pharmacy benefits to stories about Oklahoma billionaires to French yellow vests. These are powerful memes that are worth keeping an eye on in context of future inflation narratives.

Narrative Map

Source: Epsilon Theory, Quid

Narrative Attention

Source: Epsilon Theory, Quid

Fiat News Index

Source; Epsilon Theory, Quid

Narrative Sentiment

Source: Epsilon Theory, Quid

Key Articles

Oklahoma’s Future Rests in the Hands of Two Very Different Oil Billionaires

Millennials spend less than previous generations because they literally have less money, Fed says

ECB to Lower 2019 Inflation Forecast as Bond-Buying Ends

Four experts weigh in on key market factors for 2019. Here’s what you need to know

In Silicon Valley wages are down for everyone but the top 10 percent

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Multiple Ways to Lose (AAPL)

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Sentiment: Very Negative and Stable

Attention: Very Strong and Rising

Leading into Apple’s earnings announcement last November, the product-level narratives for Apple were both remarkably positive and reflective of a consistent narrative: ‘these new phones are going to be a Big Deal’. We noted at the time that the narrative around this product launch was as positive as any since the iPhone 6, which may be among the best-performing products in Apple’s history. Expectations were high.

Source: Epsilon Theory, Quid

Company-level narratives incorporated a more complete picture of the various forces facing the company, some good and some bad. In the quarter leading up to the November earnings release, we think there were two active narratives about Apple stock (shown below generally within the two oval shapes):

  1. As noted above, a product- and business-line narrative that was positive and idiosyncratic to Apple, portraying higher-priced devices in light of Buffett’s belief (and double-down) that this was an underexploited opportunity to expand margins, alongside news of the company’s increased success and efficiency in its supplier channels.
  2. A market and stock-based narrative (the lower oval) of Apple as part of a growing concern about big technology stocks, the influence of federal reserve policy and interest rates, and Apple’s fate as the company that had, to this point, fared the best.

Narrative Structure of Apple Stock – July 2018 – October 2018

Source: Epsilon Theory, Quid

Immediately following Apple’s earnings release – and more importantly, its announcement that it would no longer release unit sales figures for its flagship products, two things happened. First, the stock performed very poorly. In short, the company’s announcement flipped the surprisingly positive lens with which the market was taking in unit price information into a decidedly negative one. In this, Apple executives discovered one of two ways to lose the narrative game – to flip a positive, high attention component of the core narrative to a negative one.

The second effect, of course, is that the narrative structure shifted – quickly. The market narratives attached to concerns about technology stocks became central to all of the stories written about Apple. When authors, sell-side analysts, strategists and buy side investor letter writers wrote about Apple, they were also writing about the rest of the wreckage in technology stocks. More importantly, the only two clusters of Apple-specific topics connected to this central narrative about the stock’s performance were (1) fears about China and the trade deal and (2) concerns about the unit sales reporting policy and what that might imply about Apple’s expectations for sales. Both were decidedly negative topics in their treatment of Apple.

Narrative Structure of Apple Stock – November 2018

Source: Epsilon Theory, Quid

With this narrative structure in place, in early January 2019, Apple executives discovered the second way to lose on narrative: confirm a negative peripheral component of a high attention narrative, bringing it into the core.

When Apple guided lower on sales and pointed to China in the process, they confirmed the two only high attention, highly connected components of the narrative to the stories being told about Apple, both of which happened to be negative. What’s more, the narrative became more concentrated and more interconnected as the calendar approached 2019. As shown in the over-time chart of attention and sentiment below, our attention measure here reached near-peak levels in December 2018.

Source: Epsilon Theory, Quid

What now?

Our view at this time would depend heavily on our time horizon and strategy, but this narrative structure does lead us to a few conclusions:

  • For better or worse, Apple is now a stock whose narrative is tied up in the China Trade War narrative. If they aren’t already, we think that traders and investors who are attempting to trade this idea creatively (or do so reflexively) will now be using Apple as part of their thematic “trade war” baskets. As we have written elsewhere, we believe this is a classic game of chicken whose odds cannot be predicted. For shorter-term investors and traders, that means that we think active positions in AAPL are likely to have more or less random outcomes with significant volatility while this broader narrative dominates market attention. Shrink your book.
  • For cross-sectional trend-followers, we think that the narrative environment of a strong core narrative and consistent sentiment is more conducive than usual to trend formation over the medium term. We would still be mindful of the higher volatility and potential randomness of the issue highlighted in the first bullet above.
  • For longer-term investors less sensitive to short-term volatility, especially long-biased investors or financial advisers, we view the realization of the two highest attention, negative-sentiment topics to Apple’s narrative at once as a positive for active positioning. While any decision should be subject to your own fundamental analysis of potential emerging issues of concern for the company (on which we have no view), barring any such concerns, the major narrative threats to the perception of the company are (for the time being) very much in the open and being discounted to some extent.

PDF Download: Multiple Ways to Lose (AAPL)

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In the Flow – Real World vs. Market World

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Real World vs. Market World

The price action of a holiday week at the end of the year is usually a humdrum affair. Volumes are muted, portfolios are getting locked in, no one is looking to take on risk … but not this year. The last week of 2018 was a rollercoaster. A gruesome Monday, a wonderful Wednesday, and a defibrillating Thursday and Friday. Does it mean anything?

It means that our narratives are in flux. It means that, from an Information Theory perspective, there are limited informational barriers that constrain the market equilibrium from moving sharply up or down. When narratives are in flux, market price levels are like a marble on a glass table top. It takes very little strength in a new signal to push the marble a long way in either direction.

It reminds me very much of market dynamics in the summer of 2013, when I first wrote about unstable market price levels from an Information Theory perspective. Then as now, we were getting big moves up and down in the market, often big intraday moves, without any obvious “news” to blame or credit for the action.

The narrative uncertainty in 2013 was all about the Fed’s Taper and the resulting market Taper Tantrum. What did it mean? Was this only a market phenomenon, or did it have some great significance for something happening in the real economy?

Today’s narrative uncertainty is similarly about Fed balance sheet policy, now actively rolling off their holdings and not just slowing the pace of new purchases as in 2013. What does it mean? Is the December sell-off only a market phenomenon, or is it related to some impending recession in the real economy? Or is it maybe even a harbinger or some financial system risk?

What struck me from a narrative formation perspective this past week was the absence of drumbeating about a real economy recession. Instead I saw the early signs of a market-positive narrative being formed: “our recent sell-off is a market problem, not a real economy problem”.

The fact is that the Chicago ISM number last week was VERY strong. The US economy sure doesn’t seem to be rolling over. More importantly, you saw a few reasonably powerful Missionaries (Mohamed El-Erian, for example) talking about this strength. My bet is that this narrative effort continues this week … that you’ll hear and read the usual suspects talking about how the real economy is in good shape, how consumer spending is strong, yada yada yada. All in very sharp contrast to the OMG-we’re-going-to-be-in-a-full-bore-recession-by-March articles you were reading three weeks ago when everyone was trying to push Jay Powell into playing Santa Claus.

So what to do if the narrative plays out this way?

I’m still not interested in getting bulled up on equities so long as real economy strength will be seen as encouragement for further Fed tightening, and so long as we remain engaged in a giant game of Chicken with China. I’m not saying to short the equity market. I’m saying to reduce gross exposure in the equity market, whatever that means to you. You don’t have to dance every dance.

Treasuries, on the other hand …

As you hear “this is a market problem, not a real economy problem”, you will see Treasuries sell off.

That’s the trade as this narrative develops.

It all goes back to the central actionable idea of Things Fall Apartmake your long-dated government bonds a tactical holding. Because unless we’re in the throes of a recessionary fearfest – and that’s exactly where we were going into the December Fed meeting and its immediate aftermath – long-dated government bonds are no longer able to play the same diversifying role in your portfolio that they have for the past 30 years. But the recessionary fearfest narrative is now declining, not growing. And that means that Treasuries will have a really hard time working.  


PDF Download: In the Flow Dec. 31, 2018

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In the Flow – Sometimes the Answer to a Prayer is “No”

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Sometimes the Answer to a Prayer is “No”

Back in 2013, when I was just starting Epsilon Theory, I would go around and give talks to institutional and professional investors about the power of narrative, particularly the narrative of Central Bank Omnipotence. In plain terms, that’s the idea that markets were up, up, up in largest part because everyone believed that everyone believed that monetary policy determined market outcomes. It wasn’t that central bankers are all-wise and knew the answer to everything. It’s not a narrative of Central Bank Omniscience. No, it’s that central bankers are all-powerful, Omnipotent, and their actions (or inactions) make the market go up (or down). That’s the narrative.

The most common reaction to my talk?

You’re nuts.

Only five years ago, soooo many institutional and professional investors did not believe that a faith in the Fed (the Jupiter of the central banker pantheon) was the Why for a bull market. Particularly among value-oriented investors and old-school hedge fund managers like Lee Cooperman and Stan Druckenmiller, I heard a very different refrain – the US economy was now in “a self-sustaining recovery”, and that was Why stocks were up.

Sure, these Masters of the Universe followed the Fed closely and didn’t deny its importance in setting the broad parameters of real-world business cycles. Sure, they read every word that this Jon Hilsenrath fellow over at the Wall Street Journal would write about Fed intentions, and sure, they went to Big Bank X, Y and Z’s small group dinners with Fed governors A, B and C, and sure, they understood that Europe was safe now that Mario Draghi was adopting the Fed playbook, but being influenced by such as that was for lesser mortals. No, no … what I had to understand, dear boy, is that they watched certain infallible market and macroeconomic signals, coupled that with a bevy of analysts and PMs doing “deep fundamental dives” into individual stocks, and THAT was why they were Masters of the Universe.

Fast forward to 2018, five years later. The infallible market and macroeconomic signals have, in fact, failed. All those buy-side analysts and PMs finding “alpha” from their 30 worksheet-long FCF models and their oh-so sharp questions posed to management at 1×1 meetings and their oh-so observant site visits to this facility or that facility have, in fact, been fired. All of these Masters of the Universe like Lee Cooperman and Stan Druckenmiller have turned their hedge funds into “family offices”. Not because they WANTED to. Because they HAD to.

I’m not picking on Cooperman and Druckenmiller. Really I’m not. This is a story that’s been repeated a thousand times over the past five years, in both big and small ways. But both Cooperman and Druckenmiller, for whatever reasons, have kept themselves very much in the public eye and the public discourse since winding down their firms, trying to Master of the Universe-splain what happened.

Lee Cooperman and Stan Druckenmiller say it’s the machines’ fault, that “algorithms” have taken over the markets they loved so much and understood so well. It’s those darn machines. That’s why they can’t beat the market any more. That’s why their infallible signals failed and why they had to fire all those brilliant analysts. That’s why, with the fervor that only a religious convert can possess, these old school Masters of the Universe now pray to their Fed gods, because only the Fed can control the machines. Only the Fed can say the right words and do the right things to make the machines behave.

How do these prayers manifest themselves?

In forms like every Missionary appearance on CNBC last week, much less Jim Cramer’s rantings and ravings, beseeching Jay Powell and the Fed to show mercy on our portfolios and stop the madness of {checks notes} 2.5% short-term interest rates. In forms like last Sunday’s op-ed in the Wall Street Journal from Stan Druckenmiller and former central banker Kevin Warsh, saying that awkshuallly, 2011 was the time to exit QE, and an economy with >3% growth and an unemployment rate <4% is just too “fragile” to withstand the “double-barreled blitz” of higher interest rates and a rolling-off balance sheet.

Honestly, it’s embarrassing, especially for self-styled Fed critics like Druckenmiller, who has railed against QE and extraordinary monetary policy actions for YEARS. It’s like St. Augustine, who prior to his conversion to Christianity in his early-30s was quite the ladies man, recalling his pre-conversion prayers: Lord, make me chaste. But not yet.

The Druck equivalent: Lord, give me QT. But not yet.

I thought there was a good chance that Jay Powell would answer those prayers. He didn’t.

As I wrote last week, Powell had a clear path on Wednesday to supporting markets in a big way. He could hike by 25 bps as planned, and then all he needed to do was say the magic words: “we are watching carefully”. Watching US-China trade negotiations carefully. Watching the strength of the dollar and the weakness of commodities carefully. Watching EVERYTHING that Mr. Market is oh-so worried about carefully. Because if the Fed is “watching carefully”, then the Fed has got our back. And there’s nothing better for an investable rally than knowing that the Fed has got our back.

But Powell didn’t say this. He didn’t say anything close to this. In Fed-speak, he came pretty darn close to saying the opposite of this.

Powell told you on Wednesday that the Fed does not have your back.

What does that mean? It means that for the next two months, the market will zig and zag like crazy on every piece of US-China “news”. And the US-China narrative is getting worse, not better. Last week, the Justice Department unveiled criminal charges against two Chinese intelligence operatives for hacking, among others, the US Navy. Apparently there was some pact signed between the US and China back in 2015 where both sides pledged not to do this sort of thing, and apparently the Chinese reneged on that agreement.

My point is not that this isn’t a bad act by the Chinese. My point is that indicting Chinese spies living in China has exactly zero real-life consequences for the spies and exactly zero chance of prosecution. It is purely an exercise in narrative creation. It is purely a discretionary choice by the US government in timing and scope and publicity, all aimed at a domestic US audience. The Trump Administration is preparing you for a hard(er) line against China, because now it’s not an economic fight, it’s a national security fight. This is a clear emerging narrative in our analysis.

National security always trumps markets and economics. Always.

US-China relations got significantly more Cold War-ish this past week, which increases the downside pay-offs of any negotiation equilibrium that ultimately emerges here.

So what’s the action plan? We are back to our regularly scheduled entertainment of all Trump-Xi game of Chicken, all the time. That means you are faced with technical uncertainty in markets, not mere investment risk. That means that every rally is to be sold. That means that you take down your gross exposure.

This is a recessionary scare. This is a global trade scare. Financials won’t work here. Cyclicals won’t work here (yet). You might think that Tech would work here, because secular growth is at a premium in a recession, but the global supply chain issues for Tech are pretty daunting. If you’ve got to be long something, take a look at Consumer Staples (our latest In Focus note for ET Pro subscribers), and take a look at Healthcare (our next In Focus note).


PDF Download: In Summary Dec. 15 – Dec. 21, 2018

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In the Flow – Beating the Recession Drums

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Beating the Recession Drums

It’s too early to pick up on a Quid map, but this past week saw a noticeable pick-up in sell-side and mainstream financial media drum-beating on increased signs of an imminent recession. This “Winter Is Coming” recession narrative has been building for weeks, originally as part of the concerted Wall Street narrative effort to get Jay Powell and the Fed to stop hiking interest rates (see our Brief here), and more recently merged into the US-China game of Chicken narrative that has dominated financial media since Trump announced a 90-day ticking clock after the G20 meetings (see our Note here). All of this effort culminated in the narrative surrounding Friday’s sharp market sell-off.

Why were major US indices down >2% on Friday?

Because “weak data” shows China is heading into a “trade war” recession, and Europe and the US are next.

That’s the financial media story, and they’re sticking to it.

As always, I have no idea what the recession Truth with a capital T might be. But I do know the narrative. And in the past week I saw more of what I call “recession signal” stories than I have in a long time. Stories like housing prices rolling over in Las Vegas.

Stories like fewer people buying business suits at Men’s Wearhouse. Stories like sub-sub-prime auto financing running rampant. Stories like this company or that company maybe taking down 2019 numbers. All anecdotal, for sure, but ring-of-truth stories like this are the mother’s milk of a growing narrative. Put this on top of “yield curve mania”, where everyone and his brother is writing a story about the last time that 2s/5s inverted by 3 bps and the inevitable recession that follows … it’s a strong effort, for sure.

And it wasn’t limited to US financial press. The biggest news event for markets this week was the ho-hum ECB meeting, where Draghi et al confirmed plans to stop purchasing bonds to expand the ECB’s balance sheet, and coupled that with the usual uber-dovish song and dance at the press conference. I say ho-hum, because the European financial press is clearly bored to tears with the whole act. To paraphrase the narrative here, Draghi is now just phoning it in. He can’t even be bothered to say anything new for a pull-quote, it’s just the same old stuff about needing some sort of fiscal union and about how QE is “in the toolbox forever” and blah, blah, blah.

Here’s the problem for Europe. Everyone believes that everyone believes the economy is slowing (recession drum-beating and common knowledge creation) and everyone believes that no one believes that Draghi has a solution!

As a result, German bunds are now negative-yielding through 7.5 years. That’s just awful for any Europe-limited investor or allocator if we are, in fact, headed into a recession, because it really limits the diversification potential of a portfolio. Can these bonds go even further into negative territory, thus increasing in value? Sure. But they just can’t go up in price enough to counteract the hit that your equity holdings are going to take in any sort of recession scenario, particularly if the ECB is no longer going to be the buyer of last resort for these abominations.

Source: Bloomberg, Holger Zschaepitz

So that all sounds pretty awful for markets, right?

Oddly enough, I think there’s a very bullish scenario that can emerge this week.

If Jay Powell announces a dovish hike this Wednesday, where they raise rates a quarter point as expected but say something like “we’re taking a wait-and-see attitude on future hikes because we’re concerned about the impact of US-China trade disputes”, then everything is wrapped up in a neat little bow for Mr. Market.

The difference between Powell doing a dovish song and dance routine and Draghi doing a dovish song and dance routine is two-fold. First, it will change people’s minds about previously hawkish, taciturn Powell, and that’s what defines informational power – how much does it shock you? Second, and this is where words matter a lot, a bullish narrative requires that Powell mention US-China trade disputes. If the narrative becomes that there’s a Powell put beneath a China trade war … well, that changes everything.

To be sure, if this isn’t the story that comes out of the Fed presser on Wednesday afternoon, then the rest of the year is looking mighty, mighty lump of coal-ish. But I think it’s the most likely narrative to emerge. Taking a flyer on Powell saying all the right things on Wednesday is a very focused trade with a nicely asymmetric risk/reward framework. More broadly, this is the sort of event that has the potential to change the market narrative around US-China trade, where, to date, the Fed has not been an explicit player. Will Powell take this opportunity to insert himself into the mix? If no, then we’re back to all Trump-Xi Chicken all the time. If yes, that would be a highly market-supportive move, at least over the next few months. Should be an interesting week! 


PDF Download: In Summary Dec. 8 – Dec. 14, 2018

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In Focus: Tesla (12/2018)

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Download In Focus PDF HERE.

Sentiment: Positive and Improving

Attention: Weak and Declining

Current Narrative Map Highlights

Source: Quid, Epsilon Theory

Current Sentiment and Attention

Source: Quid, Epsilon Theory

Commentary

In our broader piece on trend-following (Figaro), we noted that narratives for Tesla had demonstrated moderate-to-high attention (i.e. internal consistency) and very negative sentiment for much of the second half of 2017 into 2018. The causes for this were many, but the most interconnected negative clusters concerned (1) continued underperformance  on production numbers, (2) Elon Musk’s unusual behavior, especially on social media and (3) a number of worrisome key departures in areas that implied potential fraud. We felt that this was a supportive environment for negative trending.

We also noted that if Tesla were to break these narratives, it would be by reinforcing the positively received areas of the narrative (esp. Gigafactory production and Asia) , and by delivering a professional earnings call that might relax the frantic “management problems” components of the strong narrative.

Did they succeed? Yes, in part, we think they did. The aggregate sentiment around Tesla has improved dramatically, but the cohesiveness of the narrative strikes us as still being very mixed, similar to this time last year. We would be less convinced of betting on recent price behaviors as part of a long-term trend until there is more resolution on the negative components of the narrative.

In the medium term (and in addition to whatever long or short thesis we had), as investors in TSLA we would focus most on:

  • How market appears to be attaching Tesla to tariff and China issue. This is becoming central to the main narrative and has deeply negative sentiment.
  • Perception of CEO behavior (“single digits weeks away” is still a popular n-gram across articles)

PDF Download: Tesla (12/2018)

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In the Flow – You Don’t Have to Dance Every Dance

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You Don’t Have to Dance Every Dance

Professional investors are wrestling with four big concerns, what I call the Four Horsemen of the Investing Apocalypse:

The Four Horsemen of the Investing Apocalypse

  1. The Fed keeps on raising interest rates and shrinking its balance sheet, ultimately causing a nasty recession in the US and an outright depression in emerging markets.
  2. China drops the trade war atom bomb by letting the yuan devalue sharply, sparking a global credit freeze that makes the 1997 Asian financial crisis look like a mild autumn day.
  3. Italy and its populist government play hardball with Germany and the ECB in a way that Greece could not, leading to a Euro crisis that dwarfs the 2012 crisis.
  4. Inflation, particularly wage inflation, gets away from the Fed, as their monetary policy tightening forces corporations to increase their risk-taking.

Humans are biologically designed to pay attention to one big thing at a time, and our media stimulus machine knows it, so every week the “story” of what’s driving markets up or down will be good news or bad news on one of these concerns. Two weeks ago the story was Jay Powell finding that old-time dovish religion, which markets loved. This week the story was Trump starting the clock on a trade war game of Chicken with China, which markets hated. In truth, of course, there is “news” about all four of these concerns happening all the time, but until further notice … if you want to explain the WHY of your portfolio to your clients or your board or your CIO or whoever it is that you have to explain yourself to, you’ll need to explain it in terms of The Story of the Week. Because even if you’re not utterly focused on that Story of the Week, THEY are.

And for the next 90 days, that Story of the Week is most likely to be the China trade war story.

Why? Because it’s got a ticking clock. Again, we are biologically hardwired to respond with full attention to a countdown to disaster (the core brilliance of the TV show “24”), and again, our media stimulus machine knows it. 

The easiest prediction I’ll ever make is that CNBC constructs a “Countdown to Trade War” video graphic over the next month or two, literally counting down the days until China-US relations detonate.

Talking about the China-Trump trade war game of Chicken is good business for CNBC and Bloomberg and all the rest, so talk about it they will. Even if there’s nothing to talk about. Actually … especially if there’s nothing to talk about. And when they do talk, I promise you that 95% of that airtime will be spent asking this guest or that guest (I would say “expert”, but in a world where Kevin O’Leary is treated as an expert in everything from algo construction to Sino-Japanese foreign relations, I’ll stick with “guest”), about the “chances” of a deal being struck anytime soon and the “likelihood” that the deal will favor the US or China.

So, Kevin, what should we do in Ukraine?

Let me be really clear about this.

Anytime that anyone talks about “chances” or “odds” or “likelihood” in the context of a game of Chicken, like this trade negotiation between the US and China, they are talking nonsense.

There are no odds in a game of Chicken.

It’s one of the hardest concepts in game theory to wrap your head around, but maybe the most important. And it has enormous consequences for how to invest over the next three months.

Chicken is a game with two equilibria – two potential outcomes for the game. You can see this mathematically in the stylized 2×2 game matrix below, with the equilibrium outcomes circled in gold, or you can just think about every game of Chicken you’ve ever seen in the movies. I’ll use “Footloose” for my example, because … Kevin Bacon. I mean, c’mon.

Both Ren (Kevin Bacon) and Chuck start in the bottom right corner of the matrix. They’re both driving their tractors straight at each other. Both are faced with a decision. Do I continue to drive or do I jump off my tractor? If they both do nothing and stay in the bottom right corner, then both players have a TERRIBLE pay-off (-100 for both Ren and Chuck). This is NOT an equilibrium, because at least one player (in this case both players) can get a better pay-off by changing their strategy from Drive to Jump.

If Ren (the column player) jumps, then the column strategy changes from Drive to Jump and both players are now in the bottom left corner. That’s a better pay-off for both players, but a LOT better for Chuck (+10) than for Ren (-10). This IS an equilibrium because NO player can get a better pay-off by changing strategies from here. Obviously Chuck isn’t going to Jump now that Ren already did, so the row strategy isn’t changing, and obviously Ren isn’t going to get back on the tractor and start driving again towards mutual suicide.

But you’d also end up in an equilibrium (neither player will change his strategy) if Chuck decides to jump (changing the row strategy and moving both players to the upper right quadrant), which is a LOT better for Ren (+10) and still better than mutual destruction for Chuck (-10).

Hence the delicious tension of the game of Chicken. Hence the reason our media stimulus machine looooves a good game of Chicken. Either player can win. Either player can lose. All you have to do to win is have more willpower than the other player. That’s it. You don’t have to be physically stronger. You don’t have to be mentally smarter. You just have to “want it more”, to use the clichè of every hack sports announcer ever. But in a game of Chicken that happens to be true. You just have to want it more.

There is ZERO information about willpower in the structure of this game.

Zero. None. Nada. Rien. Bupkis.

Go ahead and change some of the pay-offs. Make them asymmetrical. Make it a -50 instead of a -100 for one of the players. Make it a +30 instead of a +10 for one of the players. It doesn’t matter.

YOU CANNOT PREDICT THE WINNER OF A GAME OF CHICKEN FROM THE PAY-OFFS.

Sorry for the shouting.

But I get so frustrated with some of the “analysis” that you hear about this trade war game of Chicken, especially this gem that you’ve already heard umpteen times and will hear umpteen-squared more times over the next two months:

“The US will win because China has more to lose in a trade war.”

This is nonsense.

It’s nonsense because it’s talking about the pay-offs of the game, not about the behavioral driver of player strategy – willpower. Pay-offs cut both ways. Sure, I’ve known people where ‘having more to lose’ makes them jump from their tractor first. But I’ve also known people who have MORE willpower in a game where they ‘have more to lose’.

Bottom line: it’s a fool’s errand to impute resolve from starting game conditions and pay-offs.

The only analysis that has any predictive usefulness in determining the winner of a game of Chicken is an analysis of exogenous player resolve. That’s a ten-dollar phrase that means you peer into the psyche of the players and figure out who wants it more.

So who wants it more, Trump or Xi?  

Anyone who claims to have an answer to that question is either lying to you and/or lying to themselves. Not even Trump and Xi can know the answer to this question! Again, this is the delicious tension and suspense of a game of Chicken – not even the players know who wants it more. The outcome of the game only and always emerges from the playing of the game.

It’s not that the odds of the game are unknown.

It’s that the odds of the game are unknowable.

Successful discretionary investment boils down to two things: edge and odds.

In the US-China game of Chicken, you have no edge. And you don’t know the odds.

Unknown information creates the potential for alpha, for the ability to discover valuable private information.

Unknowable information, on the other hand, creates zero potential for alpha. In fact, it’s almost always an alpha destroyer, as market participants convince themselves that they have an “edge” in predicting the equilibrium outcome. They don’t.

Unknown information lives in the world of investment RISK, where you can calculate the expected value of an investment (risk and reward) and the cost of acquiring additional information to impact that relationship. This is what professional investors DO, day in and day out.

Unknowable information lives in the world of investment UNCERTAINTY, where none of our expected value calculations work, no matter what you spend on acquiring additional information.

You can’t hedge investment uncertainty.

You can’t hedge investment uncertainty because it’s not just difficult to measure the risk to your portfolio (and please remember that risk isn’t just a loss suffered but is also a gain foregone). It’s IMPOSSIBLE.

So what do you do if you can’t calculate the risk in your portfolio?

You take down your book. You reduce gross exposure.

Look, at some point there IS a deal. Games ALWAYS end up in an equilibrium. One of the two sides will blink, a deal will be struck, everyone will declare victory, and we’ll see then what narratives emerge from that. Maybe it will be a market-positive narrative to emerge. Maybe it won’t. Regardless, whatever deal emerges is not an investment regime change, and it won’t be the end of the world or the engine of a new bull market.

You may miss a spike up if trade peace breaks out tomorrow. You may miss a week-long rally if a narrative of imminent peace takes root. So be it. I’m not saying to get short. I’m not saying to go long volatility.

I’m saying that you do not have an accurate picture of the upside and downside risks to your portfolio so long as the US-China trade war game of Chicken is the Story of the Week in markets. Not because you’re missing any crucial piece of information, but because the equilibrium outcome is unknowable.

I’m saying that when large institutional portfolios see more uncertainty in markets – not greater risk, but more technical uncertainty – they do not buy dips and they do sell rallies. They rebalance by selling winners, not by adding to losers. They take down their book.

You should, too. And you should do it first.

Taking down your book means different things to different types of investors and allocators. I’ve used the phrase “reducing gross exposure” because it’s an expression that’s most familiar to long/short hedge fund managers, who make daily decisions on gross and net exposure, and have well-established processes for moving these exposures around quickly. For investors with more static or long-only portfolios, the more familiar terms of art might be “tactical overlay” or “active risk” or “discretionary overweights and underweights”.

In all cases, though, taking down your book means one simple thing:

Get closer to your long-term strategic allocation and stop doing whatever it is that moves you away from that long-term plan.

This, too, shall pass. And relatively soon. You don’t have to dance every dance.


PDF Download –  In Summary: Dec. 1 – Dec. 7, 2018

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We’re Doing It Wrong

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Ed. Note: we are thrilled to announce the launch of Epsilon Theory Professional Service, where financial advisors and investment professionals can tap directly into our Narrative Machine market research and analysis. In this note we are highlighting the value proposition of the Narrative Machine research program. – Ben


Flammarion engraving (1888)

We’re all explorers seeking to pierce the veil, hoping against hope for a vision of the music of the spheres beyond this messy world. Looking for an Answer in the clockwork machine that we all believe incorporates and underpins markets.

I think we’re doing it wrong.

I think investment professionals, quant and non-quant alike, are misusing the massive computing power that each and every one of us has at our fingertips. Whether it’s the powerful computer that we call a smartphone, whether it’s the crazy powerful multi-threaded computer that we call a laptop, whether it’s the insanely powerful computing utility we call AWS or Azure or the like … we’re using machine computing processes as an extension of our human computing processes.

This is a classic anthropomorphic fallacy.

Meaning that we can’t imagine what it would mean to use computers in some other, non-human way. Meaning that we never even consider whether there’s a human way of perceiving the world, much less what a non-human approach might be.

Here, I’ll give you an example.

In every how-do-we-use-computers-in-investing conversation I’ve ever had with anyone in tech … in every how-do-we-use-computers-in-investing conversation I’ve ever had with anyone in finance … in every how-do-we-use-computers-in-investing conversation I’ve ever had with MYSELF … the conversation, either implicitly or explicitly, is ALWAYS about using computers to find some hidden formula that will make us lots of money.

Always. Without exception. Ever.

This is a slide that ET contributor Neville Crawley made a while back, and it slays in meetings. It resonates. It sings.

Oh yeah, I see why we want this artificial intelligence system (I mean, I don’t know why you’re calling it Big Compute, but whatever). 

It’s the next level. It’s the Giant Brain, replacing the Big Brain of all those computers that DE Shaw and Two Sigma and RenTech are using to figure out markets and mint money, which replaced the Little Brain of us humans scurrying around in the pits. AI is going to pierce through all the noise and find us the signal. It’s going to identify the pattern. It’s going to tell us the Answer.

Do you feel it? I feel it. It’s why I became a professional investor in the first place. To figure it out. To find those patterns and signals that would make me rich. To find the “tell” of markets.

But that’s not how AI works. That’s not how any of this works.

AI is not a giant brain, and there is no Answer to be found.

AI isn’t even a Difference Engine, as Charles Babbage called his programmable analytic device that we now call a computer. It’s more like a Connection Engine, able to “see” the similarities in a million-fold matrix all at once. It’s a non-human intelligence, more like an insect’s compound eye + nervous system than anything human-ish. And yes, there’s an oldie but goodie Epsilon Theory note for that.

As for the Answer …

The absence of an Answer – by which I mean the non-existence of a general closed-end solution or a predictive algorithm in any physical system of three or more interactive entities and certainly in any social system – is at the core of two canonical Epsilon Theory notes: The Three-Body Problem and Clear Eyes, Full Hearts, Can’t Lose. Honestly it’s the heart of the entire Things Fall Apart series of ET notes.

This message – that there is no predictive algorithm for social systems – bears repeating over and over, because the human brain is hard-wired to seek that algorithm. We literally cannot help ourselves. I believe it’s the root of every totalitarian impulse, large and small, that the human animal has ever experienced. That totalitarian impulse is most obvious – and most deadly – in our social system of politics, but it is no less present in our social system of markets.

We think of markets as a clockwork machine, as an intricate collection of gears upon gears. We believe that if only we examine the clockwork closely enough, we can identify some hidden gear or unbeknownst gear movement that will let us predict the clockwork’s movement and make a lot of money.

Our MODEL of markets is The Machine, and every Machine has a deterministic set of algorithms that create and drive it. Every Machine has an Answer.

This model – the market as machine – is an anthropomorphism.

There are lots of historical and anthropomorphic reasons why we think of social systems as machines. But they are all historical and anthropomorphic reasons. There’s nothing “natural” about it.  And yes, there’s an Epsilon Theory note on that, too.

I’m sorry, Ray Dalio, but as a philosopher you’re a fantastic hedge fund manager. 

To be clear, market-as-machine is a perfectly useful anthropomorphic model for most investment purposes, just as Ptolemy’s Earth-centric universe was a perfectly useful anthropomorphic model for most navigational purposes. Seriously, if your goal is to sail your ship from Tyre to Ostia, then you can’t do better than celestial navigation per Ptolemy. If you want to go to the moon, on the other hand …

Anthropomorphic models break when a revolutionary invention allows us to SEE the world in a non-human way.

For the Ptolemaic earth-as-center-of-the-universe model, that revolutionary invention was the telescope and the ability to see sunspots and Jupiter’s moons and all sorts of astronomical objects and phenomena that were, literally, previously invisible to the HUMAN eye.

AI is the revolutionary invention that breaks the market-as-machine model. It allows us to SEE narrative and sentiment and all sorts of social objects and phenomena that were, literally, previously invisible to the HUMAN eye.

To be sure, this new invention that lets us see in non-human ways isn’t a sufficient condition to break an anthropomorphic model. These models become so embedded in our social institutions and our minds that, as with Ptolemaic science and the invention of the telescope, it can take a hundred years and a lot of violence for a better model to be widely accepted.

And that’s the problem with AI for most investors, quant and non-quant alike.

If you use computers in your investment research process – and I know you do – I will bet you umpteen zillion dollars that you have those computers looking at structured historical data in an effort to find some repeating pattern. I will bet you do this rigorously and intentionally if you’re a quant. I will bet that you do this all the same, but non-rigorously and haphazardly if you’re not a quant.

Whether you realize it or not, you are using the market-as-machine model. You are looking for the Answer. Go on, you can admit it. You’re among friends here. I’m like Big Lou in the insurance ads … I’m one of you. It is embedded in our minds and in our businesses. Mine, too.

But here’s the thing.

If you use AI as just another input to that market-as-machine investment research process, you will get puzzling “results” that don’t help you very much. It will be just like using a telescope to get better measurements of the retrograde motion of Mars as it orbits around the Earth in your Ptolemaic model.

You will be disappointed by AI.

I want to suggest a different way to think about markets, a non-anthropomorphic model that works WITH the revolutionary invention of AI and Big Compute.

The market is not a clockwork machine.

The market is a bonfire.

We all know the physics of fire. The underlying rules of combustion are as clear and as deterministic as any pendulum or gear movement. 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, 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.

Want to guess who spends more money on Big Compute than everyone else in the world combined?

It’s the U.S. government, through the Dept. of Defense and the Dept. of Energy.

Know why they’ve spent BILLIONS of dollars on the world’s most advanced supercomputers?

To calculate fire.

Not just any old fire, of course, but nuclear fire. This is why the most advanced computers in the world today have been built – to simulate the explosion of nuclear weapons. To see the future by calculating the future, not by analyzing the past for predictive algorithms.

It’s a hard concept to wrap your head around, this distinction between calculating the future and predicting the future, but it’s the key to thinking about your investment research process in a non-anthropomorphic way. It’s the key to successfully and profitably incorporating the revolutionary invention of AI and Big Compute into your investment research process.

Now let’s be really clear … we’re a loooong way from performing the market equivalent of simulating H-Bomb explosions with the Narrative Machine. No, we’re more at the stage of taking a rudimentary telescope and aiming it at the sky. We have neither the ability to “see” market participants at a molecular level nor the ability to “know” the physical interaction rules of these participants at anywhere near the same precision or “resolution” that the DoD can see or know nuclear reactions.

But when we show you a Narrative map of Inflation like this, that’s the path we’re on.

We’re taking ALL of the thousands of financial media articles published over some period of time that mention “inflation”, and comparing every word and every phrase in every article to every other word and every other phrase in every other article. It’s a million-fold matrix that “sees” these publications and their inchoate arguments all at the same time and measures their connectedness and similarities all at the same time, then visualizes that connectedness in dimensions that make sense to a human eye and mind – color, distance, size, position, etc.

This is narrative-space, and it’s something that investors have always felt or believed existed, but we’ve never been able to SEE. Until now. 

We can’t give you a secret formula for predicting markets from looking at narrative-space.

But we can tell you what IS in narrative-space.

What good is that?

  • We think we know some of the “rules” for calculating what’s NEXT in market participant behaviors from what IS in narrative-space. This is the Common Knowledge Game, and it’s a forward-looking, actor-based way of evaluating the path of markets.
  • More importantly, we think that YOU already know many of the “rules” for calculating what’s next in whatever corner of the market is important to you. We think that experienced discretionary investors, traders, allocators and advisors have an enormous amount of internalized knowledge about the relationship between narrative-space and market participants in their arena of expertise. We think that a visualization of narrative-space can weaponize your internalized knowledge.

Tapping directly into the Narrative Machine is not for everyone.

If you’re looking for a new variable for your regression analysis, you don’t want this. If you’re looking for a new data feed that you can analyze and arb, you don’t want this. If you’re running a purely systematic or passive investment strategy, you don’t want this.

But if any aspect of your investing or your portfolio allocation is still human … if any aspect of your investing or your portfolio allocation is still discretionary … we think you’ll find the Narrative Machine research project worth a look.

Not because we can give you an Answer.

But because we can advance your Process.


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Central Bank Omnipotence Monitor – 11.30.2018

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Access this month’s monitor slides in Powerpoint and in PDF.

Access the monitor values in Excel.

  • While our slower smoothed measure has moved only slightly, our November point estimate for the attention around central bank omnipotence has spiked to the highest point in 2018. 
  • Like the inflation narrative structure, we have observed a new center forming around the poor performance of financial markets and the expectation that central banks will adjust their policy to protect these markets. It’s early, but it is possible that we are seeing a resurgence of a central bank omnipotence narrative that has been dormant for some time. 
  • We still note that inflation and the various risks to the European financial system remain very central to these articles as well. We have not, however, seen as prominent a “maybe ending QE in Europe isn’t such a good idea” narrative emerging there.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Narrative Sentiment

Source: Quid, Epsilon Theory

Key Articles

S&P 500 Valuation Floor Is as Wobbly as 2019 Earnings Estimates

Instant view: Investor reaction on Democrats win

Italian bond yields rise as govt digs in heels on budget

Pimco Guru Calls a Turning Point for Bond-Market Returns in 2019

Dollar hits 16-month high, yen boosted by risk-off sentiment

Wells Fargo Says Buy Now in Best Stocks Entry Point in Two Years

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Inflation Monitor – 11.30.2018

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Access this month’s monitor slides in Powerpoint and in PDF.

Access the monitor values in Excel.

  • Attention to inflation narratives continued to wane in November as drumbeats for a slowing in the pace of Federal Reserve hikes became louder than discussion of continued wage inflation and price movements in emerging markets. 
  • In our view, the core inflation narrative has effectively shifted to, “Input prices may be rising, but Fed won’t let asset prices fall like this.”
  • Of some interest, the largest single cluster – and a new one – is now a cluster focused on protests and shortages. These may not be familiar to all US readers, but are increasingly an issue in other regions. 
  • This cluster and others seem to be telling stories of non-monetary causes for local inflation, especially issues like Brexit, tariffs, taxes and trade rules.
  • We observed no major changes in the usually negative sentiment around inflation, or in the fiat news / advocacy journalism language present in articles. 

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Narrative Sentiment

Source: Quid, Epsilon Theory

Key Articles

Brexit ‘Queues at Dover’ Can’t Be Solved by Bank of England

BOE Warns Disorderly Brexit Could Unleash a Savage Recession

The Fed’s Likely to Take a Rate-Hike Breather in 2019

No turning back for ECB on end to bond purchases

Fed doesn’t seem in as much of a rush to raise interest rates as stocks plunge

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US Fiscal Policy Monitor – 11.30.2018

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Access this month’s monitor slides in Powerpoint and in PDF.

Access the monitor values in Excel.

  • After the usual mid-term election narrative chatter, the importance placed on fiscal policy in the U.S. across media outlets continued to plummet in November. 
  • Along with the drop in attention to any one narrative, advocacy journalism and fiat news measures continued to decline. Our general interpretation is that the topics have generally returned to ‘policy wonk’ status. 
  • Sentiment on these topics has quickly returned to neutral levels, too as the wonks take back the baton from the more pointed advocates across news and ‘analysis’ journalism. 
  • We still see and hear investment theses built around the notion of major fiscal policy shifts in the US. Those things may come to pass, but until the narrative becomes more widely accepted and promoted, we don’t think that these theses have legs. 

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Narrative Sentiment

Key Articles

About the Coming Recession

Democrats Are So, So Bad at This

Why Richardson ISD’s longtime CFO has a ‘vote no’ sign in his yard against the district’s school tax increase election

Italy says not changing budget plans as euro partners fret

Fed Meeting on 7-8 November 2018: Impact of a Rate Rise

An Update on Quantitative Tightening: How Big of a Risk Is The Fed?

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Trade and Tariffs Monitor – 11.30.2018

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Access this month’s monitor slides in Powerpoint and in PDF.

Access the monitor values in Excel.

  • Thanks to a remarkably concentrated November point-in-time measure, our attention measure rose sharply. 
  • There is now an emerging narrative around tariffs and trade: they are a national security issue. This has the potential to be a powerful switch in rhetoric, leveraging a meme with strong emotional content to attach tariffs to territorial conflicts, intellectual property disputes and cybersecurity concerns. 
  • We would be very mindful of the ability for this pivot to sustain trade policy that might otherwise be unsustainable and unpopular.
  • While Brexit has obvious trade implications, it has been surprisingly undercovered as a trade issue. Outside of its impact on bank sustainability, it is currently almost completely divorced from any trade narratives and is not something we would expect to exert significant influence on ex-UK financial markets unless there is a material and surprising event.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Narrative Sentiment

Source: Quid, Epsilon Theory

Key Articles

U.S. Crop Giants are Doing More Brazil Deals Thanks to Trade War

U.S., China ‘not on the cusp’ of trade deal: White House adviser

Pence’s Sharp China Attacks Fuel Fears of New Cold War

November Brexit Deal Hopes Fade as U.K. Ministers Fail to Agree

Fed points to December rate hike but is worried about tariffs and debt

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Credit Cycle Monitor – 11.30.2018

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Access this month’s monitor slides in Powerpoint and in PDF.

Access the monitor values in Excel.

  • Our single point attention measure rose from floor levels in November, although our smoothed rolling measures have only moved slightly. The main cause appears to be significantly tighter and shared language across articles about fed activity and inflation, about bond funds and about leveraged loans and CLOs.
  • We’ve also seen “junk bond” take over from “high yield” as the top n-gram for some topics.
  • Sentiment, however, has rebounded back to normal levels for the topic. We don’t have a ready explanation for this, although many of our monitors took a downward turn during the election cycle. 
  • We have also observed fiat news measures rising to unusual levels, even for a topic that is very often “explained” to readers. While on its own we don’t think this has much explanatory power, we do think it tends to be indicative of newly established or changing narratives, something we will be able to evaluate over the coming months.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Narrative Sentiment

Source: Quid, Epsilon Theory

Key Articles

Home loans defaults set for ‘moderate’ rise

High oil prices to amplify fiscal pressures

Dealing with debt in the UAE: First-hand accounts

Multi-Asset Credit: Buyer’s guide to multi-asset credit

Sovereign bond yield spreads and sustainability: An empirical analysis of OECD countries

The joint dynamics of sovereign ratings and government bond yields

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FAQs and Guide to Narrative

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Welcome to ET Professional! If you’ve been reading Epsilon Theory for a long time, many of the terms and tools we use will be familiar to you. In case you’re new or just in need of a refresher, we’ve prepared a brief guide to reading and using the tools on ET Professional. 

Common Terminology

Narrative – Narrative is a word which, in common usage, describes a story that we perceive to be manufactured or artificial. Usually it is a pejorative, referring to something that is intentionally misleading, something which is decided in advance and attaches facts as convenient. This is…not exactly what we mean when we say it. When you read “Narrative” on Epsilon Theory, you should read it as “an abstracted and symbolic representation of reality that replaces that reality as the locus of our thinking about a topic.”  A Narrative may be malicious or benign, but it is always most powerful and relevant to our interests when it becomes Common Knowledge, and especially when it leverages or is itself a Meme.

Meme – When we say ‘meme’, we don’t mean cat GIFs. We are referring to globally relevant sources of narrative power, by which we mean either biologically evolved or culturally derived but robust (fine, ‘Lindy!’) pattern responses. Think about the great story arcs in literature, theatre and film, and their recurring patterns and values. These are memes. Fear of the other is a meme. When we talk about constructed versions of these memes, which attach visceral or culturally powerful ideas like fear, glory, disgust or passion to another idea, you will see us refer to a word in italics with an exclamation mark to distinguish the abstracted meme from the real term it replaces: e.g. truth! vs. truth. 

Common Knowledge – Common Knowledge, in game theory terms, is public knowledge that every agent knows that every other agent knows. It affects the game in ways that simply knowing something does not. Narratives are most effective when they become part of and leverage Common Knowledge.

Missionaries – We call the people and entities who promote Narratives Missionaries. They can typically be identified by their tendency not to provide you with facts but with instructions on how to think about a topic.

An Introduction to Narrative Maps

The summary below highlights how the maps are constructed using Quid. For most explicitly financial topics, we constrain sources to CNBC, Reuters and Bloomberg. For topics that veer into politics or macroeconomics, we use a broader range of sources with large circulation. In order to minimize false positives from republication of similar articles from wire services, we use a very low threshold to determine whether an article is considered functionally identical to another and collapsed into a single node. 

The organization into clusters can be described in a range of ngrams, which may be words, combinations of words or other short, distinctive phrases. For ease of interpretation, we further label clusters with a single prose-like description. In general, our analyses examine the closeness of topics/clusters, the sentiment of topics/clusters and the changes in both over time.

ET Pro Narrative Metrics

We current calculate and track metrics in four key areas. 

Attention: Epsilon Theory’s attention measure is a calculation we produce based on the normalized harmonic centrality of a network. That means that we take raw data of node adjacencies (i.e. which articles connect to which others, and how closely?) from a Quid-created network for a period of time, usually a month or a quarter, and calculate the shortest distance between each of the stories to establish their similarity within the network. The harmonization process is a means for inverting those distances (i.e. literally 1/X) to calculate a mean shortest-distance value for each node to each other node. We then normalize that for the overall size of the network. What we are concerned with is identifying the presence of large, indicative networks of stories with similar language that have a larger than normal influence on the entire graph of stories! That means that our Attention measure is an expression of the percentage of nodes in a network with high normalized harmonic centrality.

Sentiment: Sentiment is mostly self-explanatory in what it tracks, but for reference, Quid tracks the use of language and attached quantities of negativity and positivity to certain words. Our data set provides us with the total value of positive terms, ‘ngrams’ and phrases, as well as the total value of negative terms. This is an imperfect science. For some monitors (e.g. Inflation) we do not include sentiment at all, because articles about inflation are invariably dismal. For others, there is some risk of false positives. For example, because “lost” has negative sentiment value, the expression “lost weight” might score as being negative, when for most of us, we would gladly consider that a definite positive. Still, over a large enough group of stories, it is an effective tool when considered in comparison to prior periods of time for a particular topic or range of topics. 

Fiat Language: Establishing fiat language has been an ongoing experiment to measure the extent of Missionary activity on the front end (in the language used) rather than on the back end (in the Narrative actually constructed). We track and measure the percentage of articles on a topic during a period which use certain words which we believe are more prevalent in advocacy journalism or in journalism that tells the reader how to think about a topic. The measure is usually that percentage. 

Key Articles: In both our monitors and in the In the News content, we select a range of articles based on a measure that combines (1) closeness to other articles, (2) the number of “shortest paths” that pass through the note and (3) the closeness of the article to other clusters. In other words, we want to show the articles which are most indicative of and similar to the overall network of stories about that company, topic or issue. We think this is helpful context to the work we do in discussing and interpreting the narrative maps. 

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Inflation Monitor – 10.31.2018

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  • After several months of increasing cohesiveness around an inflation-is-coming narrative, attention to the topic has been tapering in early Q4
  • Right now we think this has more to do with the distraction created by declining equity markets, but this could change
  • Employment and unemployment discussions have been increasingly tied to inflation news in Q4, but otherwise the mix of topics has remained fairly consistent
  • Inflation-related topics are being linked much more strongly to financial markets (or at least in more volume) in the US than anywhere else in the world at this time
  • Sentiment is almost always negative for topics like inflation, but we think that the early 2018 “inflation and rate hikes are coming” narratives flipped most of the financial markets-focused media into more consistently negative language. See also Central Bank Omnipotence.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Sentiment Index

Source: Quid, Epsilon Theory

Key Articles

Bank of Korea’s Tricky Interest Rates Decision Gets Trickier

ETF Investors Are Rewriting the Rules for Interest Rate Hedging

ECB keeps policy unchanged even as growth wanes

Powell Says Fed to Keep Hiking at Gradual Pace Amid Solid Growth

Turkish economy normalizing after ‘attacks’ from abroad: Finance Minster/CNN Turk

U.S. spending rises; income posts smallest gain in over a year

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Central Bank Omnipotence Monitor – 10.31.2018

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  • The narrative of coordinated global central banking policy has been restrained for an extended period, including most of 2018.
  • After a brief rise along with inflation fears earlier in 2018, we think stories and research have settled into clusters around three active central bank narratives with modest internal cohesion: (1) “US equity and bonds markets expect a gradual pace of rate hikes”, (2) “BOJ and PBOC are concerned about trade but markets expect a light hand of intervention” and (3) “Italy, bad debts and disappointing growth are going to drive policy for the ECB.”
  • Notably, we do not observe a dominating narrative in media that “The Fed Will Save Us” or “The Fed Must Save Us” in the same way that we observed after equity drawdowns in recent years. 
  • After entering the year with a certain indifference to central bank coverage, however, reports became increasingly dour over the course of the year. We think this is primarily a reflection of the generally greater concern by this universe for equity and bond market performance over inflation concerns.
  • We also note that “rates will help savings and attract young people back to traditional banking” stories were surprisingly central and connected to highly varied topics / clusters. This is new and worth monitoring as part of an inevitable financials rotation story from sell-side sources.

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Sentiment Index

Source: Quid, Epsilon Theory

Key Articles

Speculative Edge of Stock Market is Where Rate Angst Could Bite

Global Markets – Shares bound as bulls fight back at end of brutal October

Stock market bears have their best chance in nearly four months to cut into the bulls’ 2018 lead

Student debt can ruin your dreams of being your own boss

ECB’s Coeure Still Sees Need for Stimulus, Seeks Fiscal Reforms

Italy faceoff is not expected to derail the European Central Bank’s message to markets

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Trade and Tariffs Monitor – 10.31.2018

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  • While it is only a single data point, our October attention measure rose from its very low base over the prior three months. Our aggregate rolling measure of that attention remains low.
  • Similarly, sentiment and language in articles about Trade and Tariffs have continued to be very negative in comparison to more benign and technocratic coverage of the issue in late 2017 and early 2018.
  • The sub-themes that are being most attached to markets, positioning and stocks are also the ones that have emerged with the strongest connectivity to all other themes: National Security. We think this is important. By attaching trade and tariff issues with China to territorial disputes, IP and cybersecurity, narratives here could take on a lot more influence in the minds of allocators and investors.
  • While our measures of fiat language and advocacy journalism rose in the February/March concern about tariffs, we have not yet observed that in the most recent uptick. 

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Sentiment Index

Source: Quid, Epsilon Theory

Key Articles

Asia shares bounce after rout, but sentiment fragile

Harley-Davidson posts largest profit beat in two years, Europe sales rise

Stand together, Britain’s May calls for unity on Brexit

Wall St. cuts losses as investors snap up shares

Powell: U.S. outlook “remarkably positive” with low unemployment, tame inflation

Trade retaliations against the U.S. hit Canada farmers, too

America’s global trade war finally arrives at the WTO as members dispute US tariffs

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US Fiscal Policy Monitor – 10.31.2018

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

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Sentiment Index

Source: Quid, Epsilon Theory

Key Articles

Lower For Longer Is No Longer Certain

The Credit Cycle is On the Turn

The Credit Crunch Cometh

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

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

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

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Credit Cycle Monitor – 10.31.2018

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

Narrative Map

Source: Quid, Epsilon Theory

Narrative Attention

Source: Quid, Epsilon Theory

Fiat News Index

Source: Quid, Epsilon Theory

Sentiment Index

Source: Quid, Epsilon Theory

Key Articles

More house prices falls look likely unless regulators intervene

IL&FS fallout: Finance firms face fund crunch

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

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

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

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

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