Posts by: Ben Hunt

Gradually and Then Suddenly

Author: W. Ben Hunt, Ph.D.
Date: July 18, 2017
Category: Monetary Policy
Tags: inflation, QE, productivity, labor, wages, barge

The barge of monetary policy has turned around and embarked on a tightening course. The question now is how fast it will move.

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Post-Fed
Follow-Up

Author: W. Ben Hunt, Ph.D.
Date: June 22, 2017
Category: Adaptive Investing, Monetary Policy
Tags: Trump, Fed, Yellen, Bonds, central banks, equities, data, Monty Python

A quick post-Fed follow-up to “Tell My Horse”, the best-received Epsilon Theory note to date (thank you!). I’ll jump right into what I’ve got to say, without the usual 20 pages of movie quotes and the like. Well, I’ve got one quote, because I can’t help myself. They’re the lyrics to the best break-up song ever, and they’re what Janet Yellen was singing to the market on Wednesday.

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Tell My Horse

Author: W. Ben Hunt, Ph.D.
Date: June 12, 2017
Category: Adaptive Investing
Tags: voodoo, loa, zombie, Dylan, Zora Neale Hurston, endoparasitoid, Hollow Market, career risk, voodoo-wasp

By far the most common coping mechanism to the Hollow Market — a market we don’t like and we don’t trust and we don’t understand, but a one-way up market for all that — is to hedge out career risk. That risk is not a large portfolio loss, because so many others will be in the same boat, but is rather a small portfolio loss from independent decision-making while others are making non-independent, collective gains. We accomplish this hedge through our collective embrace of ETFs + index products and through our collective tolerance for central bank magic spells, creating collective risk on a terrible scale. What’s the catalyst for the realization of this collective risk? I think it’s the $14 trillion trading portfolios held by global central banks, where wage inflation will push banks to sell assets regardless of its negative impact on markets.

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Complex Systems, Multiscale Information and Strange Loops

Author: W. Ben Hunt, Ph.D.
Date: May 31, 2017
Category: Rabbit Hole
Tags: Google, big data, machine learning, multiscale information theory, AutoML, MIT, one-shot imitation, OpenAI, Elon Musk, Two Sigma, strange loops

AI machine learning, multiscale information and building platforms for practical applications of big data and big compute (AI).

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She Screams, He Kidnaps

Author: W. Ben Hunt, Ph.D.
Date: May 24, 2017
Category: Rabbit Hole
Tags: Silicon Valley, data science, biases, language, memory, NIPS, deep learning, machine learning

Previously I shared some research on how recollections of successive events physically entangle each other when brain cells store them. As a fascinating and different approach to studying memory, in this paper a group of European researchers used Wikipedia page views of aircraft crashes to study memory.

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Mo’ Compute Mo’ Problems

Author: W. Ben Hunt, Ph.D.
Date: May 16, 2017
Category: Rabbit Hole
Tags: big compute, AI, big data, automation, autonomy, Kevin Kelly, intelligence, Silicon Valley

Unsurprisingly, we humans are pretty competent creatures within the domains we have contrived (such as finance) and spent decades practicing. So it is, generally, still hard (and expensive) in 2017 to quickly build a machine which is consistently better at even a thin, discrete sliver of a complex, human-contrived domain…

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Westworld

Author: W. Ben Hunt, Ph.D.
Date: May 11, 2017
Category: Adaptive Investing, US Politics
Tags: Trump, missionaries, communication policy, John Wick, Tower of Babel, Battleship Potemkin, Westworld, Hyman Roth, gold telephone, Macron, Zuckerberg, Father Coughlin, 2% Club, Forgotten Man, symbol manipulation, Newspaper Beauty Contest

The old and powerful Tower of Babel process is starting up again, and status quo political institutions are not long for this world. Along the way, we’ll have to endure a parade of billionaires wielding political power in unprecedented ways, aided by unprecedented technologies of social control. That’s the Big Risk for everyone reading this note, regardless of your politics, regardless of your social language, regardless of your vision of the life well lived. That’s the Big Risk we have to manage, as investors and citizens, and I’ll start by tackling the investment part.

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Future Flash Crashes, Digital Darwinism & the Resurgence of Hardware

Author: W. Ben Hunt, Ph.D.
Date: May 4, 2017
Category: Rabbit Hole
Tags: technology, big compute, AI

Remember a few years back when a bogus AP tweet instantly wiped $100bn off the US markets? In April 2013 the Associated Press’ Twitter account was compromised by hackers who tweeted “Breaking: Two Explosions in the White House and Barack Obama is injured.” The tweet was quickly confirmed to be an alternative fact (as we say in 2017), but not before the Dow dropped 145 points (1%) in two minutes.

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Alibaba’s AI, JP Morgan’s Risky Language & the Nurture of Reality

Author: W. Ben Hunt, Ph.D.
Date: April 26, 2017
Category: Rabbit Hole
Tags: big compute, AI, algorithms, video games, Alibaba, StarCraft, Facebook, Google, DeepMind, NLP, STEM, memories, physics, Chögyam Trungpa

AI has moved one step closer to mastering the classic video game StarCraft. Google, Facebook and now Alibaba have been working on AI StarCraft players, and last week a team from China’s Alibaba published a paper describing a system that learned to execute a number of strategies employed by high-level players without being given any specific instruction on how best to manage combat.

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AI Hedge Funds, Corporate Inequality & Microdosing LSD

Author: W. Ben Hunt, Ph.D.
Date: April 18, 2017
Category: Rabbit Hole
Tags: technology, big compute, AI, artificial intelligence, hedge funds, algorithms, quantum computing, Julia, income inequality, HBR, talent

Allow me to reintroduce Neville Crawley.

Neville Crawley is not only an Epsilon Theory fellow traveler and recent podcast guest, he’s also a brilliant technologist. As part of the ET 2.0 expanded sandbox, I’ve asked Neville to write a weekly-ish “Down the Rabbit Hole” column with his observations on what he calls Big Compute, I call non-human intelligences, and the rest of the world calls AI. This is the biggest revolution in markets and the world today.

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The Horse in Motion

Author: W. Ben Hunt, Ph.D.
Date: April 3, 2017
Category: Big Data
Tags: Big Data, Muybridge, Stanford, big compute, AI, horses, Remington

In the 1870s, Eadweard Muybridge developed a technology that allowed for a quantum leap forward in how humans perceived the natural world. His findings flew in the face of the popular narrative for how the natural world of biomechanics worked, but they were true nonetheless and led to multiple useful applications over time. Today we are at the dawning of a technology that similarly allows for a quantum leap forward in how humans perceive the world, but with a focus on the social world as opposed to the natural world.

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Mailbag: Life in Trumpland

Author: W. Ben Hunt, Ph.D.
Date: March 6, 2017
Category: Reader Mail, US Politics
Tags: Lady Gaga, Trump, narrative, politics, Clinton, China, mailbag, Reagan, game of chicken

The best part about this job, other than being recognized in random bars by 50-year old financial advisors who are always good to buy me a drink (hey, you take your celebrity where you can), is the correspondence with readers. I began writing Epsilon Theory 3+ years ago and from the outset I started getting emails from really smart people, truth-seekers all, making their way in this world of mendacity and inauthenticity without succumbing to it, and it’s given me — if not an optimism — then at least the occasional absence of despair about the world my daughters will inherit. I’m going to make a regular habit of what I always found to be the most enjoyable part of Bill Simmons’ Sports Guy blog — the reader Mailbag. I got more than the usual quota of great emails from my most recent note “The Evolution of Competition,” my take on the political and social polarization running rampant in Trumpworld. So without further ado…

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I’m Not Predicting, I’m Observing

Author: W. Ben Hunt, Ph.D.
Date: March 2, 2017
Category: Game Theory
Tags: Trump, Brexit, Europe, Soros, tactical, Le Pen, Buffet, equities, stocks

George Soros has a great line, one that I’ve stolen many times: “I’m not predicting. I’m observing.” We really don’t have a crystal ball, and it really is a dumb idea to pretend that we do. But what’s not dumb is to keep your eyes and ears open, observing both what the world is telling you (playing the cards) and what other market participants are telling you (playing the players), and reacting accordingly. That’s the heart of tactical investing.

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The Evolution of Competition

Author: W. Ben Hunt, Ph.D.
Date: February 7, 2017
Category: Game Theory
Tags: Trump, Chicken, Axelrod, cooperate, defect, Prisoner’s Dilemma, Team Elite

The Trump presidency is breaking us. Not because of the specifics of his policies or whether they’re right or wrong or anything like that. It’s breaking us because we now routinely talk past or yell at our friends, family, and fellow citizens, despite vast common ground on the really big ideas of what it means to be Americans or, more fundamentally still, a good human being. Game theory can’t solve this growing discordance or reverse the evolution of competition, but it can identify the issue and maybe, just maybe, show us ways to mitigate the damage.

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Fiat Money, Fiat News

Author: W. Ben Hunt, Ph.D.
Date: January 4, 2017
Category: Big Data, Narrative
Tags: Greshams Law, Anchorman, counterfeit, cow bell, Facebook, fake news, fiat, Kurosawa, Russia, wolf trap

The history of money provides instructive lessons for the dominant social issue of the past few months: fake news. There’s an important distinction to be made between politically slanted news, like when the Washington Post writes a silly article about Russians hacking the U.S. electric grid, and outright fakery. The former is fiat news, which is to “real news” what fiat currencies like dollars and euros and yen are to “real money” like a gold coin. Fake news is something different. Fake news is counterfeit news, which is to fiat news what counterfeit bank notes are to fiat currencies. The fiat news business is booming. As a result, the counterfeit news business is booming, too. And if the history of fiat money and counterfeit money is any guide, we ain’t seen nothing yet.

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The Art of the Probe

Author: W. Ben Hunt, Ph.D.
Date: December 8, 2016
Category: Adaptive Investing, Game Theory
Tags: active management, Ann-Margaret, blockades, chess, Cincinnati Kid, Common Knowledge Game, ECB, General Giap, information, Khrushchev, poker, Probing Bet

epsilon-theory-the-art-of-the-probe-december-8-2016-cincinnati-kidI’ve written a lot about The Common Knowledge Game – here, here, and here – because it’s the game of markets, i.e., it’s the central contribution of game theory to understanding how markets work. I’ve also written a lot about new technologies and new perspectives – here, here, and here – that help us see The Common Knowledge Game in action. But until today I’ve never written on a basic question: how can you be a better player in the game of markets? This is my first cut at an answer, and along the way I’ll pull examples from the game of poker and the game of nations. I think it’s a fun paper and hope you find it useful.

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American Hustle

Author: W. Ben Hunt, Ph.D.
Date: November 17, 2016
Category: Big Data, Narrative, US Politics
Tags: earthquake machine, Jay Cutler, Lady Gaga, Narrative Machine, Ocean's 11, oil, Otto, political culture, Steve Bannon, the Borg, Trading Places, Trump

epsilon-theory-american-hustle-november-17-2016-the-stingThree questions to answer today: what did the Narrative Machine tell us about the market immediately before and immediately after the November 8 election, what am I preparing for now as an investor, and what am I preparing for now as a citizen? I’m giddy about the first, quietly confident about the second, and pretty darn depressed about the third. Could be worse, I suppose.

  1. The Narrative Machine gave clear, actionable, and non-consensus signals prior to the U.S. election last week.
  2. Yes, the Trump reform and infrastructure Growth Narrative is a tailwind for stocks and a headwind for bonds for the next four years. And yes, the overwhelmingly negative constraints that massive global debt places on global growth is still a headwind for stocks and a tailwind for bonds for the next four years.
  3. Trump breaks our political culture. Politics is no longer a “marketplace of ideas” when you think the other side is comprised of bad guys. Politics becomes a zero-sum Competitive Game of self-defense, which means that anything — anything! — goes.
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You Had One Job

Author: W. Ben Hunt, Ph.D.
Date: November 3, 2016
Category: Adaptive Investing
Tags: Bayesian, diversification, dogs, empathy, Faulkner, Karnak, Marsellus, portfolio, Pulp Fiction, rabbi, Schumpeter, talent

salient-epsilon-theory-ben-hunt-you-had-one-job-november-4-2016-goGood dog trainers will tell you: every dog needs a job. It’s true for the pack, and it’s true for the portfolio. Every investment should accomplish a specific job in a portfolio, such that diversification emerges from the combination. But in the same way that it’s a common mistake to get a dog for the life you wish you led rather than the life you actually lead, so is it a common mistake to make an investment for the portfolio you wish you had rather than the portfolio you actually have. This is particularly true with alternative investments, which is why they don’t FEEL satisfying to most investors, even if the performance is okay.

A better way to think about portfolio construction? Step One: write down the macro scenarios your portfolio needs to confront successfully. Step Two: figure out the jobs your investments need to accomplish by immersing yourself in the stories of investors who confronted these scenarios in the past. Step Three: evaluate your managers for clarity in knowing their job and for a demonstrable process in achieving it.

The protection of the pack has been the human animal’s source of strength, in both fact and spirit, for a couple of hundred thousand years now. I think we’re going to need it over the next few years, too.

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Anthem!

Author: W. Ben Hunt, Ph.D.
Date: October 14, 2016
Category: Adaptive Investing, US Politics
Tags: Alien, Alienation, anthem, Ayn Rand, bubble, James Baldwin, Marx, Oswald, reset, Rhett Butler, Slacker, videogame

epsilon-theory-anthem-october-14-2016-time-thumbThere were anthems associated with the Dot-com Bubble and the Housing Bubble, anthems of a fundamental change in the real economy that brought all of us along for the ride, anthems that fit the political culture of the United States. Over the last six years, all we’ve heard is a statist, top-down, European-ish, tinny song of Central Bank Omnipotence that doesn’t fit the political culture of the United States, and that’s why the Central Banker Bubble is the most hated and mistrusted bull market in history.

It’s too late for a reset in this misbegotten election, but a reset — both in markets and in politics — is coming whether we like it or not. We can either prepare for the reset … we can shape the reset as best we can … or we can let the reset shape us.

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Virtue Signaling, or … Why Clinton is in Trouble

Author: W. Ben Hunt, Ph.D.
Date: September 29, 2016
Category: Game Theory, US Politics

epsilon-theory-virtue-signaling-september-30-2016-cutlerThe US election now looks to be neck-and-neck, pointing out a structural weakness in the Clinton campaign. I see virtue signaling galore among her supporters, communications to the Democratic tribe that you’re a good person because you’re against Trump, never mind whether or not that helps the campaign. The stakes are high, as Trump threatens to transform 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.

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Essence of Decision

Author: W. Ben Hunt, Ph.D.
Date: September 16, 2016
Category: Monetary Policy, Narrative
Tags: bureaucracy, Cuban Missile Crisis, Fed, Gatsby, Hilsenrath, missionaries, monetary policy, narrative, politics, Quid, reputation, Summers, Yellen

epsilon-theory-essence-of-decision-september-16-2016-great-gatsby-thumbAny big policy decision — whether it’s to order a naval blockade or an air strike on Cuba, or whether it’s to raise interest rates in September or December or not at all — is a combination of three perspectives: a high-level, rational expectations model, bureaucratic imperatives, and institutional politics. Unfortunately, we spend way too much time focused on the first of these and way too little on the other two, even though the latter two are far more influential on how real-world people make real-world decisions. Here’s my analysis of the Fed’s forthcoming decision on interest rates from a bureaucratic and an internal politics perspective. Seen through these lenses, I think they hike. Maybe I’m wrong. These things are always probabilistic shades of gray, never black and white. But what I’m certain about is that the bureaucratic and internal politics perspectives give a different, higher probability of hiking than the rational expectations/modeling perspective. So heads up.

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Magical Thinking

Author: W. Ben Hunt, Ph.D.
Date: September 1, 2016
Category: Monetary Policy
Tags: Fed, Frazer, Gaussian Cupola, inexorable, Jackson Hole, magical thinking, Piaget, prayers, Taylor Rule, Woody Allen

epsilon-theory-magical-thinking-september-1-2016-annie-hall-woody-allenWoody Allen closes “Annie Hall” with a joke: This guy goes to a psychiatrist and says, “Doc, my brother’s crazy; he thinks he’s a chicken.” And the doctor says, “Well, why don’t you turn him in?” The guy says, “I would, but I need the eggs.”

That pretty much sums up our relationship with the central banker ruling class. We know that they’re dangerously out of touch with reality, and we’re terrified of what they might do next. But we go along with the magical thinking crew and smile at their courtiers. Why? Because we need the eggs.

It’s easy enough to rail at the Fed and the stultifying, excruciating more-of-the-sameness that came out of Jackson Hole. But the larger problem is with us. The bigger problem is that we cannot imagine a solution for our current economic and political problems that does not rely on greater and greater state-directed spell casting. It’s time to wake up. It’s time to begin a new conversation. 

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The Narrative Machine

Author: W. Ben Hunt, Ph.D.
Date: August 17, 2016
Category: Big Data, Narrative
Tags: Narrative Machine, Quid, alpha, Big Data, Brexit, clockwork, Economic Machine, edge, Leeuwenhoek, media, network, odds, origin story

epsilon-theory-narrative-machine-august-17-2016-clockwork-orangeToday’s note begins a new chapter in the Epsilon Theory project by demonstrating a set of tools for observing the invisible network of strategic communication and game-playing that I’ve been writing about for the past three years. As in 1648 and 1776 and 1848 and 1917, we live in one of those rare moments in history where ideas are at stake and fundamental theories of the world are in flux. The Narrative Machine is my attempt to engage with that, by providing a new perspective regarding the true nature of our economic and political clockwork.

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Crisis Actors and a Reichstag Fire

Author: W. Ben Hunt, Ph.D.
Date: July 26, 2016
Category: Monetary Policy, Narrative
Tags: monetary policy, narrative, Yellen, communication policy, crisis actor, Draghi, Erdogan, eusociality, Goring, Greshams Law, Reichstag, Turkey

What’s happening today in Turkey is absolutely a carbon copy of what happened in Germany in 1933 with the Reichstag Fire. Hermann Göring in 1933 and Erdogan today are crisis actors, pretending that the Nazis or the Islamists are the only force standing between the Motherland and political traitors within and abroad, pretending that their “emergency policies” are anything less than a permanent seizure of political control. But Janet Yellen and Mario Draghi and their central bank Missionary kin are crisis actors, too, pretending that their “emergency policies”, now more than seven years old, are anything less than a permanent political shift in the global allocation of money and credit. The ends are different, but the shared means of false Narrative and crisis acting matter, because they create a world of profound inauthenticity, where ALL public speech is deemed suspect and self-serving, and where ANY public speech, no matter how demagogue-ish or false or borderline insane, is deemed functionally equivalent to any other speech. It’s Gresham’s Law of Narrative: inauthentic speech drives authentic speech out of circulation, just like bad money drives out good. Conclusion: the rise of Trump and Farage and Le Pen and their ilk is a direct consequence of the communication policy toolkit and the crisis acting employed by every Western central banker and politician over the past seven years.

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Financial “Innovation” Returns to ABS Market

Author: W. Ben Hunt, Ph.D.
Date: July 20, 2016
Category: Market Structure
Tags: ABS, securitization, thirst, Verizon, yield

epsilon-theory-financial-innovation-july-20-2016-verizonOn Monday, Verizon Wireless successfully securitized more than $1 billion in cellphone contracts and sold the notes into the Asset-Backed Securities (ABS) market. Here’s the Reuters article describing the deal. Wireless guys have been selling their contracts for years in private deals, but this is the first public securitization, and the first new “asset class” to come into the ABS market in probably a decade. Nothing like selling a cool drink of water to a market with an unquenchable thirst for yield …

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When Narratives Go Bad

Author: W. Ben Hunt, Ph.D.
Date: July 7, 2016
Category: Monetary Policy, Narrative
Tags: monetary policy, narrative, Bonds, Clinton, Fable, Greater Fool, Groucho Marx, Hamilton, Investment Income, John Oliver, Three Stooges, Wage Income

epsilon-theory-when-narratives-go-bad-july-7-2016-hamiltonHere’s my most basic view on everything that’s happening in the world right now, politically, economically, socially … all of it: the Fix is still in, but it’s getting harder and harder to maintain. The Fix is the status quo, and it’s supported by Narratives. The problem is that the status quo supporting Narratives are dying. Why? Because status quo political and economic institutions – particularly Central Banks – have failed to protect incomes and have pushed income and wealth inequality past a political breaking point. We have once again set up the global financial system as an inverted pyramid, with a $10 trillion asset class of negative rate sovereign bonds based entirely on the Common Knowledge that there is no limit to the greater foolishness of Central Banks. If this Narrative fails, the entire inverted pyramid will come crashing down again, just like 2008. The punchline: monitoring this and related status quo protecting Narratives (like the concerted effort to paint Brexit as a one-off blunder, just like Bear Stearns was painted in 2008) is the only thing that really matters for our investment reality.

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Waiting for Humpty Dumpty

Author: W. Ben Hunt, Ph.D.
Date: June 24, 2016
Category: Europe, Monetary Policy
Tags: monetary policy, Brexit, central bank, eurozone, flash crash, liquidity

Brexit is a Bear Stearns moment, not a Lehman moment. That’s not to diminish what’s happening (markets felt like death in March, 2008), but this isn’t the event to make you run for the hills. Why not? Because it doesn’t directly crater the global currency system. It’s not too big of a shock for the central banks to control. It’s not a Humpty Dumpty event, where all the Fed’s horses and all the Fed’s men can’t glue the eggshell back together. But it is an event that forces investors to wake up and prepare their portfolios for the very real systemic risks ahead.

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Cat’s Cradle

Author: W. Ben Hunt, Ph.D.
Date: June 21, 2016
Category: Adaptive Investing, Monetary Policy
Tags: monetary policy, liquidity, Bullard, common knowledge, cooperative games, Dickinson, focal points, ice-nine, negative rates, price discovery, Vonnegut

epsilon-theory-cats-cradle-vonnegutGame theory is best known for competitive games like Chicken and Prisoner’s Dilemma, but it’s the cooperative games based on Common Knowledge and focal points that really make the world go round. Unfortunately, when governments undertake emergency actions and extraordinary policies, they obliterate the focal points that make our cooperative games of investing and market making possible. Specifically, extraordinary monetary policy has obliterated the focal points of price discovery, and extraordinary regulatory policy has obliterated the focal points of liquidity. While it’s only natural to feel a keen sense of resignation under these circumstances, a reaction that Fed Governor Jim Bullard put into words with a scathing indictment of FOMC forward guidance, it’s better still to start a new conversation about how to invest here in the Silver Age of the Central Banker.

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Pressure and Time

Author: W. Ben Hunt, Ph.D.
Date: June 7, 2016
Category: Game Theory, Narrative
Tags: Common Knowledge Game, narrative, game theory, hope, infrastructure, Shawshank

epsilon-theory-pressure-and-time-june-7-2016-shawshankOver time, a policy-controlled market places enormous pressure on investors, and investors respond by inventing hopes of some future return to “normal” markets. Today the hope that has crystallized into an investment theme is the notion that we are on the verge of a coordinated global infrastructure boom. Like everything else market-related today, this theme is driven by the Common Knowledge Game, where its investment success will be driven by Narrative, not by its actual policy usefulness or existence in the real world. Hope is a powerful tonic for these difficult markets, but it’s also a social construct used intentionally by others to shape our behavior, in investing and in life. Caveat Emptor.

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Who’s Being Naïve, Kay?

Author: W. Ben Hunt, Ph.D.
Date: May 24, 2016
Category: Monetary Policy, Narrative
Tags: Common Knowledge Game, monetary policy, narrative, Alerian, correlation, FOMC, Godfather, Liam Neeson, Mysterious Stranger, Salesforce.com, Tolstoy

epsilon-theory-whos-being-naive-kay-may-24-2016-godfatherOver time, a policy-controlled market places enormous pressure on investors, and investors respond by inventing hopes of some future return to “normal” markets. Today the hope that has crystallized into an investment theme is the notion that we are on the verge of a coordinated global infrastructure boom. Like everything else market-related today, this theme is driven by the Common Knowledge Game, where its investment success will be driven by Narrative, not by its actual policy usefulness or existence in the real world. Hope is a powerful tonic for these difficult markets, but it’s also a social construct used intentionally by others to shape our behavior, in investing and in life. Caveat Emptor.

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Optical Illusion / Optical Truth

Author: W. Ben Hunt, Ph.D.
Date: May 4, 2016
Category: Adaptive Investing, Monetary Policy
Tags: oil, monetary policy, correlation, adaptive investing, causation, cholera, data analysis, emerging markets, Faust, manufacturing, Tufte

epsilon-theory-optical-illusion-optical-truth-may-4-2016-economistOver the past three years I’ve written about the Epsilon Theory perspective on Emerging Markets (It Was Barzini All Along), oil prices (The Unbearable Over-Determination of Oil), and the US manufacturing sector (The Silver Age of the Central Banker).

Today I want to show what policy-controlled markets look like in each of these areas. It’s a sobering exercise, certainly for anyone who still wants to believe that fundamental, real economy factors are a useful indicator of what’s next. The good Lord giveth and the good Lord taketh away. Right now the good Lord’s name is Janet Yellen, and she’s in a giving mood. It won’t last. It never does. But it does give us time to prepare our portfolios for a return to competitive monetary policy actions, and it gives us insight into what to look for as catalysts for that taketh away part of the equation.

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The Placebo Effect

Author: W. Ben Hunt, Ph.D.
Date: April 20, 2016
Category: Adaptive Investing, Monetary Policy
Tags: Fed, monetary policy, communication policy, headache, migraine, OPEC, placebo

epsilon-theory-the-placebo-effect-april-20-2016-migrainThe primary instruments of monetary policy in 2016 – words used to construct Common Knowledge and mold our behavior, words chosen for effect rather than truthfulness, words of “forward guidance” and “communication policy” – are placebos. Just as in migraine therapy, the placebos of monetary policy are enormously effective because they act on the brain-regulated physiological phenomena of pain. So long as the Fed and the ECB and the BOJ are playing nice with China by talking down the dollar regardless of what’s happening in the real world economy, then it’s an investable rally in all risk assets, and oil goes up more easily than it goes down, regardless of what happens with OPEC. Every day that Yellen talks up global risks and talks down the dollar is another day of a pain-relieving injection, regardless of whether or not that talk is “real” therapy.

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My Passion is Puppetry

Author: W. Ben Hunt, Ph.D.
Date: April 6, 2016
Category: Adaptive Investing, Monetary Policy
Tags: Fed, monetary policy, adaptive investing, advertising, cargo cult, insurance, quality, stock picking

epsilon-theory-my-passion-is-puppetry-april-6-2016-cars-adThe Fed wants to promote all financial assets, and their communication policies are intentionally designed to push and cajole us to pay up for financial risk in our investments, in exactly the same way that an insurance company’s communication policies are intentionally designed to push and cajole us to pay up for financial risk in our cars and homes. The Fed uses Janet Yellen and forward guidance; Nationwide uses Peyton Manning and a catchy jingle. From a game theory perspective it’s the same thing. As a consequence stock-picking has never been more difficult, requiring investors and advisors to change the meaning and role of actively managed strategies in any investment portfolio.

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There for the Right Reasons

Author: W. Ben Hunt, Ph.D.
Date: March 29, 2016
Category: Emails

The Fed wants to promote all financial assets, and their communication policies are intentionally designed to push and cajole us to pay up for financial risk in our investments, in exactly the same way that an insurance company’s communication policies are intentionally designed to push and cajole us to pay up for financial risk in our cars and homes. The Fed uses Janet Yellen and forward guidance; Nationwide uses Peyton Manning and a catchy jingle. From a game theory perspective it’s the same thing. As a consequence stock-picking has never been more difficult, requiring investors and advisors to change the meaning and role of actively managed strategies in any investment portfolio.

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Hobson’s Choice

Author: W. Ben Hunt, Ph.D.
Date: March 16, 2016
Category: Adaptive Investing
Tags: narrative, central banks

epsilon-theory-hobsons-choice-march-16-2016-destroyIn the second half of 2014, export volumes in every major economy on Earth began to decline, the result of divergent monetary policies that crystallized with the Fed’s announced tightening bias in the summer of 2014. This decline in trade activity – which is far more impactful than a decline in trade value, because it means that the global growth pie is structurally shrinking – accelerated in 2015 and 2016 as Europe and Japan intentionally devalued their currencies to protect their slices of the global trade pie. In game theoretic terms, Europe and Japan have been “free riders” on the global system, using currency devaluation to undercut the prices of competing US and Chinese products in a way that avoids domestic political pain.

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The Narrative Fix Is In

Author: W. Ben Hunt, Ph.D.
Date: March 11, 2016
Category: Europe

On August 2, 2012 Mario Draghi gave the most disastrous ECB press conference of all time. The market anticipation was enormous leading up to the event, as this was the moment where the ECB would unveil the Outright Monetary Transactions (OMT) program — a new, ultimate weapon to be deployed to rescue the euro. In truth, the OMT then (and now) was just a bunch of words. Powerful and nice-sounding words, to be sure, but just words. All hat and no cattle, as they might say in Texas. The Germans then (and now) were clearly not on board with the OMT, and European markets broke hard. Spain’s stock market dropped more than 5% that day, and Italy’s was close to that. Spain’s 10-year bonds hit a 7.2% yield, and Italy’s hit 6.3%. You can imagine what happened in Portugal and Greece.

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Welcome to the Jungle

Author: W. Ben Hunt, Ph.D.
Date: March 1, 2016
Category: Monetary Policy

epsilon-theory-welcome-to-the-jungle-march-1-2016-democracyThere is one great positive-sum game in all of human economic history — trade. But there are periods of time in human history when this core engine of growth and prosperity falters, when it becomes, at best, a zero-sum game of equal winners and equal losers. We are entering one of those times.

Why? Because this is what ALWAYS happens as independent nations struggle with the domestic political consequences of massive debt. Debt begets wealth inequality. Wealth inequality begets political polarization. Political polarization begets shocking electoral outcomes as the median voter theorem fails and shocking market outcomes as the central tendency fails. So go ahead … ask Nate Silver how well his electoral models are working. Ask any Fed staffer how well their econometric models are working. Democracy is hacked, not in the sense of some Mr. Robot f-society conspiracy, but in the sense of what Sen. Lindsey Graham appropriately calls “bats**t crazy” domestic political behavior, behavior that ALWAYS emerges under these circumstances. It happened in the 1870s. It happened in the 1930s. It’s happening today. As George Soros would say, I’m not expecting it. I’m observing it.

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The Silver Age of the Central Banker

Author: W. Ben Hunt, Ph.D.
Date: February 19, 2016
Category: Monetary Policy

epsilon-theory-the-silver-age-of-the-central-banker-february-19-2016-missionariesFor the past six plus years, ever since the Fed launched QE1 in March 2009, we have lived in an era I’ve described as the Golden Age of the Central Banker, where the dominant explanation for why market events occur as they do has been the Narrative of Central Bank Omnipotence. By that I don’t mean that central bankers are actually omnipotent in their ability to control real economic outcomes (far from it), but that most market participants have internalized a faith that central bankers are responsible for all market outcomes.

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Snikt

Author: W. Ben Hunt, Ph.D.
Date: February 9, 2016
Category: Adaptive Investing
Tags: adaptive investing, CDS, convexity, deflation, onomatopoeia, systemic risk

epsilon-theory-snikt-february-9-2016-wolverineAs longtime Epsilon Theory readers know, I’m a big comic book fan. One of the joys of a comic done well is the effective representation of a dynamic multi-dimensional narrative within a static two-dimensional art form. As the saying goes, a picture is worth a thousand words, but occasionally so is a sound. Or rather, a picture of a sound. Whether it’s the “Thwip” of Spiderman shooting his web or the “Snikt” of Wolverine popping his claws, certain classic onomatopoeias (to use the $10 word) communicate immediately everything you need to know about what’s going on and what’s about to happen.

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Rewardless Risk

Author: W. Ben Hunt, Ph.D.
Date: February 1, 2016
Category: Monetary Policy
Tags: monetary policy, negative rates, central banks, deflation, currency, Lord of the Rings

epsilon-theory-rewardless-risk-february-1-2016-lord-of-the-ringsI’m going full-nerd with the “Lord of the Rings” introduction to today’s Epsilon Theory note, but I think this scene — where Denethor, the mad Steward of Gondor, orders his son Faramir to take on a suicide mission against Sauron’s overwhelming forces — is the perfect way to describe what the Bank of Japan did last Thursday with their announcement of negative interest rates. The BOJ (and the ECB, and … trust me … the Fed soon enough) is the insane Denethor. The banks are Faramir. The suicide mission is making loans into a corporate sector levered to global trade as the forces of global deflation rage uncontrollably.

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You Can Either Surf, or You Can Fight

Author: W. Ben Hunt, Ph.D.
Date: January 14, 2016
Category: Adaptive Investing
Tags: oil, monetary policy, adaptive investing, central banks, deflation, systemic risk, currency, China, dollar

epsilon-theory-you-can-either-surf-or-you-can-fight-january-14-2016-bloombergThere’s more than a whiff of 2008 in the air. The sources of systemic financial sector risk are different this time (they always are), but China and the global industrial/commodity complex are even larger tectonic plates than the US housing market, and their shifts are no less destructive. There’s also more than a whiff of 1938 in the air (hat tip to Ray Dalio), as we have a Fed that is apparently hell-bent on raising rates even as a Category 5 deflationary hurricane heads our way, even as the yield curve continues to flatten.

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The China Narrative That Really Matters

Author: W. Ben Hunt, Ph.D.
Date: January 7, 2016
Category: China
Tags: narrative, systemic risk, China

I’m a China bull, let’s get that out of the way first. But like anything connected with the global industrial and commodity complex today, from Emerging Markets to MLPs to oil prices, it doesn’t matter what the Truth with a capital T might be regarding the real world economic or business fundamentals. The story is broken. The stocks are broken.

I’ve written a lot here in Epsilon Theory about what’s happening in China and what it means for the China growth story to break.

Most directly on the topic, read “When the Story Breaks“. It’s a quick read and introduces an Epsilon Theory perspective for how to think about China.

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Epsilon Theory State of the Union

Author: W. Ben Hunt, Ph.D.
Date: December 30, 2015
Category: Epsilon Theory
Tags: Common Knowledge Game, Epsilon Theory, Salient

For the last six months I’ve been trying to figure out how to incorporate reader correspondence into Epsilon Theory. We’ve reached a point of both reader quantity (well more than 60,000 active email subscribers here at year end, >5x where we started the year) and reader quality (I’d put the sheer firepower of ET subscribers up against any distribution list in the world) such that it feels kinda silly and selfish to put this off any longer. Plus I think that for the Epsilon Theory project to take the next big step forward, it needs the sort of reader engagement you only get by opening a window for direct participation and expression. In exactly the same way that the greatest force in fundamentally unmoored markets is the power of the crowd watching the crowd, so do I want to apply those principles of the Common Knowledge Game to help grow Epsilon Theory itself.

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Storm Warning

Author: W. Ben Hunt, Ph.D.
Date: December 14, 2015
Category: Adaptive Investing, Monetary Policy
Tags: Fed, monetary policy, adaptive investing, central banks, convexity, deflation, systemic risk

Can everyone saying “a 25 bps rate hike doesn’t change anything” or “manufacturing is a small part of the US economy today, so the ISM number doesn’t mean much” or “trade with China is only a few percent of US GDP, so their currency devaluation isn’t important” just stop? Seriously. Can you just stop? Maybe if you were making these statements back in the ‘80s – and by that I mean the 1880s, back when the US was effectively a huge island in the global economy – it would make some sense, but today it’s just embarrassing.

There is a Category 5 deflationary hurricane forming off the Chinese coast as Beijing accelerates the devaluation of the yuan against the dollar under the guise of “reform”. I say forming … the truth is that this deflationary storm has already laid waste to the global commodity complex, doing trillions levels last seen when the world was coming to an end in the Lehman aftermath. And now the Fed is going to tighten? Are you kidding me?

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I Know It Was You, Fredo

Author: W. Ben Hunt, Ph.D.
Date: December 8, 2015
Category: Adaptive Investing
Tags: Godfather, adaptive investing, convexity, portfolio management, risk management

epsilon-theory-i-know-it-was-you-fredo-december-8-2015-godfatherThere’s no more dramatic moment in all of movies than the Havana club scene in Godfather, Part II, where Michael overhears Fredo blurting out that he’s partied with Johnny Ola, Hyman Roth’s lieutenant, and lied to Michael about knowing him. The look on Michael’s face as he realizes that Fredo has betrayed the family is, for my money, Al Pacino’s finest scene as an actor, and it helped him gain a 1975 Oscar nomination for Best Leading Actor. Unfortunately for Pacino, it was a good year for strong leading man performances, as Jack Nicholson was also nominated that year for his role in “Chinatown”. The winner, of course, was Art Carney from the immortal film “Harry and Tonto”. Thank you, Academy.

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Two Discoveries

Author: W. Ben Hunt, Ph.D.
Date: November 19, 2015
Category: Big Data, Narrative
Tags: narrative, Big Data

epsilon-theory-two-discoveries-november-19-2015-mediaThe world made two discoveries last week. Everyone is aware of the first discovery – that ISIS is not “a junior varsity team” but an able protagonist in what Pope Francis quite rightly calls “a piecemeal third World War”. Very few are aware of the second discovery – the existence of a polynomial-time algorithm to determine whether two networks, no matter how complex, are identical. Both are watershed events, part of a continuing destabilization of politics and science. Neither will impact markets very much today. Both will change markets forever in the years to come.

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The Andromeda Strain

Author: W. Ben Hunt, Ph.D.
Date: November 12, 2015
Category: Epsilon Theory
Tags: narrative, books

epsilon-theory-the-andromeda-strain-november-12-2015-wildfireSometimes you read just the right book at just the right time in your life. For me, one of those books was “The Andromeda Strain”, Michael Crichton’s first (and I think best) science thriller. The 1969 book holds up unnervingly well almost 50 years later, with its spot-on description of the Orwellian impulse of modern government, both in its language and its research programs. If you enjoy Epsilon Theory but you’ve never read “The Andromeda Strain”, do yourself a favor and check it out.

I’ve been thinking about Crichton and his books for a couple of reasons. First, I just read “Lexicon”, by Max Barry, which reminded me of Crichton’s work in its pacing and science-y hook. It’s a terrific read, even if the MacGuffin – what Hitchcock famously called “the object of desire” that motivates the plot of every human story – gets a little silly by the end. Second, I always admired Crichton’s skeptical nature regarding The Powers That Be and their use of Narrative, his ability to weave a good yarn around popularized science, and of course the fact that he made a ton of money with this particular skill set. Third, by far the most common question I get from Epsilon Theory readers (more than 60,000 email subscribers now … thank you!) is for reading recommendations, and it’s high time I updated the required reading list I put together almost 2 years ago.

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Funny How?

Author: W. Ben Hunt, Ph.D.
Date: October 28, 2015
Category: Narrative
Tags: narrative, central banks, Goodfellas, inflation

epsilon-theory-funny-how-october-28-2015-goodfellasI was watching the Draghi press conference the other week, and I had to turn off the TV. I found myself getting so … angry … not just at what Draghi was saying, but also the live blog reaction and the live market reaction, that I decided I was better off stepping back from the actual event and trying to figure out why I was having such a powerfully negative emotional reaction to the entire charade. It’s not the charade itself. I mean, if I were outraged by every inauthentic display of central banker “communication policy” and the media lapdog response, I’d be in some sort of permanent apoplectic fit. In fact, neither the central bankers nor the media even pretend any more that extraordinary monetary policy has any sort of material impact on the real economy, which I suppose is actually progress on the authenticity scale in a perverse sort of way.

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Invisible Threads: Matrix Edition

Author: W. Ben Hunt, Ph.D.
Date: October 13, 2015
Category: Market Structure
Tags: derivatives, market structure, Matrix, volatility

epsilon-theory-invisible-threads-matrix-edition-october-13-2015-agent-smithThis is the concluding Epsilon Theory note of a trilogy on coping with the Golden Age of the Central Banker, where a policy-driven bull market has combined with a machine-driven market structure to play you false. The first installment – “One MILLION Dollars” – took a trader’s perspective. The second – “Rounders” – was geared for investors. Today’s note digs into the dynamics of the machine-driven market structure, which gets far less attention than Fed monetary policy but is no less important, to identify what I think is an unrecognized structural risk facing both traders and investors here in the Brave New World of modern markets.

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Rounders

Author: W. Ben Hunt, Ph.D.
Date: September 30, 2015
Category: Adaptive Investing
Tags: poker, adaptive investing, portfolio management, risk management, boredom

epsilon-theory-rounders-september-30-2015-mcdermottI’m a good poker player. I know that everyone says that about themselves, so you’ll just have to take my word for it. I’m also a good stock picker, which again is something that everyone says about themselves. At least on this point I’ve got a track record from a prior life to make the case. But I don’t consider myself to be a great poker player or a great stock picker. Why not? Because I get bored with the interminable and rigorous discipline that being a great poker player or a great stock picker requires. And I bet you do, too.

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One MILLION Dollars

Author: W. Ben Hunt, Ph.D.
Date: September 15, 2015
Category: Big Data, Market Structure
Tags: Big Data, market structure

epsilon-theory-one-million-dollars-september-15-2015-austin-powersI’ve written several Epsilon Theory notes about modern market structure (“Season of the Glitch”, “Fear and Loathing on the Marketing Trail, 2014”, “The Adaptive Genius of Rigged Markets”, “Hollow Men, Hollow Markets, Hollow World”), all of which have been very well received. I’ve also written several Epsilon Theory notes about Big Data and non-human intelligences (“Troy Will Burn – the Big Deal about Big Data”, “First Known When Lost”, “Rise of the Machines”), all of which have generated a yawn. This divergence in reader reaction has puzzled me, because it seems so obvious to me that the issues are two sides of the same coin. So why can’t I communicate that?

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Season of the Glitch

Author: W. Ben Hunt, Ph.D.
Date: September 3, 2015
Category: Adaptive Investing, Market Structure
Tags: adaptive investing, portfolio management, risk management, market structure, ETF

epsilon-theory-season-of-the-glitch-september-3-2015-blair-witchThousands of investors with stop-loss orders on their ETFs saw those positions crushed in the first 30 minutes of trading last Monday, August 24th. Seeing a price blow right through your stop is perhaps the worst experience in all of investing because it seems like such a betrayal. “Hey, isn’t this what a smart investor is supposed to do? What do you mean there was no liquidity at my stop? What do you mean I got filled $5 below my stop? Wait… now the price is back above my stop! Is this for real?”  Welcome to the Big Leagues of Investing Pain.

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When the Story Breaks

Author: W. Ben Hunt, Ph.D.
Date: August 25, 2015
Category: Adaptive Investing
Tags: Common Knowledge Game, narrative, adaptive investing, China, portfolio management, risk management, volatility

epsilon-theory-when-the-story-breaks-august-25-2015-volatilityBack in my portfolio manager days, I was a really good short seller. I say that as a factual observation, not a brag, as it’s not a skill set that’s driven by some great intellectual or character virtue. On the contrary, most short sellers are, like me, highly suspicious of all received wisdom (even when it is, in fact, wise) and have weirdly over-developed egos that feed on the notion of “I’m right even though the world says I’m wrong”. But what set me apart as a short seller were two accidents of experience. First, I didn’t come out of Wall Street, so I wasn’t infected with the long-bias required of those business models. Second, my professional career prior to investing was all about studying mass behaviors and the informational flows that drive those behaviors.

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Breaking Bad

Author: W. Ben Hunt, Ph.D.
Date: August 19, 2015
Category: Market Structure, Narrative
Tags: narrative, market structure, HFT, high frequency trading, ITG

Always confess to a small crime if you want to hide the big stuff. I remember reading this in a Robert Heinlein sci-fi novel when I was a kid, and it’s stuck with me ever since. Once you start looking for this trope you see it everywhere, and even if it goes a little over the top at times in scripted media (anyone remember the “24” season where Jack Bauer tortures his own brother, who gives up a partial truth to hide their father’s role as an arch-villain of treason?), I’m always on the look-out for it in the Narrative construction of our unscripted investment news media.

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Actually Maybe Not So Excellent

Author: W. Ben Hunt, Ph.D.
Date: August 11, 2015
Category: China
Tags: narrative, currency, China

A quick email on China’s currency devaluation last night. The news itself is big enough, but it’s the Narrative that’s developing around the devaluation that has my risk antennae quivering like crazy. What do I mean? I mean that initial media efforts to portray the devaluation as a one-time “adjustment” that’s in-line with prior policy have been overrun by stories of “shock” and disjuncture. This is true even within Rupert Murdoch’s various media microphones, which tend strongly to toe the Beijing party line. Moreover, the devaluation is not being described in Western media as Chinese “stimulus”, which it surely is and would send markets higher if portrayed in this light, but as Chinese “currency competition” and as a sign that the growth problems in China are more severe than Western central bankers would like to believe. Or more precisely, would like to have YOU believe.

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“Suddenly, Last Summer”

Author: W. Ben Hunt, Ph.D.
Date: July 29, 2015
Category: Monetary Policy
Tags: oil, monetary policy, currency, Tennessee Williams

epsilon-theory-suddenly-last-summer-july-29-2015-suddenlyI figure not one Epsilon Theory reader in a thousand has seen “Suddenly, Last Summer”, but let me tell you … it’s got everything. Katherine Hepburn in a phenomenal performance as bizarro Aunt Vi. Elizabeth Taylor cavorting in the surf. Montgomery Clift. Lobotomies. Pedophilia. Cannibalism. Honestly, it’s kind of what you would expect if Gore Vidal took a Tennessee Williams script and just went gonzo with it. Which, in fact, is exactly what happened.

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The New TVA

Author: W. Ben Hunt, Ph.D.
Date: July 23, 2015
Category: Adaptive Investing, Narrative
Tags: monetary policy, narrative, adaptive investing, central banks, portfolio management, risk management, global debt, global growth, Mad Men, TVA, utility

epsilon-theory-the-new-tva-july-23-2015-mad-menMy favorite scene from Mad Men is the picnic scene from Season 2. The Draper family enjoys a lovely picnic at some park, and at the conclusion of the meal Don tosses his beer cans into the bushes and Betty just flicks the blanket and leaves all the trash right there on the grass. Shocking, right? I know this is impossible for anyone under the age of 30 to believe, but this is EXACTLY what picnics were like in the 1960’s, even if a bit over the top in typical Draper fashion. There was no widespread concept of littering, much less recycling and all the other green concepts that are second nature to my kids. I mean … if I even thought about Draper-level littering at a Hunt picnic today my children would consider it to be an act of rank betrayal and sheer evil. I’d be disowned before they called the police and had me arrested.

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1914 is (still) the New Black

Author: W. Ben Hunt, Ph.D.
Date: July 6, 2015
Category: Europe, Game Theory
Tags: game theory, Chicken, Europe, World War I

Last week’s email, “1914 is the New Black”, was the most widely read Epsilon Theory note to date, and given yesterday’s events it bears repeating, as the echoes of 1914 are growing louder and louder. We are, I think, likely embarked on the death spiral phase of a game of Chicken, just as in the summer of 1914. The stakes are, for now at least, not nearly as cataclysmic today as they were a century ago, but the social and political dynamics are eerily alike.

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1914 is the New Black

Author: W. Ben Hunt, Ph.D.
Date: June 29, 2015
Category: Europe, Game Theory
Tags: narrative, game theory, Chicken, Europe, Germany, Greece

epsilon-theory-1914-is-the-new-black-june-29-2015-powerNothing like a good Friday-after-the-close blockbuster to set the stage for an interesting week.

At 1am Saturday morning Athens time, the Greek government called for a nationwide referendum to vote the Eurogroup’s reform + bailout proposal up or down. The vote will happen on Sunday, July 5th, but Greece will default on its IMF debt this Wednesday, and as a result the slow motion run on Greek banks is about to get a lot more fast motion unless capital controls are imposed. If you want to get into the weeds, Deutsche Bank put out a note, available here, that I think is both a well-written and comprehensive take on the facts at hand. As for the big picture, I’ve attached last week’s Epsilon Theory note (“Inherent Vice“), as this referendum is EXACTLY the sort of self-binding, “rip your brakes and steering wheel out of the car” strategy I wrote about as a highly effective way to play the game of Chicken.

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Inherent Vice

Author: W. Ben Hunt, Ph.D.
Date: June 22, 2015
Category: Game Theory
Tags: Common Knowledge Game, game theory, Chicken

epsilon-theory-inherent-vice-june-22-2015-james-deanI was at a conference, on deck for a presentation, and I had the chance to listen to the Q&A for the speaker ahead of me.

“Assuming no external shock, how much longer can this bull market run?”

The speaker, not exactly the most sparkling of raconteurs under the best of circumstances, first replied with the obligatory, “well, that’s a very good question”, and then proceeded to give a detailed, bone-dry explication of exactly how long he thought this market would run, the likely level of the S&P 500 top, and a few winning sectors and stock picks for good measure. It all sounded very smart, and I’m sure he was … smart, that is. But boy oh boy, if there were ever a living embodiment of von Neumann’s dictum that being precise is all too often a waste of time, this was it.

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Two Growth Announcements and One Not So Much

Author: W. Ben Hunt, Ph.D.
Date: June 10, 2015
Category: Epsilon Theory
Tags: monetary policy, risk management

A brief note today about Fed “lift-off” following last Friday’s jobs report. As with so many announcements that are trumpeted with great fanfare in the Golden Age of the Central Banker, I think there’s less here than meets the eye. But before we get into that, I have two growth announcements that I think are, in fact, authentic indications of something interesting afoot.

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Sometimes a Cigar is Just a Cigar

Author: W. Ben Hunt, Ph.D.
Date: May 22, 2015
Category: Adaptive Investing, Game Theory
Tags: Common Knowledge Game, game theory, adaptive investing, information theory

epsilon-theory-sometimes-a-cigar-is-just-a-cigar-may-22-2015-freudThere’s only one question that matters today in markets: why is the government bond market going up and down like a yo-yo? How is it possible that the deepest and most important securities in the world are currently displaying all the trading stability of a biotech stock?

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More Probable Than Not

Author: W. Ben Hunt, Ph.D.
Date: May 11, 2015
Category: Narrative
Tags: Fed, narrative, Yellen, Bernanke, Tom Brady

My father was a doctor who spent his entire career in a small hospital built by the Tennessee Coal and Iron company in Fairfield, Alabama. He was an ER doc way before emergency medicine was its own thing, which meant that he saw a wide gamut of cases, from knife fights to car wrecks to heart attacks. But it also meant that he saw a lot of ordinary colds and various infectious diseases, as the emergency clinic then – as now – was the only on-demand medical facility available for people who couldn’t afford or didn’t have access to private physician practices. Now one of my father’s great joys in life was watching sports on our grainy black and white TV, miraculously upgraded to a grainy color TV when I was 12. I’m sure he spent hundreds, if not thousands, of happy hours watching sports. Unless, of course, the hapless TV commentator made the mistake of excusing the absence of, say, Larry Bird from a Celtics game by saying that Bird “had a touch of the flu” and so was too sick to play, which was guaranteed to send my father into a 10-minute tirade.

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The Talented Mr. Ripley

Author: W. Ben Hunt, Ph.D.
Date: April 27, 2015
Category: Adaptive Investing, Big Data
Tags: Common Knowledge Game, narrative, Big Data, adaptive investing

epsilon-theory-the-talented-mr-ripley-april-27-2015-ted-williamsMy singular talent is seeing patterns that others don’t. That’s not a boast, but a fact, and frankly it’s been as much a source of alienation in my life as a source of success. As my father was fond of saying, “You know, Ben, if you’re two steps ahead it’s like you’re one step behind.” I can’t explain how I see the patterns – they just emerge from the fog if I stare long enough. It’s always been that way for me, for as far back as I have memories, and whether I’m 5 years old or 50 years old I’m always left with the same realization: I only see the pattern when I start asking the right question, when I allow myself to be, as Faulkner said, “ruthlessly intolerant” of anything that proves false under patient and curious observation.

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It’s Still Not About the Nail

Author: W. Ben Hunt, Ph.D.
Date: April 14, 2015
Category: Adaptive Investing, Game Theory
Tags: diversification, game theory, adaptive investing, volatility, minimax regret

epsilon-theory-its-still-not-about-the-nail-april-14-2015-historical-risk-rewardReader reaction to the March 31 Epsilon Theory note, “It’s Not About the Nail”, was probably the strongest and most positive for any note to date. The message in a nutshell: financial advisors of all stripes and sizes would be well-served to do more than serve up old-school diversification platitudes in this Brave New World of a bull market that everyone hates, and the behavioral insights of regret minimization are an effective framework for making that adaptation.

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It’s Not About the Nail

Author: W. Ben Hunt, Ph.D.
Date: March 31, 2015
Category: Adaptive Investing, Game Theory
Tags: diversification, game theory, adaptive investing, volatility, minimax regret

epsilon-theory-its-not-about-the-nail-march-31-2015-yodaI spend a lot of my time speaking with investors and financial advisors of all stripes and sizes, and here’s what I’m hearing, loud and clear. There’s a massive disconnect between advisors and investors today, and it’s reflected in both declining investment activity as well as a general fatigue with the advisor-investor conversation. I mean “advisor-investor conversation” in the broadest possible context, a context that should be recognizable to everyone reading this note. It’s the conversation of a financial advisor with an individual investor client. It’s the conversation of a consultant with an institutional investor client. It’s the conversation of a CIO with a Board of Directors. It’s the conversation of many of us with ourselves. The wariness and weariness associated with this conversation runs in both directions, by the way.

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Troy Will Burn – the Big Deal about Big Data

Author: W. Ben Hunt, Ph.D.
Date: March 16, 2015
Category: Big Data, Market Structure
Tags: Big Data, market structure, Aeschylus, Stevie Cohen

epsilon-theory-troy-will-burn-the-big-deal-about-big-data-march-16-2015-oresteiaI know, I know … I’m a broken record and a Cassandra, with 2 successive notes on Big Data. But I don’t care. This is a much larger structural risk for markets and investors than HFT and the whole Flash Boys brouhaha, it’s just totally under the radar and hasn’t surfaced yet. And unfortunately, just as I think Jeb Bush speaks for most Americans – Democrat and Republican alike – when he says that he doesn’t get what all the fuss is about when it comes to metadata collection and Big Data technologies, so do I think that most investors – institutional and individual alike – are blithely unaware of how their market identities can be stolen and their market behaviors influenced, all in plain sight

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Epsilon Theory Mailbag: Bitcoin and Big Data

Author: W. Ben Hunt, Ph.D.
Date: March 9, 2015
Category: Big Data, Epsilon Theory
Tags: Big Data, Bitcoin

One of the best parts of authoring Epsilon Theory is the correspondence I get from readers. For the past few months, however, I’ve been frustrated by my inability to respond to every writer with the same attention and thoughtfulness evidenced by their emails. Between my day job and the effort each Epsilon Theory note requires, I’ve run out of hours in the day to respond to the geometrically increasing volume of emails I receive. Having a public comments page on the website isn’t a solution for a number of reasons – some of my correspondents don’t want to be public, I still wouldn’t have time to respond to the comments, an anonymous comments page tends to become a cesspool, and the regulatory burden this would place on Salient is not insignificant – so I’ve decided to start an irregular mailbag column. For the most part I’ll be aggregating common comments and questions with a few recent news articles, and I won’t reprint anyone’s private email communication without asking permission first. Along the way I’ll try to work in some of the more insulting comments published on the public/anonymous comments pages of ZeroHedge, Seeking Alpha, and Forbes Online, as well as some lovely Tweets … it’s important to keep a sense of humor about this stuff!

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Why Take a Chance?

Author: W. Ben Hunt, Ph.D.
Date: February 24, 2015
Category: Game Theory, Monetary Policy
Tags: monetary policy, game theory, central banks, minimax regret

epsilon-theory-why-take-a-chance-february-24-2015-casino-aceThere’s only one question that matters in the Golden Age of the Central Banker: why isn’t QE working? Why hasn’t the largest monetary stimulus in the history of man – trillions of dollars of liquidity with trillions more euros and yen to come – sparked a self-sustaining recovery in the global economy?

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The Effete Rebellion of Bitcoin

Author: W. Ben Hunt, Ph.D.
Date: February 17, 2015
Category: Market Structure
Tags: market structure, Bitcoin

epsilon-theory-the-effete-rebellion-of-bitcoin-february-17-2015-hans-gruberOne of the first Epsilon Theory notes I wrote, and the one that really put this effort on the map, was about the modern meaning of gold. “How Gold Lost Its Luster” argued that gold today is not a currency or some sort of store of value; instead, it is an effective insurance policy against central bank error. That’s an Important Thing, just not as important as it used to be or as its more ardent proponents would have you believe. Today’s note is about the meaning of Bitcoin. Not its technical construction or its formal market interactions, but the behavioral WHY that gives Bitcoin its ultimate value. I caught a lot of flak for “How Gold Lost Its Luster”, and I expect some multiple of that for this note. So be it. The core tenet of Epsilon Theory is to call things by their proper names, even if that’s not the best way to make friends here in the Golden Age of the Central Banker.

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First Known When Lost

Author: W. Ben Hunt, Ph.D.
Date: February 3, 2015
Category: Big Data
Tags: Big Data, market structure

epsilon-theory-first-known-when-lost-february-3-2015-halLast Thursday the journal Science published an article by four MIT-affiliated data scientists (Sandy Pentland is in the group, and he’s a big name in these circles), titled “Unique in the shopping mall: On the reidentifiability of credit card metadata”.

Not sure what this means? It means that I don’t need your name and address, much less your social security number, to know who you ARE. With a trivial amount of transactional data I can figure out where you live, what you do, who you associate with, what you buy and what you sell. I don’t need to steal this data, and frankly I wouldn’t know what to do with your social security number even if I had it … it would just slow down my analysis.

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7 Quick Points on Europe

Author: W. Ben Hunt, Ph.D.
Date: January 26, 2015
Category: Europe
Tags: monetary policy, Europe, Greece, Euro

#1) Here are the most relevant recent notes for an Epsilon Theory perspective on the underlying political and market risks in Europe: “The Red King” (July 14, 2014) and “Now There’s Something You Don’t See Every Day, Chauncey” (Dec. 16, 2014).

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Ghost in the Machine, Part 1

Author: W. Ben Hunt, Ph.D.
Date: January 20, 2015
Category: Adaptive Investing, Narrative
Tags: narrative, adaptive investing, currency, Swiss Franc, zen

Everyone who lost money on the SNB’s decision to reverse course on their three and a half year policy to cap the exchange rate between the CHF and the Euro made a category error. And by everyone I mean everyone from Mrs. Watanabe trading forex from her living room in Tokyo to a CTA portfolio manager sitting in front of 6 Bloomberg monitors to a financial advisor answering a call from an angry client. It will take me a bit of verbiage to explain what I mean by a category error and why it’s such a powerful concept in logic and portfolio construction. But I think you’ll find it useful, not just for understanding what happened, but also (and more importantly) to protect yourself from it happening again. Because this won’t be the last time the markets will be buffeted by a forex storm here in the Golden Age of the Central Banker.

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Catch – 22

Author: W. Ben Hunt, Ph.D.
Date: January 12, 2015
Category: Monetary Policy, Narrative
Tags: oil, monetary policy, narrative, central banks, volatility, Catch-22

epsilon-theory-catch-22-january-12-2015-catch-22So much of education, I think, relies on reading the right book at the right time. My first attempt at Catch-22 was in high school, and I was way too young to get much out of it. But fortunately I picked it up again in my late 20’s, after a few experiences with The World As It is, and it’s stuck with me ever since. The power of the novel is first in the recognition of how often we are stymied by Catch-22’s – problems that can’t be solved because the answer violates a condition of the problem. The Army will grant your release request if you’re insane, but to ask for your release proves that you’re not insane. If X and Y, then Z. But X implies not-Y. That’s a Catch-22.

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The Clash of Civilizations

Author: W. Ben Hunt, Ph.D.
Date: December 29, 2014
Category: Game Theory, Narrative
Tags: narrative, game theory, Chicken, Huntington, Kissinger, realism

epsilon-theory-the-clash-of-civilizations-december-29-2014-course-of-empireBut Huntington’s “Clash of Civilizations” argument is not just provocative, curmudgeonly, and hawkish. It is, I think, demonstrably more useful in making sense of the world than any competing theory, which is the highest praise any academic work can receive. Supplement Huntington’s work with a healthy dose of Kissinger’s writings on “the character of nations” and you’ve got a cogent and predictive intellectual framework for understanding the Big Picture of international politics. It’s a lens for seeing the world differently – a lens constructed from history and, yes, game theory – and that’s what makes this a foundational topic for Epsilon Theory.

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Now There’s Something You Don’t See Every Day, Chauncey

Author: W. Ben Hunt, Ph.D.
Date: December 16, 2014
Category: Europe, Japan
Tags: Europe, Greece, Japan

Like every other male homo sapiens I know, I watch a lot of sports. There’s only one team that I watch as a fan – the University of Alabama football team (my grandfather and uncle played there, and I was raised in the Church of Bear Bryant) – by which I mean that these are the only games I watch where I could not care less about the quality of the gameplay, but only care about winning in as lopsided a fashion as possible. For example, while the rest of the world thought the 2011 Championship game where Alabama beat LSU 21-0 was a miserably boring affair, a Bama fan like myself thought it was a performance of absolute beauty. Roll Tide.

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Narrative Uber Alles

Author: W. Ben Hunt, Ph.D.
Date: December 11, 2014
Category: Narrative
Tags: oil, narrative

Yesterday the Wall Street Journal ran a front page story titled “OPEC Sees Less Demand for Its Oil in 2015”, as well as another article with the following quote: “OPEC’s output exceeded its quota by 50,000 barrels a day in November, the group said.”

That’s all true, and all supportive of today’s dominant Narrative that OPEC is broken and oil is now in free fall.

Wanna know what else is true? November OPEC production was down 390,000 bbls/day from October and down 510,000 bbls/day from September. But, hey, we can’t have crucial facts get in the way of a dominant Narrative, now can we?

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We Now Return to Our Regularly Scheduled Programming

Author: W. Ben Hunt, Ph.D.
Date: December 5, 2014
Category: Monetary Policy, Narrative
Tags: oil, monetary policy, narrative

epsilon-theory-we-now-return-to-our-regularly-scheduled-programming-december-5-2014-stand-byOver the past two weeks I’ve tried to provide an Epsilon Theory perspective on both the price of oil (“The Unbearable Over-Determination of Oil”) and the signaling role of the price of oil on energy stocks (“Signs and Portents”), and here’s the skinny: so long as the dominant Narrative around oil prices is based on global supply/demand fundamentals – even if those fundamentals are somewhat negative – that is far more constructive for oil prices and energy stocks than if the dominant Narrative around oil prices is based on monetary policy. When Saudi Arabia said, “we’re happy with oil in the 60’s”, here’s what value investors heard: “we’re not happy with oil in the 50’s”. So long as there is a perception of a floor … so long as value investors do not fear catching a free-falling knife … they will buy stuff that looks cheap. That’s what value investors DO.

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Signs and Portents

Author: W. Ben Hunt, Ph.D.
Date: December 1, 2014
Category: Game Theory, Narrative
Tags: oil, narrative, game theory

epsilon-theory-signs-and-portents-december-1-2014-batmanLike the criminals that Bruce Wayne fought as Batman, we investors are a superstitious, cowardly lot. We are constantly ascribing way too much import to this sign or that sign, constantly freaking out over the meaning and significance of this market event or that market event. It doesn’t help that the financial media world has devolved into fiefdoms of rah-rah soothsayers on the one hand and doom-seeing end-timers on the other, so that whatever our predispositions might be we can easily find Voices of Authority to read the entrails to our liking. And it really doesn’t help that we are in the midst of the greatest crisis of faith in the markets since the 1930’s, so that – as Stephen King wrote – we survive by looking for day-to-day signs to show us what to do.

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The Unbearable Over-Determination of Oil

Author: W. Ben Hunt, Ph.D.
Date: November 24, 2014
Category: Adaptive Investing, Narrative
Tags: Common Knowledge Game, oil, narrative, adaptive investing

epsilon-theory-the-unbearable-over-determination-of-oil-november-24-2014-pipeYou know you’re in trouble when the Fed’s Narrative dominance of all things market-related shows up in the New York Times crossword puzzle, the Saturday uber-hard edition no less. It’s kinda funny, but then again it’s more sad than funny. Not a sign of a market top necessarily, but definitely a sign of a top in the overwhelming belief that central banks and their monetary policies determine market outcomes, what I call the Narrative of Central Bank Omnipotence.

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Mike Tyson: Master Game Theorist

Author: W. Ben Hunt, Ph.D.
Date: November 6, 2014
Category: Game Theory, Japan
Tags: game theory, Japan

epsilon-theory-mike-tyson-master-game-theorist-november-6-2014-boxingI’ve been wrestling with what to write about the Bank of Japan’s decision last Friday where … to use a ZeroHedge turn of a poker phrase … they went “all-in-er” on balance sheet expansion and monetary policy QE. It’s hard to find a middle ground here. On the one hand I could write a copycat oh-my-god-can-you-believe-what-these-madmen-are-doing note, but frankly I’m tired of being outraged, and I suspect most Epsilon Theory readers are, too. On the other hand, I really AM outraged by the increasing number of articles and emails I read where BOJ actions and Fed actions and ECB actions are celebrated in Leni Reifenstahl-esque fashion as some modern day Triumph of The Will, as if the symbolic projection of an unlimited, indomitable, and grandiose State were the highest possible achievement for political leaders. Yes, I just played the fascist card. I don’t think I’m wrong.

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Wherefore Art Thou, Marcus Welby?

Author: W. Ben Hunt, Ph.D.
Date: October 30, 2014
Category: Epsilon Theory, Narrative
Tags: narrative, communication policy, Cramer

epsilon-theory-wherefore-art-thou-marcus-welby-october-30-2014-doctorAbout 3 years ago I was on a flight, sitting in an aisle seat, and I couldn’t help but notice the young couple having a mild argument one row in front of me, across the aisle to my right. As the woman settled into the middle seat, I saw that she had her husband/boyfriend’s name – Randy – tattooed on the back of her neck, and I saw that Randy had the letters T – R – U – S – T tattooed on the fingers of his left hand. When I saw this, I found myself thinking warm thoughts towards the couple. Clearly these were two people from a very different background than my own, but I appreciated the sacrifice and public display each had made to show a commitment to the relationship, and it reminded me of the (non-tattooed) commitment my wife and I have made to each other. I remember thinking, “you know, I bet these crazy kids are going to make it,” even though the argument never seemed to totally fade during the flight.

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Calvin the Super Genius

Author: W. Ben Hunt, Ph.D.
Date: October 14, 2014
Category: Game Theory, Narrative
Tags: narrative, game theory, authenticity, Ebola

epsilon-theory-calvin-the-super-genius-october-14-2014-cartoonHere is the most fundamental idea behind game theory, the one concept you MUST understand to be an effective game player. Ready?

You are not a super genius, and we are not idiots. The people you are playing with and against are just as smart as you are. Not smarter. But just as smart. If you think that you are seeing more deeply into a repeated-play strategic interaction (a game!) than we are, you are wrong. And ultimately it will cost you dearly. But if there is a mutually acceptable decision point – one that both you and we can agree upon, full in the knowledge that you know that we know that you know what’s going on – that’s an equilibrium. And that’s a decision or outcome or policy that’s built to last.

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Hey Spike

Author: W. Ben Hunt, Ph.D.
Date: October 9, 2014
Category: Europe, Narrative
Tags: ECB, Fed, monetary policy, narrative, Europe

epsilon-theory-hey-spike-october-9-2014-dogsGlobal growth is really bad! Hooray!

That was the verdict of US markets yesterday, as the Fed minutes “revealed” (to use the breathless phrasing of mainstream financial media) a “growing concern” with the damaging impact of European torpor and a stronger dollar on US growth, and it’s a perfect example of why I’ve called a top in the Narrative of Central Bank Omnipotence. Not a top in market price levels (although I’m increasingly thinking that, too), but a top in market faith that price levels are completely determined by central bank policy. This is an observation that I’ve discussed at length (and perhaps ad nauseam) in recent Epsilon Theory notes like “The Ministry of Markets” and “Fear and Loathing on the Marketing Trail”, so I won’t belabor that again here.

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Going Gray

Author: W. Ben Hunt, Ph.D.
Date: October 1, 2014
Category: China, Narrative
Tags: monetary policy, narrative, currency, China, dollar

epsilon-theory-going-gray-october-1-2014-chinese-officialsTwo years ago, the new seven-member Standing Committee of the Chinese Communist Party Politburo – the most powerful political entity in the country – was introduced to great fanfare. All seven men walked on stage wearing a dark suit and a red tie, but to me the most striking aspect of their appearance was their hair. Yes, their hair. Their dark, immaculately coifed, powerful hair. Despite an average age of 65, not one of these men has EVER been seen in public without sporting a mane that would make their grandsons proud.

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Best of List

Author: W. Ben Hunt, Ph.D.
Date: September 26, 2014
Category: Epsilon Theory
Tags: books

For all the new subscribers to Epsilon Theory (the original June 2013 direct distribution list has recently doubled again, for the sixth time) I know that the website can be daunting with about 100 meaty notes to sift through. We’ll be releasing an improved organization for the website shortly, along with an entirely new application we’re calling the Risk Dashboard – a real-time resource that monitors current market risks as seen through an Epsilon Theory lens . . . stay tuned! In the meantime, I thought it might be helpful for new subscribers to have a Top 10 list of the most popular notes, a Best of Epsilon Theory, if you will.

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Finest Worksong

Author: W. Ben Hunt, Ph.D.
Date: September 15, 2014
Category: Europe, Monetary Policy, Narrative
Tags: ECB, monetary policy, narrative, global growth, Europe

epsilon-theory-finest-worksong-september-15-2014-tractorThere is one great mystery in the high falutin’ circles of the Fed, ECB, and IMF today. Why is global growth so disappointing? There are different variations on this theme – why aren’t businesses investing more? why aren’t banks lending more? – but it’s all one basic question. First the Fed, then the BOJ, and now the ECB have taken superheroic efforts to inflate financial asset prices in order to bridge the gap between the output shock of 2008 and a resumption of normal economic growth. They’ve done their part. Why hasn’t the rest of the world joined the party?

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The Game of Thrones and the Game of Markets

Author: W. Ben Hunt, Ph.D.
Date: September 11, 2014
Category: Game Theory, Monetary Policy
Tags: Common Knowledge Game, monetary policy, game theory, central banks, NFL

A few brief thoughts on an Epsilon Theory connection between modern capital markets and the NFL (and between Central Bankers and Roger Goodell). The connection is solipsism – a pathological egocentrism where reality is defined by an individual’s mental perceptions and constructs.

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The Ministry of Markets

Author: W. Ben Hunt, Ph.D.
Date: September 8, 2014
Category: Narrative

I spent the past week in Switzerland, meeting with old friends and making some new ones, and just like my recent travels in the US there was one overwhelming sentiment. No one doubts the omnipotence of central banks. No one doubts that market outcomes are fully determined by central bank policy. No one doubts that central banks are large and in charge. No one doubts that central banks can and will inflate financial asset prices. And everyone hates it.

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The Name of the Rose

Author: W. Ben Hunt, Ph.D.
Date: September 1, 2014

epsilon-theory-the-name-of-the-rose-september-1-2014-connery“The Name of the Rose” was an under-rated movie in the mid-1980’s with an in-his-prime Sean Connery and a young Christian Slater (not to mention some great scene-stealing by Ron Perlman), based on an under-rated novel by one of my favorite authors, Umberto Eco. To be sure, Eco is prone to the occasional bout of overwrought ego-stoking prose (but aren’t we all!), and my take on “The Name of the Rose” is that while Eco intended it as a work of great literature masquerading as a murder mystery, it’s really a great murder mystery masquerading as literature. But as a highly entertaining yet wise examination of the power of ideas, the implacable opposition of status quo institutions to “heresy”, and the role of language in that struggle, “The Name of the Rose” has no equal in my library.

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An Ice Bucket Dilemma

Author: W. Ben Hunt, Ph.D.
Date: August 25, 2014

Something on the lighter side today, as summer winds downs here in the last week of August. Most of us have seen videos galore of the ALS “ice bucket challenge,” and I thought it might be interesting to recast a classic game theory construct – The Prisoner’s Dilemma – in ice bucket terms. So I enlisted my four daughters to be prisoners and wardens with the following scenario.

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One Little Old Russian Convoy

Author: W. Ben Hunt, Ph.D.
Date: August 15, 2014

epsilon-theory-one-little-old-russian-convoy-august-15-2014-jokerIt’s a funny world when stocks can soar on a -6.8% Japanese GDP print but stumble when a Russian armored personnel carrier finds itself on the wrong end of a Ukrainian howitzer shell. That’s what you get, though, in the Golden Age of the Central Banker, as all events are filtered through the narrative of central bank control. Weak Japanese GDP was “part of the plan”, to quote both The Joker and Prime Minister Abe, or at least the revised plan after the new sales tax pulled economic activity forward in Q1, and besides, this weakness just means that “help from the BOJ may be on the way”, to quote the WSJ.  Direct artillery fire on a Russian APC column in Ukrainian territory, on the other hand … well, that’s not part of anyone’s plan. It’s a significant escalation in both Russian provocation and Ukrainian response, an escalation that for the first time illuminates a warpath that no amount of central bank jawboning can derail or recast in a market-positive light.

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Here We Go Again

Author: W. Ben Hunt, Ph.D.
Date: August 8, 2014

From an Epsilon Theory perspective, the scariest, most market risk-creating event of the past 48 hours had nothing to do with Iraq, nothing to do with Israel, nothing to do Russia. It was Mario Draghi’s press conference. 

Yesterday Draghi re-launched the Great Fiscal Consolidation War of 2012, a multi-level game where the ECB attempts to force spendthrift sovereigns to undertake structural reforms while ostensibly going about their business of maintaining their single mandate of price stability. It’s a neat trick if you can pull it off, as Draghi kinda sorta did with the PIIGS two summers ago, but … geez, do we really have to go through this all over again?

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Fear and Loathing on the Marketing Trail, 2014

Author: W. Ben Hunt, Ph.D.
Date: August 5, 2014

epsilon-theory-fear-and-loathing-on-the-marketing-trail-2014-august-5-2014-hunter-thompsonI’ve spent the past few weeks meeting Salient clients and partners all across the country: New York, California, Illinois, Texas, Minnesota, Massachusetts, etc. With four teenage or tweenage daughters at home I don’t mind the travel, talking about Epsilon Theory topics with smart, engaged people takes me back to what I loved about academia, and I find tremendous value in listening to what investment professionals have to say about markets today. Of particular note to me is how investment professionals are experiencing markets. What does it mean to be a professional investor or investment advisor in the Golden Age of the Central Banker? Two observations surprised me, and I believe they’re connected.

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Watching the Narratives

Author: W. Ben Hunt, Ph.D.
Date: August 1, 2014

A quick note to follow up on yesterday’s market debacle. The question, of course, is whether this was simply a blip – yet another one-day BTFD opportunity – or the start of something bigger and worse. The answer, I think, depends on how the media Narrative surrounding yesterday takes shape over the next several days. That’s what I’m watching closely, and I think you should, too.

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Stalking Horse

Author: W. Ben Hunt, Ph.D.
Date: July 21, 2014

epsilon-theory-stalking-horse-july-21-2014-livre-de-chasseThe stalking horse is a hunting technique that goes back thousands of years, where a hunter finds it much easier to get a drop on wild game by hiding behind an animal or a representation of an animal that the prey finds more familiar in its natural environment than a human. My favorite description of how the stalking horse technique works comes from the 1972 Robert Redford movie, “Jeremiah Johnson”, where the old trapper Bear Claw patiently explains to newbie trapper Jeremiah that they can walk behind their horses to get a good shot because “elk don’t know how many feet a horse has”. Of course Bear Claw is right, and he and Jeremiah eat well that night.

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The Red King

Author: W. Ben Hunt, Ph.D.
Date: July 14, 2014

epsilon-theory-the-red-king-july-14-2014-alice-in-wonderlandWe’re all familiar with the Queen of Hearts from Alice in Wonderland, less so with the Red King. He’s sleeping all the while, and when Alice goes to wake him up she’s warned off by Tweedledee and Tweedledum, who tell her that everything in Wonderland – including Alice herself – is perhaps just the dream of the Red King. Wake him up and maybe, just maybe, everything goes … poof!

Europe is once again nearing a potential Red King moment, something last seen in the summer of 2012. Then the wake-up call was a series of national elections, particularly in Greece. Today it’s a restructuring of the European financial system, a process started in 2012 with the recapitalization of Spanish banks, continued with the depositor bail-in of Cypriot banks, and now at a tipping point with the imminent ECB regulatory control over all large EU banks.

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The Donkey of Guizhou

Author: W. Ben Hunt, Ph.D.
Date: July 7, 2014

A quick note to follow up on last week’s big note “The Dude Abides: China in the Golden Age of Central Bankers.” A number of readers asked if China’s accumulation of physical gold played a significant role in China’s current and forthcoming challenges to the Western monetary policy status quo. Absolutely! It has exactly the same meaning as the recently announced dollar-free natural gas trade agreement with Russia. It’s a fang. It’s a claw. It’s a tool in the construction of an alternative monetary policy regime structure.

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The Dude Abides: China in the Golden Age of Central Bankers

Author: W. Ben Hunt, Ph.D.
Date: July 1, 2014

dude-abides-2Deng Xiaoping was a survivor. That’s why I love this picture of the man, here 80-something years old, looking for all the world like Emperor Palpatine of Star Wars fame, still dying his hair jet-black and chain-smoking his Panda cigarettes. Purged not once but twice. Wife and daughter dead in childbirth. Friends mowed down by the Kuomintang. Eldest son tortured by Red Guards before being thrown out a 4th-story window. You think this veteran of the Long March, who lived in caves and ate rats … when the war was going well, wasn’t willing to do ANYTHING to set the future course of the modern Chinese State? You think that Tiananmen Square kept this guy up at night?

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Long Term Parking

Author: W. Ben Hunt, Ph.D.
Date: June 16, 2014

epsilon-theory-long-term-parking-june-16-2014-sopranosThere’s a great scene in the 4th season of The Sopranos where Tony is upbraiding his crew for their lack of “production”, particularly in the traditionally lucrative field of loan sharking. The recession is no excuse, says Tony, for failing to make money from “our thing” – organized crime. It’s a great scene because of the language, the routinization of a decidedly non-routine business. You can easily imagine Tony and Silvio as the CEO and CFO of a regional bank in 2002, exhorting their loan officers to get out there and drum up some business.

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Risk Analysis in the Golden Age of Central Bankers

Author: W. Ben Hunt, Ph.D.
Date: June 9, 2014

epsilon-theory-risk-analysis-in-the-golden-age-of-central-banker-june-9-2014-fiscal-cliffA brief note today on what might be an arcane subject for some but is a great example of the most basic question in risk management – are you thinking about your risk questions in a way that fits the fundamental nature of your data? Do you understand the fundamental nature of your data? Our business incentivizes us to build complex and ingenious models and data analysis systems in order to generate an edge or dodge a bullet. But are we building our elaborate mental constructs on solid ground? Or on quicksand?

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The Minsky Moment Meme

Author: W. Ben Hunt, Ph.D.
Date: June 8, 2014

epsilon-theory-the-minsky-moment-meme-june-2-2014-esuranceThere’s a wonderful commercial in heavy rotation on American television, where three women of a certain age are discussing one of the friend’s use of Facebook concepts such as “posting to a wall” or “status updates”. The protagonist of the scene, Beatrice, takes these concepts in an entirely literal way, attaching actual photographs to an actual wall and delivering an un-friending message in person, at which point her more hip friend says, “That’s not how it works. That’s not how any of this works.”

I have exactly the same reaction to today’s overuse and misuse of the phrase “Minsky Moment”, originally coined by PIMCO’s Paul McCulley to describe how economist Hyman Minsky’s work helped explain the market dynamics resulting from the 1998 Russian financial crisis, such as the collapse of investment firms like Long Term Capital Management. Today you can’t go 10 minutes without tripping over an investment manager using the phrase “Minsky Moment” as shorthand for some Emperor’s New Clothes event, where all of a sudden we come to our senses and realize that the Emperor is naked, central bankers don’t rule the world, and financial assets have been artificially inflated by monetary policy largesse. Please. That’s not how it works. That’s not how any of this works.

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When Does the Story Break?

Author: W. Ben Hunt, Ph.D.
Date: May 25, 2014

epsilon-theory-when-does-the-story-break-may-25-2014-wigThe most common question I get from Epsilon Theory readers is when. When does the market break? When will the Narrative of Central Bank Omnipotence fail? To quote the immortal words of Devo, how long can this go on? Implicit (and sometimes explicit) in these questions is the belief that this – whatever this is – simply can’t go on much longer, that there is some natural law being violated in today’s markets that in the not-so-distant future will visit some terrible retribution on those who continue to flout it. There has never been a more unloved bull market or a more mistrusted stock market high.

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Equity Volatility-of-Volatility Falls to All-Time Low

Author: W. Ben Hunt, Ph.D.
Date: May 12, 2014

1M implied volatility on the VIX fell to an all-time low last week. Generally speaking, this means that options on short-term market volatility increasing have never been cheaper. How is this possible, you ask, with outright war simmering in Eastern Ukraine and China flexing its muscles in the South China Sea? Because Mario Draghi is “signaling” that he’s going to launch a European version of QE.

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All that Glitters

Author: W. Ben Hunt, Ph.D.
Date: May 9, 2014

epsilon-theory-all-that-glitters-may-9-2014-catherine-the-greatI’ve received a lot of questions over the past few weeks about Russia and the Ukraine, and why I don’t include this flashpoint in my list of greatest market risks. Sorry, but I just don’t think it’s that big of a deal from a markets perspective. Russia is going to control Sevastapol, and everyone – including Obama and Merkel and whoever is calling the shots in Kiev – knows it. Period. End of story. Owning a warm water port on the Black Sea has been a cornerstone of Russian political identity since Catherine the Great in the 18th century, and there’s nothing that anyone can do (or really wants to do) to stop it.

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The Risk Trilogy

Author: W. Ben Hunt, Ph.D.
Date: May 4, 2014

epsilon-theory-the-risk-trilogy-may-4-2014-attentionGregg Greenberg at TheStreet.com was kind enough the other week to give me a few minutes (2:30 to be exact) in a video interview to enumerate the three biggest risks I saw facing markets today. At first I rolled my eyes at the request and the format. 150 seconds? Really? I mean, have you heard my Alabama drawl? It can take me 150 seconds just to order a cup of coffee.

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Core Curriculum

Author: W. Ben Hunt, Ph.D.
Date: April 28, 2014

I’ve had dozens of requests to put together a reading list for Epsilon Theory, and I’ve resisted. There’s something uncomfortable about telling people what they should read, of recommending this book but not that one to you because it happened to resonate with me. Also, as Mark Twain said, I haven’t any right to criticize other authors (unless I really, really hate their books!), and I have zero interest in engaging in the all-too-familiar academic exercise of dueling criticism. Been there, done that.

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The Business of Epsilon Theory

Author: W. Ben Hunt, Ph.D.
Date: April 23, 2014

I started the Epsilon Theory project nine months ago with the publication of a “Manifesto” and an email to a few hundred friends and colleagues. Since then nearly 7,000 investors across more than 2,000 financial services firms have signed up for the direct distribution list, and through forwarding and republishing the effective Epsilon Theory audience is several multiples of that. On a personal level the response has been overwhelming, humbling, gratifying…but most of all invigorating.

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The Adaptive Genius of Rigged Markets

Author: W. Ben Hunt, Ph.D.
Date: April 20, 2014

epsilon-theory-the-adaptive-genius-of-rigged-markets-april-20-2014-costelloDavid Byrne, of Talking Heads fame, is something of a personal hero of mine for the way he handles the business of his music. Byrne is famously protective of the copyrights associated with his work, in the sense of controlling the uses of the music for long-term goals rather than a short-term pay-off, and it’s a non-myopic approach to intellectual property I’ve tried to adopt with my own work. I also appreciate Byrne’s ability to put on a show.

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Beta Earthquake

Author: W. Ben Hunt, Ph.D.
Date: April 13, 2014

epsilon-theory-beta-earthquake-april-13-2014-free-cash-flow-yieldOne of the things I like to keep my eye on when I’m puzzling out what’s going on in the market are the specific company factors that loosely define concepts like Momentum and Value. I do this because any sort of big market move, like we’ve seen over the past week, is inherently over-determined and over-explained. That is, there are dozens of “reasons” trotted out by the financial media and various experts, ALL of which are probably right to a certain degree.

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The King is Dead. Long Live the King.

Author: W. Ben Hunt, Ph.D.
Date: April 7, 2014

What we’re witnessing right now in US markets is a shift in the Narrative structure around Fed policy, and it’s hitting markets hard because the Narrative structure around the Fed as an institution has never been stronger or more constant.

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Hollow Men, Hollow Markets, Hollow World

Author: W. Ben Hunt, Ph.D.
Date: March 30, 2014

epsilon-theory-hollow-men-hollow-markets-hollow-world-march-30-2014-apocaplypse-nowI first saw Apocalypse Now as a college freshman with two roommates, a couple of years after it had been released, and I can still recall the dazed pang of shock and exhaustion I felt when we stumbled out of the theatre. Nobody said anything on the drive back to campus. We were each lost in our thoughts, trying to process what we had just seen. Our focus was on Marlon Brando’s Col. Kurtz, of course, because we were 18-year old boys and he was a larger than life villain or anti-hero or superman or … something … we weren’t quite sure what he was, only that we couldn’t forget him.

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Two Shifting Narratives

Author: W. Ben Hunt, Ph.D.
Date: March 24, 2014

epsilon-theory-two-shifting-narratives-march-24-2014-frankensteinFirst, China. The pleasant charade that recent currency intervention was nothing more than an effort to reverse the “one-way bet” of speculators and to “increase volatility” as part of China’s accession to some brotherhood of liberal nations is starting to crumble.  Let me put it this way … you know that your preferred Narrative is in trouble when even the WSJ runs a piece titled “Yuan’s Decline Raises Concerns Over Currency War”. This is something I’ve written a lot about recently, here and here, and the political repercussions of slowing growth in China continue to make my risk antennae quiver.

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Surely You Can’t Be Serious

Author: W. Ben Hunt, Ph.D.
Date: March 20, 2014

epsilon-theory-surely-you-cant-be-serious-march-20-2014-groucho-marxIn periods of great global stress, like after a World War or a Great Depression, it’s not only our politics and economics that are thrown for a loop, but also our art and entertainment. New art, and comedy in particular, that rejects or makes fun of the ancien regime after some enormous crisis is as old as Aristophanes. This art is subversive, often masking its contempt with “low comedy” like puns and slapstick, and no one in the past century was better at this than Groucho Marx. I’ve lately found myself thinking of Fed communications as a form of performance art … some sort of Dada-ist comedy routine where Groucho might stick his head out from behind a curtain and photobomb the press conference … and never more so than yesterday. If only it were so.

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Panopticon

Author: W. Ben Hunt, Ph.D.
Date: March 16, 2014

epsilon-theory-panopticon-march-16-2014-benthamIn 1791, Jeremy Bentham published a book describing what was clearly a revolutionary design for prisons, factories, schools, hospitals – any institutional building where a few administer instruction, discipline, or care to the many. This design, what Bentham called a Panopticon, was trumpeted as “Morals reformed — health preserved — industry invigorated — instruction diffused — public burdens lightened — Economy seated, as it were, upon a rock — the Gordian knot of the poor-law not cut, but untied — all by a simple idea in Architecture!” No shrinking violet here, but the booming, confident voice of the father of utilitarianism, a man who wrote 30,000,000 words in a lifetime of social activism.

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Rosebud

Author: W. Ben Hunt, Ph.D.
Date: March 9, 2014

epsilon-theory-rosebud-march-9-2014-politicsLast Friday I wrote an Epsilon Theory email highlighting the media Narrative around China’s shift in monetary policy and associated manipulation of the yuan as a prime example of The Power of Why…a facile “explanation” designed to satisfy the business model imperative of financial media (and financial advisory services, more broadly) as well as the political interests of powerful institutions, in this case the Chinese state. I wasn’t surprised that the epicenter of this Narrative was a newspaper owned by Rupert Murdoch, whose close ties to the Beijing regime are legendary, and I tried to be kind in not calling out the beat writers who I’m sure were provided with precise talking points.

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Two Quick Points

Author: W. Ben Hunt, Ph.D.
Date: March 6, 2014

Two quick Epsilon Theory points before the jobs report tomorrow.

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The Power of Why, Exhibit 4,512 in a Continuing Series

Author: W. Ben Hunt, Ph.D.
Date: February 28, 2014

I’m often asked what I read for Epsilon Theory, and the answer is that my daily fodder is the same as everyone else’s – the NYT, the WSJ, the FT, Bloomberg, etc. But I think that I read media differently from most people, and that’s the key for an Epsilon Theory perspective. I’m not reading these articles for facts, but for the effort to lead opinion…to communicate an opinion as if it were fact. It’s not hard to read this way. Every time you see a word like “because” or anytime you read a “reason” why something happened the way it did, you just need to detach yourself from the article and consider how you are being played.

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Don’t Fear the Reaper

Author: W. Ben Hunt, Ph.D.
Date: February 23, 2014

epsilon-theory-dont-fear-the-reaper-february-23-2014-kolchakI would guess that not more than 1 in 100 Epsilon Theory readers remembers Darren McGavin in Kolchak: The Nightstalker. It’s a television series that only ran one year in the mid-1970’s, plus a couple of made-for-TV movies, but for whatever reason it made a big impression on me. A perpetually down-on-his-luck news wire stringer, Kolchak was a truth-seeker and a puzzle-solver, even if his truths and puzzles were found in the hidden corners and supernatural mysteries of 1970’s Chicago. Kolchak was Mulder before The X-Files was a gleam in Chris Carter’s eye.

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Goldilocks and the Dog That Didn’t Bark

Author: W. Ben Hunt, Ph.D.
Date: February 13, 2014

The market was down more than 2% last Monday. Why? According to the WSJ, CNBC, and all the other media outlets it was “because” investors were freaked out (to use the technical term) by poor US growth data. Disappointing ISM number, car sales, yada, yada, yada. But then the market was up more than 2% last Thursday and Friday (and another 1% this Tuesday), despite a Friday jobs report that was more negative in its own right than the ISM number by a mile. Why? According to those same media arbiters, investors were now “looking through” the weak data.

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Oh Stewardess, I Speak Jive

Author: W. Ben Hunt, Ph.D.
Date: February 6, 2014

Instead of a long-form note this Sunday, I thought I’d write a briefer note in advance of this Friday’s jobs report. I’ll be back next Sunday, Feb. 16, with a long note taking an Epsilon Theory view on portfolio diversification. Please feel free to forward this email to whomever you think might be interested, and all prior notes are available on the Epsilon Theory website. If you’re receiving this note via forwarded email and you’re not yet on the direct distribution list (and you find it a worthwhile read), I’d appreciate the opportunity to add you to the list. I’m building the Adaptive Investing framework in plain sight and in real time through these notes, and I’d welcome the widest possible participation, as well as your thoughts and comments.

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Yen Strengthens Below 102

Author: W. Ben Hunt, Ph.D.
Date: February 3, 2014

There was a clear short-term narrative developed in the financial media last week creating a focal point at 102 in the Yen/USD exchange rate. The short-Yen trade is perhaps the most crowded trade in the world right now, so a strengthening of the Yen to break below the focal point is a big deal for market game-playing behavior. The Yen broke below 102 today, which will put plenty of game-playing pressure on levered short-Yen positions in particular, and the entire equity market in general. Be careful out there.

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The Play’s the Thing

Author: W. Ben Hunt, Ph.D.
Date: February 2, 2014

epsilon-theory-the-plays-the-thing-february-2-2014-obamaAs usual, I was struck by the pageantry and sheer theatricality of this Tuesday’s State of the Union address. As usual, you had the props – human and otherwise – on full display. As usual, you had the rhetorical flourishes, the ritualized audience behavior, the talking head performances before and after. Unusual for me, though, was the professionally scripted and rehearsed television broadcast production, such that the cameras were trained on the human props before the President referred to them in his speech. A bravura technical performance, to be sure.

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Flatland

Author: W. Ben Hunt, Ph.D.
Date: January 28, 2014

The FOMC will conclude a two-day meeting on Wednesday afternoon. There’s no press conference after this meeting, no opportunity for Bernanke (in his last FOMC meeting) to provide additional “communication policy”, no opportunity for Yellen to signal her personal take on the weak December jobs report and the Emerging Markets carnage of the past week. Whatever the formal statement says is all the market will get, until, of course, Jon Hilsenrath weighs in with a WSJ article to tell us what the FOMC really meant to say.

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American Bandstand

Author: W. Ben Hunt, Ph.D.
Date: January 19, 2014

epsilon-theory-american-bandstand-january-19-2014-dick-clarkIn 1949, Yale anthropologist George Murdock spearheaded the establishment of an inter-university research organization to continue his life’s work: the cataloguing of what he called cultural universals, the social behaviors that exist in every human society across time and geography. That institution – the Human Relations Area Files (HRAF) – is still going strong today, supporting all sorts of social science research by providing a fully-indexed electronic collection of cultural anthropological studies. The goal is to find patterns or commonalities in human social behavior, and it all stems from Murdock’s List: his compilation of the 67 universal social behaviors of the human animal.

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Parasite Rex

Author: W. Ben Hunt, Ph.D.
Date: January 12, 2014

epsilon-theory-parasite-rex-january-12-2014-microscopicFrom an evolutionary perspective, the parasite is a beautiful creature. Instead of possessing a set of adaptations that make it suitable for thriving within a “natural” habitat – an ocean, a forest, a tundra, a jungle, etc. – the parasite typically finds its habitat within an organism itself. Parasites twist the core evolutionary process of adaptive radiation in a new direction, finding opportunities for new niches and species differentiation within host species that emerge over time in new geographies, not the new geographies themselves.

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Adaptive Investing: What’s Your Market DNA?

Author: W. Ben Hunt, Ph.D.
Date: January 5, 2014
Category: Adaptive Investing

epsilon-theory-adaptive-investing-whats-your-market-dna-thinkThe illustration at the top of this note is taken from Charles Darwin’s so-called “B” notebook, where in mid-summer 1837 on page 36 he wrote the words “I think” followed by the first depiction of an evolutionary tree. The rest, as they say, is history, first with the publication of “The Voyage of the Beagle” in 1839, which made Darwin famous, and then with “On the Origin of Species” in 1859, which made him immortal.

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The Construction of Robert Capa

Author: W. Ben Hunt, Ph.D.
Date: December 22, 2013

epsilon-theory-the-construction-of-robert-capa-december-22-2013-lifeUnless you’re an avid photography buff, you’ve probably never heard of Robert Capa. That’s his most famous photograph at the top of this note, taken – as the story goes – in 1938 during the Spanish Civil War when Capa, embedded with a company of Republican volunteers, snapped a shot of a comrade right at the moment he took a Nationalist bullet in the brain. Capa landed with the Allied troops on the Normandy beaches at D- Day, rode with Patton’s tank column into Paris, spent 1948 and 1949 photographing the immigrants who built Israel, and died in 1954 while documenting the French retreat from a fort in Northern Vietnam. He was a personal friend of Picasso, Steinbeck, and Hemingway.

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Whatever It Takes

Author: W. Ben Hunt, Ph.D.
Date: December 17, 2013

A few observations on what to look for in the language of the FOMC announcement tomorrow from a game theoretic perspective. Ever since Mario Draghi ad-libbed the lines “whatever it takes” in his July 2012 speech in London, a speech that together with the equally fabulistic OMT program rescued Europe and the Euro from the clutches of Spanish and Italian sovereign debt woes, this has been the go-to phrase for any politician or central banker seeking to imply unlimited resolve in bringing the firepower of the State down on an unruly market.

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The Stuka

Author: W. Ben Hunt, Ph.D.
Date: December 9, 2013

The Fed is now playing the Common Knowledge game openly and directly, making public statements through their media intermediaries to tell you how ALL market participants perceive reality, even though in fact NO market participant has a clear view of reality. Media intermediaries such as the WSJ’d Jon Hilsenrath are the equivalent of the Jericho Trumpet installed in WWII on the Stuka dive-bomber, an effort to turn a powerful tactical weapon into a strategic weapon through psychological means.

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A Dogmatic Slumber

Author: W. Ben Hunt, Ph.D.
Date: December 1, 2013

epsilon-theory-a-dogmatic-slumber-december-1-2013-snatchersIf there is a better example of the overwhelming power of Common Knowledge than the Collective Solipsism of 1984, I have yet to find it. As O’Brien patiently explains to Winston between torture sessions, Collective Solipsism is the voluntary abdication of empirical and independent thought by a large group of humans.

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The 18th Brumaire of Janet Yellen

Author: W. Ben Hunt, Ph.D.
Date: November 24, 2013

epsilon-theory-the-18th-brumaire-of-janet-yellen-november-24-2013-marxKarl Marx may not have had a small-l liberal bone in his body, but he was one of the keenest observers of the human condition to ever live, and his writings are a phenomenal resource for anyone seeking to understand our lives as social animals. In 1852 Marx published an essay titled The 18th Brumaire of Louis Bonaparte, recounting the 1851 coup where Louis-Napoleon Bonaparte (nephew of THE Napoleon) seized dictatorial powers in France. The essay was, Marx wrote, intended to “demonstrate how the class struggle in France created circumstances and relationships that made it possible for a grotesque mediocrity to play a hero’s part,” and it is here that Marx describes his view of the individual’s role in history.

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When E.F. Hutton Talks

Author: W. Ben Hunt, Ph.D.
Date: November 17, 2013

The concept of utility is the most fundamental concept in economics. It gets wrapped up in impressive sounding terms like “exogenous preference functions”, and written in all sorts of arcane runes and formulas, but all utility means is that you like something more than something else. The assumptions that economic theory makes about utility are really pretty simple and mostly about consistency – if you like vanilla ice cream more than chocolate ice cream, and chocolate more than strawberry, then economic theory assumes you also like vanilla more than strawberry – and continuity – if you like one scoop of vanilla ice cream, then you like two scoops even more. But as far as what you like, what your tastes or preferences are in ice cream or music … or health insurance plans … economic theory is intentionally silent.

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The Wages of Fear

Author: W. Ben Hunt, Ph.D.
Date: November 10, 2013

epsilon-theory-the-wages-of-fear-november-10-2013-poster.pngIn “The Wages of Fear”, Yves Montand and three other down-on-their-luck French expats agree to drive two truckloads of unstable nitroglycerin hundreds of miles across an impossibly difficult South American terrain. Driving 30 minutes apart so that the destruction of one truck won’t blow up the other, the two teams wind their way across one obstacle after another, facing the constant danger that an unanticipated bump will mean their deaths.

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Poindexter Über Alles

Author: W. Ben Hunt, Ph.D.
Date: November 7, 2013

Recent papers written by Fed functionaries and the attendant media attention serve as a reminder of the academic and bureaucratic capture of the Fed. More interesting is whether this same capture has occurred in other policy areas, such as national security and healthcare, such that QE, Obamacare, and NSA eavesdropping are all best understood as a transformation of emergency policy actions against immediate threats into permanent insurance programs against future and potential threats.

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A Game of Sentiment

Author: W. Ben Hunt, Ph.D.
Date: November 3, 2013

epsilon-theory-a-game-of-sentiment-november-3-2013-winnersSentiment is affect. Sentiment is emotion. Sentiment is fickle and transitory. In the context of investing, Sentiment is how you feel about a stock. Sentiment is NOT how you feel about a company, and sometimes it can be difficult to separate our feelings about a company from our feelings about a stock. Difficult, but necessary.

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Render Unto Caesar

Author: W. Ben Hunt, Ph.D.
Date: October 31, 2013

There are two sides to the Epsilon Theory coin — looking at market-shaping current events through the lens of game theory and history, and looking at market behaviors through the lens of information theory. The former is all about the malleability of meaning within markets; the latter is all about the constancy of patterns within markets. A stand-alone example of each is provided here.

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What Were Once Vices Are Now Habits

Author: W. Ben Hunt, Ph.D.
Date: October 31, 2013

The central banks of the West announced today that their temporary swap lines would be made permanent. Like QE itself, the meaning of this emergency policy instrument instituted in the crisis of 2008-2009 has changed from a massive short-term intervention against an acute and life-threatening economic injury to a massive permanent insurance policy against a chronic and annoying economic condition.

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The Koan of Donald Rumsfeld

Author: W. Ben Hunt, Ph.D.
Date: October 20, 2013

epsilon-theory-the-koan-of-donald-rumsfeld-october-20-2013-rumsfeldThere are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know.
– Donald Rumsfeld

There is an unmistakable Zen-like quality to this, my favorite of Donald Rumsfeld’s often cryptic statements.

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The Levelers

Author: W. Ben Hunt, Ph.D.
Date: October 13, 2013

epsilon-theory-the-levelers-october-13-2013-computersEarlier this month, Massachusetts State Secretary William Galvin imposed a $30 million fine on Citigroup because an equity analyst shared his research on an Apple iPhone supplier with analysts at a couple of investment funds before he published the research publicly. To be clear, this was not a case of the analyst telling the hedge funds his true views and writing fraudulent pieces for public consumption, à la Merrill Lynch analyst Henry Blodgett and many others, which resulted in the 2003 Global Research Analyst Settlement between the SEC and most Wall Street sell-side firms, as well as the launching of Eliot Spitzer’s political career.

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A ‘Precise and Predictable’ Yellen Fed?

Author: W. Ben Hunt, Ph.D.
Date: October 10, 2013

The pursuit of greater predictability and transparency in Fed communications is a mistake, particularly in the context of broad guarantees concerning world-shaking policies. We learned this lesson early in the Cold War through the hard knocks of Korea and Vietnam (not to mention the scares of Berlin and Cuba), and it seems a shame that we appear determined to learn these lessons the hard way all over again.

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A World of Guarantees

Author: W. Ben Hunt, Ph.D.
Date: October 6, 2013

epsilon-theory-a-world-of-guarantees-october-6-2013-namathSo how does the Story end? We are in the throes of the greatest monetary policy experiment the world has ever seen, and there are two popular Narrative arcs competing to project the ultimate resolution of the Story of QE. On the one hand we have the Happy Ending, where the Fed unwinds its $4 trillion balance sheet over time and we return to the halcyon days of either the 1990’s or the mid-2000’s, depending on your political persuasion. In this story arc the Fed voluntarily abdicates its throne as master of all things market-related in favor of its former role as a beneficial eminence grise, and we all live happily ever after.

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It’s Always Something

Author: W. Ben Hunt, Ph.D.
Date: September 29, 2013

More evidence that QE is no longer an emergency government policy, but is now a permanent government program.

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Uttin’ on the Itz

Author: W. Ben Hunt, Ph.D.
Date: September 22, 2013

epsilon-theory-uttin-on-the-itz-september-22-2013-tapIn Young Frankenstein, Mel Brooks and Gene Wilder brilliantly reformulate Mary Shelley’s Frankenstein; or, The Modern Prometheus, a tragedy in the classic sense, as farce. The narrative crux of the Brooks/Wilder movie is Dr. Frankenstein’s demonstration of his creation to an audience of scientists – not with some clinical presentation, but by both Doctor and Monster donning top hats and tuxedos to perform “Puttin’ on the Ritz” in true vaudevillian style. The audience is dazzled at first, but the cheers turn to boos when the Monster is unable to stay in tune, bellowing out “UTTIN’ ON THE IIIITZ!” and dancing frantically.

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Heeere Comes Lucky!

Author: W. Ben Hunt, Ph.D.
Date: September 15, 2013

epsilon-theory-heeere-comes-lucky-september-15-2013-dogsGrowing up in Alabama, gambling was part of the fabric of my life. Sports and card games of all sorts were constants, but the truth is that anything was fair game for a bet, from the behavior of lightning bugs to the duration of a thunderstorm. I learned important market-oriented lessons within this particular sort of educational framework, from the power of leverage in playing gin rummy with my uncle at a penny a point and Hollywood scoring (ouch!) to the Eureka moment when I gave my father 5 points on a college football team, took 7 points from my grandfather on the same team, and realized what would happen if they lost by 6.

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It Was Barzini All Along

Author: W. Ben Hunt, Ph.D.
Date: September 8, 2013

epsilon-theory-it-was-barzini-all-along-september-8-2013-godfatherLike many in the investments business, I am a big fan of the Godfather movies, or at least those that don’t have Sofia Coppola in a supporting role. The strategic crux of the first movie is the realization by Don Corleone at a peace-making meeting of the Five Families that the garden variety gangland war he thought he was fighting with the Tattaglia Family was actually part of an existential war being waged by the nominal head of the Families, Don Barzini. Vito warns his son Michael, who becomes the new head of the Corleone Family, and the two of them plot a strategy of revenge and survival to be put into motion after Vito’s death. The movie concludes with Michael successfully murdering Barzini and his various supporters, a plot arc that depends entirely on Vito’s earlier recognition of the underlying cause of the Tattaglia conflict. Once Vito understood WHY Philip Tattaglia was coming after him, that he was just a stooge for Emilio Barzini, everything changed for the Corleone Family’s strategy.

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Shifting Narrative around Central Bank Omnipotence

Author: W. Ben Hunt, Ph.D.
Date: August 27, 2013

The strong Narrative around Central Bank Omnipotence, which solidified in late September 2012, is now clearly weakening in late August 2013. There are two strands of this weakening: growing concerns over Fed competence given its reliance on communication as a policy instrument, and pronounced concerns that Emerging Market central banks are powerless to control their own monetary fate.

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The Narrative Shift around Emerging Markets

Author: W. Ben Hunt, Ph.D.
Date: August 21, 2013

The core Narrative around Emerging Markets is shifting away from growth and towards value. This is a profoundly disruptive development.

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Increased Instability in US Markets

Author: W. Ben Hunt, Ph.D.
Date: August 19, 2013

The Common Knowledge informational structure around the US market has weakened in recent weeks, making the risk/reward assessment of ALL exposures — long and short — less certain.

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Schrödinger’s Portfolio

Author: W. Ben Hunt, Ph.D.
Date: August 3, 2013

epsilon-theory-schrodingers-portfolio-august-3-2013-cat“Schrödinger’s Cat” is a famous thought experiment proposed in a series of letters between Erwin Schrödinger and Albert Einstein in 1935 as they discussed the mysteries and implications of quantum physics. As Schrödinger posed the question, imagine a cat within a closed box that also contains a small source of radioactivity, some sort of Geiger counter to detect any radiation emission, and a hammer poised to break a flask of deadly poisonous gas if the Geiger counter is triggered.

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The Framing of Macro Data

Author: W. Ben Hunt, Ph.D.
Date: July 31, 2013

A review of Narrative formation immediately after the July 31st release of Q2 US GDP data.

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Rise of the Machines

Author: W. Ben Hunt, Ph.D.
Date: July 28, 2013

epsilon-theory-rise-of-the-machines-july-28-2013-robot-2I thought it was appropriate in a note focused on the evolution of machine intelligence to start with some quotes by three of the all-time great science fiction writers – Abbott, Asimov, and Clarke – and something by the father of the short story, de Maupassant, as well. All four were fascinated by the intersection of human psychology and technology, and all four were able to communicate a non-human perspective (or at least a non-traditional human perspective) in their writing – which is both incredibly difficult and completely necessary in order to understand how machines “see” the world.

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The Tao of Portfolio Management

Author: W. Ben Hunt, Ph.D.
Date: July 21, 2013

epsilon-theory-the-tao-of-portfolio-management-july-21-2013-gamma-knifeI want to start this note in a manner that’s sure to annoy some readers, and that’s to reference the George Zimmerman trial. If gold is the third rail of financial commentary (“How Gold Lost its Luster”), then the Zimmerman trial must be the Death Star planet-destroying laser beam of such notes. But the shaping of the post-trial Zimmerman Narrative is a precise example of the behavioral phenomenon that I want to examine this week. So with considerable trepidation, here goes …

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The Market of Babel

Author: W. Ben Hunt, Ph.D.
Date: July 14, 2013

epsilon-theory-the-market-of-babel-july-14-2013-babelThe story of the Tower of Babel in the Book of Genesis, from whence we get the word “babble”, has always struck me as one of the most interesting Biblical origin myths. After the Flood, mankind is united and strong, speaking a single language. They build a great city and an even greater tower in the land of Shinar, which attracts God’s attention. God comes down from Heaven to see what Man is up to, notes that as a people with one language nothing Man sought would be out of reach, decides that this simply won’t do, and “confounds” their speech so that they no longer understand each other.

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The Music of the Spheres and the Alchemy of Finance

Author: W. Ben Hunt, Ph.D.
Date: July 7, 2013

epsilon-theory-the-music-of-the-spheres-and-the-alchemy-of-finance-july-7-2013-mars-retrogradeA few million years ago – the blink of an eye in evolutionary terms – our ancestors were roaming around some African savannah in a small band. We are still that social hunter-gatherer, for better or worse, with all the advantages and disadvantages our evolutionary heritage provides. Advantages include opposable thumbs, big eyes, and lots of neurons devoted to pattern recognition … attributes that, among other things, make our species very competent at driving cars and playing video games. Disadvantages include relatively few neurons and no sensory organs for interpreting really large numbers or physical laws that are foreign to an African savannah … attributes that, among other things, make our species poor theoretical astronomers.

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How Gold Lost Its Luster, How the All-Weather Fund Got Wet, and Other Just-So Stories

Author: W. Ben Hunt, Ph.D.
Date: June 30, 2013

epsilon-theory-how-gold-lost-its-luster-june-30-2013-kiplingLike every middle-aged white guy I know, I am a big fan of Rudyard Kipling. I grew up on his Just-So Stories and as an adult found that his novels and poems spoke to me, as they did to my father and his father before that. Kipling writes simply, directly, and evocatively. Whether it’s a poem, a short story, or a novel, the man knows how to tell a story.

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The Matrix Reloaded — Seeing Markets as Informational Structures

Author: W. Ben Hunt, Ph.D.
Date: June 27, 2013

A review of current market informational structure one week post the June 19th FOMC announcement.

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2 Fast 2 Furious

Author: W. Ben Hunt, Ph.D.
Date: June 23, 2013

epsilon-theory-2-fast-2-furious-june-23-2013-james-deanThis note is a sequel to my letter from two weeks ago, What We’ve Got Here Is … Failure to Communicate, a sequel made necessary by the market fall-out from the FOMC announcement on Wednesday. The Fed’s communications to the market are clearly not having the effect intended by Bernanke et al., and the problem remains that the Fed is clueless about the game-playing that dominates this market. The car-driving analogy used by Bernanke in Wednesday’s press conference (to paraphrase, “we are not putting our foot on the brake, we are taking our foot off the accelerator”), intended to soothe and placate, is a perfect example of the Fed’s tone-deafness.

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The Narrative Battle is Joined

Author: W. Ben Hunt, Ph.D.
Date: June 21, 2013

A review of Narrative formation efforts on June 21st to support the market.

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What’s the Opposite of ‘Green Shoots’?

Author: W. Ben Hunt, Ph.D.
Date: June 20, 2013

An initial examination of the informational inflection point generated by the June 19th FOMC announcement.

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Failure to Communicate, Part Deux

Author: W. Ben Hunt, Ph.D.
Date: June 19, 2013

A review of Narrative formation immediately after the June 19th FOMC announcement.

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Through the Looking Glass, or … This is the Red Pill

Author: W. Ben Hunt, Ph.D.
Date: June 16, 2013

epsilon-theory-through-the-looking-glass-or-this-is-the-red-pill-june-16-2013-matrixThere are unwritten rules for almost all social phenomena, from investing to writing epic poetry. Not that these weekly notes aspire to Homeric levels (although they do get pretty lengthy), but Epsilon Theory does follow one unwritten rule taken from the Iliad, the Aeneid, etc. in that I began this story in media res– in the middle of things.

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What We’ve Got Here Is … Failure to Communicate

Author: W. Ben Hunt, Ph.D.
Date: June 9, 2013

epsilon-theory-what-weve-got-here-is-a-failure-to-communicate-june-9-2013-cool-hand-lukeThere are plenty of great cinematic scenes of the Common Knowledge game in action, but this is one of my favorites. The “failed” communication of the Captain to Luke is the basis for the successful communication of the Captain to the prisoners: subvert my rules and you will be crushed. The brutal message is made in public, not so that all the prisoners can see what happens to Luke, but so that all the prisoners can see all the prisoners seeing what happens to Luke.

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Epsilon Theory Manifesto

Author: W. Ben Hunt, Ph.D.
Date: June 1, 2013

Our times require an investment and risk management perspective that is fluent in econometrics but is equally grounded in game theory, history, and behavioral analysis. Epsilon Theory is my attempt to lay the foundation for such a perspective.

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Friday Was an Important Day

Author: W. Ben Hunt, Ph.D.
Date: November 18, 2012

An initial examination of the informational inflection point generated by the Nov. 18th Boehner/Reid press conference.

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Don’t Mess with Mister In-Between

Author: W. Ben Hunt, Ph.D.
Date: November 8, 2012

Early research on the relationship between informational surfaces and structural market change.

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Jack Welch was Right

Author: W. Ben Hunt, Ph.D.
Date: October 29, 2012

An analysis of systematic error in BLS data and its role in the Narrative regarding US labor conditions.

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Donald Rumsfeld and Risk Management

Author: W. Ben Hunt, Ph.D.
Date: October 7, 2012

Early notes on investment as an exercise in decision-making under uncertainty.

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Hello Darkness My Old Friend

Author: W. Ben Hunt, Ph.D.
Date: September 29, 2012

Growing political fragmentation in Europe and its structural consequences for markets.

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Dude, Where’s My Financial Repression

Author: W. Ben Hunt, Ph.D.
Date: September 15, 2012

An initial analysis of the Sept. 15th FOMC announcement of open-ended QE.

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Why Do Words Matter So Much?

Author: W. Ben Hunt, Ph.D.
Date: August 30, 2012

Early notes on importance of Common Knowledge game in understanding market behavior.

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