Epsilon Theory

Epsilon Theory is Dr. Ben Hunt’s ongoing examination of the narrative machine driving human behavior, political policy and, ultimately, capital markets—an unconventional worldview best understood through the lenses of history, game theory and philosophy.


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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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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