Markets Will Permanently Reset Higher (My Sacrifice to the Delta Gods)

The US stock market rallied 30% in 2019. A blow-off performance punctuating a decade long bull market.

Professional money managers are pissed.

The Most Hated Rally

“Smart” money said we were in the late innings. Any bit of caution in the portfolio means you are now staring at a poor comparison to the benchmarks. I suspect the quant managers who might be evaluated on risk-adjusted returns are no happier. The rally has been steady. Low volatility. The SPX has won gold in both the absolute return and Sharpe ratio Olympics.

Relative Pain

Active managers are getting rocked. The Fidelity/Vanguard/Schwab race to the bottom on fees and the merit of indexing has been delivering brutal blows to the relative return crowd (mutual funds) and risk-adjusted return crowd (hedge funds) alike. Throw in a dose of market reflexivity and you can imagine the flight to passive strategies accelerating.

Absolute Gain

If you are an individual investor, you probably underperformed, but at least you are winning. And probably a lot more than you imagined. Your investments are an extension of your savings which you’d like to see grow to meet your future liabilities whether it’s a retirement or college fund. Measured against your realistic needs, you are sitting pretty. You would have happily locked in a guaranteed 10% return for 2019 if offered the chance on Dec 31, 2018.

Even More Expensive

Now what? If smart folks, you included, thought markets were expensive last year, you can only feel more dissonant today. We’ve all seen the CAPE charts reminding us that the stock market hasn’t been this expensive since 1999. Well, that was true one year ago as well, and look how 2019 turned out. I could compile a bunch of links showing how CAPE is a useless timing tool on any sub-10 year horizon and perhaps even longer than that.

You can drive yourself crazy and get nowhere asking how long expensive markets will march higher. No serious market observer pretends to have a high confidence answer to that question. If there was an answer it is tormenting allocators and money managers alike. Like Poe’s raven call “nevermore”.

How about the question of why are they rallying? To say more buy volume than sell volume is correct, but not especially useful. Going beyond that, you will not find a shortage of theories. The most popular, based on my state-of-the-art NLP analytics (otherwise known as browsing #fintwit), is the Fed. Central bank easing, best embodied by zero or negative interest rates in Europe and Japan, seems to be public enemy number one. Another alleged culprit has actually been passive indexing itself. This makes intuitive sense as a driver of marginal demand for shares since pulling money from active managers to allocate to say the SP500 is almost certainly going to be increasing the beta of investors’ portfolios if it is done on a dollar neutral basis. Michael Burry, of Big Short fame, has even called passive indexing a bubble.

But What If We’re Wrong

I borrowed the heading from the title of Chuck Klosterman’s book urging us to soften our attachment to the premises upon which we have built conventional wisdom. If this were easy to do he wouldn’t have needed to write a book. Blind spots are so-called for a reason.

Consider the central bank recklessness and passive indexing arguments. These appear to be reasonable explanations for how the market can be artificially or irrationally expensive. They even appear to have endpoints.

Consider these un-timeable reckonings for the central bank argument:

  • Asymmetric, short term nature of political incentives leads to hyperinflationary pressures climaxing in eventual fiat heat death. Creditors destroyed.

or perhaps…

  • A conservative central bank, inspired by the still-vibrant ghost of Volcker, tightens in response to creeping inflationary pressures. Since soft landings don’t exist, the market crashes and our record outstanding debt now teeters on a severely marked down asset base. A deflationary spiral.

How about the “bubble in passive investing” argument?

  • Eventually the inflows to passive will tip so far that active management’s price discovery process will fail to function. There won’t be enough wolves to keep the deer population in check and nature’s equilibrium will breakdown. A litany of price distortions from faulty signals will mirror how natural disasters’ can stem from unintended sequences. It’s like a climate crisis for asset pricing.

These arguments are promoted by many smart people. I’m in no position to falsify them. But I don’t think they necessarily warrant high confidence. First of all, a persistently expensive market is a complex phenomenon so there is a major burden of proof on any reductionist take that I don’t think either of these arguments has satisfied. Furthermore, the incentives of its promoters are enough to cast reasonable doubt on these arguments. To open ourselves to new reasons for the market’s relative expensiveness let’s loosen the grip on the above explanations.

Opening Our Minds

We can attack the central bank and passive indexing arguments on common ground. Both rely on a belief that the market is distorted by significant flows (whether central bank support or migration to passive). They invoke limits to liquidity and arbitrage as reasons for market inefficiency. The argument is compelling. But it’s also epistemologically diabolical in the same way that conspiracy theories recursively gnaw at the logic which allows you to dispel them in the first place.

As mathematician Jordan Ellenburg1 puts it:

“If you do happen to find yourself partially believing a crazy theory, don’t worry — probably the evidence you encounter will be inconsistent with it, driving down your degree of belief in the craziness until your beliefs come in line with everyone else’s. Unless that is, the crazy theory is designed to survive the winnowing process. That’s how conspiracy theories work.”

Those blaming passive indexing and central banks are almost certainly believers in efficient markets. Their arguments follow as so:

  • “Markets are mostly efficient.”
  • “My strategies exploit the few inefficiencies there are.”
  • “My strategies don’t work anymore.”
  • “The markets are inefficient because of X and Y”.

Well, the final conclusion is unmistakably self-serving. Building the argument in steps, the null conclusion should be, “the market, perhaps partially thanks to my work has ironed out the inefficiency I was exploiting.” The prize for this win is an incremental gift of price discovery to the world. And the checks they already cashed. But so much for their future prospects. They can ruminate a bit more on that on their yacht with all their newfound free time.

This Hurts All Investors Not Just Active Managers

If the market is indeed searching for a much higher setpoint then anyone young or who cares about someone who’s young should be concerned.

Investor Lyall Taylor 2 explains:

Most stock market investors worry incessantly about the risk of a potential market melt down. I don’t. I worry about the risk of a market meltup.

For anyone trying to grow their capital; make a living off their investments; or build a business around managing (and making money for) other investors, the absolute worst thing that could happen would be if markets everywhere were to surge and become (and remain) extremely expensive. Imagine, for instance, a world in which stocks traded at 50x earnings. If you invested, you would be offered a poultry 2% earnings yield in exchange for considerable risks.

If markets were to melt up to 50x, it would feel good for a while (if you were invested). However, your future stream of dividends would not have increased, so in truth you would be no wealthier, and furthermore, you would be confronted with the reality of poor reinvestment returns on dividends and corporate stock buybacks. In the long run, this would make you worse rather than better off, despite feeling wealthier in the short run. Bond investors understand reinvestment risk, but most stock investors do not seem too. But it works the same way for stocks as it does for bonds. 

If you’re invested, you are hedged somewhat against the risk of a melt up (a risk most people don’t identify). You can lock in a reasonable return at today’s reasonable prices, and would suffer only on the reinvestment side (an unhedgeable risk). The disaster situation would be to be sitting in cash while watching markets surge all the way to 50x.

If this scenario sounds implausible, consider that we are already facing zero or negative yields in large segments of the bond and real estate markets (reports of easing cap rates in coastal US cities notwithstanding).


  • Compared to history the market is expensive.
  • The most popular explanations rely on some market- distorting mechanisms to justify valuations.
  • The implication is there should be some reversion.

But as investors, we know that markets have a habit of choosing the path which causes the maximum pain for the most people. And it’s pretty clear that valuations ripping higher from here and pushing risky yields even lower would be a world of pain for investors and owners of capital.

Towards New Explanations for Expensive Markets

Option market makers use the expression “make a sacrifice to the delta gods”. In the course of market-making, option traders, despite trying to maintain a flat delta, may end up short an underlyer. When it goes against them, in a misguided effort to not lock in a loss, they will often cover a small portion of the position hoping Mr. Market makes a fool of the most recent purchase by pushing the underlyer back down thus minimizing their loss on the entire position. “I covered a part of the short at a high price but made a lot back on the rest”. Hence, the sacrifice to the gods.

Save me the lecture on investor bias. I’m just sharing what amounts to trader gallows humor. In an effort to make a  sacrifice to Mr. Market, let’s see if there is a case for markets to revalue much higher. Even from here.

For such a justification to be considered, I suggest it:

  • Not rely on significant claims of market inefficiency.

For starters let’s interpret central bank behavior as symptomatic, not causal. It’s not a stretch to believe this.   Many believe demographic-induced secular stagnation stalks developing economies starting with Japan, China, and Europe before coming to the U.S. It’s not impossible to see accommodative policy as being correct given the perceived determinism of shrinking workforces. Taylor actually warns us that focusing on central banks may obscure what is happening. A classic red herring.

Indeed, the ability to blame central banks for any and all bubble-ish behavior may have created a blind spot in markets, and resulted in investors overlooking the other contributory factors I discuss below.

After all, rates that are ‘too low’ are supposed to end in inflation, not deflation. So far they haven’t – in almost a decade – resulted in inflation, which suggests rates may not have been too low after all.

  • Incorporate observations of current market dynamics.

For example, seeing how money managers are throwing in the towel, which is what you would actually predict as they are compared to the market’s amazing risk-adjusted returns. A process that deepens as Soros’ reflexivity sucks remaining investors into passive indexing.

Let’s try to understand what the market is telling us with these high valuations.

Expensive Markets = Cheap Capital

The flip side of lower rates of return is a low cost of capital. Instead of asking why the market is so expensive, let’s ask why is the price of capital so low? For the same reasons that prices are ever low. Some mix of weak demand and ample supply. Capital is subject to the same economic forces as anything you can touch and feel.

Taylor explains:

In short, a combination of a growing supply of savings/capital, and falling demand for the usage of those savings. The scarcity of capital is falling. Scarcity is the foundation of returns in capitalism.

Historically, capital has been scarce (sometimes more than others), and high returns/interest rates have therefore been required to ration it to its most productive uses. However, there is no guarantee that will continue. There is no rule of the universe that says capital is entitled to a decent return (or any return).

Let’s start with the weak demand for capital.

Reduced Demand For Capital

The nature of the real economy has been changing which has reduced the capital intensity of industry. The term “data economy” is often used to signify how we have shifted from moving atoms to moving bits. Back to Taylor:

The world (or the developed world at least) is heading into something of a post-industrial era, where a lot of tangible capital is no longer needed to drive growth in productivity. Innovation is instead happening in technology, software, and services, etc, while incremental consumer demand is for relatively intangible services/experiences/entertainment, rather than ‘stuff’. These two factors are together reducing the demand for new tangible capital stock.

Productivity gains are poorly accounted for justifying the valuations. The growing power of technology is all around us. The only place it is invisible is in the productivity statistics – in my opinion because rapid productivity growth is deflationary, and because new technologies are now resulting in whole industries being demonetized. However, corporations are investing less and less in hard assets because there are comparatively limited opportunities or need for them to do so vis-à-vis the past – particularly with slowing population growth. In short, the ways in which capital can be usefully deployed has been declining, and it is probably structural.

Increasing Supply Of Capital

Taylor provides some economic explanations for the surplus of capital invoking what might be expected from mature economies that have had a good run.

Meanwhile, savings are at elevated levels, and have been for quite some time. This may be for merely cyclical reasons, but it could be partly or wholly due to structural reasons as well. One of the reasons is that wealth and income inequality have been rising rapidly over the past 30 years (something that could be cyclical, structural, or both). The more one earns, the higher one’s propensity to save, and wealthy individuals seldom consume their capital (as opposed to a portion – usually small – of the returns from their capital). Consequently, rising inequality has been increasing the world’s private-sector savings stockpile. In addition, savings-heavy economies such as China have been integrated into the world economy over the past several decades, which has further added to the world’s savings surplus (which was arguably a major contributor to the build up of economic imbalances prior to the GFC).

A Lower Discount Factor

If it weren’t enough that both the supply and demand forces were coordinating to cheapen capital, a lower perception of risk is boosting investment demand. Greed and performance-chasing are timeless behaviors that we would expect a decade into a bull market. Beware. Those explanations, like the Fed excuse, can blind us from looking further. We needn’t look far. The explanation can easily hide in plain sight.


Markets are becoming more efficient. There’s a saying that information wants to be free. It wants to get out. It takes energy to keep useful information private. And if a group has an edge in information, it will be difficult to scale since achieving anything grand requires more people. More people means more leak points. So when we combine information entropy with an explosion of interconnectivity and permissionless platforms, is it any wonder that data, intelligent analysis, and best practices become table stakes?

Increasing Efficiency

  1. Charley Ellis3 of Greenwich advisors on the evolution of investment analysis:

The number of people involved in active investment management, best I can tell, has gone from less than 5,000 to more than 1 million over 56 years. A major securities firm might have had 10 or a dozen analysts back in 1962. What were they doing? They were looking for small-cap stocks and interesting companies that might be interesting investments for the partners of the firm. Did they send anything out to their clients? No, not anything. Goldman Sachs didn’t start sending things out until 1964 or 1965, and there was just one salesman who thought it might be an interesting idea to put out. Today, any self-respecting security firm is worldwide with analysts in London, Hong Kong, Singapore, Tokyo, Los Angeles. 400, 500, even 600 people trying to come up with insights, information, data that might be useful to clients. Anything that might be useful. Demographers, economists, political strategists, portfolio strategist and every major industry team. Every major company will have 10, 12, 15 analysts covering that company. And of course, then if you go to the specialist firms, there are all kinds of people and then there are intermediaries with access to all kinds of experts in any subject you might like. We’ve got 2000 experts. And anytime you want to talk to any one of them, just let us know. Glad to provide an unbelievable, flourishing amount of information of all kinds, all of which is organized and distributed as quickly as possible. Instantaneously, everybody.

2. Now combine this transparency with what pseudonymous writer Jesse Livermore 4 refers to as “networks of confidence.”

Valuation is a function of required rate of return to which liquidity is an input. Imagine a pre-Fed wildcat bank. You would not accept such meager real rates of return because you do not have the confidence in the liquidity of your deposit. So much of our required rates of return come down to confidence. The progress of finance has been towards greater networks levels confidence which creates downward pressure on required rates of return.

3. Finally economist Ed Yardeni 5 describes how capital is so efficiently dispersed throughout the system that distressed funds are on standby waiting to provide liquidity as quickly as opportunity emerges. This private version of plunge protection is like a Nasdaq level 2 bid below the current NBBO. He thinks that absent a broad recession, the market may be able to quarantine sector downturns. Instead of a great recession, we simply adapt to “rolling recessions”. When the US energy sector collapsed in 2015 the fallout was limited as capital was callable on relatively quick notice. If the risk of spillover from sector downturns is limited we can expect fewer recessions, which is what Yardeni attributes any sustained bear market to.

  • Ease of Diversification

First, we need a quick aside on the fact that stocks have historically been a good investment. The excess return of stocks over risk-free rate is known as the “equity risk premium”. The fact that stocks are volatile is used to justify the excess return. Academics often refer to this equity risk premium as a “puzzle” since the return has historically been in excess of what their models would predict. Breaking the Market 6 actually shows that the puzzle is simply an artifact of a false comparison. Academics use index returns as a proxy for “equity returns”. But an index is actually a weighting scheme that rebalances. It’s not the same thing as “stocks”.

“Stocks” and the “Stock Market Index” are not the same thing and never have been. One is an asset class, the other is a trading strategy of that asset class. They don’t behave the same and don’t have the same properties, return, or standard deviation. You can’t use one to replace the other.

When you compare the geometric return of stocks, not a stock index you do not find an ERP!

Ok, with that out of the way, is it now crazy to think that the passive indexing trend which became popular because of its post-fee performance (Ellis reminds us that less than 20% of active managers have beaten passive allocations) will lead to lower excess returns? If they were too high to begin with, increasing access to that strategy should lead to yet lower yields going forward. But here’s the critical point — there’s no reason to expect the yields to revert to the excess levels of yesteryear. Indexing is a  simple word for a weighting strategy that periodically rebalances. The strategy is cheap to implement AND happens to generate an excess return that academics consider excessive. So excessive they call it a risk premium.

So if it’s not stocks that have an ERP but the strategy of stock indexing that actually holds the premium, how is it persisting? The mass adoption of passive you are witnessing is the invisible hand wringing the equity index risk premium out of the market. The lower forward returns the hand leaves behind will be its proof-of-work. According to Vanguard7, in the early 1950s, 4.2% of the population held stocks, and the median number of stocks held was two. The delta from today’s level of investment adoption, especially on a cost-adjusted basis, is a degree of progress more typically associated with tech or medicine.

While democratizing indexing seems like a gift to investors its euphoria will be short-lived. Indexing, by lowering risk discounts, is a more permanent boon to companies and those who need capital. Financial innovation reduces financing friction. Livermore 8 sees this as the march of progress we expect in any other industry. It’s just that the efficiency has been accruing in the direction of those who need capital. Those who supply capital were earning an inefficiency premium. They lacked information, means to diversify, and bore high transaction costs:

The takeaway, then, is that as the market builds and popularizes increasingly cost-effective mechanisms and methodologies for diversifying away the idiosyncratic risks in risky investments, the price discounts and excess returns that those investments need to offer, in order to compensate for the costs and risks, come down.  Very few would dispute this point in other economic contexts.  Most would agree, for example, that the development of efficient methods of securitizing mortgage lending reduces the cost to lenders of diversifying and therefore provides a basis for reduced borrowing costs for homeowners–that’s its purpose. But when one tries to make the same argument in the context of stocks–that the development of efficient methods to “securitize” them provides a basis for their valuations to increase–people object.

Those who need capital ate the cost of the inefficiencies that the underwriters sought payment for via fatter WACCs. The ironing of those inefficiencies is a permanent asset to borrowers and equity issuers.

  • Privilege of Knowledge

If technology has subsidized indexing from the supply side, the “privilege of knowledge” is sparking demand. This privilege, a term coined by writer and data scientist Nick Maggiulli, recognizes that the dominant strategy of buying and holding a rebalanced index was not known until the past 30 years. As Maggiulli explains9:

From 1871-1940, the U.S. stock market grew at a rate of 6.8% a year after adjusting for dividends and inflation. No investor in 1940 could’ve known this, because the data going back to 1871 wasn’t compiled by Robert Shiller and his colleagues until 1989…[if] buy and hold might seem obvious now, that’s only because we have the benefit of hindsight, ubiquitous data, and modern computational resources.

Those same resources that lowered the costs of diversifying also helped spread the word of its efficacy. Indexing is like a technology all its own. Better and cheaper. When you put a product with those features into the world, you are not surprised when it’s pulled not pushed. 10

Expensive For A Reason

The prospect of a sustained reversion in investment yields likely extends beyond the horizon of bargain-hunters’ binoculars. We may look back at historical returns and wonder why investors ever got to have it so good. We will look back and think how inefficient it once was. Can you believe people earned 8-10% in stocks and thought it should last? We may look at equity returns for the past century the way people now look at home prices. Remember when a house only cost 3x annual income? That was cute. As you look ahead, keep Taylor’s scoffs in mind:

Indeed, when you think about it, why should an index fund holder be able to lie on a beach all day and earn 10% a year? If the world needs savings, sure, that’s fine, but if it does not, then those savings ought to earn a materially lower return, if any return at all. And that is the direction the world has been going in.

What can you do about it?

If you have you participated in the re-pricing thus far, congratulations. Now what? Just as adding a 20th pound of muscle takes significantly more energy than the first, the next thousand basis points are going to require way more risk than you’ve endured until now. But to participate in the melt-up scenario the market demands you accept more risk for the same rewards. And if you abstain, Taylor reminds you of the reinvestment risk:

The disaster situation would be to be sitting in cash while watching markets surge all the way to 50x. What would you do then –particularly if the alternative was zero (or negative) rates in the bank? You’d be pretty much stuffed. If you kept holding cash, you’d have to settle for watching your capital slowly dwindle, and if you capitulated and invested, you would risk a major and permanent loss of capital if markets eventually did resettle at lower levels. I have never seen anyone worry about this risk. But they should.

If you are restricted to passive, vanilla strategies you may choose to hold your nose and stay long. I’m not qualified to advise you. But I’ll say that this is a fairly blunt hedge for a melt-up. It’s like tenting your house to get rid of ants. Consider the distribution more closely. If the market is expensive but the price of capital still has ample room to fall, it feels as though both the left and right tail are fatter. This is the solution options were built for. I don’t need to fumigate my house, I just need to shell out for some ant baits.

Evaluate Your Options

1) First the bad news. Listed financial options are probably not the answer. Why?

  • Listed call options maturities don’t match up with long term investors’ horizon (unless you consider 3 years long term). That means this type of hedge requires you get the timing right. The last thing you want is more ways to be wrong.
  • The upward-sloping volatility term structure would ensure premium pricing for the options.
  • While being long the index outright is a blunt hedge, call options, for all their extra hassle, are still not a surgically precise hedge. The right tail we are concerned with is risk premiums shrinking. This can still happen if earnings fall while multiples expand. Imagine earnings falling by 20% and the index only dropping 10%. Multiples will have actually expanded by 12.5%. I admit this sounds unlikely. But we are talking about this as a right tail event. In that context, the forces which are driving the price of capital lower may even accelerate in a recession. The financial option you actually want to buy needs to be struck on the index multiple, not the index level.

So unless a liquid market develops for the SPX 10yr 40 P/E Strike Call, I don’t see a simple financial options hedge.

2) Trend-following the index to replicate an option-like payoff. This strategy has been explored extensively with many variations incorporating momentum and dual momentum. Again, not investing advice, but these are outstanding sources to learn about trend strategies:

The strategies come in many forms but the gist is they keep you invested until the tide turns thus limiting your drawdowns.

Be warned. Trend is not a miracle-drug. You pay for this parachute in transaction costs, both explicitly and via the bid/ask spread of the signal’s entry and exit points. You can think of this whipsaw as the premium you pay for the option-like payoff. While in a financial options contract your premium is known at the outset, the trend whipsaw is a function of the asset’s future volatility and path which are unknowable. Livermore, who has also advocated for trend, makes his own disclaimers. During an interview on Invest Like the Best 11, Livermore cautioned that he is “agnostic” on trend. His creeping doubts about its future efficacy stem from his observation that in recent years there have been more whipsaws and less trend formation, possibly due to the so-called “Fed put”.

3) The last option is the most adventurous and the largest hassle. But it is the option that most directly addresses the root cause of this melt-up scenario. Start a company. If capital is cheap, the market is begging you to be an entrepreneur. I’ve written about this before in The Peace Dividend of Overvaluation.

No More Escape Velocity

So who has the most to gain from hedging the right tail?

The rich.

That it’s so difficult to hedge the right tail may even be a source of comfort for those given to schadenfreude. If the thought of a rentier class that sits back and compounds their wealth advantage for generations rubs you the wrong way then you are rooting for the melt-up. To arrive in a place in which there will be no return without substantial risk. Nassim Taleb12 has argued that the true measure of wealth inequality is the degree to which people are capable of rising or falling from classes. In a world where riskless investments yield zero or negative, nobody’s place is cemented forever. A low-yield future flattens everyone with the rich having the most to lose. Like inflation, the melt-up is a market imposed wealth tax.


In his January 2020 letter, investor Jake Taylor 13 remarks,

The return for the stock market in 2019 was quite odd. The price went up by 30%, yet earnings didn’t budge. All of the change was attributable to “valuation adjustment”.

The market is expensive by any historical measure. We talked about how painful the prospects for re-investment might be if the market marched to higher structural valuations permanently. Like you sprinted out of the gate only to discover you signed up for a marathon, not a 400m dash.

It’s popular to blame central banks, performance-chasing investors, and the rise of passive indexing. But it’s dangerous to presume that these factors are not perfectly rational. If the true equity risk premium is due to re-balance and diversification and that strategy, more commonly known as indexing, is democratized then it should reduce forward expected returns. And without any expectation of reverting to times when we didn’t know better or when that strategy was expensive to access. If capital is less scarce and in less demand it’s price must decline as capital is subject to the same economic forces that set the price of pizza or airfare. If technology cycles 14 and demographics are conspiring to suppress the cost of capital how certain are we that this is irrational?

Like Taylor15, I suspect this melt-up scenario is a tail-risk. As such the proper hedge is some very dirty combination of financial calls, equity trend exposure, and plain vanilla entrepreneurship.

I will leave you with this reminder. I am probably wrong. In fact, if this story ever took hold, sucked everyone in, and instead of the market climbing a wall of worry, ripped higher in a bull capitulation, you can thank me.

My sacrifice to the delta gods brought the rain.

Concussions and Santa Claus Amnesia

This crazy weekend reminded me of my frequent visits to the ER as a kid. I had 4 concussions by the time I was 12. Two of them happened on vacation. My concussions are part of our entire family lore. Yinh claims, based on her independent interviews with my family, that it was actually 5. I maintain it was only 3. Mom says 4 which is the number that has stuck. We’ll never know. This was in the day that you’d bump your head and everyone would try to keep you awake for the next day as if you were now a Seal trainee during Hell Week.

Family oral histories are dotted with apocryphal stories. Playing telephone as a kid could have told you that. The dubious nature of old stories is actually a narrower instance of a rule that says most of what you know is actually bullshit. Your parents told you things their parents told them. And parents are constantly lying to their kids. But this really becomes obvious when you become a parent and realize how many untruths you say just to get through the day. I had my fair share this weekend as I told Max we were going to “get some medicine” as I pack an overnight bag to head to the hospital. It didn’t hurt that Zak, 6, was in the audience.

It’s almost impossible to not want to re-examine every fact that has calcified in your mind since youth once you accept this. And you can’t not accept it without suffering some version of what I will call “Santa Claus amnesia”. The analogy is clear if you follow Michael Crichton’s explanation of Gell-Mann amnesia:

Briefly stated, the Gell-Mann Amnesia effect is as follows. You open the newspaper to an article on some subject you know well. In Murray’s case, physics. In mine, show business. You read the article and see the journalist has absolutely no understanding of either the facts or the issues. Often, the article is so wrong it actually presents the story backward—reversing cause and effect. I call these the “wet streets cause rain” stories. Paper’s full of them.

In any case, you read with exasperation or amusement the multiple errors in a story, and then turn the page to national or international affairs, and read as if the rest of the newspaper was somehow more accurate about Palestine than the baloney you just read. You turn the page, and forget what you know.”

Somehow we suspend our disbelief that our longest-running pieces of knowledge aren’t from our most dubious sources: our parents. Don’t begrudge them. It’s not their fault. It was truly out of love.

Zak and Max if you read this one day, know that that you shouldn’t die on any hills for anything I’ve ever said to you. Other than the fact that your parents love you.

And to my own parents. I don’t believe a lot of what I was told. But I love you. Thanks for taking me to the ER a lot. I know what that was like now.

Investing Is Biology Not Physics

Since the 1980s, there has been a tradition of Wall Street luring physicists from academia. Option math has more in common with the laws of thermodynamics than it does with accounting. But if the nature of markets themselves resembled any science it would be biology. Markets are governed by predator-prey dynamics. Models are adaptive. The actors learn. Doublethink and tradecraft.

In physics, the rules are fixed. No matter how many of us use the laws of gravity to keep firmly planted on planet Earth, gravity doesn’t get crowded. It keeps me just as bound to its surface as it did the Neanderthals. In markets, if I raise a bunch of money by showing people that selling volatility “harvests” a risk premium and the strategy continues to work then people will give me money to do it even more. So the strategy’s assets will grow both via inflows and via returns. The only problem is that to continue delivering the same performance on the larger asset base the strategy needs to sell ever more options. Assumptions of market liquidity when a strategy manages X will not hold when the strategy manages 10x or 100x. That’s about as close as we get to a physical law in finance.

The nature of liquidity is biological. It is subject to the whims of masses. It is the physical point where the backtest meets reality. Reality is a recursive, perma-learning system, with constraints and desires whose steers are pulled by investors, politicians, and corporations.

One of the best discussions I’ve ever listened to about what this looks like in practice is investor Andy Redleaf on Ted Seides’ Capital Allocators podcast. Redleaf has been in the game for over 40 years and was an early options market maker when they were listed in the 1970s. Since then he has followed opportunities that present themselves as markets change. A true agnostic on the hunt for profitable niches. Especially niches with structural reasons for being extra profitable. The advantage of this approach is that when the reasons go away, you know it is safe to cut and run. The disadvantage is that you cannot be a one-trick pony. You need to keep finding easy games.

For the full discussion of market history, where sources of edge often lurk, investing challenges today, and why he bought a bank check out the episode including my notes. (Link)

Susquehanna took their understanding of markets as biological to a logical recruiting conclusion — hire game players. Poker, Magic, chess, sports bettors. All games that require multi-order thinking and adapting to your environment. If you know anyone with a strong game background (and ideally some programming chops) check out Moontower reader Metaling Mage’s call for an intern. He’s a former Susquehanna PM.

You can reach out to him for details but it’s safe to say based on where he is now that this is could be one of the most selective Wall Street internships on the markets side of the business.

A Note From The ER

Since I don’t really write nor overly care about current events I’m gonna postpone what I was gonna write about this week and thank you in advance for indulging something a bit off-the-cuff and personal.

The last 2 months my family Whatsapp chat has been an emergency room on a full moon night. No less than 6 surgeries or hospitalizations ranging from an eye surgery on a 6-year old to my 85 yr old grandmother’s emergency hip surgery this week. This is close family. Every person shares 1/4 to 1/2 my dna (this expression is probably not biologically true but just as we gloss over misspelled words, you can identify what relations this refers to almost perfectly). It’s been a bit of bad luck clustered around the start of 2020.

On Friday, I called my house shortly after getting to work. I wanted an update from my mother-in-law on Zak’s fever. He was home from school Thursday and Friday. Turns out he was still asleep at 8am, but now Max (3.5 yrs old) was sick. With Yinh just getting ready to return from Japan, I was calling the workday early and heading home to pitch in. When I got home Zak was awake and on the mend but now Max was pathetic and clearly having a rough go of it. Earlier in the week, his preschool closed for 2 days because all the teachers got strep. It was an easy decision to take him to the pediatrician for some antibiotics.

At the doctor’s office, they run some tests and see he also has flu ‘A’. We didn’t do flu shots for the kids. Bad us. And since his breathing is a bit strained we head home with albuterol as well as antibiotics and Tamiflu. Parents will relate.

At home the Tamiflu makes him vomit but even more annoying is the nebulizer sessions don’t seem to slow down his rapid breathing. I call the after-hours line and the doctor on-call tells me to count his breaths in one minute. Around 60. At 50 or more she’d recommend going to the ER. So we pack a bag and off we go to John Muir in Walnut Creek. Now there isn’t going to be a scary reveal otherwise I wouldn’t write about it, so let’s diffuse that now. However, his chest x-ray shows budding pneumonia as well.

While he’s battling on 3 fronts, he is doing well. They administer oxygen and IV. Standard stuff. Parents of kids with asthma can double relate. He’s responsive to the treatments. But all things considered, we are staying the night. Actually, at least 2 nights and as I write this I’m not sure if there will be more. The ordeal started Friday so it will take a few days to peak and since pneumonia might be viral the antibiotics can’t kill two birds with one stone as they are already indicated for strep. By staying in the hospital, his immune system can get some extra support. He’s doing fine and just needs time.


As you can imagine, this is a very long day. And from the moment we checked into the ER until we were in our room for the night it was about 4 hours. There was a lot of downtime in that period. A few hopefully constructive takeaways:

1) Find a positive angle 

When I texted Yinh that I was in the ER I knew she wouldn’t open the texts until she landed for her layover in Japan. No matter how unalarming I write this text, the facts of the matter are going to induce panic. While the parent that’s present has to make realtime decisions and actually deal with logistics, the parent thousands of miles away, in my opinion, is in a worse emotional situation. She feels helpless and there is no amount of female empowerment that can suppress “working mom guilt” in a moment like that. I have the benefit of seeing that Max seems to be doing ok which is hard to believe when you are across the world and hear he has strep, flu, and pneumonia. I also have the advantage of seeing the staff’s composure and methods firsthand. I can see their reassurances firsthand and enjoy the impression that they are in control. My words, no matter how calm, are not going to stop her otherwise routine-ish flight from being the longest one of her life.


I only needed to imagine being in her shoes to reframe the ordeal as one in which I was thankful to be present. I felt fortunate to have the role I was dealt which sure beats self-pity or any other useless emotion. Every bit of uplifting perspective you can seize during emergencies is worth striving for.

2) Bedside Manner

The care at John Muir from the nurses, to the pediatrician they called in, to the overnight doctors on the peds floor was outstanding. As far as tactics, transparency, and explanations they seemed supremely competent. I felt Max is in great hands. But that feeling comes from more than competence. It’s the way they present themselves. The bedside manner. I feel invited into the process but more as a board member. While I have ultimate say, it’s clear that the folks in the trenches know what’s best. Despite that, they are never arrogant or dismissive of my thoughts yet also firm about what is called for. Combine this with the composure and even-handedness that they exhibit and it’s a masterclass in communication.


Crisis or simple brushfire, when dealing with non-experts, mind your bedside manners. Be a pro. How would an ER doctor act?

3) Focus

With a long weekend coming up and no travel plans, we were looking forward to a hike with friends, some downtime, and a chance to cross some chores off the list. Max had other plans. From the moment you decide you are going to the time warp known as the ER, you know your plans are over. More than that, all external stimuli fade to the background. The contrast is unreal. Chat messages, your reading queue, obligations, and whatever you were kind of working on in your brain’s standby mode simply fades to grey. The only thing in bold colors is the task at hand — get Max what he needs. It’s a very focusing experience. Circumstances aside for a moment. It was a state of presence I felt good in. I don’t think it’s quite the same “flow” that silent-mode advocates strive for. It’s almost the sense that nothing but what’s in front me matters. It’s the same feeling I had the day my kids were born. I think it’s a healthy feeling but it might also be irresponsible or nihlistic. I suspect that people who climb or surf big waves have found a way to bottle it. Interested in your thoughts on this.


Your “presence” capacity has headroom. Find ways to access it.

How You Say It > What You Say

It’s date night. You’ve been wanting to try the new spot. It’s crowded. The reward for a wait would be a cozy table pressed against your neighboring diners. Hmm. Nothing is more grating on the ears than the courtship ritual of hipsters on a date whose evening insurance policy is just a right-swipe away. Makes for feckless banter.

But you’re both feeling good. Showered. About as groomed as you’ll be on a weekend. The kids are watching iPad at home, grandma’s on sentry duty. The radio dealt Billie Jean on the way over. So you play it cool. Take the seats at the bar. Your cocktails arrive in front of you. Pause to cheers and snap an “ussie”. In the time it takes to upload it to the ‘Gram, Google settles your question — Elvis sold more records than MJ.

Phones down, back to one another. You’re discussing “who is the real king of pop”. Units-sold is just one aspect and you aren’t the types to waste time arguing facts so you deferred to the internet. More back and forth. You’re sparring with pads on. Exchanging taps. “Good point”. “True”. It’s a dance of its own. If only the hipsters could hear you. I imagine they’d cringe like a psychiatrist hearing the words “life coach”. Nevertheless, the playful dispute stays smooth until Kris responds, “Actually…”

End scene right there.

Here’s a happiness hack for you:

Read the damn room.

This date night debate is for zero stakes. It’s not about truth. It’s not the setting for a Juilliard-level surgery of pop music psychohistory. There’s nothing to gain from appealing to expertise. To invite the feeling of resignation that says every matter is already solved. How many fights could have been avoided if this moment were re-imagined? Why should the verbal monopolize the focus? There are so many other stimuli serving the moment. It’s a tyranny of intellect that the words are mistaken for the real communication that was going down.

If you can read between the lines, you’d know that I blew up a date-night by being a jerk. I was dense. Now I’ve been married too long to have done this obstinately. I hope I don’t have an insecure need to be “right”. I’m quite aware there’s a broad plane across which reasonable people can disagree. This was second level stuff.

This was about subtlety in the way I made her feel during a benign disagreement (it wasn’t about Elvis). If you are actively trying to be agreeable but come off condescending you might be mansplaining. Even if you are correct, assuming it’s a matter that has a correct, what’s the point? Reason is a slave to the passions as David Hume put it. Action springs from feeling not logic. To be effective, whatever that means in context, remember that how you say is often more important than what you say.

It’s no secret that body language and tone are tells. Non-verbal communication is an “honest” biological signal because it’s hard to fake. This week I have some fun links to help you think about how we communicate.

70% of how you look, 20% of how you sound, only 10% is what you say

  • Check out Eddie Izzard from one of my favorite all-time comedy specials Dress to Kill (Link; start at 2:20)

The Scariest Accent

  • Another from a favorite comedy skit. Trevor Noah breaks down the scariest accent. He makes a clever insight on how we perceive a foreign language vs a foreign accent. (Link)

How Not To Sound Like An Evil Robot

  • I can be so guilty of this. A short and funny guide to word choice by Slatestar. (Link)

Ecological Rationality 

  • Ecological rationality is defined as knowing which heuristic works in which environment.  Professor Kahneman is rightly lauded for being the father of behavioral psychology. It’s a field that points out all the failure modes and blind spots in our shortcut thinking. You’d think the field was settled given how large Kahneman looms. But the work of Gerd Gigerenzer says otherwise, redeeming our so-called biases in real-world settings. His disagreements with Kahneman are often quite technical and therefore less polarizing than some would like to portray. I most like how it exposes a false paradigm where rationality is pitted against mental heuristics.

Many smart, successful people fail in rationality tests inside a lab because rationality is defined rather narrowly. It’s logical rationality – about not violating some law of logic or probability. But, outside the lab, in the real-world, we cannot do well with just with logical rationality, we need ecological rationality – the kind of thinking that helps us get what we want in an environment that’s uncertain and dynamic. (Link)


  • The single biggest problem in communication is the illusion that it has taken place. — George Bernard Shaw
  • Never offend people with style when you can offend them with substance. — Sam Brown

Podcast Episodes

  • One of my top 10 podcast episodes ever is Patrick O’Shaughnessy interviewing Eric Maddox, the US interrogator in Iraq whose work led us to Saddam. Must listen. (Link)

This week we explore a rare and underappreciated skill through the lens of an incredible story. My guest is Eric Maddox, whose name you probably don’t know but won’t soon forget. Just trust me that you need to listen to this entire episode, and listen carefully—because that is what the episode is ultimately all about: how to listen to others, with care and empathy, in the age of distraction.

  • How To Improve Your Speaking Voice. World-renowned voice coach Roger Love goes on Art of Manliness (Link)

Roger explains why having a clear, confident, pleasant speaking voice is important for success in your career and your life, the biggest ways people sabotage their voice, including voice fry, uptalk, and being nasally, and how these issues can be addressed and eliminated. Roger also shares how to speak in a more masculine way, and why you’re probably not speaking loudly enough. 


  • Why singing and speaking are basically the same
  • Why the voice you have is not necessarily the voice you were born with
  • The reason so many people dislike hearing their own voice
  • The most common vocal bad habits
  • The rise of uptalk (valley talk), and how it’s different from going up in melody
  • What role does anatomy play in our speaking voice?
  • Why men try to artificially lower their voice, and the physical risks of doing so
  • Brass tacks tips for improving your voice
  • What is voice fry? Why are people doing it?
  • How to avoid sounding angry
  • Why people almost always speak quieter than they should
  • Why you mumble and how to fix it
  • Why your voice is more important than your words

Hands On Resources to Teach Kids About Business

A friend asked me if I knew of any podcasts geared towards teaching kids at middle school ages about business or money. I was surprised that while there are tons of articles online about how to teach kids there is very little directed at kids themselves. Here’s what I could find.


  • Warren Buffett’s Secret Millionaires Club (Link)

A video series inspired by value investing’s most famous practitioner.

Videos, blog, and games

  • Hands-On Banking (Link)

Their tagline is “Money Skills for Life”. Videos appropriate at youngsters from elementary through high school.

  • Finance In The Classroom (Link)

A collection of resources from lesson plans, videos, and exercises covering K-12. The activities by grade are especially worth a look.

  • Flocabulary (Link)

Hi-quality video lessons. Seems directed towards teachers and has a paywall but there’s a free trial

  • Khan Academy (Link)

I’ve watched all the Khan Academy finance vids. It’s is a great source but probably out of reach for a middle schooler.

  • Two Cents by PBS (Link)

A weekly series about personal finance.

  • Camp Millionaire: A Money Workshop For Children (Link)

A game and activity-based financial education program for children 8 to 16 years. This site is one of my favorites for learning about value investing and mental models. The camp sounds awesome, just not sure if it will be in your area.

  • Children’s Business Fairs (Link)

An organization that helps towns create local business fairs operated by kids. These fairs look like flea markets or science fairs. They are nationwide and you can even bring one to your town.


A note on games

I would credit a lot of my reasoning about business and money from playing games. While actually investing is the ultimate game to learn from here are some of my recommendations to get kids and teens starting to think about investing.

  • Extremely incomplete information games: Poker and Magic the Gathering

As a trader trainee, our curriculum included lots of poker. There is no better controlled environment for  learning to make decisions under uncertainty. Many fellow trainees had extensive Magic the Gathering backgrounds for similar reasons.


  • Fantasy sports and sports betting

Point spreads and draft positions are valuable early lessons in market efficiency


  • Tabletop games

Catan (Link)

Richer than Monopoly and less antagonistic. I’ve never met anyone who didn’t enjoy playing this game. Lessons in negotiation, market dynamics, odds, and planning.

Acquire (Link)

A cool intro to stocks using a real estate theme

Power Grid (Link)

A bit higher on the complexity scale. Auctions, networks, optimization, opportunity costs, replacement costs, and cutthroat market dynamics.

Illusions, Empathy, and the Hackability of Perception

“Hey, what happened to the dinosaurs? Weren’t they just here?” Maybe comets killed the dinosaurs, maybe they tripped and fell. What’s the difference? We’ll never know. We couldn’t solve the Kennedy Assassination, we had films of that. Good luck with the Stegosaurus.”

–Jerry Seinfeld from his 1993 book SeinLanguage

As a teen, I read that book probably 20 times. My brain was full of Seinfeld takes thanks to the book basket next to our bathroom toilet. The book is still in that bathroom more than 25 years later.

Good luck with the stegosaurus

I remember having that exact reaction in the wake of the “dress illusion” that swept the internet nearly 5 years ago.  You can be staring at the same picture as your neighbor and disagree on the color. Then in 2018 the yanny/laurel debate exposed how different our audio perceptions are. These illusions are unsettling. If we can’t agree on what appears plainly before us, what hope is there for mutual understanding on issues.

It’s a cynical thought. And I’m not sure it’s wrong. The minimum amount of structural disagreement that would exist if everyone agreed on the same facts is disturbingly high. Call me naive, but this was a dark realization. And once you notice how futile striving for agreement is, the world does nothing to help you unsee it.

The Hackability of  Perception 

Scott Alexander writes:

“I’ve been focusing a lot lately on the idea of the Bayesian brain and its input channels. Some input channels, like vision, are high-bandwidth; we get so much data about the real world that we usually see pretty much what is really there.

Other channels, like pain, are low bandwidth. This is why the placebo effect works – we get so little data about how much pain is coming from different parts of our bodies that even our strongest percepts are wild guesses, where we fill in the gaps with predictions and smooth away conflicting evidence. If our predictions change – ie we know we just got morphine and morphine lowers pain – then the brain will happily change its guesses. This would never happen with vision – I can’t use the placebo effect to make you think an orange crayon is blue – but pain is low-bandwidth enough that it works.

Vision, with all of its flaws, represents a ceiling on perceptive fidelity. Sensations like pain are lower bandwidth. Vision is hackable but less so than pain. And unfortunately, logic and reason are even more hackable.

He continues:

Reason is one of the lowest-bandwidth channels of all, which is why biases are so omnipresent and rational debate so rarely changes anyone’s mind. Most people revert to their priors – the beliefs of their tribe or the ones that fit their common sense – and you have to provide an overwhelming amount of rational evidence before the brain notices anything amiss at all.” (Link)

And then the lesson appeared.

The Real Meaning of Empathy

I’ve often thought of empathy as being able to put yourself in another’s shoes. Commiseration for what you have not experienced but could imagine. Pain, loss, anxiety. We can relate to these feelings. But that is only half of what it means to be empathetic.


Because you presume that the other person’s sense of loss correlates with how you would feel in the same scenario. But if you can’t agree on what color the dress is, how can you know how Mary feels when she loses her dog? True empathy requires tremendous humility. You are not living their loss through your eyes but accepting that your eyes are irrelevant. In a world in which we simply will never agree, empathy that is contingent on being able to relate is an empty virtue.

These illusions teach us that sometimes we can’t relate. Empathy needs to be ok with that.

For the past few years, I have seen illusions as a heat check. They are as humbling as they are entertaining. Magic shows, mentalists, and illusions are a constant reminder that our perceptions are heuristics that can be exploited. And if our thoughts are built upon our perceptions, we should afford them leeway in proportion to how much error lives in what we see, hear, and remember. Humility is not optional if you value honesty.

Paul Graham has described our minds as a compiled program that we’ve lost the source code to. It works, but we don’t know why.

How Do We Protect Ourselves From Illusions

1) Recognize we are not natural fact-checkers. Be humble since you are usually not thorough. (Link)

2) Be aware of biases

Nick Maggiulli highlights:

  • The peak-end rule: we tend to focus on the most intense and the most recent parts of a memory when judging an experience. Professor Dan Ariely has pointed out that this flies in the face of conventional wisdom to rip band-aids off quickly. He was a survivor of severe burns and used this knowledge in advising nurses about the daily removal and redressing of his bandages.
  • The serial-position effect: People tend to remember the first things (primacy) and the last things (recency) in a list, but tend to forget the middle things. Nick cleverly demonstrates this with the following example:
    • You sluhod be albe to raed tihs snetnece tohguh amlsot ervey wrod is spleeld icorenlrcty.

3) Appreciate that your memory is not a video camera

Professor Dan Gilbert on our memories being edited and unreliable:

“We try to repeat those experiences that we remember with pleasure and pride, and we try to avoid repeating those that we remember with embarrassment and regret. The trouble is that we often don’t remember them correctly. Remembering an experience feels a lot like opening a drawer and retrieving a story that was filed away on the day it was written, but…that feeling is one of our brain’s most sophisticated illusions. Memory is not a dutiful scribe that keeps a complete transcript of our experiences, but a sophisticated editor that clips and saves key elements of and experience and then uses these elements to rewrite the story each time we ask to reread it.”
Taking advantage of illusions

The Placebo Effect

We already saw how the placebo effect can be used to trick the low-bandwidth input channel of pain. Dan Ariely has claimed that the “mind is so powerful as evidenced by the placebo effect. The link between expectations and beliefs is astounding.”

Scott Alexander (a psychiatrist by trade) recaps the explanation of the placebo effect from Surfing Uncertainty and when you would expect it to be most effective:

Perceiving the world directly at every moment is too computationally intensive, so instead the brain guesses what the world is like and uses perception to check and correct its guesses. In a high-bandwidth system like vision, guesses are corrected very quickly and you end up very accurate (except for weird things like ignoring when the word “the” is twice in a row, like it’s been several times in this paragraph already without you noticing). In a low-bandwidth system like pain perception, the original guess plays a pretty big role, with real perception only modulating it to a limited degree (consider phantom limb pain, where the brain guesses that an arm that isn’t there hurts, and nothing can convince it otherwise). Well, if you just saw a truck run over your foot, you have a pretty strong guess that you’re having foot pain. And if you just got a bunch of morphine, you have a pretty strong guess that your pain is better. The real sense-data can modulate it in a Bayesian way, but the sense-data is so noisy that it won’t be weighted highly enough to replace the guess completely. 

If this is true, the placebo should be strongest in subjective perceptions of conditions sent to the brain through low-bandwidth relays. That covers H&G’s pain and nausea. (Link)

An example from my recent trip to the Lawrence Hall of Science

Consider this statement again:

In a low-bandwidth system like pain perception, the original guess plays a pretty big role, with real perception only modulating it to a limited degree

In the virtual reality exhibit currently on display, there is a recording playing. I’ve reproduced it here. If you’d like to play along, have a friend silently mouth the word “far” in sync with the recording. If you look at them while they do this, that’s exactly what you’ll hear. If you look away, you’ll hear what I actually recorded. In the exhibit, they show a silent video with 2 people mouthing different words. As you flip your gaze between them you hear what they are mouthing although the recording is always saying the same word.

More fun illusions

Here are 2 optical mind benders I’ve collected over the years.

  • The cafe wall (Link)
  • Sinusoidal waves (Link)

Notes From Saudi America

Saudi America
by Bethany McClean

On Aubrey McClendon, founder of Chesapeake

  • McClendon went all-in on shale buying land in Austin Chalk region when he saw Devon energy’s success drilling horizontally.
  • McClendon would overpay for land. His world-class salesmanship would allow him to raise capital more effectively than competitors.
  • He would be bailed out in 2000s when oil and gas prices rise and shale lands were in high demand.
  • By 2012, Chesapeake was trying to rebuild after the crash of 2008 and gas prices depressed. They would raise capital globally and make deals with pipelines that would require them to produce large quantities of gas regardless if price. They were basically funding themselves by selling the equivalent of naked puts on gas.
  • The board was replaced and McClendon stripped of chairmanship. Icahn even took a seat. But the company and governance were a disaster.
  • McClendon left and started AEP which would create a portfolio of companies with an interest in specific drilling operations.


  • Known as the “Apple” of oil
  • In 1999 Enron spun off EOG (“Enron oil and gas”) when Jeff Skilling became dismissive of businesses requiring hard assets.
  • EOG and Continental (Harold Hamm’s co) were first in the Bakken where production would increase 10x in the first decade of 2000s.
  • Encouraged that the fracking technology worked although unspectacularly (the industry and academics were still skeptical) they started acquiring land in Eagle Ford for under $500 an acre. Then in 2010, at the 4 Seasons Houston they announced there was 900mm barrels contained in Eagle Ford.
  • A look at EOG which has positive returns.
    • Only wells with at least 30% irr since about half of that is required to cover overhead including land and infrastructure.
    • Requires profitability at $40 oil so that it can survive full price cycles.
    • Means that there is limited capacity to invest since land prospects can be much worse (“better rock is exponentially better”)

Fracking is 2 technologies

  • Horizontal drilling and high pressure water to crack open rocks. A proppant (ie a sand usually from Wisconsin) is used to keep the crack open to let the oil or gas flow.

Shale depends on unsustainable economics

  • In 2015, Einhorn at the Sohn conference showed that even with oil at $100 the shale industry was incinerating cash. He called out Pioneer in particular (a descendant of a merger with Pickens Mesa Energy). Shale Wells have too steep a decline rate. A Bakken well declines 69% in year 1 and 85% in 3 years vs 10% pa for conventional). Einhorn argued that frackers’ pitches don’t account for cap-ex and cost to acquire leases. He showed that they embellish their estimates of reserves to investors (vs what they report to SEC standards). He and SailingStone of SF showed how comp was tied to production, not profitability. They both agreed that has was much better biz than oil.
  • Pension backed PE firms are financing shale 2.0 which is marked by better technology and more precise operations. 35% of horizontal drilling is done by private PE-backed companies. Rates of return remain unsustainable for all but the most efficient operators who are generating positive albeit still uninspiring returns.
  • Decline rates always mean you need to spend more to stay in place. The shale transformation was a Lollapalooza effect of Bakken, Eagle, and Permian hitting all at once. It may very well be a one-time price effect. And the more efficient we become on drilling the faster we deplete the wells.

The crude oil export ban

  • The crude oil export ban had been in place since the 1970s.
  • But there was now a growing movement to overturn the ban backed by oil producers while refiners and environmentalists opposed it.
    • Many saw it as a counterweight to the political leverage of unfriendly powers such as Russia and the Middle East. Europeans were already grateful for the US agreeing to export LNG, keeping Russia from having a near monopoly on gas sales in Europe esp in Germany.
    • Many argued that the decline in global prices would more than makeup for the reduction of domestic supplies and that in boosting global supplies the political premium baked into oil prices would ease.
  • The collapse of oil prices in 2015, the “condensates” exemption, and being part of a larger spending bill provided cover from detractors as the bill was passed in Dec 2015. Environmentalists would gain an extension to solar and renewable subsidies.

My takes plus a Munger insight

  • The byproduct of commodity businesses is really an investment product.

A levered slice of volatile returns. The companies are closer to derivatives than they are businesses. The derivative is on the price of the commodity. The leverage is operational (call option struck on breakeven cost structure) and financial (companies have debt financing). The derivative is economically tied to the commodity via land rights which collateralize additional debt financing.

  • Sloppiness can occur when policies are seen as good for the public.

Greenspan saw rising energy prices as a threat to the economy and he suggested we invest in LNG import terminals. The fear of risings prices hastened the 2005 Energy Policy Act which exempted drillers from disclosing the chemicals used in fracturing.

  • Is Saudi’s timing of their portfolio rebalance performance-chasing?
Aramco IPO proceeds used to diversify Saudi America by creating a sovereign wealth fund. Shorting oil to invest in overpriced businesses a la SoftBank?  Strange move. The investments are not even in human capital and accumulation of tacit knowledge. It’s financial in nature only which seems not just expensive but shortsighted when the explicit goal of MBS is long term vision.
  • While increasing the security of US energy supplies seems like a net positive it’s unclear what the ramifications are longer term.

Shale for example has reduced our reliance in unstable regimes. But many of those regimes such as Nigeria were not major threats. If an insecure bully has some moderate economic leverage against you it may be better to pay them to control them. If you remove the leverage you also destabilize the equilibrium. An equilibrium you were ultimately in control of. You may find yourself now facing a desperate, rabid adversary who despite a smaller stature now has its back to the wall. You have exchanged a stable, modestly negative state for a wildly uncertain modestly incrementally positive (perhaps fleeting) state. This is especially true when the dog whose bark is louder than its bite is in a region concerned with terrorism and nuclear proliferation.

  • Munger: we should be conserving oil and delaying gratification until we are certain about the extent of its future needs.

This is because fertilizer, pesticides and other ag products are made with hydrocarbons and there is no technology that has replaced that. “Like the topsoil in Iowa, you wouldn’t want to use it as fast as possible” he believes the shale boom was lucky and we shouldn’t just consume the gift. He recommends we commit to production enough to remain competitive in its technology while maintaining reliance on foreign oil. Let them deplete their reserves until we have a better understanding of what the future barrel is worth. Remember that the US being the first to switch to unconventional oil and gas required it to be the first to run out of conventional oil and gas.

Shale has been a subsidy to the economy and it’s very unclear to what extent we should drill aggressively or more thoughtfully since the future demand for oil is devilishly uncertain (there is more certainty around gas supplies). Is this another example of being short-sighted and drilling at all costs while oil execs and consumers win or if we’d be better off with higher near term prices and renewables even more competitive?

Notes From Chop Wood, Carry Water

Chop Wood, Carry Water

by Jason Medcalf

Quick Summary and Review

A sensei teaches a modern day student to be a samurai archer in Japan. The focus on process is wax-on, wax-off a la Karate Kid. As an apprentice, the protaganist spends most of his time “chopping wood, and carrying water” which he is initially impatient with. Of course, as anybody familiar with Mr. Miyagi would forsee, the mental and physical effort is transferable to the mastery of archery. The lessons are communicated with contemporary parables. Sticky and timeless. This book would be a perfect gift for a teen or recent grad.

Why Try To Be Great

You have one life

Pain of regret lasts longer than the pain of failure.

Don’t pretend you get to live twice.

You will be irreplaceable even if you are not the best.

  • When you go on a self-directed journey you’re learning things and developing skills that make you highly irreplaceable.

You don’t find traffic after going the extra mile.

A bold new world

  • Things that used to be virtually impossible to build and create on your own can now be done with just a few clicks.
  • Very few people have woken up to that truth, because doing so requires getting uncomfortable and breaking away from much of what they’ve known their whole lives. They would rather have the perceived illusion of safety with a consistent job, even if it’s one where they are completely disengaged doing things they don’t believe in, all while complaining about how unfairly they’re being treated, despite being able to quit at any time. They have been so brainwashed by a system that encourages disengagement, passing tests, and buying stuff you don’t need to impress people you don’t like, that they can’t see the reality: that there are fields all around them, just waiting to be farmed.
  • Very few people understand this because they have been studying old maps their whole lives. The territory is new. 


Falling in love with process

Start small and focus on what you can control.

  • Chopping wood and carrying water is the price for admission to reach sustained excellence. Like the roots of a bamboo tree, it is a long and arduous process of invisible growth, where you are building the foundation that is necessary to sustain success. For many years it may feel as if nothing is happening, but you must trust the process and continue to chop wood and carry water, day in day out.

The importance of little things. Inches

“Now you see how much an inch is worth. Every adjustment at the firing line means the difference between hitting the target or missing it. And the same is true in life. Every little thing we do, no matter how mundane, matters greatly when it is multiplied by the number of times you do it. Over time, even the smallest habit or choice can change our lives immensely. Do you know what separates most wildly successful people from everyone else, John?”

“Luck?” Akira shook his head, no. “Hard work?” Again, no. “Coming from the right background?”

Akira just smiled, “Inches, John. That’s all that separates them.” (This was pretty much Al Pacino’s speech in Any Given Sunday).

Think about your group of friends from high school. You’re all from the same area, you’re all the same age, and most of you have had a very similar set of opportunities. And right now, someone might look at all of you and be unable to really see much of a difference in your lives. But in ten years, an underachiever might be incredibly successful, while another who flourished in high school may be struggling to even survive. But I can as the difference in their lives will always come down to inches.

Most people are so consumed with their day-to-day lives, that they never pause to see the big picture. And in the big picture, every single choice matters, no matter how small. Everything you choose to read, listen to, or look at. Everything you think about, dream about, or focus on. And especially, your circle the people you surround yourself with and allow to influence you can make all the difference in who you become. Inches might look small up close, but added up over the right amount of time, they can cover any distance in the universe.

You don’t rise to the occasion you sink to the level of your training.

What to Expect on the Path to Greatness


  • Don’t believe the myths. Greatness is far from sexy, it is dirty, hard work usually required to be done in the dark. When no one is watching your dreams are so far off they feel like fairy tales.
  • There will be distractions. There will be people who tell you that you are stupid or crazy for doing it.
  • Most people do not try to realize their potential because they’d rather protect their ego.
    • People won’t understand. Most are more invested in their ego than a mission.
    • Evil’s greatest weapon is discouragement.
    • When we see people who were like us achieve greatness we often retrofit labels like “talented” or “chosen”. This protects our egos which did not do what it takes to achieve greatness. (It reminds me of how people’s perception of Tom Sawyer when they discovered he had money. And how they retroactively applied that perception, seemingly having forgotten the orphan’s rascal behavior.)
  • Cites 74% of people knowingly give a wrong answer to not stand out.
  • “Greatness isn’t for the chosen few. It’s for the few who choose.” – Jamie Gilbert
  • Everyone wants to be great until it’s time to do what greatness requires.

Temptation to take shortcuts

  • There will be people who try and lure you off the path with quick fixes and get rich quick schemes. But you must be wise and stay the path, and continue to build your foundation by chopping wood and carrying water every day. Greatness isn’t sexy, it is the dirty, hard work that is often very boring. Your greatest challenge during your time here will be to faithfully keep your focus on the process, while surrendering the outcome.

Comparison traps

  • Comparison is the thief of joy and short-sighted. Compare to yourself. Your former self and your potential.

The grass is not greener on the other side. It is greener where you water it. 

Don’t give advice unless asked

  • There will be people who ask you for wisdom but you must never cross boundaries without an invitation.
    • When the student is ready, the teacher appears. Often a good idea to ask if the person is looking for advice or just venting and wanting to be heard. 
  • “The difference between a pest and a guest is an invitation.” – James Richards

Improve Your Mindset

Rewiring your brain for encouragement

  • We don’t remember experiences as objective events. We remember them by the stories we tell about them. By focusing on what we did well, we can turn our memory into encouragement. Rewiring is tedious work.
    • Example: writing down at least 15 positive things that you did or happened that day. This is an action which promotes a growth mindset.
    • Instead of seeing moments as tests, view them as opportunities to learn.
    • Another good habit: write at least 2 things you learned that day.

“Humility is not thinking less of ourselves it’s thinking of ourselves less.” – CS Lewis

  • To fuel yourself with encouragement watch your inputs: what you consume, who you surround yourself with, how you talk to yourself, what you visualize.

How to stop comparing

  • Enumerating what you are grateful for including basic like health and clean drinking water.

Reframing setbacks

  • Just as the dimples on a golf ball allow it to travel further, hardship prepares you to persist. Talent or winning a lottery can be a curse since it skips the character-building that is usually required to get far. So look at setbacks as investments which will pay off in the future.

Talent is nothing without character.

Talk to yourself instead of listening to yourself.

  • How you label your feelings affects how you filter their meaning which affects their impact. Are you “nervous” or “excited”?
  • Ask yourself, “what is one thing I can do to make the situation better?” rather than “why is this happening to me?”
  • Nobody is forcing you to do anything. You choose what you do.

“There is only one thing you have to do in life, and that is die. You are always doing what you want to do because there is always a choice. You may not like the choices or the consequences, but you always have a choice. When you tell yourself that you have to do something it creates a negative internal energy, but when you realize you want to do something it creates a more beneficial internal energy.”

Remember this next time you think you don’t have enough time.

My Favorite Takeaways

The advice is simple and timeless

  • Just not simple to execute. Like losing weight. The strategy is straighforward but it is not easy.

Surrender what is out of your control while committing to what is.

Living by principles instead of feelings

  • Feelings are fickle.

Many days, you aren’t going to feel like working out and honing your craft. Many days, you aren’t going to feel like treating people really well. Many days, you aren’t going to feel like being unconditionally grateful. Many days, you aren’t going to feel like giving your very best.

But the principle says you are going to reap what you sow. The principle says that diligent workers are going to serve kings instead of ordinary men. The principle says to turn the other cheek. The principle says to seek wise counsel. The principle says to speak life and not death.

At the end of principles there is life, freedom, hope, joy, and peace.

The most you can expect from feelings is happiness. But like every other feeling, happiness doesn’t last. That’s exactly why trillion-dollar industries try to keep you chasing it because it is perpetually unavailable.

You are building your own house

  • The achitect parable

The architect, desperate to retire, is implored to design one final house. Since his heart is not fully in it, he cuts corners. Only at the end of the project does he learn that the firm that commissioned it, built the house for him. If he only know he was building his own house he would have designed it with maximal effort and pride. In life, we are all “building our own house”. 

Progress is not steady

  • Zoomed in it can look random with ups and downs and detours.
  • Zoomed out it is a step-function.

Remember this when you hit the inevitable detours and plateaus. 

Setbacks are investments

  • The grit it takes to overcome setbacks will be the basis of your confidence when hard times come. And they always do. By doing hard things you are training for life.

You are not as alone as seems

  • Curate your inputs and who you surround yourself with. Fill your environment with inspiration not naysayers.

Notes from Capital Allocators: Charley Ellis


About Charley: Charley Ellis is the founder of Greenwich Associates, author of 16 books, and one of the most sought-after industry advisors worldwide.

Otter Transcript (Link)

1. The Case for Indexing

The Evolution of Markets

Investing Environment 50 years ago

  • A device that reported the last, high and low prices and trading volume was cutting edge tech.
  • The money game used to be like stealing candy from children. 10% of trading at most was done by institutions.

Sparse Institutional Players

  1. Statewide branches were allowed but interstate branching was not allowed for banks. So every mid-sized and larger city had two or three trust departments.
  2. The second group would be the major insurance companies in Hartford
  3. There was a little bit of mutual fund activity up in Boston, a little bit New York and there might be some on the west coast.

Abundant Retail Investors

Were they hard to beat? No way. They were easy to beat. The secret to successful active investing is to have what’s called, it’s a little bit nasty term, but called “willing losers.”

  • Nice people who bought or sold once every year or two, usually an odd lot because that’s how much money they had. About half the time it was AT&T.
  • They bought because they’ve been given a raise or a bonus or an inheritance. And they sold because they’re sending kids off to college or buying a home or some other sensible purpose that had nothing to do with what’s going on inside the market.
  • They didn’t know very much, but that didn’t matter. They were buying a few blue-chip stocks that they read about in magazines.

Investing Today

The Talent Boom

  • Analysts

The number of people involved in active investment management, best I can tell, has gone from less than 5000 to more than 1 million over 56 years. A major securities firm might have had 10 or a dozen analysts back in 1962. What were they doing? They were looking for small-cap stocks and interesting companies that might be interesting investments for the partners of the firm. Did they send anything out to their clients? No, not anything. Goldman Sachs didn’t start sending things out until 1964 or 1965, and there was just one of the salesmen thought it might be interesting idea to put out. Today, any self-respecting security firm is worldwide with analysts in London, Hong Kong, Singapore, Tokyo, Los Angeles. 400, 500, even 600 people trying to come up with insights, information, data that might be useful to clients. Anything that might be useful. Demographers, economists, political strategists, portfolio strategist and every major industry team. Every major company will have 10, 12, 15 analysts covering that company. And of course, then if you go to the specialist firms, there are all kinds of people and then there are intermediaries with access to all kinds of experts in any subject you might like. We’ve got 2000 experts. And anytime you want to talk to any one of them, just let us know. Glad to provide so an unbelievable, flourishing amount of information of all kinds, all of which is organized and distributed used as quickly as possible. Instantaneously, everybody.

  • Global

The second thing is, Well, I hear about the CFA program. How’s that working out? Well, it’s off to a pretty good start. 135,000 people have passed the exams and another 250,000 people in the queue. The biggest crowd is the US, the second biggest crowd is China. The third biggest crowd is India. Its global. Yeah, of course its global. It’s all over the place — people want in on the good thing.

  • Trading

99% of trading is done by computers. Pros. We went from 3 million shares a day in 1960 to 5 billion today. And they know everything, you know, as soon as you know, and you can only buy from them and you only sell to them. How good a chance do you have of having this whole workout? And the answer is not very good.

Why so much competition?

  • Well, first of all, the investment world is probably the highest paid line of work for large numbers of people. It’s wide open to everybody. 
  • You don’t have to retire at 65 or 70. You can keep going to 80 or 85.
  • So the benefits around the edges that are quite nice. Anybody in the investment business knows once in a while, maybe once every 10 years, some unbelievably attractive opportunity, not really right for clients because it’s too small to specialize. But some really attractive opportunity comes up and says I would like you to invest in me. And it doesn’t always work out. But sometimes it can be beautiful. 

Paradox of Skill

So there you are professional investor, you have noticed that you’re getting better and better and better over the years because your skills keep getting better. You’ve got better tools to work with…You have research services like you’ve never had before…more sources of information, you get it very, very quickly, and can act anytime you want.

…So does everyone else

  • Flattening of skills

As more and more people get the same kind of computing power, the same kind of information, the same speed of access, more and more people get more and more equal to each other.

  • Flattening of info advantages

As recently as the 1980s, if you want to have a private meeting with senior management, all you had to do is show that you’ve done your homework that you were asking intelligent, probing questions, and that you had been coming back on a regular basis to this company. You were a serious investor. You could be invited to a dinner where the senior executives would talk about what their plans are for the future of the company. You could get a comparative advantage.

Today, the SEC now requires any public company that shares any useful information to any investor it must simultaneously make a diligent effort to be sure everybody gets that statement information. No more private conversations with management.

  • The increasing role of luck

All of us are in mixture of skills and good luck, when the old days, good luck when all that important, the skills really made a big, big difference. But the skills that they have might have diminished in their percentage or relative importance because they’ve got these fabulous tools in unbelievable supply. And it’s that that makes them all increasingly equal. Even though they’re getting better and better. They’re getting less and less different.

  • Playing bridge with all the cards face-up

Because everybody knows everything that everybody else knows, you may manage it a little differently, may make some mistakes a little differently. You may do some smart things a little differently. But it’s very hard to do significantly better than the other guys when they’ve got everything that you’ve got.

  • The genie isn’t going back in the bottle

Candidly, there isn’t any doubt in my mind that that transformation has already taken place so forcefully. And for really good, understandable reasons. It’s not going to reverse.

Indexing is the Logical Response

Unprecedented breadth and quality of competition means efficient pricing. Active management is a losing game when you consider that, adjusting for survivorship bias, 84% of funds underperform.

Benefits of Indexing

  • Top quartile performance, maybe top decile
  • Minimize fees which are a huge drag.
  • Lower taxes if you hold long-term

It’s passive and boring which helps you stay with it. Once you start transacting your behavioral biases undermine your goals.

“Passive” is poor label

He hates the word “passive” since it has labeled a great strategy with a very negative connotation word. Nobody wants to be called passive.

Caution on Smart Beta

  • These things do have real merit over the long, long, long term. But if you think about it for a minute, when will sales organizations ramp up their selling effort the most? And when will nice people who haven’t thought about it as carefully as they might be most tempted to say “let’s go with it”, of course, is after a very good period of rising prices. So if value has been working very, very well, the demand for interest in buying into and the supply interest in selling people on value factor investments will rise to a crescendo at the top and then people get disappointed.
  • The guys who have for years specialized in factor investing are going to find they can’t make as good a profit from doing it as they used to, because of the crowd. But they’ll still probably do a pretty good job for themselves and for their investors.
  • Beware those who are in it because it’s a good commercial opportunity. Intermediaries that are in it because they think “hey, this is a new way to beat the market” are going to create a self-disappointing experience and it’s a shame.

Indexing in China may be a mistake

  • The Chinese market is still dominated by retail investors which requires understanding how retail investors track past price performance and project future price performance.
  • You might find yourself being indexed with foolishness rather than an index with rigorous professional expertise.
  • This extends to indexing in emerging markets as well because there’s an unusual, different dynamic.

2. Concerns Over Indexing

Expensive Markets

There is concern that markets are not going to give what people need over the next 10 or 20 years. When Ted suggests that active management might outperform expensive public markets Charley replies with my favorite line in the interview:

Ted, Ted, Ted, you shouldn’t be talking that way.

He does not believe active will outperform.

How does Charley invest?

I’ve got two kinds of investment. One is index funds, which I’m happy with and just really comfortable with. And the second is an index fund equivalent in many ways –Berkshire Hathaway (he goes into his personal reasons for that).

Is there place for active management?

  • The bar for inclusion is exceedingly high. Charley, himself, has access to the brightest investors and sticks with indexing himself:

I’ve used myself as an example. I have probably as good a network of friends in the investments world as anybody, particularly in the active management world. I know, because of service on a whole bunch of different philanthropic investment committees, I happen to know an awful lot of guys who are really talented at picking talented people. And I meet with them on a regular basis. So you think, “hey, Charley, you are probably as good a position as anybody to be able to pick and choose terrific active managers.”

Why doesn’t he do more of the “clever” things that can be done?

Easy answer. I’m not good enough. I don’t know enough.

  • If not for Charley, who is active for?

Let’s be candid. You and I both have tremendous admiration for David Swensen. He should not be indexing. You know, why? He’s got all kinds of competitive advantage. Everybody loves David Swensen. Everybody loves the idea of working for Yale. He’s got the best team on his side, working with best managers anybody ever had. If you have a relationship with Yale, you know, it’s going to be a long term relationship, they average 10 years, their mentor relationship, something like 14 years. That’s the average, even though they usually invest with people at day one or before day one when they get into business. If you look at a list of their investment managers, you say, “geez, I don’t recognize most of those names.” That’s right. Nobody else does either. So a very unusual kind of investing. Guts, intellectual precision, and they do slightly better on asset mix. Half of 1%, maybe slightly better on manager selection, half of 1%, maybe got a team of 30 guys who are working to be sure they keep it up. And they got a network of friends and admirers all over the world, they get the best call, they do all kinds of vendors. So there are organizations like that and they’re not very many of them. Who else? There are pockets of managers who are extemely specialized and have their own money in the game, maybe some from outside investors. Basically a handful of managers with no real competition.

“If you are really an exception, you don’t have to index you can do something really different. But you have to be really good at your exceptional way of doing things. And you have to be not very widely followed or copied, because you’ve got to be almost alone doing it.”

  • How about private equity?

He makes a criticially important point here about the inversion in the supply/demand of capital :

The real competition today is not by the investment managers to get your investment money. It’s by the people who’ve got money to get access to the best investment managers. And that’s been true for the last decade and venture capitalist have clearly true in private equity. And that’s a really important differentiation.

He continues:

I don’t think there’s any very large pool of capital that has not addressed the following question. We have a commitment to a higher rate of return than we’re now getting. What can we do to increase our rate of return? Answer: Private equity. Great, so why don’t we put not 10%, but 20 or 30%. Let’s say 33% into private equity. And we’ll do it in a very imaginative way. We’ll have a couple of specialists who work on selecting the private equity funds employed by US, Canada, we can’t pay very high salaries because our fund structure doesn’t allow us to do that. But we’ll do the best we can. And we’re going to make a major commitment to private equity. Fine. So does everybody.

What is the PE landscape as a result?

They have more money than they’d really like to have. In fact, they’ve got cash balances they can’t use yet. They’re competing with other guys with a lot of money too. So the entry price for private equity has been going up and up and up.

Some people say “we’re not going to raise more money, we’re going to stay as small as we can, we’re going to specialize in our particular niche, and we’re not going to take new accounts.” So that takes them out of the equation. There’s another group that says, “Well, you know, if everybody wants us, we’ll have to be opening up more capacity. We’ll just take the money. Let’s see if we can find a way to invest it as we go along. But might be difficult, but we’re gonna try and you know, it’s always worked so far.”

Well, you could have a huge flood of cash going into private equity. You can ruin anything by raising the entry price.

The theoretical limit of indexing

  • What has to happen for the price discovery function to fail?

First, if you have 30% of the value of the market indexed, that’s not 30% of the trading activity, it’s a much smaller fraction. So what you have to do is have enough assets indexed to reduce the trading activity enough so that enough of that million plus people who are making their living as active investors comes down and down and down. Enough people need to decide “I’ve looked at it very carefully, and I’ve decided I’m quitting the business. I’m going into medicine, law, farming, ranching…”

What is it that people are going to go into that they think they’re going to find a more satisfying? Honestly, it’s not as good as it was, but it’s still the best game in town. It’s gonna be very hard to get people to give up on going into active investing.

  • If they do cut back a lot, how much do you have to cut back?

You’d have to cut back so far that there was not a residual group of people who are pretty darn good at price determination. My own guess would be somewhere around 85% would have to quit, just because it doesn’t make sense anymore.

Mix in the combination of interest of active managers, overconfidence, and people’s desire to be better than average and it doesn’t seem likely that the competition would abate enough to undermine price discovery.

3. The Pension Crisis

Scope of the Problem

Public pension plans are impossibly underfunded

If you look at what are the biggest problems we as a nation have in the investments world, it’s pensions or retirement security. You can see it easily in the state and city funds that are seriously underfunded. They need 7.5% rate of return which they’re not going to get because they’ve got 25% in 2.5-3% bonds. They’re just not going to get it.

Households are underfunded

If you look at individuals, half the population does not have a retirement plan. For those that do 401k is increasingly dominant, taking over from defined benefit system. The average person approaching age 63.5 which is the retirement age in this country is thinking:

“I’ve got 165,000 smackers in my account. Why my wife and I are going to Florida to play some golf, some tennis, have some fun. We’re gonna have great years. We’ve earned it. It’s been a long long working run, but we’ve earned it it’s going to work out just fine.”


Anybody with any knowledge about investing knows right away — $165,000 if you take money out, from 63 years old to 85 or 90 is not enough. You’re not going to have anywhere near enough per year, cobbled together with social security to make anything like a decent connection.

Something over 65% of your life time health expenses are spent in your life six months. Well, that’s where half the bank for personal bankruptcies come from all kinds of trauma that goes with that as well assisted living expensive and dementia. So we’re going to have a real problem with old age, retirement security.

Political nightmare

So what are people gonna say?

“God damn it. I worked hard all my life I played by the game rules as everybody laid them out. And I was supposed to be able to retire at a decent age and enjoy retirement. That’s part of the deal.”

But the answer they will get back?

“Sorry, but nobody else understands that to be the part of the deal. And you’re on your own.”

So you will have a giant generation that is angry, focused, and motivated to do something about this false promise.

If you think we’ve had divisive politics in the past, imagine what it would be if you had millions of people and their relatives all saying “It isn’t fair. It isn’t right. These guys got screwed.” I think we’re going to have a terrible societal problem, political problem.

How Did We Get Here?

The retirement problem is rooted in an era of different needs and circumstances.

History of the retirement age

  • Age 65 came from Social security which dates back to 1935,

which came from:

  • Railroad Retirement act in 1923,

and even before that:

  • Churchill and Chamberlain jointly put forward in the United Kingdom retirement at 70, but people thought that was unfair because the Germans used 65.

And here’s where we get to the root…

  • German’s retirement age dates back to early 1880s

Baron Von Bismark tried to unify the German municipalities via technology namely the telegraph and the railroads. The telegraph combined with the post office allowed instantaneous communication anywhere in Germany.

We’re going to bring coal and iron ore from the rural and other areas to where the steel mills are and we’re going to build steel mills and have tremendous industry. And then railroads are going to be able to bring people from the cities out to the countryside for weekends, vacations  can be normal, and we will bring from the countryside, fresh fruit, fresh vegetables, all kinds of wonderful things that for people to eat, it’s going to make everything terrific. That’s great.

But where are you going to get the workers to work on the railroad?

Offer lifetime employment.

You get them to come out of the forest because they can get lifetime employment. That’s terrific. What do you call that? That’s guaranteed. This is a commitment. It’s the honor of Germany. Okay. Let’s go.

So what happened?

Well after a couple of years there were accidents on the railroads. Trains ran into each other, people were killed. Public outrage and scrutiny.

What’s going on?

Well, let’s send a study group and find out what the heck is going with these accidents. Well, we found out what the answer is in the work. Laying tiles, lifting heavy ties, brailles, shoveling coal, all kinds of heavy work. They’re saying to the older guys in their late 50s and 60s, your too old for this kind of work. You take the easy job. You’ll be in charge of the switches.

Then what happened?

So the switches are being manned by guys in their early 60s. A beautiful summer’s day and no trains coming in for the next couple of hours, why not take a little nap? And they’re just taking a nap, forget to wake up, and the accident happened. 

The solution?

Guarantees for life. Pay them not to work. To be cost effective find the min-max where it costs not too much to solve most of the problem. And the answer was 65. Most people don’t live to 65 in those days in Germany, but those who do are really doddering, so they will only last for another couple years after 65 anyway.

An obsolete model

We have inherited and retained a retirement model that is a poor fit for our post-industrial circumstances.

    • People live longer now. The ratio of non-working to working years has increased.
    • People are able to work longer as manual labor’s share of the economy has declined.

Dealing with the Crisis

Extend your savings

  • Take social security later…instead of 62 if you wait until 70.5 you make 76% more inflation-protected for the rest of your life. If you wait, you have fewer years in retirement, so they’re willing to give you a larger amount.
  • Continue funding your 401k in your 60s. These are the easiest years to save money. So you can ramp up your savings, dump it into the 401k as fast as you could. (also there are catch-up allowances)

Do all of these things and your chances of being in serious financial trouble in retirement go from awful to not too bad. So if we act soon, we could make a big, big difference in what could otherwise be one of the worst problems our society has ever faced.

Why has this been so challenging to solve?

The big problem is nobody’s paying attention to it. It’s too late. Congress is dealing with politically urgent issues. We need to agree to raise the retirement age to 70 but it’s easy to say that when you are not a ditch digger or coal miner.