From his farm in rural Connecticut, Dr. Ben Hunt, the author of the popular investing newsletter Epsilon Theory, has whiled away countless hours pondering how abstract concepts like media and market narratives – and other similarly “unstructured” data – can be broken down and modeled so that they can be more easily understood by investors and traders.
Given Hunt’s diverse interests, it’s hardly a surprise that Grant Williams and Hunt covered topics as diverse as Game Theory and ant biology during the latest interview in RealVision’s investor series. The interview began with Hunt recounting the details of his childhood in rural Alabama, and how he first developed an interest in probability and games after reading Ed Thorpe’s landmark book on card counting, “Beat the Dealer.”
Hunt was a latecomer to finance. He developed an interest in capital markets at the age of 40 after earning a PhD from Harvard and launching a successful software company. For Hunt, the attraction to markets wasn’t the financial reward, but rather the challenge of working on one of the most complex and challenging puzzles of our society. And for a while, Hunt believed he had it figured out. While rival funds were sinking in 2008, his fund outperformed. However, Hunt struggled during the early years of the recovery, eventually deciding to return his clients’ money and instead focus solely on discerning the forces driving markets in this new paradigm. For Hunt, the first breakthrough came back in 2012 following Mario Draghi’s infamous declaration that the ECB would do “whatever it takes” (within its mandate) to save the euro. The market’s reaction to Draghi and the ensuing rhetoric from central bankers on both sides of the Atlantic helped Hunt to understand the new dynamics. In place of market “fundamentals” like economic growth, inflation and real interest rates, the narrative being propagated by the central banks (and their seemingly unceasing asset purchases) had become paramount in the market’s psyche.
And it was really trying to figure out, well, how do you invest in this different world because something has changed? Something has changed. How do you make money? And that’s what I’ve been wrestling with was not knowing. The game, which I thought I had kind of figured out– and we’ve done really well. I mean, you know I had a career year in ’08. The solutions I had found– it wasn’t working. There was something else at work. And it was really, I think, the summer of 2012, where it first really hit me what that other thing was. This was the summer where Draghi have his Whatever it Takes” speech. And I thought I knew the politics. I thought I understood the dynamics and set up the trade that would play for this. And I was wrong. I was wrong. And it set it up with a very asymmetry, so it wasn’t a big hit financially. But it was a big hit in terms of, what’s really going on here? And that’s when I started really trying to think about this to solve this puzzle. And how can words– again, the unstructured data. Forget about the econometric data and other stuff we can see. And forget about understanding how you know political coalition’s work and all like that. What is this with just these words making such a difference?
And unfortunately for market skeptics, the damage done to the natural process of price discovery thanks to this unprecedented central bank intervention cannot be easily undone. “You can’t unring this bell,” Hunt said.
How is the world different today than it was before the central banks started buying stuff? My answer is, well, look. You can’t unring this bell. You’ve got $20 trillion worth of stuff. It may go down, but it can also go up again. You don’t uninvent these things. So this is a new permanent feature of our investing environment. The other new, and permanent, feature is the extensive use of our words and the conscious creation of narrative to try to drive investor behavior.
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There’s nothing new about this. What is new– two things. One, central bankers finally figured this out. And that’s why we have– every day, you trip over yourself finding another Fed governor giving a speech or the like. It’s a very conscious policy. It is absolutely part of this. That’s where narrative comes from. It really is hardwired in us. We are trained to respond to this stuff. It makes us very successful. I wouldn’t take it away for the world because just like the ant, and the bee, and the termite, our ability to communicate, and our puppet strings, because the communication, is how and why we build cathedrals, and go to the moon, and do all the great stuff that we do as a crowd.
Right now, the two most important figures responsible for shaping the dominant market narrative are Mario Draghi and Jerome Powell…their influence far outweighs even world leaders like President Trump.
As you’d expect, the two most powerful missionaries in the world are whoever is the Chairman of the Federal Reserve and whoever is the president of the ECB. So right now, Powell and Draghi are, by far, by an order of magnitude, more influential in shaping, creating these narratives than any one else–like, 1/10 the influence of a Powell or a Draghi is going to be a Trump or a Merkel. Well, the story we believed in– value investing or quality investing– it’s not that it went away– this is the point of the three-body problem– it just doesn’t matter as much anymore.
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It’s not that it’s not that value doesn’t exist anymore or value doesn’t work anymore. It’s that it’s going to work differently. What do I mean by that? What I mean by that is that the impact of central bank buying– the mechanistic $20 trillion, and the impact of everybody is now in on the act of creating narratives and doing it in a very effective way– what I think that means is these things create what I call, “meta stability.” And what I mean by that is that the period of time where value doesn’t work is going to, I think, last a lot longer than it has in the past. And that’s so difficult for people in our business.
And while there’s no escaping the all-encompassing market narrative being propagated by central bankers, investors can still find ways to insulate themselves by questioning every piece of news and information they receive about markets.
Well, you’re never going to isolate yourself from these folks. And you wouldn’t want to. But you can insulate yourself. And I think the most important way to do this– and this is something everyone can do– is not to read more or read less. Read differently. Read differently. And what I try to do whenever I read an article in the journal, or I’m listening to CNBC, ask yourself, why? Why now? It’s so rare that it’s actually a breaking piece of news. And what is rampant today is what I call Fiat news. It’s a Fiat currency. We’re creating currency, money, out of our imaginations. Fiat news is really the creation. We’re going to call it news, but it’s really opinion.
When politicians, central bankers and pundits try to bundle their information with an angle that instructs the reader how to think, it’s up to the reader to not take the bit, Hunt said.
And this is what everyone tries to do. Again, I don’t mean this as a bad thing. But this is what politicians, or bankers, or investors, or anyone who gets in front of a camera– it’s what we’re doing right now– we’re not just shaking our finger at people, we’re not just telling them what, we’re not just telling them the facts. We’re trying to tell them how to think about those facts. And when it’s presented as fact, as news, that’s what we are bombarded with. So this is my first line of defense– to ask, why? Why now?
Of course, market narratives are nothing new. Analysts have sought to spread opposing narratives of individual stocks since the birth of modern markets. The difference now largely comes down to scale: It’s the birth of the meta-narrative. Fortunately, Hunt believes that this narrative can be broken down, analyzed and understood using contemporary technology like Natural Language Processing.
And so I’ll say that thinking about value, and growth, and quality as stories is kind of the PhD topic– that’s kind of the advanced study– so if we’re kind of thinking of a continuum of these things, it’s stories about companies. Like, what’s the story about Tesla? Or what’s the story about IBM? Everyone can kind of, OK, yeah, I’m familiar with that. On the far end, what I’d like to convince everyone is that things like, growth and value– those are stories too. In the middle here is things like the story around inflation and the story around trade. So let’s start with those. And what you can do, I think, today, is with these technologies that are based around what’s called “Natural Language Processing,” NLP– it’s a branch of artificial intelligence. The thing is very powerful. It’s a way to apply the massive processing power that drives big data and AI– but to do it in a very specific way. And the very specific way is to read—read all the articles, all the transcripts, all the recordings, of the transcripts of every CNBC episode, and the like– not as a human does, where we’re doing serially and very selectively, and read this article or that article– but to read them all, and then to compare them all with each other so that we can really, again, visualize.
The power of these narratives cannot be understated, Hunt said. After all, central bankers’ willingness to intervene may have saved capitalism from an all-out collapse during the financial crisis.
And in a lot of ways, the great financial crisis and then the willingness, and the ability of central banks to come in and prop the entire system up– I think it saved the world in March of ’09. I really do. But we’ve seen this in other periods of enormous debt– the 1870s, the 1930s, where emergency government action becomes permanent government policy. And I’m not saying that’s good or that’s bad. I’m just saying it is.
But the risks haven’t disappeared – they’ve just been repressed for a time. We’ve seen this before, Hunt said. But the real question is: How long can this permanent government intervention hold the system together?
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