Opus 2: What Will and Will Not Change?

Along with Anti-Reflexivity, Dog Walking, & Liszt's Consolation No. 3

Today’s Musings

We Are All Socialists Now

America: the last standing, pure capitalism where free markets reign and the private market always trumps its public counterpart. Just kidding. We are just as socialist as Europe, the Nordics, etc.

The U.S. Government (counting only the fiscal spending, ignoring the $4 trillion+ in monetary policy) has now spent more combating the invisible virus than they spent on the Korean, Vietnam, Gulf, and Iraq Wars all combined, adjusted for inflation. We are now approaching Nordic levels of government spending as a percent of GDP (48-50%) with the latest stimulus pushing 2020 expected expenditure to nearly $9 billion.

As the markets started their precipitous falls, the CNBC talking heads and pundits came on demanding the U.S. government catch the falling knife. Over the last decade, those same people bragged about America being the last standing free market, an economy without the heavy hand of the government intervening. We are capitalists on the way up, but socialists on the way down.

What Will and Will Not Change?

It is preemptive to think about what all of this will change moving forward, but that is the job of capital allocators at the end of the day. So, what will and will not change?

Socialized Healthcare: We don’t have the exact data yet, but it is not outlandish in my mind to say that a disproportionate amount of the poorer people in society will pass away as a result of Covid-19. The below map shows a loose correlation so far with wealthier neighborhoods (i.e., Upper East & West Sides) are at much lower infection rates than poor neighborhoods farther outside the city center (broader Bronx, Jamaica, Borough Park, etc.) where healthcare access is worse and the workforce is entirely service-based and mostly essential:

Financially and socioeconomically speaking, the virus is indifferent as to who its host is,\. But, the worse off people within our cultures are the ones that 1) have non-WFH jobs and must continue working to keep the barebones economy running 2) have no optionality to stop working because of the lack of savings and 3) have the most community-focused culture in their daily lives which will lead to the most severe spreading of sickness. This inequality of death will only increase the voices behind the "Medicare For All” camp and, more broadly, a change in the health system.

As I have written previously, our healthcare system broke because it is a hybrid of two combative structures. It is becoming well known that a majority of our healthcare system costs come from the admin required for the convoluted pricing and mixture of payers. This will change.

Banning of Share Buybacks: I have previously touched on the impact of share buybacks on equity performance - roughly 15% of the returns in the current bull market. Mostly driven by debt, repurchase programs have accounted for up to 90+% of free-cash-flow within stagnant industries such as airlines, manufacturing, etc.

The airline industry bailout must include equity issuance to the U.S. Government so the regulators can have voting power over the firms that are receiving tax-payer money. The finance textbooks will no longer include “buying back your own equity” as one of the best ways to maximize shareholder equity.

Volatility: My latest post is regarding the future of volatility - I hope to have this published in the next few days. For most of the last millennium, interest rates have uniformly gone down, in turn, meaning a decrease in known risk or, at the very least, and better understanding and modeling of known risk:

Since 1971 and the arrival of the current central banking paradigm, much of the asset pricing models were driven by both the fundamental performance of the asset and an expectation of what the central banking bodies will do. Ben Hunt accurately labeled this phenomenon as “The Three-Body Problem” where this exogenous force (monetary policymakers) has made it physically impossible to predict the market confidently.

In short, will the future be more or less volatile? The monetary bodies have allowed their Jekyll Island Creature to escape much like Audrey II from Little Shop of Horrors. The hybrid model of a free(ish) market backed by an infinite money supply has shown its true self in the last few weeks. We are now entering the strong form of monetary policy where the policymakers will be liquidity originators, rate-setters, money supply dictators, and work in tandem, rather than independently, with the fiscal authorities. Therefore, measurable volatility at the surface level (i.e., markets, economic data, etc.) will continue to fall as the whack-a-mole player grabs the biggest hammer on the shelf. This will eliminate all psychological / anthropological bubbles like The Great Depression and the 2008 financial crisis. The new-found horror of biological disasters will now be hedged against with billions, if not trillions, in new research funding - made easier by the new MMT paradigm described above. The final pseudo-known risk is a geopolitical / terror driven crisis. Covid-19 has shown global powers can coordinate against a common enemy and I expect this behavior to mostly continue after the virus subsides. While 2019 did see a rise in revolts and a subjective fall in freedom, I think these are off-trend blips in the broader movement. More nations are moving toward democratic structures, while subcultures (Hong Kong, etc.) are gaining more of their independence from the parent countries.

For further reading, recommend diving into Politico’s round-up of opinions on this idea from people far smarter than myself. Daniel Korski also has a good round-up of more dystopian ideas.

Covid Anti-Reflexivity

"Reflexivity: When cause and effect are the same. People think Tesla will sell a lot of cars, so Tesla stock goes up, which lets Tesla raise a bunch of new capital, which helps Tesla sell a lot of cars." - Collab Fund

It is an interesting thought exercise to think about crises in the reflexivity context and how different collapses react to the reactions of people. The market <> economy relationship is entirely reflexive: the market front-runs economic data in the expectation of weak readings and then the economy slows further because capital markets derisk, in turn, scaring consumers.

Biologically pandemics are anti-reflexive; they worsen only when people’s attitudes towards them are dismissive and ignorant. As I stated in Opus 1, the only thing to fear today is the lack of fear itself. I feel better about the whole situation each day as the general public becomes more fearful. Put another way, the greater the reaction to the effect, the less severe the root cause is.

Imperialistically motivated wars, and their subsequent power vacuums / crises, are reflexive. The entrant of a foreign power to stamp out an “evil” force only motivates more participants to fight against that foreign power (*cough* America) to defend their culture and system. The greater the reaction to terror cells, the more terror cells pop up and pushback.

Economic cycles are uniformly reflexive (until the irrational capital dries up or an exogenous event happens) - see the Tesla example above, the Dot Com cycle, 2008 MBS behavior, 1960’s computing hardware, etc.

What other systems are anti-reflexive?

Homework Reading

The Mother of All Cognitive Illusions - Robert H. Frank

The 2020 election will be chalked full of discussions (childish, yelling arguments actually) surrounding personal income taxes. They are the #1 source of government revenue, so it makes sense there is so much focus. But, a look back in history provides essential context for where we are today.

“How will higher taxes affect me?” the natural first step is to try to recall the effects of similar events in the past. When high-income people try to imagine the impact of higher taxes, Plan A is to summon memories of how they felt in the wake of past tax increases. But that strategy doesn’t work in the current era, since most high-income people alive today have experienced steadily declining tax rates. In World War II, the top marginal tax rate in the United States was 92 percent. By 1966, when I graduated from Georgia Tech, it had fallen to 70 percent. In 1982 it was 50 percent, and it is now just 37 percent. Apart from brief and isolated increases almost too small to notice, top marginal tax rates have fallen steadily since their World War II peak. Similar declines have occurred in other countries.” (12 min read)

The Merits of Bottoms Up Investing - Brett Bivens

Brett’s post and the broader comparison between bottoms up investing and top-down, thesis-driven investing, especially in the context of venture investing, has drastically changed the way I think about my job. While I have always been a macro thinker, I need to realize I don’t know what happens tomorrow, let alone five years from now.

“Our job is not to see the future; it’s to see the present very clearly. This alignment shines through clearly across the partnership — whether it is Sarah Tavel talking about her investment in Chainalysis, Chetan Puttagunta explaining the logic behind his investment in Sketch, or Eric Vishria responding to a "request for startup" in the Open Source space: "We're not top-down like that. It is so organic. When an entrepreneur pitches and tells a story that provides an insight that makes you think about the world differently, that's when I get really, really excited. And that's why it is really hard to be top-down and why we don't tend to be particularly thesis-driven.” (20 min read)

Beyond the Trees - Adam Shoalts

I just finished Beyond The Trees last night, which was a read that kept popping up in the backcountry Reddits and discussions. The book is a daily journal of Adam Shoalts: a Canadian backcountry trekker canoed across Canada from the Demster Highway to Hudson Bay in three months.

“Nowhere makes you feel as small and insignificant as wandering alone across ancient lava flows that were already a billion years old before the first dinosaurs ever walked the earth. Nowhere makes you feel so alive as on a pristine lake, the spray of cold water in your face and an impossible horizon to be reached with your paddle strokes. Nowhere I know conjures up so much enchantment and wonder as an ancient forest, with fragrant spruces and tamaracks, birdsong, and wolves that look you in the eye. There’s a kind of magic to these wild places; the kind of thing that can’t be captured in words.” (252 pages)

Walking the Dog Is the Only Time I Feel Sane - Lisa Miller

A timely piece in light of the micro isolationists we have all become. As an owner of a Golden Retriever, our walks are the only normal thing about this strange new routine we have all adopted.

“The feeling of normalcy the dog walk gave me was so intense it was like a fantasy of an old routine. While in the park, I could pretend that what was happening in my apartment — the rearranging of furniture to make more workspaces, the teenager sleeping in on a weekday, the cooler of vegetables out on the fire escape — wasn’t happening. The dog took her shit, and I picked it up with one of the plastic bags I usually keep in my pocket, and I dumped the whole mess in a garbage can and noted that the can was empty, meaning that the garbage service in the park was functioning, and also noticed that workers in trucks were doing maintenance on the baseball fields and shrubs were being pruned. Other people out with their dogs said hi, and smiled, and it all felt very busy and regular, like the park on any other day, just that I was a little more awakened to what was beautiful about it.” (12 min read)

Today’s Music

Franz Liszt’s Consolation No. 3 (S. 172, R. 12) - Performed by Murray Perahia

While last week’s Chopin piece was my all-time favorite piece to listen to, Liszt’s Consolation No. 3 is my favorite to play. This is both because of its calming effect but also because Chopin’s Fantaisie-Impromptu is far too difficult.

The left-hand anchors the entire piece with a calming arpeggio structure switching between D-flat major, B-flat 6th, and A-flat 7th.

Murray Perahia’s performance has the most calming character behind it in comparison to some of the modern performers (namely Lang Lang & Valentina Lisitsa) and I have always found Horowitz’s world-famous performance of the piece to be a bit too fast and flat at times.

The Encore:

My current repeat listenings are more contemporary artists with a minimalism style:

The Broad Sun - Chad Lawson - Many will have herd Chad’s Nocturne in A Minor; his soundtrack pieces are equally beautiful.

Sol and Luna - Joep Beving - A piece made for nothing less than an epic movie soundtrack. An Icelandic native, Joep is quickly becoming one of my favorite 21st-century composers.

Fire - Fabrizio Paterlini - All of Fabrizio’s pieces have incredible emotion behind them.