Epsilon Theory

Today’s markets require an investment approach viewed through the lenses of history, game theory and market structure, detailed in Salient chief investment strategist Ben Hunt’s acclaimed Epsilon Theory newsletter.

FEATURED POST

American Hustle

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

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

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

You Had One Job

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

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

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

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

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Anthem!

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

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

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

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Virtue Signaling, or … Why Clinton is in Trouble

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

salient-epsilon-theory-ben-hunt-virtue-signaling-september-30-2016-cutlerThe US election now looks to be neck-and-neck, pointing out a structural weakness in the Clinton campaign. I see virtue signaling galore among her supporters, communications to the Democratic tribe that you’re a good person because you’re against Trump, never mind whether or not that helps the campaign. The stakes are high, as Trump threatens to transform every game we play as a country – from our domestic social games to our international security games – from a Coordination Game to a Competition Game.

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Essence of Decision

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

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

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Magical Thinking

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

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

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

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

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The Narrative Machine

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

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

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Crisis Actors and a Reichstag Fire

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

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

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Statements in this communication are forward-looking statements.

The forward-looking statements and other views expressed herein are as of the date of this publication. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Salient disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

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