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What It Is and What It Isn’t.

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Michael Crichton, who wrote “The Andromeda Strain” when he was in med school and went on to pretty much invent the scientific thriller genre, liked to tell the story of what he called the Gell-Mann paradox, named after his friend Murray Gell-Mann, the physicist who discovered quarks and brought this behavioral phenomenon to Crichton’s attention. To paraphrase:

“Whenever I read an article in the newspaper, and it’s about something where I know exactly what the facts are – for me it might be a Hollywood business deal, for Murray, physics – I am always amazed by how the article invariably gets it exactly wrong. Not just wrong in the facts of the matter, but wrong in interpretation, impact, motivation … everything. It always makes me so angry to read these articles. But then I turn the page and read an article on something I know nothing about, say Palestine, and I go, ‘hmm, that’s interesting.’ It’s as if I’m struck by amnesia when I turn the page.”

Anyone who has worked in a field that becomes grist for the media mill knows the Gell-Mann paradox all too well. For me, the latest example was the constant media drumbeat last week that the market sell-off – in sharpness if not in origin – was because the “Machines” were feeding off each other and creating “selling pressure” on markets. The bogeymen were the usual suspects – Risk Parity and other systematic strategies that “Target” volatility in some [wave hands here] arcane but undoubtedly dangerous fashion.

Almost everything that I heard proclaimed last week by the usual talking head suspects on the subject of systematic strategies and “Selling pressure” – a subject that I know really well and am professionally immersed in – was wrong. Not just a little wrong. Completely wrong. Wrong in fact. Wrong in interpretation. Wrong in impact. Wrong in motivation. Just jaw-droppingly and mind-numbingly wrong.

Epsilon Theory

But I also know, courtesy of the Gell-Mann paradox, that nothing I can do or say will make much of a difference in countering all this. I mean, I can point you to what’s been written by other people who are similarly immersed in these strategies, here in long-form at AQR and here in bite-sized form by our very own @wrguinn. I can tell you that, in my opinion, what you read in these links is entirely accurate and truthful. I can tell you that, in my opinion, almost everything you heard or read about these Strategies last week is hokum. But it won’t make a difference.

Why not? Because Gell-Mann paradox. Because everyone who isn’t professionally immersed in these strategies (99.999% of the financial services world) is going to believe, or at least suspect is true, whatever they’re told by a media Missionary. Just like I am on any subject I’m not professionally immersed in. It doesn’t make us bad people. It doesn’t make us stupid people. It means we’re people!

We are hard-wired to respond positively to Missionary statements in a Common Knowledge Game, and right now what everyone knows that everyone knows is that “machines” create “selling pressure”.

I can’t fight that. All I can do is mutter Eppur si muove and move on. Look it up.

So … moving on … we published a piece last week on Epsilon Theory that captures what we DO think is responsible for what’s going on in February (and the months ahead), titled The Fundamentals Are Sound”.

What IS responsible? We think it’s every asset owner in the world rethinking their portfolio risk in an Inflation Is Coming world.

To be clear, we don’t know what the inflation Truth is. But we think we know the inflation Narrative. It’s a story where input prices and commodity prices have been strong for months as part of the “Synchronized Global GrowthNarrative. It’s a story where “Wage Inflation” made its long awaited Narrative debut in the February jobs report. It’s a story where every market Missionary – from the White House to the Fed to the ECB to the BOJ to the PBOC to the Banks to the Street – is hell-bent on getting behind this story and declaring victory.

I’d argue that there is no more important question for long-term Investors and Allocators than getting the inflation question right. You don’t have to be precisely right, but you sure better be generally right. That’s the source of the “rethink” that’s happening right now, and that’s why we don’t believe that what’s happening in markets is a temporary blip or a “technical” adjustment. It’s the first stage of a fundamental shift in the behavior and beliefs of investors, and that’s a really big deal.

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