Transcript00:01SVEN HENRICH: Sven Henrich, been running Northman Trader for about six years.00:05Originally, private investors, way background was corporate management actually in corporate00:10strategy internationally, always been looking at companies and opportunities.00:14Hence, the background and analyzing stock markets comes natural to me.00:19Our business model is really looking at identifying the big moves.00:24We’re not day traders where we’re looking at swings, so be it long be short.00:27Of course, as part of that, we’re looking at the macro environment markets in general–00:32central banks, what have you, although that’s secondary, the key is technicals and being00:38able to identify the big turns and that’s what we do.00:41You see me on Twitter, @NorthmanTrader or on the website, northmantrader.com.00:48Yeah.00:49In April, I had put out a piece called, “Combustion”.00:55It was this whole notion that both bulls and bears need to be mindful of potentially this01:01really uplifting scenario.01:02We had a big turn from the lows of 2018.01:06We’re literally all central bank policy combusted by them and the view was we’re going to be01:11raising rates, we’re going to be having a reduction in the balance sheet on autopilot.01:15Then of course, markets dropped 20% and then yields dropped, actually started the other01:21way around.01:22Basically, it was yields heading to 3.2% on a 10-Year in October, and that sparked a whole01:27selloff in my mind, but basically, central bank’s completely reverted policy.01:33The Fed had this whole job owning operation all year long from tightening to easing and01:39rate cuts are coming.01:41That’s what they’ve been doing all summer long.01:43In April, what I said was we’re going to keep going on this trajectory until something breaks.01:50We had a quick correction in May, we had some of the same negative divergences that we have01:56in the fall.01:57Something interesting happened here, because we had a temporary high and then we had the02:03correction.02:04Then in July, we came to a new high and we had a correction.02:08In June, actually, I had put out this piece called, “Sell Zone,” this was at the end of02:12June, just before the Fed meeting in July, and the notion was this period, this price02:18zone between S&P 3000 to 3050 is a sell zone, listed a whole bunch of technical factors02:24for that.02:25We had the initial reaction.02:26It was coming off the heels of the Fed rate cut, the first rate cut since the financial02:30crisis.02:31We dropped from 3028 down to about 2780 on the futures contracts.02:37A snappy technical reaction.02:39Then it all started again with trade optimism and more rate cuts coming and so we rallied02:45again into September.02:47My view in April was that would be this potential for a blow off top move and the ultimate target02:54of that was about 3100 as an extreme case.02:59Now, what I find interesting here is that in September, we got back to this 3000 zone03:05that I had identified at the end of June as a sell zone, 3000, 3050.03:10We got another rate cut.03:13The ECB cut, and we got to 3022, just below the July highs and we dropped again and so03:21now we have to rate cuts, two drops, potential for double top because we have these all new03:28highs up and sold in the last year and a half.03:31There’s not been yet evidence that any new highs are sustainable so markets have been03:35this wide range.03:38In 2019, primarily driven by multiple expansion, either by trade optimism, or by the Central03:45Bank put and my question in general has been, what’s the efficacy?03:49Is there a sign that central banks will actually start losing control of the price equation?03:55We’re at the edge of control here.03:57We’re still in this phase here with the China trade negotiations.04:02Global macro has been slowing down throughout the year, the US was the island and the sun,04:08if you will, because global markets actually peaked in January of 2018 and then the US04:13decoupled from the rest of the world.04:15Europe, very close to a recession here.04:19The manufacturing data is maybe now spilling into the services sector.04:24There is now risk that we’re ultimately going into a global recession into 2020 and what04:30central banks obviously, have clearly stated, their intent is to extend the business cycle04:36by any means necessary, and we can talk about that separately.04:40We’re now at this critical point.04:42Will we get a trade deal that’s substantive?04:45By substantive, I mean that actually impacts CEO confidence.04:51Keep in mind, this whole year and a half year with this trade war going on, companies have04:57been holding back on CapEx investments, business investments, and now, we’re seeing a slowdown05:01in hiring.05:02Remember, with a 50-year low in unemployment, the official unemployment rate, and jobs growth05:08has been slowing down.05:11If you get a– and I’ve been very consistent on this, if you get a substantive trade deal05:16that addresses all the big issues and causes companies to say, “Okay, now we’re more confident05:21again,” then yes, you can have a massive blow off rally and now, with easing central banks05:28and the oldest liquidity coming in, you can have that run.05:31The question is, are these parties really in a position to say we’re going to have a05:36substantive trade deal?05:38There does not appear to be any sign of that whatsoever.05:41We see a lot of positioning, actually this week even, we see China in the US aggravating05:47the tactical battle, if you will.05:49China is– in this morning’s indicating they may be open to a partial deal.05:53What does a partial deal really mean?05:56Is there probably a relief rally surrounding a partial deal?05:59Probably.06:00We can all speculate in the sense that, “Okay, well now, it’s not going to get any worse.”06:05It’s a stalemate.06:07We’ve basically, everybody’s waving the flag.06:10Mr. Trump wants to get reelected in 2020.06:13Can’t afford a recession.06:14The Chinese don’t want things to get worse either.06:17Everybody’s holding back.06:18Fair enough.06:19That could happen, but is it enough to then get confidence back to say, now, we’re ready06:24to invest when the big issues remain unsolved?06:29That’s obviously the question that no one can answer.06:31Now, of course, the flip side to this is there’s not enough that the parties either can agree06:38to that gives anyone any confidence because keep in mind, all the slowdown has perpetuated06:44in the last year and a half.06:47There has not been any sign of slowing down, maybe a little bit civilization in China but06:51now, the US is slowing down.06:53In fact, I think it was the Fed’s Rosengren that came out last week, and says he’s expecting06:571.7% GDP growth for the second half of the year in 2019.07:03Not exactly convincing when you have a market that has rallied on nothing but multiple expansion07:09in 2019.07:10There’s a lot of risk both to the upside and the downside from my perspective.07:19On the one hand, yes, there’s some similar elements.07:21On the other hand, people like to say it’s different this time.07:24Well, it really is different this time because, look, in the past, we’ve had situations where07:29we’ve had high debt, and we’ve had yield curve inversions, we had all these things that are07:33taking place at the end of a business cycle, but never before have we seen so much intervention,07:40so much jawboning and never before have we come out of a business cycle where central07:46banks have not normalized in any shape or form.07:50This is uncharted territory.07:53I think we’re all– I don’t know what the expression is so maybe we’re all mollified07:59or pacified in a way because markets have changed so dramatically over the last 10 years08:06as a result of permanent central bank intervention.08:09I get it from any investor perspective, because we’ve all been trained, literally trained08:16to know that any corrective activity in markets is contained.08:23It’s contained within a few weeks, within a few days, within a few hours.08:28All bad news is priced in immediately.08:31We saw it in December.08:33This was the most substantial correction we’ve had since 2011.08:37Why did that happen?08:38It stopped right when Mr. Mnuchin came in with his liquidity calls to banks and with08:43Mr. Powell flipping policy on a dime.08:46We’re flexible suddenly.08:49This is this point where you never have anything that sticks from a price discovery perspective.08:57My concern in general and the voices in the summer was that we’re creating these markets09:03that disconnect ever farther from the underlying size of the economy.09:09Well, there’s two trains of thoughts.09:14First of all, this is a history part of it.09:18History actually tells us that the inversion we have on the 10-Year and the 3-Months actually09:22precipitates a recession every single time.09:25The question is the timing of which.09:27Now of course, you have other yield curves.09:28Some of them which are inverted, some of which are not, but it’s really the point of the09:34steepening.09:36Once that inversion reverts back into a steepening phase, that’s when usually the recession comes.09:42We’re not at the point yet where that steep learning has taken place.09:46However, the 10-Year and 3-Months, it’s been inverted for several months now and that’s09:51typically one of these classic warning signs.09:55There’s another school of thought that says basically, well, none of this matters anymore10:00because we have central banks intervening and blah, blah, blah, blah, blah.10:03I’m not of that viewpoint.10:06I think the signals are there.10:09What’s missing for the bear case, frankly, as I called it the missing link is the fact10:15that unemployment is still okay.10:18There’s not been a minute where it’s been slowing.10:20We haven’t seen that flip yet, where companies are suddenly really going into layoff mode.10:27That’s what interesting looking at Q3 earnings now, because a lot of companies will show10:34either flat or actually negative earnings growth, which brings me back to this multiple10:38expansion.10:39We’ve been running to market highs, not because of great earnings growth.10:44Earnings growth is flat to weakening here in this quarter and so companies are experiencing10:51margin compression.10:52Then there is that point where they want to start looking at the largest expense line10:58item, which is jobs.11:03What’s been so interesting and the reason I kept saying that all new highs are sells11:08is because all these new highs are coming on specific technical signals and sector divergences.11:16Especially looking at this year, again, we see– well, last year was basically again,11:22this was tech, it was Fang-led.11:24It was the big tech companies.11:27All new highs came on negative divergences on the technical basis and they were sells.11:31What was interesting, ever since 2018, the markup of the market has radically changed.11:37Last year, the banks were leading, the small caps were leading, right into these September,11:43October 2018 highs.11:45That has completely changed in 2009.11:48You overlay a chart with the SPDRs vis a vis small caps and transports and the banking11:53sector, it’s a horror show.11:56When we’re looking at the S&P like in September and again, within all-time highs, I can tell12:00you if you go back to exactly last year, the banking sector small caps and transports,12:06they’re all down to 11% to 13%.12:09They’ve not participated.12:10In fact, they’ve been in months long ranges.12:15It’s amazing because you see these rallies go up as and hey, people get bullish again.12:20Then they drop right back to the bottom but the bottom is holding.12:24Even this week, again, the small caps, transports and the banking sector, right on the edge12:28of support and they keep bouncing.12:30Now, I look at this from a technical perspective, I say, “Okay, well, the more often you tag12:35a certain area, the weaker it becomes either to the upside or to the downside.”12:40We’ve tagged these areas now multiple times and for a rally to convince, for new highs12:47to convince and to be sustainable, we need to see those sectors partake and get above12:54resistance.12:56Until I see that, I’m very suspicious of any new highs if we get new highs and from my13:04perspective, going back to this whole trade deal, unless we see a substantive trade deal,13:09I view any rallies to new highs as sells because that’s basically what they’ve been doing.13:15Just one more thought on this whole sector piece, there’s a chart I’ve been publicizing13:20quite a bit that’s called the “Value Line Geometric Index.”13:23It’s a fascinating technical indicator because all these indexes are market cap based.13:30The Microsofts, the Apples, the Amazons obviously have a dominant impact on an index like the13:36QQQ because they’re worth a trillion bucks each.13:40If you take all the stocks and put the same dollar value on them, let’s say everyone is13:45worth 100 bucks, and now track their relative performance, you get a completely different13:50picture.13:51What we’ve seen since 2018, since the September 2018 highs, is that all new highs that were13:57made on the S&P come on the lower reading on the value line geometric index.14:03That’s another one of those signals that tell you, “Okay, these new highs have been a sell.”14:08See that picture change, then you can have sustained new highs.14:12To me again, it comes all about efficacy of what the central banks are doing whether we14:16get a solid trade deal or not.14:18Because in so far, none of these things have shown any impact or suddenly changing the14:24growth equation in the economy.14:31Volatility has been fascinating.14:32I’ve been publishing quite a few pieces on the VIX in the last few months.14:37The VIX, I hear this all the time and I keep having to push back.14:42People are saying you can’t chart the VIX because it’s a mathematical derivative product.14:47Yes, you can chart the VIX.14:49In our job, what we do, obviously, we always have to look for what is relevant.14:55We can all have our opinions.14:58What markets should do or shouldn’t do, they will do what they will do and what we have15:04to do is keep ourselves on this and to see what is relevant.15:07We know a lot of algorithmic trading is part of markets.15:12They follow programs as well.15:14You always have to look at, “Okay, what are they looking at?15:17What are they sensitive to?15:19What are they reactive to?”15:20Because we want to be able to interpret risk reward short or long on that basis as well.15:27What the VIX has done over the last two years is fascinating.15:30There’s been very specific what I call compression patterns in the VIX, especially on the low15:36end.15:37It can drive people nuts.15:38It can get caught, consolidate on the low end and then boom, you have a spike.15:44That seemingly comes out of nowhere, but it doesn’t.15:48It’s in the charts.15:49I call them these compressing wedges.15:53Now, what’s been happening on the big picture on the VIX is as the S&P has made new highs15:58each time, the VIX and the in between periods has made higher lows.16:03There’s a trend of rising volatility.16:06Obviously, December last year was the big spike.16:10It’s the lows, what happens during the lows?16:13Remember, 2017 was the most volatile compressed year ever because we had global central bank16:19intervention, we had the upcoming tax cuts, there’s no volatility markets from a trading16:25perspective, I hate that.16:26I love volatility, I want to see things move, but now that we’ve had these selloffs, even16:32the smaller ones, if not been able to contain volatility to the extent that they’ve been16:38able to do in 2016 and 2017, since 2018, we have a trend of higher lows.16:46Now, the VIX is again in a compression pattern that suggests the possibility of a sizable16:52spike still to come this year so we may have one more hurrah before the yearend rally that16:59we so often see in markets.17:05I think this whole shift of passive is fascinating.17:08Maybe a couple of comments on that.17:10I haven’t seen this discussed anywhere.17:12Just my impression.17:13I’m wondering how much of the shift from active to passive investment is actually a consequence17:20of central bank intervention.17:23What is driving passive?17:24Well, you talk about management fees on the active side.17:27Well, the main driver for the movement to passive is that people have given up.17:32They see active investors lagging the indices.17:35Why are they logging the indices?17:37Because everything is geared towards the big cap stocks.17:41The intervention– if you’re really careful in analyzing and you’re smart and you have17:46a smart team, if you diversify in the universe and you get hammered anywhere you lag in the17:54indices, and passive allocations keep allocating passively.18:00It’s like this dumb machine that doesn’t care how much it pays.18:05It doesn’t care what the valuations are, doesn’t care about any of that.18:11To your point about signaling, yes, it’s amazing when you see– and that’s why I’m coming from18:16a technical perspective, you see charts that are massively, massively historically overextended18:24but no one cares because you have this passive machine that keeps investing.18:28I think I mentioned this last year, too, it’s like, are people actually aware what they’re18:33competing with?18:35Because you and I may have a sense of, “Okay, this is getting very expensive,” but a machine18:42doesn’t care what it allocates.18:44The ETF doesn’t care what it allocates.18:47It just has to do rule based.18:51You’re sitting in the market with entities that don’t care if they overpay.18:57Classic example is Apple.19:00Take that stock as an example.19:03It’s obviously hugely valued.19:05It’s a big company.19:07It’s a trillion dollar valuation, but it keeps buying back its own shares.19:12Obviously, as a big company, it benefits from these passive allocations.19:16What people don’t realize is that Apple has the same amount of earnings that it had in19:242015.19:25Four years later.19:26Absolutely no change in earnings, same amount of earnings, but people are paying almost19:29twice the price for the same stock.19:31Why?19:32Because Apple’s been buying back its shares, therefore reducing the float and save for19:37the same amount of earnings produced a much higher EPS, earnings per share, bigger.19:43It looks like it’s growing, but it’s not.19:45That’s my point about this whole pacified machine that has been created.19:52You, since corrections are not allowed to take place for an extended period of time,20:00you’re looking at all of sudden at yearly charts.20:03We have stocks, as I mentioned before, like a lot of sectors are lagging behind, and the20:09big cap stocks keep holding everything together because all the money goes towards them.20:15Because corrections are so short, we have yearly charts that show nonstop gains for20:2310 or 11 years.20:26There’s absolutely– the December corrections even show up in these charts because they20:30were still up on the year in many cases, so you look at Starbucks and Disney.20:36Disney is a good example.20:37Up 11 years in a row.20:39Well, this is this fantasy that’s being propagated now.20:43Because I just put my money into passive funds, I don’t have to think about it.20:47It’s risk free central banks always intervene and so we have these massive charts that are20:52vastly extended.20:53Even the technical indicator I watch.20:56On any chart timeframe, you will find this useful.20:59Be it on the daily chart, the weekly, the monthly, the quarterly and the yearly, it’s21:03the five exponential moving average.21:06Even on a daily chart, you see vast extensions above it, it will reconnect either to the21:12upside or the downside.21:14If you see massive extensions on the weekly chart, at some point, it will reconnect.21:19The reason I mentioned this is there are stocks like Microsoft that are 50% above the yearly21:27five EMA.21:29Why is that relevant?21:30Because if you look at the history, look at a stock like Microsoft, you can go back to21:35its inception and this stock always connect every single year like clockwork.21:42There were two exceptions, Microsoft, my favorite example.21:47One was the year 2000.21:48It was in 1999.21:50It was completely extended, did not touch the fire a yearly five EMA.21:54Then the second year was 2001 when it went way above, and then it obviously plummeted21:59down with the NASDAQ crash and reconnected, and now.22:04It’s now on its second year, it hasn’t even touched it.22:06It’s vastly extended.22:07From my perspective, I look at all this with what central banks are doing here.22:12I see risk building that these reconnects, technical reconnects, will take place at some22:19point.22:20When they do all of these stocks all of the sudden have 30%, 40%, 50% downside risk.22:28This is the undiscovered country.22:30It really is.22:32Look, I’m coming from a training perspective.22:35I’m resentful of central banks simply because of the volatility compression that they have22:40aimed to do.22:41In fact, Jay Powell came out yesterday, made a very telling statement with regards to repo22:47and overnight money markets.22:49He literally said we have to calm markets down.22:52We need to calm.22:54Where’s that in your charter?22:55Where’s that in your job description to calm markets down?23:00Look, markets are supposed to be free flowing in price discovery, but it’s telling because23:04he has to control that aspect of the interest rate equations, he has to control it.23:10That’s the point.23:11Everything is controlled.23:15When I look at this experiment that has taken place over the last 10 years, and I’m just23:21absolutely flabbergasted that this is not being pressed more critically by journalists,23:27by the media and by the public discourse.23:31QE, lower rates were emergency measures to deal with a crisis.23:37That was the original intent.23:39Ben Bernanke, QE1.23:42Then came QE2, and then twists and turns, then QE3.23:48It morphed into permanent intervention.23:51The promise was always we’re going to normalize, becoming come out of financial crisis, everything23:57that we do, low rates were going to incentivize growth in the economy.24:03They haven’t.24:04It was the slowest growth recovery in history.24:06In the meantime, low rates have enabled this incredible debt expansion.24:12Now, we also got eyes always glaze over with debt no one even– the numbers have gotten24:17so big and continue to get ever larger that no one even can fathom these numbers.24:22Here’s a fun one.24:23In the last 10 years, the US has added more debt to its balance sheet than in the previous24:3142 years combined.24:32That’s this vertical curve we have and there’s no end in sight.24:37When the Fed, last year, tried to normalize its balance sheet and try to raise rates,24:45which they managed to get to, basically, the lowest point of raising ever, it all fell24:52apart.24:53The 10-Year hit 3.2% in October of 2018.24:58That was the end of it.24:59The debt construct cannot handle higher rates and so they were forced to capitulate.25:05My question and the answer to your question is, can they keep this going forever?25:10Which is interesting to me, coming back to this point I made earlier about valuations25:14of asset prices vis a vis the underlying size of the economy.25:19In the year 2000, when the NASDAQ bubble burst, the overall market cap of the stock market25:26got to about 144% of GDP.25:28That was it.25:31It was just too high above the economy.25:35That’s where the crash happened.25:36That’s where the recession came.25:39Then we re-inflated.25:40This was the lead up to the housing bubble.25:43Cheap money, who caused the housing bubble?25:46Well, we can argue it was the Fed with cheap money and this cheap money had to go somewhere25:51and so we offered credit and subprime mortgages to people who can’t really afford it.25:57The stock market rose to about 137% of GDP.26:02Guess where we topped in January of 2018?26:06144% market cap to GDP.26:09Where did we top in September of 2018?26:13146% stock market cap to GDP.26:16Where did we end this summer in July?26:18144% stock market cap to– there seems to be this natural barrier that says, “Okay,26:24well these valuations have to be justified somehow.”26:29When I now see the Fed saying, okay, well– back in September, where we’re back at 144%,26:35what are you trying to do here actually?26:38Obviously, what you have done, what all the central banks have done has not produced organic26:44growth anywhere near the growth that we’ve seen in previous cycles.26:50That’s why the ECB still in negative rates and they’re trying to do more than negative26:53rates.26:54For me, that the question is one of control, efficacy.27:00Does this produce another lasting jumping an asset prices?27:05There is no answer to that question yet, but there may be signs.27:10For me, the first sign was, okay, this July rate cut when we had that sell zone of 3000,27:163015.27:18Does the Fed rate cut actually produced sustainable new highs?27:21The answer to that was no.27:24Then in September, we had the second rate cut.27:26Did that produce sustainable new highs?27:28No.27:29Yesterday, Jay Powell talked about increasing the balance sheet again, but don’t call it27:36QE, wink, wink.27:38We sold off.27:41Those are those three specific signs, events where the Fed has not succeeded in producing27:48new market highs or for that matter, new growth.27:53I think the question is very much outstanding.27:58Once we know what’s happening with this trade deal, we need to keep reassessing the mechanics28:02of markets and the technicals and see if we can actually see a sizable turn in the economy.28:09I’m highly skeptical.28:12Because all we’re doing is just keep enabling more debt and demographics are not changing28:20as a result of that.28:21The deflationary cycle is not changing as a result of that.28:25Beyond temporary highs, I have to see where that’s producing anything on the macro form,28:32and so far, it hasn’t.28:36I think we have to differentiate two things.28:40The MMT part, it’s your classic capitulation.28:44We don’t know how to solve any of the world’s problems, because that equation is ongoing.28:51Because we have demographics that are sending a very clear signal.28:57Working age population, by the way, I’ve posted out a few times.28:59I find it fascinating.29:01For the first time ever, the growth in working age population is actually going negative.29:06That tells you everything you need to know.29:08There’s a huge demographic change going on as the baby boomers were retiring, how do29:13you produce growth with those numbers, unless you believe in some AI productivity fantasy,29:20which we don’t have evidence for that yet.29:25MMT to me is the ultimate absurdity of it all.29:32Free party, free credit.29:34We keep printing money and there’s no consequences.29:37MMT adherence will obviously push back hard on this, but even central bankers like Jay29:44Powell are very much opposed to MMT.29:47I personally think is a fantasy, as well.29:50In terms of your question about fiscal policy, can now governments come up with infrastructure29:58programs or what have you to really push that equation?30:03This is where I’m going to have a different take on everything.30:06Now, this brings me back to what we’re seeing in the political sphere in the United States30:10and the United Kingdom, in Germany, everywhere across the west.30:14We have social fragmentation, the likes we haven’t seen in our lifetimes, at least.30:24It’s hard to see political cohesion anywhere.30:28Germany, for example, used to have three or four parties, not a six, seven and no one30:33has a majority of any sort.30:36The UK Brexit is a classic example.30:40It’s impossible to come to any agreeable solution that’s been going on for years.30:46The United States is, impeachment aside, what’s happening down that front, this fragmentation30:54has been going on for at least 20 years.30:56It just keeps getting worse and worse and worse, and how do you get to a complex policy31:03solution that enables you to actually implement structural solutions if you can’t agree on31:10a common reality, and there’s no common reality on anything right now.31:15Although to be fair, Democrats and Republicans in the US always agree to spend more money,31:20that’s what we just saw again in this latest budget round.31:24I remain unconvinced that fiscal– even though I hear Draghi claiming for more fiscal spending,31:33I don’t see the political cohesion to bring something like that about– German, interestingly,31:40on a side note, they’re actually running it surpluses.31:43They’re getting criticized for that, which makes actually, I think Germany really an31:47interesting place to– if we do have a global recession, what country is actually able to31:54really deal and stimulate ultimately.31:58They’ve been very disciplined and holding off on this point, but I suspect they may32:02have more ammunition than anyone else when we do hit a recession down the road.32:09How do you see the end of the cycle playing out?32:11I am actually looking for a yearend rally, because I think what happened in December32:17of 2018 was superbly rare.32:20It happened only once before and that was in December of 2000.32:25That’s how rare these December dumps are.32:27However, I’m just going by what I know now, and I don’t know what’s going to happen with32:31the trade deal and this time, the other.32:32What I do know now is basically what I see in the charts is there’s just another very,32:38very sizable volatility spike to come.32:42I can’t tell you when that comes, it would maybe make sense for that to happen in October32:48or into November.32:50Then that spike is probably be a buy in markets for a yearend rally, can see that happening.32:57I expect the Fed to cut rates again in October, maybe throw another one in December.33:02We’ll see.33:03I think ultimately, the question is, and I’ve been posting this chart for months now.33:07It’s this broad megaphone pattern.33:09If they can get above it, we can have a massive all liquidity and ala March 2000.33:18It was just crazy blow off the top.33:21I’m not predicting this.33:23I’d actually don’t want to see that.33:24I think stuff like that is just going to be horrid ultimately, because it will just exacerbate33:29the pain on the downside.33:31If markets cannot sustain new highs from here, I think going actually back to an earlier33:37question you asked about historical example, look closely at 2007.33:42We made a high in July, we made a high in July this year, then the Fed cut rates in33:47September of 2007.33:49Because that was their response when subprime was contained.33:53Don’t worry about– there is no recession.33:55That’s the same narrative we’re hearing now, there’s not going to be a recession.34:00The recession came only two months after– three months after the Fed cut rates.34:04It came in December of 2007, when no one saw or admitted a recession was coming.34:11After that rate cut in 2007 in September, markets peaked in October, and that was it.34:16No one– this is the fascinating thing, see, market tops are only known in hindsight with34:23enough distance.34:24They’re not apparent or anyone at the time.34:28That’s why I’m just using that as an interesting example and as a threshold to say we must34:33make new highs from here or we’re risking, we’re actually made a double top in July and34:39in September of this year, so I think people need to watch the price action very carefully34:44from here.34:46Just finishing up on 2007, when markets made on marginal new high in October of 2007, and34:52the Fed was cutting rates, Wall Street projected price targets of 1500 to 1600 to 1700 for35:012008.35:02All of them.35:03All of them were bullish in December, not knowing that the session officially actually35:09started in December of 2007.35:11The S&P close the year at 800, 880, something like that, cut in half, basically.35:20I think what we all need to be closely watching for is efficacy of what happens on the trade35:26front, efficacy on what happens with the central banks and the price action in the charts.35:32Do we see participation coming from the small caps, transports and the banking sector?35:40Yes or no?35:41Will we see sustainable new highs or not?35:43If we don’t see new highs, risk for double top, watch what the VIX is doing and then35:49it remains a range bound market for now with opportunities and both sides but I think there’s35:54some critical thresholds that have taken place.35:57Punch line, no bull market without central bank intervention.36:02It remains an artificial construct.36:05I am worried that all of us have a warped perception of value of what markets should36:13be doing because, let’s be very clear here, we would not be at new highs in or we would36:19not have hit these current levels of 3000 in the S&P were it not for complete central36:25bank capitulation, four rate cuts, jawboning trade optimism, all these valuations have36:35to be justified at the end of the day.36:38You cannot lose one of these equations and so markets remain artificially inflated.36:45The question is if, like in 2000, or in 2007, central banks efficacy loses out.36:52Remember, they had to cut rates by over 500 basis points to stop the bleeding back then,36:58and now, they barely have 200 basis points to work with.
Finite players play to beat the people around them. Infinite players play to be better than themselves.
I could’ve been reading an article analyzing Roger Federer and Rafael Nadal. Except I wasn’t.
ENTER: Simon Sinek
I was listening to Sinek (he was talking at Google) use game theory to describe the kinds of ‘games’ companies engage in: finite games, where the objective is to win (or cause all other participants to stop playing), or infinite games, where the objective is to continue the game as long as possible.
I first came across this line a few months ago. It has stayed with me since then. Suddenly, companies and leaders were falling into either one of these categories for me. If you are an entrepreneur, quite likely Sinek’s line speaks to you too. And you’ll start placing companies into one of these categories. I hope you will, at least.
Take Sinek’s examples as a starting point. Microsoft (under Ballmer’s leadership) executives used to tout how much better their products were compared to Apple. Apple, at the same time, however talked more about end results they were working to achieve. Microsoft, says Sinek, was playing a finite game, whereas Apple was onto an infinite game of self-improvement. Which approach is better did you ask? The business results of both Microsoft and Apple from the time speak volumes about the merits of each approach.
ENTER: Paul Graham
Understanding finite vs infinite games isn’t merely an exercise in the abstract. There is more. Lace it with investor and writer, Paul Graham’s mental model of good vs bad test, and I’d argue that we have a conceptual framework that is critical for business leaders anywhere.
Graham’s recent post about unlearning is a masterclass in understanding the merits of startup life relative to life at institutions like schools or large corporations.
The most damaging thing you learned in school wasn’t something you learned in any specific class. It was learning to get good grades.
Graham’s core idea is that it’s important to know whether you’re spending energy solving a challenge that’s directly connected to reality (studying for a good test), or a challenge that isn’t, usually imposed by an authority (bad test). Recognizing and destroying bad mental models may be even more valuable than adding new ones.
What is the litmus test for a good or bad test? Bad tests are inherently ‘hackable,’ meaning that with clever and directed energy, we can often find a shortcut to ‘scoring well’ on that test and acquiring a label of success without fully solving the underlying challenge. Good tests, on the other hand, are ‘unhackable,’ so we can either succeed at solving the challenge to a varying extent, or fail entirely.
A test in a class is supposed to measure not just how well you did on that particular test, but how much you learned in the class.
Good tests like curing cancer, making education free for anyone, or even winning a tennis match are inherently more engaging because the best scientist, entrepreneur, or player will typically win in each respective scenario.
ENTER: Elon Musk
Sinek and Graham’s models seemed familiar the first time I encountered them, and I wondered why. In filing away these new mental models, I was reminded of their neighbor in the idea world: thinking from first principles, especially as popularized by Elon Musk:
Physics teaches you to reason from first principles rather than by analogy. So I said, okay, let’s look at the first principles. What is a rocket made of? Aerospace-grade aluminum alloys, plus some titanium, copper, and carbon fiber. Then I asked, what is the value of those materials on the commodity market? It turned out that the materials cost of a rocket was around two percent of the typical price.
SpaceX went on to cut the cost of rocket launch by ~90%, while still making a profit.
Why didn’t the giant aerospace incumbents figure this out first?! In my view, the incumbents were busy playing finite games against their competitors, hacking bad tests, and thinking derivatively from their last quarterly results, rather than from first principles. Textbook opportunity for disruption.
Sinek + Graham + Musk For the Win
Good tests map beautifully to infinite games and first principles thinking. All three mental models seem to reinforce a simple message: think like a scientist.
Infinite leaders, says Sinek, filter decisions first through the unchanging values of a company. And only then, factor in the company’s dynamic interests. This may result in sub-optimal single decisions and failures along the way. However, over the years, the long string of decisions strung together will be more cohesive and, therefore, valuable (assuming the company’s values are well set up).
The political environment of a classroom, or large company, is often set up to reward those that hack bad tests and finite games, since the isolated outcome looks favorable. We don’t consider how that outcome will eventually be strung together with other outcomes in order to fully connect with reality.
The book What Have You Changed Your Mind About? chronicles painful realizations by experts playing a finite game in their area of expertise. In it, a successful hedge fund manager, Nassim Taleb (author of the excellent book Antifragile), talks of how he lost faith in probability as a guiding light for making decisions.
Good tests, infinite games and first principles thinking aren’t for everyone. For others, it’s the only way to go.
Helpfully, and devastatingly, startups afford little-to-no buffer from the real world. The company either solves the challenge, or dies. This kind of instant feedback and intolerance for ‘hacks’ forces infinite game leadership at startups – painful in the short term, but ultimately more rewarding for everyone involved. And the true test of an entrepreneurial leader? As Satya Nadella said, while transitioning Microsoft from a finite game to an infinite game, leaders must find the rose petals in a field of S#$@.
What bad tests or finite games are you putting energy into? Where have you applied first principles thinking?
In this, the first episode of the Exponent podcast, we talk about our background, Microsoft and disruption, and the meaning of culture. We also explore our goals for this podcast, and just a bit about Taiwanese garbage trucks.
- If Steve Ballmer Ran Apple link
- The Halo Effect:…and Eight Other Business Delusions that Deceive Managers link
- Skating Towards the Goal link
- Bill Gates’ Steve Jobs Moment link
- Friction link
- Note: The Internet Explorer rendering engine is called Trident, not Triton
- Companies get disrupted when they focus on maximizing profit and less on building the best product.
- Steve Balmer was a sucessful CEO from the standpoint of maximizing shareholder value for a ~10 year period.
- But what about in the long run: 30 or 50 or 100 years
- What is the purpose of corporations?
- Should companies milk their core business over a lifecycle and not try to maintain themselves after that.
- Would it be better for Microsoft to generate billions for shareholders and have them reinvest in a bunch of startups.