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Hi friends 👋,
I’ve been writing about a lot of fast-growing companies and protocols recently, but I keep hearing that the macro environment is going to dictate returns in very specific ways, so I figured it was worth writing a short one on the madness of the crowds and The Current Financial Thing.
Note: None of this is financial advice. I’m not a financial advisor, and I’m a terrible trader. This is just meant to be an entertaining commentary on the behavior of the crowd and the wisdom in following it. Hopefully, you disagree with me and it makes you think for yourself.
Let’s get to it.
The Current Financial Thing
It’s funny that those who take finance particularly seriously dismiss meme stocks.
“Leave the memes to the kids,” they chortle during long bull runs, “We’ll get back to doing real finance once the bubble bursts and the madness subsides.”
And then the markets turn and rates go up and a war starts and crypto tanks and growth stocks tank and meme stocks really tank and startups will, inevitably, once they’re forced to raise and mark-to-market, tank.
“Be careful out there, there's gonna be a lot more pain. Rates will continue to rise and multiples will continue to compress and companies will need to tighten their belts and growth will slow and senior leadership will leave and growth will slow further and all but a few of the best startups – let alone crypto projects – will die.”
Which is funny because this, too, is a meme. It’s a story that people tell each other to cut through all of the trillions of things they could be paying attention to. Re-telling this story is a way for people to signal that they, too, get it. That they, too, take finance seriously. That they, too, are looking forward to the separation of wheat and chaff.
The difference is, meme stock traders know they’re trading a meme.
Now certainly, the growth bears have some math on their side. The higher the discount rate, the lower the present value. But that’s easy. That’s the same first-order thinking that everyone’s agreed upon. The idea that printing has led to inflation which will lead to more hikes which will kill growth companies and risk assets is The Current Financial Thing.
So everyone talks about rising rates and hyperinflation and war and food shortages and nuclear threats and supply chain issues and energy prices and IPO windows slammed shut. They create – and may often feel – fear, uncertainty, and doubt (FUD).
The markets are too complex for anyone to know, with the degree of confidence with which some people pretend to know, what’s going to happen tomorrow, let alone in a week, a month, or a year. That’s what memes are for. That’s why people agree on The Current Financial Thing. Throw in Twitter’s algorithmic feed, and people can come to agree with each other more strongly, more quickly than ever before.
The Current Financial Thing is a play on the I Support The Current Thing meme, which Ben Thompson analyzes brilliantly.
On the internet, he argues, we can find many things worthy of our support, so many, in fact, that it just makes sense to “outsource our intuition for which events matter” most. And that makes sense. There’s only downside in supporting Putin or opposing Black Lives Matter.
Opposing The Current Financial Thing, however, or at least realizing that when everyone agrees that the market is going to tank, they’re probably wrong or too late or off-timing, might hold some alpha. In fact, trading on the predictable ways that humans react in times of panic drives the most successful quantitative hedge fund of all time.
RenTech’s FUD Eating Algorithms
Humans are so predictably irrational that the best-performing hedge fund in the world has outperformed the market by 1000x since 1988 in large part by trading on our fear, uncertainty, and doubt (FUD).1
Renaissance Technologies (“RenTech”) is a quant fund founded by mathematician Jim Simons. Quant fund means that instead of people choosing which assets to buy and sell, RenTech’s mathematicians, statisticians, physicists, and shape rotators build algorithms that trade assets based on the patterns they find in enormous amounts of real-time and historical data.
RenTech’s original fund, the Medallion Fund, is legendary. Since inception in 1988, it has generated 39% annualized returns net of fees. That’s particularly notable because it charged 5% management fees and 44% performance fees, whereas a standard fund charges 2% and 20%. Nick Maggiulli wrote a great piece going over all of the mind-blowing ways the numbers were impressive in Of Dollars and Data, like the fact that $1 invested in 1988 would be worth $19,518 in 2018.
Obviously, given the performance, understanding how RenTech does it has been a fascination of finance types for a long time. In 2019, Gregory Zuckerman published an excellent book, The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution, that gives the most complete glimpse.
Jim Simons, the book, and Gregory Zuckerman
So how does RenTech do it?
The heart of the Medallion Fund’s strategy is to bet on mean reversion – the idea that prices come back to their long-term average trend after asset prices get out of whack.
But how and why do prices get out of whack in such a way that the algorithms have been able to consistently take advantage of them for over thirty years? Medallion researcher Kresimir Penavic gave a simple explanation that’s stuck with me since reading it:
What you’re really modeling is human behavior… Humans are most predictable in times of high stress — they act instinctively and panic. Our entire premise was that human actors will react the way humans did in the past … we learned to take advantage.
The most successful 30+ year run in the history of finance essentially boils down to efficiently trading the fact that humans are, as Duke econ professor Dan Ariely would say, predictably irrational, particularly when we’re scared.
In that sense, Medallion is kind of a mirror turned on humanity, existing as an abstraction layer above our petty day-to-day actions. Its returns can be viewed as almost an index of how predictably irrational humans are at any given time, and how easy it is for the robots to take advantage of our silly human emotion. Want to guess its three best years?
Image Credit: Institutional Investor
The fund’s three best years were 2000, 2008, and 2020, when it gained 98.5%, 82.4%, and 76% respectively.
While us humans panicked, Medallion’s robot traders laughed.
Most recently, just a few months after Zuckerman released his book, the world fell apart and then recovered in the span of a few days in March 2020. The Medallion Fund returned 76% in 2020, even as RenTech’s other funds – funds with longer holding periods that are less responsive to human emotion – underperformed.
Medallion performed best in the worst markets. In other words, Medallion’s algorithms do best when humans are all in agreement that everything is going to shit. Medallion feeds on FUD.
I can’t find any information on how Medallion performed in 2021 or thus far in 2022, but I’d wager that it’s had an exceptionally strong couple of months. Humans are doing that FUD thing again.
The past few months in the market have felt surreal.
Salvador Dali, The Persistence of Memory, Plus a big red down line
We’ve all known a pullback was coming at some point in private markets, crypto, and public growth equities. We all knew rates were going to go up. We all knew inflation was increasing even if it didn’t show up in CPI. Everyone has predicted all of this for months, some have been predicting it for years.
But when the crash actually came, people got scared. The dips that they were so looking forward to buying became a lot less appealing when they arrived.
Oh my god I love dips I’m so high conviction just wish we could get a dip so I could buy more amirite? OK, here is a dip. Ohhhh *that* dip? I meant the *other* kind of dip. This is a bad dip. I do not like this dip.
Part of the reason is that the facts on the ground both are different and feel different when they’re actually happening.
Six months ago, for example, very few people would have predicted that the Fed finally raising rates would coincide with a new war, let alone this specific new war between Russia and Ukraine, with all of the fear and sadness and anger that war brings. It would have been difficult to imagine the actual feeling of waking up and seeing big red numbers each morning, and then reading smart people saying that things were likely to be bad for a long time.
Then, everyone with a microphone seemed to get very bearish, in the same ways, for the same reasons, at the same time.
VCs launched tweets and blog posts and podcasts about the impending crash in late-stage valuations. They all agreed that it would mostly be limited to late stage, that early stage should be fine, and that it would take a few months to play out.
On February 21st, before the war started, Insider posted this inane FUD drivel:
That headline is meant to drive fear, uncertainty, and doubt. “Will I survive?!” it dares the reader to ask. Read on, and Linette Lopez quotes a series of value investors and short-sellers – the group of people most desperate for a crash – and holds up their word as gospel. The article doesn’t wonder if, maybe, there might be a sustained pullback, but declares confidently that we’re going to have a washout, and that there will be few survivors. FUD.
This is Insider. It’s known to be a little sensationalist. But it’s also a perfect, cartoonish encapsulation of the mood more broadly.
Everyone seems to be certain about how things are going to play out, and it’s going to be bad. Many of the people out there yelling about a market decline and return to responsible valuation are those who would benefit from either:
- A market pullback, or
- A perception among investors that they’re the experienced, responsible ones in a sea of crazy intemperate gamblers who’ve been getting away with murder.
Now I fully recognize my own biases, too. I’ve deployed venture money for the first time during this post-COVID bull run, am long crypto, and am generally bullish and optimistic on technology. I would stand to benefit financially and reputationally from prices continuing to go up. I even believe that reading about tech companies is less exciting for people in a bear market (unless I pull a heel turn and start writing salacious stories about companies crashing, which I won’t), so Not Boring and I would benefit from the market partying like it was 2020 every year.
But I’m the first to admit I have no idea what’s going to happen.
During the bull run, there seemed to be a constant chorus of bears arguing that prices would come back down to earth; this bear market (a pullback of more than 20%) seems to be a lot more one-sided.
That’s not to say that bears are wrong. In fact, I wouldn’t be surprised if they’re all right and everything goes back to selling off after this little bear rally.
I just also wouldn’t be surprised if the market bounces back and keeps growing.
The only thing I’m pretty sure about is that large groups of people all agreeing about something as complex and dynamic as the market are almost always wrong.
The general bearish certainty feels like the kind of signal that Medallion would feed on. Abstract away all of the underlying stuff and just look at how the humans are behaving.
With everyone agreeing on a sustained crash, predicting the opposite was so simple a human could do it. On March 15th, at 10:52am ET, a friend who wishes not to be named texted:
“I also think we’re nearing a bottom. Just based on the amount of midwit tourists prognosticating about impending doom.”
He called the local bottom almost down to the hour.
There’s obviously a lot of luck and coincidence there, and this could certainly be a bounce before a bigger sell-off. The bigger bear market could last years, like the dot-com crash.
But the fact that everyone seems so sure of that makes me wonder. I think there’s a generalizable lesson: be skeptical when everyone agrees with each other.
And I think there’s an addendum: *especially when they all agree to the downside.
(Alright, fine: Be fearful when others are greedy, and greedy when others are fearful; but be especially greedy when everyone else is fearful in the same way for the same reasons.)
The Madness of the Crowds and the Current Thing
In 1841, Scottish author Charles Mackay wrote a book that’s still required reading for young finance hopefuls, Extraordinary Popular Delusions and the Madness of Crowds.
In it, MacKay covers a range of historical periods during which the crowd collectively lost its mind, from alchemy to witch hunts to markets. Specifically, he kicks off the book with three economic bubbles, or financial manias: the South Sea Company bubble, the Mississippi Company bubble, and the most famous of them all, the Dutch Tulip mania.
The quote at the top of the essay comes from the book:
Judging by the three examples that MacKay chose, it seems that he believes people go mad to the upside – that they overpay for something like Tulip bulbs because everyone else is doing it, before coming to their senses. Getting too bullish is the manic behavior; being too bearish is just being overly cautious.
(Fun fact: apparently MacKay greatly exaggerated the irrationality of the Tulip buyers; according to historian Peter Garber, Dutch Tulips exhibited normal pricing behavior. But the meme stuck.)
Maybe because so many young financiers read MacKay, or maybe because fear is more powerful than greed, that’s the mental model that seems to have won out. Roughly:
- Bullish = irresponsible and mad
- Bearish = responsible and measured
Some permabears are exceptions to this rule – always being a bear, when markets trend up over time, is seen as a curmudgeonly if not downright mad position – but generally, bearishness and skepticism are looked upon with respect.
But the implication from the Medallion Fund seems to be the opposite – that people are most predictably and exploitably wrong when they panic, not when they get too excited.
Behavioral economics is full of examples that show that people behave irrationally with respect to their downside. Daniel Kahneman and Amos Tversky’s Prospect Theory, for example, describes how people respond differently to gains and losses of the same magnitude, and birthed the concept of loss aversion: people tend to prefer avoiding losses to acquiring equivalent gains.
It’s no wonder, then, that people tend to respect warnings of impending doom with more seriousness than promises of impending riches, particularly if a lot of smart people are all warning the same things at the same time.
The result, as we’re experiencing now, is that the crowd can coalesce around one idea even when it’s not an exciting speculative bubble. It just doesn’t seem like an extraordinary popular delusion when the crowd is selling and rotating into safer assets.
But it kind of is. It’s the financial version of The Current Thing.
Last week, Ben Thompson wrote a great piece called The Current Thing, inspired by Elon Musk’s tweet:
Thompson argued that in a world of abundance and decentralization, certain central ideas or memes accrue more power. The concept mirrors Aggregation Theory, his classic framework for understanding where value accrues on the internet, but for ideas.
With so much information to process, and so many causes that we could care about, the easiest path is to just support the thing that all of the other people seem to be supporting. There’s less thinking and less reputational risk. Just as no one ever got fired for buying IBM, no one ever got canceled for supporting Ukraine.
Similarly, it seems that given such an intensely complicated world and global financial system, it’s easier to outsource macro thinking to the most experienced, confident, and sober voices in the room. The markets aren’t as clean to interpret as, say, which stance to take on Putin’s invasion, which means that people are even more willing to outsource to experts. That’s true despite the fact that all of that complexity makes it practically impossible for experts to know what’s going to happen.
Compounding all of that, Twitter’s algorithmic feed intensifies anything that trends, so fluctuations in human perception tends to overextend in that trend’s direction (and will probably snap back just as quickly). Thompson wrote that “the Internet, thanks to its lack of friction and instant feedback loops, makes any position but the dominant one untenable.”
The financial case is interesting, because there are two sets of judges. The subjective judges are Limited Partners (LPs), the people and institutions who invest in funds. LPs likely watching to make sure that their fund managers are saying and doing the things that show that they’re protecting their money, and fund managers need to say the right things publicly to appease them. The objective judge is the market, which cares not for optics or proclamations, just results. The market doesn’t care whether you agree with The Current Financial Thing.
Take the market’s response to the Fed rate hike a couple of weeks ago.
On March 16th, the Fed approved a 0.25% rate hike, the first since December 2018, and kept up its hawkish language, something that The Current Financial Thing would suggest is bearish for growth assets. In response… tech and crypto rallied, with the Nasdaq making its biggest four-day move since it bounced back from the COVID tank in March 2020. What happened?
- Maybe it’s that they focused on the front of the curve, which is relatively better for growth assets like tech.
- Maybe it’s that China vowed support for economic growth and capital markets in an unexpectedly pro-markets move.
- Maybe it’s that bad things were priced in.
- Maybe it’s that the bears got tired.
- Maybe it’s a mix of all of the above, or something else.
Point is, the market doesn’t care and I don’t fucking know, and I find it hard to believe that if anyone does, they’re leaking their alpha in real-time on twitter. But that hasn’t stopped people from pretending that they know how this global weave of macro factors interacting and influencing each other in unpredictable ways in real-time is going to work.
That’s the macro level. Take the areas where I’m more comfortable: crypto and startups.
After crypto crashed off of its highs, for example, the sober voices quickly turned bearish on price. Smart traders knew that there was more pain ahead. The rational ones looked at the charts and predicted that BTC would hit the $29k range before bouncing back, or that ETH would retest $1,700 before climbing. Between the charts and the macro, it was practically a foregone conclusion: retesting the lows and wiping out shitcoins was crypto’s The Current Financial Thing.
Then, without bottoming anywhere near those prices, crypto started coming back in-line with the broader growth and tech market.
CoinMarketCap (I’ve had to update this 3 times because ETH keeps rallying)
Prices very well may still re-test last spring’s lows before this is said and done... but they might not. Certainly, it hasn’t played out the way that many confident predictoooooors have predicted to date.
Or take startups. Over the past few weeks, a lot of VCs have formed a consensus around how macro is going to play out and what that’s going to mean for startup valuations and opportunities for liquidity. This All-In podcast conversation sums up that point of view most cleanly, and I expect that it will become the industry Schelling Point in the coming days:
To be clear, David Sacks, Chamath, and Brad Gerstner just expressed this idea clearly on a platform a lot of people listen to and share. Their opinions reflect those that many of the smartest, most experienced people in the space have held for weeks or months.
The Current Financial Thing in venture is to invest in great companies at reasonable valuations, which… of course… and to advise companies to conserve cash and get profitable. And that strategy – biding time until late stage prices come in-line – may very well be correct for the time being.
The scary part is just how much consensus is forming around the same idea, and how silly any other idea seems.
- Imagine going on a podcast right now and saying that you’re bullish on late stage private tech companies, and arguing that enterprising investors should get out there and invest while everyone’s focused elsewhere.
- Imagine telling late-stage founders to double-down on growth while all of their competitors retreat into profitability mode.
- Imagine not agreeing that late-stage companies that raised at high multiples are in trouble while early stage companies are probably OK.
I’m not even saying that I don’t agree with the general sentiment. It would be great to invest in future $100 billion companies at 20x revenue multiples instead of 100x!
I’m merely highlighting that I doubt it’s as simple as it’s being presented and that any idea that doesn’t align with The Current Financial Thing looks silly in the moment.
Simplicity and consensus give the illusion of safety.
But there’s a clear and important difference between The Current Thing and The Current Financial Thing: upside.
Going against the crowd on The Current Thing is practically all downside. Imagine tweeting in support of Putin under your real name as an American or European.
Going against the crowd on the Current Financial Thing, though, holds the potential for upside. From the outside, that seems to be an incredibly oversimplified and dumbed down explanation for how the Medallion Fund has done so consistently well.
Dispassionately betting on mean reversion after humans overreact is easier for an algorithm to do – in an ongoing series of millions of quick trades – than it is for a human to do, particularly in a bear market. Running away from danger and retreating to the safety of a group is hardwired into our DNA.
Maybe The Current Financial Thing is right this time, and this is the Dot Com Bubble or Global Financial Crisis all over again, and companies better get lean or perish.
Again, I don’t know.
But I do know that a lot of people seem to be outsourcing their thinking to anyone with experience, a very strong grasp of the first-order consequences of current market dynamics, and a confident recommendation on what to do. As a result, there seems to be an awful lot of consensus for something that is far too complex for consensus.
That’s not to say anyone’s wrong, or that there’s no way to predict some of the things that are going to happen. Sequoia’s 2008 R.I.P. Good Times deck is legendary for a reason.
Sequoia R.I.P. Good Times
Getting conservative in 2008 was a smart play; the pain lasted another year. But Airbnb was founded that summer, Uber was founded in the spring of 2009, and a Sequoia competitor, a16z, was founded the next year with an aggressive, pro-founder stance.
There wasn’t one right way to treat the Global Financial Crisis, and the biggest returns actually went to the ones who were most aggressive. It was relatively easy from inside of the pullback to predict that the markets were going to be tight for months or even years; it was impossible to predict the new companies that would be born out of the crisis and usher in a new era of growth.
I don’t think there’s one right way to treat this one, either. Definitionally, there’s beta in following The Current Financial Thing and the potential for alpha (including outsized losses) in doing something different.
Personally, I’m maintaining a long time-horizon, buying dips in the assets I want to hold for the next decade, and continuing to invest in startups that I think have the potential to be worth more than $10 billion by pushing the limits of bits and atoms.
Put another way, if we all saw this coming at some point, and I think a lot of people did, then I’d be worried about anyone changing their strategy too drastically right now. I’d be particularly worried about those pivoting too hard towards The Current Financial Thing after it’s become The Current Financial Thing, when the alpha’s been agreed away.
I tend to be overly optimistic, but I acknowledge that there’s a possibility for things to get much, much worse. Maybe we have a little rally here, asset prices get more out of control, more risk gets fed into the system, and then something really catastrophic happens. Doing late stage deals at 1000x ARR probably wasn’t a great idea before or after rate hikes (although there are always exceptions). I just doubt things go wrong in the orderly, predictable way that the predictoooooors are predicting.
Over the next decade, though, things are going to get really fascinating. I don’t think people have grokked what advancements in space, climate, web3, health, and other bleeding edge tech are going to do to the world in that time-frame, particularly if and when they intersect. (More on some of this next week 👀)
I guess the point is, don’t outsource your thinking to me or anyone else. Use them as inputs, blend them in with your own goals and timelines, and then make your own decisions.
There’s no alpha in following the crowds, particularly when they’re panicking, and it would be madness to miss out on growth just to follow The Current Financial Thing.
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Thanks for reading, and see you next week,
Yes, I understand that there are a million things that can explain the outperformance of the Medallion Fund, some very technical and arcane, and that no one outside the firm knows what they are due to its legendary secrecy. For this piece, I’m leaning into former Medallion researcher Kresimir Penavic’s explanation regarding human behavior; I think Medallion’s ability to take advantage of gaping arbitrage opportunities during a liquidity crunch and risk parity fund degross is a little less applicable to the average reader, and outside of my ability to explain well anyway.