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Hi, I'm Jim O'Shaughnessy and welcome to Infinite Loops.
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Sometimes we get caught up in what feel like infinite loops when trying to figure things out.
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Markets go up and down, research is presented and then refuted, and we find ourselves right back where we started.
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The goal of this podcast is to learn how we can reset our thinking on issues that hopefully leaves us with a better understanding as to why we think the way we think and how we might be able to change that to avoid going in infinite loops of thought.
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We hope to offer our listeners a fresh perspective on a variety of issues and look at them through a multifaceted lens — including history, philosophy, art, science, linguistics, and yes, also through quantitative analysis.
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And through these discussions help you not only become a better investor, but also become a more nuanced thinker.
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With each episode we hope to bring you along with us as we learn together.
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Thanks for joining us, now please enjoy this episode of Infinite Loops.
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Disclaimer: Jim O'Shaughnessy is chairman and Co-Chief Investment Officer of O'Shaughnessy Asset Management, where Jamie Catherwood is an associate.
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All opinions expressed by Jim, Jamie and podcast guests are solely their own opinions and do not reflect the opinions of O'Shaughnessy Asset Management.
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This podcast is for informational purposes only, and should not be relied upon as a basis for investment decisions.
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Clients of O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.
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Jim O'Shaughnessy: Well, hello everybody.
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It's Jim O'Shaughnessy with yet another Infinite Loops.
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Somebody said to me, "You're always excited because you have such great guests."
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And the answer is yes, I am.
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I'm the luckiest guy in podcasting. Easiest job.
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I just get super brilliant people to come and tell me all the ways I'm wrong or give me their theories about that I can jump on.
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So today is January 28th, 2022, and you are going to realize why I named the date and year as we get into our discussion.
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My guests are OSAM research partner Jesse Livermore.
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For those of you listening to this, I am using air quotes like Dr. Evil.
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Jesse is not his real name, but he chooses to remain anonymous.
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One of the most brilliant market thinkers I have had the good fortune to know and work with.
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When he says he's going to write a report, it could be a book or a PhD dissertation, and it's almost always 100% smart, 100% looking at things from a different angle.
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But wait, there's more, because I have another genius on with me today, Lily Francus, who you might have remembered from the first time I had her on the podcast.
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She was just emerging then by writing some of the most brilliant things about finance. And guess what, guys? It was her hobby.
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She was a PhD candidate in another field, but she finally came over to the dark side, we enticed her to the dark side of the force, and is the director of quantitative research for Moody's. Welcome, Lily. Welcome, Jesse. Jesse Livermore: Thanks. Thanks for having me.
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Lily Francus: Thanks, Jim.
3:39
Jim O'Shaughnessy: So what we're going to do today is talk about something near and dear to all three of our hearts, but you guys have done much better research than me, quite frankly.
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And what we're talking about is bubbles.
3:52
Now, everybody knows the common examples given for bubbles.
4:00
Let's see if after I say South Sea Trading Company and maybe quote Isaac Newton that, "We can measure the motion of heavenly bodies but not the madness of men," that we don't talk about those old bubbles before.
4:12
I think let's stipulate, number one, bubbles happen all the time, right?
4:20
I think all of our guests would agree on that.
4:24
Number two, I've never seen, and I've been in the market since 1982, I've never seen a bubble that didn't pop eventually.
4:32
I remember 1989 like it were yesterday and everything was Japan.
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All the movies they were making were about how the Japanese were going to take over everything in the world.
4:45
They were buying all of the American companies.
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The land under the Imperial Palace was worth all of the real estate in America.
4:57
And I just remember thinking, "This is fucking crazy.
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It just can't keep going like this."
4:57
But we're going to talk psychology when we get...
5:05
So I don't want to steal the thunder.
5:08
But my two guests today think about bubbles, especially you, Lily, because I just got done reading all of your stuff on bubbles, in a very specific way that I'd like to start out, Lily, with you explaining a bit of why all of the focus on bubbles recently and then some of your conclusions.
5:31
Lily Francus: So I think in general, the time we grow up in, especially as we go into the markets, really impacts the way we do things.
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I've been pretty vocal that I started, of course, working in around 2015.
5:48
So I had investments and stuff, but I didn't pay too much attention to the markets until about 2020.
5:54
I have a finance background to some degree.
5:54
But if you go through an American education system in college, unless you do pure finance, your knowledge basically grew up to how to value a bond and a simple one at that.
6:11
So a lot of my perspective has been shaped by the post-2020 market, and many people of the US, as leaving that regime.
6:20
And undeniably, either you could call the whole regime a bubble or you could call certain sectors of the market bubbles.
6:32
And in that respect, when I was thinking about trading and when I was thinking about how I view the market at large, it was hard to ignore the idea of bubbles in general.
6:37
There are certain periods, if you maybe started around 2003 in the markets until 2008, where perhaps you've been shaped more by the bear market and ideas of things like value investing, for example, which come more in vogue when liquidity dries up.
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But if you started, and obviously it's used as this derogatory view, the children of the 2020 market, and it's very true in a lot of respects, to survive, you need to understand what the heck is going on.
7:19
Obviously, there was a point where any idiot could make money.
7:19
I mean, one of my most common jokes, with especially more professional trader friends, is that I wish I was dumber in lot respects because I think that was an optimal trading strategy, especially in 2021.
7:38
A lot of people made very good money essentially trend following and its most magnificent extreme, but they were completely unprepared for the massive regime shift, especially in growth stocks, which hit around February 12th of 2021.
7:53
There were obviously lingering, you could call them, almost aftershocks, and that's actually how I've described them in most of my research and analysis, that we saw a second phase of this growth bubble around November of 2021, but undeniably we've entered some sort of regime shift. Jim O'Shaughnessy: Yeah.
8:14
One of your great insights, I think at least, is the tying liquidity to the sustainability of bubbles and how, if you are paying attention to things like liquidity and how it can get drained, which I think is important, but you go into at some length, that's very interesting for people who probably don't think that way.
8:34
Jesse, you're more of a like, "Oh, okay.
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So I see that thing called the US stock market over there.
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I am going to take it down to the studs.
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I am going to reason from first principles.
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And then I am going to tell you the way it really works and how sometimes it deviates from that, with a particular attention to these periods of mass hypnosis."
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You want to give us your take here on bubbles? Jesse Livermore: Yeah.
9:10
I think Lily made a great point about how you're influenced by the era that you grow up in and particularly your formative years.
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So my first experience in investing was in 1999, and I made and ended up losing.
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So I made and ended up losing about $5,000 on a stock called ION Networks.
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And that stock, so that was a lot of money for me.
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That was all my money at the time, right? Jim O'Shaughnessy: Ouch.
9:38
Jesse Livermore: Because I was a college student.
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So, that influenced me pretty significantly.
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And then, so the 2000s came around and we watched that whole process.
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And then into the housing bubble it happened again, at least the word bubble was being used again, right?
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And this time I was a little bit more trained. I had learned my lesson. And so I try.
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Mentally, I was on the side of those who thought that things were excessive. Right?
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And so I didn't really have much exposure to any of the things that happened or that took bad outcomes there.
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And then, that's made me a fish out of water in the current environment because those were my formative years.
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Those have influenced me significantly, and also my personality type.
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I'm more of a bond type person rather than a stock type person. You know what I mean?
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In terms of what I like, I like cash flows.
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I like things that are tractable.
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I don't like trying to bet on what other people are going to think and how other people's feelings are going to change and how mood is going to swing.
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I like to try to focus on fundamentals.
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And so in terms of that formative aspect, I mean, I'm definitely a fish out of water here. Yeah.
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Lily Francus: Oh, I was going to say, it's interesting to reason about what fundamentals are.
10:57
There's obviously very a simple case study, as like you could imagine.
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I mean, it's not that simple but it's the simplest I can think of.
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A treasury bill, for example, let's say we do a three month duration of it.
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It's pretty straightforward and pretty intuitive to calculate what's your expected rate of return.
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You're not as sensitive to stuff like rate expectations in the future changing.
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But fundamentally, if you think of anything more complicated like a discounted cash flow of a stock...
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I was having this discussion with a friend about Microsoft, for example, trading at 12, I think it was price to sales or earnings, no, sales, definitely sales, versus seven times earnings historical average.
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He was using it as a reason to say it's overvalued.
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My point was, "Okay, why is 7X, why is that the rule?
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Why fundamentally do we believe that these fundamentals are any more or less fragile than the means that, let's say, a retail investor uses?"
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There is a long run history, but there is no golden rule or natural law saying that Microsoft should be 7X it's price to sales.
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Jim O'Shaughnessy: So, that's a really interesting thing, and I want to continue that conversation because one of the things that I learned early on is that you are a fool if you decide that you're going to use an absolute, i. e.
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, "I will never buy Microsoft," if we're talking about Microsoft, "at more than seven times earnings or sales.
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If it gets to there, I just will wait because it will always come back." Not true.
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And the other thing people think about us is that we are deep value investors. Untrue.
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We are quantitative investors, quantitative basically free riders, honestly.
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All these people do this really incredibly deep due diligence and they bubble up.
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Because it's a complex adaptive system, it doesn't come from the top, it comes from the bottom and it gets changed into numbers.
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And then you can use those numbers to make pretty good guesses.
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Momentum, you mentioned earlier, fantastic. Fantastic tool.
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We tested momentum all the way back to the 1920s and it beat the market in every decade, even the depressionary '30s.
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So momentum brings in the idea that markets are priced by imperfect beings called human beings.
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And Jesse, I want to bring you in here because during one of our conversations, you made the very sensible statement, "Well, I think there's two ways to determine value of anything, of any asset class, a ubiquitous formula."
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And that is whatever its intrinsic value is, and we're going to talk about how do we get to that, plus the emotional value, for lack of a better word, that is attached to it by the buyer, right?
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So my friend, Rory Sutherland, great marketer, he's like, "The value of almost anything is determined by the person buying it."
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And then I had another on the podcast, or I was talking to him at some point, and he challenged me.
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He said, "Can you think of a single asset, other than a commodity..." Okay?
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And he made the argument, "Even there I could make the argument there was some emotional value."
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He says, "Can you make the argument or can you, rather, name any asset which does not have an emotional value attached to it?" Jesse? Jesse Livermore: Wow. Oh, boy.
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So, yeah, and I want to be real careful here not to come across as trying to say something that's really basic and obviously wrong around this.
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So I completely agree with what Lily just said, for example, about Microsoft and what's the right multiple for something?
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It's much more deep than that when you ask that question.
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If I come out as a valuer and just say, "Wow, my intrinsic value model says that it's supposed to be..." That doesn't work.
15:16
That's not how the world works.
15:16
You can't invest like that and be successful.
15:21
But I would say this, just let’s get even more basic, right? Value is happiness. Okay? Lily Francus: Totally.
15:27
Jesse Livermore: That's what value is to a human organism. Okay?
15:27
Value is positive emotion, positive experience.
15:32
Now, there are certain things that can bring positive experience directly, right? Consumption. Right?
15:37
So the ability to consume food, to have a house over your head, right, that's going to affect your hedonic situation, your wellbeing.
15:42
That's the core real value of what we're all after here, right?
15:47
And some things deliver that directly, right, like food does to the stomach. Okay?
15:53
Other things deliver it indirectly because you know that you can take those things and trade them for the things that you want. Right?
15:59
And so I would say this, the intrinsic value of...
16:04
Like, if I owned Microsoft right now, and I couldn't trade it to somebody else, I couldn't flip it and make a profit and then spend the money, I had to just own Microsoft for eternity, and then when I die, I can bequeath it to my heirs, right, what would the value of it be to me just to own it in itself?
16:28
And the answer is it's producing real things, right? It's producing software.
16:28
And in this economy that that software has a translation to hedonic value, right?
16:32
People get value in their own lives and they're able to achieve their goals by using that software, and they're able to produce things.
16:44
And so that's going to tie it back to something real that's not just transactional, right?
16:48
They're building real things.
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And the real things are actually tied to real hedonic outcomes.
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And so when Microsoft produces that stuff in a specialized economic system, Microsoft can generate cash, right, for the owner of the business.
17:02
And the owner of the business can then take that cash and then, via the transfer, get stuff that actually the owner wants, like food and shelter and a vacation, which is what I want. Right?
17:10
So, that's the intrinsic value.
17:10
So I sometimes try to define intrinsic value as the maximum price you would pay to own something if you were bound by law to never be able to sell it. Right?
17:21
And all you can do is bequeath it. Right?
17:21
That would be intrinsic value. You're right.
17:26
Nothing in a market trades at intrinsic value, because the moment something has intrinsic value, right, there's the possibility somebody else might want it. Right?
17:30
And that is going to give it what you called emotional value, but I would say another word might be extrinsic value.
17:40
In Lily's blog I think Lily calls it "liquidity value" sometimes, right?
17:40
Extrinsic value or liquidity value would be the fact that you know that you can convert it into cash right now.
17:49
So Microsoft is a stream of cash flows that goes out a hundred years, let's say, and you don't get the cash flows now.
17:54
So, that's different than cash right now.
17:54
And so you have to price, for example, that whole...
17:59
If you want to think about it intrinsically, you would have to discount all those cash flows out into the future.
18:03
But the moment I know somebody else will buy this security from me right now, it takes on a whole new form. Right?
18:08
Because now it's actually cash now and it's cash now that is dependent upon someone else's enthusiasm, someone else's confidence, that someone else in addition to that person will then buy it and so on.
18:20
So I don't dispute at all that the market operates off of extrinsic value, that the critical variable is psychology, is mood, is all those things.
18:32
And as an investor, you have to manage those.
18:37
I think selfishly and based on the personality type that I have, I really like the idea of stuff that doesn't require me to service somebody else.
18:44
I like stuff that doesn't require me to predict somebody else's mood.
18:50
So if I use the example of a retailer, right?
18:54
I would hate to be a retailer of fashion stuff right now, because I'd have to predict what types of clothes next year are going to be really fashionable and really in demand.
18:59
And then I'd have to step in the mind of a teenager or step in the mind of some fashion type person, right?
19:12
And I would have to anticipate that.
19:12
And I'm not good at that, right?
19:16
So what I would really like is instead to have something where I don't need that, because what I have in itself is already valuable to me.
19:21
And if I could own Microsoft at, let's say, 10 times earnings and just collect the cash flows all day, I would be happy. It'd be done. Right?
19:29
Whatever my intrinsic value is.
19:29
Obviously, I can't, because this is a real world and we have a market and we have extrinsic value attached to things.
19:33
And so you have to play that game.
19:39
So when I talk about intrinsic value, I'm not talking about it like a value investor where I'm coming in and trying to pass judgment on the market and say, "The market needs to come down to my estimate of what's intrinsic." No.
19:47
I'm just expressing what the maximum price I would pay for something is if I couldn't sell it.
19:51
And when you think about that, that's kind of like the floor for pricing.
19:56
Once you can get to that price, you don't have to worry about other people at that point when you make a non-leveraged investment.
20:02
You can just make the investment and then whatever other people do is their problem.
20:06
Jim O'Shaughnessy: Lily, what do you think?
20:10
Lily Francus: Well, I was going to say I basically 100% agree with that.
20:11
I mean, Jesse quoted my points in some respects.
20:18
So, yeah, I mean, I guess one differing point, that I view emotional value as a fundamental value itself.
20:25
So going back to the question of, what is the price of this if I cannot trade it?
20:30
That is the fundamental value of any asset.
20:30
Commodities, of course, have their intrinsic value.
20:37
So if I need oil, there is a price at which I will pay for it to, let's say, fuel my planes or fuel my car.
20:44
That would be an intrinsic value.
20:44
And it's hard to argue there's really an emotional component of that, except maybe on a second-order it was like how badly I want to use my plane or use my car.
20:54
But I do view liquidity value or exchange value as the fundamental ingredient of the bubble, going back to our main topic, in a sense, that it arises from this mismatch of expectations of what other people value an asset at versus, let's say, yourself.
21:14
So I guess a lot of my thinking in bubbles stems from this discomfort view that in classical financial or economic thought, bubbles are thought to be this fundamentally irrational behavior.
21:33
If you're buying an AMC stock at $70, by no metric in the world is it worth $70.
21:39
It is clearly this application of a greater fool theory in the sense that you are hoping to sell it at some point for more than $70.
21:48
You're not, as Jesse's pointing out, hoping to hold it and recouping the cash flows.
21:53
So it is interesting- Jim O'Shaughnessy: Excuse me, excuse me.
21:59
So, in other words, just to shorthand that, you're putting all of the value on the transactional value of the asset?
22:08
Lily Francus: Mm-hmm (affirmative). Jim O'Shaughnessy: Yeah. Lily Francus: Yeah.
22:10
I mean, it's interesting because there are obviously certain assets, like a fiat currency, which, you could argue, are all exchange value.
22:17
If I gave you a dollar of them and said, "You can't ever sell this for anything.
22:25
It's good for toilet paper or burning, maybe. I don't know.
22:25
It's cotton, so it's not even good for either of those anymore." Sorry about that.
22:30
Jim O'Shaughnessy: No worries.
22:34
Lily Francus: But fundamentally, every asset you would expect, just like Jesse was saying, to have some mixture of this exchange value.
22:41
If everybody agrees on a fundamental value, there really should never be any mispricing because why would anybody have any impetus to pay more for it?
22:53
You could argue maybe they would have some emotional value, but that would also change what the fundamental value of the asset is, or at least what people view it in the market.
23:03
So it is interesting as we enter these bubble periods that they are sustained by this idea of continuous exchange.
23:10
And I think another key point that Jesse mentioned was the idea of leverage, which if you are holding this asset of fundamental value and you are not leveraging it, then you are completely independent of what other people think.
23:23
You could hold it indefinitely and presumably recoup your cash flows, regardless of if the market price is zero or $100 million.
23:35
But once you add leverage to the mixture, not only does it allow certain individuals' opinions to have heavier weight on the market price, and realistically it is difficult to argue that we do not incorporate the view of a price of the market into our investing decisions.
23:51
I think you could imagine it almost as this two pronged approach where when we have a stronger grasp of what the fundamental value should be, then we may weight that heavier, and going to Jesse's example, you may be able to completely discount the noise of the market.
24:12
But when you get to the class of companies or class of assets that have such ambiguity in their true value attached.
24:17
So the arc complex is a great example.
24:25
These are companies that in my lingo, I call having heavy, fundamental variants.
24:32
In the sense that they could be worth zero, they could be the next, I think she was quoting what, $30 trillion in autonomous driving added to the GDP by 2030.
24:45
When you have those asymmetric bets, it's really hard to, I guess, not only for a person, but also for the market or at large, to really come to an understanding of what the price or the true fundamental value of it should be.
24:57
So you end up waiting more heavily past basically behavior price and what other people are doing versus your understanding of value.
25:10
Jim O'Shaughnessy: I just heard several really good points there, and I want to just lead the discussion back to that.
25:15
First off, I've been doing this since 1982.
25:22
I have never, ever seen a market wide financial collapse that at the heart was not overleverage.
25:34
That was at the heart of every single collapse I watched happen.
25:34
The one that I had personal experience with was long term capital management, and then obviously, the great financial crisis where the firm that I had just left, Bear Stearns, was forced into selling itself to JP Morgan because of a classic run on the bank.
25:57
Bear was not over leveraged.
25:57
And this is the knock on effect that I think creates bubbles and that's why I'm getting into this, because I want your opinion, Jesse and Lily about whether I'm right here, or whether, as usual, I'm wrong.
26:15
I watch, literally, the run on the bank at Bear Stearns.
26:15
I don't have the exact number, but they had 17 billion in capital, unlevered, totally unlevered.
26:24
Then their customers lost confidence in Bear Sterns.
26:36
So the point that I make, as often as I can, and people laugh because they just think it's so incongruous.
26:45
But free markets are based on trust.
26:45
And if you do not trust your counterparty, bank runs happen, companies collapse, all of this happens regardless of how much money they actually have, or gold even.
27:03
If you want to get really crazy, do they have like an underground gold mine that they can have unlimited access to? Doesn't matter.
27:15
If you don't believe in them and you don't believe that they will in fact do that, you're going to get your money out of there, you're going to panic.
27:20
And so overleverage leading to everyone being suspicious of their counter parties, leading to the game of musical chairs on the Titanic.
27:39
I think there are, because I know you've written about it, Lily, and so have you Jesse.
27:39
So, a, if I'm right, explain the process that okay, we can identify a bubble has happened. Yes or no?
27:58
Let's make that the first question.
27:58
Jesse, I'm going to start with you.
27:58
Is it possible for us to not retrospectively, but during the bubble's occurrence consistently say, "Oh yeah, that's a bubble.
28:16
We studied those in third year of bubbleology." Jesse? Jesse Livermore: Yes.
28:22
I want to be careful in the answer there.
28:22
It's not something that happens very often.
28:22
And when you say it, there's no way to say it from a place of a hundred percent certainty, that would be unreasonable.
28:32
So I think one key added ingredient is this concept of arbitrage, right?
28:38
Is there some seed in this process that ensures that the price will come back down to where it "should be." Right?
28:45
And so like if we just use an example of, let's say, GameStop as a stock.
28:52
Let's suppose that instead of...
28:52
I mean it went to 400 or 483, or whatever it went to.
28:56
Let's say it went to 483,000.
28:56
Let's say that was the price.
28:56
Let's just take it to the maximum extreme.
29:03
And it was there and everybody is trading it on like 99.
29:03
9999999% extrinsic value.
29:12
And the confidence that someone else is going to be there tomorrow to pay even more for it.
29:17
Could you say that it is a bubble?
29:17
Now, you couldn't just say, "Hey, well the intrinsic value is $4 per my DCF analysis." You couldn't do that.
29:22
You could've said that the whole way up.
29:28
And you could say that even when the stock is at $8.
29:28
And you could say that for anything in the world, you could say that, "It's trading above intrinsic value."
29:32
Because it has intrinsic value.
29:36
It has transactional value.
29:36
So that can't be the sole basis for claiming that it's a bubble.
29:40
But what if you knew that the company could issue an infinite supply of shares and sell into the market and has no reason not to.
29:45
Then you could say, "Okay, there's an arbitrage here.
29:51
The replacement cost of GameStop's assets is a tiny fraction of the price of this company."
29:58
There is no scenario where the company is not going to be massively incentivized to just sell, sell, sell as many shares as possible.
30:03
And the selling flow itself might be enough to bring it down.
30:09
That would be one possibility.
30:09
Another possibility is, could you see that there's some belief there that's just so obviously wrong that nobody really cares about because it only applies, let's say, a year out.
30:18
Let's suppose it was an oil trust that was going to expire.
30:24
And you would own no oil cash flows from the oil trust, but everyone's trending it at the current earnings as if their current earnings are going to go on forever.
30:29
And you could look in the 10 K and see that it's going to expire in a year.
30:32
But nobody cares because that's the year from now.
30:32
So there's a time bias in terms of how people are thinking about that asset.
30:42
And you can see that if you just pay attention to that time difference and wait you going to get something that's going to force the price back to something closer to its intrinsic value.
30:51
Now, I want to be careful here because there's this one kind of elephant in the room of Bitcoin and the whole crypto complex, where you have something that literally has never had any intrinsic value at all.
31:01
It's not like it's trading with a little bit of intrinsic and some extra.
31:06
It's just literal really as close as you could possibly get to being completely worthless in and of itself as something to have on your computer. But it's still trades.
31:16
And to Lily's point, you also have currencies that you have to explain too, because currencies, they're paper.
31:20
The paper in my wallet doesn't really have any value at all.
31:26
I would say with the currencies, one of the reasons a little more comfortable with currencies is that this concept of like the foot in the door.
31:35
The government basically can translate your use of that currency into your happiness.
31:40
Because if you don't use the currency, they can put you in prison.
31:40
Or they can lock you up or they can fine you, or they can do whatever they want.
31:45
So they have a way to translate the adoption of this medium into something that sticks.
31:49
With Bitcoin, you don't have that.
31:58
It's something that we've all kind of settled on as something that we're going to use.
32:04
I don't want to get in front of the question, that's for later in the conversation.
32:04
But I guess to answer the question, I think it's really important that we not get liberal in our use of the word bubble, and that we really specify that there's got to be something about what's happening that allows you to reliably say that, either via arbitrage, either via some sort of obvious time difference that people are ignoring, that would allow you to be confident that it's going to come back down.
32:29
And then the question will be, well then why is it already coming down now then?
32:32
And it could be because people are really stupid.
32:32
It could be because people don't care about the future, they care about right now.
32:36
It could be because of the effects of leverage, it could be the effects of people's portfolios and how short selling has affected that.
32:40
And all of that's fair game, I think so. But.
32:46
Jim O'Shaughnessy: Lily, Lily, what do you think?
32:48
Lily Francus: So it's interesting.
32:51
I mean, Jesse's partly going to hate my answer because my answer, when I think about what a bubble is, fundamentally, I've never been able to give a better answer than just the liquidity value of an asset.
33:04
Essentially, you could get fancy and say that a bubble is a sustained disconnection from the fundamental values.
33:11
So if, I call it moneyness, after John Coltrane's paper about the 2000 bubble and convenience sealed.
33:24
There is no one singular factor that can identify, especially, pre the pop of the bubble, that it is a bubble because, as Jesse pointed out, there is necessarily, in the idea of a bubble, this idea that it can pop.
33:38
Because, otherwise, it's not a bubble.
33:43
I mean, fundamentally, if you think of the value of fiat currency, it does share a lot of remarking parallels with a GameStop, in the sense that, intrinsically, the value of it is significantly less than what we use it for exchange.
33:55
And part of it does come from this idea that the government has this staked interest in the markets.
34:01
We pay taxes in, ergo, perhaps it's not a happiness, but this idea of unhappiness that can be inflicted by not properly valuing the dollar.
34:13
But I do view that more in this idea of a stable bubble.
34:20
The dollar itself is stabilized by this external actor who has this monopoly on these forts.
34:27
This is pretty basic understanding of monetary theory.
34:27
But it doesn't necessarily, to me, implied that that is the only type of staple bubble.
34:35
Bitcoin is so early to tell.
34:43
It is a very interesting case, but I do believe, primarily, the driver of a bubble is fundamental variance, and the driver of the bubbles collapse's the collapse of variance.
34:58
So once you get this, basically, idea, that reality will eventually come back...
34:58
And you will see that usually with earnings.
35:04
I mean, a great example is Tesla earnings, recently, went down 9%.
35:08
You see on these speculative stocks that earnings tend to be, the sort of, sell the news event because every time earnings occurs, you are removing some level of future ambiguity in the company value.
35:21
The primary driver of a bubble or the primary risk factor is price.
35:28
And is understanding that especially at the later stage of the bubble, there will be someone else who wants to buy from you.
35:33
And if you remove this idea that the company will suddenly revalue itself and become worth the most optimistic version of itself that you bought it at.
35:48
For example, let's say maybe SpaceX does become the astronaut launching service of the points in the next 50 years or something.
35:55
Removing that from the equation, the fundamental reasons to buy the company is because you believe someone else will buy from you later.
36:06
And if you go down that train or do backwards induction, at the end of it, you have to believe that someone will view the fundamental value of the company as higher than the current price it is now.
36:17
So once you basically start getting these factors and bring it back to reality.
36:24
So something like the existence of short selling, where actors are now incentivized take risk to try to reset the value.
36:33
That's something that's been implicated in many cases as one of the factors that pops a bubble.
36:42
But, more importantly, it just goes broadly under this idea of variance collapse, in the sense that Bitcoin is special and so is currency.
36:50
Because, like you said, it has no fundamental value.
36:55
Nobody would argue that in 50 years, Bitcoin's value intrinsically, AKA without the ability to exchange it, will be different than it is now.
37:03
And because of that, there's also no collapse because there's obviously speculators on price, but when I, let's say buy a Bitcoin, there's no event in the future, realistically, that will change mine and the markets to value of other prices itself.
37:24
Jesse Livermore: Yeah, I completely agree.
37:27
And I also want to say, I mean, I want to pick up on a point that I think is really powerful that Lily made, around the idea of the collapse of fundamental variance.
37:31
So if you think about it, ultimately, if everyone has a fundamental mindset, the thing that will bring a bubble back to reality is arbitrage.
37:42
And it's extremely hard to arbitrage something when you don't really know what you're arbitraging, because you have a lot of fundamental variance.
37:50
When you start adding uncertainty, you start adding mystery, start adding like the inability to like pin something down as to what it actually is in the future, the harder it's going to be to like confidently arbitrage it.
38:04
So you have the factor of like how much time it would take to hold it in the arbitrage.
38:09
And then also, the fact that you don't even know what it is.
38:11
So like with Arc or with some genomic science or something, you can't even...
38:11
I mean, to be able to even pin down what you're talking about is impossible.
38:16
So it's so hard at that point to do that.
38:20
I think one point I will make though, is that let's suppose we had a Bitcoin that Satoshi could create more of, infinitely, and the supply wasn't locked.
38:30
To me, I think there's also the role of the mechanical aspect.
38:30
That like, the fact that Bitcoin's supply is effectively locked is a critical aspect of what allows it to become, in Lily's words, a sustainable bubble.
38:42
Is the fact that you don't have that mechanical pathway through which you can get supply just continuing to grow and grow and grow until you tap out and the price starts coming down.
38:53
So like with GameStop, I'm a little bit less confident that it could become a sustainable bubble at $483,000, because any person with half a brain is going to just be selling that like crazy from the inside the company.
39:07
And the company will be basically just pulling in cash and cash and cash and things will meet in the middle at some point.
39:12
And then, one other point around the arbitrage is that, so if you look at like the rules that we all operate on.
39:29
When we make a judgment that the price of an asset is going to fall, we usually do so based on a set of heuristics and rules, like, okay, the company just reported bad earnings and we're supposed to be investing fundamentally, other people care about earnings.
39:41
So I better sell this stock if I know this information before everybody else, because everyone else is going to sell it.
39:49
So it's like, the fundamental rule has kind of become a heuristic that everyone believes that everyone else will transact on right now.
39:54
So it's not that like when Microsoft bombs earnings, or that's not a bad example because they had great earnings.
40:00
But if you picked somebody who had...
40:03
Like when Robinhood bombs earnings and the stock drops 10%, the real actual thought process is, okay, earnings matter because I know how people think and people think fundamentally and earnings matter.
40:16
So the other people out there that are trading with me, they're going to sell this on this news so I better sell it first.
40:19
Or if I have opportunity to sell at a small discount, I better sell it because the discount's going to get bigger because this is a really big miss.
40:30
At that point, you're almost playing outside of the fundamental world because really the actual cost to the asset is something that plays out over a very long time.
40:37
And it would only be felt, in other words, it wouldn't necessarily be felt.
40:45
That loss that Robinhood is experiencing, it wouldn't be felt immediately, it would be felt over a long period.
40:51
But because you know that other people are going to express it right now, you express it right now, and you sell it right now, and you get out of it right now.
41:00
And you take it very seriously as if this is a driving force behind what the price is going to do.
41:04
And so, the key thing is that sometimes little things can get a foot in the door and kind of become heuristics.
41:10
For example, the very idea of a discounted cash flow and how it might affect value versus growth.
41:16
If you think about that, so it's become increasingly popular recently to think about the value growth complex as kind of like a play on interest rates and discount rates.
41:28
And there's an actual arbitrage there.
41:28
So that, this is a scenario, if we had like a growth stock and a value stock, and everybody in the market basically just ignored the heuristic that these assets should trade relative to each other, based on interest rates or discount rates.
41:46
If everybody just ignored that, there would be an arbitrage.
41:50
And the arbitrage is that if the discount rate rose and the growth stock, which has cash flows a hundred years from now, let's say, the growth stock and the value stock would both have to fall in price to be able to compete with the other stuff, the cash and the bonds in the system that are now offering a higher return.
42:08
And mathematically, if you were to hold for a hundred years and you wanted to get a higher return from those two assets.
42:12
And you wanted the value of the growth asset, you wanted both of their returns to increase by say, 1%.
42:22
You would have to mark down the growth asset by more in terms of current price, because the value asset, when you mark it down, it has present cash flows, and it's going to be able to reinvest at those higher rates of return.
42:34
And so it's like it's getting a cushion from the fact that the more you lower it, this is way of describing basically duration of bottom math, it's intuitive.
42:43
Is that as you lower the price of the value stock, the value stock has some of its cash flows present right now.
42:47
So it can put those cash flows back into itself.
42:52
And by that very fact, it ends up having to fall less to deliver the same return increase.
42:57
And so everybody right now is trading on that obsessively.
42:57
And I remember back before the 2009, 2008 crash, I used to post on a site called Investors Hub.
43:03
And we never talked about this.
43:09
This was never discussed, like value growth, discounted cash flow. "Oh my gosh, high rates.
43:13
We need to buy value stocks."
43:13
And so nobody ever said that.
43:13
And so this could easily be ignored, and nobody would notice. This difference.
43:18
Because the arbitrage takes such a long time to actually play out, you could get away with ignoring it for decades as being relevant.
43:28
And it's not even that significant.
43:28
But the fact that people know that there is an arbitrage creates a foot in the door for that relationship.
43:32
And then from there, it grows into something that everyone now is focused on and worrying about and trading on. And so, I think...
43:43
I don't even know how I got on there, but anyways.
43:43
I'm way off on a tangent.
43:50
But I guess the point is that with respect to the relationships that we see, there's kind of an element of the fact that they get a foot in the door allows them to become really big and important and really significant and really ever present.
44:01
And that's often how bubbles pop.
44:01
They don't pop because the actual arbitrage it takes a hundred years plays out, or because people actually sat and decide, I'm going to take that a hundred year arbitrage.
44:11
They pop because people see that there's an arbitrage and that affects their heuristic rules for how the asset's going to trade.
44:20
And then that changes their focus now.
44:20
The focus isn't just on, "Oh, is this going to be on Reddit tomorrow with people quoting whatever, and then it's going to keep going up?" No.
44:25
It's like, now people are going to worry about the actual fundamental aspects and that's going to come back into play and then drive it back down. So I'll turn it over.
44:33
I kind of went on a tangent there, but I apologize.
44:37
Jim O'Shaughnessy: No worries. Lily, go.
44:38
Lily Francus: What you said reminds me very heavily of a discussion that Emmanuel Derman had on Twitter a while ago.
44:47
I remember, I think he's mentioned this several times, but the success of Black-Scholes, for example, as option pricing, or more specifically, as a way of thinking about the different factors that are involved in pricing options, so using it as a sort of a coordinate system, has impacted the market.
45:03
Because when you have these models, when you have these ideas, when you have these means, that spread, basically.
45:08
The market is this immersion property of people deciding on valuations.
45:17
And like I said, in the simplest respect, if you think of an asset where the simplest would be, if I had a hundred bucks and I was like, how much you'll pay for this?
45:30
And you'll tell me a hundred dollars.
45:30
Because no sane individual would pay more than a hundred dollars for a hundred dollars right now.
45:35
It gets more complicated, of course, as you add different factors, as cash flow will go into the future.
45:41
As you get farther and farther into the future, you have more and more uncertainty.
45:46
And this reflects in term structures across the market, across asset classes.
45:51
But fundamentally, what you're really describing is this idea of you could call them institutional means, as a friend pointed out to me recently.
45:58
It's just this idea of how people are valuing assets is based on not only what they actually value the asset at, but what they're viewing other people to value the asset.
46:12
So in your case of the growth and value arbitrage, it's the Keynesian beauty contest that Keynes described in the thirties, right?
46:25
But essentially, it gets more and more powerful in bubbles because as you get this fundamental ambiguity, more and more of your rationale is based on what you are viewing other people doing, which you usually extrapolate from alternative data sets from market price, from trade exhaust, certain other ideas.
46:42
We're trying to really suss out positioning and understanding what others are doing versus your actual understanding of assets value.
46:54
That's why you see, in general, bubbles do form around these novel paradigms, or very, I guess you could say, hard to value or understand concepts.
47:02
So the internet bubble, it's not a surprise that happened when most people were not on the internet.
47:10
Or cryptocurrency bubble, similarly.
47:15
And very few people actually have interacted with cryptocurrencies or have technical understanding.
47:20
So that makes it way more susceptible to drawing on this idea of the madness of crowds or the growth value arbitrage you mentioned.
47:26
It doesn't take much collapse to really trigger a full on collapse because you are looking at signals in the market, which are really other people reacting.
47:37
So it really creates a snowball effect.
47:42
Jesse Livermore: Yeah, I agree.
47:42
And let me say, I think you helped me get back to what I was going to say when I got on that tangent.
47:45
Is that, so the sustainability of a bubble, the sustainability of a bubble is, in a way, one variable that's going to matter a lot is how difficult is the arbitrage itself?
47:58
If we were talking about something that's an arbitrage where I have to wait one month to get the payout, and I can hedge it or whatever, like everyone's going to do it.
48:10
And everyone's going to be thinking fundamentally and be worrying that way from the start.
48:14
But if the arbitrage is something...
48:14
and this is a really good point that Lily made around the idea of there being a lot of invariance just in terms of what we think the actual fundamental value is, which is just a lot of uncertainty.
48:26
The more you have things like uncertainty added in, and the more you have things like time added in where you have to wait a ton of time to actually get the payout, to actually be anything meaningful.
48:34
The more that's built into the equation and for how the arbitrage would work, the harder it is to have that force really assert itself.
48:40
If people really don't believe it matters, what a PE multiple is, or that the fact that one stock has a really high PE multiple and another stock doesn't.
48:51
That can go on for a really long time, because to arbitrage that in a way that would actually lead to a profit and then collapse the difference of the mispricing, could take a long time if everyone else is not cooperating.
49:02
And there's no necessary reason why other people have to cooperate.
49:07
So if GameStop goes to some huge price and then other stocks are trading at...
49:13
Like if GameStop goes to $483,000, and then you've got Microsoft trading at 10 times earnings, you would think that everybody would sell GameStop, and then buy Microsoft.
49:19
And there would be a shift in the market and people would say, this is a much better deal.
49:22
But if people are kind of latched onto other thought processes, and if you can keep those thought processes in place... they may be short-lived.
49:32
But if they stay in place, then you can have the GameStop situation last forever.
49:37
I mean, notwithstanding the mechanical situation might throw a wrench in it if they start to increase the supply.
49:41
But if Bitcoin goes to, let's say, a hundred trillion.
49:46
And you've got stocks that are actually producing real cash flow that you could also own instead of this useless thing.
49:52
The arbitrage that creates, it's not necessarily something that is going to translate into cash now if you have people that continue to be willing to pay for that Bitcoin and to keep paying higher prices and higher prices and higher prices.
50:07
There's nothing that would stop the person who buys Bitcoin from continuing to do better than you over the time horizon that you care about.
50:16
And that time horizon is not an infinity of years.
50:16
We would say that, assume that in an infinity of years, eventually, the cashflow producing thing is going to actually produce a better return for you.
50:26
But you can't even say that because it could go on forever.
50:31
Lily Francus: In May of last year, I wrote a good...
50:34
Obviously, a lot of people know me from writing about GameStop in general, the option squeeze and stuff...
50:38
Was this idea of the salience model, where you see this very characteristic behavior of bubble assets, which is related, in I think a lot of ways, to this idea of, if you go back to the two portions of what percentage of your view or evaluation is dictated by a fundamental understanding of what it is.
50:58
So let's say low fundamental variance is a hundred dollars is a hundred dollars.
51:03
And what percentage of variance is dictated by price and essentially the behavior of others. And you know one of...
51:09
But one of the interesting behaviors is if you kind of apply the [inaudible] model, similar to the credit risk, where you understand it.
51:16
Let's assume an asset is valueless, an implication is that whatever price it is trading at is the equilibrium price between the future upside and the future downside.
51:31
That's the log one price, right?
51:37
So, one of the ways that I've understood bubbles to react over time, is that they set a new floor price.
51:48
In the sense that it's almost [inaudible] of an option where if GameStop goes from, let's say $10 to $100, and then down to $40, that $40 is embedding information that the market believes that there is still more upside left on GameStop than there was at $10.
52:07
Because otherwise, if we all agree that GameStop is valueless, it should be trading at $10 or less.
52:16
And we see this characteristic behavior where you see basically this over time.
52:16
It's almost like an exponential decay of these bubbles that you see usually in aftershock.
52:25
And then you see a trickle basically to zero overtime.
52:32
Jim O'Shaughnessy: So much good stuff here.
52:37
But let me lead with my friend, Mike Green, has a really interesting theory.
52:44
And that is that indexes have so dominated the market.
52:44
And indexes are clearly price-takers.
52:55
They do no fundamental analysis.
52:55
If stock X, Y, Z is 7% of the index, they buy 7% of that stock.
53:06
And Mike's thesis, which is really interesting to think about, is have we gotten to a point in the market where there isn't enough mass, if you will, to the price discovery portion of the market?
53:28
And Mike would say, for example, short sellers.
53:28
Short sellers, it's I guess popular for certain groups to hate short sellers, but they bring rationality and discipline to marketplaces, by engaging in price discovery and discovering a price that they think is much lower, in most instances, than the current traded on.
53:52
And Mike Green's theory is that there aren't enough of those people.
53:59
Lily, first you, and then you Jesse.
53:59
Lily Francus: So it's interesting.
54:04
Going back to, my god, I was clearly a big fan of this paper, John Cochrane's paper in 2000, about the tech bubble, where he looked at the behavior of, I believe this was 3Com and Palm stock.
54:15
And one of his understandings of why this bubble in this stock for instance got significantly large.
54:27
I mean it was largely, I believe, based on the value of this private subsidiary at the point, but essentially this idea of restriction on short selling.
54:35
Because when you think about what Justin was saying about arbitrage or this idea that bubbles will pop largely because there exists some flaw in the pricing that will lead to potential profit.
54:56
Obviously the most direct approach is to gamble on the market price right now.
55:01
If you do the, let's say the growth value arbitrage that Jesse mentioned, you're going to see it take 10, 20, 30 years to realize your gains, where it's potential, it's pretty likely that you're understanding of right expectations, you're understanding of economic changes, all that ambiguity will dwarf whatever profit and edge you actually have in conducting this arbitrage.
55:24
Versus conversely, when you allow short selling in this market, you can realize gains fairly instantly, as long as you get market consensus to agree with you.
55:39
Obviously there is increased risk in the sense that stocks have unlimited upside and finite downside.
55:43
But fundamentally, what short selling does is it kind of basically incentivizes actors to try to set a realistic price and if they do believe that the risk is worth it, then they can put pressure on the price downwards.
55:58
And in bubbles, what's interesting is if you go back to this idea of fundamental value versus liquidity value, which are really this idea of is there a fundamental way to value something versus what am I getting from just other people's signals, then this downward pressure on price is a pretty powerful signal that could drive the bubble. It's off to clots.
56:22
Jim O'Shaughnessy: Interesting. Jesse?
56:25
Jesse Livermore: Yeah I think that's a really good point.
56:26
And it's almost like you can almost see the point if you think about it in terms of a reverse bubble, right?
56:30
We're talking about bubbles right now about stuff that's really where the price is way above the intrinsic value, to some extent that we just determine it's dangerous or it's inappropriate or whatever.
56:43
But if you thought about a reverse bubble, right?
56:43
Let's suppose that I'm the government, right?
56:46
And I'm going to short Apple stock.
56:46
I'm going to shorten it until the price is 10 cents, right?
56:53
And from there now it's what, 165 or 170, whatever it went to after the earnings.
56:57
I get it short to 10 cents, and I tell you, I'm putting a bid out, I'm shortening this thing to 10 cents.
57:01
You can't margin me out because I have an infinite balance sheet, okay? If you did that, right?
57:06
The process to arbitrage that would not be so hard, right?
57:06
Because what you would have to do...
57:13
there's the issue of if the government was selling securities, they'd be soaking up cash.
57:17
So you'd have to get the cash back into the system.
57:17
But if the government found some way to put the proceeds of Apple sales back into the economy so that you could keep buying, right?
57:24
You would have a situation potentially, where people could easily buy and not have to face any of these constraints that a short seller faces, any of the constraints that a lever person faces, you could just buy.
57:34
But we are trying to arbitrage something in the other direction, when it's going too high, right?
57:38
You have all these instabilities and all these additional risk factors that are of a consequence of market structure.
57:49
And just the way that transactions occur, it changes the entire calculation, right?
57:49
If I see GameStop at $483,000, right?
57:55
I can't just say, "Well, I'm just going to go short GameStop."
58:00
You could just destroy yourself that way.
58:00
You could end your whole financial career that way, because of the asymmetry and all the risks.
58:04
So I think that part of what makes...
58:04
If arbitrage or a return to fundamental thinking is what drives the collapse of bubbles, right?
58:13
It's especially hard with bubbles because the way of implementing the arbitrage sometimes involves additional risks, right?
58:27
That make it unattractive, or that make it costly, that force you to focus on the short term, and that keep you anchored to that question of, "What is going to happen with GameStop tomorrow?"
58:36
If I'm a guy that's coming in, or I'm a trader that's coming in to short sell GameStop, because it's way too expensive and this is ridiculous.
58:41
I can never take my mind off of tomorrow, right? I can never do that.
58:47
I've got to be thinking about tomorrow the entire time, right?
58:47
And what's going to happen tomorrow is going to be of paramount importance no matter what the future holds, because it could destroy me.
58:57
Whereas if all I had to do was buy Apple at 10 cents, right?
58:57
I can just buy Apple at 10 cents with my own capital, right?
59:02
And just hold it and let them pay me whatever the dividend is, three or four dollars a share, right? And we're good.
59:08
So it's much more complicated with it on the upside, and the arbitrage mechanisms are more fragile and less reliable because of that very fact that Lily mentioned. Jim O'Shaughnessy: Yeah. Lily? Lily Francus: Yeah.
59:22
It's interesting because the idea of short selling is an idea of leverage.
59:22
There is no, to my understanding, there's obviously ETFs which mimic it, but even at those cores, they are also leveraged in the sense.
59:32
And leverage is what Jim was talking about as a system instability.
59:38
It obviously magnifies your potential gains and losses and many traditional economists review leverage and the existence of the business cycle as fundamentally, this war between optimism and pessimism.
59:48
I find that too philosophical for me.
59:56
It's obviously a topological approach almost where of course, if you are buying something on leverage, you're optimistic about the price.
1:00:01
So, I wouldn't say it gives us any more insight into how the market works, although it does make some nifty models.
1:00:05
But essentially, leverage is interesting because it creates this idea of fragility, where you have leverage.
1:00:19
There's obviously a bar rate.
1:00:19
So you could argue, there is some fragility over time, you can't sustain a leverage position indefinitely.
1:00:24
But your risk factor taking a leverage position from let's say rate expectations changing, is much lower than market normal volatility.
1:00:41
So realistically, your primary risk factor on leverage is a change in the spot price of whatever asset you are leveraging.
1:00:48
And what's interesting is options and the growth of options as well, are this idea of non-recoursable leverage.
1:00:55
And that's potentially more scary because leverage that is recoursable usually has a way of rinsing itself out.
1:01:00
People get burned, people lose everything.
1:01:07
When you have recourse, people tend to make much different decisions than when they only will lose the premium of the option.
1:01:14
So you create these distortionary scenarios, where there's an asymmetric upside.
1:01:22
If, let's say you buy a call on a GameStop right now, it's trading around $100, then if you go to 480.
1:01:27
But if you buy the call with, let's say, trading at 6% or 5% of it's asset value.
1:01:34
So your maximum downside is 6% of GameStop's current price. Your upside is 300%.
1:01:43
And what that does fundamentally, is it changes how people are measuring risk, and it changes what people should be accepting as a fair price for an asset.
1:01:50
Because fundamentally, when you are leveraged or when the whole system is leveraged, what it is, is magnifying the volatility of the asset price, which is increasing your risk.
1:02:05
But if you are non-recourse leveraged, you do not bear the risk.
1:02:11
Someone else is bearing the risk for you.
1:02:11
Jim O'Shaughnessy: Jesse, before you go, Lily, that is one of the central challenges of trying to figure out finance, right?
1:02:23
Because what you've just said is absolutely right.
1:02:23
And so this idea of, well why not? Why wouldn't I do that?
1:02:35
All I can lose is the little bit of money that I put up, right?
1:02:40
And it's almost like, that seems like a gamble.
1:02:40
Even if my odds of winning are really low, what am I out really? Right?
1:02:49
And then compared to recourse leverage.
1:02:58
They pay much closer attention to that. Lily Francus: Yeah. [crosstalk]. Sorry.
1:03:01
Just have one more thing.
1:03:01
It also touches on this idea of the marginal dollar in solvency economics.
1:03:06
Like you said it's a gamble.
1:03:06
A lot of what you saw last year, you could argue was changes and consumption patterns by retail investors who suddenly got, let's say, more money from stimulus or from the economy heating up, and they're willing to gamble with it.
1:03:22
Because once you've already met your needs, your marginal dollar, you might have much higher risk tolerance than you believe on your marginal dollar.
1:03:33
Jim O'Shaughnessy: That is so great because it ties right back, Jesse, with your idea of happiness.
1:03:34
But you were going to try to respond to the conversation we were having [crosstalk] just a moment ago.
1:03:46
Jesse Livermore: Yeah, I was just going to say that, additionally, with respect to the option situation, right?
1:03:48
You can express bearish bets with options and limit your downside risk, right?
1:03:55
But the problem is that you have to have a counterpart to those options obviously, and so the risk is going to somehow get priced somehow, somewhere.
1:03:59
And in terms of Delta hedging and all the option complex and all that stuff, but also the option has a date, right?
1:04:13
And so, what's the farthest out you can get for the option? A year, two years.
1:04:13
That forces you to again, be myopic, be thinking short term.
1:04:18
Because if you don't have what you're thinking is going to have happen now, right?
1:04:22
Then you're going to lose all your money, even if you're right.
1:04:22
And so you can't just focus on being right.
1:04:27
You got to focus on the timing aspect again.
1:04:27
So it brings the horizon really, really short, right?
1:04:31
Jim O'Shaughnessy: I actually love that, because hyperbolic discounting is a real thing.
1:04:35
And I bring that up and people say, "Time arbitrage, that's bullshit." No, it's not.
1:04:42
Not if you are doing a lot of your investing with instruments that have a drop dead date, right? Lily Francus: Yeah.
1:04:55
It's interesting because it's something I've talked about actually was recent drama in the cryptocurrency market since I traded.
1:05:02
It's a fun market if you believe the fundamental value is zero or something.
1:05:08
But what's interesting is that a lot of these bubble assets, if there existed a term structure on a forward that was not directly tradable.
1:05:13
So, let's say I gave you this promise that I will give you GameStop shares in two years, but you can't trade it.
1:05:20
Because obviously if you can trade it forward, the price of it is equivalent to the interest rate compounded, it's pretty basic finance 101, but if you couldn't trade it, what you would see on all these bubble assets, at least theoretically is pretty heavy backwardation.
1:05:35
That people's basically demand for the asset has been pulled forward to the instance.
1:05:43
And that is one of the primary price pressures.
1:05:49
And you could even view this under the leverage lens as the primary risk of leverage is you have this absorbing barrier where it exists somewhere on the assets price, 20%, 10%, 30%, where fundamentally, if that barrier hits, you lose everything. It does not matter.
1:06:10
Let's assume leverage is linear here and it's obviously not.
1:06:10
But what happens is that your risk is magnified substantially because you are now susceptible to changes in volatility and just normal volatility fluctuations.
1:06:24
So, when you take a leverage position, you are essentially short time itself because volatility and I talk about this, is really this way that the market measures time.
1:06:36
And as your primary risk from leverage is volatility, then you cannot afford to wait.
1:06:44
Jim O'Shaughnessy: Jesse?
1:06:49
Jesse Livermore: I completely agree.
1:06:50
He has an excellent point.
1:06:50
I mean, it's almost like you want, it's tempting to want to even use the idea of backwardation as we talked about initially, is there are other signs of bubbles, that you can use.
1:06:57
You have to be careful in how you frame it, but just the very fact of an extreme backwardation right?
1:07:02
In something that isn't consumed, right?
1:07:09
If it's oil and it's consumed, then there's a reason for it to be higher now than later. Right?
1:07:13
Cause people are going to use it now and it's going to go away.
1:07:13
But if it's a stock that's going to live for a hundred years and there's this massive backwardation, it's almost like that itself can be kind of an indication of some problems...
1:07:30
Market malfunction somehow.
1:07:30
Lily Francus: [crosstalk] Yeah, and, if only we had some kind of market for that, but most people would buy a five-year GameStop [inaudible] Jesse Livermore: Yep. Exactly.
1:07:39
If you could try to think about, simulate that kind of a market or find somewhere to say this is in backwardation but...
1:07:44
Lily Francus: [crosstalk] What's interesting...
1:07:47
Jim O'Shaughnessy: No, I'm just fascinated by this question.
1:07:51
Can we come up with that asset? What do you guys think? Is that possible?
1:07:57
Jesse Livermore: I mean the risk is going to have to go somewhere, right?
1:07:59
I mean I'm sure that we would, somebody somewhere is going to be making this not work is my intuition.
1:08:12
Jim O'Shaughnessy: Right. Lily?
1:08:17
Lily Francus: I will put on my option hat and essentially say, this is part of the idea of implied borrow rates and the implied dividend of an asset.
1:08:22
I mean, if you look at assets that do have options and let's say you sell a combination on, it's something like, you sell a call for, it's a lot easier if it's not American obviously, but even for calls, American calls are practicing as European calls.
1:08:40
So at least you have that niceness.
1:08:45
But you sell a call, you buy a put, you buy, let's say, the spot of an asset, what you are essentially betting on between now and then is changes in the bar rate, which are the reflection of, what is the demand to short sell the asset?
1:08:58
You would at least view that as related to the idea of a bubble, because if you have this bubble or at least theoretically, that has this available arbitrage, you would see higher demand for short selling it because people would want to realize that arbitrage, as you mentioned, the primary blocker for that is both accessibility and risk.
1:09:25
Although, you could argue risk is really just accessibility in a certain mindset.
1:09:25
So, that is sort of a measure of the implied forward of an asset.
1:09:34
It isn't, let's say, perfect where you have this no true condition, but you can sort of rock, for example, what is the markets view of what this should be trading at in the future based on looking at, the short basically or implied bar rate, dividends, stuff like that.
1:09:57
Jim O'Shaughnessy: So, just to show you how ancient I really am.
1:10:00
I started my career in the market in 1979, 1980.
1:10:12
And I had been fooling around with math and the Black-Scholes option pricing model.
1:10:19
And I thought there was some really exploitable information that that model was allowing leak out.
1:10:28
And the cool thing was, there was no internet.
1:10:28
So, very few people even knew what the Black-Scholes option pricing model was.
1:10:32
And so I literally picked the computer that I bought at a Texas instruments, I can't remember it's number, because there was a module available for it that priced implied volatility using the Black-Scholes model.
1:10:53
Now, each one took five minutes to price that implied volatility, but there was a mathematical anomaly that I won't bother getting into here, that I discovered, that was very tradable.
1:11:08
It wasn't tradable like, Ooh, I'm going to make a killing.
1:11:15
It was tradable like, oh, I got a single, I got a double.
1:11:15
And I struck out, yes of course, but not very often until an academic wrote a paper about that anomaly and it disappeared.
1:11:32
So that's what I want to ask both of you right now.
1:11:32
In this hyper-connect, now that was then, what I mean, that's the paleolithic period, right?
1:11:39
You had to actually get that academics paper in hard copy and read it and then work out the math and think, oh, you know what?
1:11:46
I can take advantage here and guess what?
1:11:56
There's 10,000 other people doing the same thing.
1:11:56
So, the anomaly and the arbitrage goes away.
1:12:02
My question to both of you is, is there a mathematical model such that it's awareness of said model, the awareness of the varying factors of that model, how it's put together, etc.
1:12:21
Is there any model that can exist in a hyper-connected age without getting arbed out of existence? Lily, you first. Lily Francus: Momentum.
1:12:39
I would argue there's really two types of edges in the market.
1:12:39
There's and I'm a child, so now don't take anything I say for face value.
1:12:48
But there are edges that perform better with crowding and there are edges that perform worse with crowding.
1:12:53
And essentially, there are certain edges that become real because people believe in it.
1:12:58
I would imagine momentum is one of them in the sense that, the more people that are trading momentum by definition, they will be buying an asset, when you are buying, they'll be selling it when you're selling.
1:13:09
I've heard some interesting models that for instance, trade on, let's say 120 minute candles in the crypto markets.
1:13:18
So a guy I talked to, was like, "well, what if I trade on the 119 minute candles?" Basically.
1:13:27
So, in those cases, yeah.
1:13:27
I mean, there's many evidences of models that actually become the rule because people use it.
1:13:35
I'd argue obviously fundamental analysis is one of them, in the sense that the way that we view, the more people that agree with how you view the fundamentals of an asset, the more likely you are to benefit from it simply because they'll be trading in the same direction as you.
1:13:54
But I do believe that obviously, most edges we talk about on the market do lose potency as more people know about it.
1:14:00
Because you could argue on the other side, if you have a model for instance, like momentum, the most basic one.
1:14:13
It may be profitable in certain instances to counter trade you.
1:14:13
Where if you know that people are trading momentum itself, you could basically use that as an exploitable opportunity.
1:14:18
And that's basically the thesis of the efficient market, right?
1:14:24
I mean, it's hard to believe from what I've seen and what I've read that the market is truly efficient.
1:14:29
But I do think that it is asymptotically efficient.
1:14:34
If you look at it on the daily, for example, it may not be efficient on how price is.
1:14:41
But if you look at it over time, the daily may be priced according with microstructure, the short term timeframes may be priced according to flows.
1:14:48
And the long term is priced according to the economy.
1:14:52
Jim O'Shaughnessy: So interestingly, Mandelbrot, I think you should buy his book on the market, just for the chapter that literally annihilates efficient market theory. And he does.
1:15:04
And for those who don't know, Mandelbrot was a mathematician who came up with fractals and with a lot of super cool Mandelbrot sets etc.
1:15:19
If you're a GIF aficionado, there's a bunch of them.
1:15:19
But he also was, I loved his mind because everything he looked at, he was like, "Huh, I wonder that why that is that way."
1:15:36
And that he would go dig into it forever.
1:15:36
And he wondered about market prices.
1:15:36
And so, he went and got the daily price, and the reason I'm telling this story is because of the way you ramped the efficiency of the market, which is very smart by the way.
1:15:50
Because what Mandelbrot did was, he got the daily changes in cotton prices and he had a data set that was longer than a hundred years.
1:16:03
And his conclusion was from that data.
1:16:03
And he did some other data sets as well that had equally long time periods.
1:16:10
From that, that markets were not in fact log normal.
1:16:10
They were chaotic normal.
1:16:17
And if they're chaotic normal, both of you know, but I'll explain for our audience, a chaotic-normal distribution has much flatter and longer tails and has a far peakier middle.
1:16:21
So unlike that log normal with that, Ooh, so easy up and down of the circle, it covers nearly 70% of all outcomes.
1:16:39
Chaotic-normal distributions, most of it is in the tails.
1:16:39
So Jesse again, sorry for my little digression. What about you?
1:16:49
Do you think that there is Jesse Livermore: [crosstalk] Yeah, I completely agree with Lily on that, I think that it would be something like momentum, some sort of process where the attempt to capture profit from the implications of the model becomes the basis for profit, right?
1:17:03
It feeds the process, right?
1:17:03
So, if we all, if it's 2011 and the model says that Bitcoin is going to become, the world's global currency that we're all going to be using in some point in the future, right?
1:17:14
And it's going to be a source of significant profit.
1:17:17
The very fact that people believe that and attempt to try to capture it as profit would actually, in no way would that arbitrage anything away, it would just intensify the process, right?
1:17:28
It would be the, the positive feedback would itself make for a theoretically endless possibility of profit, if you could keep that belief in place. Right?
1:17:42
And there would be no need for it to get arbed away.
1:17:42
We could go until our net worth's are all, a hundred gazillion dollars.
1:17:47
Jim O'Shaughnessy: Do you think, Jesse, that right now on January 28th, 2022, we are in multiple financial bubbles?
1:18:00
Jesse Livermore: Ooh boy. Man.
1:18:05
Jim O'Shaughnessy: I told you it was going to be unfair.
1:18:07
Jesse Livermore: Honestly, I'm going to say no, I'm not going to go there.
1:18:09
I would point to the game stop stuff but that's come down a lot.
1:18:14
I'm going to say no, I don't think the equity markets are in a bubble.
1:18:14
I don't even think honestly that ARC is in a bubble.
1:18:19
I think that there's credible pathways to which that could all work out.
1:18:26
The growth complex it's already come down a lot.
1:18:26
Real estate, definitely not in a bubble.
1:18:32
There's a real organic demand behind a need for increased housing.
1:18:37
Equities, the problem is this, you don't...
1:18:37
When you have a zero interest rate, a 7% inflation rate and you've got stocks priced at higher than their average historically, maybe significantly higher.
1:18:49
There's no answer for what the right price is.
1:18:49
What return do you want over treasuries, which is negative, 2%, let's say.
1:18:54
Let's say the return on a treasury bill is negative 2% real right now, relative to the inflation target.
1:19:00
How do you price that and say that the equity should be yielding 3% or 4% or 2% or 5%? It's impossible.
1:19:05
So, I don't see one, I don't think that there's a level of euphoria right now that matches what existed in 2000.
1:19:17
If we had it, we had it last year but I think some of that's come down and deflated. So my answer's no. Jim O'Shaughnessy: Cool. Lily.
1:19:25
Lily Francus: So I guess it's difficult because as I've described, my definition of bubble is very opaque in the sense that it's really any prolonged discontinuity between a fundamental and the market price or liquidity value is essentially the bubble value of an asset.
1:19:45
I do think that certain segments of the market are still notably frothy in the sense that they may never realize the fundamental evaluation that is equivalent to the current price.
1:19:51
I guess if you call that a bubble, I will try to leave it up to the reader to think which ones it would be, but obviously crypto either is in a bubble or certain segments of the market clearly in bubble phases.
1:20:12
I do think that as Jesse pointed out that growth was pretty reasonably slaughtered.
1:20:12
It's unclear to say whether it's still in a bubble in the sense that if it's still fairly valued or not.
1:20:27
I would argue, my lane would be no, that there's still more downside that's available especially in certain segments, but yeah.
1:20:33
One thing I did find interesting, which Jesse brought up, which fundamentally agree with is of course, when you are looking at evaluations of these companies, you have to understand what the actual discount rate is.
1:20:51
Because if you compare it to, let's say 2000 where you had treasuries yielding 6% or something versus now, of course, the cost of capital is different as well as people's understanding of what risks are going to tolerate but my question to you is
1:21:12
when we think about these assets, especially ones with longer durations, like a growth asset, we're not only pricing the current rate of or the current discount rate, we're actually looking at what do we expect it to be at in 30 years? So we need to understand, do we expect this
1:21:24
So we need to understand, do we expect this current economic environment of low rates to continue?
1:21:30
There's obviously some decent analysis stating that there's only a certain rate that the Fed funds rate could go up to before the government couldn't pay back its debts or the fixed to floating rates of mortgages, which set this implied cap on what kind of risk freeway we could be looking at.
1:21:49
But do I have confidence that will be the same in 30 years? I don't know.
1:21:58
Jim O'Shaughnessy: I think that's a great answer because as both of you point out there are limits, there are bounds of which you can have the government set the rate to a place where the government itself cannot repay its indebtedness and there are so many factors going on because of so many asset classes also being available.
1:22:27
My, for what it's worth in this, as I often say, I have an infinite time horizon because I have children and grandchildren and I have charities that I want to give away a lot of money to so I don't give a shit. I'm 61.
1:22:41
My time horizon is infinite.
1:22:41
You super smart people will be around a lot longer than me and I love that.
1:22:49
That's great because I'm a bounded optimist, let's put it that way. A rational optimist.
1:22:56
Will we cause all sorts of idiotic, foolish mistakes? Of course, we do. We always will. We're humans.
1:23:02
That's one of the things we excel at but I think there's also a lot of very smart humans who help us out of those mistakes and I think one of the best ways to do that is things like this.
1:23:14
So I'm incredibly thankful that we now live in a culture where people like you, Lilly and you, Jesse can be hurt and have so many people actually listen to this.
1:23:30
You might not believe how excited people were when I said I was recording with you two.
1:23:37
So I love this idea that I call the great reshuffle. This isn't a part of it.
1:23:44
Competence over accreditation.
1:23:44
You were studying for a PhD, Lily, in something completely other than finance.
1:23:52
Jesse, I won't go where you are but I can safely say what you do and excel at, I might add, has nothing to do with finance.
1:24:01
Yet you have been offered jobs blind by some of the biggest names in finance and that kind of world, I think is very exciting.
1:24:08
That makes me happy because the ability to exclude people based on their race or ethnicity or sex or any of those things left a lot of geniuses who went undiscovered and un-found because you couldn't come into the club, because you couldn't move to that neighborhood, because you didn't have the right degree and guess what?
1:24:39
None of that matters very much anymore at all.
1:24:39
If you are competent and you can demonstrate it and you can have proof of work, man, the world's going to be your oyster.
1:24:53
So you're not going to sneak away though, without answering the final question, which is always the same and I'm going to start with you, Lily, because just last time, Jesse wanted more time to think about it.
1:25:02
You get to incept the entire world's population.
1:25:10
In other words I used to present it as you're going to be the Empress for or a day but you don't even have to be that because you can't kill anyone, you can't pass any laws, you can't compel but what you can do, is you can, if we're thinking about Douglas Adams, you can be an earworm.
1:25:27
As that earworm you can incept two ideas in the world's entire population and everyone is going to wake up the next morning thinking the idea that you came up with is their idea and they're going to act on it. What do you got?
1:25:41
Lily Francus: I guess it's something that's been more pertinent last year.
1:25:45
A lot of people I know struggled, myself included with the after effects from pandemic especially if you were an extrovert.
1:25:57
I think you got way more slaughtered by the idea of lockdowns and isolation than more introverted folks and I think that the first one is just this understanding of putting mental health first.
1:26:13
It's something that fundamentally a lot of people still are uncomfortable talking about in large groups where understanding that they may struggle with certain things or even, I think it's even worse for men in a lot of respects because especially male on male friendships, you don't, from what I've observed at least, you don't demonstrate this level of sensitivity and level of basically vulnerability.
1:26:40
I think that it's very important, especially in this current climate where people are struggling and people, it's not rare to be depressed, it's pretty much the norm or was especially in 2021.
1:26:53
There's been studies that millennials can gain 40 pounds during the pandemic and other groups gained pretty similarly.
1:26:59
I think older people of course were very isolated.
1:27:06
My own grandmother told me about her own depression and how she hasn't seen people.
1:27:11
I think, I really do hope that we move toward a world where we treat mental wellness, at least along the same veins as physical wellness and the second one is related to that as well.
1:27:23
Is this idea of happiness and productivity. I'm a workaholic.
1:27:30
I think it's pretty obvious from Twitter, from what I've done, I wish I could turn off my brain a lot of times and won't work.
1:27:39
I think fundamentally for me that's always been because of this idea of running out of time.
1:27:46
I think a lot of us want to prove ourselves as mattering on this planet, especially given life is finite.
1:28:00
A lot of us, I think the cardinal center is not wanting to matter.
1:28:00
It's more that we may sacrifice what is important and our own ability to persevere for temporary productivity gains or temporary.
1:28:08
I know I've done that many times in my life.
1:28:17
I've always discounted my own happiness in exchange for, well, maybe I can finish this startup or maybe I can finish building this today or maybe I don't need to go to see my friends, I could go work on something else.
1:28:28
Fundamentally that never works out in the end.
1:28:34
Life, I think what we talk about is human bubbles. Life is about happiness.
1:28:37
The idea of value is happiness or utility and you aren't going to succeed without caring for yourself.
1:28:43
I'm not saying you should care only for yourself.
1:28:49
I think for most of us, I hope that part of caring for others is part of our own happiness but you cannot always focus on this grind culture.
1:29:00
You cannot always put work first.
1:29:00
You have to make sure you're okay, even if that means delaying certain aspirations.
1:29:04
Jim O'Shaughnessy: I love it.
1:29:09
I agree wholeheartedly with both.
1:29:09
I tend to think that happiness is a byproduct and not an end of itself.
1:29:16
It is a byproduct through having a purpose, through having a set of relationships but also in that I believe that some of the wisest people that I've read at least, have said, you can only begin to help others after you've helped yourself and people rebel a little bit at that, thinking that they're going to demonstrate altruism.
1:29:48
If you yourself are a mess, it's going to be difficult for you to help someone else who's a mess.
1:29:52
What you might want to do is work on yourself first, then get going.
1:29:52
But I completely agree and like both of those.
1:30:00
Lily Francus: One more thing, an analogy I have is when I blew out my car, when I was about 16, driving up a pretty steep hill.
1:30:09
At the end of the day, if you don't take care of the car, you can push it forward but if doesn't move along.
1:30:14
Jim O'Shaughnessy: Exactly.
1:30:18
Jesse, what do you got for me?
1:30:18
I gave you a lot of time to think on this one.
1:30:23
Jesse Livermore: First of all, I want to echo I completely agree with Lily's emphasis there.
1:30:24
Let me do one thing real quick.
1:30:30
Let me just caveat my prior answer because I'm having some regrets here.
1:30:30
In saying that there are no multiple bubbles, I don't want to say that there aren't bubbles though.
1:30:34
So NFTs, all that stuff, I am not saying that stuff's not a bubble.
1:30:38
I just don't even want to go there.
1:30:42
I've gone there so many times but with respect to, if I can implant some ideas into people's heads, one idea would be a lesson that I learned from the field of psychology, which is that your quality of life is a function of where your attention is spent.
1:30:55
So just like we allocate capital, a person who wants to be as happy as possible should think about how they allocate their attention.
1:31:07
And what sorts of things that they constantly stimulate in their lives with social media and with other things because that really is an important aspect of how you end up feeling.
1:31:14
Some things we're not designed to arbitrarily decide where our attention goes.
1:31:14
If there's something bad going on in our life, we have to put our attention on it and fix it.
1:31:19
That's why we have negative emotions, evolutionarily, so that we can put attention on things that need to get addressed.
1:31:26
But a lot of times there's silly things that don't need to be on our attention that are driving us nuts and if we could just cut those out right or just they're interfering with our ability to pursue what we love and enjoy.
1:31:35
If we could cut those out or control those a little bit better, including negative people sometimes, it's a much cleaner way to a better experience of life.
1:31:47
I'm not pretending like I'm an expert in terms of implementing that.
1:31:47
But I do sense the truth of that, as it was when I read it in one of these psychology books and another one is, let me caveat that.
1:31:58
So an additional point is that one of the key ingredients of happiness is propitiousness.
1:32:05
What that means is when you're in an environment that is supportive, that is constructive, where there's perpetuity, there's the prospect of gains and not a lot of threat.
1:32:17
In those kinds of environments you tend to feel emotions that are useful evolutionarily in those kinds of environments.
1:32:21
So if you're in a bull market, you want to have, it makes sense for a person that's in a bull market, let's say, to be really, really have a positive mood and really have a high appetite for risk and to be just feeling great and wake up with the kick in their step and all that stuff.
1:32:33
If you're in an environment where there's a lot of threat, there's a lot of conflict, a lot of tension, a lot of negativity, it makes sense evolutionarily for you to have a different mentality where you're more sensitized to danger, you're more sensitized to downside, to loss to.
1:32:45
And so if we have any control over our own environments and the environments of our fellow human beings, we should want to, for ourselves and for others, try to encourage propitious environments and not feed negative environments that are, feed conflicts, just try to avoid because all you do is create suffering. That's my first point.
1:33:05
The second point would be free will.
1:33:10
This is a little bit controversial but I would say, this is my honest answer, if I could program into everyone's brain a little bit less of a belief in free will, I think that there would be a lot of positive that would come from that.
1:33:19
Because in my view, we evolved the illusion of free will as an evolutionary mechanism for distinguishing between voluntary behaviors that are responsive to feedback and involuntary behaviors that are not.
1:33:31
Like digestion is not responsive to feedback but if you want to hurt somebody and you punch them, that is responsive to feedback.
1:33:36
In terms of how the brain works.
1:33:40
So we've evolved to think that one of them is controlled by a soul and is free will and the other one is like biology. They're both biology.
1:33:46
The value in realizing that is that when you think that something is originating from some core soul of free will it really feeds anger.
1:34:00
It feeds a desire for retaliation.
1:34:00
It feeds a desire for taking actions that are going to change that person's perspective and that person's values, for example, or if it's yourself, guilt.
1:34:09
Which is the same thing turned inward, which is, and that stuff can be useful but it sometimes can be not useful.
1:34:15
Sometimes the best things is just focus on fixing things as they are and accepting them and fixing them and making them not happen again or making...
1:34:19
If you made a mistake, not making the mistake again, it's much easier to let go of all of the heavy emotion and reactivity that comes from bad experiences.
1:34:28
If you don't attach so strong to the idea that you're in full control of what's happening.
1:34:33
Because in reality there's so many things that are happening inside your brain, in your environment, in your life that I would say everything 100%, in my opinion, is a function of those inputs and you, quote, unquote, you, the soul is not really the powerful player you think you are in all the things that are happening. So I'll throw that out.
1:34:56
Jim O'Shaughnessy: So, I love that one.
1:34:56
Not controversial at all.
1:35:06
Lily, do you have a comment?
1:35:06
Lily Francus: Yeah, I was going to say, it's interesting because I'm actually writing a post now.
1:35:08
One of the things that I recently chatted about was crypto [inaudible] and risk because fundamentally in crypto, the basis is anonymous culture where you saw recently this blow back against this known scammer who was [inaudible] unmasked him and his anonymous identity.
1:35:26
What you said really speaks to the core of identity itself.
1:35:34
I guess it's a salient Jesse, because you're pseudonymous or pseudo... I can't speak properly.
1:35:41
Jim O'Shaughnessy: That's fine. That's all right.
1:35:46
Lily Francus: You have an identity here.
1:35:48
You are a person that we are interacting with, even though, for example, I do not know who you are.
1:35:52
So the question is, obviously this to be a very philosophical but it also has financial implications as you're seeing these pseudo... Anyway.
1:36:02
Jim O'Shaughnessy: Pseudonymous. Yep.
1:36:05
Lily Francus: Pseudonymous identities controlling large sums of money or being able to interact with people online or enter into these transactions that we normally ascribe to humans.
1:36:12
What does that mean for our concept of identity itself? Jesse Livermore: Oh boy. Lily Francus: Yeah.
1:36:23
Now, I literally think that I'm going to make a note on that and that's going to be maybe our second half of this.
1:36:29
I would say, so first off, free will, I understand the point you're making Jesse, but I do think that, and especially the point by the way around the illusion of control.
1:36:46
The desire for illusion of control, in my opinion, has probably led to more bad things for humanity in general, than many, many other, what I would call evolutionary programming bits in we domesticated sapiens.
1:37:05
But I think that in a variety of things, I would prefer...
1:37:16
I'm not quite sure that you can make it a thesis is free will.
1:37:23
Do we have free will or not because I don't know that it's falsifiable and that would be- Jesse Livermore: Sapien. Jim O'Shaughnessy: Yeah. So, [crosstalk].
1:37:32
Yeah, because, so I think that Max Planck comes in here and he's hardcore, which is if your theory or thesis is not falsifiable, it isn't a theory or a thesis, it's a belief.
1:37:51
And you can believe anything you want.
1:37:51
So I think we have to bring the Planck like rigor to these kinds of ideas.
1:37:58
But I also think that the...
1:37:58
I don't spend a lot of time.
1:38:08
It's so funny that free will comes up here because in the last six weeks, so many people, so many of the smartest people I know have been like, the conversations have been going for 15 minutes and then it's like, hey, Jim, do you believe in free will?
1:38:25
And it's interesting to me because that's the Jungian collective unconscious or the board cloud up in the sky, morphic resonance, but I do think that the assumption of free will actually leads societally to many much better outcomes.
1:38:46
Jesse Livermore: Yeah and let me caveat what I said.
1:38:51
So I want to be real careful there.
1:38:51
On the Max Planck point, I completely agree with falsifiability as a standard.
1:38:56
The way I would approach it is it's almost like I'm arguing and arguing against free will, I would be arguing against God, for example.
1:39:03
I don't have to be able to define the term, if somebody else believes it I'm going to put pressure on that.
1:39:07
So I don't think the concept of free will even makes sense if we really drill down, we're going to find that it's like the concept of God, it's vacuums, it has no real tangibility and thought.
1:39:15
So, that's the first point.
1:39:15
Second point, hundred percent agree.
1:39:20
We evolved, in my view, the illusion of free will for a reason.
1:39:26
It is how we identify the behaviors and other people that are responsive to feedback because if you...
1:39:31
Right now, let's say if I were to get really angry that the sun came up this morning and then it rained and it rained on my parade, that's of no evolutionary value for me to get angry about that.
1:39:41
So I don't feel free will when that...
1:39:41
I don't perceive agency when that happens, I don't think, oh, that was some person that caused that. I'm angry. I just accept it. It's really easy. It's just that nature.
1:39:50
But when somebody turns on my sprinklers in my apartment or in my house and sprays everything down with water, so if the flood or the rain comes because of somebody's action and they wanted to do that there's a critical need to feel anger.
1:40:09
And to feel a retaliatory instinct to change that person's value system that led to that behavior.
1:40:14
So we need that in a core sense and we could never get away with not punishing people or with not having a retributive base system.
1:40:20
What I'm saying is that in terms of the flexibility around that, when we have flexibility, it can be very good sometimes.
1:40:27
So if you made a mistake in your life and you really regret it and you're stuck with regret, if you realize that anybody in your situation that had your same inputs and your same genetics and your same neurological condition, would've done the same exact thing.
1:40:41
It can soften some of the intensity of that experience and make you feel like you're part of nature, rather than this individual thing that caused the problem to come into existence ex nihilo.
1:40:51
The problem is built into nature.
1:40:58
You have to make mistakes to learn sometimes and that's just how it is and there's no way to escape it.
1:41:01
And anybody in your shoes that had made, that had been in the same situation with the same set of inputs, in the same starting point, would've ended up in the same place.
1:41:10
There's no you that's in there moving it around.
1:41:10
If you can believe that and it...
1:41:10
There's a lot, there's good reason to believe it.
1:41:16
If you can believe it, it can really help to be an antidote to intense guilt, intense sadness, intense regret, which is often an important driver of depression. Jim O'Shaughnessy: Yeah. And... Go ahead, Lily.
1:41:27
Lily Francus: Logically it's...
1:41:30
Logically it's... There's obviously benefits to both respects but I do, I would clarify it with Jim here on this idea that I think potentially this is almost the narcissism of the homosapien, you could call it, where we have to believe it's some respect that we are special,
1:41:46
in the sense that, this is where you get stuff like mind, body duality but you have some interesting work from, that I just checking out from folks like Terry Sadowski, who's actually a computational neurobiologist that you see in San Diego, who's written a lot about consciousness. It is interesting to understand we're still very early stages on understanding what
1:42:04
It is interesting to understand we're still very early stages on understanding what is consciousness, especially from the physicalist point of view, because I think the first roadblock of course is defining what is consciousness at all and the answer is we don't know.
1:42:19
Jim O'Shaughnessy: That's right and that's why this is going to be our hard stop because I think this is going to be another fantastic...
1:42:29
Guys I'm going to hear from you anyway.
1:42:29
But I think we could have a fascinating conversation about all of the other aspects that makes the market the way it is, that have nothing to do with the financial side of the market.
1:42:42
I think that markets are complex, adaptive systems, learning systems and we can go with that one for a long time but listen, this has been so much fun. Lily, thank you.
1:42:56
I hope you will come back on with my friend, Jesse.
1:42:56
Jesse, thank you and thank you for all of the incredible insights you've offered as an OSAM research partner. We truly appreciate it. And wow, so much fun.
1:43:10
Thank you so much for being on. Cheers.
1:43:18
Jesse Livermore: That was a blast.