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Hi friends 👋,

Happy Monday!

I’ve been writing about a lot of fast-growing companies and protocols recently, but I keep hearing that the macro environment is going to dictate returns in very specific ways, so I figured it was worth writing a short one on the madness of the crowds and The Current Financial Thing.

Note: None of this is financial advice. I’m not a financial advisor, and I’m a terrible trader. This is just meant to be an entertaining commentary on the behavior of the crowd and the wisdom in following it. Hopefully, you disagree with me and it makes you think for yourself.

Let’s get to it.

The Current Financial Thing

Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.

It’s funny that those who take finance particularly seriously dismiss meme stocks. 

“Leave the memes to the kids,” they chortle during long bull runs, “We’ll get back to doing real finance once the bubble bursts and the madness subsides.” 

And then the markets turn and rates go up and a war starts and crypto tanks and growth stocks tank and meme stocks really tank and startups will, inevitably, once they’re forced to raise and mark-to-market, tank. 

“Be careful out there, there's gonna be a lot more pain. Rates will continue to rise and multiples will continue to compress and companies will need to tighten their belts and growth will slow and senior leadership will leave and growth will slow further and all but a few of the best startups – let alone crypto projects – will die.” 

Which is funny because this, too, is a meme. It’s a story that people tell each other to cut through all of the trillions of things they could be paying attention to. Re-telling this story is a way for people to signal that they, too, get it. That they, too, take finance seriously. That they, too, are looking forward to the separation of wheat and chaff. 

The difference is, meme stock traders know they’re trading a meme.

Now certainly, the growth bears have some math on their side. The higher the discount rate, the lower the present value. But that’s easy. That’s the same first-order thinking that everyone’s agreed upon. The idea that printing has led to inflation which will lead to more hikes which will kill growth companies and risk assets is The Current Financial Thing. 

So everyone talks about rising rates and hyperinflation and war and food shortages and nuclear threats and supply chain issues and energy prices and IPO windows slammed shut. They create – and may often feel – fear, uncertainty, and doubt (FUD).

The markets are too complex for anyone to know, with the degree of confidence with which some people pretend to know, what’s going to happen tomorrow, let alone in a week, a month, or a year. That’s what memes are for. That’s why people agree on The Current Financial Thing. Throw in Twitter’s algorithmic feed, and people can come to agree with each other more strongly, more quickly than ever before. 

The Current Financial Thing is a play on the I Support The Current Thing meme, which Ben Thompson analyzes brilliantly. 

Elon Musk @elonmusk

March 14th 2022

90,009 Retweets752,596 Likes

On the internet, he argues, we can find many things worthy of our support, so many, in fact, that it just makes sense to “outsource our intuition for which events matter” most. There’s only downside in supporting Putin or opposing Black Lives Matter. 

Opposing The Current Financial Thing, however, or at least realizing that when everyone agrees that the market is going to tank, they’re probably wrong or too late or off-timing, might hold some alpha. In fact, trading on the predictable ways that humans react in times of panic drives the most successful quantitative hedge fund of all time.

RenTech’s FUD Eating Algorithms

Humans are so predictably irrational that the best-performing hedge fund in the world has outperformed the market by 1000x since 1988 in large part by trading on our fear, uncertainty, and doubt (FUD).

Renaissance Technologies (“RenTech”) is a quant fund founded by mathematician Jim Simons. Quant fund means that instead of people choosing which assets to buy and sell, RenTech’s mathematicians, statisticians, physicists, and shape rotators build algorithms that trade assets based on the patterns they find in enormous amounts of real-time data.

RenTech’s original fund, the Medallion Fund, is legendary. Since inception in 1988, it has generated 39% annualized returns net of fees. That’s particularly notable because it charged 5% management fees and 44% performance fees, whereas a standard fund charges 2% and 20%. Nick Maggiulli wrote a great piece going over all of the mind-blowing ways the numbers were impressive in Of Dollars and Data, like the fact that $1 invested in 1988 would be worth $19,518 in 2018.

Obviously, given the performance, understanding how RenTech does it has been a fascination of finance types for a long time. In 2019, Gregory Zuckerman published an excellent book, The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution, that gives the most complete glimpse.

So how does RenTech do it? 

The heart of the Medallion Fund’s strategy is to bet on mean reversion – the idea that prices come back to their long-term average trend after asset prices get out of whack. 

But how and why do prices get out of whack in such a way that the algorithms have been able to consistently take advantage of them for over thirty years? Medallion researcher Kresimir Penavic gave a simple explanation that’s stuck with me since reading it: 

What you’re really modeling is human behavior… Humans are most predictable in times of high stress — they act instinctively and panic. Our entire premise was that human actors will react the way humans did in the past … we learned to take advantage.

The most successful 30+ year run in the history of finance essentially boils down to efficiently trading the fact that humans are, as Duke econ professor Dan Ariely would say, predictably irrational, particularly when we’re scared. 

In that sense, Medallion is kind of a mirror turned on humanity, existing as an abstraction layer above our petty day-to-day actions. Its returns can be viewed as almost an index of how predictably irrational humans are at any given time, and how easy it is for the robots to take advantage of our silly human emotion. Want to guess its three best years? 

The fund’s three best years were 2000, 2008, and 2020, when it gained 98.5%, 82.4%, and 76% respectively. 

While us humans panicked, Medallion’s robot traders laughed. 

Most recently, just a few months after Zuckerman released his book, the world fell apart and then recovered in the span of a few days in March 2020. The Medallion Fund returned 76% in 2020, even as RenTech’s other funds – funds with longer holding periods that are less responsive to human emotion – underperformed. 

Medallion performed best in the worst markets. In other words, Medallion’s algorithms do best when humans are all in agreement that everything is going to shit. Medallion feeds on FUD.

I can’t find any information on how Medallion performed in 2021 or thus far in 2022, but I’d wager that it’s had an exceptionally strong couple of months. Humans are doing that FUD thing again. 

FUD SZN

The past few months in the market have felt surreal. 

We’ve all known a pullback was coming at some point in private markets, crypto, and public growth equities. We all knew rates were going to go up. We all knew inflation was increasing even if it didn’t show up in CPI. Everyone has predicted all of this for months, some have been predicting it for years. 

But when the crash actually came, people got scared. The dips that they were so looking forward to buying became a lot less appealing when they arrived. 

Packy McCormick (📜,📜) @packyM

Oh my god I love dips I’m so high conviction just wish we could get a dip so I could buy more amirite? OK, here is a dip. Ohhhh *that* dip? I meant the *other* kind of dip. This is a bad dip. I do not like this dip.

March 14th 2022

5 Retweets223 Likes

Part of the reason is that the facts on the ground both are different and feel different when they’re actually happening. 

Six months ago, for example, very few people would have predicted that the Fed finally raising rates would coincide with a new war, let alone this specific new war between Russia and Ukraine, with all of the fear and sadness and anger that war brings. It would have been difficult to imagine the actual feeling of waking up and seeing big red numbers each morning, and then reading smart people saying that things were likely to be bad for a long time. 

Then, everyone with a microphone seemed to get very bearish, in the same ways, for the same reasons, at the same time. 

VCs launched tweets and blog posts and podcasts about the impending crash in late-stage valuations. They all agreed that it would mostly be limited to late stage, that early stage should be fine, and that it would take a few months to play out. 

On February 21st, before the war started, Insider posted this inane FUD drivel: 

That headline is meant to drive fear, uncertainty, and doubt. “Will I survive?!” it dares the reader to ask. Read on, and Linette Lopez quotes a series of value investors and short-sellers – the group of people most desperate for a crash – and holds up their word as gospel. The article doesn’t wonder if, maybe, there might be a sustained pullback, but declares confidently that we’re going to have a washout, and that there will be few survivors. FUD. 

This is Insider. It’s known to be a little sensationalist. But it’s also a perfect, cartoonish encapsulation of the mood more broadly. 

Everyone seems to be certain about how things are going to play out, and it’s going to be bad. Many of the people out there yelling about a market decline and return to responsible valuation are those who would benefit from either: 

• A market pullback, or

• A perception among investors that they’re the experienced, responsible ones in a sea of crazy intemperate gamblers who’ve been getting away with murder. 

Now I fully recognize my own biases, too. I’ve deployed venture money for the first time during this post-COVID bull run, am long crypto, and am generally bullish and optimistic on technology. I would stand to benefit financially and reputationally from prices continuing to go up. I even believe that reading about tech companies is less exciting for people in a bear market (unless I pull a heel turn and start writing salacious stories about companies crashing, which I won’t), so Not Boring and I would benefit from the market partying like it was 2020 every year. 

But I’m the first to admit I have no idea what’s going to happen. 

During the bull run, there seemed to be a constant chorus of bears arguing that prices would come back down to earth; this bear market (a pullback of more than 20%) seems to be a lot more one-sided. 

That’s not to say that bears are wrong. In fact, I wouldn’t be surprised if they’re all right and everything goes back to selling off after this little bear rally. 

I just also wouldn’t be surprised if the market bounces back and keeps growing. 

The only thing I’m pretty sure about is that large groups of people all agreeing about something as complex and dynamic as the market are almost always wrong. 

The general bearish certainty feels like the kind of signal that Medallion would feed on. Abstract away all of the underlying stuff and just look at how the humans are behaving. 

With everyone agreeing on a sustained crash, predicting the opposite was so simple a human could do it. On March 15th, at 10:52am ET, a friend who wishes not to be named texted: 

“I also think we’re nearing a bottom. Just based on the amount of midwit tourists prognosticating about impending doom.” 

He called the local bottom almost down to the hour.

There’s obviously a lot of luck and coincidence there, and this could certainly be a bounce before a bigger sell-off. The bigger bear market could last years, like the dot-com crash. 

But the fact that everyone seems so sure of that makes me wonder. I think there’s a generalizable lesson: be skeptical when everyone agrees with each other. 

And I think there’s an addendum: *especially when they all agree to the downside.

(Alright, fine: Be fearful when others are greedy, and greedy when others are fearful; but be especially greedy when everyone else is fearful in the same way for the same reasons.)

To learn about the more sober madness of the crowds and what that has to do with the Current Financial Thing…

Continue Reading Online

Thanks to Dan, Dror, and Ben for reading and giving feedback!

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Thanks for reading, and see you next week,

Packy