Hollow Men, Hollow Markets, Hollow World

John Mauldin

Apr 02, 2014


I’m sitting in the British Airways lounge at Heathrow terminal 5, or in other words in my usual office, and trying to catch up on my reading. I was particularly intrigued by my good friend and economic philosopher Ben Hunt’s latest Epsilon Theory post, which he callsHollow Men, Hollow Markets, Hollow World.” As he points out, an increasingly smaller portion of trading in the markets is between individuals looking to actually own a fractional portion of a public company for the long term. Instead, trading is gravitating to machines competing with each other in milliseconds and for a profit of milli-cents.

I get the rationale behind the supposed benefits of high-speed trading; but I have to confess, I just don’t buy it. If it was just another way to truly profit from normal commercial activity, I would pretty much have a hands-off attitude. But from everything I can see, high-speed trading is sucking billions of dollars out of the market that would otherwise go to individuals and institutions who are actually there to serve what was once the purpose of Wall Street: to provide new companies with capital and individuals with the chance to participate in the growth of the country. High-frequency trading is a zero-sum game. It takes money from “us” and gives it to funds with instant access to the exchanges.

The fact that high-frequency trading does not work half a mile across the Hudson River because even that short distance slows down the transactions too much, is testimony to the fact that something is truly out of whack. When the speed of light is a barrier to entry, you know we have entered a new era. I am not one to stand in front of the accelerating wave of technology and cryStop!” I am rather simpleminded, and it seems to me that if you simply instituted a rule that all buy and sell offers have to at least exist for an outrageous amount of time like one half second, that it would at least begin to level the playing field. The fact that large institutions are gravitating to exchanges where high-frequency trading is not allowed is evidence that the deck is stacked against the smaller investor. A point here and a point there, and pretty soon you’re talking real money.

But in today’s OTB, Ben Hunt doesn’t really focus all that much on high-frequency trading but rather on the fact that so much of economics and investing itself is hollow. Our job, he says, is to find the signal amidst all the noise. This is an Outside the Box that you will need to think through as opposed to merely read.

They will be calling my flight to South Africa in a few minutes. I’ve been thinking back over the ten times or so that I’ve flown to South Africa in the last 20 years. I first went there in the apartheid era. The moods in the country seem to shift with each visit. I can remember talking with people who were sure that South Africa would become the next Zimbabwe. “Apocalypse Now” could certainly describe the mood of those times. And then there are times when there is an optimism so intense it is hard not to get infected. I wonder how South Africa will feel this time.

South Africa really is one of my favorite countries in the world. I think my vote for most beautiful city would have to go to Cape Town (although I admit it comes down to personal taste, as there are quite a few spectacular harbor cities dotted around the world). If the weather permits, I will take my first hot air balloon ride. I’ve tried three or four times over the years and always had bad weather postpone my flight. Flying over the African savannah, looking down on lions and elephants, antelope and rhinoceros, zebra and giraffe sounds rather idyllic. I need to enjoy my time at Kruger National Park, because my hosts have put together a rather aggressive schedule for next week. Even so, I will get to meet scores of South African businesspeople and investors and hopefully gain a renewed sense of where one of the more important countries in the world is heading. I will report back from the frontlines. Until then, have a great week.

Your ready to be in a real bed analyst,

John Mauldin, Editor
Outside the Box


Hollow Men, Hollow Markets, Hollow World
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Apocalypse Now (1979), based on “Heart of Darkness” by Joseph Conrad

Kurtz: Did they say why, Willard, why they want to terminate my command?

Willard: I was sent on a classified mission, sir.

Kurtz: It's no longer classified, is it? Did they tell you?

Willard: They told me that you had gone totally insane, and that your methods were unsound.

Kurtz: Are my methods unsound?

Willard: I don't see any method at all, sir.

Kurtz: I expected someone like you. What did you expect? Are you an assassin?

Willard: I'm a soldier.

Kurtz: You're neither. You're an errand boy, sent by grocery clerks, to collect a bill.


It is my belief no man ever understands quite his own artful dodges to escape from the grim shadow of self-knowledge.

The question is not how to get cured, but how to live.

Joseph Conrad (1857 – 1924)


Billions of dollars are flowing into online advertising. But marketers also are confronting an uncomfortable reality: rampant fraud.

About 36% of all Web traffic is considered fake, the product of computers hijacked by viruses and programmed to visit sites, according to estimates cited recently by the Interactive Advertising Bureau trade group.

– Wall Street Journal, “The Secret About Online Ad Traffic: One-Third Is Bogus”, March 23, 2014


Over the last decade, institutional management of equity portfolios has increased from 54% to 81%. ...

Institutional buys and sells accounted for 47% of trading volume between 2001 and 2006, but only 29% of trading volume since 2008. ...

One of the most significant results of the tension between fewer market participants and larger parent order sizes is that the share of ‘real’ trading volume has declined by around 40% in the last five years.

– Morgan Stanley QDS, “Real Trading Volume”, Charles Crow and Simon Emrich, April 11, 2012


I first saw Apocalypse Now as a college freshman with two roommates, a couple of years after it had been released, and I can still recall the dazed pang of shock and exhaustion I felt when we stumbled out of the theatre. Nobody said anything on the drive back to campus. We were each lost in our thoughts, trying to process what we had just seen. Our focus was on Marlon Brando’s Col. Kurtz, of course, because we were 18-year old boys and he was a larger than life villain or anti-hero or superman or ... something ... we weren’t quite sure what he was, only that we couldn’t forget him.

When I reflect on the movie today, though, I find myself thinking less about Kurtz than I do about Martin Sheen’s Capt. Willard. Both Kurtz and Willard were self-aware. They had no illusions about their own actions or motivations, including the betrayals and murders they carried out. Both Kurtz and Willard saw through the veneer of the Vietnam War. They had no illusions regarding the essential hollowness of the entire enterprise, and they saw clearly the heart of darkness and horrific will that was left when you stripped away the surface trappings. So what made Willard stick with the mission? How was Willard able to navigate within a world he knew was playing him falsely, while Kurtz could not? I don’t want to say that I admire Willard, because there’s nothing really admirable there, and this isn’t going to be a web-lite note along the lines of “Three Things that Every Investor Should Learn from Apocalypse Now”. But there is a quality to Willard that I find useful in recalling whenever I am confronted with hard evidence that the world is playing me falsely. Or at least it helps keep me from shaving my head and going rogue.

The WSJ article cited abovewhere it now seems that more than one-third of all Web traffic is fake, generated by bots and zombies to create ad click-throughs and fake popularity – is a good example of what I’m talking about. One-third of all Web traffic? Fake? How is that possible? I mean ... I understand how it’s technologically possible, but how is it possible that this sort of fraud has been going on for so long and to such a gargantuan degree that I don’t know about it or somehow feel it? I’m sure that anyone in e-commerce or network security will chuckle at my naïveté, but I was really rocked by this article. What else have I been told or led to believe about the Web is a lie?

But then I remember conversations I have with non-investor friends when I describe to them how little of trading volume today is real, i.e., between an actual buyer and an actual seller. I describe to them how as much as 70% of the trading activity in markets todayactivity that generates the constantly changing up and down arrows and green and red numbers they see and react to on CNBC – is just machines talking to other machines, shifting shares around for “liquidity provision” or millisecond arbitrage opportunities. Even among real investors, individuals or institutions who own a portfolio of exposures and aren’t simply middlemen of one sort or another, so much of what we do is better described as positioning rather than investing, where we are rebalancing or tweaking a remarkably static portfolio against this generic risk or that generic risk rather than expressing an active opinion on the pros or cons of fractional ownership of a real-world company. Inevitably these non-investor friends are as slack-jawed at my picture of modern market structure as I am when I read this article about modern Web traffic structure. How can this be, they ask? I shrug

There is no answer. It just is.

My sense is that if you talk to a professional in any walk of life today, whether it’s technology or finance or medicine or law or government or whatever, you will hear a similar story of hollowness in their industry. The trappings, the facades, the faux this and faux that, the dislocation between public narrative and private practice ... it’s everywhere. I understand that authenticity has always been a rare bird on an institutional or societal level. But there is something about the aftermath of the Great Recession, a something that is augmented by Big Data technology, that has made it okay to embrace public misdirection and miscommunication as an acceptable policytool”. It’s telling when Jon Stewart, a comedian, is the most authentic public figure I know. It’s troubling when I have to assume that everything I hear from any politician or any central banker is being said for effect, not for the straightforward expression of an honest opinion.

The question is notIs it a Hollow World?”. If you’re reading Epsilon Theory I’m pretty sure that I don’t have to spend a lot of words convincing you of that fact. Nor is the questionHow do we fix the Hollow World?” Or at least that’s not my question. Sorry, but being a revolutionary is a young man’s game, and the pay is really bad. More seriously, I don’t think it’s possible to organize mass society in a non-hollow fashion without doing something about the “mass part. So given that we are stuck in the world as it is, my question isHow do we adapt to a Hollow World?” As Conrad wrote, the question is not how to get cured, but how to live. How do we make our way through the battlefield of modern economics and politics, a world that we know is hollow and false in so many important ways, without losing our minds and ending up in a metaphorical jungle muttering “the horror, the horror” to ourselves?



Two suggestions for adapting to the Hollow Market piece of a Hollow World, one defensive in nature and one for offense.

On defense, recognize that modern markets are, in fact, quite hollow and everything you hear from a public voice is being said for effect. But that doesn’t mean that the underlying economic activity of actual human beings and actual companies is similarly fake or bogus. The trick, I think, is to recognize the modern market for what it IS – a collection of socially constructed symbols, exactly like the chips in a casino, that we wager within games that combine a little skill with a lot of chance. There is a relationship between the chips and the real-world economic activity, but that relationship is never perfect and often exists as only the slimmest of threads. The games themselves are driven by the stories we are told, and there are rules to this game-playing that you can learn. But it’s a hard game to play, and it’s even harder to find a great game-player who will bet your chips on your behalf. A better strategy for most, I think, is to adopt an attitude of what I call profound agnosticism, where we assume that ALL of the stories we hear (including the narratives of economic science) are equally suspect, and we make no pretense of predicting what stories will pop up tomorrow or how the market will shape itself around them. What we want is to have as much connection to that underlying economic activity of actual human beings and actual companies as possible, and as little connection as possible to the game-playing and story-telling, no matter how strongly we’ve been trained to believe in this story or that. I think what emerges from this attitude can be an extremely robust portfolio supported by more-than-skin-deep diversification< /a> ... a portfolio that balances historical risks and rewards rather than stories of risk and reward, a portfolio that looks for diversification in the investment DNA of a security or strategy as well as the asset class of a security or strategy.

On offense, look for investment opportunities where you have information that reflects an economic reality at odds with the public voices driving a market phenomenon. This is where you will find alpha. This is where you can generate potential returns when the economic reality is ultimately revealed as just thatreality – and the voices shift into some other story and the market matches what’s real. These opportunities tend to be discrete and occasional trades as opposed to long-standing strategies, because that’s the nature of the information beast – you will rarely capture it in a time and place where you can act on it. Almost by definition, if the information is being generated by a public voice it’s probably not actionable, or at the very least the asymmetric risk/reward will have been terribly muted. But when you find an opportunity like this, when you have a private insight or access to someone who does against a market backdrop of some price extreme ... well, that’s a beautiful thing. Rare, but worth waiting for.

I’ll close with a few selected lines from TS Eliot’s The Hollow Men, because I’m always happy to celebrate a time when poets wore white-tie and tails, and because I think he’s got something important to say about information and communication, authenticity and deception.

Between the idea

And the reality

Between the motion

And the act

Falls the Shadow


What is the Shadow? I believe it’s the barrier that communication inevitably creates among humans, including the mental barriers that we raise in our own minds in our internal communications our thoughts and self-awareness. Sometimes the Shadow is slight, as between two earnest and committed people speaking to each other with as much authenticity as each can muster, and sometimes the Shadow is overwhelming, as between a disembodied, mass-mediated crowd and a central banker using communication as “policy”. Wherever you find a Shadow you will find a hollowness, and right now the Shadows are spreading. This, I believe, creates both the greatest challenge and opportunity of our investment lives ... not to pierce Eliot’s Shadows or to succumb to Conrad’s Heart of Darkness in our hollow markets, but to come to terms with their existence and permanence ... to evade their influence as best we can, all the while looking for opportunities to profit from their influence on others.


Last updated: April 1, 2014 6:58 pm

Debt troubles within the Great Wall

Credit cannot outgrow GDP forever, even in China. The question is how it will stop

Ingram Pinn illustration


Is China different? Or must its borrowing binge, like most others, end in tears? This is now a hotly debated topic. On one side are those who predict a Chinese Minsky moment” – a point in the credit cycle at which, as Hyman Minsky foretold, panic grips the financial system. On the other side are those who insist that China’s debt mountain poses no threat to the planned growth of the economy: the authorities say it will be above 7 per cent and above 7 per cent it will be. Which side is right? “Neither” is my answer. China will not have a financial meltdown. But the end of its credit addiction will result in lower growth, properly measured.

Three facts about recent economic developments seem to be quite clear.

First, if you take the official statistics at face value, China’s net exports shrank from 8.8 per cent of gross domestic product in 2007 to 2.6 per cent in 2011. This was offset by a jump in the share of investment over the same period, from 42 per cent of GDPalready extremely high – to 48 per cent. There are reasons to doubt reported levels of investment, but it is less reasonable to question its abrupt rise.


Second, linked with the rise in the share of investment was an explosion in credit and debt. According to the International Monetary Fund, by the final quarter of last year totalsocial financing”, as the Chinese authorities describe it, had reached 200 per cent of GDP, up from only 125 per cent before the crisis

Moreover, much of this increase had been outside traditional banking channels. Instead, there has been explosive growth of what one might call a “shadow banking system with Chinese characteristics”. This does not rely on the complex securitisations or wholesale markets now notorious in the west – but rather on new intermediaries, such as trusts, and innovative instruments such as wealth-management products. According to Fitch, the credit rating agency, credit outstanding to the private sector is now as big, relative to GDP, as it was in the US in 2007.




Third, China’s growth rate has slowed from 10 per cent or more in the past decade to about 7 per cent in 2012 and 2013. This is still high. But it is not quite as high.

Imagine you were told of an unnamed economy that had soaring investment and credit, but falling growth. A rising proportion of investment activity was being funded by debt, while at the same time returns were falling. You would surely expect an unhappy ending.


There are those who argue that “this time is different”. Peter Sands of Standard Chartered has noted several differences from pre-crisis conditions elsewhere

China has borrowed to fund investment, rather than consumption; companies are the main borrowers; and the country is not dependent on foreign lenders. In addition, the renminbi is not freely convertible into foreign currency.



The first two points are weak. Minsky’s theory of financial instability was in fact about corporate finance. Moreover, the debts that loomed so large in the US in the 1930s and Japan in the 1990s were also largely corporate

The quality of the investment is what matters, and on this there are reasons for doubt. A recent study by IMF staff argues that China may have been over-investing by between 12 and 20 per cent of GDP. Some of the money spent on real estate and industrial capacity is likely to have been squandered.

The other two points are stronger. China not only is a net creditor but also has exchange controls. Domestic creditors cannot take their money out of China. If they pull out of one part of the financial system, they will have to put it back into other domestic assets. The People’s Bank can deal with any run. Moreover, according to the IMF, even China’saugmented public debt” – which includes spending by local governments that is not always captured in official data – was only 45 per cent of GDP in 2012. The Chinese government could, beyond doubt, bear any conceivable losses if it wanted toparticularly since, unlike Japan in 1990, China has a relatively undeveloped economy that still possesses good longer-term catch-up potential.




Yet this does not mean all is well. As the late Herbert Stein, economic adviser to president Richard Nixon, famously remarked: if something cannot go on forever, it will stop. Credit cannot grow faster than GDP forever, even in China. The question is not whether it will stop, but how – and when

The longer this goes on, the greater the risk of a nasty surprise down the road. Furthermore, some part of the recent growth has almost certainly been an illusion: investment that does not generate much of a return is in part waste, rather than valuable output however beneficial its immediate impact on demand may seem to be.

The accumulation of debt is likely to end not with a financial bang but with a whimper, as growth peters out. According to the IMF staff, low interest rates for household savers have helped subsidise investment to the tune of about 4 per cent of GDP a year

Small and medium enterprises face a higher cost of capital because of the priority given to larger corporations. These implicit taxes on households and SMEs will probably have to rise, harming the economy, if investment is to be sustained at these exalted levels.




This leaves the Chinese government with an apparent dilemma: let the debt accumulation continue, creating bigger problems in the future; or implement rapid reform and risk a fall in investment and a bigger unplanned slowdown now. The solution must be a middle way: accelerate adjustment and reform, while sustaining aggregate demand through monetary and fiscal policies operated by the central government.

China’s ability to postpone a crisis might lead the powers-that-be to prefer the option of adjustment delayed. That could prove a huge mistake. Growth cannot be sustained by increasing indebtedness indefinitely

Reform and rebalancing are essential. From what I heard at the China Development Forum last month the Chinese authorities understand this. Indeed without these reforms, their plan for liberalising the capital account could be lethal. China can avoid a financial crisis. That is a boon, though it also risks reducing pressure for reform. Yet reform must come – and the sooner the better.



Copyright The Financial Times Limited 2014