.Reminiscences of a risk operator. // 9:47pm Gnva - 2.2.5.2021 // 1,500 words=5mins.
LARGE INVESTMENT BANK TRADING FLOOR - DAY
Frame is filled with the face of PETER SULLIVAN, a 27 year-old risk assessment analyst. He has a Doctorate from MIT and is staring intently into a large bank of computer screens.
Elevator door opens and FOUR HUMAN RESOURCES PEOPLE come out of the elevator carrying large file boxes. Scope of the floor now comes into frame. There are more computers than can be imagined…PETER gives a knowing glance to the guy sitting next to him, SETH BREGMAN, a young analyst in his early twenties.
SETH: Is that them? PETER: (nods yes)
The HUMAN RESOURCES people turn and separate into a large glass walled conference room that runs along the floor as almost every person on the floor watches.
SETH: Are they going to do it right there? PETER: Yeah.
WILL EMERSON, sitting next to them, leans back in his chair.
WILL EMERSON (whispered): Have you guys ever seen this before?
SETH: No.
//INTRO: Dear kids - by now your history books will have discussed Covid19-coping strategies from the 2020-2023 era. One of mine has been working out semi-consistently, while also getting on the Peloton wave (that was a company that was bought out once the stock popped - now rebranded). In January of '20 a bunch of friends started a challenge so we could all encourage each other, which started an early 5am run tradition. Out in the morning dark recently discussing GME, stonks, and pathways, a friend reminded me of Margin Call - a lesser known ‘08 crisis film.
At a pivotal point the CEO states: “There are three ways to make a living in this business: be first, be smarter, or cheat. Well, I don’t cheat. And although I like to think we have some pretty smart people here in this room, it sure is a hell of lot easier to just be first.”
The context is that the risk team + the salty sales leader + the young President + the CEO - are all applying parabolics and systems to this new 'problem' (subprime/CDOs). They think forward to the exposure nature - ease of transmission/contagion, explosive or linear, moving at horse / car / or jet speeds - and then apply prior learnings to this new wrinkle in the system. The CEO response = given XYZ, we go_first, and_fast.
Now I have received numerous questions lately on options and derivs given the GME/WSB/Robinhood circus (link = CFA explanation for Hunt Bros/Gamma Squeeze). And to understand that, as well as Covid’s first Super Bowl in ‘20, this letter will focus on Exponentials (Systems for next time). Both were present in Feb. 2020 (including for Shakira) and both are present this weekend in 2021. I already mentioned Elon and Vlad last week, so we will skip them, but the 2 topics are also relevant to their companies - Robinhood and Tesla/Solarcity…and deeply relevant for risk in the time of Covid. If you do not understand these twin topics, no amount of political twitch streams, twitter frenemies, or earnings call explanations will make sense.
MAIN: One of the most misunderstood parts of the global pandemic was the potential (not guarantee) of Parabolic Growth. Yaneer and Nassim got there in January '20 given hard math (Appendix in #1). Bill Ackman, a hedge funder who dives into short-selling, activist, and long-only also got there. Since most readers don't actively trade, don’t worry about his $27M CDS trade from mid-Feb ‘20 to closing it on 3/23/20 becoming worth $2.6Billion (*the NYT termed it "the best trade ever" given ~100x). But what you can learn from him in the first 5 minutes on CNBC video is where he describes exponentials in simple terms - exponential, daily compounding…
“Beginning in late January I was getting increasingly bearish and I woke up with a nightmare,” Ackman said. “And my nightmare was you have this virus that replicates and infects incredibly rapidly.
A theme we will revisit is that one of the strangest, most irreconcilable behaviors that shocked me last spring was - why were people not applying their own prior learnings to Covid19? By 2020, billions had experienced exponential growth through:
>> whatsapp/wechat mobile, alibaba or mercado libre shopping, tiktok/insta/snap fun, the Orange Revolution and Arab Spring movements, and the "trending" features that scaled spotify/youtube/FB/twitter.
>> as more and more people talk, buy, entertain, protest, stream/view/like/144-character text - the faster the circle expands and feeds on itself, growing exponentially.
Recent examples in social media that hit my inbox this week (click to enlarge):
*note the CH chart is pre-Zuckerberg going on last night (which broke the app, again)
Yet somehow the misunderstanding of: 1-exponentials and/or 2-the inability/unease in applying thinking to systems, led leaders/parents/educators everywhere to minimize the potentials while yearning for the normal.
A contrast to the Ackman lesson above happened during those weeks:
DonQ: what is our mask situation on-shore?
Person X: we have secured 100,000 masks, don’t worry about it (plus hint hint, you are not in China so stay out of it).
DonQ: ok, so I’m no supply chain guru, but if you want to do numbers, we eat those with Wheaties at home so = 100K n95s rated for 5 hours of work exertion basis 3M box in my front closet means that for a workforce of 10K or let’s go easy and say 5K, you only have a few days of supply (2x per day, some get taken home to help kids/older parents, as time extends more get taken home, etc). So let’s not discuss total masks, let’s talk about day’s supplies of masks. How many days/weeks?
Person: you don’t get it, and you are not in China, and you are not…
DonQ: but the maths!
That call didn’t go much longer, but it fueled concern that if this well-intentioned person, who didn’t realize what market closures or fast falling yield curves meant, was not thinking in securing 1M masks to start, what about others, in other teams, in other companies, etc. We will go deeper into "thinking in systems" soon, but it's reverse "system thinking" has unfortunately become a funny mba-speak term plastered on ineffective corporate posters.
MAIN 2: Back to Margin Call - right at the beginning, layoffs are starting on the trading floor. If you have never seen, felt, been shocked by it - you just don’t know. I’ll never forget experiencing it live in Sep 2008 on the UB_ floor off Park Avenue (sorry I am distracted, but they are doing layoffs just right now and my friends are getting impacted - what were you saying?). The issue is you think it's only happening to your team, your floor, your company. But during crisis it's happening across the system, and the impact is many teams, many floors, many companies going at once (brick/mortar retail 2018-20 which you can read about in this morning’s uninspiring BLS Non-Farm report).
Same with upside down, global markets. Exposure contagion. At speed. Others realizing that their numbers are dancing to the same song yours are.
So as Super Bowl weekend came people were starting to get concerned (big exit of foreigners from China/some travel bans/and the death count had hit 300), but there was still a lack of internalizing that Chinese New Year break had been extended with forced stay at home and exchange closures (imagine if 4th of July got extended?)
Palm Beach Post on Trump and the political back and forth pre-big game
Pelosi flying to Miami to settle a wager, see SF49ers press conference youtube
Vanity Fair reporting right after the game on critical half-time show details
That last Friday morning before the Miami Super Bowl I ran into an old friend down at the gym - him of the distressed world having a particular mastery for finding diamonds under the rubble of broken capital structures. We discussed the merits of Covid19, specially related to markets (my simplistic view for High Yield was to short any business model that depended on lots of people being together - too bad I got my sizing wrong on small end), but just like many we both kept our normal weekend life.
While leaving that gym a different friend called and we had this long debate on the merits of beginning to have regular calls on this growing virus. Why, why not, what will seniors think, do junior team members care, how will it help, will it hurt, does it even matter, how fast is this moving, can it grow, what does your boss think, what does mine, so what? So many questions, so many unknowns. Plus we were being told we were not doctors (true) - but we knew the markets (true) - and what were we sensing was not normal (true).
Ultimately our little discussion, with both of us wanting the best, became emblematic of discussions that every agency, city, company and school would begin to circle around. Stocks in US got rocked (DOW down 600pts) into the afternoon as Covid was termed a Public Health Emergency with impact on travel and entry.
When you smell the storm coming, what do you do? When there is uncertainty are you set up with asymmetry? There is a Precautionary Principle to think through [9 min]:
WRAP-UP: Two days later we get to Super Bowl Sunday 2020 and after Shakira/Jlo's half-time, we would finally get the on-the-ground reaction as markets in China would re-open. Most hardcore investors left the football parties (or woke up early in Europe) to get plugged in. I love living history with others, so after missing the 4th quarter for one of those max-dilbert calls that you laugh-cringe at later, a few friends and I got together virtually for the markets open to hear it live, full-blast directly from China.
First prints = 9% down, 2K stocks go limit down 10%, and PBoC enters stage.
“…And although I like to think we have some pretty smart people here in this room, it sure is a hell of lot easier to just be_first.”
Just_be_first
//END/>Invite friends, Read archives, SUBSCRIBE = erraticnarratives.substack.com
[[Disclaim: Individual, non-corporate views; not investment advice; may be long/short]]
APPENDIX Curriculum: Erratic Narratives are late-2020s AP Finance letters
13. Intro to Exponential Functions by best/free educator globally - Kahn Academy: if you buy 10 people 10 coffees on week 1, and those 10 buy 10 others coffee in week 2, etc. - how many weeks would it take before 1M coffees (masks?) [7min video] Exponential growth functions | Algebra II | Khan Academy
14.Short gamma squeeze explanation: https://realinvestmentadvice.com/what-the-hunt-brothers-can-teach-us-about-gamma-squeezes/
15.Ackman from Pershing Square on Hell is Coming - CNBC March 18 2020: https://www.cnbc.com/2020/03/18/bill-ackman-pleads-to-trump-to-increase-closures-to-save-the-economy-shut-it-down-now.html
16.Best trade ever by William Cohan in New York Times: https://www.nytimes.com/2020/04/29/opinion/coronavirus-hedge-funds.html
17.Precautionary Principle when down is further than up: https://www.youtube.com/watch?v=FUgHKX0clhU
18.Time magazine on China re-open snap down in markets: https://time.com/5776558/chinese-stocks-plunge-coronavirus-outbreak/