A Conversation with Mark Spitznagel
American Consequences
by P.J. O’Rourke
June 2018

One of my favorite investors is Mark Spitznagel.

Of course, I admire his success. He is the “Ursa Major” among bears, having correctly (and very profitably) called the stock market crashes of 2000 and 2008.

Since then he has “fenced the bull” with his multibillion-dollar Universa Investments hedge fund that not only actually hedges (something many hedge funds, busy making huge derivative bets, forget to do) but is also structured to profit in rising markets.

Mark is an intellectual investor. In his book, The Dao of Capital, he combines the rigorous logic of libertarian Austrian economics with the Chinese philosophical tradition of harmonious flow of natural forces. (Hint: Central banks aren’t a natural force.) Forbes magazine called it “one of the most important books of the year, or any year for that matter.”

But what I like about Mark is that he’s fun to talk to. You can tell by choosing almost any quote at random from Dao:

Mark is also an unrepentant Heartlander, born and raised (and raising his family) in Michigan, a graduate of Kalamazoo College who can still recite his college yell

So, what did he do when he got rich? He started a goat farm.

Idyll Farms, in Northport, Michigan, produces artisanal chèvre from pastured goats (not grain-fed, cooped-up nannies). The cheese has won Best in Class at the World Championship Cheese Contest and multiple awards, including Best All-Milk Cheese, from the American Cheese Society. And if praise like that from the American Cheese Society doesn’t make your heart skip a beat, you should get out of the Heartland and stay out.

Mark seemed to be the right person to ask about the main thing that puzzles me about the Heartland – its vast array of undervalued assets.

He and I discussed how the Heartland is full of famously sensible, friendly, and hard-working people. It contains a large portion of the most productive agricultural land in the world. The housing stock is extensive and cheap. Industrial sites and commercial locations are ready and waiting. Natural disasters – minus the occasional tornado – are rare. The climate is temperate. The location is central to every form of transportation.

We talked about how the Heartland has water to shame the West, educational attainment that’s the envy of the South, and a freedom from congestion about which the East can only dream.

“Why isn’t the Heartland booming?” I said.

Mark described it as “a chicken and egg problem.” He said that the Heartland would boom if millennials, and “knowledge workers” in general, wanted to live there, but those people would want to live in the Heartland only if the Heartland boomed.

Mark told me about moving out of Los Angeles and back to Michigan because of the values (moral and material) that the Heartland offers… and because of the anti-business attitude that California maintains. But it was his family that he moved. He moved his company to Miami and now commutes north-south.

(Mark inexplicably claims to more than make up for his jet-setting carbon footprint with his hippie, carbon-sequestering goat pastures.)

“Why not move your business to Michigan?” I asked.

“There’s just a general expectation of where a hedge fund like mine should reside. And it’s because of the people I need to hire,” he said. “It’s about where these hip ‘quanty’ geniuses want to live.”

I said, “Maybe if Amazon put its second headquarters in Kalamazoo…”

“But it has to be cool to work for Amazon.” Mark noted, however, that Kalamazoo does have a craft beer – Bell’s. He also noted, “Be careful what you wish for.”

And true, a Heartland overrun with Seattle sensibilities would take the heart out of the place.

But in Mark’s view, Heartland difficulties run deeper than the location whims of talented people. The problem is that Heartland assets are hard assets – a wealth of land, infrastructure, and workforce.

“Our central bank monetary-led boom has made debt replace wealth for a long time. That’s not sustainable, of course. (We are ‘mining’ our soil for short-term gain.) We’ll see a return to the significance of productive stuff again I think, and that even includes farming – maybe especially farming. And the Midwest has a pretty good track record with productive stuff. Hard assets will matter again. But of course, I sound ridiculous even saying such things. Like a grumpy old grandpa.”

Artificially low interest rates have sent people off to chase yield in softer kinds of assets – causing asset bubbles.

Yield-chasing can’t last. It’s not good business. And the places where the yield-chasing is being done aren’t the places where good businesses will be built.

The Heartland states, Mark said, have to “be like Texas – better yet, Switzerland – business friendly.” And he said they were getting there. “Michigan is a right-to-work state now.” (Meaning that employees can’t be forced to join unions against their will.)

This once would have been unimaginable in the state that was Jimmy Hoffa’s home (and probable burial site after he disappeared on the way to lunch with two Mafia members).

Mark talked about how federalism is working “the way the founders wanted it to work. People are leaving states that aren’t business-friendly. They’re voting with their feet.”

“Hard assets will return,” Mark said. “The Heartland will be back. It will matter again.”

by Brian Stoffel
April 3, 2018
The Motley Fool

Stoffel: I read recently that you gave an interview -- I think it was on Bloomberg -- where you talk about where your own skin is in the game. One thing you wrote is that it is not rational to be long stocks without having some sort of hedge against stocks. That's because their valuations are so high, because there are tail risks...?

Taleb: No -- even if the valuations were low. If the market delivers a crazy valuation, it can deliver a crazy valuation in any direction.

Stoffel: So, for your normal person who works as a plumber or an electrician, what is a good hedge against stocks? Just cash?

Taleb: Well, the point is as follows: if your assets are $100 and you allocate $50 to stocks, then you are ergodic -- assuming those $50 are allocated to stocks, you don't want to decrease them at any point in time.
Let me explain the foundation of the problem: All of these analysts who look at you and the stock market assume that if you invest in the stock market, you'll replicate the performance of the stock market. The problem is, if you ever have an "uncle point" -- where you have to liquidate -- then your return will not be the stock market's. It will be the returns to your "uncle point" -- which is negative.
In other words: The market can have a positive expected return, and you have a negative expected return.
It's very similar to Russian roulette. Russian roulette is a very simple example. If you play Russian roulette with a positive expected return of 80% -- or, whatever it is, five out of six?

Stoffel: I haven't played, so I'm not sure [laughter].

Taleb: [laughter] You can't cheat to be dead. So it's the same thing with casinos. If you gamble in a casino at a roulette table, even if you have a positive expectation, you're guaranteed -- eventually, at some point -- to go bankrupt ... even though you had a positive expectation.

Stoffel: And that's the difference between ensemble [average] and time [average], correct?

Taleb: Exactly. Because probability over time depends on what happened right before. Whereas probability of the ensemble doesn't have to worry about what happened before it. So you have that discrepancy...when you invest.
So as an investor you need to think about it in these terms: no investor knows what's going to happen to him or her in the future. You don't know -- I mean, the market may deliver whatever people claim it will deliver. But if you have a drop in the market that may force you to liquidate -- particularly a drop in the market that may correlate with your loss of business elsewhere -- then, automatically, your returns will be the returns from today until that drop in the market. It de-correlates from the market.
And this is not well understood by finance people... unless you trade. I know a lot of people, for example, when I was short bonds. When I'm short bonds, people think that, hey, typically I will lose money if the market rallies. And the opposite actually happens.
I tend to make money when the market rallies although I'm short. Because -- typically -- you pick your points -- maybe you're only short for 30% of the year, not the whole year -- so you're dynamically hedged. And you pick your points, and you go in and out.
So I noticed over time -- for example -- my best returns from markets are the opposite of what the market has done. So negative correlation. That's simply because I'm long the markets, typically. And I like to buy after dips -- just buy after dips... even in a bear market. And of course, get out after the market recovers. Even in bear markets, you can make money.
This is well understood by traders. Traders say the direction of the market doesn't matter much. It's your techniques that matter.
But for investors, the same applies, unless this is an amount of money that you will never liquidate, and you transmit across generations.
What I've been doing is saying: If you have an investment -- as an institutional investor, forget the individual investor -- and you don't have a tail-hedge protection, then your returns are virtually going to be zero -- over the long run.

Stoffel: Because it's the same as playing Russian roulette...

Taleb: Exactly. If you have tail-hedge protection, then your return will be higher than the market. Because ... you can get more aggressive during the times when people sell.
This is not well understood. My strategies have been to overload with tail options ... and not because you get a good payoff if the market collapses. It's because it allows you to buy when nobody has dry powder.

Stoffel: It's basically the same for an individual investor as having a huge chunk of cash sitting on the sidelines that they can use to buy stocks low. Is that correct?

Taleb: Yes, but the problem is for the individual investor if you miss the rally. You see, I have a larger exposure to the rally -- and my exposure increases via options on the way down. I don't recommend individual investors use options.
The risk of having a lot of cash is that if the market rallies -- for the individual investor, it doesn't work well -- you have all this cash, you missed on a big move. 

Stoffel: And you never know when your time is going to come. So you're losing to inflation as well.

Taleb: Exactly. So the idea -- the wisest and most appropriate approach -- is to let the institutional investors have the tail hedges themselves.
Or to do what I call the barbell: to have a smaller amount allocated to the most volatile things, rather than a larger amount allocated to medium-volatile things. There are techniques around it.
It took me 28 years to figure out the flaws in the models proposed by so-called academics -- people without skin in the game.
Stoffel: Like the Scholes model?

Taleb: No -- the Scholes model is for fat tails.
They're all connected, but there's one central thing: Even if you're not using the Gaussian distribution, you're still long. And it's analyzing things as one step rather than analyzing life as a series of steps.
Ironically, that's my first book: Dynamic Hedging. That's my first activity -- dynamic hedging. When you look at the activity, you're trying to figure out, "What's the smartest approach I can have given the opacity of things?"