A Mixed Performance

Talking about both the US election and my debate with Randy Cohen on Passive

• Election Insights: Voter turnout highlighted dissatisfaction with current national priorities. Despite polarized campaign rhetoric, there are indicators of potential unity, as seen in the lack of widespread #RESIST sentiment I had feared — at least so far

• Cabinet and Economic Appointments: With a Republican majority in the Senate, Trump has a clear path to appointments, beginning with Susie Wiles as Chief of Staff. There is speculation about Scott Bessent as a potential Treasury Secretary so I share my recent interview with him at Simplify’s ETF conference

• Inflation and Recursive Dynamics: Bessent’s concept of “recursive inflation” explains how price inflation feeds upon itself. However, unlike the 1970s inflation, current inflation rates appear transitory, stabilizing due to limited population growth and evolving consumption patterns driven by AI and tech.

• Debate on Passive Investing: A recent debate with Randy Cohen revealed divergent views on the impact of passive investing. Randy’s arguments were a bit surprising, arguing that valuations were not high and that passive investing has a tiny and limited impact; unfortunately, his models were built on a flawed premise which I discuss

Top Comment

Sena chimes in, presumably from his dynastic throne:

I want to make sure I'm understanding the significance of Bitcoin essentially being held by ETFs from a market structure and financial flows perspective. I'm not sure I'm asking the best questions here to achieve this.

What are the implications for Bitcoin "market" dynamics given that Bitcoin is mainly being held, in effect, by the ETF crowd?

Prior to the spot ETFs operating, I'm not sure if there even existed a meaningful market for Bitcoin, considering how much wash trading may have been (or still is) occurring.

Are the algorithmic management practices of such ETFs indifferent to the Keynesian Beauty Contest aspects of crypto exchange Bitcoin "markets", such as "seasonality", "hodling", halving years (this was addressed implicitly in your chart adjusted for mining flows), and so-called Fed "monetary policy"?

MWG Replies:

Bitcoin ETFs hold about 6% of outstanding bitcoin, but now account for the vast majority of the exit liquidity.

2) Mining is ~450 coins/day which, all else equal, would imply daily price declines of 0.85% per year if no new money entered the system. My analysis suggests this is more like 3% per MONTH with no ETF flows (intercept on chart in blue). This tells you that ETF buyers are the exit liquidity for existing holders in the Ponzi. Nothing else matters really as the 85% r-sq tells you ETF flows are by far the largest source of inflows. Once those stop, or reverse, they have to find another sucker.

3) There will always be patterns in price behavior. If there weren't we'd find them because our brains are wired to do so as part of storytelling. None of that really mattered except "HODL" which conditioned small holders to be inelastic to price (don't sell ever). The halvings were important in early years to restrict new supply as a fraction of existing holdings, but no longer. Fed monetary policy has effectively zero impact except in creating the HODL narrative.

The Main Event

On Tuesday, Americans turned out to vote and delivered a message that they were dissatisfied with the country's current priorities. While Twitter is awash with “liberal meltdowns,” I would argue the key message remains one of potential unity. While this may sound absurd in the context of a fractious campaign season, as a reminder my primary fear was a reemergence of the #RESIST mentality. The depths of the Democrats’ defeat seems to have sunk in, and while it is far too early to tell we have not yet seen an explosion of #RESIST in the public domain. While Google trends projects it, the data is simply too sparse to tell at this point:

Regardless of whether Republicans take the house, Trump now has a clear path to his Cabinet appointments via a Republican majority Senate. His selection of Susie Wiles as Chief of Staff has begun the administration on a positive note, countering fears of misogyny. I have received several calls regarding Scott Bessent as Treasury Secretary. I am a huge fan and would offer readers my interview with Scott during Simplify’s annual charitable conference. There were a few clips worth highlighting, but my favorite begins at approximately 8:30 into the interview where Scott highlights the importance of humility:

One term he uses, which I happen to agree with, is the concept of “recursive inflation.” A recursive process is simply a time series process at which each step refers to the prior result. Compounding is a simple example:

\(X_1 = X_0(1 + r)\)

A more complex example is the inflation in automobile insurance, which has become one of the “lagging” components that is still elevating inflation. Insurance is typically purchased on an annual contract, with the insurance company estimating future costs of performing their obligations (repairing your crashed car) based on historical inputs — how many miles do you drive, how many accidents have you had, what are the costs of repairing/replacing your vehicle. When unexpected changes in these variables occur, they lead to losses. When faced with losses, insurers have a second hurdle — regulators.

All else equal, these regulations mandate drivers purchase insurance AND that insurers operate profitably. Using Progressive (PGR) a leading insurer with an emphasis on auto insurance, profitability post-pandemic has lagged pre-pandemic levels, but has now recovered.

Predictably, insurance price inflation has begun to retreat. I would be very surprised to see motor vehicle insurance inflation above 5% a year from now:

Will it rise again? As Scott notes, “It’s complicated.” Because insurance is mandated, customers have few substitutes other than driving illegally. As the cost of insurance rises, more customers will choose to drive without insurance. When, predictably, these individuals get into accidents the other driver’s insurance is the only source of compensation for both drivers. Net result? Costs rise further, prices rise. Welcome to Scott’s recursive inflation, also a driver of anti-immigrant sentiment.

Where I differ from Scott is my belief in the underlying root cause of the recursion. My models suggest the inflation of the 1970s was recursive due to a continuous outward shift in aggregate demand due to population growth, combined with failure to support supply growth (higher interest rates, energy production barriers due to Clean Air Act, and environmental sentiment, and imported oil). As we are seeing worldwide, inflation has fallen precipitously, despite high fiscal deficits, supporting my contention. The inflation RATE has proven transitory. The level, however, has not retreated due to the above dynamics. But until global population growth returns in force, I am very skeptical of a structural shift in inflation levels tied to commodities. In my view, this chart has aged well:

There’s a second “ace in the hole” as “services” continue to convert to products with tools like AI. While a recovery in services consumption as a percent of total consumption has helped power household spending, this spending downshifted at exactly the trend hypothesized in my May 2023 post, Billions and Billions Served.

The same dynamics held for the Great Depression, when the widespread adoption of (debt-financed) household products like vacuums, washing machines, and personal automobiles decimated the informal household employment industry of cleaning women, washerwomen, and “cabbies” (derived from “cabriolet” — a one-horse-drawn carriage).

As further information flows in, we will learn the new Trump administration agenda. If it is filled with candidates like Scott Bessent, I am hopeful we minimize the pain of navigating this period. However, there are risks that Trump’s future picks will be more like Steve Mnuchin. As I said in my most-commented post, “I Choose to Believe.”

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And now for a discussion of passive, starting with the debate with Randy Cohen I expect to air on Rational Reminder sometime in the next few weeks. I was disappointed in both myself and Randy. As is made clear in the closing comments, Randy had an agenda, viewing me as some form of Svengali attempting to rapidly throw out arguments to overwhelm listeners without explaining clearly. He believed this because he listens to podcasts at 2x speed (as do I).

Randy’s first argument was easily dispelled — “Is there a bubble at all given valuations are only 22x forward EPS?” It’s worth illustrating my response. First, those quoting forward EPS and converting that into a P/E are using a metric that has no historical comparison. The work on historical P/Es is always based on realized GAAP EPS. Forward estimates have only existed for about 30 years. If we compare like-for-like, there’s not much debate valuations are remarkably high, having recently eclipsed the DotCom peak: