Episode #467: Starkiller Capital’s Leigh Drogen & Corey Hoffstein on Crypto Momentum, Conspiracies, GBTC, FTX, & More

Episode #467: Starkiller Capital’s Leigh Drogen & Corey Hoffstein on Crypto Momentum, Conspiracies, GBTC, FTX, & More

 

Guest: Leigh Drogen is the GP and CIO of Starkiller Capital, an institutional investment management firm applying quantitative strategies to the blockchain based digital asset space.

Corey Hoffstein is a co-founder of and Chief Investment Officer at Newfound Research and a research partner and advisor with Starkiller Capital.

Date Recorded: 1/25/2023     |     Run-Time: 1:13:50

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Summary: In today’s episode, the guys update us on a wild year in crypto. We talk about the GBTC trade, the value of FTX bankruptcy claims, and even some conspiracy theories around Binance.

Then we get into their recent paper, which looks at the momentum factor in crypto markets, and the benefit of using trend-following strategies within crypto to avoid drawdowns like the one we’ve seen in the last year. As we wind down, the guys say if they think crypto is starting a new bull market.

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Sponsor: YCharts enables financial advisors to make smarter investment decisions and better communicate with clients. YCharts offers a suite of intuitive tools, including numerous visualizations, comprehensive security screeners, portfolio construction, communication outputs, and market monitoring. To start your free trial and be sure to mention “MEB ” for 20% off your subscription, click here. (New clients only)

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Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com

Links from the Episode:

• 2:50 – Welcome back to our guests Leigh Drogen and Corey Hoffstein
• 6:26 – The Zero Proof’s Sean Goldsmith on The Meb Faber Show
• 9:18 – The narrative about the crypto collapse
• 11:16 – How Leigh and Corey managed to sidestep the collapse
• 13:40 – Advice for people who are thinking about crypto
• 16:17 – The inherent arbitrage mechanisms that make ETFs a superior structure to Closed-end funds
• 22:54 – Leigh & Corey’s post-mortem thoughts on FTX
• 25:48 – Conspiracy theories about Binance and Tether in 2023
• 33:33 – Cross-sectional Momentum in Cryptocurrency Markets
• 42:07 – Thoughts about the pace of crypto when analyzing its momentum
• 44:32 – Major takeaways, participating in shorts, and benchmarks to use in crypto markets
• 48:46 – The lack of transparency with crypto
• 51:45 – Additional thoughts on their Cross-sectional Momentum Paper
• 54:14 – The number of tokens they’re tracking in their portfolio’s universe
• 56:36 – What they’re thinking about as they look out to 2023
• 59:29 – The best use cases for crypto and tokenomics excluding brokers
• 1:02:38 – The slowing of inflation and other thoughts on TradFi
• 1:08:57 – Final thoughts, winding down, and when they’re all going surfing
• 1:10:11 – Learn more about Starkiller; starkiller.capital; Cross-sectional Momentum Paper

 

Transcript: 

Welcome Message:

Welcome to the Meb Faber Show where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer:

Meb Faber is the co-founder and chief investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Sponsor Message:

Today’s episode is sponsored by YCharts. That’s right. One of our first and favorite sponsors is back. YCharts is still one of the only places you can find the shareholder yield factor and net payout yield factors for stocks and can screen for both. You all know this if you follow me on Twitter, but a chart I’ve been looking at over the past year or two is the Grayscale Bitcoin Trust or GBTC. A lot of sites let you easily track the price, but YCharts shows you the premium or discount NAV each day going back to 2013 when the fund was launched.

Similar for other closed-in funds. Leigh, Corey and I talk about it in today’s show, but it’s not uncommon to see a fund trade at a big discount, which is around a whopping 40% as I record this in early February. A pretty big swing from the 30ish percent premium it was in December, 2022. You won’t hear me talk too much about crypto charts here, but it’s a fun one to track over time in YCharts. I don’t have a position, but I like to follow it. Do you want to learn more and get a 20% discount if you’re a new subscriber? Click the YCharts link in the show notes and tell them Meb sent you.

Meb:

Hello my friends. We got another amazing show today with not one but two returning guests. We’re joined by Leigh Drogen, CIO of Starkiller Capital, which applies quantitative strategies to blockchain based digital asset space, and Corey Hoffstein, co-founder and CIO of Newfound Research.

And a research partner and advisor to Starkiller. Today’s episode, the guys update us on a wild year in crypto. Isn’t that every year, by the way? We talk about the GBTC trade, the value of FTX bankruptcy claims, and even some conspiracy theories around finance. We get into their recent white paper, which looks at the momentum factor in crypto markets. You know I love it. And the benefit of using trend following strategies within crypto to avoid drawdowns like the one we’ve seen in the past year. As we wind down, the guys say if they think crypto is starting a new bull market. Now, before we get to the show, I got a favor to ask. We’ve seen a huge bump in listeners over the past few months, so if you haven’t subscribed yet, be sure to do so. And if you already are subscribed, go leave us a review, on Spotify, Apple, or whatever platform you use. Please enjoy this episode with Leigh Drogen and Corey Hoffstein.

Gentlemen, welcome back to the show.

Corey:

Thanks for having us.

Leigh:

Thanks for having us. Yeah,

Meb:

Where do we find you guys today?

Leigh:

I’m up in Whitefish, Montana. We’ve gotten some pretty good powder this winter, so been up on the mountain a little bit. Corey and the rest of the Starkiller team were up here over the weekend and I sent them all home a couple days ago.

Meb:

Corey, give us a review of Whitefish.

Corey:

Man, I’ll tell you, I told my wife I was about to buy a condo there. It is to me like the perfect town. It is it tiny, but there’s enough going on. You’re right on a lake for the summer, right on Glacier National Park. They’ve got a super family friendly mountain, but Meb, you’ll love this, tons of side country and back country.

So I’m going along trying to learn the mountain. I see this guy hiking up on a ridge and I’m like, whenever I see someone hiking, I know they’re going to the powder stash. So I take my board off, I start hiking behind the guy. I finally catch up to him and as I’m walking up the ridge, I’m seeing all these people doing avalanche training and they’re like doing beacon checks. And I’m like, I’m going to turn around now because I don’t have any of that stuff on me.

Meb:

Got none of it. I thought you were going to say something funnier. Like, this guy was going to the bathroom and he is like, “Dude, why are you following me? I’m trying to find a spot to…”

Corey:

But I know you as a bit of a powder hound, you appreciate those mountains that give you… I mean, what was great about this mountain was it had some great difficult pieces, but it was also like you could see all the blues for all the kids learning to ski. It would be an awesome mountain to live on with the family.

Meb:

Well, you don’t need a condo, you just live with our local Starkiller PM and he can just give us a little bedroom. I’m embarrassed because Leigh, last time we talked on this podcast, listeners, it was late ’21. I said, You know, I’ve been trying to go to Glacier for the last two years, keeps getting interrupted by COVID or just life. We’re going to go this summer. And sure enough we didn’t go. So you hear it again. 2023, we’re going to go this summer along with every other tourist, but you going to be around to be a tour guide?

Leigh:

Dude, we’re here all summer. That’s the best part of the year. So we’d love to have you. And yeah, I’d say literally the best couple of weeks of the year in the park are the last two weeks of June because they don’t allow cars in yet. But you can take the E-bikes all the way up to the pass and everything’s just super green. There’s nobody there. It’s an amazing couple weeks.

Meb:

Well, we’ll book it so clean out the guest room. Corey, I’ve had a hard time flight tracking you. For a while you were hiding out in the Caribbean. For a while you were in Boston. Every time I see someone wearing kind of a trendy robe at nighttime in Venice Beach, I’m like, wait, is that Corey? Hold on, no. He’s not back. Where do we find you now? Where’s home?

Corey:

We are outside of Tampa, St. Pete.

Meb:

I used to spend a lot of time in Land o’ Lakes as a kid. I had a cousin there, impressed upon me a lot of dubious clothing choices, which I bring back to North Carolina. Z Cavariccis, Vanilla Ice, all that jazz. But you got probably the most…

Corey:

I’m really just learning the area. I really don’t know this part of the country all that well. I only know it because my grandparents retired down here many, many years ago to Sarasota. But I haven’t spent a lot of time in Tampa.

Meb:

Well, I’m excited to see your evolution into our Florida man. You probably have the biggest update of anyone. You want to share’

Corey:

Oh, I can guess what you’re talking about. I got a kid coming man, which is why you find me here and not deep in the Caribbean sipping on rum.

Meb:

I actually did a podcast that will probably be out before this with a good friend who started a new offering called the Zero Proof, which curates non-alcoholic drinks. So for this past few nights I’ve been sampling non-alcoholic beer, wine and last night it was rum, which was interesting to say the least. But anyway, listeners check out the zeroproof.com. But I was hoping this would be kind of a trick question because Corey would be like, “Yeah, I have this big announcement. I have some new ETFs coming out.” And then I was going to send this episode to your wife and be like, “Babe, do you notice? I mean, he’s soon to join dad Twitter and he is over here talking about ETFs still.”

Corey:

Do you know how it goes, Meb? At a certain time you could have sent that and this time you can send that to the SEC if I’m talking about it. We’re in the quiet period.

Meb:

Yeah. Well, SEC has a lot more on their plate certainly than a couple of podcasters talking about the things we do. Than certainly the things that I keep tweeting about on, infinitely worse violations. But anyway. Well, gentlemen, this is going to be a lot of fun. We’re going to bounce around. I figure we’ll talk with Leigh first about where life has been the last two years. I mean, fall of ’21, crypto. We were talking a lot about what you guys were up to with Starkiller. Give us an update, walk us through. It’s as usual, not been a boring, quiet last couple years in your world and with everything going on. Give us an update.

Leigh:

Well, it’s interesting that you use the word boring, right? Because honestly the last nine… Basically since April has been incredibly boring for us. But that’s kind of predicated on the type of strategy that we run. At Starkiller we run basically a momentum and trend following driven strategy on liquid crypto tokens. And so we came into ’22 and it looked like there was some transition going on and some things kind of rolling over.

And by April the trends had completely broken down and we had just absolutely exited the market all together. And honestly since then it’s been incredibly boring sitting there. But in trend following strategies, some of the hardest part is just being zen, sitting there in cash, or our delta neutral and yield strategies. But those are not exciting in any way whatsoever. They’re meant to be boring if you do it well. And yeah, up until really a couple weeks ago we’ve been doing nothing and now it looks like maybe a new trend is exerting itself, which is nice. But largely it’s been a company building exercise and an exercise of research and just trying to sit on hands.

Meb:

So this period was a little more mellow for you guys, but it’s been full of pump circumstance, agony, ecstasy, everything in between for everyone else. What the hell’s been going on in the world? We got SBF, we got FTX, we got GBTC, we got 19 other names that I’ve never even heard of. You want to give us sort of a narration of what’s going down in the world?

Leigh:

Yeah, I mean, look, the overarching thing is that we had another one of these typical crypto collapses where everything is down 80%, 90%, 95%. And look, coming into starting this firm, that was literally one of our core thesis, is that we’re going to go through this probably four or five more times before the asset class calms down and the growth kind of mellows out and the vol comes down. And the individual issues associated with the leverage in the system or literally the fraud and everything in between is… To me they’re just kind of… they’re just tickers.

It could have been anything. It was going to be some name attached to every single one of these different concepts, but I think we’re towards the end of it now. And one thing in conversations that I have to keep reminding myself of and others, the team, is that if we look back at the history of markets and financial collapses and exactly what has gone on here in crypto again, is that these things don’t get resolved until well after the bottom is in normally, right?

So people go to jail after the bottom, the regulations get written after the bottom. All of the bankruptcies get cleaned up after the bottom. All of those things are always months or years after the asset prices bottom. So if you’re waiting for all these things to sort themselves out, you’re going to be way late for whatever the next cycle is.

Meb:

How have you managed to, and maybe you haven’t, but you’re here. So how have you managed to sidestep and avoid, right? Because I listen to a lot of heartbreaking podcasts and articles about people who had funds, who got caught up in whatever the topic may be. If it’s the FTX is the most recent certainly. And I like your Twitter because you have a lot of spicy takes and conspiracy theories to boot, but is a lot of this common sense, due diligence, luck, what?

Leigh:

I think it’s two things and then definitely some luck on top of that. So one is we have DeFi portfolio manager who is incredibly in the weeds regarding all of these protocols, the teams, the actual code. And so we do very deep due diligence on everything that we get involved in from a counterparty risk perspective. And we’ve been able to sidestep the vast, vast, vast majority of the things in the ecosystem that have gone wrong there. Obviously associated with that, we have great advisors like Corey that keep us focused on the right things instead of meandering towards strange trades that we think could be profitable but don’t fit our… Corey, what’s the word that we always use?

Corey:

Mandate. Don’t fit the mandate. We don’t want that mandate drift.

Leigh:

Don’t have mandate drift. So we’re got research ideas that are idiosyncratic trades all the time that we think could be profitable, but we’ve really tried to stick during this bear market to exactly what we do at the core.

And then yeah, that comes into the second thing, which is really just we are a trend associated model. And the trends have been bad and we’ve sat on our hands, which has not been easy or fun, but it has certainly saved us a lot of money. And I think coming into this, part of our thesis was crypto is about to survive and advance. You just have to survive these periods and advance to the next one where the overall growth in the actual underlying fundamentals of the protocols and chains and users, it just lifts all boats. And that’s when you want to be involved. You do not want to push on a string because there’s so much fraud. And so the counterparty risk stuff and the trend stuff and having good advisors like Corey has really done it.

Meb:

For people listening who are either involved, not yet involved, what’s the advice on… Is it just like, don’t play in the sandbox unless you really want to put in a lot of effort? Or is it something where they can say, “No, look, you can focus on exchange traded vehicles, you can host with Coinbase or Fidelity and maybe feel okay.” What’s the general sort of status of how people should be thinking about this, individuals or advisors?

Leigh:

Yeah, so I think there’s three ways for individuals to invest. One is you can literally buy some ETH and Bitcoin, lock it away for the next 10 years, close your eyes, pay zero attention to the volume and come back at that point. Very hard to do because if you do look, you’re going to see at some point that you’re up 10X, 15X, 20X, 30X, and then if you look again in 10 months, you’re going to be down 90% from that peak. So the vol is puke inducing, but if you can stash it away, I think that that’s likely a very profitable strategy.

You can try and do what we do, which is honestly not rocket science. It’s pretty direct, but you have to pay a lot of attention and you have to be disciplined and you have to be able to execute trades and things like that.

Meb:

Zero chance. So let’s move on to three.

Leigh:

Or you can day trade, right? You can day trade coins, which as we know from every other market and every study that it’s lottery. Individuals are not good at it.

Meb:

But for the people who want to do number one is the starting point template… If I’m like, look, I just want to do the Vanguard of this. Is it trying to do exchange traded products?

Leigh:

Yeah. Here’s the problem with crypto, and we talk about this in the paper that we’ll get to. But there is no S&P 500 index. There’s not even a NASDAQ 50. Because these are not profitable, stable companies. Every single one of these things is an early stage of venture bet and we all know what the kind of distribution of returns amongst venture bets is and the propensity for them to completely fail and go to zero. And so while the S&P 500 has a turnover of 4% a year, the turnover of the top… If you wanted to make a top 10 or 15 kind of token fund, the rebalancing and the turnover would just be incredibly high. And so there really aren’t any great products for an investor to just index into.

Meb:

The two areas that I wanted to ask another question on is one, for a long time I said, look, I love the idea of closed-end funds. We talked about them many times over the years. I mean, going back to my oldest book. When I said this GBTC…

Leigh:

What a doom take.

Meb:

But I always said, I said this was interesting. You could put in mental orders to buy it in case there’s a giant flush or something terrible happens, which they seem to happen all the time. At minus 50, 60, 70, 80, 90 all the way down. And then all this crazy stuff started happening. And then I kind of looked at it, I’m like, well, I don’t even know if that’s a safe bet anymore. It’s just this very all of a sudden moved from a normal closed in pile for me to all of a sudden a very complicated difficult pile and I don’t know where it stands. Is it something best avoided or is it reasonable to consider that as a trade?

Corey:

One of the things we have to deal with the closed-end fund is the premium and discount to NAV, right? One of the things that makes ETFs so great is the inherent arbitrage mechanism that tends to keep price and the net asset value of the underlying basket pretty tight. We’re talking about a closed-end fund, that arbitrage doesn’t exist. And so you can have this… That price can deviate wildly from the value of the underlying assets and that communicates something to you about how the market feels about that vehicle. So correct me if I’m wrong Leigh, but about a year ago that fund went from trading at a pretty meaningful premium during the bull run as people had a high demand for it to starting the trade at a discount. And now it’s trading at a very significant discount. I think it’s like a 50% discount.

So you could in theory if you buy it, say you’re buying Bitcoin at a 50% discount, if that premium collapses back to fair value. But I think it speaks to how the market feels about the vehicle, partially the fee being charged there as well as potentially the creditworthiness of the parent company. There’s some news out there about how they are being tied in with all sorts of potential credit issues.

Now you would think that if they were actually buying the underlying Bitcoin, that really shouldn’t be a problem. The fund should be insulated. But you never know how this stuff is going to play out. And so I think what you’re seeing is a lot of people are saying there’s a lot easier ways to buy Bitcoin or Ethereum or whatever it is. I’m not going to get involved with a 2% plus fee fund. I want to self store, have my own storage, and I don’t want to have to deal with this premium or discount issue. So I just think unfortunately, it was an innovative concept when it first came out, but I think at this point the structure is just inherently wrong for the underlying asset.

Leigh:

I do love how part of, maybe a large part of what’s happened to several large crypto institutions, both hedge funds and lending desks and all of the above, including Alameda and FTX, is just a very naive attempt to arbitrage this discount. As if they just said, “Hey, look at the discount. There’s a lot of money to be made here.” And just didn’t think at all about why that discount was there or could it persist or could it even go lower?

And just, like these aren’t the sharpest tools in the shed in this industry. We talk a lot, and I say this in a half joking way, but it’s only half joking that crypto is the dumbest industry, the dumbest asset class on Earth. These are not A players out there. The A players in crypto who have come in are the market makers who are cleaning up. They are largely not the funds and the lending desks. These are B and C players, and you just saw what happens when those guys are given a ton of leverage to blow themselves up.

Meb:

The thing about closed-end funds is they inherently are sold during the initial offering to usually a bunch of unsuspecting investors where there’s a fee taken or a toll. And they almost always are pretty high fee. You don’t see a lot of 10 basis points, 20 basis points closed-end funds. So you have a tax if you sit around for a while. And unless there’s some reason that discount is going to close the problem with the long history of closed-end funds is you can get stuck in them.

And so there’s a lot… There’s an old great website called Closed-End Fund Connect. Herzfeld used to write about these back in the day and some oscillate based on sentiment. So if you have the emerging market ones, they would sometimes oscillate, or countries based on what’s going on. Cuba was always my favorite example because it would be at an 80% premium, 50% discount. Even Ackman during COVID was a big one. I think he had a different reason for his discount. But GBTC was interesting, but there was always the like, what would cause this to close? And that’s the hard part. So if it doesn’t close for 10 years, well that 2% toll becomes meaningful as opposed to if it closes next month.

Corey:

Well, and I think it’s also a question Meb, not just that is, are you trying to be long Bitcoin, right? If you’re trying to be long Bitcoin, maybe you can say, “Okay, I’m going to take a gamble and pay the toll.” But if you’re trying to trade this in a way where you can sort of close the arbitrage, you would have to in your brokerage account, buy GBTC and then you want to be short Bitcoin somewhere else. Well, are you going to short Bitcoin futures? There’s a cost to carry there. There is a huge amount of margin you need to post. So maybe then you go off and go to a crypto exchange where you try to short Bitcoin. Well, that’s actually harder and especially today, now that most of the major futures exchanges like FTX have collapsed. It’s not easy for a US player to trade that. You’re not getting cross collateralization.

So it’s not capital efficient. So one of the reasons that this discount isn’t being sort of, quote, unquote, “arbed away” is because there’s frictions in the market. It’s difficult. There’s limits to the arbitrage here. It’s actually one of those classic textbook examples in many ways. So I think the discount represents a couple of things, but I think a lot of people always question, well, why isn’t this getting closed by people buying this? And it’s because trying to actually implement the trade is non-trivial.

Leigh:

And also just not a lot of liquidity in GBTC, right? Which is part of what caused the discount.

Meb:

It’ll be fun to watch it play out. I don’t know that I have a strong guess. We used to talk about FTX bankruptcy claims that a dime on the dollar being a good bet or are they still trading down there and what’s your kind of postmortem on this whole mess?

Leigh:

Yeah, we’re at 19 cents now. Yeah, look, my view is that they’re going to claw back a lot of this from everywhere that Sam gave out money, which is pretty extensive. They will likely also claw back money from the people who removed cash from FTX in those couple of days, which is a significant amount of money. And then look, if the market does get going from here, you’ve got a bunch of assets in their venture portfolio that we’re looking at one of them from the last couple days, Aptos, which is up 4X, 5X in the last couple weeks.

So there is a possibility that the venture portfolio actually does well and whatnot. But I think 19, 20 cents is probably still cheap. I’d say by the end of this, my expectation is that those claims probably trade somewhere in the 40 cent range and that’s probably the max that they trade at. And then if you really wanted to hold those FTX claims all the way for the next 5, 7, 8 years or however long it takes, I’ll bet you get 80 cents back, 90 cents back. But the time value of that money is obviously, you probably want less of it now than more of it later.

Meb:

So you’re setting up a Starkiller SPV just to load up the truck with these or what?

Leigh:

No, but I did have an idea that I did run by some people that was quickly shot down, not because it’s a bad idea, but because the regulatory aspect is really tough. What I think somebody should do is set up an offshore DAO to raise money the same way that ConstitutionDAO did. Remember when those guys wanted to buy the Constitution? So basically you set up a lockbox, people put ETH in the lockbox, you then have the DAO go bid on the bankruptcy claims by the claims, the ETH gets turned into, used to buy the claims. And then you issue a token from the DAO that is a claim on the DAO’s ownership of the bankruptcy claims.

And now you’ve got a liquidly traded bankruptcy claim market. The problem is that that is a security and the second that you have 1 cent of American money, the SEC is going to be down your throat. So not easy to do, but some somebody should… I don’t know. Somebody should take a stab at it.

Meb:

Yeah. All right. Well, sounds like a lot of work. Anything that under the quote, “invites” more SEC scrutiny is where I want to be as far away as possible.

Leigh:

I agree.

Meb:

One of the spicy takes you’ve had recently, and I don’t follow this as much, more just out of curiosity, is your Binance theories. Where do we stand on Leigh’s list of conspiracy theories for 2023 right now? Tell listeners what I’m talking about.

Leigh:

So I have a whole bunch, but this is the one that I really truly do believe. There’s two here associated with Binance that I really do believe in. So when we talk about a lot of these brokerages and exchanges or whatever you want to call them and stablecoins like Tether, it’s very likely that these institutions were at some point insolvent, have done very illegal things, laundered money extensively, knowingly, et cetera. Just all pick a bag of all the bad things and they’ve done it, right?

The question is are they insolvent today, are they doing those things today, and will they continue to do those things tomorrow? My main conspiracy theory is that basically Binance being 80% of the volume in the market today is now in a sense a too big to fail institution. And we know the DOJ has been in extensive conversations with them. We know that they’ve done all these bad things in the past.

They admitted to another one of them yesterday where some of their bridged assets were not actually held one-to-one, collateralized one-to-one with the underlying assets. They’ve been co-mingled with other user funds in wallets. Frankly, they probably don’t even know where all the assets are. It’s a mess. Just like FTX was a mess. My conspiracy theory is that the DOJ has basically made a deal with Binance to say, “Look, you’re too big to fail. If we took you down, it would unduly hurt all of the consumers in the industry who have investments on a lot of different levels. And so what we’re going to do is we’re going to use you as a back door to basically monitor all of the illegal stuff going on that flows through you. And through you we are going to clamp down on the actual people doing the bad stuff, not you who is facilitating it.” That’s my best guess at what’s going on here right now.

Meb:

Yeah, I’ve always assumed that that was kind of the best case for the NSA. I mean, if I want to think about surveillance, that seemed to me it would be such a perfect way to do it.

Corey:

What’s the Scoville rating? How spicy was that conspiracy theory Meb?

Meb:

I mean, well for me that is low. I think it’s actually quite plausible.

Corey:

I take that as a… It’s like mayonnaise to me. There’s no spiciness to this conspiracy theory. It seems pretty plausible.

Meb:

I don’t think the crypto community would agree with you though. I think outsiders would.

Leigh:

No, they wouldn’t.

Meb:

Right. I think crypto would be like no way. There’s no chance that’s like… Uh-huh. Because then it strikes the core of so many of the closely held beliefs of independence and libertarianism and decentralized. All of a sudden it’s like your worst nightmare. Anyway.

Leigh:

Here’s my spicier one. Tether shows up a couple months ago and releases a kind of view on its books and somewhere in between then and six months before then, there is a 6 billion USDT denominated loan on their books. Not Tether, a USDT denominated loan, right? Now, why is Tether giving out dark loans to a borrower that they won’t name in that size, in a USDT denomination?

My theory is that CZ at Binance borrowed $7 billion to plug a hole in their balance sheet and he probably collateralized it with BNB just as Sam was collateralizing his loans with FTT. This rehypothecation of governance tokens is just a scourge throughout the industry. And I would be surprised if at some point CZ hadn’t done it as well.

Meb:

The public market group of us who has experienced fraud and mayhem for a really long time in our world, there’s always the red flags that seem so obvious. And when you look at them, they often come in, not just pairs but groups of 20. But all of these companies to me, and I’m on the outside, but all the ones that are non-transparent, not interested in audits, all these things that just go down the list. Unwilling to post what their collateral is. It’s always like you’re guilty until proven innocent in my mind in those scenarios. It’s not like-

Leigh:

If it walks like a duck and quacks like a duck, it’s a duck. Yeah.

Corey:

People often point out with Tether for example, they always say it’s like what a top six auditor. Which means it’s clearly the sixth auditor, right?

Leigh:

Not top four.

Corey:

You don’t say top four. And so people go, “Well, it’s because they can’t get one of the big four.” And I actually, my cynical take there is, well, maybe they try to get the big four and the big four won’t even touch them for reputational reasons. I mean, what? Do I think they’re clean? Probably not. Are they trying to make their way clean? Probably. Right?

But I certainly think if you’re an Ernst & Young or someone like that, do you want to take the reputational risk of auditing Tether and having them pull one over you? Probably not. What’s the upside of doing that? So I actually wonder if a lot of their inability to work with the top four auditing firms is because the auditing firms don’t even want to touch them.

Leigh:

The Saddam Hussein theory of crypto markets, which is you can get in trouble just by looking really guilty even if you’re not actually that guilty.

Meb:

Yeah, I was wondering where that was going. I was like, what was the analogy? How’s this going to work?

Corey:

I was like, Saddam Hussein theory. I haven’t heard this one.

Meb:

But again, from a group that’s been in public markets and transparency is just out the wazoo, it’s always odd when these things are not totally above board in every… And so I think a lot of it is probably, look, it was Wild West when things began and some of these groups had so much success, it just blew by their competency. And all of a sudden it was like the fake it till you make it. But all of a sudden they’re just now large and a big organization with a ton of money and they’re like, Well, shit. I can’t fake it. We’re just too late. We’re…” Anyway.

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So you guys wrote a paper, which I read and would love to hear you guys dive deep into it. It’s a paper that I think this community of listeners can relate to and will enjoy. But you actually, Leigh hinted to it and maybe just internally before you decided to go transparent with it a couple years ago. Some of the ideas and concepts, maybe not the specifics. But talk to us about you all’s new piece.

Leigh:

Yeah, so I think you’re alluding to the fact that in 2017 I had sat down with a friend who runs another pretty large quantitative equity asset manager. And we did some of this work. It was really early in ’17 to look at cross-sectional momentum in crypto. There just weren’t a lot of coins, it wasn’t liquid. And so from a really deep efficacy perspective, I wouldn’t say the research that we did then would’ve passed any kind of real muster. But we got a chance to sit down and use all the resources that we have here at Starkiller to really put it together this time in the right way. With Corey really kind of driving the philosophical bus there around the paper and keeping us on track. And in the style of AQR, I think we’ve produced something that should be pretty valuable for the community from a… And it’s not rocket science.

We’re basically looking at does a set of coins that performs best over the previous 30 days or 15 days or 10 days or 60 days, and we look at a broad range of different timeframes. Does it continue to perform best over the subsequent 7, 14, 30 days, whatever it is? And unsurprisingly, we find that there is a really significant momentum anomaly in the crypto markets. And that anomaly lines up with the timeframes associated with this hot ball of money theory of crypto.

Where there’s a handful of narratives at any given time over the course of about a month that tend to play out and continue to push momentum cross sectionally. And what we basically find is that if you look at the performance of this liquid group of tokens over the previous 30 days, the top quintile of those names just absolutely crushes the bottom quintile over the subsequent seven. And that is a easily exploitable thing that we obviously take advantage of. But if you think about our asset selection model at Starkiller, from a really, really basic naive perspective, that is the beginning of it. And it’s probably something like 60% to 70% of it because it simply, it works.

Corey:

I think one of the big innovations, if you don’t mind me saying that in this paper is, none of the listeners of your podcast will be surprised that momentum works. You’ve been a long time proponent of momentum, this is something you’ve been talking about, or trend following. But one of the difficult questions in crypto in particular is that what are you trading? Where are you trading it? And what price are you trading it?

When you talk about testing momentum in developed equity markets, well the S&P 500, as Leigh mentioned, doesn’t have a lot of turnover. Go to crypto market. Anyone can launch any token at any time. You can have Shiba Inu, Doggy, Rocket Token just get launched today and shut down tomorrow. And so from an institutional allocator perspective, the question is, “Okay, how do we make sure we’re trading stuff that we as institutional fund managers would actually pass our screens?”

So that means liquidity. What venues are they trading at? Are they the right type of tokens? Some tokens are just going to get infinitely inflated to death based on tokenomics. We certainly don’t want those types of tokens or they might be stablecoins or algorithmic stable coins. That’s not what we’re trying to trade either. But even just the simple question of, what is this coin worth is non-trivial, right? Again, you ask what is Coca-Cola stock worth? Great. I think Coca-Cola is on the New York Stock Exchange. You go to the New York Stock Exchange, you look at what it’s trading at, that’s the price.

Well, when you ask what’s Bitcoin worth? It’s, well, what’s it worth at Binance or FTX or on Uniswap or some of these other DeFi protocols? And while the market makers have gotten better recently at keeping that in line, there can be massive, especially in the historical data, massive price differentials between what Bitcoin is trading at, several percentage points and at certain times when whales are moving markets, I mean, it can be tens of percentage points for some of these smaller tokens.

So even just asking the simple question of, all right, we want to run this momentum strategy, we’re saying we’re buying this token. Do we actually know what the price of this is that we’re executing and do we think we could execute in the size that would be attractive to run a fund at? There was so much legwork from our co-author, Kevin, on getting all the data ready. That was a huge part of the meat of this paper. And it shows up in, I don’t know Leigh, two sentences?

Meb:

And the sentence that jaw dropped for me was, as soon as I was reading the universe, initial universe is like 30,000 coins. And I was just like, “Oh, dear God.” If you were to say, “Meb, how many crypto possible token currencies are there?” I would’ve probably said like a 1000. And I was like, 30,000 potential… And I was like, “Oh, hell no.” This paper… What a nightmare. I’m like, I would’ve just been like, “Okay, goodbye. Forget it.” That’s more than all the stocks in the world. So I mean, including the really small stuff. So you guys soldiered through for some reason. And by the way, just quick comment, this wasn’t written in the style of AQR because there wasn’t 75 footnote.

Corey:

I was going to say not …

Leigh:

…zero footnotes. Yeah.

Meb:

So all right, well keep going. So that to me would’ve been like a data nightmare. Stop, forget it. So how did you guys even source this or is this exchange data that Kevin dug up? Or how do you get that stuff?

Leigh:

What we basically did, or what Kevin did, was we take this data set from a company called Nomics. And Nomics provides the ability to access all of the individual markets, meaning every single crossing pair on every centralized exchange and every liquidity pool on every decentralized exchange. So we’re getting the individual markets for every cross, and then we go in and we combine them. We see what those prices are, and then basically we’re lining up all the different closing prices from all the different markets and they can be significantly wide. Because some market hadn’t… Literally some decentralized market may have not had a trade that day.

And so then we need to narrow down what the actual kind of tradable price was based on this range of different prices at the end of the day. And there’s a model in there that we use to do that, to get that price.

And then what we do is we use a volume filter. So we say the aggregate volume amongst these specific clean exchanges that we’re whitelisting has to be over a certain amount for half of the previous 30 days to include it in the potential asset selection pool for the portfolio. So yeah, there was a lot of work that went on producing these candles and producing all that data so that we could do it clean and know that you could actually trade these things. Because you want the ability to trade the new stuff. Because crypto is a constant and very quickly innovating industry. And so you can’t leave out some of the smaller things because they can go from being worth $20 million to being worth $10 billion very quickly if they catch adoption. And so you can’t just say, “Oh, the market cap is low.” No, no. It needs to be in there if there’s enough liquidity.

Meb:

So I’m lazy and I look at this and I think about cross-sectional momentum. I like it playing out for me just because I don’t looking that much on a monthly timeframe. But crypto, is it just by its nature that it’s so volatile, it’s just like, you got to look and update this more often? How do you think about it? Is it so fast acting that this really needs to be a little bit quicker timeframes or what?

Corey:

Yeah, I mean, the quick answer to your question, Meb is that, yeah. You got to refresh this pretty frequently. In traditional finance markets, we’re used to that like 12 minus one month momentum and you can sort of refresh your portfolio on a monthly basis over a longer horizon. And the expectation is, securities are being priced on true economic actions. Whether it’s earnings or fundamental changes in economies. And that stuff tends to be slower moving. And so the momentum tends to emerge more slowly. With less fundamental anchor within crypto, things can move much more quickly. And so I’m sure you’re aware, but maybe some of your listeners are aware, there’s a theory to momentum called the rational inattention theory. Which is that, as human beings, we only have so much time in our day and we can only dedicate so much of our brain power to certain things.

And so one of the arguments for why momentum exists and persists is it’s because where attention has gone. And so within crypto, the argument might be, you tend to get these what are called seasons. So it might be altcoin season, it might be L2 season, it might be NFT season, and all the money sort of rotates into that area. You get a ton of bubbleish behavior and then it rotates out for the next season. And I think what you sort of have is that rational inattention playing out, but in a very short period of time. So what we found at least empirically in the data, which sort of aligns with our experience and operating in this market is that those seasons last about a month, month and a half. And so you have to be looking at a short-term horizon and you have to be refreshing that portfolio on a weekly basis.

Meb:

Do I remember that you snuck in some rebalancing luck into this paper? Did I see …

Corey:

A very tiny… I did at least make Leigh test it on multiple days of the week. I said, I won’t make you tranche the whole portfolio, but if you don’t test it on days of the week, I’m not putting my name on it.

Meb:

And so talk to me a little bit about some of the takeaways. One of the biggest surprises… Well, first we’ll start with one of the not biggest surprises is not shockingly, momentum works. I mean, crypto to me is one of the most pure price-based parts of all of investing, at least relative to a lot of traditional finance supply and demand. With real world economy. They’re more traditional. So it’s not surprising that momentum works there too. And it works great. And it works in a stair step fashion from best to worst. So I’d love to hear you guys talk about two things. One, presumably this isn’t something somebody’s going to be running market neutral because it’ll just, I assume blow up or just be impractical.

Corey:

Not even feasible potentially.

Leigh:

Not feasible. Yeah.

Meb:

I mean, can you short? Is shorting in general even a thing in you all’s world on a practical level?

Corey:

It was easier when FTX was around and you could trade PERPs. Well, it’s harder to get on Binance, but for institutional investors, trading perpetual futures on FTX allowed you to effectively short. You were paying a borrowing cost and the funding rate, but sometimes you actually earned a funding rate if you were short. So yes, you could. Now it’s much harder, right? Because when you think about what does actually shorting mean, it means you need to borrow someone else’s security or token or whatever it is, sell it into the market and then you buy it back at a later date.

To do that on chain through a DeFi protocol is harder. So what you can do effectively is borrow at these lending protocols like Aave, but they don’t have the long chain of coins. Or you might be able to borrow Bitcoin and borrow Ethereum and then you can go sell it yourself and that’s effectively a short position. But you’re not going to get this huge long name of coins. There’s not enough liquidity. So you can’t short. Testing this as a long, short portfolio is really infeasible unless you’re talking about maybe the top 10 coins at any given time.

Meb:

And the second was like, what would the top quartile do? It did like 50% or something?

Corey:

It depends on the time period you’re talking about. So the in sample testing period, which was pre ’21, I believe it was something like 50% annualized. Should be noted that was just a three or four year period. And then the outer sample, which included 2022, which was an absolute disaster, I believe it was negative 1% annualized.

Leigh:

Yeah.

Meb:

And then the spread was even more, right?

Leigh:

Huge. Yeah.

Corey:

Yeah. It was a pretty big spread.

Meb:

But the humorous takeaway to a lot of this, and this is hindsight too, but just lobbing into old Bitcoin did okay too.

Leigh:

So we talk about that in the paper. The question was, what benchmark should we use for this? And we talk about how using Bitcoin, and we did, because it is the asset that is the easiest to buy. It probably represents most of individuals and some very large institutions kind of lot in crypto, “Hey, we want to be in crypto.” “Okay, just buy some Bitcoin.”

But there’s obvious massive survivorship bias associated with the fact that Bitcoin has done well and a lot of other coins haven’t. But if we look at it, Ethereum over the course of our paper actually performed an order of magnitude better than Bitcoin. So should we use Ethereum? Bitcoin is 40% of the total market cap of crypto at this point. Ethereum representing another 20%. So together 60%. We also did produce a equally weighted portfolio of all of the coins that met the liquidity thresholds on any given week. And then rebalanced them and we show the returns there as well. And Bitcoin significantly outperformed that equally weighted portfolio as did the top quintile of the momentum basket. But yeah, this goes back to our discussion around, there really is no great kind of crypto index to say that that should be the benchmark.

Meb:

Why not? When can we get the Starkiller market cap/equal weight indices?

Leigh:

Well, if you tell me the actual market cap of all of those coins, then we could do it. But one of the things about crypto is, it doesn’t exist. The transparency associated with some of these even large protocols regarding what is the actual liquid market cap or are we using only the available traded market cap? It’s just how you put together these things would be… There’s a lot of hand wavy kind of logic that you would have to use.

Corey:

I think another big point here, Meb, is does any of this survive trading costs? Right? Because again, I think for us as practitioners, we really wanted to approach this paper from a practitioner’s viewpoint. Can we work with a large enough universe that you could run a fund on this? Can we actually screen for the correct prices on the exchanges we would trade on? And will it survive trading costs?

Because trading costs in crypto can be egregiously high. If you’re not paying attention… I don’t want to pick on Coinbase, but you go naively buy on Coinbase and they are taking a massive chunk of your capital just in a transaction cost. Even FTX and Binance, you’re talking before impact, just pure trading costs, 10, 15, 20 pips. And so you can imagine for a very high turnover portfolio that you’re running 30 day momentum turning over hundreds of percentage points per year, those costs really add up.

And so what we found is there’s a sort of a breakeven cost around 50 to 60 basis points. That so long as you can keep your transaction costs below that, the strategy is still viable. And I think for some people that might not be possible. But for a full-time fund that’s managing their impact, working with OTC desks, really working their trades across exchanges and trying to minimize transaction costs, I think it’s a very feasible strategy.

Meb:

So practically speaking, Leigh, is it doable for you guys? Is it a lot of work? Do you have to do it across a dozen different counterparties? How does this work in the real world?

Leigh:

So working on Coinbase and we can use TWAPs and a handful of different OTC desks. We’re not trading every single day. If you look at these strategies, they’re kind of like a weekly turnover. And even with that weekly rebalance, you’re really only turning over about a third of the book each week. And that’s if you like systematically follow those, the cross-sectional strategy, which we don’t. It’s a piece of what we do. It’s not the whole thing.

So yeah, it’s really feasible. And you’re not talking about hundreds of tokens in that portfolio. You’re talking about something between 10 and 20 of them at any given time. So it’s a very feasible thing to be able to execute, but you have to pay attention. And for some of the smaller stuff, you can’t just throw a market bid at it, or else you’re get yourself into trouble.

Meb:

So as we stay in the crypto world and wind down with this paper, anything we didn’t cover on it that you guys think is particularly interesting, insightful? Are there other groups that this is either on the allocation side, finding an audience for or competitors too?

Leigh:

Yeah, so the other piece which was kind of a bit of an afterthought that we threw into the paper at the end was kind of the trend following overlay to the cross-sectional model. And we even write about it in the paper. We say basically, even if you were to execute this purely cross-sectional model fully long the entire time, the drawdowns are puke inducing, right? It’s 75% drawdowns. And so I would not bet that many institutional allocators would be up for that kind of model, even with the kind of returns that it does produce.

And so we add in another big piece of what we do at Starkiller, a naive version of a model that we use, which is just a basic 5, 50 exponential moving average crossover on Bitcoin as the signal for the portfolio to go in and out of cash. And we show what that does to the returns of that top quintile momentum portfolio.

And unsurprisingly, it very significantly increases the returns, it reduces the drawdowns, all of the things that you would want a trend following strategy to do. And what we’re trying to get at is that these two things need to be married in a strategy. That simply just being balls to the walls long at all times in crypto is not very smart. Even if the long term returns associated with that top quintile portfolio are good. The underlying kind of other metrics are certainly not. So yeah, we look at that.

In terms of other groups doing this, we’re not aware of any kind of sizable funds that are running stuff like this. But I’m sure that there are funds that are using pieces of it in their strategies. When we look at our, what would you call peers, and I don’t know if that’s even the right word, the liquid token funds out there, most of them took 80%, 85%, 90% drawdowns over the last 12 months. And so we’re pretty sure that they’re not using a lot of risk management in that strategy. They’re basically just picking tokens. In my opinion, you kind of need to marry the two things in order to be able to survive and advance to the next cycle.

Meb:

And so what is the reasonable universe for a institutional player like you guys? Do you have a universe of, is it 10, 100, 1,000, things that you guys would consider trade?

Leigh:

So in the paper, yeah, we actually show a chart of the number of tokens that are liquidly available throughout the time series of the research. And then the daily total volume of a theoretical portfolio, the top quintile portfolio. But looking at the least liquid coin in that top quintile portfolio times the number of coins that would be in the portfolio.

I mean, this is part of how we judge what is the total capacity of it. Over the time series of the research, you see the total universe that we’re able to select from go from 10 coins to at a certain point, I think it’s up to something like 400 or 500 in a given week. So right now we’re probably towards the middle of that range, but certainly we haven’t given back all the liquidity from the last couple of years.

Corey:

Yeah, you’ve definitely seen a significant drop in liquidity and I think as we’ve learned, a lot of the liquidity that was in the system was just borrowed money. So it was just the same money sloshing around. Multiple people trading.

Leigh:

Borrowed five different times.

Corey:

Yeah, exactly. So with those liquidity constraints of making sure we can operate a fund at reasonable size, a lot of those lower liquidity tokens have dropped out of the universe. And I think that’s a natural part of the evolution of this space. You had a lot of garbage come into the crypto world. That’s part of the growth cycle. That gets called out in a bear market. I’m sure we’ll see growth again. But at this point, assuming our capacity is constrained by the least liquid token that we trade, you can easily operate a $100 million, $200 million fund in this manner, in this space.

Meb:

Cool. Well, that’s a decent chunk of change. So I look forward to the Starkiller summer fishing trip when these things take off again. Which, it seems like they might be starting. As you guys look out to 2023, what’s on your all’s brains? Now that you’ve birthed this paper? What else is on your all’s minds? I know this could be an endless, entire another podcast, but what else do you guys think about?

Leigh:

Yeah, I think we might be turning a corner here in the market. We constantly talk about how the bottom doesn’t happen after everybody goes to jail or after all the regulations are written and things like that. So you have to put aside some of the more dubious fundamental aspects and focus on price and focus on adoption. I think there’s a lot of innovation in the ecosystem now. There’s a lot of builders who’ve been working on things that haven’t launched their projects or coins because we’ve been in a bear market. It’s not a good time to do it.

And I think if you get prices stabilizing here, you’re going to see them come to market with new coins. And I think one of the things that anecdotally we’ve learned and known for a while, but you could see it in the paper, is that really the coins that perform well in the next cycle will very likely not be the ones that perform well in the previous cycle.

Because the previous ones have a lot of bag holders now. They’re fully owned. The new tokens, people need to acquire them. And with limited liquidity, that’s part of what pushes momentum. So we’re looking forward to maybe some actual new coins coming to market, new projects. And I think the industry has a lot of fundamental philosophical things to deal with, like KYC, right? Should these protocols be KYC’d? Should the chains be KY’s? The centralized versus decentralized exchange stuff and where people are actually trading and getting liquidity, I think is something they’re grappling with. That we’re going to deal with this year. Should there be arbitration for transactions on chain? It’s very hard to get big institutions to want to come into crypto and put a lot of money to work if their wallet gets hacked, and then the money is just gone forever and there’s no arbitration and no way to get it back.

So I think there’s this concept of varying layers of arbitration that might be introduced. And then there’s just transaction speed. And I think one of the ways that we look at this is, in the tech bubble, the liquid that everything was sitting in was fiber. We built a lot of fiber. And in the 00s we used that fiber to build real businesses on the internet. I think we’ve just gone through this period where we’re trying to build block space and the ability to transact on a blockchain at reasonable speeds and reasonable costs, and I think a lot of venture capital is just thrown at all of that. And in the next year or so, I think we’re going to come out of that with the actual products of all that money and all that spending that will represent kind of the fiber.

Meb:

So other than the picks and shovel, so other than businesses that are directly supporting just crypto launches, so excluding brokers, excluding miners, what have been the best use cases or companies or protocol… Really that’s turned into like a business? If that makes any sense.

Corey:

So there’s actually, there’s very few. And part of the problem is that, especially from a tokenomics perspective, the second you start tying earnings to these tokens, they become securities. And so everyone’s trying to skirt the SEC. So you end up with this no man’s land of what is a governance token, how to value it? Some of the projects are earning plenty of money. But the way I think about this space Meb, coming from a traditional finance background is, crypto right now, especially in the most recent run of decentralized finance is like speed running the history of traditional finance.

Everything that you have in traditional finance is now being brought on chain in a hyper composable way without limitations. So all of those things that prevent you in the traditional finance world from access, whether you have access to certain products, whether you’re qualified, whether you have enough money, or whether you have the right licenses, all of that gets eliminated with crypto. And you can suddenly start, for better or worse, to build and trade really weird financial products.

We saw that run up. I think there is a potential for a huge business there. You’re seeing people try to take things and bring things like mortgages on chain, real estate on chain. I think all of it has a potential, but to Leigh’s point, the space got so flooded with capital. For me, what I’m watching over the next year is how does that flood of capital sort of flow out, right? Much like we’re seeing in the traditional space all within private equity and VC and private REITs, we need to see all that repricing.

We need to start seeing down rounds in crypto. Or we need to start seeing these companies give back money and shut down as sort of for the forest fire to really have burned everything out. Because you saw obnoxiously high valuations for white papers at the end of last cycle. I had, someone asked me to invest in something based on a white paper that was having a $400 million valuation.

Meb:

Well, Corey, I mean let’s be honest, but you missed your calling as a white paper aficionado.

Leigh:

Yes.

Corey:

Nothing annoys me more.

Meb:

If anyone should have been able to take advantage of this, it should be you.

Corey:

I know. So just to round out my point, there was so much money put into the system that is still hidden in these private treasuries. The question is what’s going to happen with that capital? Do those projects want to go on and can they live up to the valuations? I suspect not. I suspect they’re going to have to do down rounds, but there might be a lot of founders that just decide the opportunity cost is too high to keep going forward with these protocols that likely won’t survive. They’ll give the money back and I think that’ll be very healthy for the system.

Meb:

Back to Tratify, anything else in that world you guys are thinking about or on the brain for 2023? It’s been a weird couple years.

Corey:

Yeah, I’ll tell you what’s on my mind, what scares me. We’re seeing the impulse and inflation slow, but historically, if you go back to the 1970s, you had these three big impulses. You had this first impulse that then basically went to zero. Then you got a bigger second impulse that then almost went back to zero. Then you got a big third impulse. And with the sort of economic whipsaw effects that you can see, … whip effects with just in time production cycles that almost the entire industrial complex has moved to over the last 20 years. What concerns me is that everyone is feeling very comfortable that we have inflation under control. History tells us inflation can come back very quickly.

Leigh:

So I’ll give you another hot take Meb here. We had this discussion on the trip. I think that we’re not just as humans, but just as a society, as institutions, I think we’re getting smarter. I think we’re getting better at managing the economy. I think that we’ve learned from our mistakes in the past. I think Bernanke learned from the Great Depression. I think that Powell has learned from what happened in the ’70s. And I think everything leads me to believe that they are not going to take their foot off the gas here until they have victory well in hand.

And that maybe we learned that lesson of the ’70s and we’re not going to repeat it. Right? And that the bond market seems to think that they are going to repeat that bad mistake. They’re spitting in Powell’s face right now. And I think Powell is sitting there just like Bernanke did and saying, “No, I’m seeing this through.” I think the rest of my team seems to think the humans are still as stupid and valuable as we’ve always been, but I have more faith in humanity today.

Corey:

So it’s not that… All right, we’re going to have this debate live in the last two minutes of this podcast.

Leigh:

Yeah, let’s do it.

Corey:

It’s not that I think humans are just as stupid. It’s that I think there are profound implications for the way securities are priced if you say that central banks can control the volatility of the economy. If you can say central banks, monetary and fiscal policy is able to effectively eliminate the far left tail of economic events, smooth out earning cycles, then I think it means that stocks have to price with significantly less volatility. That they become much more bond-like. And maybe that’s the answer. Maybe the S&P 500 should converge eventually to trade like a basket of corporate bonds.

Leigh:

So that might be true, if the mix of companies and businesses in the S&P 500 was the same as it was 20 or 30 years ago. But today it’s much more heavily weighted towards innovative companies with a high disruption multiple in both directions that can get disrupted or disrupt other businesses. And so I think these two forces counterbalance each other.

Corey:

I’m not sure if it matters if you hold a broad basket because the one going out, it gets replaced with the one coming in, right?

Leigh:

Maybe.

Corey:

And so I guess my point is, if you look at the earnings of the S&P 500, and by the way, fundamentals have always been less volatile than prices. We’ve known that, but I’ve always seen it… That’s sort of big question that I think it was Shiller who originally posed. To me, that big question is about prices trying to front run the potential tail risk of what can happen with fundamentals. Again, if you eliminate that tail risk, I’m not sure why prices would continue to be vulnerable. If you take away risk, things should trade like the risk free rate.

Meb:

Well, but there’s two parts. One is, Corey is about to be surprised with explosive diaper inflation here shortly. So he got a lot of costs coming down his way soon. But second, that might be Leigh’s spiciest take is that the Fed governors are on top of it, learning a lot. I think if there’s anything that garners more universal consensus, it’s that everyone hates the Fed and thinking that people learn over time.

Leigh:

They do, especially in crypto. Everybody in crypto seems to hate the Fed. They hate the US. I feel like a leper because I think the Fed does a pretty good job. I think the US dollar is our best export. I think it’s the source of our power. I don’t think sovereign money is going anywhere, even if you do get this big crypto ecosystem that has utility. I don’t know. It’s an idiosyncratic view within my industry that I don’t know how I landed there, but…

Corey:

I just want to be clear for all listeners, that is Leigh Drogen talking. Not Corey Hoffstein.

Leigh:

Not Corey. Corey just doesn’t want all the hate mail, just doesn’t want all the terrible DMs on Twitter from the crypto community.

Meb:

They’re an easy target because you can complain no matter what. They waited too long. They were too early, they were too late. They did too much. They did too little. And timeframes be damned. You can always shake your stick at them. But I’m excited that the dollar is high because as I mentioned I’m going to Japan and the yen is at levels that hopefully I can bring back some Hibiki at a reasonable cost.

But the interesting part, and this is very subjective and just BSing, but I always think that if I was in the Fed’s place, and what you care about at this point is legacy, getting things right. Not being remembered as the guy who was in charge when inflation went nuts. That’s acceptable. Hey, COVID happened, inflation went crazy, whatever. But being known as the guy that let it stay out of control or like the early ’70s where it came down, we backed off and then it went nuts again. That would be in my mind every single day. I just like, don’t want to be remembered as that person. That’s it.

Leigh:

Yeah.

Corey:

Yeah. The utility function of the Fed chair versus what’s good for the economy, right? I think that you have that agency issue.

Leigh:

I believe in the American economy.

Meb:

Yeah, we all love the Fed. That’ll be the consensus on this one. Any last thoughts gentlemen as we start to wind this down?

Leigh:

When are we going on a surf trip, Meb? When are we going to Indo? I’m going in May, I think.

Meb:

As I’ve described on the podcast, I’ve just resolved to be a Wavestorm surfer at this point. So three to five foot waves where I can take out the Costco foam board is like the happiest I’ll ever be. So if you’re allowed to take a Wavestorm to… Where’d you say, Maldives? Where’d you say?

Leigh:

Indo. To Indo, yeah.

Meb:

Yeah. I’ve never been, I would love to go, but this is the blue level of skiing. I’m happy. I’m in my mid 40s. I’m like transitioning to be a long boarder. I don’t know, but I like the water warm, so I’m game. Starkiller, Cambria mashup. Newfound. We’ll take all three and go somewhere. But I like Whitefish, man. Summertime in the mountains is the best place in the world. So have you come across any grizzly yet?

Leigh:

Yeah, we’ve seen a couple in the park, but just kind of riding bikes through. Definitely didn’t stop and want to interact with that.

Meb:

So late June. I’m going to mark it on my calendar. Best time to go. I didn’t know E-bikes became a thing. Because that kind of changes it. I always knew you could take bikes in early, but I’m like, damn, that’s going to be a lot of work. I don’t know if I can get away on a bicycle.

Leigh:

Getting up to the top of the pass there on a regular bike, that’s a lot of work. Yeah, I don’t really… I’m not up for that.

Meb:

Gentlemen. It was a lot of fun as always. We need to do it more often. Give the listeners best place to go to find out what you guys are up to and find more info.

Leigh:

Yeah, the paper is at starkiller.capital and if you just go look at the insights tab, it’s at the top of that right now. And you can find everything else about the firm and us there. Corey.

Corey:

Yeah, I was going to say it’s all at Starkiller and you can also find us both on Twitter, probably a little too active on there.

Leigh:

Yeah. For our compliance and COOs. Yeah.

Meb:

And you can find the other things that Corey can’t talk about somewhere at Newfound, but you’ll have to email him for those. We’ll also put the paper in the show note links. Listeners, if you don’t like reading white font on a black background, we’ll give you the alternate as well.

Leigh:

Is that a faux pas? Is our whole website …

Meb:

Some people like Bloomberg this way. Some people like it that way. Some people like black background charts. Some people like normal charts. Some people are crazy, some people are not. It’s your thing. Gentlemen, thanks so much for joining us today.

Corey:

Thanks for having us, man.

Leigh:

Thanks, Meb.

Meb:

Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at the mebfabershow.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.