Another must read piece on volatility, fragility, liquidity and what to expect going forward. The below is the introduction to, by what we find to be one of the best in the field of understanding and explaining volatility, Christopher Cole of Artemis Capital Management, his last piece, Volatility and the Fragility of the Mean.
There are these two young fish swimming along, and they happen to meet an older fish swimming the other way, who nods at them and says, “Morning, boys, how’s the water?” And the two young fish swim on for a bit, and then eventually one of them looks over at the other and goes, “What the hell is water?”.
-David Foster Wallace, This is Water (2005)
“This is Water” is the title of a commencement speech delivered by David Foster Wallace that has become a masterpiece of meta-thinking. If you haven’t listened to it, put down this paper and do so now. It is worth 20 minutes of your life.
The Foster Wallace parable of two young fish ignorant of the medium that defines their reality is so important on many levels. Foster Wallace contends that we swim in a world defined by self-centered thoughts, that serve to make reality visible, but should never be mistaken as fundamental truth.
In capitalism the medium that defines reality is fiat money. To this point, does money exist? This seems silly to ask but it is very important philosophically. Yes, money exists in the sense that you can purchase goods and services with it. At the same time, money is only important because of a collective belief in it, and is worthless without that. This is true of any human construct: markets, words, brands, and nation-states… all abstract mediums that have meaning because we collectively believe they do, and hence they give form to reality, but are not real independent of our thoughts.
In markets and in life, we swim in mediums of thought abstractions… the same way a fish swims in water. When the medium collapses, so does the reality… causing us to question the nature of both. As Foster Wallace eloquently explains, “The immediate point of the fish story is that the most obvious, ubiquitous, important realities are often the ones that are the hardest to see and talk about.”
Volatility is always the failure of medium… the crumpling of a reality we thought we knew to a new truth. It is the moment where we learn that we are a fish living in a false reality called water… and that reality can change… or there are other realities. True volatility isn’t the change of the thing, it’s the changing of the medium around it and the realization that the thing never really existed in the first place.
This is all you need to know to understand when the volatility storm will truly come. It is not about valuations, money printing, or where the VIX is at any point. When the collective consciousness stops believing growth can be created by money and debt expansion the entire medium will fall apart violently, otherwise it will continue to be real. The belief that the medium is the reality is what holds the edifice together temporally.
This letter is divided into three key themes: The first part will discuss fragility of the market medium; the second will discuss how the volatility in February was a symptom of a much greater liquidity problem; and the third will discuss how flows are more important than fundamentals when the medium dominates truth.
Out of the fishbowl and down the drain we go…
For the full must read report please click here.