Transcript: Benn Eifert on the Mania That Was Even Bigger Than Meme Stocks

When people think about the market mania we recently experienced, the most glaring thing that comes to mind is the meme stocks. In early 2021, the huge moves in names like AMC and GameStop exemplified this new Robinhood, r/WSB, crypto world. But there were activities much more egregious than some retail traders buying odd lots on Robinhood. Serious, professional investors and traders lost huge sums of money giving out unsecured loans to crypto hedge funds like 3AC, which then proceeded to incinerate their money. In other words, lots of people, with a range of sophistication, threw out some basics of risk management wholesale. On this episode of the podcast, we spoke with Benn Eifert, founder and CIO at the boutique volatility hedge fund QVR Advisors, about how manias happen, and the big lessons everyone should learn from the market over the last two years. Transcripts have been lightly edited for clarity.

Points of interest in the pod:
The craziest thing Benn saw in markets —  03:24
The crazy stuff that institutional money did — 04:42
The importance of narratives in investing — 09:19
What happens to late entrants in a bubble — 12:01
So why did people buy ARK? — 14:14
Parallels between tech and commodities — 19:32
How do you tell a visionary from a huckster? —  21:41
What does retail activity in options look like now? — 25:28
Why is it so hard to short bubbles? — 29:24
Do low interest rates cause bubbles? — 32:42
How much craziness is left in markets? — 39:32
So what does Benn think of crypto? — 41:29
Tips for avoiding the next mania — 45:30


Tracy Alloway: (00:10)
Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.

Joe Weisenthal: (00:14)
And I'm Joe Weisenthal.

Tracy: (00:16)
Joe. There's been a lot of crazy stuff that's happened over the past couple years.

Joe: (00:21)
Oh, you think? I don't know. What makes you say that?

Tracy: (00:24)
Well, okay.

Joe: (00:26)
Besides literally everything.

Tracy: (00:27)
Besides everything? Well, the most remarkable thing, when I think about this year and the bottom falling out of a whole bunch of stuff, is that this is exactly what everyone, or what a lot of people said would happen, right? People looked at tech stocks, people looked at crypto and they said, ‘this looks unsustainable. It looks like a bubble. Or it looks like a mania. Why in the world are people buying this stuff?’

Joe: (00:54)
Well, you know, it's funny thinking back to like the top of the meme market in early 2021, and people are like, ‘oh, this has got to be the top.’ It's like GameStop. And it turned out to be exactly the top and that like never happens. But I guess if you say this has got to be the top enough, then eventually it will be. But if you look at like some of those measures, Morgan Stanley puts together this great chart of like the cumulative P&L of Robinhood traders since the start of the pandemic and it basically peaked right in February 2021, and then it's been downhill ever since. So it really was the top.

Tracy: (01:27)
Right. I think retail investors basically erased any gains that they made from 2020 to 2022. So, looking back with the benefit of hindsight, it seems inevitable that all of this, you know, would turn out this way. But as we were describing, there's still people who jump into these things, right?

Joe: (01:46)
Totally. In the grand scheme of things, people always joke like hindsight is 20/20, but I've never actually believed that's true. And we know that's not true because we look at history all the time and dispute what actually happened. And so there's never actually any agreement, nonetheless, you know, with this sort of like cycle having played out of all these people entering the market, getting excited about some of the craziest stuff there is, everyone calling it top and then a downturn, it's probably not too early to start asking the question, what did we learn the last two years about how markets work?

Tracy: (02:17)
Yeah. I think that's right? And obviously some stuff is still shaking out. But I think we have enough here to at least do a review of everything that we've seen now over the past couple years and how, you know, investors can avoid some of the mistakes they may have made in that period.

Joe: (02:33)
It's time to start learning.

Tracy: (02:34)
Yes. Okay. The learning hour on Odd Lots. Well, I'm pleased to say we have the perfect person to discuss this. We're going to be speaking with Benn Eifert, who has been on the podcast a number of times talking about retail investing, talking about derivatives, the impact of retail getting into derivatives on the market. He is of course, a managing partner at QVR Advisors, which is a boutique hedge fund that specializes in volatility derivatives. So Benn, thank you so much for coming back on Odd Lots.

Benn Eifert: (03:05)
Tracy, Joe, it's so nice to be back. I missed you guys.

Joe: (03:08)
It's been way too long.

Tracy: (03:10)
So maybe to begin with, there are so many crazy things we could start with, but what do you think was the craziest thing that you saw in the market over the past couple years? Was there a moment where you were just like, I cannot believe this is happening?

Benn: (03:24)
Ah, the craziest moments of the last few years is a really, really, really tall order, right? I would say actually I found the sizes of the unsecured loans that very large, and you might have thought sophisticated, investors and credit organizations were giving to Three Arrows Capital, two and a half, you know, two and a half billion dollars for Genesis alone with like no collateral. I mean, you come into this just thinking, look, these are big boys. These are wealthy people who've created a tremendous amount of money and they wouldn't just do completely, obviously crazy stuff like that. And then it turns out that the answer is, of course they do.

Joe: (04:08)
Well. That's such a great answer. And I'm glad you said that because obviously we did this intro and we talked about like, ‘oh, the retail craziness and people buying AMC in GameStop on Robinhood.’ But of course you're right. Like actually these were pros. These were people who were very successful and essentially like building an industry and lending billions of dollars unsecured to a crypto hedge fund that we know in retrospect was not doing anything particularly sophisticated. That's actually way crazier than buying shares of GameStop.

Benn: (04:42)
Absolutely. I think retail gets all of the attention and you know, we can talk about that all day and there's all kinds of interesting stuff there, but I think people forget that the role of institutional investors in this process and the way that institutional investors start to buy into narratives and start to, you know, start to develop this fear that they're missing some huge technological revolution, and then do incredibly crazy things in huge size, is almost a more interesting story.

Joe: (05:12)
Can you actually talk a little bit more about the psychology, the sort of institutional FOMO, because again, retail FOMO is really obvious. If your friend, you know, suddenly made $10,000 or $100,000 or more like trading call options on Robinhood, maybe you want to get into it, but you probably, I assume in your capacity as a hedge fund manager, you probably talk to a lot of sophisticated investors, institutions. You must see the institutional FOMO side in a way that the rest of us don't. How does that work? How do they sort of like get in the brain space where they become comfortable or obsessed with taking these huge risks?

Benn: (05:53)
Absolutely. I think it's, you know, on the face of it, institutions are probably better at noticing things that just seem obviously crazy and silly. You know, they're less likely to buy into very poorly framed ‘look, you can make 1000% a month doing this’ kind of pitches, right? Institutions have, generally speaking, smart people and they're able to recognize those kind of things very quickly. But what I think is really key here is that momentum is very dangerous for institutional investors precisely because it's a real financial markets phenomenon, right? It's one that's had tremendous amount of proper academic research for a long time. It's clearly an effect that exists in a sense. And momentum is the tendency of things that have been going up lately to keep going up in the near future.

And the best explanation really, I think, for historical momentum effects, is that something important is changing behind the scenes about the world, right? And it's poorly understood and skeptical old fashioned or grumpy investors try to fight it. Right? Warren Buffett says, ‘look, I can't own Google or Amazon in 2010 or 2011 or 2012, because look at these PE multiples, they're kind of high. I don't really understand what these guys are doing.’ And then they turn out to be these huge transformative businesses, right? And that's a real thing. And it results on average in various ways in sometimes it makes sense to own things that have been going up even if you don't totally understand why. But the longer that returns momentum builds in some particular area, the more over time, even institutional investors that are, you know, generally sophisticated and skeptical, feel the need to get involved, because they start to think, look, I must be missing out. I don't totally understand this, but I must be missing out on something transformative.

I can't be the guy who's sitting here in this room in five or 10 years and say, ‘yeah, I didn't own Amazon.’ Or I didn't get involved in that new thing. And I completely missed out and everybody else made a ton of money doing this and I just didn't get it at the time. And I think institutional investors also probably have a pretty high tolerance and almost sometimes an attraction to complexity, right? It makes them feel smart, makes them feel in the know about something new. And often of course, complexity can obscure the sources of risk that are actually being taken in an investment.

Tracy: (08:22)
So just on the idea of momentum, this is something that I feel was different about the past couple of years, maybe on the institutional side, as well as the retail side. But it feels to me like people used to, if they saw something that they thought was a bubble or didn't make sense, or, you know, it was a mania in one form or another, I think people would shy away from it thinking that this is a bad investment. But it feels like over the past couple of years, people sort of wholeheartedly just jumped in, knowing that a lot of the price action wasn't necessarily justified by fundamentals, but thinking that you could go in, you could make some money and then hopefully get out on time. Is that behavior that you've observed? Like, is it that nihilistic? Or is it really about the narrative and people just not wanting to miss the next big thing?

Benn: (09:19)
I think there's an inherent cyclical to it just with human memory and institutional memory and the experience of investors, right? I mean, there's just simple, important factors here. Like how long has it been since the last big mania that people were piling into that ended really poorly, right? Allowing the collective consciousness of excess and crash to fade and time for new narratives to build and time for those new narratives to generate returns and to tempt new investors, you know, time for new frontiers to emerge that we can create new narratives around. I mean, if you think back really to the last couple of decades, I mean, it's been a pretty long slow bull market cycle since 2009, right?

We've had some minor disruptions. We had some European sovereign debt issues and we had a few other things, but really things have gone really, really, really well for a long time and market participants, you know, the memory of the tech bust is pretty long faded, certainly in terms of actual institutional knowledge of investment organizations, as opposed to just in lore of the old people. And that leads market participants, you know, over time to start taking more and more silly risks and to become more and more susceptible to creating narratives around, you know, some of these new things. I think it's gonna be much harder, you know, in the next three or four years, probably we won't see a bunch of, you know, brand new really, you know, really crazy things develop -- famous last words. I mean, we probably will because I said that.

Joe: (11:05)
Something that I've been thinking about too, and it really fits with this idea of like the sort of last institutional holdouts, the people that fight the new thing, that people that are skeptical of tech, the people that are skeptical of crypto, and then eventually they sort of get dragged along and then eventually many of them capitulate, not only does it seem like many of them capitulate in some way or another, it seems like in the late stages of the boom or the bubble specifically, you get the most egregious behavior. And I don't remember the exact dates, but I'm thinking of some of these loans to like Three Arrows Capital or some of these moves into Luna, the stablecoin ecosystem that crashed, they happened really late in the cycle. It seems like there's this effect where not only do the final folks get dragged across the line, they seem to really do it in size at the worst possible time.

Benn: (12:01)
I think that's totally right. I mean, if you look back again at this, what has been a very long slowish, you know, bull market cycle where things have been good, it was really only, call it, 2020, that was sort of the turning point where all of a sudden everything started to just go parabolic together at the same time across public markets, across private markets. You know, I think a big part of the institutional role in that really came from this huge psychology around private assets and private investments being this fantastic place to be, you know, big sources of innovation, stable returns, because, you know, without mark to market volatility, right, you saw just really in the last few years, you see the formation of VC growth funds, right? So you always used to think of venture capital as, you know, these nerdy, weird engineers doing cool science experiments and backing these early stage companies to do really disruptive stuff.  Whereas growth funds were all about raising mega institutional scale capital at full fees with long lock and plowing that into companies that were already valued at $200 billion and just had a completely different asymmetry to the return profile.

And you had corporates like SoftBank and hybrid public private hedge funds like Tiger, you know, coming in to compete for deals, to get those deals with startups, by saying, ‘look, we have bigger checks and we're not gonna ask you any annoying questions. We're not gonna do due due diligence. Like, I want you to sign the term sheet in 24 hours that I just sent you.’ And that was really, you know, alot of that came from, I mean, and I think I had a Twitter post about this, but you know, 2019, 2020, I would go to conferences with big institutional investors. And the only thing that you would hear about was how big asset owners were taking money out of liquid alternatives type of investments and moving them into privates because the returns in privates had been so high and there was such a perception of such limited risk in practice.

Joe: (13:57)
It also seemed Tracy, if you look at a chart of like Softbank, the stock, that's how you erased, like years’ and years’ worth of gain. So SoftBank is where it was in 2017. And it's like, yeah, if you do these big investments late in the game, you just wipe out years of gains.

Tracy: (14:14)
So actually this is something that I wanted to ask, you know, a lot of the craziness that we've seen has been focused on tech stocks, either in the public market or tech investments in the private market, through venture capital and things like that. And you were talking about narratives earlier and fear of missing out. Is there something about tech specifically that makes it more vulnerable to people getting very excited about it? I guess there's so much technology that is pitched as life changing or world changing in one way or another. It feels like it's easier maybe to build a big narrative out of it to try to get more people into it.

Benn: (14:53)
I think that's exactly right. So, I mean, just to be clear, technology itself is not the problem, right? I mean disruptive technological innovation is what drives the world forward. And, you know, Silicon Valley and venture capital plays a really important role in that. And that's great, but that technology inherently has this characteristic, right? That you're not selling a current set of cash flows or a well-trodden path of how, you know, that can be valued by people with spreadsheets in some kind of relatively formulaic way. It's about selling a vision of the future and a vision of what could be and how that can play into future economics and trying to relate that to past innovation. And that's a very nebulous thing in the end. And it's something that is inherently susceptible to hype and narrative, particularly when the, I think, as you've seen in recent years, particularly when financial markets set up ways for people to get actually paid and to monetize that kind of narrative and hype, right? As opposed to, ‘Hey, I finished building this company and then it becomes a big company. And then I get really rich,’ right?

When it becomes, ‘I sell this vision of a future that's really disruptive. And then I can issue a token and I can sell it to retail and I can make a billion dollars just by doing that without actually building anything.’ Or similarly, you know, in technology, if I can create a startup that gets valued at $300 billion, and then I can go into the secondary market and I can get liquidity as a founder and sell a lot of my shares to like institutional investors that want to get some, right? And I think that's the inherent trick with technology is that it is inherently by its nature, much more susceptible to narrative-driven, you know, valuation and narrative-driven thinking.

And that is what it is, right? That's not something that's gonna go away, but it's something that investors, you know, have to be really cautious about how to differentiate. And you get, it's like the early phases of a technology cycle. You get those nerdy engineers building really cool stuff in the garage, but then the MBAs start to show upright? That’s kind of a classic line in Silicon Valley. And you end up with a lot of huckster types coming in to kind of ride along the wave because there's so much money involved and that's where you get the trouble.

Tracy: (17:09)
Can you explain ARK to us? Like, what was that about? Because, you know, Joe mentioned the SoftBank chart. If you pull up the ARK Innovation ETF, it's pretty similar, basically erased like two years of gains. But, you know, Cathie Wood  was out there talking about how the technological revolution was going to increase GDP growth to like 50%, which I think is a number that has never been experienced in terms of GDP growth ever in the history of the global economy. But what was that about and why did people seem to buy into a vision that, you know, on the surface was pretty easy to pick apart?

Benn: (17:52)
Yeah. I mean, it was a perfect storm. I think of timing and narrative…

Joe: (17:56)
We have to have these like firework sounds go off [every time someone says ‘perfect storm’]

Benn: (18:03)
It was this perfect storm of timing and compelling narrative, right? I mean, 2019, 2020 retail investors and individual investors were just starting to see this huge upsurge in interest in markets and trading and participation in markets that we hadn't seen since the previous tech boom back in the nineties. And a lot of that interest was centered around, you know, new era, new economy technology stocks. A lot of the smaller speculative type of names that were coming to the market through SPACs. And, you know, Cathie did a really good job of capitalizing on that interest and offering a really simple way to get exposure, you know, not to any specific stock, but to this idea of disruptive innovation, right? And that's a theme that really appeals to a lot of folks, you know, a lot of young folks, but not just young folks.

And she, you know, she's charismatic and she does, did a great job on TV and she was able to attract huge inflows. And of course, the trick with all of that is, you know, I mean, she's made a tremendous amount of money, and good for her, on management fees on those vehicles. But if you look at kind of the net capital destruction in the process, it's been enormous, right? Because she was, you know, those inflows were partly responsible among lots of other types of things for driving up the prices of many of those types of companies dramatically. And ultimately way, way, way out of line with any kind of, you know, probability of success and probability of monetization.

Joe: (19:32)
I just had this sort of realization actually that I'd never really thought about before until Tracy's question about like narratives and why tech? Because it seems to me the other area where you see this is commodities where there's like incredible stories that people tell -- peak oil was a huge one. The endless rise of China was another one. We're not gonna have enough copper and lithium for the demand for EVs for that next 10 years. And then of course you have all like, you know, the hucksters and financiers, who are like, you know, “give us your money for this mining project up in the Yukon where we're gonna strike gold” or whatever. It feels like commodities and tech are like these evil twin brothers or distant cousins where it's like as a society, we oscillate between a tech cycle, nineties, a commodity cycle, 2000s, tech, the 2010s, where we just sort of like pass back and forth between like, are we in a tech story cycle or a commodity story cycle? I don’t know if that's a question. Just sort of something I'm thinking about, it seems like there's these big, big swings that go back and forth between the two.

Benn: (20:38)
It's totally true. I mean commodities since the beginning of time have been just the most massive cyclical boom bust area, right? Where you have shortages and prices get driven up and people and companies hoard. And then eventually that, you know, leads to an economic downturn and commodity prices collapse. And there's a huge glut and this is, you know, not a new thing and it's a perpetual thing. But to your point, it gets tied up in all kinds of narratives that people create around how, you know, we're gonna run out of fossil fuels and oil prices are gonna go to infinity and then yeah. And it goes back and forth and back and forth and we're doing it again now of course. And I think it complements, it’s in some sense, commodities are like this very simple, fundamental thing as compared to technology. But they get tied up in these macro stories. Which make, you know, macro is always really hard, right? Because you know, the world is changing and you always can have some conception of, you know, the way in which the world is changing and why it's going to lead to this huge extrapolation.

Joe: (21:41)
This actually sort of gets to my next question. How do you know who's just a storyteller in real time versus someone who is actually correctly identifying a new trend because, you know, you mentioned Warren Buffett in the beginning, he was wrong. Not all of the curmudgeons in a certain area, get vindicated in the end, he was wrong to dismiss the Googles and the, you know, the Facebooks in 2010, he ended up making a fortune on Apple and that compensated for a bunch, but he was wrong on this. And so in real time, investors really are faced with a tough decision because sometimes the world changes and it can be really hard to disambiguate in real time between who is a huckster, trying to, you know, sell their token or whatever, versus someone who's identifying a real change that's happening.

Benn: (22:35)
It's really, really hard in real time -- to your point. And I think that the reason it's really, really hard is because again, we talked about momentum is a real phenomenon and structural change in the world. And technological change is a real thing, right? And so you have to keep an open mind and you can't take the curmudgeon approach, right? Where anything that's new or anything that people are excited about or that's going up in price sort of must be wrong. And you see a lot of that kind of thinking, kind of behavior. That's the wrong mental frame, right? I think it's easier to think about identifying and screening out the stuff that has a lot of red flags and is fairly clearly actually a bunch of hucksters, as opposed to on the margin, solving the Warren Buffett question, right?

You know, was there a path for Warren Buffett to figure out that Google and Amazon were real things back in 2010, 2012? There there might not have been. I think that identifying red flags of very likely problems, right? I mean, I think you get into things like, okay, do we have projections of returns that are way, way above historical equity returns or based on, you know, nonsensical statements like the Cathie Wood one that we talked about, right? GDP growth of 50% because of artificial general intelligence. You can fairly quickly say, ‘okay, I don't know exactly what's going on in the world, but like, that's not real.’ I think another one, and this I think is very important and hits institutions more, but claims of returns significantly exceeding, you know, the risk free rate but with little or no risk.

And that's the one I think that ends up leading to much bigger problems in financial markets and much bigger problems in the global economy, right? Because people with nice suits and ties and very big offices look at an 8% or 9% or 10%, relatively low risk return. And they think about how they can put leverage on that. And they think about how they could have a five year run making really good money and get paid a lot. And that's incredibly appealing. And that's actually the nature of a lot of the biggest losses that you saw in crypto and so forth. It wasn't necessarily folks buying, you know, Dogecoin and losing a catastrophic amount of money. It was people saying, wow, this anchor protocol, this thing yields 20% and there's like a Harvard professor that wrote the white paper and, you know, there's all these credible VCs talking about it. And if I can get 20% on that, and then if I can borrow $10 billion to do that, like I can get really rich, really fast.

Tracy: (25:04)
Yeah. That didn't work out so well. Just on the topic of leverage, can you talk a little bit about what you've seen in derivatives specifically? So your specialty. So I know we had a retail jump into the options market and that helped to fuel a lot of the meme stock investing frenzy. But I'm curious what you've seen on the institutional side as well?

Benn: (25:28)
Yeah, there have been some spectacular blowups in the derivatives space that were primarily institutional products over the last five years. And again, I think all the same root causes where again, just nothing bad [has] gone wrong really since 2009 and more risk tolerance [built] up. So, you know, you can think about, for example Allianz Structured Alpha is a really good example where, you know, this is a brand name platform, investor base was big public pensions and many tens of billions of dollars. And you have a case, and you can go read about it on the SEC website and the DOJ where, you know, the portfolio managers were taking more and more risk selling leveraged tail risk, using options in a relatively complicated strategy and just outright lying about the risk they were taking and  the positions that they had to investors, in order to put up a return stream that looked pretty good and drew in more and more capital. And then eventually blew up in March of 2020 and, you know, resulted in a whole bunch of lawsuits and, you know, presumably probably prison and so forth. Right?

So it's the kind of thing that lots of big investment consultants had looked at that strategy and said, ‘Hey, this looks good.’ Lots of big institutional investors fell for it for years and years and years. Just without asking those questions about, ‘well, how can this return stream exist? Is this a plausible return stream given what trades are supposedly in the portfolio?’ And the answer’s absolutely not, but those questions are critical to be asked, right? I think similarly you saw structured tail risk selling out of, you know, firms like Malachite and some of the Canadian pensions like AIMco that manifested itself as good steady returns, but then in March of 2020, you know, involved spectacular blowups and explosions sort of taking on toxic tail risk that the banks didn't want.

And again, consultants backing these kind of approaches and saying, ‘yes, this is the smart relative value strategy.’ So I think it all comes back to what is this return stream coming from? What is the manager telling you about what the return stream is coming from? If the answer is ‘it's really complicated, we're really smart. We can't tell you.’ It's not that that can't possibly be true, but it should raise a lot of scrutiny in terms of how much you feel you need to understand about the positions. You know, people ask and I always say things like, look, you should be able to get a snapshot of historical positions, not necessarily current positions. And you should be able to understand exactly what the positions are, what the products are, what the risks are, and be able to understand return attribution. And if you can't do that, then you just shouldn't get involved. You should let the, you know, let the momentum effect kind of walk away.

Joe: (28:19)
I want to ask another question about sort of, I guess it's the challenge of fighting the trend or the challenge of being skeptical? You know, another one thing that we've seen in the sort of like inflationary, maybe like peak post mania market, is that certain investing strategies that really did terribly in the 2010s are doing well. And I'm thinking about like some of the strategies that are employed by say, AQR of like long, cheap stocks, short, expensive stocks, those did very poorly throughout much of the 2010s. But not only did they do poorly and they've now turned around at the very late stages, they did absolutely awful. And so they did really terrible in 2020. It seems to me like part of the problem for any institutional investor is not just that it's costly to hold out for things to revert to the mean, or for a trading strategy to work out, it's that it gets especially costly in the late stages of the thing. So like your costs really go up right before the time when it's about to work.

Benn: (29:24)
Betting against manias is really, really, really hard. You hear, I think, about the success stories, like we all loved watching The Big Short, and that was really fun. And, you know, there is a piece of it where it's arguably easier at least to some extent, to bet against a mania or a bubble that has certain time dependent catalyst features like, okay, these mortgages are actually all defaulting right now. And there's like a timeline for that to feed through into the payoffs on these instruments. And like, we don't know the exact timing, but, you know, it's 2007 and it's go time. But even that, like a lot of people were early. And a lot of people you didn't hear about in The Big Short put those trades on in 2005 and got blown out, right?

Joe: (30:12)
You can't just wait seems to be the problem.

Benn (30:15):
You can't just wait and that's actually the easier version, right? When there's a mania in things that are equity-like that have unlimited upside, right? It's not just that you're paying some premium to have an option or to be in a credit default swap or something. But you're trying to like short GME right? That or anything else that's, you know, short a crypto token. The risk is wildly asymmetric against the short position. Because that instrument could go up by five times or 10 times or 20 times, and your risk grows exponentially in a short position as that happens, but you can only ever make, if it goes to zero, you make like one time. Right? and so to your point, it's an extremely difficult game that not a lot of people try to play.

I mean, we would just never touch anything like that, regardless of how crazy we think that the world is. And, you know, there's things you can, okay. Maybe I can do limited loss trades and options or something, but like options on really crazy bubbly things are very expensive for a very good reason. So it's, I think that's one of the inherent tricks, right? And there's an academic concept called the limits to arbitrage. That's really important here. I mean, and arbitrage is a word that gets thrown around way too much. It's kind of almost totally irrelevant to this, right? Even if something is inherently worthless, there's no arbitrage.

Tracy: (31:48)
One thing we haven't spoken about really yet is whether or not there was something in the broader environment or the macro situation that made the past couple of years, again, I guess more vulnerable to these types of manias and frauds, in some cases. And a lot of people will point to, in the case of retail investors, people being stuck at home, getting stimulus checks, social media, you know, no commissions trading at Robinhood and places like that. And then of course you have the very broad backdrop of just low interest rates and the cost of capital being very low, the cost of money basically being very, very low and having plenty of liquidity sloshing around the system. Is there something that when you look back on the past couple of years, that is one of the reasons that we saw so much froth?

Benn: (32:42)
I think there are a lot of different contributing factors. And I think this is usually how things go. So I would say commentators tend to focus very, very heavily on low interest rates and quantitative easing and so forth. I mean, I think there's a role for cheap money on the margin, especially in areas like real estate. But I think that really the direct role of low interest rates or QE here is very overstated. I mean, you look at the history of interest rates and quantitative easing geographically around the world for the last 20 years. And, you know, there's very little, you know, Japan's been doing QE for a very long time. I mean, we had low interest rates in the US for a long time. Previous manias weren't necessarily associated with low interest rates. And one way to think about it is like with tech stocks going up a hundred percent a year and crypto tokens paying 20% yield. Like if you have to pay 3% or 4% to get leverage versus 1%, I mean, it just doesn't matter if you are in the frame of mind, but like you want to do those kind of investments. I mean, the idea, and I joke about this on Twitter a lot, but yeah, the idea that like the Bitcoin folks would've just bought a bunch of Treasuries if Treasuries paid 6% or 7% is, on its face, ridiculous. And they would all tell you that.

Tracy: (33:57)
Well, wait a second. I have seen at least one person on Twitter claim that one of the reasons Bitcoin is down now is because everyone's buying those inflation-protected treasury bonds

Benn: (34:08)
I-bonds yeah, exactly. It's pretty funny, right? I mean, I think it's much more about the collective perception of relative risk and return and the growth of narratives justifying that perception, and then the broad socialization of more and more people into that perception. I do think where rates and QE comes in is perceptions of the role of cheap money coordinating investor expectations or kind of the ‘money printer go brrrr,’ you know, ‘buy everything’ meme. I think that's actually important. That's probably much more important than the direct impact of rates being a little bit lower and being able to get leverage, right? Is the contribution to the narrative that like all of this stuff just has to go up.

And I do think, I come back, you know, ultimately, and you pointed out other phenomena, I do think what has been important when you look specifically at retail options trading and a lot of the aggressive market participation that has showed up over the last few years, I do think the pandemic played a real role. I think that there's a self-reinforcing dynamic to the social internet aspect to it, right? It's not just people sitting at home in their brokerage account doing stuff by themselves. They're increasingly in Discords or on Twitter or in some kind of social group or Reddit’s WallStreetBets. That's like a community that's fun where people talk about investing and they teach each other stuff and they, you know, they overcome the activation barrier of like, ‘how do you open a brokerage account? And how do you put money in it? And how do you actually click a button to trade?’ and all this stuff. And like once that's there and once it's a fun entertaining social thing, and it has a group gambling component to it, it becomes much easier to kind of get out of control and much longer lasting, right? Then, you know, it has all the power of the engagement, you know, clickbait of the internet associated with it. And I think that was really important.

Joe: (35:58)
I want to ask you a follow up on that, but before I forget one point, you know, you mentioned this sort of like myth that it's all about cheap money and a point that Mark Dow, who's a trader very active on Twitter, often points out is in the housing bubble in the mid 2000s, you know, some of the most egregious like ninja loans and subprime activity happened like 2005, 2006, well into the hiking cycle. So even in real estate, which we all sort of can accept as probably the one area that's most linearly connected to interest rates, you still saw manic activity well after the Fed started hiking, you know, they got as high as like 5% in 2006 and there was still all kinds of wild stuff going on then...

Benn: (36:45)
And the same, by the way, was true of the ‘80s Japanese real estate bubble and Scandi real estate bubble.

Joe: (36:50)
Yeah, so it’s not just like this interest rate dial that sets the level of speculative froth. But on the question of call options, and I think the last time we talked, I think it was early 2021. And it was really about this question of retail call buying activity and how it's changing markets. I don't want to say distorting, but maybe distorting or changing markets. Just curious, what do you see right now? Are they still out there? How big of a presence are they relative to where they were last year versus where they were in maybe 2018 or 2019 and sort of more normal markets? And are there other people who haven't given up yet or haven't capitulated, and are still trying to do like the 2021 playbook? What do you see now?

Benn: (37:30)
Yeah, so I threw a chart up on that on Twitter probably a couple of weeks ago. And it's, you know, it looks a lot like the price charts of Peloton and everything like that. So there was this huge surge in retail option trading activity and not just retail, by the way, also institutional option trading activity and volumes. Retail kind of moved first and institutional caught up, and institutional actually peaked a little bit later than retail peaked in late 2021, actually. So a little bit after you would think of as like the peak of the Robinhood P&L, that was more like November, I think. And at that time option trading volumes were 10 to 20 times higher than baseline pre-2020 range, which is just unbelievable.

And then what happened since was a pretty steady collapse, you know, with some rally back attempts, but now we're back to maybe only 2X over baseline, so it's still elevated. And I think it will remain somewhat elevated. I think back to kind of the social gambling dynamic. I think that that has a long tail to it. People used to ask me a lot in 2021. Okay. How is this gonna end? What's actually going to make individual investors, you know, and some of the fast money hedge fund types that are starting to trade like this, what's going to make them give up? And my view was always, look, it's not gonna be obviously a March 2020-like event where there's a fast, big market crash and then things recover because a lot of this option  option trading, it's option buying, right?

It's kind of long convexity. You pay a small amount of premium to get a whole bunch of upside if there's a giant move. And that's perfect for crashes, right? Because you're like, ‘oh, I lost, you know, I lost my a thousand bucks or whatever, and then I'll do it again tomorrow.’ It's really the long slow grindy market kind of sideways or down that eventually drives people out. Because they're spending money, they're spending premium, they're spending premium, they're spending premium and it's, you know, it's just burning for six months for a year. And I think that's what we've seen.

Tracy: (39:32)
So speaking of driving people out, is there, is there any craziness left or has all these sort of air been kicked out of the market's tires? What do you see?

Benn: (39:42)
Ha, excellent question. I mean, I think there's plenty of craziness left. So I think both in crypto and in tech, there are many funky crypto tokens that are down 90%...

Joe: (39:53)
But they can only drop 10% from there.

Benn: (39:55)
Yeah, exactly. Can only drop 10% more as we constantly joke, but whose market cap is still billions and billions of dollars. And you know, they're just jokes, right? So I think, you know, it's hard to argue that that stuff doesn't eventually go to zero. And then within what you would think of as like the ARK basket and, you know, the Goldman Sachs index of speculative software stocks, again, there were a lot of companies that experienced valuations in private markets and sometimes eventually in public markets of $30, $40, $50 billion, that just, it's very hard to see them ever being worth anything. And a lot of those names are down a lot. They're down 90%, but they're still worth $5 billion or $3 billion. The things that have gone down the most are not always the cheapest. Right?

Sometimes they are, but in this case, I think that's not obvious at all. I think there's a great Kindleberger quote that the period of financial distress is a gradual decline after the peak of a speculative bubble that precedes the final and mass panic and crashing, driven by the insiders having exited, but the suckers/outsiders hanging on and hoping for a revival and then finally giving up. And it feels like that's where we are. Sort of the insiders have been kind of quietly and steadily getting out. There's apparently still quite a lot of demand, for example to sell shares in the secondary market of startups that are down 90%, right? You've got founders that on paper briefly were worth $20 billion, and now they're worth $2 billion. And they're like, you know what? That's still pretty good. I want to see if I can turn that into cold, hard cash.

Joe: (41:29)
You know, speaking of crypto, what do you think about it overall? Because I mean, it's really tough. You have so many institutions [that have gotten into it], you have probably some of the smartest people, you know, or that we know, [that] have gone into crypto. There are certainly interesting elements of decentralization, etc., that I think are intuitively very appealing. And on the other hand, it's a space that's been absolutely riven with every red flag in the book, basically since day one.

Tracy: (41:56)
This is something that never ceases to amaze me about crypto, which is that one person can look at it and go, ‘this is world changing technological disruption.’ And another person can look at it and go, ‘this is clearly a fraud and a Ponzi. And, you know, people are just throwing money into this useless thing.’

Benn: (42:17)
Absolutely. So I have a lot of very smart friends in crypto and, you know, I try to keep a pretty open mind. I mean, I think that my default is there's a lot of investment in infrastructure that, you know, might have payoffs that are hard for me to predict and know, you know, which areas are gonna really be important in 10 or 20 years. And, you know, there's a lot of work in there. There  are use cases in improving settlement and payments and God knows what, and like we'll find out in 10 or 20 years. My median case would be like, there's some actually really valuable stuff that comes out of that. And again, to your point, lots of really smart people working there. I think that part of the issue is really so much money got made early and attracted so many followers on who were trying to get rich.

And then that really came to totally dominate the space and everything visible about it. And a lot of the, you know, ‘OG’ original crypto folks have been vocal about that too. I think ultimately, you know, everything has to ultimately derive value from real products and services that people spend money on in a sustainable way. But crypto, I think at the core of it, crypto really owned and brought to the forefront, this idea that financialization is first, right? And the use cases sort of follow and that you're supposed to have, it's this very like pure Chicago Department of Economics, efficient markets idea, right? That like, if everything is priced a priori, the market is sort of all knowing and all seeing and people will identify the things that are gonna work and they're gonna finance those. And like the world is gonna be utopia. And it's completely ridiculous.

It, you know, what actually happens in practice is that if you can create a narrative and create a hype cycle around your company and you get the right VC backing and whatever it is, and then you can create money by issuing a token and you can sell it to retail n humongous size and you can make hundreds of millions or billions of dollars for doing absolutely nothing. And that happened over and over and over and over again. And it was sort of institutionalized as a business model by certain venture capital firms that, you know, are big backers of this space. And I think that's the core issue.

Joe: (44:28)
Well, I forget who made this point, but yes, you might say that crypto has attracted the best and the brightest of the last several years, but if they're the best and the brightest, they might be the best and the brightest at figuring out how to make life changing amounts of money in six months, which is not necessarily the foundation of a sound new industry.

Benn: (44:50)
Yeah. You give people really strong financial incentives and it's really hard to resist, right? It’s easy to obviously point fingers at the most egregious people in the space and Do Kwon, and all these guys, but like if you create a world in which it's really easy for charismatic hustle-type people to get really rich by scamming people, they're gonna do that. And you have to expect that, like, that's just how the world is gonna be. And I think that's what the incentives that we've set up in crypto have really done.

Tracy: (45:19)
So what's your big advice to investors or anyone listening to this podcast? How should they avoid the next mania? What should they watch out for?

Benn: (45:30)
I mean, I think that the things that I always come back to are again, to really look out for people trying to credibly claim these astronomical return profiles or pretty high returns with very little risk, because you just have to think of it as the world is full of a lot of very smart, very competitive sharks who run very big businesses that really like getting rich. And if there was an opportunity to make 10% or 20% risk-free in front of you, they would've already taken that away from you and done it first. And what it means if you see something like that is that it's not real, you know, and there's either some kind of fraud or there's some kind of extraordinary risk that you're not seeing. You have to be really wary of extrapolation. And that kind of comes back both to the commodity story you were talking about and to, you know, Bitcoin and all kinds of things, right? Sort of extrapolating recent extreme investment performance into the future.

You have to really be very skeptical of overly complex investments with non-transparent sources of return, right? Where people are trying to tell you, this is really good, because it's really smart and it's really complicated. And I know you don't totally understand it. And you have to also be ready to recognize the psychological tricks that the investment world plays on you. Again, a lot of these things, it seems like it should be so obvious, but it's not, right? There's a lot of laundering of credibility, right? Legitimization of investment schemes by the backing of authoritative people or people you feel like you should trust. Because especially at peak cycle, people are very willing to lend their credibility to, you know, things that are gonna get them paid. You know, think of, again, the Harvard business school, professors writing the white papers for Ponzi schemes, like Anchor. Using social consensus and group psychology to normalize ideas and narratives and to pressure people to stop asking questions, you know, big Twitter mobs telling you you're an idiot and you're not gonna make it, right? And then very much so kind of scarcity or immediacy, like, ‘look, you're gonna miss the boat. You don't get it. And it's like time to get on board or miss the boat.’ That's I think really critical.

Joe: (47:45)
Let me ask you one last question [about] the positive spin and we've had guests say this and other people will say this, that out of this will come a very sophisticated class of investors, people who learned about options training. People love your content. I saw, you know, the WallStreetBets crowd, you know, loves when you jump on there and actually walk through the math and walk through some of the risk-taking frameworks of this stuff. Are you optimistic that there will be like a cohort of you know, people who maybe got scarred or burned, but also learned some sophisticated stuff that will have a good combination of skills and knowledge coming out of this period?

Benn: (48:24)
So I really hope so. I mean, I'll tell you 10 or 15 years ago, I remember working with a good friend who's now a VC on ideas for investor education. And how do you get people to even care about financial markets and investing and pay attention? Because back then it was totally impossible to get the young generation to even think about this stuff. And it's really good that individual investors have gotten interested in investing. And I feel like, you know, sometimes I hope I don't give the opposite tone, right? Because it's so easy for people to get tricked and all this kind of stuff. It's fantastic. But I think a lot of times people have to learn from their own experience. It's just really hard. I mean, you know, Hegel said we learn from history that we just can't learn from history. People have to one way or another go through their own experiences of mistakes and things not going well to really internalize lessons. And what I really hope is that people are able to take hold of those lessons and, you know, stay interested in financial markets and stay interested in investing and learn how to make good decisions as opposed to feeling so scarred by it that they just walk away.

Tracy: (49:32)
All right, Benn, it was lovely having you back on the show to talk about the lessons of history, recent history that I guess we won't necessarily actually learn, but it was fun to chat -- let's put it that way.

Joe: (49:45)
Yeah. That was fun. It was great. Thank you so much.

Speaker 4: (49:48)

Tracy: (50:03)
So Joe, I really enjoyed that conversation. It's always great having Benn on because I feel like he gives good perspective on retail and also on institutional. But one thing that struck me was just the last bit of the conversation about, you know, things that are making money naturally attracting people who want to make fast money and I guess it seems obvious in retrospect, but I do think it's a good reminder.

Joe: (50:33)
No, it really is. And I think, look, if you're really smart in any field, but if you're really smart, you might, you know, people in this space are smart enough to spot the inefficiencies, smart enough to spot the suckers, smart enough to figure out like what can make life-changing amounts of money in a short period of time. And a lot of really smart people did, but it's really hard. And I think, you know, going back to the middle of the conversation in real time, I think it's just extremely hard to know where you are in this cycle and what's the difference between a bubble and a new regime or a new thing.

Tracy: (51:11)
Oh, totally. And also even if you correctly pinpoint where we are in the cycle, you could still make mistakes. So I'm thinking of, you know, all the people who thought that inflation was going to rise over the past couple years and they bought Bitcoin and gold. That hasn't worked out so well.

Joe: (51:27)
No, it's really hard. And you know, again, a lot of the most costly errors come in the final stages, whether that's jumping in too big, whether it's trying to short the thing. I mean, that's the crazy part. Think about crypto over the last year. There's two huge ways to lose money. You could have gone really big in at the peak or you could have gone short like a few months earlier and gone out of business within a few months. So the ability on either side of the trade, just tremendous opportunities to lose a fortune.

Tracy: (51:59)
Yeah. Or you could have gotten out, you know, in like 2017 or something like that.

Joe: (52:04)
You know what you know what my red flag is for a scammer? I've told you this right?

Tracy: (52:10)
Someone with a newsletter?

Joe: (52:12)
Yeah. Well, either a newsletter or a fund manager who quotes Greek philosophers up at the front. That's like the big red flag. It's like, you see a letter at the beginning and it’s some like quote from Marcus Aurelius. Is he Roman? I don't know. Or like Cicero or something like that or whatever it is. It's like, stay away. That's my trick. It's worked for me.

Tracy: (52:33)
Don't we have a newsletter?

Joe: (52:35)
Yeah. But we don't quote the ancients to bolster our claim. Let’s leave it there.

You can follow Benn Eifert on Twitter at @bennpeifert.