Episode Summary
Executive Summary: Patrick O’Shaughnessy interviews anonymous investor Jesse Livermore on how to think about markets, valuation, trend, and evidence. The conversation centers on Jesse’s framework for combining intuition, analysis, and statistical inference, then applies it to inflation, accounting distortions, trend following, supply effects, value, and momentum.
Main Topics: Three modes of inference (Priority: 5/5): Jesse separates intuition, analysis, and statistical inference, stressing each tool’s strengths, limits, and failure modes. Inflation and valuation distortion (Priority: 5/5): He argues inflation understates depreciation, overstates earnings, and biases long-run valuation measures like CAPE. Integrated equity and free cash flow (Priority: 5/5): He develops retained-earnings-based valuation to better approximate true book value and test profitability. Trend following under changing regimes (Priority: 4/5): He supports trend structurally but worries smoother future cycles and Fed intervention may reduce its edge. Supply as a market driver (Priority: 4/5): He argues asset supply and scarcity materially affect returns, using preferred stocks as a vivid example. Why factors work (Priority: 4/5): Value and momentum are explained through earnings path dynamics: mean reversion for value, extrapolation for momentum. Truth-seeking and workplace design (Priority: 3/5): He closes with a philosophy of dissent, status, and a pass-through method for surfacing honest objections.
Key Arguments: Intuition is cheap and fast, but only reliable in stable, high-validity environments. Analysis handles regime change and is transparent, but it is easy to miss one decisive flaw. Statistical inference is closest to reality, but multiple comparisons and vague sample sizes can fake signal. Inflation understates depreciation under historical-cost accounting, inflating reported earnings. Free cash flow is a better valuation check because it uses actual capital outlays instead of guessed depreciation. Integrated equity, built from retained earnings, produces a stronger valuation and ROE lens than raw book value. Trend works mainly by avoiding large drawdowns, so fewer future crashes could weaken it. Supply matters because the market must clear all outstanding assets; scarcity can support valuations. Value works when the market over-discounts bad news and future earnings recover over time. Momentum works when the market extrapolates strong fundamentals and later overdoes the pricing.
Data Points: Time in the military: 5 years - Jesse’s service before grad school and investing in earnest College investing period: late 1990s - His first exposure was during the tech bubble Graduate school macro period: 2007 to 2009 - He was trading heavily during the financial crisis CAPE valuation era discussed: 2011, 2012 - He says accounting changes affected CAPE then Return on integrated equity: about 4% - Average ROE after adjusting book value with retained earnings and inflation Example utility preferred yield: 3.85% - Union Electric preferred stock issued in 1946 Example debt yield: 3.55% - Union Electric 40-year first lien mortgage bond Alcoa preferred yield: 4.25% - Preferred stock issued on January 20, 1947 Alcoa senior debt yield: 5.76% - Same-company debt used to show preferred scarcity effects Union Electric preferred par value: $100 - Callable at 10% above par Union Electric preferred market size: $7.5 million - Illustrates how scarcity can affect pricing
Pivotal Quotes: "the search for truth" — Patrick O'Shaughnessy: His framing of Jesse’s overarching intellectual project "I think that inflation is going to be low forever. I'll come out and say it." — Jesse Livermore: His strong long-run macro view "Everybody in this room that's watching, you have a job." — Jesse Livermore: His proposed process for collecting dissent privately
Implications: Listeners should treat long-run market signals as regime-dependent and keep testing assumptions against out-of-sample evidence.
From the Transcript
Disagreement in a very, very respectful and non-threatening way, all that work can be thrown out. He can do it, one person, he can do it from a position where he doesn't have as much risk. I absolutely love that. And I realized two things as you're describing that idea. Sometimes I love when there's episodes of the podcast where I realize what the title is going to be during the conversation. So I just realized that the title of this one is going to be The Search for Truth. Because if you think about physics, philosophy, everything you talked about at the beginning, and just then, the unifying thing. Theme and kind of what you seem to be doing is just searching for truth in all sorts of different ways. And the second is a new concept that maybe we can, you know, another time flesh out more, which was brought to my attention by a new friend named Jake Weinreb. And Jake told me about this idea in companies, I guess, is the context that he introduced me to it: of the line, that if you're an above-the-line organization, you're committed to that search for truth and learning. And if you're below, you're more focused on ego and being right.
Of panics because you don't have the same highs and lows. I don't want to say it reduces volatility, but in that direction type of thing. I think another thing on that same point is just, I think that inflation is going to be low forever. I'll come out and say it. I think that inflation is going to be low forever. I think that interest rates are going to be low forever. I won't even stop and say, like, oh, we're going to do 50 years of a reset. No, forever. That's my view. And I think if that's the case, it gives the Fed a lot more room to be supportive. The one thing that would stop the Fed from being able to support markets, to be able to keep conditions right for people to be bullied. Would be if you had a legitimate inflation problem, then their hands would be tied. But I don't think that's ever going to happen. Can you say as much more about that as you can? Inflation specifically, this is something you and I haven't discussed in a lot of detail. So, what's the basis of that belief? Well, I don't understand inflation. I don't think anyone does. I think it would be foolish to pretend like you do. I think part of my conclusion there is just having believed that inflation was going to come back for 10 years. I'm at the point now where I'm ready to give up. But also, I think that there's something demographically, there's something in terms of the structure of a mature economy, in terms of the way that we become anchored to prices.
In front of the boss, I think the best way to do it would be for the boss to say, okay, John is going to give a presentation. He's going to present on his thesis. Now, everybody in this room that's watching, you have a job. Your job is to listen carefully to his thesis, take it in, think about it. I want you to then come up with reasons why, or I want you to identify the biggest weaknesses in his thesis for yourself. Here's what I want you to do with those, with those things that you identify. I don't want you to voice them in here because that's. It's going to create a big brawl. I don't want to do that. I want you to take your insights, your thoughts, your findings, what you think is the weakest aspects of his case, and maybe the strengths too, if you keep it both ways. And then I want you to send them to me, the boss. So, what does that do? First of all, it eliminates the fight, it eliminates all the politics that might happen if there's disagreement and challenges. What it also does is it preserves the incentive of the employees to actually voice the opinion of dissent because the
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