Investing in a Flows Driven World | Cem Karsan

[00:00:00] [SPEAKER_06]: It's not the greater use of options that will reiterate or make a decline worse.

[00:00:05] [SPEAKER_06]: It is how those options are currently in this environment being used.

[00:00:09] [SPEAKER_06]: We have $5 trillion coming in, give or take and the average amount that moves markets

[00:00:14] [SPEAKER_06]: is $150 billion.

[00:00:16] [SPEAKER_06]: You probably want to be long before that happens, right?

[00:00:20] [SPEAKER_06]: We're in a 75-80% winning type scenario with this market, but there is a very fat

[00:00:26] [SPEAKER_06]: laughed tale.

[00:00:28] [SPEAKER_06]: As you mentioned, if something were to happen, if this market were to decline 20%,

[00:00:33] [SPEAKER_06]: watch out.

[00:00:34] [SPEAKER_06]: Right as everybody is proclaiming active investment dead, my view is that active

[00:00:39] [SPEAKER_06]: investment is actually right on the verge of a new bull market.

[00:00:45] [SPEAKER_03]: Welcome to Excess Returns where we focus on what works over the long term in the markets.

[00:00:50] [SPEAKER_03]: Join us as we talk about the strategies and tactics that can help you become a better

[00:00:53] [SPEAKER_03]: long-term investor.

[00:00:54] [SPEAKER_01]: Jack Forehand is a principal at Validia Capital Management.

[00:00:57] [SPEAKER_01]: The opinions expressed in this podcast do not necessarily reflect the opinions of Validia

[00:01:00] [SPEAKER_01]: Capital.

[00:01:01] [SPEAKER_01]: No information on this podcast should be construed as investment advice.

[00:01:04] [SPEAKER_01]: Securities discussed in the podcast may be holdings of clients of Validia Capital.

[00:01:08] [SPEAKER_04]: In this episode of Excess Returns, we're joined by Jim Carzon of Kai Volatile

[00:01:11] [SPEAKER_04]: Advisors for an in-depth look at the state of global markets and how

[00:01:14] [SPEAKER_04]: geopolitical events in the Middle East and Ukraine are impacting risk

[00:01:17] [SPEAKER_04]: investors in the broader economy.

[00:01:18] [SPEAKER_04]: We also cover a lot of other things like inflation, the Fed's latest move,

[00:01:21] [SPEAKER_04]: market flows, options, expirations, his outlook for value stocks and the

[00:01:25] [SPEAKER_04]: investability of AI, and where he sees markets going for the remainder of the year and beyond.

[00:01:30] [SPEAKER_04]: Jim will share his insights on how the current market backdrop compares to other

[00:01:32] [SPEAKER_04]: times in history when populism and inflation were elevated and how that

[00:01:36] [SPEAKER_04]: impact of returns and investor behavior.

[00:01:38] [SPEAKER_04]: As always, thank you for listening.

[00:01:39] [SPEAKER_04]: Please enjoy this discussion with Kai Volatile.

[00:01:41] [SPEAKER_04]: Jim, great to see you.

[00:01:43] [SPEAKER_04]: Thank you very much for coming back on Excess Returns.

[00:01:45] [SPEAKER_06]: We appreciate it.

[00:01:46] [SPEAKER_06]: Always a pleasure to be here.

[00:01:47] [SPEAKER_06]: Always really enjoy these conversations.

[00:01:50] [SPEAKER_06]: Before we get into all the things we want to talk to you about, we did just want to

[00:01:53] [SPEAKER_03]: mention yesterday we crossed the—and it's still small.

[00:01:56] [SPEAKER_03]: It's really not a big deal, but we crossed the 20,000 subscriber mark on YouTube.

[00:02:01] [SPEAKER_04]: So congratulations.

[00:02:03] [SPEAKER_04]: Yeah, thank you very much.

[00:02:04] [SPEAKER_04]: And the reason I just wanted to mention that to you is you,

[00:02:07] [SPEAKER_06]: all of the guests that always come on are super generous with the time and the thoughts

[00:02:11] [SPEAKER_06]: and wisdom that you share with our audience.

[00:02:13] [SPEAKER_06]: And so it's because of the willingness of people like you to come on, talk to us,

[00:02:19] [SPEAKER_06]: and share your opinions, your diverse thoughts on the markets.

[00:02:23] [SPEAKER_06]: And so if you know, thank you for always being great and super generous with your time.

[00:02:29] [SPEAKER_04]: Jack and I sort of appreciate it in our audience as well.

[00:02:31] [SPEAKER_06]: Kai, do you say the truth of matters?

[00:02:34] [SPEAKER_06]: I enjoy this.

[00:02:35] [SPEAKER_06]: Life is short.

[00:02:36] [SPEAKER_06]: And we get an opportunity to educate, make a difference, really kind of propel

[00:02:42] [SPEAKER_06]: kind of some of these ideas out into the world.

[00:02:44] [SPEAKER_06]: And so thanks for giving me a butt for.

[00:02:46] [SPEAKER_06]: It's wonderful to be involved.

[00:02:48] [SPEAKER_05]: It's funny to you.

[00:02:49] [SPEAKER_05]: Like you kind of showed us what was possible.

[00:02:50] [SPEAKER_05]: Like when you first came on, you probably had maybe a thousand subscribers.

[00:02:53] [SPEAKER_05]: And like in our videos, we're getting a few views here and there,

[00:02:56] [SPEAKER_05]: but we released your video and I was like, wow.

[00:02:58] [SPEAKER_05]: So this is what we could do if things work out on YouTube.

[00:03:01] [SPEAKER_05]: This could really happen.

[00:03:02] [SPEAKER_06]: That's great to hear.

[00:03:03] [SPEAKER_06]: I'm glad I can help again.

[00:03:05] [SPEAKER_06]: I can't think of a couple better guys to be involved with.

[00:03:08] [SPEAKER_06]: So that's great.

[00:03:09] [SPEAKER_06]: Thank you.

[00:03:09] [SPEAKER_06]: So yeah, let's get into it.

[00:03:10] [SPEAKER_06]: We have a lot to get through and you know, this hour here.

[00:03:13] [SPEAKER_06]: So I think where we want to start with you is on the Middle East

[00:03:16] [SPEAKER_06]: and what's going on there.

[00:03:18] [SPEAKER_06]: Just from a market perspective, how do you sort of view situations?

[00:03:22] [SPEAKER_06]: Well, that specific one, but do you see it as a major risk to the market?

[00:03:26] [SPEAKER_06]: I mean, how do you think through things like this?

[00:03:28] [SPEAKER_06]: Yeah.

[00:03:29] [SPEAKER_06]: So as usual, I think in things macro geopolitical things as the weighing machine,

[00:03:37] [SPEAKER_06]: right?

[00:03:37] [SPEAKER_06]: It's not something that I think people like to think of them as kind of acute

[00:03:42] [SPEAKER_06]: short-term market events.

[00:03:45] [SPEAKER_06]: And I think they matter to the extent they change the big pictures.

[00:03:50] [SPEAKER_06]: And so yes, it matters, but it may not matter to markets in the short term.

[00:03:54] [SPEAKER_06]: And we've seen that again and again, right?

[00:03:56] [SPEAKER_06]: We've seen geopolitical escalations and things that happen that seem scary and big

[00:04:04] [SPEAKER_06]: in terms of geopolitics, but that it may not affect the earnings price of the S&P 500.

[00:04:10] [SPEAKER_06]: Right.

[00:04:11] [SPEAKER_06]: In the short term, but it could have a step effect at some point down the road.

[00:04:17] [SPEAKER_06]: It could lead to a higher degree of risk for something that really does matter in the future.

[00:04:25] [SPEAKER_06]: And so as it relates specifically to what's happening in the Middle East,

[00:04:29] [SPEAKER_06]: you know, the way we thought about this, and we've been out in front of talking

[00:04:31] [SPEAKER_06]: about this for about four years now, is that we're entering a period of

[00:04:35] [SPEAKER_06]: significant global conflict driven primarily from, you know, by protectionism and the closing

[00:04:42] [SPEAKER_06]: of borders, which at its root is because of populism and inequality.

[00:04:48] [SPEAKER_06]: And we continue to see a walk down that road, a bifurcation across major powers.

[00:04:55] [SPEAKER_06]: I would put at that axis the number one and number two economy in the world

[00:04:59] [SPEAKER_06]: as the biggest drivers of that, you know, the U.S. and China.

[00:05:03] [SPEAKER_06]: And but it's every country essentially trying to look out for their own interests

[00:05:10] [SPEAKER_06]: in the context of seeing a world where not everybody is cooperating.

[00:05:14] [SPEAKER_06]: And now we are at a point of competition.

[00:05:17] [SPEAKER_06]: And, you know, if you think about that in the broader sense, that started I think in

[00:05:23] [SPEAKER_06]: 22 with the biggest geopolitical event, which was Russia moving on Ukraine.

[00:05:28] [SPEAKER_06]: And and at that point, Russia and China announced a joint communique that was

[00:05:35] [SPEAKER_06]: oddly not talked about nearly as much as it should have been,

[00:05:37] [SPEAKER_06]: which was essentially a joint partnership to counter the West.

[00:05:40] [SPEAKER_06]: And that wasn't essentially I said essentially it wasn't implicit.

[00:05:44] [SPEAKER_06]: It was pretty explicit.

[00:05:46] [SPEAKER_06]: And Iran has kind of joined that broad axis.

[00:05:50] [SPEAKER_06]: You can call it something like World War Three and Be Bombastic.

[00:05:54] [SPEAKER_06]: I don't think you have to.

[00:05:54] [SPEAKER_06]: I think the key here is you have certain entities that are better trying to counter the power

[00:06:00] [SPEAKER_06]: of the U.S. and the West more broadly and are willing to push back both in economic warfare

[00:06:07] [SPEAKER_06]: and in global conflict.

[00:06:10] [SPEAKER_06]: And the Middle East when Hamas, you know, attacked, you know, which is by the way

[00:06:16] [SPEAKER_06]: Iranian vessel attacked, you know, Israel, you know, that was the beginning of the second front

[00:06:25] [SPEAKER_06]: on this war in my opinion.

[00:06:28] [SPEAKER_06]: The timing of that was not a coincidence.

[00:06:31] [SPEAKER_06]: If you look back when they did that, it was literally the day before the pact

[00:06:35] [SPEAKER_06]: was being signed was between Saudi Arabia and Israel for broader cooperation.

[00:06:41] [SPEAKER_06]: If you are China, Russia, Iran, the last thing you want is Saudi, right?

[00:06:49] [SPEAKER_06]: It was one of the biggest, obviously, controller of oil prices being kind of you want to separate them,

[00:06:57] [SPEAKER_06]: right, from from from the West.

[00:07:00] [SPEAKER_06]: I'll argue maybe a little bias on this one, but Turkey as well.

[00:07:04] [SPEAKER_06]: Turkey is the easternmost member of NATO as it relates to Russia.

[00:07:09] [SPEAKER_06]: Important military power, economic power in the region.

[00:07:13] [SPEAKER_06]: That was also a way of peeling away Turkey from the West in a lot of ways.

[00:07:17] [SPEAKER_06]: So both Turkey and Saudi have been much more kind of back and forth between those two sides

[00:07:22] [SPEAKER_06]: since that happened, which was a great, it's also a way to thin out military for other conflict

[00:07:30] [SPEAKER_06]: broadly.

[00:07:31] [SPEAKER_06]: So if you're thinking about the U.S. is sending all this money to Ukraine,

[00:07:35] [SPEAKER_06]: now they're sending money to Israel and military equipment.

[00:07:39] [SPEAKER_06]: You have aircraft carriers in the Middle East, Mediterranean that are now occupied.

[00:07:45] [SPEAKER_06]: These are all things that make the bigger picture and probably what China is trying

[00:07:51] [SPEAKER_06]: to accomplish more possible.

[00:07:53] [SPEAKER_06]: So I would put these all as, look at what's happening in the bigger picture.

[00:07:56] [SPEAKER_06]: And what does this mean?

[00:07:57] [SPEAKER_06]: And how does it fit into the broader picture?

[00:07:59] [SPEAKER_06]: And our view here is that it's an escalation and continued escalation along a path that we've

[00:08:07] [SPEAKER_06]: broadly seen for four years and will likely continue.

[00:08:10] [SPEAKER_06]: I think determinists is China moving on Taiwan at some point, whether that's in a year or in

[00:08:16] [SPEAKER_06]: four, we believe it has more than a 50% chance of happening in the next four years.

[00:08:21] [SPEAKER_06]: And I think architecture to a great extent whistling by the graveyard on the risks that

[00:08:27] [SPEAKER_06]: we continue to see in terms of escalation across the board.

[00:08:31] [SPEAKER_06]: So that's how I would think about the Middle East.

[00:08:33] [SPEAKER_06]: I would think about it in broad trends and what it says about the continuation of those

[00:08:38] [SPEAKER_06]: trends and the reiteration of our viewpoints.

[00:08:41] [SPEAKER_06]: But I care about it less in terms of its acute importance in terms of day-to-day trading

[00:08:46] [SPEAKER_06]: in the markets and what that means for the next month, per se.

[00:08:49] [SPEAKER_06]: Yeah.

[00:08:49] [SPEAKER_06]: Now, I think that's the tough thing for investors is you go through these things

[00:08:53] [SPEAKER_06]: and the market seeks to hold up and stocks are doing well.

[00:08:56] [SPEAKER_06]: And you kind of make it through and you have people coming on and say that this isn't going

[00:09:00] [SPEAKER_06]: to affect the US economy, but then you take China and Taiwan, it's like what is the

[00:09:06] [SPEAKER_06]: event that's going to break or be something that really does it in some way?

[00:09:12] [SPEAKER_03]: So as investors we kind of get maybe a little bit not bias, but we look at those

[00:09:18] [SPEAKER_03]: past experiences and say, oh, we can just push through and then something else comes up

[00:09:21] [SPEAKER_06]: that's bigger than anyone can really imagine and that will have or could have in fact.

[00:09:26] [SPEAKER_06]: Absolutely.

[00:09:27] [SPEAKER_06]: I mean, China moving on Taiwan will have dramatic trading consequences, real economic consequences

[00:09:34] [SPEAKER_06]: which are acute.

[00:09:36] [SPEAKER_06]: I think if it has like a COVID type thing, something that is undeniable and will have

[00:09:39] [SPEAKER_06]: it that instantaneous effects on the economies of different countries, supply chains,

[00:09:47] [SPEAKER_06]: major inputs and commodities.

[00:09:51] [SPEAKER_06]: So yeah, something like that.

[00:09:52] [SPEAKER_06]: I'm not saying geopolitical doesn't matter today or tomorrow, but you have to understand

[00:09:56] [SPEAKER_06]: what events actually have short term effects and what are just part of a much bigger kind

[00:10:02] [SPEAKER_06]: of maybe quilts or mosaic of things that are coming together to make the probabilities

[00:10:09] [SPEAKER_06]: of that bigger acute issue happening.

[00:10:12] [SPEAKER_06]: And I think that's really how we're thinking about this one.

[00:10:15] [SPEAKER_05]: Does the rising use of options exacerbate this?

[00:10:18] [SPEAKER_05]: So if you look at any of the charts about the use of options from 2020 to now,

[00:10:22] [SPEAKER_05]: like way more people are using options now.

[00:10:23] [SPEAKER_05]: If you do get a big event like China invading Taiwan, I mean,

[00:10:26] [SPEAKER_05]: do we get a much bigger decline because of that?

[00:10:30] [SPEAKER_06]: So to be clear, it's not the greater use of options that will reiterate or make a decline

[00:10:36] [SPEAKER_06]: worse.

[00:10:37] [SPEAKER_06]: It is how those options are currently in this environment being used and where

[00:10:41] [SPEAKER_06]: the positioning is at this moment.

[00:10:44] [SPEAKER_06]: And to be clear, if that issue happens in two years and that positioning is

[00:10:48] [SPEAKER_06]: different, then it will have a different effect.

[00:10:52] [SPEAKER_06]: The point here is there is massive reflexivity to options and options positionings.

[00:10:57] [SPEAKER_06]: Right?

[00:10:57] [SPEAKER_06]: So if there is a lot of short tail, short vol positioning,

[00:11:02] [SPEAKER_06]: you know, at a time when an acute event happens, it will exacerbate it.

[00:11:06] [SPEAKER_06]: We've talked a lot about this.

[00:11:07] [SPEAKER_06]: I just mentioned COVID, right?

[00:11:09] [SPEAKER_06]: COVID started, the decline for COVID in markets started on the day after February

[00:11:15] [SPEAKER_06]: OPEX.

[00:11:16] [SPEAKER_06]: That wasn't a coincidence.

[00:11:18] [SPEAKER_06]: It ended the day after March, athletics.

[00:11:20] [SPEAKER_06]: That's not a coincidence.

[00:11:21] [SPEAKER_06]: It was a Z bottom that ended exactly on that day and then came sporing back.

[00:11:26] [SPEAKER_06]: Did COVID matter?

[00:11:27] [SPEAKER_06]: Was COVID an acute issue?

[00:11:28] [SPEAKER_06]: Did it cause supply chains that have dramatic effects?

[00:11:31] [SPEAKER_06]: 100%.

[00:11:32] [SPEAKER_06]: But to be clear, the move that we had in the speed and timing of that move

[00:11:37] [SPEAKER_06]: was 100% exacerbated and magnified as a function of the options and broad convex

[00:11:44] [SPEAKER_06]: positioning in the market.

[00:11:46] [SPEAKER_06]: We know this going back to 1987 before options were traded, you know, the way they have,

[00:11:52] [SPEAKER_06]: you know, they currently are.

[00:11:53] [SPEAKER_06]: It's not just a function of what the event is.

[00:11:56] [SPEAKER_06]: It's a function of the supply and demand of markets and those massive convex positioning

[00:12:00] [SPEAKER_06]: tied to nonlinear products that is poor and in balance.

[00:12:05] [SPEAKER_06]: It will drive reflexively convex outcomes.

[00:12:10] [SPEAKER_06]: And so when that's the case, we see convex outcomes to be clear.

[00:12:15] [SPEAKER_06]: There are avenues and there are times I apologize on where that positioning is the opposite,

[00:12:20] [SPEAKER_06]: where people are very well hedged.

[00:12:22] [SPEAKER_06]: I think 2022.

[00:12:24] [SPEAKER_06]: I think that's a great example, right?

[00:12:26] [SPEAKER_06]: 2022 we had the opposite scenario.

[00:12:28] [SPEAKER_06]: People were incredibly well hedged.

[00:12:30] [SPEAKER_06]: Why?

[00:12:30] [SPEAKER_06]: Because COVID had just happened.

[00:12:32] [SPEAKER_06]: Anybody who was short moll got taken out to the cleaners.

[00:12:34] [SPEAKER_06]: Anybody who was long vol for that made an incredible amount of money.

[00:12:37] [SPEAKER_06]: So survivorship bias, all of the, most of the world was very hedged.

[00:12:41] [SPEAKER_06]: People, there was broad understanding that Russia might be moving on Ukraine.

[00:12:46] [SPEAKER_06]: This was not a complete black swan.

[00:12:48] [SPEAKER_06]: It was more of a gray swan.

[00:12:50] [SPEAKER_06]: And so people were very well hedged for it.

[00:12:52] [SPEAKER_06]: And what 2022 looked like was a incredibly low vol, you know, tick, tick, tick and implied

[00:12:59] [SPEAKER_06]: law got decimated into those.

[00:13:01] [SPEAKER_06]: As opposed to being a one month 30% decline, what do we get?

[00:13:06] [SPEAKER_06]: We get a, you know, at worst 20% decline that happened over the course of nine months.

[00:13:11] [SPEAKER_06]: And so very different outcome, right?

[00:13:14] [SPEAKER_06]: Very low volatility and very different reflexively outcome.

[00:13:17] [SPEAKER_06]: And that's how I would characterize it.

[00:13:19] [SPEAKER_06]: It's not that options and the increase of options trading is increasing volatility.

[00:13:24] [SPEAKER_06]: That's not true.

[00:13:25] [SPEAKER_06]: It can both dampen and increase volatility.

[00:13:29] [SPEAKER_06]: But, but positioning and positioning tends to be a focus of the function of trend, right?

[00:13:33] [SPEAKER_06]: So if you have something that's making money again and again, again, what happens?

[00:13:36] [SPEAKER_06]: People pile into it, right?

[00:13:38] [SPEAKER_06]: And so if you could sell vol and it works and it's also reflexive and drives less volatility,

[00:13:43] [SPEAKER_06]: well people are going to keep selling vol until it breaks.

[00:13:46] [SPEAKER_06]: And now when it breaks, you know, then you're going to have a bad outcome.

[00:13:49] [SPEAKER_06]: And so, you know, that's just on the sales side.

[00:13:51] [SPEAKER_06]: The same happens on the buy side.

[00:13:53] [SPEAKER_06]: And so as that positioning gets big, it exacerbates that position.

[00:13:59] [SPEAKER_05]: And how do you see people being positioned right now?

[00:14:01] [SPEAKER_05]: Like I would think a lot of people have a short vol right now, but maybe I'm wrong.

[00:14:04] [SPEAKER_05]: I don't follow the unseen.

[00:14:05] [SPEAKER_05]: So maybe August 5th or something like that might have,

[00:14:07] [SPEAKER_05]: you might have washed some of that out.

[00:14:08] [SPEAKER_05]: Are people still heavily short of vol right now?

[00:14:10] [SPEAKER_06]: So to be clear, whether how short people are a vol is both a function of

[00:14:17] [SPEAKER_06]: how recently a vol then has happened and may cause losses versus not happened.

[00:14:23] [SPEAKER_06]: A and B, it's a function of potential events, potential kind of counter effects,

[00:14:30] [SPEAKER_06]: structured product issuance, a lot of different factors.

[00:14:33] [SPEAKER_06]: And right now specifically, because we have election vol, which is very high,

[00:14:37] [SPEAKER_06]: we have November and December in January positioning with incredibly high skew

[00:14:43] [SPEAKER_06]: because December is the biggest apex every year followed by January and single stocks.

[00:14:48] [SPEAKER_06]: And because we have this wobble in August, September that really forced skew and some losses

[00:14:55] [SPEAKER_06]: in certain portfolios, we have a lot of poor,

[00:14:59] [SPEAKER_06]: you know, convexity, poor positioning on the on the left tail in equity markets

[00:15:06] [SPEAKER_06]: specifically. We're seeing incredibly high skew, you know, on the election on out.

[00:15:13] [SPEAKER_06]: I would argue higher that we've seen in other elections even,

[00:15:15] [SPEAKER_06]: even though the event vol is about in line or maybe the lower,

[00:15:20] [SPEAKER_06]: the actual skew where the convexity itself is very, very,

[00:15:24] [SPEAKER_06]: I'm down in balance. Dealers are shorted and have raised the price for it

[00:15:28] [SPEAKER_06]: because because there's been so much hedging in that in that world.

[00:15:32] [SPEAKER_06]: So reflexively, that tends to make the outcomes right distributed

[00:15:37] [SPEAKER_06]: because assuming we don't have a crash at the pricing is quite high,

[00:15:41] [SPEAKER_06]: you know, you're likely to have a very positive outcome. But it also does create a, as you mentioned,

[00:15:47] [SPEAKER_06]: if something were to happen, this is a dangerous window.

[00:15:52] [SPEAKER_06]: And I would argue that's not just through January that you'll continue to have some of

[00:15:55] [SPEAKER_06]: these issues into early next year, given where skew and longer term positioning is.

[00:16:02] [SPEAKER_05]: There's something like August 5th changed positioning a lot. Like on one hand,

[00:16:05] [SPEAKER_05]: I would say, wow, there was a major, major spike that could have washed the people out.

[00:16:08] [SPEAKER_05]: But on the other hand, it reversed right away. So did anything really change because of that?

[00:16:12] [SPEAKER_06]: Yes, it did. It did because it's not people think of positioning in two dimensions

[00:16:19] [SPEAKER_06]: that that oh, it was a very big positioning and now it's small, right?

[00:16:23] [SPEAKER_06]: That's kind of not how it works. The options are a three dimensional surface.

[00:16:28] [SPEAKER_06]: And there's not just that they are, you know, nonlinear.

[00:16:32] [SPEAKER_06]: And so you can get situations where, like we did in August, where people were incredibly long,

[00:16:39] [SPEAKER_06]: short dated gamma that they were hedge for the actual realized move that happened.

[00:16:46] [SPEAKER_06]: Certain entities made a lot of money on that move because that move happened earlier.

[00:16:51] [SPEAKER_06]: If it hadn't, by the way, if that had moved, it happened in September as opposed to August.

[00:16:54] [SPEAKER_06]: This is how kind of specific some of these things are and how much like path is important.

[00:16:59] [SPEAKER_06]: If it happened in September, I would argue that that decline would have been much more

[00:17:04] [SPEAKER_06]: significant, much more dramatic and an incredibly painful thing for markets, not a 10% loss,

[00:17:10] [SPEAKER_06]: 25% type loss. We would have had a major, major issue if that decline happened in September.

[00:17:15] [SPEAKER_06]: It happened in August. It happened early and most of the street was very well hedged with

[00:17:18] [SPEAKER_06]: three September options and able to hedge the max risk there.

[00:17:23] [SPEAKER_06]: The problem is but what losses did happen is for people that were hedge,

[00:17:28] [SPEAKER_06]: but didn't have a kind of extra gamma, there were net short options out there

[00:17:31] [SPEAKER_06]: in September, in particular in October, November, December is that skew exploded.

[00:17:38] [SPEAKER_06]: Right? And those options that they were for everybody was particularly short relative to

[00:17:41] [SPEAKER_06]: everything else went to an X tree and you had kind of six Sigma plus moves in Vega versus

[00:17:48] [SPEAKER_06]: gamma. It's something that you don't really see particularly not fast to move.

[00:17:52] [SPEAKER_06]: And that cost them really kind of like specific losses in certain,

[00:17:56] [SPEAKER_06]: certain multi strategy books and certain little trotches. Right?

[00:18:01] [SPEAKER_06]: And the net effect of that was to net raise that skew and keep it now much higher than it was.

[00:18:06] [SPEAKER_06]: And there is still quite a bit of short exposure out there. Now people have been

[00:18:10] [SPEAKER_06]: managing it and moving it around and finding ways to get it back at lower cost.

[00:18:16] [SPEAKER_06]: And so it's not as acute as maybe, you know, it was. But also and to be clear,

[00:18:24] [SPEAKER_06]: certain mentioning got washed out. Right? And when I got washed out,

[00:18:26] [SPEAKER_06]: those people are no longer, you know, have this poor exposure.

[00:18:31] [SPEAKER_06]: But I would argue, yeah, I mean that was a driver of making now the positioning as I

[00:18:35] [SPEAKER_06]: mentioned poor. And that poor position can now down the road cause a bigger issue.

[00:18:42] [SPEAKER_06]: Again, it has to be the right path. We have to have it happen when other people aren't

[00:18:45] [SPEAKER_06]: hedge. You know, timing matters. And generally that happens with bigger

[00:18:50] [SPEAKER_06]: moves in the underlying market. So if you can get a major drive here higher to

[00:18:56] [SPEAKER_06]: 6200 and the SMP, you know, something really high that really gets people off sides that way.

[00:19:00] [SPEAKER_06]: And then you had to drop it right like that causes just a much bigger impact

[00:19:04] [SPEAKER_06]: can make markets a little bit more dangerous from several different perspectives.

[00:19:10] [SPEAKER_06]: And again, that's often why those kind of really crazy outcomes happen before a decline.

[00:19:15] [SPEAKER_06]: And but again, that positioning is now poor and it does represent a tail. It's just a matter of how

[00:19:23] [SPEAKER_06]: the path going to work out. And at what point does that poor positioning in the tail

[00:19:28] [SPEAKER_06]: become a problem if it doesn't all maybe at some point there's enough supply and there's

[00:19:33] [SPEAKER_06]: enough things or markets plastic enough for that through December where Vol comes down,

[00:19:36] [SPEAKER_06]: we buy pass. So the skew and the skew kind of settles in. Then we kind of resolve some of that

[00:19:42] [SPEAKER_06]: risk in there and the positioning becomes more balanced. But yes, I would argue what happened

[00:19:46] [SPEAKER_06]: in August currently is a driver for some of the major tail exposure that exists out here in the market.

[00:19:54] [SPEAKER_05]: I wonder if you can talk about macro a little bit. Last time you came on was April 30th for

[00:19:57] [SPEAKER_05]: our live stream for charity. And since then inflation has come down some, the Fed just

[00:20:01] [SPEAKER_05]: did their first cut and surprised many people by doing 50 basis points. Like when you look at

[00:20:05] [SPEAKER_05]: the overall macro landscape right now or what you see.

[00:20:11] [SPEAKER_06]: So I have a big long term picture, right? I'm thinking 10 years, 15 years. And by the way,

[00:20:17] [SPEAKER_06]: we started talking about this four years ago. So you know, this, this is a big picture thing and

[00:20:22] [SPEAKER_06]: in our estimation, we've were broadly going down that path. We have we have seen no deviation

[00:20:28] [SPEAKER_06]: from from the bigger picture. Of course, people like to focus on the three months,

[00:20:32] [SPEAKER_06]: six month outcome, the nine month outcome, right? Well, you know, the but inflation is down, right?

[00:20:39] [SPEAKER_06]: Like your, your view, your 15 year review is, is not coming true. Well, no, that's,

[00:20:45] [SPEAKER_06]: that's not how it works. You know, if you think about what, what we've been saying in terms of

[00:20:49] [SPEAKER_06]: inflation is, you know, again, to give a the best metaphor for a time period that we can 1968 to 1982

[00:20:56] [SPEAKER_06]: again, we choose that period because it's the last period that interest rates went up.

[00:21:00] [SPEAKER_06]: But during that, that period, we had four periods where inflation came down dramatically,

[00:21:07] [SPEAKER_06]: where we went into, you know, we had two major

[00:21:12] [SPEAKER_06]: recessions during that period. And during the first one, inflation came down from seven

[00:21:18] [SPEAKER_06]: all the way down to two. So they did come down to 2%, which is the current target, right? So

[00:21:25] [SPEAKER_06]: that is not a surprise. That happens because the Fed reserve is trying to control inflation and

[00:21:31] [SPEAKER_06]: they're raising interest rates and they're managing the key here is structural inflation,

[00:21:37] [SPEAKER_06]: secular inflation, which are driven not by the business cycle, but are driven by structural

[00:21:42] [SPEAKER_06]: factors within the product, the global economy. And they're managing those with cyclical

[00:21:48] [SPEAKER_06]: factors. They're managing those with tools that manage the business cycle. So are we slowing

[00:21:53] [SPEAKER_06]: down, you know, as an economy because they took interest rates to five and a half percent.

[00:22:01] [SPEAKER_06]: And they held it there for a while. Sure, that's been a major driver for why we they how they'd

[00:22:06] [SPEAKER_06]: managed to slow the economy. But the slowing of inflation is obviously been very slow, right?

[00:22:14] [SPEAKER_06]: It has happened very painfully, very slowly. And it's happened in the context of

[00:22:21] [SPEAKER_06]: not only has it happened slowly, but they still haven't reached their target. And we're talking

[00:22:25] [SPEAKER_06]: about, you know, recession, right? I would argue where inflation can come down to 1%. And that doesn't

[00:22:32] [SPEAKER_06]: change the structural inflationary pressures. The key here is the asymmetry. And I'll

[00:22:39] [SPEAKER_06]: highlight what happened 60 to 82 as an example, the asymmetry of the inelasticity of interest

[00:22:45] [SPEAKER_06]: rates in these environments. So if you lower it, when you start to lower interest rates, and this

[00:22:50] [SPEAKER_06]: is what happened in other cycles, in this demand push type economy that we are in, right? It's a

[00:22:56] [SPEAKER_06]: demand push economy. What do I mean by that? Because money is going to people no longer to

[00:23:00] [SPEAKER_06]: go into corporations right now. We're doing fiscal spending or sending, you know, we're

[00:23:04] [SPEAKER_06]: putting up protectionist measures, we're sending money to people in this type of an environment.

[00:23:10] [SPEAKER_06]: And when that happens, and you're in a demand push economy, you have a lot of pent up

[00:23:14] [SPEAKER_06]: demand when you raise interest rates, that demand continues to grow. And I'll think about it in terms

[00:23:21] [SPEAKER_06]: of real estate, right? People locked in low interest rates are stuck in their homes. Just because

[00:23:26] [SPEAKER_06]: interest rates went higher didn't dramatically slow the economy. What it did is it said, okay,

[00:23:32] [SPEAKER_06]: any new demand coming on, it's going to be more expensive for you, right? It's going to be

[00:23:36] [SPEAKER_06]: harder for you to drive that kind of demand. But that demand sitting there building, what

[00:23:41] [SPEAKER_06]: happens when you lower interest rates? Now you have all this pent up demand, it comes rushing

[00:23:45] [SPEAKER_06]: back in the market right now. All of a sudden, all these secular inflationary pressures now get

[00:23:50] [SPEAKER_06]: no longer balanced with the cyclical pressures of higher interest rates. Now they are

[00:23:58] [SPEAKER_06]: now they're being stimulated by lower interest rates from a cyclical perspective.

[00:24:04] [SPEAKER_06]: And then again, this is what we saw in 6082. And then what we saw then was inflation

[00:24:08] [SPEAKER_06]: just picked right back up, right? Because all of this demand came roaring back. And so on top of

[00:24:15] [SPEAKER_06]: that, by the way, when the economy slows, it's not just the role that the Federal Reserve is playing

[00:24:20] [SPEAKER_06]: by lowering interest rates and releasing pent up demand. It's also the responses less likely

[00:24:24] [SPEAKER_06]: to be just the Federal Reserve much like we saw in 2020. It's much less likely to be just the

[00:24:29] [SPEAKER_06]: Federal Reserve coming in and lowering interest rates. This time around, you're probably

[00:24:32] [SPEAKER_06]: going to see more political, right, fiscal, fiscal policy again, I see more spending.

[00:24:38] [SPEAKER_06]: To support economy that's slow. So if we continue to see fiscal spending, which again is driven by

[00:24:43] [SPEAKER_06]: populism and particularly millennial kind of increase in voter demand and voter share,

[00:24:51] [SPEAKER_06]: you're going to continue to see more inflation. And again, we think the cyclical effects are

[00:24:55] [SPEAKER_06]: already symmetric and elastic and it's likely to drive a significant uptick in inflation

[00:25:02] [SPEAKER_06]: if we do go into recession. So I expect to see the type situation where interest rates come down.

[00:25:11] [SPEAKER_06]: And again, we've highlighted this as steepener is an incredible trade during that time. You don't

[00:25:15] [SPEAKER_06]: have to wait on what you'll see as higher interest rates start to happen in the back

[00:25:19] [SPEAKER_06]: and the curve as the front curve, front of the curve is coming down. And that's exactly

[00:25:24] [SPEAKER_06]: what we've seen. So the best trade has been to be in steepeners. And we believe that'll

[00:25:29] [SPEAKER_06]: continue to be the case. Great time to continue to be focused on that type of a trade as well.

[00:25:35] [SPEAKER_05]: Housing is something I've been thinking a lot about because I can't completely wrong. I never

[00:25:38] [SPEAKER_05]: thought we'd see rates go up like that and housing, you go up with it. And now I'm trying

[00:25:42] [SPEAKER_05]: to think of my wrong the other way. Like I'm thinking as rates come down, that's going to,

[00:25:45] [SPEAKER_05]: like you said, pent up demands that it come out and it's going to stimulate housing in

[00:25:48] [SPEAKER_05]: the war, but it is somehow going to unlocks supply and maybe I'm not that wrong too. So

[00:25:51] [SPEAKER_05]: I'm not going to give you thoughts, but I'm just sort of struggling with that.

[00:25:54] [SPEAKER_06]: Yeah. I mean, we were pretty adamant that real estate is a great place

[00:25:57] [SPEAKER_06]: to be broadly, particularly in real estate is not a monolith, right? Not commercial real estate,

[00:26:03] [SPEAKER_06]: but in single family starter homes household formation and wealth creation

[00:26:10] [SPEAKER_06]: is a millennials who are the primary home buyers at this point on the residential side

[00:26:16] [SPEAKER_06]: is up to 45% of where baby boomers were at this age, up from 40%. That's the last four years.

[00:26:22] [SPEAKER_06]: So dramatic, dramatic issues in terms of not just wealth inequality, but importantly,

[00:26:29] [SPEAKER_06]: generational wealth and then Horry, millennials on down have been labor for 40 years in a period

[00:26:36] [SPEAKER_06]: where as we've talked about in the past, in a period where money has been driven to capital,

[00:26:42] [SPEAKER_06]: corporations have been incredibly profitable. There's still at record profit margins

[00:26:47] [SPEAKER_06]: because of globalization because of technological development and both of those are driven by

[00:26:51] [SPEAKER_06]: incredibly low interest rates. So at the end of the day, that's the driving force. The driving

[00:26:57] [SPEAKER_06]: force is a generation, actually multiple generations who have as labor underperformed

[00:27:03] [SPEAKER_06]: puns and that are saying this system isn't fair and doesn't work for us. They were

[00:27:07] [SPEAKER_06]: other than stuck at home with mom and dad unable to create families and have children.

[00:27:13] [SPEAKER_06]: And these are really, and I've seen by the way, multiple generations in their

[00:27:17] [SPEAKER_06]: particular in the lower end, their parents underperform and now they're underperforming

[00:27:22] [SPEAKER_06]: their parents. And so that loss of status, that frustration drives political pressure

[00:27:29] [SPEAKER_06]: and dramatic political pressure. And the cost of the golden goose that the Fed

[00:27:36] [SPEAKER_06]: thought they created, which was low inflation and strong growth, was inequality. The reason they

[00:27:44] [SPEAKER_06]: control price was because they weren't sending money to people. They were sending it to

[00:27:48] [SPEAKER_06]: the top and the top doesn't spend. They created his asset inflation because those people invest.

[00:27:54] [SPEAKER_06]: And the more they invest, the more you drive for profits or corporations which drive globalization

[00:28:00] [SPEAKER_06]: primarily as well as technological development. That's what we've seen. But we're reversing

[00:28:04] [SPEAKER_06]: that at the end of the day. Millennials are becoming every four years. We don't think

[00:28:08] [SPEAKER_06]: about four years doesn't seem like a lot but every four years, a lot of baby boomers are dying

[00:28:13] [SPEAKER_06]: off and a lot more millennials, Gen Z everybody are moving into political kind of dominance.

[00:28:19] [SPEAKER_06]: And that's what's driving policy. And we're repaying the costs of inequality. This is not

[00:28:26] [SPEAKER_06]: a new story. I mean people act like this is a story that doesn't go back 100 years.

[00:28:31] [SPEAKER_06]: This story goes back 10,000 years, 20 cocks in years. Everything power corrupts absolutely.

[00:28:39] [SPEAKER_06]: And the top gets the lion share of the profits sides. You could call survival a fittest of you.

[00:28:46] [SPEAKER_06]: You could argue goes back a billion years. But the reality is at the end of the day,

[00:28:51] [SPEAKER_06]: at some point there are more people than the top 1%. And at some point there's a let

[00:28:56] [SPEAKER_06]: them eat cake moment and the masses come back and there's the hell to pay. And

[00:29:04] [SPEAKER_06]: that's the broad period we are in. Again, I'm not saying it's going to be a revolution,

[00:29:07] [SPEAKER_06]: but this is when revolution happens and why it happens. And you have to understand the political

[00:29:12] [SPEAKER_06]: forces, it's much more predictable than people realize. This is generational.

[00:29:19] [SPEAKER_06]: I think the key thing is and why cycles happen is people don't realize that inequality isn't

[00:29:24] [SPEAKER_06]: just top and bottom. It's generational. And the second you realize that labor

[00:29:29] [SPEAKER_06]: is youth tends to be youth. And capital tends to be each then you realize that the changes in

[00:29:37] [SPEAKER_06]: these happen generationally. And this is a major driver for cycles. And you could have seen this

[00:29:44] [SPEAKER_06]: come in 10 years ago, now timing it to the year or what was the thing that set it off. You

[00:29:49] [SPEAKER_06]: needed the right to be brought left by the demand from the populism, which is what Trump

[00:29:54] [SPEAKER_06]: did right here in the US. And we saw others globally do the same. And you had to see

[00:30:00] [SPEAKER_06]: the left was already left but went even further, right? And the former Bernie Sanders and AOC.

[00:30:04] [SPEAKER_06]: But you needed the whole political spectrum to move left and B, he needed a catalyst.

[00:30:10] [SPEAKER_06]: And COVID was that catalyst. In 1965, I believe it was or 1964, I apologize.

[00:30:17] [SPEAKER_06]: Those candidates assassination. That's what led to the catalyst can be any number of things.

[00:30:22] [SPEAKER_06]: That led to LBJ being able to pass the great society program.

[00:30:27] [SPEAKER_06]: But these are all steps, right? They're kind of step functions along.

[00:30:32] [SPEAKER_06]: People in the world responds to incentive, right? It's pretty simple. It doesn't happen linearly.

[00:30:38] [SPEAKER_06]: It happens on path and with all kinds of random things along the way. But you have to be prepared

[00:30:46] [SPEAKER_06]: and understand that probabilities are increasing for those things and that catalyst

[00:30:50] [SPEAKER_06]: will eventually come along that will drive a kind of a step function towards those things.

[00:30:56] [SPEAKER_05]: So is it fair to say given your outlet that you think the Fed probably made a mistake in

[00:30:59] [SPEAKER_05]: cutting rates? I mean, you've talked in your previous appearances about then being a boxier

[00:31:01] [SPEAKER_05]: that it's challenging for them to respond to the cyclical stuff with what's going on securely.

[00:31:06] [SPEAKER_05]: And do you think it was a mistake to cut rates?

[00:31:08] [SPEAKER_06]: It's not a mistake. The Fed doesn't have a choice. The Fed,

[00:31:12] [SPEAKER_06]: the Fed, it's not like by keeping interest rates higher they're going to

[00:31:16] [SPEAKER_06]: create a better outcome, right? They are the stock much like they had this

[00:31:23] [SPEAKER_06]: golden goose that things free, right? Well, that seemed like they had absolute control and they

[00:31:28] [SPEAKER_06]: could do whatever they want whenever because they were in a deflationary environment. They could

[00:31:32] [SPEAKER_06]: just stimulate monetarily, stimulate monetarily, stimulate monetarily every time and not have an

[00:31:37] [SPEAKER_06]: inflationary effect yet still stimulate the economy. That seems too good to be true.

[00:31:40] [SPEAKER_06]: Guess what? It was. It just wasn't too good to be true for that five year, 10 year, 15 year period.

[00:31:47] [SPEAKER_06]: You know, eventually I drove enough inequality, enough political imbalance that now

[00:31:52] [SPEAKER_06]: you gotta pay the piper. At least the extent that we as a society are

[00:31:59] [SPEAKER_06]: decide, right? And when I say we, the boaters or those that have enough control over to

[00:32:05] [SPEAKER_06]: in different countries to go for a more, to favor median outcomes. To really say,

[00:32:14] [SPEAKER_06]: okay, this system is not currently fair and we want something that is going to be more fair.

[00:32:20] [SPEAKER_06]: But as long as that's the political pressure and people are willing to do whatever they need to

[00:32:25] [SPEAKER_06]: do to make those people happy, which is what politics is all about, we're going to continue

[00:32:30] [SPEAKER_06]: to see, let's see that outcome. So we translate this to markets. One of the things I've learned

[00:32:37] [SPEAKER_05]: from your previous appearances is when we have these big up years, there's a lot of flows as we

[00:32:41] [SPEAKER_05]: get towards the back end of the year that might lead to the market going up even more. Is that

[00:32:45] [SPEAKER_05]: what you're seeing as we head towards the end this year? So now we're transferring from the

[00:32:48] [SPEAKER_06]: weighing machine, right? The big picture to the voting machine, right? What happens in

[00:32:54] [SPEAKER_06]: supply in a man and this is what drives the staff. Like everybody thinks about the weighing

[00:32:58] [SPEAKER_06]: machine and the big picture where we're going, but often looks at the six month outcome or in

[00:33:03] [SPEAKER_06]: the case of this last year, markets are up over 20% and like are confused because that doesn't fit the

[00:33:11] [SPEAKER_06]: big picture, right? That we're talking about any issues that everybody's seeing. But that can

[00:33:18] [SPEAKER_06]: happen because of very specific supply and demand factors that may have nothing to do with the

[00:33:24] [SPEAKER_06]: long term picture. As it relates to this last quarter, there are a couple of really big effects.

[00:33:30] [SPEAKER_06]: We've talked about seasonality before and that seasonality comes across when you say that word

[00:33:35] [SPEAKER_06]: as some magical construct like it's just, oh, we tend to do well in these periods. But people

[00:33:40] [SPEAKER_06]: don't understand the actual supply and demand that drives them. There are two major forces

[00:33:46] [SPEAKER_06]: that drive that generally that are on hyperdrive in a year like this year. And so let's

[00:33:53] [SPEAKER_06]: discuss those. Let's start there. What are those two two factors? There's more than two, but these

[00:33:57] [SPEAKER_06]: are the biggest ones. One in any year companies make money, economy grows, there's embedded inflation,

[00:34:07] [SPEAKER_06]: money has to be reinvested, right? And and that money or that collateral, if you will,

[00:34:13] [SPEAKER_06]: people call the wealth effect. I would like it calling it the multiple because that makes

[00:34:18] [SPEAKER_06]: it seem like this is all just humans going and buying things and they may have more

[00:34:22] [SPEAKER_06]: money so they're gonna spend more money. That's actually not what it is. What it what the wealth

[00:34:26] [SPEAKER_06]: effect is, is if if things become more valuable or there's more money out there on the majority

[00:34:33] [SPEAKER_06]: of the world talking banks funds, including the real money sovereign sovereign country,

[00:34:39] [SPEAKER_06]: everybody is managing money not based on dollars or notional amount. They're managing it based

[00:34:44] [SPEAKER_06]: on on on risk on leverage. The whole system is built on leverage bank loans and money based

[00:34:51] [SPEAKER_06]: on leverage, right? A fund invest money in a non correlated way often or or even a correlated way

[00:34:58] [SPEAKER_06]: based on the amount of risk exposure they have, they get more money. They are going to increase

[00:35:03] [SPEAKER_06]: the risk exposure on the real estate markets. It's all leverage, right all the way down. So

[00:35:10] [SPEAKER_06]: in in a year where the market's up, this is exacerbated because more money is created.

[00:35:15] [SPEAKER_06]: So markets up 20%. The basic math is the US market is about 60 trillion dollars. The global

[00:35:23] [SPEAKER_06]: market tell another $60 trillion. It's $120 trillion, things that are tied to the US equity

[00:35:30] [SPEAKER_06]: markets and are valued as a function of them whether it's private equity or other things.

[00:35:34] [SPEAKER_06]: Amount about another 120. So you're talking somewhere let's wave our hands at it $250 trillion

[00:35:40] [SPEAKER_06]: of equity linked assets $250 trillion. If the market's up 20%, that's $50 trillion of new money

[00:35:49] [SPEAKER_06]: of new collateral to imagine your real estate property went up by 20%. Now you have 20% more

[00:35:55] [SPEAKER_06]: collateral, your your asset is just worth more. The bank will lend you more money against that

[00:36:00] [SPEAKER_06]: collateral. And so the way this works is that money gets readvested now some of that happens

[00:36:05] [SPEAKER_06]: at the end of at the end of a day some of that happens at the end of a week some of that happens

[00:36:10] [SPEAKER_06]: at the end of the month, some of the end of the quarter some at the end of the year. Right so

[00:36:13] [SPEAKER_06]: it's not like all of it just gets readvested here one or day one of the of the new year.

[00:36:18] [SPEAKER_06]: But some very meaningful amount have long lag times and new funds, new vehicles,

[00:36:25] [SPEAKER_06]: new things get started at the beginning of the year. And let's say let's wave our hands

[00:36:30] [SPEAKER_06]: at it but let's say that's 10% of that $50 trillion that's $5 trillion of the day that

[00:36:38] [SPEAKER_06]: has to happen in the first couple weeks of the year. Right some of them had to do it on J1

[00:36:44] [SPEAKER_06]: something get to kind of ease into it but they got they better get started right.

[00:36:48] [SPEAKER_06]: $5 trillion in the context of I want to be clear, this is the part that most people are

[00:36:52] [SPEAKER_06]: not taught about markets. About 100 to $125 billion is the average amount the average

[00:37:01] [SPEAKER_06]: incremental amount that moves markets on a given day. So when you see the market up 2% by the way,

[00:37:06] [SPEAKER_06]: which you know, based on the math that we just said is is about $5 trillion right or

[00:37:22] [SPEAKER_06]: $5 trillion. It's like a it's like a leveraged venture capital deal where where they're releasing

[00:37:29] [SPEAKER_06]: 2% of the flow but based on where that 2% trades, the whole market the whole valuation of that

[00:37:35] [SPEAKER_06]: entity is being the whole market is that way and that's the world doesn't understand is the

[00:37:40] [SPEAKER_06]: amount that's moving markets is a very small amount of money but the amount of what in collateral

[00:37:46] [SPEAKER_06]: that increases as a function of that or contracts is dramatic. And this is a big thing that leads

[00:37:51] [SPEAKER_06]: to not only momentum in markets one way but can lead to dramatic liquidity issues on the downside

[00:37:57] [SPEAKER_06]: as well. So January 1, if we have $5 trillion coming in, give or take and the average amount

[00:38:04] [SPEAKER_06]: that moves markets is $150 billion dollars, you probably want to be long before that happens

[00:38:10] [SPEAKER_06]: right on so it up years and and by the way, that's why did what we call the Santa Claus

[00:38:16] [SPEAKER_06]: effect and the January effect that four week period essentially that month, the last two weeks of

[00:38:22] [SPEAKER_06]: the year, the first year have an 87% winning rate. And on average return 1.25%, which are crazy.

[00:38:31] [SPEAKER_06]: Like if you look at 125 years of history, and you look at those numbers, it's not a coincidence.

[00:38:35] [SPEAKER_06]: This is not Santa Claus, by the way, it's supply and demand. So that's a major major

[00:38:40] [SPEAKER_06]: driver. And again, that's, I get I get that that's sitting out there December 31. When do you

[00:38:45] [SPEAKER_06]: start planning for that? How do you run that what is the what is the but the key is there's

[00:38:49] [SPEAKER_06]: an incremental buyer and the world knows it that's coming into January 1. Now, if the market declines

[00:38:55] [SPEAKER_06]: 20% before then that comes off the table, right? So very important. So it's kind of a game of chicken

[00:39:00] [SPEAKER_06]: as you get closer, right? So very important to watch their second thing, which is very important.

[00:39:07] [SPEAKER_06]: Again, somebody's things seen in Randolph's, but they're very important.

[00:39:11] [SPEAKER_06]: Starting at Thanksgiving in the US, going through MLK day in January, you have more holidays during

[00:39:17] [SPEAKER_06]: that two month period, right? Then it's by far than any other time during the calendar year.

[00:39:24] [SPEAKER_06]: And importantly, not just holidays, not actually just days off. But the actual time to volume

[00:39:30] [SPEAKER_06]: weighted time during that period is dramatically lower for the days that the market is open.

[00:39:34] [SPEAKER_06]: Why? Because Thanksgiving, Christmas, New Year's, these are not just this isn't the same thing as

[00:39:41] [SPEAKER_06]: Veterans Day, right? Like, these are days where people take the whole week off. They, you know,

[00:39:45] [SPEAKER_06]: they go, they go home, they stop, they stop managing money markets, they shut down positions.

[00:39:52] [SPEAKER_06]: So liquidity goes down, volume goes down. And that 125 billion or so

[00:39:58] [SPEAKER_06]: average that moves markets goes down to about 75. So dramatically less point.

[00:40:03] [SPEAKER_06]: And that volume, what we call volume weighted time, which is kind of a term we, we, we came up with

[00:40:08] [SPEAKER_06]: is essentially this the amount of time that you actually have trading happening, right? It's

[00:40:14] [SPEAKER_06]: the amount of actual activity in the markets is 60% of what it is over the rest of the year.

[00:40:22] [SPEAKER_06]: 60%. Why does that matter? Why is that positive? Well, it's a couple reasons. One,

[00:40:27] [SPEAKER_06]: because we already talked about how much money is coming on Gen 1. But more importantly,

[00:40:31] [SPEAKER_06]: you have all of this skew in the market, these bond and charm was we talked about the natural buyback

[00:40:37] [SPEAKER_06]: in markets. And now markets are less liquid. And you have even more acceleration because time is

[00:40:44] [SPEAKER_06]: collapsing very quickly, ball is coming down very quickly. And so you have an acceleration

[00:40:49] [SPEAKER_06]: of that buying and that buying pressure is more impactful each day. On top of that,

[00:40:53] [SPEAKER_06]: on top of that pressure, December and January, the biggest apexes of the year every year,

[00:40:58] [SPEAKER_06]: December starts out as leaps in the indexes. It's the most heavily traded, all the structured

[00:41:03] [SPEAKER_06]: products, everything tend to be tied to the end of the year. Well, that creates more open interest

[00:41:09] [SPEAKER_06]: that drives more bond and charm was then it creates more skew, which is a higher price,

[00:41:14] [SPEAKER_06]: which means there's more deltas to kind of buyback on top of that, particularly here like this

[00:41:19] [SPEAKER_06]: where it's an election year, we just talked about us skew expanded dramatically, right?

[00:41:24] [SPEAKER_06]: In August, now you have dramatically high skew, massive positioning back there, a bunch of dealer

[00:41:30] [SPEAKER_06]: short deltas against it that assuming again, big assumption that we don't decline sometime here

[00:41:36] [SPEAKER_06]: between the beginning of those flows really kicking in is going to kick into hyperdrive in terms of

[00:41:41] [SPEAKER_06]: structural positive flows. And again, sitting on the other end of that on January 1st is

[00:41:46] [SPEAKER_06]: that reinvest so now put those two together. Probabilities aren't very good for this

[00:41:51] [SPEAKER_06]: market kind of declining in and if it doesn't decline, it more important to like predicting up

[00:41:56] [SPEAKER_06]: or down the distribution that we're looking at for this market going into the end of the year is

[00:42:01] [SPEAKER_06]: incredibly right bias with left that tail. So instead of being a 60% winning, probably we're in

[00:42:09] [SPEAKER_06]: a 75 80% winning type scenario with this market. But there is a very fat left left tail as you

[00:42:16] [SPEAKER_06]: mentioned, if something were to happen, if this market were to decline 20%,

[00:42:21] [SPEAKER_06]: watch out right like the plan 15%. Okay, that becomes a little bit more dangerous right 25%.

[00:42:27] [SPEAKER_06]: Like this thing could you have a bomb sitting there in the box in the bottom of the market.

[00:42:32] [SPEAKER_06]: Now, is that probable? No, it's incredibly improbable. But it's real and the convexity

[00:42:39] [SPEAKER_06]: and the risk to a market in that situation is truly dramatic.

[00:42:45] [SPEAKER_05]: Yeah, this is such interesting stuff to learn as a long-term investor because we hear just things

[00:42:49] [SPEAKER_05]: like Santa Claus rally and we don't really have any idea what's going on. And if it's

[00:42:53] [SPEAKER_05]: interesting just to hear what actually is going on behind the scenes and just before I head

[00:42:56] [SPEAKER_05]: back to Justin, I would really recommend you did the Keeping It Simple podcast recently with

[00:43:00] [SPEAKER_05]: Andy Constan and Mike Green and Harley Dassman. And I would really recommend that because

[00:43:03] [SPEAKER_05]: that's a like I learned so much about market structure, repairing for this listen to that

[00:43:07] [SPEAKER_05]: episode. So I would highly recommend anybody listen to that. Yeah, great group of guys,

[00:43:10] [SPEAKER_06]: a wonderful conversation. But yeah, definitely check that out. It's kind of crazy to think that

[00:43:19] [SPEAKER_06]: you know we're basically 30 days away from a presidential election here and we're going to

[00:43:24] [SPEAKER_04]: have a new president. And how are you thinking about the impact on the election on the markets?

[00:43:33] [SPEAKER_06]: Yeah, so I got to the more structural effects and how they're bigger this year and all the

[00:43:37] [SPEAKER_06]: things but what we didn't talk about is what's not the same every year, right? And that's

[00:43:41] [SPEAKER_06]: the election particularly the kind of election where we're immense.

[00:43:46] [SPEAKER_06]: When I step back and look at where we are in a kind of bigger picture, right? And I talked about

[00:43:54] [SPEAKER_06]: that period 68 to 82, right? Elections are particularly populist elections like we're talking

[00:44:03] [SPEAKER_06]: about are incredibly positive years. A couple statistics I've mentioned these in kind of

[00:44:10] [SPEAKER_06]: a couple of spots but I just think it's so important and meaningful for people to understand.

[00:44:16] [SPEAKER_06]: If you look, you hear all the time about how election years are very positive, right?

[00:44:20] [SPEAKER_06]: But if you look at 125, sorry 100 years of history, you go back to the 28, 1928. And you look at

[00:44:27] [SPEAKER_06]: about 100 years of history and you take all the elections since in the United States since

[00:44:32] [SPEAKER_06]: 1928. All of those election years combined are up about 12 and a half, 13%.

[00:44:39] [SPEAKER_06]: That's pretty positive, right? And they have a win rate of something like 80% or something.

[00:44:46] [SPEAKER_06]: Now what people don't realize is if you take just the elections as follows, 64, 68,

[00:44:55] [SPEAKER_06]: 72, 76, 80, right? Those five, right? And you took those five out of the election,

[00:45:02] [SPEAKER_06]: out of the data set. The actual return of the SMB 500 in the election years is 5.5%.

[00:45:12] [SPEAKER_06]: Now, wow, that's a pretty big difference. So what happened in those five election years?

[00:45:16] [SPEAKER_06]: By the way, they're just back to back elections during, guess what, 68 to 82.

[00:45:20] [SPEAKER_06]: That same period we're talking about, which is a populist period,

[00:45:24] [SPEAKER_06]: traumatic impotuous period. What happened in those five years? The average return during that

[00:45:28] [SPEAKER_06]: period was 21.5%. Every single one of those years was positive double digits. There wasn't

[00:45:35] [SPEAKER_06]: not even a single digit year out of those five. And guess what? If you take the last two elections,

[00:45:41] [SPEAKER_06]: including this one, we're not double the year, but to assume we end up where we are right now,

[00:45:45] [SPEAKER_06]: which is 20%, the average performance of those was also 21%. This is not a coincidence. You have

[00:45:54] [SPEAKER_06]: seven populist elections, periods where there's a massive populist push. You can argue all you want

[00:46:01] [SPEAKER_06]: that the pretty clear in terms of spending all the trends that we're seeing are very similar.

[00:46:06] [SPEAKER_06]: Those seven years to have those type of positive returns consistently

[00:46:10] [SPEAKER_06]: is not only an outlier in a data set. The consistency is fairly incredible.

[00:46:18] [SPEAKER_06]: What makes it even more incredible is if you then go look at the market performance

[00:46:23] [SPEAKER_06]: outside of those election years during those periods, dramatically negative. So if you pulled

[00:46:29] [SPEAKER_06]: out those five years from that 17 year period, let's go back if they're 64 to 82,

[00:46:41] [SPEAKER_06]: the real returns of the market for that whole period was down 50%. Down 50%, real terms,

[00:46:50] [SPEAKER_06]: and nominal terms up slightly positive. If you pick those five years out, it's a 90% decline

[00:46:58] [SPEAKER_06]: in markets over that period. So the other years in that 17 period, take those five years out,

[00:47:04] [SPEAKER_06]: 12 years, almost every single one was a losing year. And the ones that were losing, there were

[00:47:10] [SPEAKER_06]: several dramatic decline like 35% type years. So it's this really weird juxtaposition,

[00:47:16] [SPEAKER_06]: you have this broadly very inflationary populist period, interest rates are broadly

[00:47:21] [SPEAKER_06]: securely increasing, that's very poor for assets, demand push economy. But guess what? On election

[00:47:27] [SPEAKER_06]: years, incredibly positive. We're seeing the same thing. We're seeing the exact same thing.

[00:47:35] [SPEAKER_06]: If you look at what happened in 2020, other than the March kind of issue, we had a decent year

[00:47:43] [SPEAKER_06]: 22, we had a really poor year, the market went nowhere until the beginning of this year, literally

[00:47:47] [SPEAKER_06]: going back to that year, the market has gone nowhere and real terms is actually down

[00:47:51] [SPEAKER_06]: until this year. We're seeing another 21% rally here in the markets. You take from that data what

[00:47:58] [SPEAKER_06]: you will. I don't think this is a good time at the end of 2024, after a 20% run in a broadly

[00:48:06] [SPEAKER_06]: populist period with all the issues that we've talked about, de-globalization,

[00:48:12] [SPEAKER_06]: protectionism, populism, all of the commodity issues were underpinning that we've seen,

[00:48:17] [SPEAKER_06]: all the potential risks out there, and not to mention where valuations are record margins

[00:48:23] [SPEAKER_06]: to be looking to get long at the end of this year. That said, you'd be crazy in my opinion to

[00:48:30] [SPEAKER_06]: not be bullish into the end of this year, assuming we don't get a dramatic sell-off in

[00:48:36] [SPEAKER_06]: the next month. And so that's the broad view and that's the broad context, which I think

[00:48:42] [SPEAKER_03]: you need to be thinking about these markets. And do you think that's just a function of investors

[00:48:48] [SPEAKER_03]: speaking that there's going to be some type of positive change in catalyst or

[00:48:52] [SPEAKER_04]: something better is coming for the country, for the economy? And that's what

[00:48:56] [SPEAKER_04]: the market effectively is discounting in those election years?

[00:49:02] [SPEAKER_06]: Part of it. People get told all the good stuff, right? But at the end of the day,

[00:49:06] [SPEAKER_06]: in a very contested election, which is every, by the way, if you go back to

[00:49:10] [SPEAKER_06]: all the elections I talked about in the 60s and 70s, by the way, they were all incredibly

[00:49:15] [SPEAKER_06]: contested elections. There was only one election out of all those years where the incumbent won

[00:49:21] [SPEAKER_06]: and that was Nixon and he got kicked out of office. That's not true, by the way, take that

[00:49:26] [SPEAKER_06]: data set out again from all the other data incumbents usually get a second term. It's

[00:49:31] [SPEAKER_06]: a function of the environment. So in these contested elections, the incumbent is looking

[00:49:38] [SPEAKER_06]: to do anything they can in a very, at a time where it's almost a liability to be an incumbent,

[00:49:43] [SPEAKER_06]: right? Because people want change. They're incentivized to do whatever they can to support

[00:49:49] [SPEAKER_06]: the market because they need at least a positive market outcome to try and get reelected.

[00:49:55] [SPEAKER_06]: On top of that, it's a populist period. And people, particularly that youth that's coming

[00:50:01] [SPEAKER_06]: to the voting age are looking for some way to correct the lack of fairness and the inequality

[00:50:09] [SPEAKER_06]: in the economy. So yeah, people follow incentives. Guess what? Politicians give a bunch of giveaways

[00:50:15] [SPEAKER_06]: and do whatever they can to support markets during those years, and they do it at all costs.

[00:50:20] [SPEAKER_06]: But it's borrowing from the future. At the end of the day, there are things that

[00:50:24] [SPEAKER_06]: are only going to drive more structural inflation, bigger issues in the broader

[00:50:28] [SPEAKER_06]: picture. So yeah, some of its hope for change. But I think the bigger part is just more spending,

[00:50:36] [SPEAKER_06]: more cyclical inflationary asset and broadly inflationary pressures that come due in terms of

[00:50:46] [SPEAKER_06]: the cost of them down the road but right now are cyclically stimulated.

[00:50:52] [SPEAKER_06]: One of the things we like to ask people, and I know you know Mike Green pretty well,

[00:51:01] [SPEAKER_04]: and he has these views on the passive flows impacting the market and stock prices. Do you

[00:51:07] [SPEAKER_04]: have any opinions on Mike's thoughts around that? Yeah, absolutely. Mike and I have talked about

[00:51:13] [SPEAKER_06]: for years, completely agree with the process and the framework. It's very much true.

[00:51:25] [SPEAKER_06]: There is a natural momentum factor to passive investing, and that passive investing has

[00:51:31] [SPEAKER_06]: grown to such a scale that it is one of the primary drivers of momentum in this market.

[00:51:41] [SPEAKER_06]: Now, the part where I kind of differ or disagree is with the idea that hey, this is inevitable and

[00:51:48] [SPEAKER_06]: this will just continue and markets have changed forever. I really think it's a function of,

[00:51:53] [SPEAKER_06]: and I'm going to back up here, I think passive investing as much as it's been sold

[00:51:58] [SPEAKER_06]: to the world in the narrative is that passive investing is some new innovation. It is the

[00:52:04] [SPEAKER_06]: the new way to invest it's low cost, great. Just set and forget it like easy. Why wouldn't you just

[00:52:12] [SPEAKER_06]: set your money away and passively invest? Indexing to be clear was introduced about 150 years ago.

[00:52:19] [SPEAKER_06]: So this idea of passive investing is not a new idea. The reason it's become popular is because

[00:52:25] [SPEAKER_06]: interest rates went from 20% to zero and we saw a massive boom in equity performance

[00:52:31] [SPEAKER_06]: at 60-40 is the easy set and forget it. Everybody just assumes that's how you invest.

[00:52:37] [SPEAKER_06]: Now actually, if you ask your average person how do you invest? You buy assets for the long term

[00:52:41] [SPEAKER_06]: and you keep buying. That's the viewpoint again 1968 to 82. My period right before passing

[00:52:47] [SPEAKER_06]: the testing started there was a lot of passive investing. You know why? Because it didn't work

[00:52:53] [SPEAKER_06]: because 1968 to 82 you lost 70% of your money in the equity market. If you had any duration

[00:52:58] [SPEAKER_06]: over 42 years, not over one year, two years, five years, 10 years, over 14 years,

[00:53:03] [SPEAKER_06]: you lost 70% of your money. And in the bond market you did just as poorly if you had any duration

[00:53:09] [SPEAKER_06]: in the portfolio right? You get cash by the way you probably did as poor. So passive investing

[00:53:15] [SPEAKER_06]: didn't happen. What came about during those periods? Hedge funds, right? Value investing,

[00:53:21] [SPEAKER_06]: think Warren Buffett. You know a lot of things that that not really talked about as much

[00:53:25] [SPEAKER_06]: active investing broadly was very popular because it worked. But guess what? That's not what you hear

[00:53:32] [SPEAKER_06]: from people now, you hear about passive investing. So tell me what's going to happen if we see a

[00:53:36] [SPEAKER_06]: 15-year period where the market that goes nowhere and in real terms loses 70% of its value. If that

[00:53:43] [SPEAKER_06]: were to happen, what happens? How? That's the incentive. If we're right and we think

[00:53:50] [SPEAKER_06]: that's what's like, why did it happen? What happens to passive investing? And my view is that

[00:53:54] [SPEAKER_06]: Mike's view is and I think it's a defensible to you, like who knows, let's see, is that the powers

[00:54:00] [SPEAKER_06]: that be at Vanguard are so entrenched that and politically connected that all the 401k flows

[00:54:08] [SPEAKER_06]: and everything will continue to flow to all these passive vehicles. And it's going to change.

[00:54:12] [SPEAKER_06]: I do. I think we'll have maybe passive investing but maybe more passive investing in

[00:54:17] [SPEAKER_06]: active vehicles. That's interesting, right? Those are working. That's what's working. Guess what?

[00:54:22] [SPEAKER_06]: People go to what's working. If they go five years and they're not making money in the market but

[00:54:26] [SPEAKER_06]: they see an active manager who's making 10, 15% a year, guess what? Those things are going to get

[00:54:33] [SPEAKER_06]: the assets. And so I think we're right as everybody is proclaiming active investment dead.

[00:54:40] [SPEAKER_06]: My view is that active investment is actually right on the verge of a new bull market. And

[00:54:51] [SPEAKER_06]: 15 years from now, primarily investing in that right when they should be passively investing

[00:54:55] [SPEAKER_06]: in 60, 40 years. It's just the way markets work. And so I think, yes, passive flows are a primary

[00:55:04] [SPEAKER_06]: driver as we speak. But I think just as we're talking about them and assuming that they will

[00:55:09] [SPEAKER_06]: reflexively create more of the same forever that we are at the cusp of much like everything

[00:55:15] [SPEAKER_06]: else in this world of its imminent demise. Yeah. I mean, it's from 2000 to 2009 when the

[00:55:21] [SPEAKER_04]: S&P 500 went nowhere. Very few investors were in the S&P, but yet people like to look back and say,

[00:55:30] [SPEAKER_06]: well, if you would have been the S&P over the last 25 years, you would have gotten this. But I mean,

[00:55:34] [SPEAKER_06]: it was a lost decade there and everyone was piled into whatever it was, the BRICS,

[00:55:38] [SPEAKER_06]: value stocks did well during from that period. So I think that's a very good point to recognize

[00:55:45] [SPEAKER_04]: that people pile in and usually investors on the whole are late. And it's been a great,

[00:55:50] [SPEAKER_04]: listen, I mean, it's been a great 15, 20 year period for passive. But to your point,

[00:55:56] [SPEAKER_04]: maybe a lot of it's been interest rates and other things that had an influence that. So

[00:55:59] [SPEAKER_04]: it's good as sort of systematic value investors, particularly Jack,

[00:56:03] [SPEAKER_06]: we're holding out hope for the reversion in cheap stocks, right, Jack?

[00:56:07] [SPEAKER_06]: You're giving it the little hope here, Jamry wants some hope.

[00:56:09] [SPEAKER_06]: I think that data set regarding elections is pretty striking. And by the way,

[00:56:13] [SPEAKER_06]: I didn't go looking for that data. I had this thought, I was like, wonder how

[00:56:19] [SPEAKER_06]: these election years are. And it's go look at the data, it's pretty striking. And it's

[00:56:23] [SPEAKER_06]: for these specific periods during this specific time, all the political

[00:56:28] [SPEAKER_06]: effects are also incredibly in line with what we're seeing. So just follows again. And again,

[00:56:35] [SPEAKER_06]: this is the moment, right? We'll see. We'll see. This is the moment the next year or two is

[00:56:41] [SPEAKER_06]: are we going to start seeing with more fiscal stimulus, with more

[00:56:45] [SPEAKER_06]: kind of continuation of the broader secular trends we're seeing? Are we going to see

[00:56:50] [SPEAKER_06]: an uptick in inflation at some point here? And that is the populist impulse going to continue.

[00:56:56] [SPEAKER_06]: I'm willing that this that's just getting started. And I think it's a function of generational

[00:57:01] [SPEAKER_06]: change. It's not a straight line. But I do think that those types of situations mean

[00:57:07] [SPEAKER_06]: you're essentially in a regime change. And that's an incredible opportunity for relative value

[00:57:12] [SPEAKER_06]: opportunities, systematic investing, lots of other strategies that have not been able to compete with

[00:57:19] [SPEAKER_06]: kind of 11, 12% annual equity returns. But again, I don't think it's a coincidence that we're at

[00:57:26] [SPEAKER_06]: record profit margins where all of these metrics similar to like we were in 68,

[00:57:33] [SPEAKER_06]: right? These trends are changing.

[00:57:39] [SPEAKER_06]: Just two more quick questions here before we wrap it up. The first one about AI. So I just saw that

[00:57:49] [SPEAKER_04]: open AI got something like $160 billion valuation to just close like a six and a half

[00:57:55] [SPEAKER_04]: billion dollar round. But just do you have any thoughts on AI from like a productivity

[00:58:00] [SPEAKER_04]: perspective and then also an investment perspective? Have you given any thought to those two?

[00:58:07] [SPEAKER_04]: How can you not? Right.

[00:58:09] [SPEAKER_06]: Actually, I haven't thought about it. I've just had my chat GPT thinking about it for the last

[00:58:15] [SPEAKER_06]: couple of minutes. But no, the look, it's important. I'm not going to sit here and say,

[00:58:25] [SPEAKER_06]: you know, big structural changes and technological development don't drive major long-term

[00:58:36] [SPEAKER_06]: deflation and growth broadly. That said, I do think it's important to remember that

[00:58:46] [SPEAKER_06]: a primary driver for technological development is is to money is is the ability to invest

[00:58:56] [SPEAKER_06]: in things that are not yet profitable. Deal with all of the new, you know, before all the network

[00:59:03] [SPEAKER_06]: effects come into line and the regulation and all the input costs, everything gets sorted out.

[00:59:09] [SPEAKER_06]: There's a period of low profitability for generally these things. And it takes a lot

[00:59:14] [SPEAKER_06]: of investment. And investment comes from cheap money, right? Well, you've been amidst a technological

[00:59:20] [SPEAKER_06]: bull. You could argue not just from since 1995 when Creavesdown lowered the natural state of

[00:59:32] [SPEAKER_06]: interest rates, but really since the 1980s and the supply side push by Reagan

[00:59:39] [SPEAKER_06]: and by the Federal Reserve at that time as well. So doesn't mean we've had, by the way,

[00:59:47] [SPEAKER_06]: since the invention of the wheel, right? Incredible. They don't seem as big now, right?

[00:59:53] [SPEAKER_06]: Because this just seems like oh, we're this is big. You're when you're at the edge of the curve,

[00:59:58] [SPEAKER_06]: it just seems like everything is just bigger, bigger. But relative to the time, these

[01:00:02] [SPEAKER_06]: every innovation that's come before us has been a dramatic innovation and change how fast and how

[01:00:09] [SPEAKER_06]: quick the world is changing and push this growth. But it doesn't go in a straight line.

[01:00:14] [SPEAKER_06]: And the investment in this new technology and the speed at which it's accelerated

[01:00:18] [SPEAKER_06]: is very much tied to money being available. I would argue that Amazon, Uber, Tesla,

[01:00:27] [SPEAKER_06]: go down the line, all these companies which for the majority of them didn't make money for 20 years,

[01:00:33] [SPEAKER_06]: right? Would never have existed. The technologies that we now rely on and are used to saying,

[01:00:42] [SPEAKER_06]: okay, this is a day to day part of our lives would not have been around if the money

[01:00:46] [SPEAKER_06]: had not been cheap, right? So AI is a culmination of that, right? We've been working on

[01:00:52] [SPEAKER_06]: artificial intelligence. You've heard about artificial intelligence, at least I have for

[01:00:55] [SPEAKER_06]: about 30, 40 years. It's not new. But the invent it, the investment did 0% interest rates,

[01:01:01] [SPEAKER_06]: drove enough of a boom in Silicon Valley and across the world to generate kind of enough

[01:01:07] [SPEAKER_06]: investment to really make huge progress. What happens when the tide goes out? We're actually

[01:01:13] [SPEAKER_06]: starting to see it a bit right on in not an AI specifically but in broadly in tech. And I

[01:01:21] [SPEAKER_06]: would argue if we have an economic slowdown interest rates to continue to go higher, we're

[01:01:25] [SPEAKER_06]: going to continue to have harder and harder times for the growth industries and good old industries

[01:01:32] [SPEAKER_06]: like manufacturing, etc., which are kind of boring, are actually going to do better because they get

[01:01:38] [SPEAKER_06]: cash flows today. And those are the entities that are ultimately going to have the money

[01:01:42] [SPEAKER_06]: to purchase and fund growth and other technologies. So but what is

[01:01:47] [SPEAKER_06]: likely to get interest rate to increase a slowdown and it doesn't happen overnight

[01:01:53] [SPEAKER_06]: in technological tenotlimate and tech, which has been the core of everything that's worked,

[01:02:00] [SPEAKER_06]: right? Globalization in tech, right? If you bet on those things for the last 35, 40 years,

[01:02:05] [SPEAKER_06]: they're incredibly wealthy person period. If those things are slowing downs,

[01:02:11] [SPEAKER_06]: right, with a higher cost of money and populism, I think it's going to be slower than people expect.

[01:02:19] [SPEAKER_06]: That's why the overs. I think the exuberance is overdone. It doesn't mean that we're not

[01:02:25] [SPEAKER_06]: going to continue to evolve and AI is not going to continue to be very important to

[01:02:30] [SPEAKER_06]: kind of how the world works. But guess what? To your point, it's going to reduce costs

[01:02:36] [SPEAKER_06]: and it's going to change. There are in a populist period, do you think labor once AI to the extent

[01:02:43] [SPEAKER_06]: that we're talking about its development? Do you think government is going to not put

[01:02:50] [SPEAKER_06]: regulation around AI? There's all kinds of examples already happening where labor unions are

[01:02:58] [SPEAKER_06]: demanding certain restrictions to AI as a function of regulation. So to mention we're starting to hear

[01:03:07] [SPEAKER_06]: about, oh wow, there's a lot of energy that needs to go into a lot of this. We also have issues related

[01:03:15] [SPEAKER_06]: to microprocessors. Is there enough? What if there is a war in Taiwan, right? All of these

[01:03:21] [SPEAKER_06]: things are things that people are just kind of whistling by because the hope and the view on AI is

[01:03:29] [SPEAKER_06]: just seen as world changing today, tomorrow. And yes, it's important, much like the internet

[01:03:34] [SPEAKER_06]: was important. By the way, in 2000, obviously the valuations aren't where they are. We're not

[01:03:41] [SPEAKER_06]: there right now, but in 2000, the world was right. The internet was the most important

[01:03:46] [SPEAKER_06]: thing that could possibly happen. It didn't stop 97% of the internet companies going bankrupt.

[01:03:52] [SPEAKER_06]: It didn't stop the NASDAQ from dropping 91%. So I just think it's important to take these things

[01:04:00] [SPEAKER_06]: in a measured way and to look at the bigger picture and understand that the only thing

[01:04:05] [SPEAKER_06]: driving the growth of these industries is not just the idea, it's not just the

[01:04:11] [SPEAKER_06]: the growth and how this is going to change the world. It needs picks and shoves. It needs

[01:04:17] [SPEAKER_06]: inputs. It needs regulation. It needs all of these things. And we're at a point where that's

[01:04:22] [SPEAKER_06]: been going for 30, 40 years. In my opinion, that's in the process of slowing down.

[01:04:26] [SPEAKER_06]: And it's going to be very hard for growth industries, AI being at the tip of the spear.

[01:04:31] [SPEAKER_06]: So I would be very, again, bullish of AI long term, hard to say who the winners are going

[01:04:36] [SPEAKER_06]: to be. Hard to say. Don't think it's going to be as quick as people expected. I think there's

[01:04:41] [SPEAKER_06]: going to be a lot of bumps along the road. So I would be very cautious with some given some of

[01:04:45] [SPEAKER_06]: the valuations. Oh, Jim, we have a new standard closing question. I think you're one of the first

[01:04:50] [SPEAKER_06]: people we're going to ask this to. So the question is what is the one thing you believe

[01:04:55] [SPEAKER_06]: about investing the majority of your peers would disagree with you with?

[01:05:00] [SPEAKER_06]: Options are not a derivative. They are the underlying when people refer to options and all

[01:05:10] [SPEAKER_06]: the volume increases and wow, the phrase that everybody uses is it's, wow, the tail is

[01:05:16] [SPEAKER_06]: starting to wag the dog. I'm here to tell you that options are the dog. What do I mean by that?

[01:05:23] [SPEAKER_06]: Well, pretty simple. If you look at a stock or a bond or any asset, right,

[01:05:29] [SPEAKER_06]: people it's two dimensions either goes up or desk what I gave you two stocks,

[01:05:34] [SPEAKER_06]: white label, no name on it, same market cap, same industry, same everything you would say, well,

[01:05:40] [SPEAKER_06]: those are the same stock. What if I peel back that option train and show you that one is incredibly

[01:05:46] [SPEAKER_06]: right distributed with a left tail, the time which that distribution is completely different

[01:05:51] [SPEAKER_06]: and the growth trajectories are different. Whereas on the other one is the exact opposite,

[01:05:56] [SPEAKER_06]: you know, very much a value stock, maybe, maybe left distributed right fat tail in case they come

[01:06:02] [SPEAKER_06]: up with a solution completely different stocks. The actual option they're giving you nodes and

[01:06:07] [SPEAKER_06]: probability across the full distribution of what this thing looks like at the end of the day that

[01:06:13] [SPEAKER_06]: asset whether it's a stock or bond has a full three dimensional picture of its characteristics

[01:06:19] [SPEAKER_06]: of what the asset is. The asset itself is the thing, not the stock price, not the asset value.

[01:06:27] [SPEAKER_06]: The asset value is just a summary of that full distribution by arbitrage, every node on that

[01:06:34] [SPEAKER_06]: distribution that represents this asset is summarized by one price, which is the asset

[01:06:41] [SPEAKER_06]: price, the stock value, the bond value, everybody started in that asset died every simple

[01:06:46] [SPEAKER_06]: two dimensional world. And derivatives are new, so we call them derivatives because they're derived

[01:06:51] [SPEAKER_06]: from this thing. But the reality is they're not a derivation, it's a better technology,

[01:06:55] [SPEAKER_06]: it's a better way to full we're going from two dimensional sheet to, you know, a hologram,

[01:07:01] [SPEAKER_06]: seeing the whole thing in its full essence. And the reason it hasn't been used more until

[01:07:07] [SPEAKER_06]: more recently, but again, we've seen secular growth since I've been in business for 25 years,

[01:07:11] [SPEAKER_06]: and it's been exponential. But the reason is, is because of network effects,

[01:07:15] [SPEAKER_06]: much like a technology, even if it's a better idea, you need to build infrastructure for and you need

[01:07:22] [SPEAKER_06]: more volume and you need more participants for it to be an active and to become the core thing

[01:07:28] [SPEAKER_06]: that people everybody uses. What do we had at last 25 years since I started in the business?

[01:07:33] [SPEAKER_06]: We went when I started in 1998, we had a one, one quarterly expiration in the S&P 500,

[01:07:41] [SPEAKER_06]: and options were priced at every three to 5% in the market. That's it. Now we have every day,

[01:07:48] [SPEAKER_06]: we own by the way, the multipliers were 250. We have every day expiration, we have every five

[01:07:52] [SPEAKER_06]: points in the S&P, we have an option we have options for every single major equity and every

[01:07:58] [SPEAKER_06]: single asset across the world. We have more education, we have access through

[01:08:04] [SPEAKER_06]: frokridge and regulation has thinned out to allow much more access, not to mention we've

[01:08:10] [SPEAKER_06]: gone from 250 multiplier to 100 to 50 to 10 to 1 to now 0.1. It is incredibly available now,

[01:08:19] [SPEAKER_06]: and people are beginning to get educated understand, but the reality is, we're still

[01:08:23] [SPEAKER_06]: at the tip of the iceberg. It is a superior way to position based on information that you have on any

[01:08:29] [SPEAKER_06]: asset, you can express any point without the same taking the full risk of the whole asset at

[01:08:35] [SPEAKER_06]: any point in time or moneyness on that asset. And that is just a superior way to express

[01:08:42] [SPEAKER_06]: information. So my view is that the world is going to options and that option will be

[01:08:47] [SPEAKER_06]: the primary way to invest in the future. And whereas, even though notionally there's more trading

[01:08:55] [SPEAKER_06]: volume and realistically it's still 1% of total investment that happens in the market.

[01:09:00] [SPEAKER_06]: And my belief is that if you look forward in 20 years, 40 years even, we will be in a completely

[01:09:07] [SPEAKER_06]: different world where options sit at the core of investment. So that would be my one different

[01:09:12] [SPEAKER_06]: view. I think that again, probably biased as a function of my where I come from and what I see.

[01:09:18] [SPEAKER_06]: But that is, that's my one thing that I think most people would disagree with.

[01:09:24] [SPEAKER_06]: Thank you, John. Always a class act. Really appreciate it. We hope to have you on against

[01:09:28] [SPEAKER_06]: wonderful being here. Thanks for having me. But forward to the next one.

[01:09:31] [SPEAKER_03]: This is Justin again. Thanks so much for tuning into this episode of XS Returns.

[01:09:35] [SPEAKER_03]: You can follow Jack on Twitter at at practicalquant and follow me on Twitter at at JJ

[01:09:40] [SPEAKER_03]: Carboneau. If you found this discussion interesting and valuable, please subscribe in either iTunes or

[01:09:46] [SPEAKER_03]: on YouTube or leave a review or a comment. We appreciate it.