The No Landing Scenario with Cem Karsan

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

[00:00:04] Join us as we talk about the strategies and tactics that can help you become a better long-term investor.

[00:00:08] - " Hey guys, this is Justin. In this episode, Jack and I sit down with Jim Carzon, founder CIO and managing principal at Kai Volatilia Advisors.

[00:00:26] For a wide-ranging discussion about the economy, macro-related themes, structural inflation, volatility, structured products, the importance of thinking and product abilities when investing, and much more.

[00:00:36] Jim's past episodes have been some of the most widely watched or downloaded, so we were excited to have him on to get an update on his latest thinking and learn about what he sees on the horizon.

[00:00:45] As always, thank you for listening. Please enjoy this discussion with Kai Volatiliy's Jim Carzon.

[00:00:50] - Jim, thanks for joining us today.

[00:00:53] - It's pretty bein' here. Thanks for having me. We wanted to have you back on to talk. Markets, macro, fed, inflation, tactics, I think some long-term perspective, and I think what investors can sort of learn as they think about the markets earlier in the year here.

[00:01:10] It's interesting. It's like the leadership has gotten narrow again after a pretty strong fourth quarter for stocks across the board in risk assets.

[00:01:20] I think this discussion will be an interesting one and one that our audience can learn and grow from.

[00:01:29] I think a Jack had mentioned to you. I think both in 2022 and 2023, the chats we had with you were among the most popular, both on our YouTube channel and on downloads.

[00:01:42] We really appreciate you coming back and talking to us and our listeners because I know they enjoy it.

[00:01:46] Again, great bein' here. I really enjoyed the conversation last time, lookin' to build on that.

[00:01:51] Again, always insightful questions, so excited for the conversation.

[00:01:55] - Maybe let's just start at a broad level, but we can open it up with inflation.

[00:02:01] Inflation has come down since you were last on, but it is somewhat sticky.

[00:02:07] But at the same time, the economies remain pretty resilient. Consumers hung in.

[00:02:13] Just in general, what's your overall take on the macro landscape right now and has your thesis changed at all over the past 12 months, let's say?

[00:02:25] - I'm always on the outlook for a counterfactual. One thing we don't do here is traders, if you're a good trader, be dogmatic, right? That's how you get hurt.

[00:02:33] That said, I haven't seen a counterfactual. Very much, I believe, in the structural realities of inflation,

[00:02:44] I think an important framework to think about what's going on is really this, and I've tried to be pretty clear about this, and a lot of the conversations I've had,

[00:02:53] is this structural inflation that's happening versus the cyclical disinflation that's kind of countering it.

[00:03:02] And I think most people think about inflation as one thing. It's very simple. Are we having inflation or are we not? No, it's not that simple.

[00:03:09] What do I mean? I do not spend too much time on this, but to really focus, structural inflation is a function of rebalancing, things that are happening under the hood,

[00:03:20] that are causing inflation, whereas cyclical is really about what's happening to GDP and economic growth.

[00:03:29] And for about 40 years, all that mattered was the cyclical inflation, and that's why people have gotten so simplistic about what matters because we had the same structural trends,

[00:03:38] which were disinflationary, which the cyclical pressures could just battle against.

[00:03:45] The Fed could have basically right puts whenever it wanted, stimulate lower interest rates, and that would increase longer term disinflationary pressures,

[00:03:55] which were driving that long-term disinflation. But it would slow down, accelerate the economy, I apologize in the short term.

[00:04:03] And what's happened now is that we have structural inflation, and that really is a function of a rebalancing of inequality,

[00:04:11] all the populism trends that I talk about. And that is a function actually. It is a pendulum swinging back from all the Federal Reserve monetary policy effects that have driven that inequality.

[00:04:23] There's several generations, about 40 years, millennials on down, and we've talked about this before, that feel like the system is broken and doesn't work for them.

[00:04:35] And now they're becoming a voting majority, slowly, every four years.

[00:04:39] And so that structural place, which is labor rights, protectionism, de-globalization, increased costs of commodities as a function of competition and resource scarcity.

[00:04:53] All of these things have nothing to do with GDP and cyclical effects. They have to do with rebalancing effects. Money going to the poor means 100% velocity of capital,

[00:05:04] velocity capital of one. Money going to the rich means much, much lower velocity.

[00:05:10] Those two effects are in contrast. And the Federal Reserve is cyclically, because they only have one tool, monetary policy, cyclically trying to dampen the inflationary structure.

[00:05:19] But in the process, they're doing the exact opposite of what they used to do. They used to create disinflationary pressures.

[00:05:26] Now they're actually by raising interest rates. They're creating more long-term inflationary pressures.

[00:05:31] And they're going to have a very hard time countering those inflationary pressures. And it puts the Fed in a box.

[00:05:37] And that's how we got into stackflationary environments in the past. And that's where I think we're heading as we are now.

[00:05:43] I'll leave it there and we can dive in.

[00:05:46] It's very interesting, because I don't know the past 15 or 20 years, it's like a lot of times you hear the Fed is the only game in the town and they have this wide, massive influence.

[00:05:58] And of course, they do. But if these structural inflation pressures are here to stay, you can certainly see how the Federal Reserve has less influence on maybe that higher-level inflation that might be here.

[00:06:14] They have a dual mandate. It's pretty simplistic. It's that easy. The economy is just two things. It's an unemployment and price stability.

[00:06:22] Obviously not, but that's how it's constructed. And inequality doesn't matter to them. All these other things that matter about what's happening in the hood don't matter.

[00:06:30] And as a function of that, they've had disinflation that they've been able to create. And that's a perfect system.

[00:06:37] If they can have disinflation, then lean against it with more and more inflationary monetary policy, it's free.

[00:06:43] But it's not right. They're their costs and that cost is inequality.

[00:06:47] And we've borrowed from the future by taking that cost of inequality. Now, we're paying the piper.

[00:06:53] If we believe as a people that not all that matters is maximizing GDP, but we want to maximize median outcomes for people, and it's a different system.

[00:07:04] And it's not as efficient. It's more inflationary. And it really puts the Fed in a difficult position.

[00:07:11] You alluded to this, but how much is the Fed having an impact here? People have talked about the idea that obviously we have a lot of fixed rate mortgages that are not impacting people who do have capital or getting paid higher interest rates on that capital.

[00:07:22] So you could argue income is going up, which might be inflationary. Like when the Fed is increasing rates here, how much of an impact are they actually having on inflation?

[00:07:30] So there's two parts to that. One, they are having an effect, but they're short-term effects and they're a long-term effects.

[00:07:39] And there's a lag to those effects. Those effects are automatic. They had to take quite some time.

[00:07:46] If they do QT, those effects are pretty, they actually do liquidity removal, which there's been a debate whether or not they're actually doing that or not in the bigger picture.

[00:07:57] But if they do that, there's a direct effect. There's not much of a lag to that. That's a direct effect to assets at least, which then translates pretty quickly into a wealth effect.

[00:08:08] If they're increasing interest rates, which is our primary focus, that takes time. And that takes time because, again, people have locked in rates and some of them are five years, some of them are 10 years, some of them are 30 years.

[00:08:20] And so a lot of that works at a lag. Now, the costs are translating to more rents, though, because people can't now buy homes as easily.

[00:08:32] The cost to people is much higher to go buy home, millennials on down who haven't been able to buy home.

[00:08:37] And so they're forced to rent. And there's a massive supply of demand and balance in terms of supply of properties and people who want to need to rent.

[00:08:46] So they are feeling in terms of rents. And that is more of a structural issue, right?

[00:08:51] So they're not actually stopping inflation in that part. They're increasing inflation, which is kind of counterintuitive.

[00:08:59] So a lot of the things that they do have have unintended consequences, and they are sickly going to dampen kind of demand in the short term.

[00:09:09] And they are having success with that. But it's very uneven.

[00:09:12] And in some parts, they're actually making this structural inflation worse.

[00:09:16] And again, we talked about it before, but in higher interest rates, and tends to be correlated with more labor rights, right?

[00:09:28] Because there's a little bit more power to labor in those situations and de-globalization as well.

[00:09:35] And those are structurally inflationary.

[00:09:37] The more we take money away from corporations, which are the primary borrowers of money, the less power and influence they have, and the more we send it to people, the more power and influence they have.

[00:09:49] And at the end of the day, those people are, they want help for themselves and the protectionist policies that we're seeing.

[00:09:58] So again, it's a complicated picture. The reality is some of the things they're doing are cyclically going to, at some point, if you make money unavailable, that is going to slow the economy.

[00:10:09] But it's not going to be evenly across the economy. And in some parts structure, you're going to massively increase structural inflation.

[00:10:15] And I think that's what's happening.

[00:10:17] Where are you from a probabilistic standpoint on the soft landing thing?

[00:10:22] It seems like the market has basically discounted that. And it seems like that's the consensus view.

[00:10:28] And quite honestly, I'm kind of getting bored with the soft landing term.

[00:10:31] So let's come up with something else here, something that we can get some buzz going on, right?

[00:10:35] Yeah, no landing, is the end of the tournament.

[00:10:38] There is no landing happening.

[00:10:41] There is still some structural...

[00:10:46] And by the way, I want to be clear, it's not like things kind of landed and solve it. Things may cross at a certain point.

[00:10:51] It may get a 0% inflationary point, but that doesn't mean we've accomplished the mission.

[00:10:58] The problem there is that means you're heading into a recession and you may have significant problems while structural inflation is still relatively firm.

[00:11:07] And we've gotten it to 2%, but the economy is kind of going in the wrong direction.

[00:11:13] My view is that we haven't had a landing and as we've seen with labor, we continue to see.

[00:11:20] I mean, all the last three, everybody's saying soft landing, I'm still hearing it because markets are kind of doing well.

[00:11:24] You know, narrative follows price.

[00:11:26] But if you actually look at the CPI, if you look at the unemployment numbers, they've all been hot for two and a half months.

[00:11:33] And we produced 350,000 jobs last unemployment.

[00:11:37] That was a massive beat.

[00:11:40] How much people are still calling that a soft landing? When did we land? What do we land on?

[00:11:44] I'm very confused, unemployment is, you know, so no, I think structural inflation is still very much alive and well.

[00:11:54] All the trends that are feeding into it, we see every day, right?

[00:11:58] More geopolitical conflict, more trade wars with, you know, China.

[00:12:03] You know, we are labor rights. You see a new kind of union deal or a new kind of strike happening every day.

[00:12:10] So those things are not going away.

[00:12:13] And we're, we're again battling that by trying to slow the economy.

[00:12:17] We are getting slowness, like slowdowns is part of the economy, but those parts are dangerous.

[00:12:22] The commercial real estate issue is going to rear its head.

[00:12:25] We're seeing it, you know, in these banks, you know, in the run on some of these banks,

[00:12:30] we are seeing all the malinvestment rearing its head as they raise interest rates.

[00:12:34] That will have an effect that will slow the economy, but it will be incredibly uneven.

[00:12:41] And the question is, when that happens, in my opinion, the closest thing to what we're going into is stagflation, right?

[00:12:49] Not a soft landing. And that sounds very different, right? That's, there's similar, but very different things.

[00:12:56] What do you think they're going to do, you know, given this no landing scenario?

[00:12:59] You know, on one hand, you could argue they should be keeping rates where they are, you know, given no landing.

[00:13:03] But on the other hand, they're going to be getting a lot of pressure to cut.

[00:13:05] The market expects them to cut if an election year, you know, what do you think they're actually going to do as the year plays out?

[00:13:11] I do think that they are going to be easier than people expect as we saw in December that primarily for political reasons.

[00:13:23] And this isn't a conspiracy. I think the reality is, you know, there is, they can go one of two ways.

[00:13:32] They're in a box. They can either try and get inflation down, or they can try and not have a recession.

[00:13:39] And they have a choice, right? They have to make, they have to prioritize one over the other at this point.

[00:13:46] And it's a subtle decision, but the subtle decision ends up coming up to

[00:13:52] who's in control and who, you know, what do they want longer term?

[00:13:56] And I think the reality is, in a political season, they are going to continue to be overly stimulative.

[00:14:06] So, you know, my view is that they probably will cut.

[00:14:10] I don't think it's going to be quick. I think that they're going to have, could be constrained.

[00:14:14] And we've been saying this for a while, buy hot numbers, right?

[00:14:18] And that the market is also going to continue to front run them, you know, as until they actually do it, you know.

[00:14:26] So, my view is very much that they will cut and be easier than they should relative to the inflation that we're seeing.

[00:14:35] And that markets will react positively. And that's primarily is because on baseline, we don't want to recession this year.

[00:14:43] Right? Nobody wants to recession this year. It's a political year. All the powers that be that important to note, you know,

[00:14:50] it's not just political in terms of political powers, but Powell's going to be out of a job come January.

[00:14:57] Right? His, his, you know, what is his legacy?

[00:15:01] What does he, how does he want to leave this? Does he want to leave amidst a recession?

[00:15:05] You know, what is, what are the political powers that he's more aligned with? Right? Pretty, pretty clear.

[00:15:11] Powell won't be the central bank president chairman. Sorry, if, if Trump gets elected.

[00:15:18] So there is a

[00:15:19] Confluence events here where politics does creep into all this and that's been the case since Arthur Burns even before that, right? And nothing has changed.

[00:15:29] And so do you think that eventually, maybe not, you know, this year obviously we probably continue to have a strong year. They're cutting things are going well. Like eventually we see a resurgence in inflation here.

[00:15:39] Yes, and I think that's what the steeping of the yield curve is telling you as well. I think the easier we are now.

[00:15:46] And you know, assuming the Fed does pivot and lower rates, I think that means worse inflation ironically later.

[00:15:56] And so I think the market is wake up and we were out in front of this. By the way, we've been talking about this for nine months.

[00:16:02] This is what's going to happen into the slowdown in the economy that the Fed will be forced to pivot. And when they do, longer term yields will actually go higher or stay where they are while the front end comes down.

[00:16:15] And that is a regular thing in the last 40 years. You know, when you go into recession, you usually see the whole curve shift down, right? And then the front, you know, kind of come down.

[00:16:26] So we actually think that the 10 year will not only stay here, but potentially go even higher in an election year if we're all being if we're all stimulating.

[00:16:35] And you know, guess what fiscal is going to stimulate as well. What do you think is going to happen to supply and demand given issuance and given all of kind of the liquidity pressures that we're seeing.

[00:16:47] So, so yeah, our view is very much that the 10 year on out actually stays firm, you know, actually yields go flat to higher, and that the front end of the curve does come down.

[00:16:58] And eventually that's actually the worst thing that can happen, because that reinforces inflation.

[00:17:05] We know the long term yields are actually the biggest issue that long term inflation expectations are the biggest issue for the Fed, because if people start saying, Oh, wow, inflation is structural, and if markets start saying that two things happen.

[00:17:19] One, you can borrow money at now cheaper interest rates to buy everything pinned down, right, which increases demand for those things and pushes the price.

[00:17:28] But too, it also brings forward demand in terms of inventories and consumption, right, which is what happened in the seventies, which eventually then you get into a loop, which they tried to break and they couldn't in the seventies.

[00:17:41] And I think that's the one thing that's kind of been missing. I think I think that is the next step in this scenario.

[00:17:48] And it's going to be made worse by pressures like higher oil due to geopolitical conflict, higher cost of labor due to geopolitical conflict.

[00:17:59] And a lot of inefficiency, you know, that we're seeing across across the economy.

[00:18:05] So do you think the problem is not necessarily say like the 4% sticky inflation, but we could actually see a resurgence back to the types of levels we saw before here.

[00:18:13] I'm going to paint a picture. Everybody thinks about the 1970s. And I hate to always be focused on that. That's the last period of inflation we have seen.

[00:18:20] We haven't seen inflation in 40 years structural inflation. So it's the best proxy. And again, there's a lot of differences. You know, I want to be clear, we are not 19, the 1970s exactly, but it rhymes.

[00:18:31] It rhymes.

[00:18:32] And what happened in the 1970s inflation went to and the first bout went to six and a half percent or so in call it 1967 68.

[00:18:44] And then the fed came in and raised interest rates. And what happened inflation went down to 3%. Right.

[00:18:53] Plation came down to 3%. We were in a very mild recession for some time. They couldn't get it really to come down much more than that.

[00:19:02] And in 1972 after about a year and a half, two years of recession, they said, okay, we're going to cut rates.

[00:19:09] And what happened, that's when inflation went to 12%. Right. Now that structural inflation had really become kind of embedded and the cyclical kind of pressures they were putting on it to kind of slow it.

[00:19:22] We're taking off and push the other way. And inflation took off.

[00:19:26] Why? Because they were running a demand push economy. That was the great society program. We're doing tons of fiscal spending.

[00:19:33] We were in the Vietnam War. We're spending a lot of the Vietnam War. We had a lot of, we had a new Cold War happening, a lot of trade wars and de-globalization. I mean, this sound familiar.

[00:19:43] And so started stimulating inflation went to 12. Well, what happened? 74. We now had to deal with inflation. We've had 73, 74, the Fed started raising, raising interest rates again, trying to quash inflation handed down to 6%.

[00:19:59] But they got it down to 6% amidst a really deep recession in 1974, 1975.

[00:20:06] A very deep ugly recession and people, that was stagflation. That's what my opinion is coming. Stagflation. Maybe not to that extent. Right? I don't want to kind of overstate this. Right?

[00:20:16] But this stagflationary environment is where we are. And what do you do now when you're in a deep recession and inflation is still 5.5%, 6%.

[00:20:28] We haven't seen that yet, right? But that's where we're heading in my opinion. And we're at least 4.5%, 4% inflation into a deeper recession.

[00:20:37] And that's not now. That's the next step. And at that point, all these structural effects become much more powerful in the long-term yields and inflation expectations go up.

[00:20:48] And if that loses control, the Fed loses control over those circumstances. And that's the Fed's nightmare.

[00:20:54] And it's happened before. And I think we're working towards it's not happening overnight. It doesn't happen. It happens over the course of 5, 10 years.

[00:21:03] But I think that's where we're heading, unfortunately. And the only way to work our ways through this, there is no solution except for paying back what we've spent in a sense into this period.

[00:21:19] We need a rebalancing in a sense. And if we're rebalancing wealth inequality and that's our political focus and we're going to do protectionism and onshoring and rebuild our economy in that sense, these are the costs that we have to pay and it takes time.

[00:21:35] You mentioned a lot of the similarities with the 70s. I'm just wondering, do you think there's some major differences to investors should keep in mind as they kind of look at how this might play out relative to how that played out?

[00:21:44] Significant differences, two in particular that I would highlight one.

[00:21:49] It's the first one everybody else to highlight. I think the other one is more kind of something we've been talking about, but the debt, right? Like we had our debt to GDP is way higher, right?

[00:21:59] And that forces a different reaction function before the Federal Reserve and for government broadly.

[00:22:06] I'm in the minority on that piece in the sense that I don't think that's as critical. It will affect policy. It will affect political dialogue.

[00:22:15] It will play a role in markets and be something a narrative that everybody's talking about where he's starting to hear it.

[00:22:22] But in my view, that will lead to some type of a debt jubilee. Ultimately, it could be a monetization. It could be literally hitting a button and just doing massive amount of QE and buying.

[00:22:33] All of the treasuries and then hitting a button to make it disappear.

[00:22:38] But something along those lines, I know that sounds dramatic, is kind of where that leads.

[00:22:43] And in my opinion, that doesn't actually affect. It doesn't make the dollar collapse. Everybody thinks that's the case.

[00:22:51] Everybody thinks that's a massive, massive negative for the US and that they won't be able to continue to deal with that and create all this debt.

[00:23:01] My view is actually similar to when Nixon took us off of the gold standard, which was essentially a debt jubilee, right?

[00:23:08] That the dollar will get stronger in that process. The second our debt to GDP just magically drops because we get rid of it.

[00:23:16] Guess what? That's a positive for the dollar and that concern now is gone.

[00:23:22] That's what happened when we got taken off the gold standard.

[00:23:25] At first, there was a panic. People thought, "Oh, the dollar will collapse."

[00:23:29] But once they realized that the value of the currency is really a function of power and nothing else, right, then the dollar got stronger.

[00:23:37] And I think that's what will eventually happen and why this debt issue is not as big an issue as people expect.

[00:23:42] Because we can ultimately get rid of our debt. It will be an ugly episode of it. It will be volatile.

[00:23:48] That sounds polyanish, but that's the truth. There is no 80% of global economic development.

[00:24:00] We are 92% of trade happens in the dollar with the biggest military, yada, yada, yada.

[00:24:09] There's nobody who is an alternative. A couple years ago, everybody was like, "Well, China."

[00:24:16] Here we are. Make a look at what's happening there.

[00:24:19] So my view is that's not the biggest problem, but that will be the dialogue.

[00:24:23] That's what's different this time and will be a big issue along the way. I don't think it ultimately matters.

[00:24:28] The bigger issue, ironically, which nobody's talking about is structured.

[00:24:32] There were no derivatives in the 1970s. Market structure was very, very different.

[00:24:39] And that sounds like, "Oh, why is the ... come on, you just talked about global debt and now you're talking about something small like structure product."

[00:24:45] It's way bigger than people understand.

[00:24:48] What structured products and derivatives broadly allow people to do is they allow them to, instead of just go to the bond market

[00:24:56] and take their money out of equities into the bond market, they allow them to take money out of the equity market

[00:25:01] and put it in bond and still take risk with those assets.

[00:25:07] How does that work? Derivatives were created for primarily capital efficiency.

[00:25:12] You don't buy an asset when you buy a derivative. If you buy a future, I don't have to put up the money.

[00:25:18] I just have to put up margin capital, just enough to make sure I don't.

[00:25:21] If I lose money, then I cover that risk.

[00:25:23] And that capital efficiency means, whether it's options or futures, that you can take that money that you're getting put into T-bills, get 5.5%.

[00:25:31] And then structure a yield with that collateral on top of that.

[00:25:35] And so there's a massive growth in structured product demand. And by the way, everybody thinks this is new.

[00:25:42] It's not new. It's new relative to inflation here in the U.S.

[00:25:46] But if you look in Asia, structured products in some countries are dramatically bigger than the equity market.

[00:25:52] That's how big they are.

[00:25:54] And they define volatility. They define market action.

[00:25:57] People are, this is a foreign to people here, right? But anybody in the Volspace knows this is not a foreign small thing.

[00:26:05] Volatility in the Korean market, South Korea was crushed for decades because mom and pop primarily didn't invest in equities.

[00:26:14] They invested in structured products at their corner five and die.

[00:26:19] And that had a dramatic effect on implied volatility and support probably for assets.

[00:26:26] That's what we're beginning to see here.

[00:26:28] And I think the growth of the structured product business is going to really provide liquidity back to equities and risk assets broadly.

[00:26:38] That hasn't been there in past market cycles.

[00:26:40] And we'll create a very different reaction function to market specifically as it relates to inflation and the flows that come as a function of inflation.

[00:26:50] And again, we can dive into that a bit more. But again, in past cycles in the 1970s, money came out of the equity market and into the bond market.

[00:27:00] Because if you could get five, 10% yields, why would you invest in the equity market? And that really crushed multiples.

[00:27:07] Now you're getting people going into the bond market, but they're also a big chunk of them are also starting to use that collateral, at least the bigger players and those are more sophisticated.

[00:27:18] To go then layer that collateral, those T bills to make more yield in some form or another.

[00:27:24] And that tends to be while compressing and send money liquidity back into a very stabilizing, particularly in the middle of the market in the indexes back into provide stability and support and compress wall.

[00:27:37] That's what has led to this historic dispersion trade that's really started in 2017. It just continues to go in one direction.

[00:27:45] But I think we will continue to see that. And I think that will change outcomes somewhat going forward.

[00:27:53] What do you think the risk of these structured products is? I've learned a ton about this kind of stuff, but I've learned anything in the markets when anything seems like a no-brainer.

[00:28:01] It's an obvious thing to do. It can go on for a very long time, but eventually something bad typically happens.

[00:28:07] So do you think there's a major risk of these things to the market?

[00:28:11] Yes, there is. They're ball dampening here locally. And they're not levered. These are not levered trades. For the most part, they're distributed across the market in a way that is not like a long-term capital management or an XIB,

[00:28:30] where all this risk is concentrated on one thing that can then explode and really affect everything.

[00:28:35] It's just a lot of other people delivering from the equity market into a product that is equally low leverage, but non-corelaze.

[00:28:44] The reality is if this goes on long enough, eventually people start taking silly risk. At some point, if everybody out there says, "Well, ball supplied, nothing can go wrong, I'm going to sell more ball and I'm going to keep selling ball."

[00:29:01] Then it gets concentrated in a fund or a place that's doing this and doing it, taking kind of risk. So it creates this kind of moral hazard, I guess, which I think could be very dangerous eventually. Nothing goes on forever, right?

[00:29:13] And eventually the risk just gets too big and concentrated somewhere else. The other problem with them. So that's number one.

[00:29:19] Number two, look at China. You may have heard about all the autocollables and what's happening in China right now, but then it's a big enough existential issue in China.

[00:29:30] That even all the structured product writing and everything doesn't matter. That's so big, they're having massive issues that the market has actually had already started a massive decline.

[00:29:44] And actually all these structured products are accelerating and making it worse now.

[00:29:50] And because banks have to hold them and they're nonlinear, they have breaking points and they're hard to hedge for banks. So banks are being forced into situations where they become sellers of the market.

[00:30:02] And actually as you approach them, the hedging of them is very, very dangerous and structurally can create massive losses in certain portfolios.

[00:30:10] But banks are where that risk ends up being. And so banks already have a tail on them just by definition, right? The bank almost by definition is a Ponzi scheme. Like it's a lever.

[00:30:21] You have a very small amount of capital leveraged underneath the hood. So there's always a massive tail on banks.

[00:30:28] And now there are all these assets sitting on these structured products are primarily being issued by banks.

[00:30:33] And a lot of them are sitting on their balance sheet.

[00:30:39] Foods. They're offsetting that with more vanilla options, right, other things that they can hedge it, which works quite well until you get really close to those structure products and where the issue is primarily is and strikes and other things. And then it starts to become this massive like, oh, mismatched hedge in the equity market, you know, the options of all market versus what the structure products actually look like under the hood and can create really dangerous concentrated risk at certain banks that are holding those structured products.

[00:31:08] So yes, the answer is it's not a free lunch. Never is like you said. But those risks really reside in two places, which is one, just the over arching. Hey, the more you dampen volatility at some point, it's a moral hazard. And people just keep selling it till it gets to a point where the potential energy gets worse and the risk gets concentrated.

[00:31:25] And two also, once a rip move actually can break out of this, it's harder to do. But once that can break out of this kind of ball compressed environment, at some point, there is enough mismatch between how banks hedges that there can be a problem at the core banks in these structured products that sit on banks.

[00:31:42] And let's earmark this and remember this, because if and when this happens, I want to point back to this, but it almost always does happen.

[00:31:50] And again, just look at what's happening in China right now. These snowball, like autocollables are playing a significant role in some of the decline that they're seeing there right now.

[00:31:59] Can I just ask a day? Can I just ask like a basic question? We run very plain vanilla standard long only strategy. So this idea is, you know, outside of our area of expertise or how we run money. But so with the structured product, let's say we have an investor,

[00:32:17] a million dollar portfolio that has a 60/40 stock bond allocation. So with the structured product, would that be like for the bond portion? That would be roughly $400,000 they could put up, you know, some small portion of that to get the derivatives exposure that would effectively be something like a 40% bond position.

[00:32:41] And then that extra capital comes back into the equity sleeve. Let's put it this way. You can actually buy a structured product from the bank that does essentially what you're saying, or you can, people who are sophisticated can structure it themselves kind of what you're implying.

[00:33:01] But the core idea here is a derivative allows you to get that T-bill rate and then use that T-bill that you have now as collateral to take risk.

[00:33:16] I see. And that risk, you can take in several different ways, anything that's a derivative will demand collateral, some proof, some good collateral, which a T-bill is that you can repay a loss if it were to happen.

[00:33:32] And there's value to that. Right. So the point is a T-bill is risk free. And you can get that risk free rate, right. And then later on top of it, some risk.

[00:33:43] And that because the risk you can take, there are all kinds of risks you can take that are not market risk. You could go sell the very low leverage. You could go sell a 20% out of the money, 25% out of the money, whatever percent you want out of the money, put a year out or two years out, right.

[00:33:58] And you could go do something similar on the call side, because why does he want this is a very basic example. There's a bunch of other things that you could do.

[00:34:05] And maybe that one year strangle you sell, very low leverage by that. I mean, one to one, meaning cash secured puts, cash secured calls.

[00:34:18] Maybe that yields two and a half percent.

[00:34:21] Guess what? I'm not making five and a half. I'm making eight percent. And I'm completely non-correlated. As long as the market doesn't go down more than 25% or up more than 25%, I'm going to make that money.

[00:34:33] And if it does go up more, I only lose, you know, 1% for every 1% over that the market goes up. And it's coming out of what I've already, that 8% I'm already making.

[00:34:41] So you have a big cushion. These things are very appealing in a world where, you know, 8% per year, right? Non-correlated.

[00:34:49] In a world where we don't know, is the market going to be down 20% this year? Is it going to be up? We have less confidence in that based on a lot of the factors we're talking about based on valuations.

[00:34:57] It's a pretty appealing value proposition. And the point here is that you'll go higher, right? Those only go higher, right?

[00:35:06] And you get to get that table rate, but still take risk. That's non-correlated.

[00:35:11] That's the value proposition. And again, you can't blame Joe Asset Advisor or Mom and Pop for saying, "Wait, I don't want to be 100% beta to this market, but I still want that 8% yield.

[00:35:23] And I'm willing to take that extra risk." This is a basic example. There are other ways to go about this or other non-correlated kind of...

[00:35:30] I mean, imagine now that you're stacking a bunch of diversified bets instead of just 25% out, 25% out in different markets in different ways, right?

[00:35:39] So you're a bit more diversified on that yield. And now your risk goes down to one event or another, but you're still getting a non-correlated return of 8.5, 9, 9.5, 10%, right?

[00:35:49] Sounds pretty interesting. Hopefully that...

[00:35:53] Another thing explains...

[00:35:54] Thank you.

[00:35:55] Another thing that's... I think sort of along similar lines, but has gone on a lot since we last talked to you is this zero DTE options idea.

[00:36:03] When we last talked to you, it was a thing, but it was not the thing that it is right now. It's risen a lot.

[00:36:09] And I'm wondering if we could just get your take on that as well.

[00:36:12] I mean, do you see that as a big risk to the market? I mean, it seems like as an outsider, like the use of those has gone up dramatically.

[00:36:19] Do you see some sort of major risk to the market associated with that?

[00:36:22] So it's nuanced, right? Everybody wants black or white, right? It's nuanced. In some ways, it's better, less risky.

[00:36:34] In other ways, it's significantly more risky. Let's talk about how... Let's start with the why it's less risky first,

[00:36:44] because that's like the less... The conversation my people aren't having.

[00:36:49] If you look at what happened with derivatives in the past, in terms of causing major issues, it tends to be... There's a liquidity imbalance, right?

[00:37:00] If somebody gets short, think long-term capital demand. What are the first two words there? Or the first word, they're long-term, right?

[00:37:08] The opposite of zero dt. Why was long-term capital management problem? Because they were based... They were selling vol one, two, three years out.

[00:37:17] And when they had to come back and buy it, they couldn't wait until it expired. They couldn't wait until it went away.

[00:37:26] It was stuck in a position that was illiquid. And at that point, much like when oil can go to -30, it doesn't matter what it's worth or not worth.

[00:37:34] The reality is, a value of an asset that's illiquid can go to any price, as long as there is an imbalance of supply and demand.

[00:37:43] So, when you're trading options and derivatives that elongated... By the way, 2008 was a similar story. 2008, part of what caused the structural issues we saw is 10-year long-term variant swaps, which are barely traded now because of the crisis that we saw underneath the hood there.

[00:37:58] Went to a 60 implied volatility. 10-year implied volatility was priced at 60%. Think about that. Think about that.

[00:38:08] 10-year implied volatility. The assumption was that we were going to be at a 60% vol for the next 10-year.

[00:38:15] Logical. If I go at oil going to -30, it doesn't make sense. It was a function of liquidation. People were so broken that they had to cover at absurd prices.

[00:38:27] So long-term derivatives represent a leveraged problem in a liquid market. 0DT doesn't have that problem. 0DT, if you put them on today, they're gone tomorrow.

[00:38:41] And if the market crashes because of something, guess what? The next day, nobody's going to sell it because they don't want to take that risk.

[00:38:48] So that's the positive. Volume moving from longer-term to shorter-term means there's less liquidity risk past one day.

[00:38:58] Now, let's talk about the risks. The risks are it's the most powerful moment. The gamma on it is so massive on a zero-days expiration.

[00:39:10] Never mind zero-days expiration. 1-hour or 2-hour options. Anything can happen. A dramatic move in a very short period of time can create massive losses very quickly.

[00:39:22] And because it's so concentrated, there is no way to hedge that part of the distribution other than the hedge it was here on DTE.

[00:39:33] Think of it as the GameStop and meme name issue we saw. But we saw again there as prices, crazy things, absurd things could happen, right?

[00:39:43] In a very short period of time because it represented a place on the distribution of that a market maker and entity trying to absorb that risk can't hedge.

[00:39:51] The only way to hedge GameStop is to hedge it with GameStop. The only way to hedge these meme names was to hedge it with themselves.

[00:39:58] They have no correlation to other names. Again, a bit of a reach in terms of a metaphor, but a similar idea.

[00:40:07] Zero DTE, you can only hedge with zero DTE, which creates a loop. I was at the CBOE's Risk Management Conference earlier or late last year in October, and this was a big topic obviously.

[00:40:22] And they put the biggest market makers, several of them on stage for as conversation about zero DTE.

[00:40:28] And in the last set of questions, a good friend of mine, that's a market maker, I won't name him here is, you know, reach stood up and asked a question.

[00:40:40] He said, "How in the world do you guys hedge this risk?" And I kind of got quiet. I said, "Each of them agreed. We hedged them with other zero DTE."

[00:40:48] So when you see the CBOE come out with, "Look, it's balanced. The market in zero DTE is very balanced." Right? The market makers are flat consistently.

[00:40:58] There's not a risk here. There's not an imbalance. It's because their hedging zero DTE was zero DTE. They have to be balanced.

[00:41:06] Now, why is that a risk? Because when you're in a loop and a closed loop where you can't lay off the risk anywhere else, what happens if somebody comes in tomorrow?

[00:41:17] And we've seen this already. It happened a little earlier this year. There was a relatively small trade that happened in a big block that took all the market makers out of some, you know, near out of the money puts.

[00:41:30] And what that did is it created a cascade and we were sitting there very placly. I can forget what the date was a month ago, seeing very placly all day.

[00:41:38] And the next thing you knew we were down almost 2% based on one order. Because everybody had to go buy back that gamma and that gamma loop creates a cascade, which can really feed on itself.

[00:41:51] Now let me just imagine a liquid scenario where I come in and I just, "Hey, look, this market's vulnerable. I'm going to go buy 5,000 out of the money puts on the offer, above the offer. Just take them off."

[00:42:06] And there's nobody to now provide other than the market makers themselves who are short. Right? Liquidity for those same options they're buying back.

[00:42:14] What does that do? That creates a massive short term, a bit, you know, gamma squeeze in the market. So you can create a massive, there's structurally a risk here that you can create a massive squeeze in terms of gamma in a short term move that can be very dangerous.

[00:42:27] It accelerates the probability of a one day crash. The odds of that are much higher now that these are these are, you know, structurally in the market.

[00:42:37] But in terms of longer structural issues, the day that that crash. And that could feed on to other problems in the market and create the bigger issues that are not in zero DTE.

[00:42:47] But it's again a different risk and a different reality. The last thing I'll say is regulators have not caught up to the amount of size and structure of these zero DTEs.

[00:42:57] This is the other issue you may have heard me talk about this. I don't want to spend too much time on it. But the regulatory requirements for zero DTE are just not, they're just now starting to even charge any margin on these because margin itself was daily.

[00:43:11] You could train zero DTE and never post margin. Now, no clearing entity, like a bank or entity is going to let you come in with zero dollars and trade these things and not be mindful of your risk.

[00:43:23] I would think, but it does create a moral hazard where people will walk this big customer.

[00:43:29] You know, if I can give them slightly better, like not check his margin to all make a lot of money and get that and instead of going the money, you know, the business going to so and so.

[00:43:37] We've seen this with plenty of hedge funds, right. Get, I will, you know, name all all the names that we all know. But again, regulators don't force a requirement and you leave it up to just the clearing houses to do that.

[00:43:51] Inevitably, that still creates massive risk. So that is another issue that I think that will be addressed. Regulators are kind of on the case. They're just moving very slow.

[00:44:00] There's a, there's a, I'm sure there's many pieces, but if listeners, there's a Reuters piece titled zero day options, just a, you know, a sector in US stock volatility, but this is from December 21.

[00:44:12] So I think that's the, you know, that that was the day or the week somewhere in there. So investors that are listening want to kind of go and, and learn more about what you're referencing. That's, that's the time period in there.

[00:44:29] What you were getting at is something I've been thinking about a lot, which is, to some extent, you'd think this would be isolated to one day.

[00:44:35] But I also was wondering, like, if you got some sort of major move up or down on that day, would that affect, you know, dealer flows associated with options further out in the future? And it could cascade beyond the day.

[00:44:46] Yeah. I don't know the answer to that. But that's the thing I was thinking about a lot.

[00:44:49] Yeah. So it can, it can, but, but what we're seeing is a significant decrease in some of those options.

[00:44:55] And then, and the volume is more or less moved to zero DTE. So there's less, my point is less leverage in the longer dated stuff.

[00:45:04] But again, to your point, yes, once you, if you were to get a 87 style crash.

[00:45:10] Right. Yes, that's going to have knock on effects and all kinds of other assets and all other kinds of places. And then, yeah, zero DTE may not be the problem after that.

[00:45:18] It may have been the spark. But then the problem is kind of brought to the forefront in lots of other places.

[00:45:25] Just a couple more for me before I hand it back to Justin. I think your followers would kill me if I didn't at least ask for some problems when we have you on.

[00:45:32] You know, we just got through a period in January, which was a potential window of weakness and we survived that. Okay.

[00:45:37] What are you seeing going forward as we head into the middle of the year?

[00:45:41] Yeah, so the window of weakness, right? It's like it's so simple. You just kind of short, short the market when that window weakness comes, right?

[00:45:54] It's obviously not that simple right and that's what I always try and

[00:45:58] Educate on it's it's a time when certain positive flows, right are absent. It doesn't mean the market goes down in that period. It's just a lot of the somebody's structural positive flows that support against the downside. Now, go away. Now, that doesn't mean you're going to crash, right? It's not like there's a bunch of selling pressure. It's not the same thing is, oh, there's a bunch of selling that's happening. And so important to note that when we entered this January period,

[00:46:28] that vol was very well supplied and that there had also just been a pivot, which back in December,

[00:46:36] early December, nobody really first saw we definitely didn't where the Fed had now expected

[00:46:43] all of a sudden to to provide massive, you know, stimulus and reverse, you know, reverse

[00:46:50] some of their the views in the market of of how much liquidity they would be providing.

[00:46:54] So we got to early January and mid January and we were pretty public coming into that that

[00:47:00] look you kind of you kind of have to look for it and realize that this is coming. But in

[00:47:04] the context of that, think about what the other flows are. And at that point, it became pretty

[00:47:08] clear to us that that the more likely scenario was was February if we were going to get a

[00:47:13] decline at all. Right. This is an election year. We've said this from the beginning if

[00:47:19] this and this is the this is the chance for the market to take its to to take a little

[00:47:23] tumble to pay back the 25% rally we've seen in three months. Right. And if it doesn't

[00:47:32] happen, right, you know, you have to be prepared for something much more parabolic to the upside

[00:47:40] this year. And it's important to know and I've said this before, what you know about

[00:47:47] these structured flows doesn't just tell you, imagine you have, you know, 40, 50% of the

[00:47:53] picture call it 40% of the picture of structural flows. You don't know what 60% of the flows

[00:47:58] are. Right. If you don't know what 60% of the flows are, but you know what the 40% are

[00:48:04] is other people have no idea. Right. What does that do that changes the probability distribution

[00:48:09] of what can happen because you know what 40% of the the flows are. But it also tells you

[00:48:15] about the 60% you don't know based on what's happening in the context of the 40% that you

[00:48:21] do know. Right. So the fact that the market's been this strong, right, in the context of

[00:48:27] some of these windows, you know, in this window in particular, I think tells you a lot about

[00:48:32] the liquidity circumstances and what's happening otherwise. Um, that again, we tend to see this

[00:48:41] type of movement before a reversal, by the way. So I think, you know, this market up ballup

[00:48:45] that we've been calling for, we have seen starting in mid January, that's when we said,

[00:48:49] look, be very proactive with being long volatility. Because any move up from here would also be

[00:48:55] more likely market up ballup, which is true, which is what we've seen. So you've had a

[00:48:58] bit of an edge, you know, the way to bet on this before a crash comes think about 99.

[00:49:04] I got started the business 98 when the first things I experienced in 99 is massive volatility

[00:49:10] increases into rallies. And the way the tech bubble burst, right, and we've seen this in

[00:49:16] other, whether it's O eight or, um, you know, other other declines in the past is it's not

[00:49:22] just important to squeeze out short interest. So the speed of the move start getting more

[00:49:25] accelerated towards the top, right? Because people start betting against saying this is

[00:49:29] crazy. You know, those values are too high. The market needs to come down for under,

[00:49:33] uh, under allocated. So that creates a bit less supply and, you know, supply in the market

[00:49:38] can, can move very quickly the upside, but it also, because volatility starts increasing

[00:49:41] the upside and we're sliding historically to lower balls like these, uh, these calls

[00:49:46] or price on lower balls, it can unpin implied volatility, right? It can create a SNET scenario

[00:49:51] where, where there's enough people willing to say, well, ball keeps going up on the upside,

[00:49:54] why wouldn't I be long ball? And they keep buying volume on pins. And that's what we're

[00:49:59] starting to see, by the way, um, you know, we're said, the longer term ball and it started

[00:50:03] to perk up quite a bit. And, uh, we're starting to see that in, uh, May, June, July, August,

[00:50:11] September options are really maintaining their value. And if anything going up in terms of

[00:50:16] implied volatility, and that can create a SNET scenario where the market becomes less

[00:50:21] pinned and allows for a decline in markets. So I actually think the market moves and what

[00:50:28] we've seen, uh, broadly in the last several weeks are very supportive of the, of the, of

[00:50:33] the view that come mid February that we could, you know, the probabilities are increasing

[00:50:39] of a decent decline. I think if we get up near that, the higher end of what we were kind

[00:50:44] of expecting 50, 50, 50, 100 or so in the S and P, uh, maybe even, you know, a, a flash

[00:50:51] quick move up above that and then kind of back down, especially if we're entering that

[00:50:55] window where things are weakness, um, it could be, you know, it weak, this could be, you

[00:50:59] know, the shot that you, that people have been looking for to kind of short it until

[00:51:03] then until February 14th, you really can't get out in front of this. And I've been very

[00:51:07] clear about that. This is not the type of market you want to short, um, until you get

[00:51:12] the sign that, um, that things are really turning in that window. Um, and, and again,

[00:51:18] if it doesn't come, right, if it doesn't come and it doesn't work, you know, if you're

[00:51:21] not getting the check, checking the boxes, what needs to happen beforehand, um, you can't

[00:51:24] just wait, right? You have to, you have to be very constructive given the liquidity circumstances

[00:51:30] that are being, you know, pushed into the market. Otherwise. And, you know, given, you

[00:51:35] know, it's an election year, the amount of coming, uh, monetary and fiscal support that

[00:51:39] we're likely to see it. What you, what you just said, you know, you use that word probability

[00:51:44] a ton. And I think that's one of the biggest lessons people like us who are outside of

[00:51:47] the options world. Can you learn from people who are inside the options world? You know,

[00:51:50] you kind of mentioned, when you talk about window of weakness, everybody's like, just

[00:51:53] short the market, you know, it's going down, like you're not thinking that way. You're

[00:51:56] thinking about a probability distribution of a bunch of different outcomes that could

[00:52:00] happen. And you're thinking about weakness as a little bit higher in that probability

[00:52:04] distribution that it normally would be. And I think that's something all of us as investors,

[00:52:08] you know, whether we live in that short term world or not can learn from, you know, somebody

[00:52:11] who understands options is this idea that everything is sort of a probability distribution

[00:52:15] of potential outcomes in the future.

[00:52:16] Jack 110% if I couldn't make a point like on every conversation I have, it's that one

[00:52:22] point. There is a significant opportunity in prediction when you're predicting probability

[00:52:30] distributions. It is much harder to predict up down. Right. What I can tell you up very

[00:52:37] often is, okay, the probability has gone from normal to right, very right distributed,

[00:52:42] but fat left tail. The expected return may not change, right. And to your average person

[00:52:48] there be like, well, you'd said it was right distribution, you said we're going up. Yes,

[00:52:54] the probability that is a higher percentage of going up. But if you go down, it's going

[00:52:58] to be a big fat tail. Right. And that type of a setup allows if in the options market,

[00:53:03] you can take those bets and make high conviction probability best that are in line with that

[00:53:08] based on the distributions. You can make a lot of money on that prediction. And that's

[00:53:13] easier to do. But that doesn't mean in the window of weakness, that you just go flat

[00:53:18] long. Yes, the high it's a higher percent winning rate of going long. But if it goes

[00:53:22] down, it's going to be a massive fat left tail, and you're going to lose a lot of money.

[00:53:27] Right. In that scenario, what you should do, and this is a good example for February

[00:53:32] and the March, right? March is a massive open interest of options because of structured

[00:53:38] products tied to quarterly expirations. As part of why we saw the massive tail in 2020

[00:53:43] from the day after February expiration to the day after March op-ex, right? Very I think

[00:53:47] we're the only people that ever talk about this that everybody talks about COVID in the

[00:53:50] market crash. But nobody talks about the fact that it was literally to the day of the options

[00:53:53] expiration cycle for March. And the reason was because all that open interest in March,

[00:53:59] we knew about COVID in late December, early January, we topped, you know, on the day of

[00:54:05] February op-ex and crash were exactly a one option cycle, right? And then V backup, not

[00:54:12] a coincidence, right? And the distribution there was very, if we hadn't crashed there,

[00:54:18] the market was likely to continue to push higher because there were all the divana and

[00:54:21] charm flows that come back as a function of the decay of all those puts in the market

[00:54:26] for dealers. But given that the move accelerated to the downside and there was a big enough

[00:54:31] impetus, the amount of gamma in those took over and created a massive liquidation. And

[00:54:38] that's the type of structure that happens during these big open interest, big, these

[00:54:44] big expirations where there's lots of risk that dealers are holding, can become more

[00:54:50] right distributed with a fat lift tail. And so the trade wouldn't have been in that window

[00:54:54] of weakness there, right? To necessarily short it or go long would be to, you know, to wait,

[00:55:04] you know, buy a put to capture that tail and be long stock, then to be long volatility

[00:55:09] for that move. And once the market started accelerating into it and the risk was clearly

[00:55:14] there to go short into it, really, right, to let your shorts run. But if you had gone

[00:55:21] a week, we could have through that Feb expiration and it hadn't happened. I'm telling you,

[00:55:25] I know it sounds crazy, but that COVID crash never would have happened the way it did.

[00:55:28] The path would have been very different, which means that the reaction function of government

[00:55:33] would have been different too, which is crazy. These derivatives and the market reaction

[00:55:37] are so much tied in the short term to these cycles and these periods. And it seems random

[00:55:41] to people. It's not random. The realities, the structural realities are there. I can

[00:55:45] tell you about the probabilities, but the path, you know, will depend on several other things

[00:55:50] and other liquidity factors.

[00:55:52] I love that point about probabilities. It's so important when thinking about all different

[00:55:58] types of investing. And I think it relates to sort of the last two questions that we

[00:56:02] wanted to ask. And these are sort of tied at the hip in that when you're when you think

[00:56:08] about the next few years and the markets, what would you say are you most concerned

[00:56:14] about? And then what would you say you're most optimistic about two sides of the same

[00:56:20] coin? I'm going to give you one answer to that, but positive and negative. My biggest

[00:56:26] fear, and I wouldn't say the next two years, I'd say over the next five to 10 years, I'm

[00:56:30] going to give you a bigger, longer timeframe, is that we're entering a period of significant

[00:56:39] de-globalization and geopolitical conflict.

[00:56:45] I can't understate this, right? China and the US bifurcating, the way they are, is incredibly

[00:56:54] dangerous. It's incredibly dangerous. We're likely to go, we're already at war, right?

[00:57:02] Questions how hot will it get? And that's not just traditional war, cyber warfare. It's

[00:57:12] you know, again, COVID is a clue to other types of warfare, right? It sounds scary and almost

[00:57:20] unbelievable to people that we can enter a period of that kind of geopolitical conflict,

[00:57:26] but that's what's happening. And the reasons are not just how people feel. It's this populism,

[00:57:32] it's this protectionism, it's this decision by us as a people to America first, right?

[00:57:39] And I get it and I understand why, but that reaction function is not changing and to the

[00:57:43] extent it doesn't change, that creates a massive problem in the short term.

[00:57:52] But crisis, and this is the other side of that coin, crisis by definition is necessary.

[00:57:58] What the Federal Reserve, you know, are bounding fathers to be turning in their graves if they

[00:58:03] were here, that we created this extra governmental group that is in charge of the economy called

[00:58:08] the Federal Reserve. We create it because we want to smooth out the business cycle. Why

[00:58:14] do we have all these booms and bust when we could just fix them? It's all about the

[00:58:19] unintended consequences. If you stop burning the underbrush, if you don't allow for crises

[00:58:25] to happen, what you get is a sterile government, right, that doesn't have a mandate ever because

[00:58:35] nobody ever has a crisis to unite people together to pass and reform the system.

[00:58:40] And what we've done is we've created a political system here in the U.S. where nothing gets

[00:58:44] passed and nothing gets done and everybody goes to other sides, and we haven't had reform

[00:58:49] in what that does and the absence of reform is create entropy. Citizens united, jeering

[00:58:56] meandering, go down the list. The system is broken and it's corrupt at this point. And

[00:59:02] it is that way because we haven't had a crisis. We haven't had anything that forces people

[00:59:07] to come together and unite to say, Hey, we have to fix this. And so this potential risk

[00:59:13] of a real forest fire is bigger than it's ever been. And we're going to have a big forest.

[00:59:19] That's where we are. I said I'd be optimistic. A forest fire means we can reset, reform,

[00:59:29] and rebuild. And I think if you look at the last two times, we had massive forest fires,

[00:59:35] whether you think about the 30s and 40s, right, the greatest generation. If you think

[00:59:41] about the 1960s and 70s, you think about all of the reform and the changes that happened

[00:59:47] during that time, during both of those times, you ask anybody for me to those generations.

[00:59:52] They will tell you they thought the world was coming apart at the seams. If you look

[00:59:56] at what's happening now, they laugh. You think things are bad now. You should have been there

[01:00:01] in the 1930s and 40s, right? You should have been there in the 1960s. But because of those

[01:00:08] crises, our government and our system became stronger, as a people came together and created

[01:00:14] new reforms and things that needed to happen, right, to continue on for the next 40 years.

[01:00:20] And it's what laid the groundwork for the booms that we've had. So the most optimistic

[01:00:26] thing is that a crisis is coming and that we need it. And if we don't have it, the problems

[01:00:30] will be way more existential down.

[01:00:32] Impactful stuff. John, really, really, really appreciate your time. Thank you very much.

[01:00:39] Always a pleasure to speak with you. Great being here, guys. Thanks for having me back.

[01:00:42] Look forward to many more.

[01:00:43] Thank you.

[01:00:44] Be well.

[01:00:45] This is Justin again. Thanks so much for tuning into this episode of XS Returns. You

[01:00:50] can follow Jack on Twitter @practicalquant and follow me on Twitter @JJCarbono. If you found

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[01:01:01] leave a review or a comment. We appreciate it.

[01:01:04] Justin, Carbono and Jack Forehand are principles at the Lydia Capital Management. The opinions

[01:01:08] expressed in this podcast do not necessarily reflect the opinions of Lydia Capital. No

[01:01:11] information on this podcast should be construed as investment advice. Securities discussed

[01:01:15] in the podcast may be holdings of clients of Lydia Capital.