Practical Lessons from Cem Karsan | Inside the Hidden Forces Moving Markets

[00:00:00] That's one part of one critically important thing, the only thing, which is supply and demand. I think so many people just lose sight of that simple little thing. How many buyers are there and how many sellers are there? Most everybody thinks about the world and buy or sell, but the reality is an option is actually not a derivative. It's the underlying of each asset. It's a risk management tool, valuation is.

[00:00:28] And at the end of the day, when those kids stop firing, that's all that matters. Everybody is proclaiming active investment dead. My view is that active investment is actually right on the verge of a new bull market. It's not the greater use of options that will reiterate or make a decline worse. It is how those options are currently in this environment being used.

[00:00:56] So Matt, today we've got clips and we're going to talk about one of the most popular guests we've ever had on Excess Returns. The most popular guest, for starters, is this backdrop here I see. Jack Galifianakis, you're between one fern. Is there another fern back there? What's going on here? I need another fern. You need another fern, man. The whole straight man thing is kind of a good thing for me. The best way I have any chance of being funny is probably the straight man thing. So I'm wondering, maybe I could actually do an interview like that because I could do it with a straight face the whole time. You probably could.

[00:01:23] Good. So one of our most favoritest guests ever, tell the good people who are about to talk about clips. Yeah, so we're going to talk about Jem Krasan. I've learned so much from having Jem on. What's interesting about this is Jem is an options trader. He deals in options dealer flows. And sometimes our longer-term investor listeners will say, what can I learn from this? Because this is such a different world than me. But I think there's so many principles behind what options traders and what Jem does.

[00:01:49] And also his views on the macroeconomic world, I think there's so much we can all learn from him, even if we're applying a very, very different investment strategy than he is. I love talking both to and about people like Jem and his work because whether it's Jem or Chris Abdelmosia or Matt Cashman or some of the other options people, Brent, all these people we talk to who live in this space. They live in the world of probabilities and they live in the world of like dissecting the variables under those probabilities.

[00:02:17] It is such a unique way of thinking and it is such a valuable way of thinking about all the other stuff we do. And it's as true in both valuing stocks or bonds or whatever else as it is in thinking about life stuff. So useful. I love these clips. I can't wait to share them. So just a little disclaimer before we start. Many people see the picture of Jem on the YouTube cover and are thinking, I'm going to get the breadcrumbs. So the breadcrumbs are his current views on where dealer flows are saying the market might go.

[00:02:44] Unfortunately, you're not going to get those today, but I think this is much more important stuff because I think the framework around what he does is more important necessarily than his day-to-day view on what dealer flows are. Not only that, I think you take the stuff like this as this is the book of how you understand this stuff to then take it forward and unpack the views when you see them unpacking. Here's what's going on right now in the market with dealer flows and whatever else. If you don't have this background stuff, yeah, you might get some really cool sounding sound bites out of it.

[00:03:12] But this is the background that helps you step into those current views when you see them out doing the gigs talking about what's happening right now in markets. So we've had Jem on five times. We've got clips, I think, from four different episodes here. So you'll see younger Jem without the facial hair. You'll see younger Jack without a lot less gray hair. But the first one we're going to do here is we asked him the first time he was on, I think, we asked him our standard clothing question, which is if you could teach one lesson to the average investor, what would it be? Here's what he said. So we talked a lot about dealer positioning already. I think that's the biggest takeaway, right?

[00:03:40] That's part of why people kind of follow me and are interested in kind of what we're talking about. The other day, like I mentioned, that's one part of one critically important thing, the only thing, which is supply and demand. I think so many people just lose sight of that simple little thing. How many buyers are there and how many sellers are there? We obfuscate this by thinking about second order factors like fundamentals.

[00:04:10] Fundamentals matter. The cash flow of the corporation is part of that supply and demand. But we lose sight of how many buyers versus sellers are there ultimately. You should never, ever lose sight of it. And I guess my corollary to that and what I'll leave you with outside of that is liquidity. That word is everything. Liquidity can mean the thing that spurs demand and that creates enough liquidity to keep it going.

[00:04:38] It can also mean the removal of it, right? Is there isn't enough demand or there's not enough money to go around. But it's also important to think about when you're trading or you're positioning, how liquid you are and how liquid the things you're investing. Ultimately, it doesn't matter how much demand there is today or tomorrow for something that won't ultimately have liquidity at some point. It doesn't matter what its earnings are if it doesn't have access to markets.

[00:05:06] That's true in the option space as well. That's true, true in derivatives and everywhere. When you invest in something or you put a trade on, you better believe liquidity. You better have been in a position of strong liquidity, particularly in a period like this. There's a reason the name, the word long-term is in long-term capital management. I can't stress this enough.

[00:05:32] Long-term capital management blew out because they were short puts that were long dated against things that are short. They were short illiquid things versus things that were liquid. If you position yourself in a place of illiquidity, particularly as a period of lack of liquidity in a leptocurtic market with fat tails, which is what we're in right now, you will ultimately lose.

[00:05:58] And no matter how good the bet looks, no matter how cheap something may seem, you will be in a position of illiquid lack of buyers versus sellers. And when you get to that point of a lack of buyers versus sellers and you're on the wrong side of that, you will lose a lot of money. So never lose sight of supply and demand.

[00:06:23] Always understand your liquidity point and always think of it in terms of the amount of money that is available at any given moment to fund supply. This was interesting for me because it's a very unique take on our closing question relative to other ones we've seen. But I think it's something that all of us that maybe exist in the long-term investing world need to understand a little bit more, which is how much liquidity matters and how much supply and demand matters. Because those are both huge things.

[00:06:49] And like thinking about this as a value investor, it's great for me to think, oh, these are cheap companies with great fundamentals. Well, if supply and demand doesn't dictate that more people are buying these companies and nobody's paying attention and nobody cares, that certainly impacts my long-term investment strategy, even if I'm a long-term value investor. But this whole idea of, you know, liquidity at the margin, it's supply and demand first, but then it's liquidity at the margin.

[00:07:12] And the easiest way to see this is probably things like real estate, where it's, you know, my house is not being bought or sold every day to my knowledge. My mortgage apparently is, but my house isn't. But the liquidity at the margin for this stuff is what determines the price. And that's that balance of supply and demand when you go into it. I think we see this all the time. We saw it most recently, and I'm still debating this.

[00:07:32] When I talked about the book that our friend Jason Buck read and the people in the comments who are looking for the book, clearly the demand for book, the book is far greater than the supply of the book because I made the book up. But people don't seem to understand that. And I'm really tempted to set up that eBay store with my one sole copy of what is clearly a very rare and valuable book and see how high I should set the price to see if anybody will take. But it's supply and demand, understanding what that balance is, and the liquidity at the margin.

[00:08:02] That is useful in every aspect of financial life. And also as a financial planner, as you use alternatives in someone's portfolio and those alternatives are liquid, that's something you've got to keep in mind. Like you can't get into a situation where somebody needs cash and the liquidity is not there. So that's like a more extreme example of liquidity is really, really important. Like you've got to have the liquidity to meet your needs. Oh, yeah. Never be a force seller is rule 101 of financial planning. Just all the situations where you'd be a force seller, take it off the table.

[00:08:28] And I'll never forget speaking to some people who got the crypto people are wild for this stuff because of the now numerous like 90% declines or whatever we've experienced. And you can literally be somebody who has a little bit of something. And all of a sudden your net worth has 10x in a very short amount of time. And it's like, it's all here and understanding if you don't take it out and it goes back down, or if you tried to take it out on the way down, that is far reaching ramifications.

[00:08:57] That liquidity, I still flashback, you know, fever sweats to the days of when with a coin, whoever basically would like gate like, oh, you can take out $10,000 once a week. And I remember meeting this person who had more money than she could understand because some, you know, person told her years ago she should put like $1,000 into this thing. And all of a sudden it's worth like not a million dollars, something crazy. She's like, this is more money than I've ever had. And it's like, well, you got to start taking it out. And she was like, well, I can get $10,000 once a week out of this thing. And then you're just watching it decline, decline, decline.

[00:09:28] And it's liquidity at the margin, man. Shows up over and over and over again. Got to plan around it. So this next one is the number one lesson I think about investing and about life that all of us can learn from options traders, which is this idea that everything is probabilities. And all of us want certainty. We want the markets going up, the markets going down. But like everything is about probabilities. So here's a much younger version of Jack asking Jem about this. You alluded to a concept that I think is really important. And, you know, a lot of people will take your work on Twitter and they'll try to use it in a binary way. So markets going up or markets going down.

[00:09:56] And like just thinking about it's clear you think about all of this in probability. So can you talk a little bit about the importance of thinking probabilistically? Yeah, that's such a great point, great question. I try and hammer on this as much as I can, but some people just aren't used to thinking that, right? As an options trader, all we do is probability all day, right? Every option has a probability and it's part of a broader distribution. Right. And I've made this argument. I'll make it again on here. You know, most people call options a derivative. Why?

[00:10:26] Because it's come from, you know, originally people looked at stocks and bonds. That's how financial markets started. So people egocentrically think anything that's based on that is a derivative. But mathematically, if you think about what options are, they're actually a representation of the full distribution of anyone assets outcomes. Ball is not an option, that asset class. Options are not an asset class. They are a product. They are a perspective on any asset class.

[00:10:55] And they're much more flexible and robust and a clearer view of the full entity, which is an asset, whether it's a stock or a bond or commodity. And what I mean by that is any option represents a different point on the outcome, the distribution of outcomes. At any point in time, it's a three-dimensional surface of probabilities that the market's betting on any outcome. As opposed to a stock or a bond or commodity, which is actually a binary, like you said, are either up or down.

[00:11:24] So most everybody thinks about the world and buy or sell. But the reality is an option is actually not a derivative. It's the underlying of each asset. And the asset price is the summary, right? It's the expected value of that total distribution. And so understanding probability and you can have two stocks, for example, same industry, right? Same market cap, no name.

[00:11:51] And you would think as a stock trader that those two stocks are the same exact stock, but the underlying distribution of them could be incredibly different. One might have a really fat right tail. One might have a very fat left tail. One might be left distributed. One might be right distributed. Completely different assets. Completely different personalities. Completely different people. It's like looking at two people that are the same weight and the same color and sitting at the same people. They're not the same people. They have different probabilities, different sets of characteristics.

[00:12:21] And so options represent the full distribution of outcomes. And we really need to think about probabilities when we're betting. I would argue there's no reason to trade stock or bonds or anything ever because you're much better suited to trade the specific part of the distribution that you want to bet on. It's much more flexible, much more robust. I think this is a big reason why we've seen a secular, since I've been in the business for 24 years, a secular increase involved in options trading. It's not just cyclical.

[00:12:50] It's very much secular. And that's because the adoption is these are superior products. They allow you to bet on much more precise outcomes in much more precise probabilistic ways. And I think that's important. That's how we should all be looking at markets and thinking about the world. When we make decisions, whether we do it mathematically or not, we do probability in our heads. What are the odds of this? Is this a good idea? Why? We're multivariate thinking about different outcomes and probabilistic coming to some type of conclusion in our heads.

[00:13:17] We may not rationally think about that all each day, but we should. And doing that actually comes to better outcomes. I just think this is so important to understand because no matter what type of investor you are, if you think – we have this tendency to think, this is my opinion and this is the way the world is going to play out. Value stocks will ride again or something. And it's always important to think about things in probability. So even as a factor investor, like if you ask me over the next 20 years, using these factors, using value, are you going to outperform the market? I would say absolutely.

[00:13:47] I think the odds are very strongly in my favor. Are they 100%? They absolutely are not. There's versions of the world where that doesn't work. And that's so important to understand in anything you're doing in investing is what are the percentages on the other side of what I'm doing and can I live with those percentages? I think they're very important questions to ask yourself. I like to tell clients when we talk about probabilities, what I actually want you to hear is most of these are probably wrong.

[00:14:13] Probabilities are just a convenient way for us to talk about what is probably wrong but only in many cases very slightly correct or right. So probability and understanding that more things can happen than will happen. So we're going to talk about a range of outcomes. Expect most of them to be probably wrong or not the future that's going to come into our present. Then we can start to just go, this is what planning is for. This is how we plan for a succession of really great events or a succession of really bad events or a succession that blend both of them together.

[00:14:43] It's ways for us to start carving out those paths without just one thing that when three things go against what we projected, we're going to be lost in the wilderness with no idea what to do. You got to learn to think this way. Simple as that, right? Even whether you're a value investor or you're charting out the financial plan or your retirement strategy, you got to learn to think this way. Yeah, even in life and everything. It just gets you in trouble when you don't think this way. When you start thinking about in definitive, this is 100%, this is a 0%, you just get yourself into trouble.

[00:15:11] So I just think it's always important if you can always ask yourself that question when you have high conviction about something, what are the odds? What are the probabilities? And try to go back. Not that you know them exactly, but that's not the point. The point is understanding that there are probabilities on the other side and doing your best to understand what those probabilities are can save people a lot of trouble, I think. Absolutely.

[00:15:31] And the last piece just on the probability thing too, it's also really useful to think even in the very, very slim chance that this negative thing happens, if this negative thing happens, how much does it actually hurt me? And that's the other part of this too. These guys understand, somebody like Jem is going to understand that actual math behind those tail risks.

[00:15:52] Those stuff that go, great, you worked your whole life up to retirement, but then boom, brain cancer or something else happens or some horrible debilitating thing or you lose your spouse or whatever it is. There's these little things that change everything. And sometimes they're very low probability events that have massive payoffs to the downside versus the other stuff too. Sometimes just sending that extra email or doing that extra piece of effort, you're like, I'm going to shoot my shot on this thing and see what happens. Sometimes those are the things that open up the biggest opportunities in our life.

[00:16:22] If we're thinking about probabilistically about the world around us and that range of outcomes, we can start to understand low risk, high reward, or low reward, high risk and balance that stuff out in life. Yeah. And on the investing side, long-term capital management is your best example of that. Totally. People who had thought like there was some minute probability of some horrible thing going wrong, but the consequences when it went wrong were catastrophic and it destroyed an entire firm.

[00:16:46] So it's just, it's important to think about that because these random little things that you don't think can ever happen in investing do sometimes. And you've got to be able to, you've got to be able to withstand them. I have to tell you the story. It'll be up on the Epsilon Theory channel on an intentional investor interview very, very soon. Kevin Weir has a story about, I think it was the long-term capital management, or at least it was during the Asian currency crisis. So his wife takes this vacation and she's on vacation and she's in Thailand and all these places.

[00:17:13] And she's been like sleeping in cots and on like stone floors and awful things for like two weeks straight. So she calls up Kevin, like on the trading desk where he's working. And she's like, I am so sorry. I don't know what the credit bill is going to be. I don't know how to do the currency conversion, but I literally got in a cab. It was like, I need to stay in the best hotel in this city tonight because I need a bed and I need all the comforts of human living that I've been denied for the last several weeks. And he was like, you know, you do the uncomfortable to your wife.

[00:17:42] Like, uh, yes, dear. Fine. But now you're trying to do the currency conversion. You're like, how bad am I going to get hit for like 8,000 Thai bot or something like that? So the great gift of the whole scenario was like it was in the middle of this currency crisis. He's like, I go from being panicked that this one hotel might've cost me $10,000 or something to being like, it was like a $200 bill. The randomness cuts in both directions, people. You never know that Kevin Weir story. One of a billion in that interview.

[00:18:11] Just, just saying. So this next tip is one I put in for Matt Ziegler because I know you think about this stuff a lot as a financial planner, but this is Jim talking about timeframes. Time is such a huge component of how I think about the world and how our products operate. Um, back up a second and say, you know, one way that we're unique. And I kind of mentioned this beginning is that we look at the world and not just two dimensions up and down.

[00:18:35] We really try and think about the distribution of outcomes and distributions are not just static time. You're dealing with that in the time. And that's kind of, uh, comes from my world of optionality, but it's also a very philosophical kind of approach. And so time is a critical component to prediction. Um, and, uh, it's not just a, uh, component because of compounding and the value of net present value of, of, uh, cash flows.

[00:19:03] It's, it's powerful because different things operate with different lags and have, uh, affect prediction on different timelines. So to your point, we very much think about, uh, secular kind of, uh, trends, uh, and put those in on their own kind of timeline. Right. And lay them over with a faster acting, uh, you know, other effects, uh, some which operate on minutes and hours, right.

[00:19:28] Um, uh, market microstructure is the world in which, uh, everything works and positioning effects, uh, within that market microstructure. But underneath it, there are bigger trends. And as you mentioned, some of them are just compounding, right. And, and, and the value of money and, and, and to your point, like certain things you want to own, you know, things that make money over the long run. So there's a value to that. That's very slow.

[00:19:52] And there are, as you know, uh, you know, over any time period, less than a decade, uh, fundamental values are a, uh, almost, uh, not almost, they are a zero, uh, percent prediction to outcomes. So even on a yearly basis or a multi-year basis, they do not provide a framework for how to invest that said we live longer than 10 years.

[00:20:15] We live generally on average about 80 years, and there is a value to looking at decade plus outcomes and fundamentals, but that does not play a huge role in my, uh, in, in, in my investment theses. For the most part, I'm looking at prediction and what's likely to happen. Um, we are currently in a period that is very different than the last 40 years. In my opinion, we can get into that a little bit. Um, and, and that is a secular thesis, which is 10 to 14 year thesis.

[00:20:43] And that very much affects our general approach. Um, that said within that context, that's a long period. There are going to be years and multi-year periods that, that operate based on, on kind of medium term, uh, flows and, and realities that are cyclical, uh, flows within that secular kind of framework. And, um, and then even then reducing to monthly, uh, quarterly, monthly, weekly, we have, uh, more positioning and short-term flows perspective.

[00:21:12] All of these are overlaid when we're making our investment, uh, decisions across the portfolios. So for someone like Jem, this is important because he has different things he does. Like he's got his option dealer flow stuff, which is more short-term in its nature. And then he's got his big picture macro views in terms of what he thinks is going to happen in the world. And marrying those things together can be very challenging. It'd be very challenging for all of us because all of us, if you think back to financial planning, you'll have a better example than me. We have short-term needs. We have long-term goals.

[00:21:39] Like getting everything right from a timeframe expect perspective is still important. Jeb Carson, we can, we can all agree. He's the Steve Miller of finance, right? Like this is a, he is the space cowboy himself. Time keeps on slipping, slipping into the future. What a beautiful sentiment inside of this clip on financial planning terms. This is why we always talk about calendar, then cashflow, then balance sheet. You have the time and the way stuff unfolds. You have cash flows over those times, which produce either surpluses or deficits.

[00:22:08] And those surpluses or deficits show up on the balance sheet. And basically the things that we've accumulated or the debt that we've gone into. And we can map those things backwards from the balance sheet into cash flows, into what happens across the calendar too. This is the whole idea of planning. As we work across timeframes, we're always focused on what's on the calendar, what's on the balance sheet, and what's going to be the surplus or deficit that's either going to drain assets off the balance sheet or put us into debt. What are those ramifications? What do they mean for later in the calendar?

[00:22:37] Being able to zoom in and out of various timeframes and ask yourself those questions, it's important for your financial life because you're going to figure out what assets am I setting aside for this future need, whatever it may be, kids in college, retirement, you name it, gift to some other generation or a charity, whatever. You can think that way. But then you can also think about this stuff with our personal values too. You know, you're raising your kids. You're trying to instill certain values with them.

[00:23:02] Values come from experiences, kind of like cash flows, where you have a surplus or a deficit of lessons that are learned. You are banking those lessons. And there's good ways to do this and there's bad ways to do this, meaning there's lots of emotional debts you can put your family into too. If you understand the way this stuff stacks over time, I literally think you're 80% there. So I absolutely adore the way that he explains timeframes in this way. It means so much to me to hear. Yeah, so this next one's from the Show Us Your Portfolio interview we did with him.

[00:23:31] And what's interesting about those interviews is we get to talk to a ton of different people about how they manage their own money. And then the goal there is not necessarily to say, like, viewer, here's how you should manage your own money, because we've got everything from, you know, traders to Rick Ferry to everything. But I just enjoy the takes people have on how they think about it. Like, for instance, we just did Mike Taylor. I think it was one of the most entertaining episodes we've ever done. But, I mean, he's a former, you know, hedge fund Citadel guy who's got, like, a team of traders around him, like, sitting on a trading desk.

[00:24:01] Like, your average person can't do much with that. But there's lessons within that that you can learn. And I think that's the same thing with Jem here. So here's Jem talking about how he manages his personal portfolio. My roots are in the market-making world, right? And so why do I start there is, you know, when I started in this business, I didn't start from a perspective of how do I buy, you know, assets at a cheap price? Or how do I get bait in the portfolio and dollar cost averaging?

[00:24:27] It really came from a relative value risk basis. How can I extract edge, right? And that's a very different kind of world. I think to a person, every person who is a market maker for an extensive period is a good risk manager. They have to be. The way they look at risk is very different. They look at it, like, because if you're taking on liquidity, not by choice, putting on positions, but taking on liquidity, you have to be able to look at relative value and see where the risks are

[00:24:55] and really manage a portfolio. And generally, there's a decent amount of gross leverage in these market-making portfolios, as you might imagine. So that even means there's more, you know, pressure in the system that you have to be able to manage. So I really get a roundabout way to answer your first question is I really look at it as how do I take advantage of things that I think are mispriced and relative to the things around them and relative to the opportunity set. We have two engines that drive our portfolios.

[00:25:24] One is a relative value market maker framework. We're in static space, not predictably, looking at the world and saying, how does everything in it, call it a 10-dimensional matrix, relate to one another and what's out of place? That's one. And then two, the second one is predictably taking that forward and looking at it into the future and saying, relative to the distribution of potential outcomes going forward, what's mispriced, what should be here and is here? And how does that look going forward?

[00:25:51] So again, trying to find out relative to everything else and relative to the predictive outcomes, where is there an opportunity? It's not necessarily just buying an asset and saying, is this cheap? Is this expensive? And playing in two dimensions. It's a very different kind of approach. Are you trying to tell me at forehand capital over there, you don't just have a, like, you're in this, like, eagle's nest cockpit with all your traders around too? You trying to tell me that's not reality for you, Jeff? I've always wanted the screens. I thought it would be really cool, like, all the screens behind me. I mean, obviously, I would have nothing to put on them.

[00:26:21] I'm not even sure what, like, I've got a bunch of value stocks and I'm using factors. Like, what am I going to put on the screens? But I've always thought the screen setup was really cool. So, you know, someday maybe I'll just set up the screens just so I can do it. Someday you should do it. Just do it. But when I think about Cliff Asnes' lesson, though, like, about look at your portfolio lesson, I'm like, is the screens really good? Is that going to be a good thing or a bad thing? If I'm just going to look flashing in front of me on the screens all day. You're going to look so cool, though. So what is it? What's your take on these? I've noticed this, too.

[00:26:47] Anybody who's been a market maker has a different way of understanding this stuff. And I just it's so interesting. Everything is edge. So they don't start from betas. They don't start from like, let me get my allocation to stocks and my allocation to bonds. They're like, let me take all the places I have an edge and let me pile those things on top of each other. And that's how I manage your money, which your average person can't do that because they don't have edge in very many places. But someone who actually does have edge, it's an interesting way to think about it. And it's a totally it's like a complete flip of the way most people think about their own portfolios.

[00:27:17] And what do you think about? He calls it, you know, thinking in two dimensions. I think he said thinking in two dimensions. What do you think about that? Just being able to sort of like step back and think about it's almost you're imagining the world as it might be back to the probabilities idea. You're imagining the world that it might be. And you're looking for like the dispersion on where we are now and what creates those forward opportunities. I feel like you as a value investing guy, you think this way already by default.

[00:27:43] Yeah, not as much as he does, but you're right from the perspective of like he doesn't think up and down. Everybody thinks up and down on the market. He doesn't think up and down. He thinks about like what is the distribution of returns? How might the path play out? And how can I put on a position that'll benefit from that rather than just up or down? And so it's not something your average person can do, but it's an interesting way to think about the world because the world is more three-dimensional than two-dimensional. And so it's just an interesting way to think about it.

[00:28:10] And that's what options, you know, he thinks options will become much more used in the future. And I don't know if that'll happen or if it'll be good or bad or anything like that, but that's what options are. They allow you to bet on certain things in a three-dimensional world relative to just betting up or betting down. So all my obscure parlay bets on like how many times Taylor Swift's going to be on the Super Bowl or what the set list is or Kendrick's show, you're telling me these are actually useful skills that I'm honing for the future of financial services? Absolutely.

[00:28:40] Or that iron condor I put on yesterday? I actually don't know. I don't even know what an iron condor is because I don't. Iron condor, iron butterfly, all this stuff, it blends together in my head. I've never actually put one of these parlay bets on, but I am fascinated that they exist and that people think they have edges on this stuff. So that'll be the day I get the screens, right? If I do the iron condor, I'm going to go the screens to like, see what's going on with the iron condor. I'll ask Brent what an iron condor is because I really have no idea. You're going to get the screens and an iron condor tattoo.

[00:29:09] That's the, that's the challenge here. So this next step is from his original interview with us, which is years ago at this point, but I think this is something he still says. And this is something I think that's really interesting. So here's talking, here's Jim talking about valuations and how it relates to an airplane. So we kind of gave this, we've given this analogy before, um, I'll do it here again, but you know, uh, there think of, uh, valuations as a, as the altitude on an airplane, right? Um, yeah, ultimately that altitude doesn't matter if you're on that airplane, whether

[00:29:38] you're at a thousand feet or 20,000 feet or 30,000 feet doesn't affect your trajectory. Um, what matters is the liquidity that's ultimately firing those jets, which is that moderate supply demand imbalance. If there's more demand that supply than markets go up. Right. Um, and you don't really care about that valuation, but it is a risk management tool. Value matters when the jets stop firing. And that's why it is somewhat predictable over a 10 year and multi-decade period,

[00:30:07] because it doesn't matter for long periods of time, but then ultimately it does matter as a put on a business. It's a risk management tool. It's a risk management tool. Evaluation is. And at the end of the day, when those jets stop firing, that's all that matters. How far off your, off the ground you are is ultimately the, the, the most important factor. And guess what? Those jets are sput, sput, sput, sputtering. Right. Um, and as they do, all of a sudden people are looking for looking out the window saying,

[00:30:37] holy crap, we're, uh, I don't know if I can use that on your podcast, but we are way off the ground. Um, and, and, um, you know, the reality is, um, the stocks that aren't that far off the ground who have a much easier job, not only landing the plane, but they happen to have a generator on board. This is an interesting take because we've all been talking about how valuations don't matter and, or how valuations haven't mattered in the market in a long time. And maybe it's, it's not that they don't matter. It's thinking about how they do matter.

[00:31:06] And so this example of this airplane is up there and in a Zirp world, you know, the valuations don't matter that much because, you know, we've got plenty of altitude and people aren't that worried about it. As we transition into a different world, maybe it'd be a little bit different, but I think this idea of valuation being your altitude is an interesting take. Valuations matter when the jets stop firing. And apparently I put in my notes here, it looks like I picked the wrong week to stop sniffing

[00:31:33] glue, which would also be really fun to just do airplane quotes for this whole thing. But I won't subject the audience to that glory. I'm surprised you didn't do it for the whole episode. It would be, it would be, if you had time, you probably would have gotten it done. If I had more time, we would have had nothing but airplane quotes through this whole, this whole episode here. I've been speaking jive on all these Jim Carson clips. The, uh, the idea though of the jets stop firing, I think is really powerful. I also relate this to, I can't help but think about this in like the Zirp world, extra Post Malone F1000 album cover.

[00:32:03] The, uh, you ever see that family guy episode where he puts jet fuel in the truck or in the car? I have not, no. So it's like this idea of like, it's jet fuel. So maybe if I put it in the car, then the car flies like a plane. That kind of feels like Zirp and the way that he described it, like completely inexplicable, almost against the laws of physics and crazy stuff happens. If you have the creativity to do it, all the people who show the Cape charts or the JP Morgan guide to the market chart. So the, the PE is three standard deviations above its long-term average, all that stuff.

[00:32:31] This is the metaphor you're looking for to help you understand that. If the jet fuel is still firing in some way, if the monetary or fiscal stimulus or some combination of both is helping to fuel this plane and keep it going. A, it's still going to have some momentum even when the jets kick out, but also valuations aren't going to matter until you've pulled that away. I kind of, I really actually love this metaphor of it as of airplane too, and how it can stay elevated. Really, really cool. Yeah. Maybe you think about like a long time ago and I haven't done it.

[00:32:59] I haven't been active in a long time, but I got my pilot's license like a long time ago. And like that, that's part of the training is, you know, they, they basically pull the, pull the engine back. And like, if you're not a pilot, you think, oh, this thing's going to fall out of the sky or whatever, they put the engine back, but you've actually got it. You can actually coast for like a really, really long time. There's a certain procedure you follow to prepare the plane to glide as much as possible. And yeah, it's very cool. Like those things will just, they're just like a glider. It's very peaceful. That's gotta be like, I don't know how peaceful this is going to be if it happens in the market, but it's peaceful in the plane.

[00:33:27] It's peaceful in the plane where the option flow positioning isn't stacked against you. Is it like, and I have to imagine too, the, the silence of that must be deafening in its own way. Yeah. Yeah. It's very weird to be up there with no sound. Now, having said that, if it happened in the real world, it's not peaceful. Um, if my plane has no engine and I'm trying to like, I'm trying to coast the thing back to like a field to land it in, it would, it would not be peaceful. It's, it's peaceful because the, the, we know we can turn the engine back on whenever we

[00:33:55] want to, uh, in the real world, it would be less peaceful. No, you're, you're not screaming, screaming panic into the, whatever, into the receiver there. What do we got next? Active investing? Where are we taking this? Yeah. Yeah. So this is, you know, you and I did an episode with Dave Noddick, which is great. And I recommend people listen to it, uh, where we took all the different takes, you know, we started with Mike Green's views on passive investing and we took all the different takes we've gotten from our guests and we put them together in one thing. So I won't go into that in too much depth, but this was Jim's take on passive investing.

[00:34:23] Mike and I've talked about this for years, uh, uh, completely, uh, agree with, with the process and the, and, and the framework. It, it very much true. Um, uh, you know, there is a natural momentum factor to passive investing, uh, and that passive investing has grown to such a scale that, uh, it is one of the primary drivers of, of momentum in this market.

[00:34:51] Now, the, the part where I kind of differ or disagree is, is with the idea that, Hey, this is inevitable and this will just continue and markets have changed forever. I really think it's a function of, and I'm going to back up here. I think passive investing as much as it's been sold to the world. And the narrative is that passive investing is some new, uh, innovation. It is a, it is the, the new way to invest. It's low cost. Uh, you know, uh, great. Just set it and forget it like easy.

[00:35:21] Why wouldn't you just set your money away and passively invest indexing to be clear? Was it, uh, was introduced about 150 years ago. So this idea of passive investing is not a new idea. The reason it's become popular is because interest rates went from 20% to zero and we saw a massive boom in, in equity performance. Uh, you know, 60, 40 is, uh, the easy set it and forget it. Everybody just assumes that's how you invest. Now, actually, if you ask your average person, how do you invest?

[00:35:50] You buy assets for the longterm and you keep buying. That's the viewpoint. Again, 1968 to 82, my period right before passive investing started. There wasn't a lot of passive investing. You know why? Cause it didn't work because 1968 to 82, you lost 70% of your money in the equity market. If you had any duration over 14 years, not over one years, two years, five years, 10 years, over 14 years, you lost 70% of your money.

[00:36:15] And in the bond market, you did just as poorly, uh, if you had any duration in the portfolio, right? You get cash, by the way, you probably did as poor. So passive investing didn't happen. What, what, what, what came about during those periods? Hedge funds, right? Value investing, big Warren Buffett. Uh, you know, a lot of things that, that not really talked about as much active investing broadly was very popular because it worked. Um, but guess what? Uh, that's not what you hear from people. Now you hear about passive investing.

[00:36:44] So tell me what's going to happen if we see a 15 year period where the market net, that goes nowhere and in real terms loses 70% of its value. If that were to happen, what happens? No, that's the incentive. If we're right and we think that's what's likely to happen, what happens to passive investing? And, and my view is that, you know, Mike, Mike's view is, and I think it's a defensible view that like, who knows? Let's see.

[00:37:09] Is that, uh, the powers that be at Vanguard are so entrenched, um, that, and politically connected that, uh, all the 401k flows and everything will continue to flow to all these passive vehicles. And it's going to change. I, I do. I think, I think we'll have, uh, maybe passive investing, but maybe more passive investing in active vehicles. That's interesting, right? Those are working. That's what's working. Guess what? People go to what's working. If they go five years and they're not making money in the market, but they see, uh, an

[00:37:38] active manager who's making 15, 10, 15% a year. Guess what? Those things are going to get the assets. And so, uh, I think, uh, I think we're right as everybody is proclaiming active investment dead. Uh, my view is that active investment is actually right on the verge of, of, of, of a new, uh, you know, uh, bull market. And, and I think personally, I think, um, people unfortunately will be 10, 15 years from now, primarily investing in that right when they should be passively investing in 60, 40, I guess. Um, it's just the way markets work.

[00:38:08] This was one of the more interesting ones to me because he agrees with Mike's work. And I think a lot of us agree with Mike's work because Mike's work is very strong where he differs with Mike is he believes that when, if we eventually get to a point here where the market's just not going up and up and up and up and where these more diversified portfolios do better, that could derail the rise of passive investing. Because one thing we always know is people will chase what's working. And so if we get to a point where the S and P struggles for a really, really long period of time, these more diversified multi-asset portfolios are doing better.

[00:38:38] People may move their assets there and we may not see the rise in passive investing. We've seen the, the part that, and I feel like I'm just, maybe I'm just not smart enough to grasp the nuance of this. I understand that index investing has been around for forever. I understand that that as an approach has been around for forever, but isn't it, hasn't it just been way easier since the seventies with Bogle and Vanguard to actually buy and implement that index? Yeah, it was indexed on team, but the biggest thing was when the sort of the default option

[00:39:07] in 401ks became passive stuff. Yeah. The QDIA passive option is by, yeah. That's what it really picked up because now people are just, without doing anything, people are just putting more and more and more money into passive, but also obviously the underperformance of active managers plays a big role here because it convinces more people to be passive. Sure. And that gets into Jim's arguments, which is if that changes, not the underperformance of active managers, but this idea that nothing beats the S&P 500, if that changes, if there's things out there that are available in low cost for people that do beat the S&P 500 for

[00:39:37] an extended period of time, does that derail this whole, these passive flows? And I think it's an interesting question. I think it's an important question to ask, even if either the probability is low or the idea of what the triggering event that's going to get us there is hard to actually frame out. But I think it's a really important question to ask, not just because little kids might still want to grow up to be active managers, but because I think it also gets to the heart of what purpose do capital markets serve?

[00:40:06] And that's 60, what was it? 66 to 82 or something like that, that period that he cites in here where it's the heyday and you think about that's where the Buffetts come from and all these other hedge fund stories. Yeah, it's really interesting to think about that evolution. And are we going to go through another version of that? Yeah, that 68 to 82 period is really interesting. And it's something that's going to come up in some of these other clips too, because it is not that we're going to have the 70s over again, but it's an interesting period to look to if you want to understand what's going on now for those of us that never saw inflation in our lives. Yeah.

[00:40:36] And I mean, never forget summer of 69 when Ryan Adams got that first six string, you know, that changed everything. It did. The good, just incredible investing insights from us here. Incredible. The best. So moving on to the next one, this is something that those of us that are outside the options world think about a lot. And I think you hear some more wild takes on places like CNBC and around the internet about what this might mean. So we asked Jim, obviously way, way, way more people are using options in the post-2020 period.

[00:41:06] A lot of people are talking about that's going to melt down the market. We asked Jim if it's true. So to be clear, it's not the greater use of options that will reiterate or make a decline worse. It is how those options are currently in this environment being used and where the positioning is at this moment. And to be clear, if that issue happens in two years and that positioning is different, then it will have a different effect.

[00:41:32] The point here is there is massive reflexivity to options and options positioning, right? So if there is a lot of short tail, short vol positioning, you know, at a time when an acute event happens, it will exacerbate it. We've talked a lot about this. I just mentioned COVID, right? COVID started, the decline for COVID in markets started on the day after February. OPEX. That wasn't a coincidence. It ended the day after March athletics. That's not a coincidence.

[00:42:02] It was a Z bottom that ended exactly on that day and then came sporing back. Did COVID matter? Was COVID an acute issue? Did it cause supply chains? Did it have dramatic effects? A hundred percent. But to be clear, the move that we had and the speed and timing of that move was a hundred percent exacerbated and magnified as a function of the options and broad convex positioning in the market.

[00:42:27] We know this going back to 1987 before options were traded, you know, the way they have, you know, they currently are. It's not just a function of what the event is. It's a function of the supply and demand in the markets and those massive convex positioning tied to nonlinear products that is poor and imbalanced. It will drive reflexively convex outcomes. And so when that's the case, we see convex outcomes.

[00:42:54] To be clear, there are avenues and there are times, I apologize, where that positioning is the opposite, where people are very well edged. I think 2022, I think that's a great example, right? 2022, we had the opposite scenario. People were incredibly well hedged. Why? Because COVID had just happened. Anybody who was short mole got taken out to the cleaners. Anybody who was long bull for that made an incredible amount of money. So survivorship bias, all of the, most of the world was very hedged.

[00:43:22] People, there was broad understanding that Russia might be moving on Ukraine. This was not a complete black swan. It was more of a gray swan. And so people were very well hedged for it. And what 2022 looked like was a incredibly low ball, you know, tick, tick, tick, and implied law got decimated into those. So as opposed to being a one month, 30% decline, what do we get? We get a, you know, a, at worst, 20% decline that happened over the course of nine months.

[00:43:51] And, and so very different outcome, right? Very low volatility and very different reflexively outcome. And that's how I would characterize it. It's not, it's not that options and the increase of options trading is increasing volatility. That's not true. It can both dampen and increase volatility. But, but positioning and positioning tends to be a focus function of trend, right? So if you have something that's making money again and again, again, what happens? People pile into it, right?

[00:44:19] And so if you can sell ball and it works and it's also reflexive and drives less volatility, well, people are going to keep selling ball until it breaks. And then when it breaks, you know, then you're going to have a bad outcome. And so, you know, that's just on the sales side, the same happens on the buy side. And so as that positioning gets, it gets big, it exacerbates kind of that positioning. So this is such an important point, not just for people who follow the market or people who use

[00:44:43] options, but this, this idea that behind the scenes, like what's going on is so important to understand. And so it's not that there's a more use of options. It's what people are doing with the options. So in certain cases, the rise of options dampens volatility. In certain cases, it could exacerbate volatility, but that's what the, the world usually is. The world is usually not this black and white thing. The world is usually some element of gray. And I think it was important that, that he got that in this take that all these panicking

[00:45:12] things about the rise of options, maybe at some point they will be right. And maybe there will be an event that options make a lot worse, but also it's not necessarily the extreme of the ticking time bomb that many people think it is. First off his explanation of the OPEX timing around COVID is probably one of my favorite examples of this. And I definitely learned this from him first of just like, look at the COVID crash or whatever you want to call it and basically bookend it with the option expiration dates.

[00:45:41] What an interesting way to think about both like the decline, the recovery and everything that goes on. That's fascinating. Second giant takeaway from this. I definitely want to use the word exacerbate more in my day-to-day life. And I'm thinking that maybe like instead of a panic room or like a panic in the markets episode, we could have like a step inside the exacerbatorium or something like what a great word. I don't use it enough. By the way, I hate that word because it's a word I think would work very well on the YouTube covers.

[00:46:08] But the problem is the long words on the YouTube covers don't allow you to use the kind of font you need to use to be successful. So there's, there's certain really long words that I just really like hate because I want to use them. I think they would work, but I just can't use them in the font size. I need to use them. Not that anybody cares about that, but it's a part of my day-to-day life. So you're saying the, my, my show idea for step inside my exacerbatorium is a, that's too many, too many. That's definitely not getting underused. Definitely not getting underused. All right. One more failed show. Back to your COVID thing as well.

[00:46:36] Like for people who don't believe that these option dealer flows matter at all. And again, for someone who's investing for 20 years, they don't really matter because you have such a long timeframe, but people who think they don't impact the market. I mean, look at COVID and Brent and I have talked about this in the OPEX effect a lot as well. Like we basically had a situation where things were looking really bad in COVID. They had been bad in China. They were bad in Italy. Market was not going down. Look, why is the market not going down? It doesn't make any sense. We have an options expiration. The next day, the market starts an implosion that goes on for a month.

[00:47:03] And then by the way, at the end of that month, we have just a crescendo in selling and on the options expiration, again, the market bottoms. Like again, this isn't everything. It doesn't drive everything in the markets. But if you think this is irrelevant, like think about that. What a crazy coincidence it would be that the market top and the market bottom were exactly on options expiration dates. Like it just couldn't be a coincidence. It is an amazing insight into the story. And it's also an amazing reminder about the point you made.

[00:47:32] If you're a long-term investor, you don't really care about this. You do care about it. If one of those days is when your RMD was scheduled to go off or your like monthly distribution or whatever was happening on that day. But the amount of noise that this introduces into like day-to-day markets is actually really profound. And you have to remember that as somebody, even if you're passively or more long-term exposed to this. I can't remember. It might've been Corey Hofstein.

[00:48:00] Somebody just like put a thing out was just like to the people who are poorly trading my investment products. Like, can I just show you what's happening at the end of the day when you put this order in? Like this hurts me as the person offering this strategy to see you executing it this poorly. We all need to be aware of this stuff because it, it creeps into the noise factor on days when stuff is actually happening. Even if we have a long-term view, I will forever be thinking about that COVID story and the way that he teed that up.

[00:48:29] So the second question we always ask in our show is your portfolio interviews is about retirement. And it was probably will come no surprise to you. We have never had one person who said they're going to retire on that show. Every single person is like, I'm going to work until I die. Like Mike Taylor was like, they're going to take me in a body bag, the trading desk or something, which was the most more extreme version of what everybody else had said. So here was Jim's take on that. This is going to sound almost cliche, but work is an extension of self, right? Work is not a thing that you do so that you can do the rest of your life.

[00:48:58] I'm fortunate to have my work be an extension of what I love. Uh, that's kind of naturally kind of happened, uh, as I've moved, I, you know, through this, through this process, um, it's, it's a, this business is a platform for my dreams and aspirations. And I tell the guys that work here and the girls that work here, it should be a dream, you know, a platform for theirs as well. That sounds super cliche. I know, but it's true.

[00:49:24] Um, we try and affect positive change and educate with this platform. Uh, we try and create things that we think are, are cool. It can also do those things. Um, so, um, and ideally this is, uh, there's a reason it's named Kai volatility. That's my son's name, right? Uh, ideally this is a platform for them as they grow as well. Um, it is not about for me making money at this point. Fortunately, I've been, uh, you know, put in a position where, uh, where it's no longer

[00:49:52] about sustenance, it's about, uh, dreams and aspirations. And I'm fortunate to be able to do that. But, but that, those are my goals. Uh, my goals are not to go sit on a beach and, uh, wither away. Uh, life is short and, and, uh, I'm fortunate to have a platform. So the reason this quote is in here, Matt, is because some, some of these clips, I'm just like, I have to put this in for Matt because Matt's going to have a great take on this. And so this idea that work is an extension of self, I figured is something you might have an opinion on. I have an opinion on this. I loved his answer to it.

[00:50:20] And it calls back to this idea that I was talking about before the calendar, the cashflow and the balance sheet and applying it to stuff. That's not just financial values. Working is basically exchanging your time, your energy, whatever, for some amount, your human capital for some amount of financial capital. And then if you go to work every day, ideally that's turning into some type of surplus where that money is now going to go get invested or whatever else. But the same thing shows up when you spend time with your kids, when you build time with

[00:50:49] your family, when you, you don't just grump off the thing or, uh, you know, you walk the dog without the AirPods in and you actually interact with the little guy while you're going around the block. There's lots of surpluses and deficits that show up across life. And I would take it so far as not just to say work is an extension of self, but anytime we are choosing to spend an activity and proactively trying to get something good out of that activity, we are seeking to create a net positive surplus by that activity. That gets banked somewhere.

[00:51:19] It gets banked in our relationships. It gets banked in everything we do. This is in a nutshell, the key to a meaningful life. I love the way that he frames this and it just, it resonates with me so deeply. Do you think about this? I've been in so many conversations where, and I use the air pod and the dog walk example. My dog knows dogs, plural. No, if I put my AirPods in before a walk and I've, I've actually eradicated it. We don't walk with the AirPods in anymore. I've gotten rid of that partly because I live in a neighborhood where I don't always trust

[00:51:47] the other drivers coming around the corner, but I would put those things in and my dog's like, Oh, you're not paying attention to me anymore. This isn't fun. That little act of goodwill. It's so real. Yeah. And there's the more extreme version of it is that all of us that are parents have to be careful about is that your cell phone, your kids. Um, because if you're playing with your kids and the cell phone is in the vicinity of you, like there's just this tendency to be like, Oh, the work email just flashed or some other thing came up. And like, you got to get the thing out of there because your kids absolutely notice if you're

[00:52:15] sitting there and you're playing with them, but then you're like, look at the phone and you put like, they notice. And it's not the way to be present with your kids. So like, it's another example of the same thing, but your kids absolutely know when that phone is around. If you're playing, you are running a deficit, your, your work, your choices in that moment are actually creating an emotional deficit. And that deficit is being banked. It's really important to think about those things and how they step up in our stack up in our relationships with others, because those things can bank and they can be, they can be,

[00:52:45] uh, debts in the form of deficits that stack over time where, yeah, let's face it. If all you do is like, let your kid play on the iPad, cause you're busy on your phone. And you're going to have some issues at some point down the road. Conversely, if you go proactively present in the situation and I forget, I think it was, it might've been like Trevor Noah or somebody like that. It might've been in his book where he talks about, you know, going to see his dad. And this is pre cell phone, smartphone everywhere era.

[00:53:13] But like his mom would drop them off, you know, once, once a week or every other week or something for his like weekend with dad. And you get there and like, dad would just be staring at him and be like, all right, what that's horrifying, especially when you're a teenager, you're like dad, I don't want to hang out with you. But the other part is like, all right, what are we getting into today? Complete unshakable presence. We'll build something that will bank something else. And I think the other thing with this, this work is an extension of self thing is I think

[00:53:41] this plays into the idea that many people who do retire and they're like, you know what I'm going to do? I'm going to cut off everything tomorrow. And I got the eight iron and I, this is going to be the happiest life of all time. Like it usually doesn't work out. Um, when you make that kind of big break. And I, and I think that plays into this whole thing as well. Yeah. We walk through people when they're retiring and they always like laugh at it at first, slowly come to terms with it. And then are thrilled. They did it. I will tell people get out of calendar, get a blank calendar out, get an old calendar out, uh, buy the calendar for two years out on Amazon.

[00:54:10] Cause you can do weird stuff like that now. And literally just go like, what are my days, weeks, weekends, start just throwing stuff on there and stare at all the blank space. That's literally the point of the exercise. See all the blank space on a calendar when you're like, Oh, I'm finally going to do it. I'm going to take that trip to Italy for six weeks and then go, okay, cool. Like, Oh, you know, here's 10 and a half months that are still blank space. What are you going to do to not lose your mind?

[00:54:36] And if you just wrote play golf on every single one of those days, some people that's going to be okay. And that's really going to be their thing. But the reality is it's like, I'm going to play golf, but I'm going to have lunch with my friends after, or I'm going to do this walk with my wife before whatever. They're going to start to stack other things into it. You have to start building a new identity around those, those behaviors. Work is a great catch all term. Even if it doesn't mean work for a paycheck, work is a great catch all term for a thing we do on purpose to try to get something out of it.

[00:55:06] So our last step here is about elections. And we obviously just had an election and people aren't that interested in elections right now, but I think this is a great example of why digging into the data is so important. So here's Jim talking about the returns in election year. And I talked about that period, 68 to 82, right? Elections are particularly populist elections. Like we're talking about are incredibly positive years. A couple of statistics.

[00:55:33] I've mentioned these in a couple of the spots, but I just think it's so important and meaningful to, for people to understand. If you look, you hear all the time about how election years are very positive, right? But if you look at 125, sorry, 100 years of history, you go back to the 28th, 1928, and you look at about a hundred years of history and you take all the elections in the United States since 1928, all of those election years combined are up about 12 and a half, 13%.

[00:56:03] That's pretty positive, right? And they have a win rate of something like 80% or something. Now, what people don't realize is if you take just the elections as follows, 64, 68, 72, 76, 80, right? Those five, right? And you took those five out of the election, out of the data set.

[00:56:28] The actual return of the S&P 500 in the election years is five and a half percent. Now, wow, that's a pretty big difference. So what happened in those five election years? By the way, they're just back-to-back elections during, guess what? 68 to 82, that same period we're talking about, which is a populist period, dramatically popped up to this period. What happened in those five years? The average return during that period was 21 and a half percent.

[00:56:55] Every single one of those years was positive double digits. There wasn't, not even a single digit year out of those five. And guess what? If you take the last two elections, including this one, we're not double the year, let's assume we end up where we are right now, which is 20%. The average performance of those was also 21%, right? This is not a coincidence. You have seven populist elections, periods where there's a massive populist push.

[00:57:23] You can argue all you want that the pretty clear in terms of spending, all the trends that we're seeing are very similar. Those seven years to have those type of positive returns consistently is not only an outlier in a data set, right? It's the consistency is, is, is fairly incredible. What makes it even more incredible is if you then go look at the market performance outside of those election years during those periods, dramatically negative.

[00:57:53] So if you pulled out those five years, right? From that, that, that, that 17 year period, 60, let's go back and say 64 to 82, the real returns of the market for that whole period was down 50%, okay? Down 50% real terms, right? And nominal terms up slightly positive, right?

[00:58:18] If you pick those five years out, it's a 90% decline in markets over that period, right? So the other years in that 17 year period, take those five years out, 12 years, almost every single one was a losing year. And the ones that were losing there, there were several dramatic declines, like 35% type years. I usually don't hear too much on our podcast where I'm like, I absolutely did not know that. But this is one where I was like, I absolutely did not know that.

[00:58:44] Like everybody talks forever about election year returns are always better than, you know, normal years. So you want to be invested in election years. And when you dig into the data, you get a complete like bifurcation of that. You get like this one period, 68 to 82 drove all of that. And outside of that, every other election, you know, not every other election year, but the average election year is actually well below the market. And I just think that's important to understand because when you just go into the year and everybody's like, it's an election year, the market's going to outperform.

[00:59:13] Like it's important to understand what is underneath that distribution. Do you ever think about this from with the value investors hat on? I know you're ignoring that stuff because like the data and the data set and the way you approach this stuff. Do you ever look at this stuff narrowed in on those on this level at all, where you look at events like elections and how they manipulate the data? Not really, because it doesn't. I do it personally because I like to understand what's actually going on, because I think when you see something happening in the market, it's better to understand what's behind

[00:59:42] it and what the data tells us. But I mean, it's very hard to do anything with investment strategy about this kind of stuff because, you know, we're purely factor investors. So, you know, I don't know what I would build around something like this. But it's a good example to say, like, if you were building something like this into a factor strategy, you'd have to understand that distribution because if you build something in there to be like, oh, you know, I'm going to put a little more weight on something in an election year. Well, you better understand like what that looks like, because if, you know, 10% of the election

[01:00:08] years drove the entire thing and the other 90% were very different and you're investing people's actual money where they're going to judge you based on what's happening in these, you know, the shorter period of time and the odds are it's actually going to be a bad thing because the distribution was driven by a bunch of really good things. You better understand that when you're changing your strategy. So those distributions behind the scenes are so important because everybody likes to look at the average, but the average often doesn't tell us a lot of what's actually going on. I think that's a profoundly useful point.

[01:00:35] And I also think it's really important that knowing you're not going to be measured over or hoping not to be measured over the extremely short time horizons doesn't mean you still shouldn't play with these questions against the data set and try to understand what to take away from that, right? Yeah, that's right. And also, by the way, you're certainly going to be judged over these extremely short time horizons. Oh, yeah. You know, whether you want to or not, whether you show your long-term charts or whatever, you're going to be judged over these. So it's important. You don't make any changes. But one of the things I've learned over the years is you can't say when something's happening

[01:01:03] in the market that's short term and it's impacting people's portfolios, you can't be like, yeah, we don't pay any attention to that. We're quant investors. People do not want to hear that. People want to hear an understanding of what's going on. This is an example of that. If something's happening in an election year and I need to explain to clients what's going on, it's probably good that I understand this full distribution versus me just being like, yeah, in the average election year, the S&P does 2% better than it normally does. This level of knowledge is very important in trying to explain something like that. Yeah.

[01:01:32] I think it's incredibly useful to not only learn how to ask these questions, but learn how to... You just got to know how your data set overlaps with these other data sets. This is how we get through communicating stuff over time. Because what you will see sometimes is you'll see a client come to you and say, election years are way better than normal for the market. Right. I want to add to my equity allocation because of election years are better. Well, if I understood this full data set, would I do it? Because I know in most years they're actually worse and outliers have driven the return.

[01:02:00] So given that this client is going to judge that decision on that one year, do I want to add to it? And the answer is I probably don't. And also the answer is if I explain that to the client in detail, they may not want to do it anymore. You mean it's not just, I've got this 3X single stock ETF that I want to talk to you about. Let's get the juice. I have never associated with those in any way. You and me both, my friend.

[01:02:28] I guess it could work on why maybe people should not be associating with those things. But nonetheless. This is great. Anytime we get to talk about the jam croissant himself is a good day. I'm glad we got to work through these clips. And anytime we can focus people, I think, on what you can learn from his work overall versus what's happening with the next options expiration and what can I do with that. Because I think what people can learn from his work is so much deeper than that. And I think that's like what's happening in the next options expiration is a very, very

[01:02:57] small part of what people can learn from him. So hopefully with these clips, we've gotten to that in this episode. I think so. And I can't emphasize that enough. Look at the background and the experiences that he's had over his career that's given him this lens to see the world through. If you step back, you study the clips and the stuff like this that we're trying to show you on these episodes, you can now take this and apply that lens to a whole bunch of different stuff in life because I'm never going to be an options market maker. I'm never going to do those things.

[01:03:23] But I am going to apply these types of frameworks to working on a financial plan or something else from people all the time. It's really incredibly useful in just the way that he labels, segregates, and names things. And if anybody wants any of this in more depth, we've got five interviews on the YouTube channel with Jem. You can just search Excess Returns Jem Crisson. Thank you, everybody, for joining us. And we'll see you next time. Thanks so much for tuning into this episode. If you found this discussion interesting and valuable, please subscribe in either iTunes or on YouTube or leave a review or a comment. We appreciate it.

[01:03:52] Jack Forehand is a principal at Validia Capital Management. Matt Ziegler is managing director at SunPoint Investments. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients at Validia Capital or SunPoint Investments.