SI389: The Market Is Pinned, But Risk Is Growing ft. Cem Karsan & Alan Dunne

You're about to join Neil's Castro-Plarcin on a raw and honest journey into the world of systematic investing and learn about the most dependable and consistent yet often overlooked investment strategy. Welcome to the Systematic Investor Series. Welcome back to the latest edition of Top Traders Unplugged for each week we take the post of the markets from the perspective of a real space investor. It's Alan Dunn sitting in again this week for Neil's who is still in sunny Miami and I'm home already, but here in the hot seat talking to Jim today. Jim, how are you? Doing great. Here in Chicago in the hot seat, believe it or not, 61 degrees in sunny and Chicago in February. Nice. So no major or snowstorms disrupting things in Chicago. No, we were able to sidestep it. We never get the sidestep. We always get the front kind of snow of the face, but no, this time somehow we sidesteped it. Very good. Well, pending to talk about, we've no shortage of macro teams and topics and interesting developments in markets. Obviously, equities continue to gyrate, the rotation trade, etc. and markets under a little bit of pressure today already. But maybe just to talk about performance because I was helpful just to get the performance in context. We've had a very strong run for managed features in the last six months or so continuing this month. So on the month now, Sucked in CTA indexes of 2.96% and Sucked in Trend index of 3.38%. And here today, the Sucked in CTA indexes of 7.8% and the Trend indexes of 8.25%. And for the short-term traders, also doing well, 0.8% on the month and 3.15% on the year. So certainly positive sentiment around that. And I think coming from eye connections this week, that was certainly felt in terms of positivity around hedge funds in general, but CTAs also certainly participate in that positive narrative. Obviously, a lot going on markets wise, but in terms of hedge fund performance and CTA performance, it's been a good stretch, Janus. Absolutely. And we again have talked about this with Homer, with all kinds of other people across the board here. I think the reality is this is going to feel a lot like 22. And you know, Niels and I were talking a little while back about this. 22 is obviously a great year for Trend. Why? It actually ties into our vol complex when vol is well supplied. And we're going to get into this. I'm sure with dispersion a little bit later today. What you end up discovering is that the rotation is much higher and that rotation paired with a clear trend and broadly once that rotation starts. It represents a lot of opportunities for those who understand what's happening under the hood. Yeah. So I think that's that's what we're beginning to see expect more that this year knock on wood for people like us, but but I am again quite optimistic for this year trend. Good so for I mean that's probably a good jumping off point. I mean in terms of where we're at at the moment. Obviously you look at the broader indices and in the S&P 500, the mass act edging a little bit lower, but broadly in a range for the last kind of two to three months. But within that obviously a huge amount going on in terms of dispersion in terms of rotation and big moves at the sectoral level, industrials, and material sucks doing well obviously. Stable and yes and stable soon well as well and software under pressure. I mean the temptation is always to sign a macro narrative to us. But you know obviously there's a lot going on from a an options and a market flow perspective as well. So what's your perspective on what's driving it? Yeah we always try and educate on this. Obviously we've been talking about this for good five years publicly, but hope you know every time sometimes we still confuse people. This is the most important concept of how markets work these days. And if you don't understand this in your market, see you're missing one of the biggest most important things in markets. And the reality is that markets are one of the biggest proponents components in markets these days are options and things that look like options. Things structured products and other things that sell forms of vol particularly upside and at the money vol. And those are primarily at the index level. And because they're at the index level and they're because they're bigger than ever. What you get is a lot of vol compression, which means the indexes themselves are quite pinned until a big enough that then happens or something that can release that vol or make it squeeze higher, which generally is a move up or some type of bigger they're going to prevent that's a shock or true surprise to markets. The broader index then is pinned and that happens because again dealers are long the vol that they're getting delivered. They have to buy when the market goes down and sell when the market goes up and over to capture profit. This pinning effect, which is vol compressing at the index level and this is the part that's very counterintuitive forces things at the single list level to move away from each other. Why would that happen? Why would single stock vol actually tend to increase and why would importantly correlation dramatically decrease when that happens? Pretty simple, idiosyncratic risks still exist in the world. There is always some news. Right. If news happens by definition, you know, something happens to one stock based on earnings and other stocks, the eopasses away, new new drug comes about those drugs will move because they're not the vol centers themselves. And idiosyncratic news matters for that one stock. But if the market is pin, that means things have to go the other way to compensate for this. And so what this does is this drives massive rotation, dramatic rotation. And actually what we see is increased volatility historically at the single list while index is pinned. And so we saw this in 2017 when we had for the first time really at scale when we had the lowest realized volatility in history and 125 years of history by 30% paired with also the lowest correlations in history by 25%. There's no coincidence there. You see an outlier right of two things relative to the long scope of history. And ever since then, we have only seen a different almost a bi-modal change to how this version works. How single list relative index works. And there's there's a reason for that. And that's the growth of options and structured products and their effects on the underlying at the index level. So that is happening in spades. We called for that about four months ago. We said, wait, the next six months till about April, May, you will see not only vol compression, the index level, but massive rotation. And that's what we're seeing. So it's important to understand that's the true driver here. This is a topping process that's defined by sideways chop. And even though the ball of like risk is expanding the index is pinned as a result. And that's driving historic dispersion and should be surprised in a topping process that we are seeing the generals being shot. This is what happens is this is how it works. If the generals are being shot and there is going to be weakness there, you have to see strength somewhere. The index is pinned and and shouldn't be a surprise of that money goes to more defensive under performing areas places are more that are more that we're out of favor and under owned. And that's why we've seen things like staples explode higher in a way that's almost incomprehensible to people right like 30%. You know, for something that is not growing earnings really it's not a it is a it is a structural phenomenon that is the counterweight to the other side of what's happening underneath the hood. Something like energy again great great performance why same reason again what people will paint some of that is a use in credit by the way to be clear because of the things going on the Middle East etc. And those are driving some move in energy but that's been dramatically shorted under owned early in the year. So shouldn't be surprising if you get a little positive news there a little bit of push on something that's under owned especially given the pressures and the other items that are core to to the market leadership. That that would get a huge kind of push up the one side starts going well that pushes the other things down as well and so this is this is the process that is so critical to understand and allows for prediction understanding of rotation when to move and where to be. And obviously you destroyed the kind of the impact on the index is that the kind of the range stays intact I guess driven by the gamma flows I guess I mean are you looking at the schedule of expires to give an indication of when this might be more susceptible for a break out. Yeah absolutely so you you see often these headlines that this op X is the biggest op X in history will hear that like all the time now and the reason is is because almost every op X is the biggest in history. The growth of structured products and the growth of options flows is not is secular and is. It's exponentially increasing at this point. It is such a small part of the market that is accelerating and creating adoption. I like to liken it to kind of a tipping point for a technology. We have, it is a more precise tool. The problem is it didn't have enough volume and network effects to, for adoption until more recently. In the impetus now, obviously paired with those network effects of a need for more non-correlation, more capital efficiency is driving and not just a bull cycle, but an exponential growth there. Each expiration matters more 'cause they tend to be issued at explorations, but obviously the most important ones are the quarterly effects. We've talked about this at length. March, June, September, December, always the biggest. It's not a coincidence that historically, we've seen tons of vol events, when the vol events happen, in that Feb. March window, in that August to September window. Selen May go away is not a coincidence. These are things that are structural to those realities. What I think I would highlight that's important and why I feel strongly that this vol compression will continue despite the bad macro and despite what I think is a topping process is because we are, it seems like we are clearly side-stepping with the vol event in the Feb. March window, which is kind of what I expected this year given the size of all compression, which will mean support into March topics. And that's counterintuitive to people who think up, down, right? But the reality is when you have short put exposure to dealers and dealers are short stock and long call and long volatility at the money. What that drives is either a activation of that left tail in the markets that then creates of all of them or which is rarer, but when it happens, it is a Tinder box in a sense, so many things are marketed. But if that doesn't happen and it doesn't start early in a cycle, that risk needs to be bought back, meaning the futures, hedges and what's being protected against those structured products needs to be bought back. And that is ultimately a buying structural pressure. Those are those vana and charm flows that we talk about. And those vana charm flows are coming there and they come, you can see them during different parts of the day. And this is why we keep getting sell off and then buy back, sell off, buy back, expect more of that regardless of this military action that we're probably like to see in Iran. Expect that despite all of the other things where you can go through today in macro and how wild a world is in the short term. But once more, tropics comes through with those vana charm flows dramatically drop off. And that would be a period where I would be much more cautious getting into late March into April once those flows are off the table. It doesn't mean, again, those those flows come off the table. It doesn't mean we're gonna have a valve in again. It means valves like this, they'll be compressed. It's just the supportive flows come off the table and you're much more likely to see kind of a stair step down continuation of some kind in that window. So my view is, you know, there's probabilistically that the window is much more sound may go away this year. Maybe it starts in April. But we've been talking about that for a while now. - And the view that this is very much a topping process as opposed to a consolidation ahead of a move up. Obviously we're seeing more negative process action in what you call the general, the previous leaders. Is that what's given you confidence into the topping process? - Yes, I think there's a couple of things. A big one is here. Let's put this way. Consumer staples are up 30%. There's a reason markets when they rotate this way are seen as weak. That is not where the growth is. That is not where multiples are going to expand. That is not where if they get more money, consumer staples aren't going all of a sudden put that back to work and drive a capex cycle. Or it is a defensive part of the market. There is a limitation to how far and how fast as certain areas of the market can go. And meanwhile, now that we've gotten music, for example, in software to a point, there's so much concentration and leverage in those parts of the market. That despite the market itself being a placid, you're creating a massive risk underneath the surface. There are people who are in institutions that are stuck, that have to get out and that if it gets worse, we'll have to liquidate. Despite what we're seeing at the index level is nothing exciting. Think something like long-term capital management, the way a risk really appears from a placid market pinned environment is through concentration, leverage, and liquidity. Concentration, liquidity, and leverage. Always is the reason that things go from a placid state to something bigger. So what we're seeing is that under the hood. If you look at private equity and private credit, that should be a surprise to you. I've been again talking about that for a while, being a kind of canary in the coal mine that it will get worse. That itself is a tinder box sitting underneath the market. And when something comes down 50%, software has all of a sudden. Everybody starts playing for to buy calls. This is gonna come back right away. This has been an incredible opportunity. Guess what? Dead cat bounce, dead cat bounce, dead cat bounce. It's not a surprise because there's overhead supply that needs to get out that stuck. And ultimately until those that are stuck get out, that part of the market is stuck. I'm not saying software is going lower per se. It is incredibly cheap. I actually am very bullish of software come six months from now. Put it on your board, put it up and come back to it in six months or nine months or whatever it is, right? But the truth of the matter is that part's not coming up quickly anytime soon. The leadership has major issues. And the part that we've rotated now too is reaching its capacity for how far it can go. And so at some point this falls out under its own weight. So yes, do you answer? Yes, it's partially from the outside looking in. It's partially because of what's happening under the hood. But understand that that itself is a representation of reality, not the opposite. And that the actual rotation is a function of pressures in the system holding things at bay. But the reality is the market's already on its way to that. Well, you mentioned kind of three factors, or two, which are related to a third, which is AI. But I mean, we're talking about private credit. And we've all been talking about private credit and the risks in the space and how, just because you put a label of private, I don't know, it doesn't mean it's diversifying. And we're very much seeing that. Obviously, a lot of the private credit exposures are to software, which has been underperforming. And obviously the big thing with driving software is this shift in the narrative around AI. And obviously we had more out this week around that with this research report from the Satrini Research Report, which has been much discussed and very provocative, you'd have to say. But paints are very stark, I suppose, picture of the potential impact. I mean, the software side of things is only one part of it. Obviously, the deflationary impacts, the impacts on white color workers, et cetera. I mean, I think most people in the market would obviously see it as a very extreme representation. But it does point to a fairly logical narrative we could be into a significantly more disinflationary period if we get this greater adoption of AI. So curious to get your thoughts on that and where that fits in and how it made drive markets from there. The most important thing about the Satrini piece, which again, everybody that I was shocked, people who don't even really follow markets, kind of high net worth individuals who are, you know, that are not even looking at markets on daily basis or asking me about the article, right? The biggest and most important thing that that article showed me was that how anxious the world is about this. The conversational fact that we're talking at length about this sub-stack article by somebody who is actually, we won't even get it, this isn't a comment on him or whatever. It's not like a research piece out of Goldman Sachs, although they all now responded to it. That is the biggest, most important thing we should recognize. And why is that important itself? Because there is a political consequence to this that everyone is ignoring. There is a social zeitgeist and anxiety that is to what is about to happen. And it is not just starting to slowly come into the, the psyche it is now starting to explode. Okay, and that is so critical. And we all like to think about things in a closed loop as if, oh, this is technology operates in this world where outside of reality, it does not. operate outside of the real world, it is part of a much bigger real world with other things that affect it. Okay. And so I think that the real thing that people are completely underpricing in my opinion is the real time pushback and political backlash that I would expect coming from this. That is the most important thing that you can think about. Let me first that paired with I'll give a couple more things before I want to get back to that is there is way more friction in the system than people expect to. I'm not saying it's not coming fast. It is coming fast and it's coming fast when people expect and they should wake up and people need to adopt it. And yes, but but not just the friction in the system, not just the political backlash and the regulatory things that have not caught up to it, which will start to catch up. But importantly, you know, there's all kinds of questions, big corporations enterprises about how they adopt these things and how it's going to be used. Just because a new technology comes about and changes the world doesn't mean the adoption of it. It happens as quickly as people think. And historically, that's all always the case. And importantly, that so you have friction in the system that's being underestimated. You have a incredible based on the talking about the article and incredible pushback and political backlash that's likely coming quicker than people expect. And lastly, there is there's an assumption that again, this is all in a vacuum. This assumes no global conflict, no internal appeal, no commodity shortages, free flowing capital and strong liquidity continues. Yes. And none of those things are guaranteed. And I will actually highlight as we're talking through today, I am willing to bet that one or more of those become a problem in the next year or two. And so my point is is is not only that this is far from guaranteed this world that that is being painted. But it is much more likely than not incredibly uncertain in one of many, many paths and a less likely one at that I would pay. I will I will follow back on to the most important part as I mentioned, which is the pushback and political backlash piece. Everyone, as you're seeing in the long end of the curve now and everyone in the political dialogue has now turned deflationary universally, you can see it in positioning. I have now for, you know, six years, been talking about how we are in the next 20 years, starting six years ago, going to a structurally higher interest rate environment, died to populism. Not surprisingly, this has been we've talked about this throughout time, the big pushback to that. Well, what about AI? This is the big conversation. This is the most important thing in finance, the discount rate. What is going to happen to the price of money? What is going to happen to the long end of the curve? This is now the third time in six years that the world has turned deflationary again. And every single time was right before a more inflationary push. I do not know how quick this will be deflationary. And I'm not saying that technology is not deflationary since the beginning of time, you know, growth of technology is deflationary. And I understand the speed of this is quick and that it's accelerating. But one thing I know for sure is that populism and the growth of populism is increasing demographically. That's why I know it for sure because the baby boomers are dying off and the millennials who are believe that they need a much more fair system and that the system is broken or coming to political dominance. We know that. That's demographics. And that's accelerating just demographically. Never mind the level of frustration because they are not getting what they want as we saw this last year. Actually, the K-shaped economy is becoming more K than ever. And add into that the now combustible AI realities because this is not just deflationary, but this is hurting the exact kind of cohorts that are most of pain. Yeah. I ask you was COVID deflationary? If we sat here before COVID and looked at COVID, we would say that's probably going to be really deflationary. All of the waves of inflation that we see in history are driven by a catalyst. A catalyst that then releases the political realities that are actually underneath the hood. So I would ask people to not worry so much about the deflation that is likely coming from the catalyst, which is AI. I would instead look past that for what the much bigger trend is and what is likely to come as a result. Yeah. Well, that's interesting because when I read the Cetrineu report, one thing that is notable is that it doesn't discuss any policy reaction at all. There's no mention of what the Fed would do in this environment. I think it does touch on kind of yields falling. But I mean, this is at the heart of, you know, we can talk about Kevin Warrer. She even, I mean, he has touched on this if you go back to his TV interview. I think I saw it on CNBC last summer. He said, "AI makes everything cheaper." So he's already been positioning for this. So I mean, that's one dimension and then you've got fiscal side as well. But as you say, in the first instance, and COVID was the same. I mean, the initial impulse from COVID was disinflationary, deflationary. How long did that last? Well, it lasts. Yeah, she's about a couple of quarter maybe. I mean, if you shut the economy down, it does stop demand growing pretty quickly. But as soon as it comes back, and you've got to supply. But the way you get markets going, by the way, in the summer to last year, is you get markets down. So then you can generate a response. And the response itself becomes the thing that moves markets paired with. People getting short institutions with the zero percentile last June. And then guess what? Now they're back at the, you know, they got up to the 50th and now I'm back down to the 40th or so. Right? Yeah. And so, yeah, this is not a conspiratorial thing. If you're sitting in that chair and you're basent at all. And you're trying to figure out now that there's this overhang of, you know, you have all the refinance. And you have all the refinancing of debt and liquidity draw and markets themselves, which are the biggest driver liquidity have now slowed and are no longer kicking in and you can no longer do. You know, issuance at the short of the curve and increasing that like you were before your kind of stuck. No, exactly. You get into the market going into the midterms or into the rest of the year. What do you do? Yeah, take it down to take it up. So, so that's part of the whole story here. And I think that pairs really well with the AI realities that we're seeing. And so, I think markets look forward. And so I would encourage you to yes, be prepared for the deflationary part. But if the deflationary part will last a minute. And the real story is still the big one, which is the secular realities underlying populism and the move of money from the top to the bottom and the political necessities of that. But does that mean you're skeptical about the actual ultimate level of adoption of? No, absolutely not. Okay, what this means is we're heading to UBI and that we're heading to people getting big checks at the bottom to placate and get people in the bottom of the distribution less angry. Yeah. So likes of UBI be enough. I mean, if people are losing their 300,000 jobs a year, you know, UBI doesn't have, doesn't have you that much. What's it going to take to beg people not be in the streets? Yeah. Okay. So that's what they're going to do. Yeah. And that's a lot. There is an interesting debate about this because of what any new technology that has a productivity impact or supply elements to demand elements. There is the kind of economic viewpoint that higher productivity means a higher neutral rate. Because you get a, it encourages a bill out of capex to take advantage of the technology. So in that scenario, if the Fed is actually cutting rates in response to dysenflexionary pressures that they're moving in the wrong direction, which, and we had this debate kind of back in the, what green spends new paradigm, you know, in the 90s, where you're originally keeping rates on hold it, but ultimately had to raise rates. But I mean, back then part of the discussion was around financial stability. Less about that. Yes, but this is also about financial stability. I mean, this is, yeah, understand there's another narrative we're not even talking about, which is US debt. The reality of the situation is this is an unsustainable level of debt. And it is growing at an unsustainable rate. And in a populous period, that's not going to slow down. It's going to increase. So there is no way out of this and the stoptiles into our conversation about the Fed. And this is the why the Fed and the Treasury are now on the verge of shaking hands and becoming coming, you know, not independent. Yeah. And there is a debt Jubilee coming. That is the first and most major, and we've known it for a long time, but that is the actual first actionable sign that it's coming. And they're not just shaking hands and saying, "We're going to work together and communicate they're saying why." And the why is because the Fed needs to buy, you know, in Trump's words, they need to buy the US debt. And publicly talked about that's what we're, you know, by the leadership. That's what's happening. We need to turn on the printing press or however you want to think about it, hit the button, make all the zeros go away. To be clear, that itself is not. You know, as people think, the people think that's a big time dollar a week or, you know, relative to the benefit, it's actually dollar strength because the second you kind of wipe that all out, you have a debt Jubilee start from scratch again. But I do think that this, what we're talking about here and the Federal Reserve involvement and the turning on the printing presses that is evably coming as a result of the AI story, everything also is being done because quite simply it's going to help. It's going to be an excuse to solve the bigger issue, which is the US's overhang of debt. So expect a response at some point in the next, you know, call it three years while Trump is in office, in my opinion, of a, you know, amidst some crisis, the crisis that is coming to, where you hit the button at the Fed and make all, you know, the debt kind of get adjusted. We saw this, by the way, in Japan, I don't know why we're going to be shocked that this is going to happen here. We supported it. We, this wasn't Japan's idea as much as it seems. It was supported by the US Federal Reserve and as our allies in Japan, we needed to kind of help fix that problem there. And we did over 30 years. And guess what, you know, there is no external debt anymore in Japan and we will move to a similar scenario here. So my point is that is linked in to the coming crisis and the, you know, AI, it all was coming together in a way that is a picture beautifully into a very simple solution and that solution is really the only way out. Yeah. I mean, one of the expressions of that kind of concern about, you know, debt monetization and maybe dollar concerns, obviously, has been the metals, gold, silver. We saw an explosive move higher and down a big correction. I mean, we're from an options market perspective. How does that look now? What's the expectation there? Yeah. So again, I think this is important. I think you know this. But in late 21, early 22, we were very adamant. One thing we pounded the table on. I'm here along with a lot of other places is the best performing asset over the next 20 years. And I said that it's again, five years ago, four years ago, would be gold. And that the not only would it be the best performing asset, but it would be the most volatile over the next 15 to 20 years. We said that again, four, five years ago when it was a very unpopular opinion and that the answer was to buy out of the money calls on gold because you both benefited from volatile, market up, fall up and you got the convexity that has been the best trade that you could possibly have made during that period. That is not over. Again, that was a 15 year no pun intended call. We are a misdesecular move. Now that is not a three month call. That is a 15 year call, which we are about five years into call it. And so this is how you play this game. You play it with out of the money volatility to the upside and it will be volatile. And actually the beginning of these moves, they are more right tail volatile, but eventually they become more to sided volatile with right tail volatility. And the reason is the more something triples, the more speculative interest there is, the more social zeitgeist understanding of the reality there is. These are later adopters early adoption means people hot, everybody needs in. But once people start getting into a convex product, it becomes more to sided volatile because you have to keep flushing out the weak hands. And that's where we are now entering in terms of precious metals. It has entered the social zeitgeist people understand the realities they are speculating it is moving fast, but you are going to get some real tail wagging and this impression of metals going forward. The most unique thing to what has happened to gold so far that will not happen is that it has been one side. And so expect if we are moving towards things like a debt jubilee, that the, that the, are we in the inflation or re inflation? The very fact that we are asking that question at the scale where it means there is at least a very different narratives on both sides and in the ability for people to lose faith in the reality and then re adopt the reality. But I think the bigger structural reality is the one that is more secular than I have been talking about. And that is that gold is structurally from lots of reasons. As the same reasons I talked about five years ago going on. So if you want a short term answer and not in a big kind of 15 year story. I, a lot of speculation has come in even though I am a big structural bull and I would never in a million years short precious metals. I am always going to be long some structural amount and trading around it and particularly with vol. I would expect that that is seeing that I see this year as much more of a 22 type year market down, vol down before a reversal later in the year. Seeing as I see that my guess is that people will not be able to hide in precious metals this year much like they did in 22, 22 they got bailed out for precious metals. People have got longer and longer precious metals and I think this will get pulled in increasingly to a beta one kind of market down kind of environment for six months or so and then it would be a time again to buy it with convexity to the upside later in the year. That view on equities market down, vol down is, I mean that's because people are already positioned for that or they have down side to Varanas salad or is there something else? It's part of it for sure. So it's several things. One, massive structure participants that's driven by people trying to get out of equity exposure and non correlation and the more they move into non correlation and move to these types of trades reflects their vol composing as well. That's the biggest part, the very important big part as well is that vol data to markets is cyclical. It shouldn't be a surprise. We've talked about this a link. You can literally draw a sign curve for vol reaction relative to market move like for downside moves going back to 2015. Why? People are hedge, guess what? The market doesn't go down fast and if people are not hedge, when it does go down it goes down fast. Not just hedge, it reflects the gamma effects of those realities. So I mean, again, I walked through this history at length several times but if we just got a massive vol, everybody's fighting the last war. If we just got a massive vol event last April and even the August before, we had an incredible success of adding vol to the portfolio during those periods. Everybody said, "Why would I sell my stocks? I can just go buy some downside protection and that'll protect me and I can be along the market with beta. I leveraged and just owned some vol." That's what everybody thought after 2020. It should have been a surprise that 22 came and told everybody the opposite. What happened after 22? Market down, vol down, do you remember that? I mean, that was pretty painful for anybody who was in the vol space or trying to hedge. Everybody mass exodus to vol as hedges and if anything, the vol selling accelerated because if it makes money in the meantime, it's not going to help you when the market goes down and why on it? 23, 24, 25, right? All compression and then, boom, vol event, vol event. We're on the other side of that. You better be hedge. The market's crazy. The world is crazy. You got to own puts. Don't want to sell my stock. It's up all this money. I don't want to pay the taxes, et cetera, et cetera. I put a band-aid of vol on it. That should help. The pain trade is what happens when the market goes down. What is the most painful thing to the most number of people? The answer right now is market down, vol down, precious metals down. That is the most painful trade. So if you want to know what the highest probability is, that's the highest probability. I mean, away from the macro, there's plenty of geopolitical and risk. out there at the moment, and events unfolding. We've got, you know, concerns around Iran, the possible strike there. Are these events adequately priced? Are they gonna be meaningful? Are they greater risk events than currently priced, would you say? - The reality is markets in a, as you know, are our voting machine. And so a lot of what we're talking about, the macro matters and it matters more on a multi-year basis and things like that are big, structurally important things, like what is happening in Iran are very important structurally to economic outcomes, but really only in the sense that they somehow affect the flow of capital and the flow of kind of economic consequences. And so us going into Iran, which yes, it does seem, you know, as much as I think there were, it's a way out. And there would have been a preference by this administration and for a way out of this. They were pressured heavily by a consortium of the, you know, across the Middle East to avoid this outcome, but Iran has been, you know, bolstered, you know, this has become a proxy, or bolstered by China and has held kind of an in strict opposition to some type of a kind of a deal. We are going to go into Iran and it's going to happen soon. And my view is that, that is, you know, as much as they are trying to prepare for the oil energy effects, that is an accelerant to a global conflict. We are going towards, and I've been saying this again for five years before Russia Ukraine even happened going towards a broader global conflict, you know, then as well as a proxy war, Iran's a proxy war, you know, Israel, in Gaza's a proxy war, and eventually Taiwan will be a proxy war. The reality of where we are right now is this is an important accelerant. The Middle East has always been the most dynamic spark in accelerates to global conflict. And this one is my opinion and important. So that said, it's not what's going to drive some big shock today because it's understood it's well known. It is only through the flow of oil in the short term that that could be a much, you know, if we saw huge spike in oil and they weren't able to control that, which I think they will because they coordinated with Saudi, etc. But outside of that, you know, I think this is more an accelerant to a much broader process. So it needs to be measured and weighed. It likely needs, means more of a breakdown and bifurcation of world order, which has been or been training training to trending towards for quite a while now. And but that we don't need to run to happen or not happen to see that's where things are going. This is just a kind of an accelerant and a moment, an important moment in that. And we're heading there. And from a market perspective, you're obviously it is reasonably well priced in expected at a stage won't come as a shock if there is a move. But I mean, second order impacts are more prolonged impacts. What I think about it this way. We knew COVID was happening in December, you know, the narrative of it being important. It didn't matter till until late February or middle of middle of late February. This is important. And it's maybe not a COVID situation, but pair this global increase in global conflict, which is only accelerating from here. Parrot with the political voting kind of laws that are being passed in the US that's going to happen around midterms and the like the internal appeal that's happening. So external appeal, internal appeal in the US pair that with the AI disruption we just discussed. You know, this is a building of pressure and a system that is very structurally. And by the way, we're record valuations at the same time. So these are it's a recipe, right? It doesn't mean the market is going to crash. It does not mean that the pressures on the system, the risk relative to the potential returns in the system are are building and are importantly dangerous for markets. And but the flows will dominate between and I think much more likely they're not unknown things, right? That's the other thing. It's the, you know, the pot being boiled. So so again, an argument for market down, Valdem, you know, a slow controlled demolition that then necessitates a response, but is not is is not, you know, at least for the powers of the year in the US does not lead to an uncontrollable situation that they could not then kind of manage. And so this is again, the most likely path for lots of reasons I've mentioned. But but but again, just because those things are happening and known does not mean they're all already priced, you know, sense. I mean, you talk about, you know, Valdem, already been elevated in in equities and metals and curious to get your thoughts and fixed income because obviously yields have been very much trapped in a range. But three and a half years now. So is that an area where we could see that Vald expansion and what would that mean? Great question on answer is if we are in entering a, let's say one a nine month period or so into the end of a midterm period that is likely building in pressure with reactionary forces and it is a deflation, seen as deflationary with a potential to likely, I would say likely inflationary response. How do you trade that? And the answer is building pressure in a system, the sumo market, I like to call it. Lots of just because two tech talk plates are pushing strong enough against each other that something doesn't move, doesn't mean it's safe. Because the more pressure that's in a system, the more combustible it is once a move happens. So my answer is in the short to medium term, I think it is vol compressing much like tectonic plates are vol compressing. But the ultimate response will be a dramatic release of volatility in that space. And I think that's probably, you know, six months plus out. But I think if you play for, you know, coming significant dramatic structural volatility there in the future, whilst still being, you know, short of that volatility in the short term, I think that is probably the big structural play there. The mentioned briefly their elections, obviously that's the midterms are a big factor. And kind of that I suppose looming over the markets in the back in the year. I mean, obviously the, I suppose the narrative today has been, you know, the administration is going to want to run the economy harsh to keep policy easy, you know, get price to stand, get wait stand, have had mixed success on all of that state. And obviously the economic data has looked a little bit disappointing. Q for GDP coming in well below expectations. So there's the kind of the economic element to it. And then there's the kind of the practicality around the voting and some of the concerns around that, you know, and possible. Yeah, older intimidation, et cetera. And which we've talked to people like Gary get personal and on the podcast as well. So hey, I mean, where do you see this playing into that kind of trajectory of markets, you know, you've been talking about possibly Dan cover later midterms, obviously will be in November. So where does that fit into that timeline? Yeah, so if you understand incentives, there's a structural flows and this blind a man, but then there is for the things that we don't know that are more human, the bigger picture things, those are those can be kind of modeled broadly based on incentives. And it's that's a harder thing. But it is actually, you know, statistics are a thing and human beings themselves and entities do react to those incentives. So the reality is that, you know, all politicians and this is a kind of probably a magnified version of this are trying to maintain control and stay in power. Well, the altissions dictators leaders, however you want to think about it, people in power want to stay in power. The question is, how far are people willing to go to stay in power? And we've gone to an extreme in terms of, I think, how far this administration is willing to go to stay in power. And I think that's not controversial at this point. We talked about it. Maybe when it was controversial, you know, state of the union, you know, just happened in President Trump with pretty vocal again at hinting to how he plans to be here for a third term, ha, ha, laugh about it, say the quiet part out loud. That is very much true. And I've talked about that for a year, plus very publicly. You know, if you are intent to do that, you're intent to maintain power. I know about this. because I come from a part of the world where this has been the case. And by the way, the playbook has been played out and put in front of Trump for a long time. He's become very close to Erdogan. And he's watched how he's managed these things. This is not a coincidence. There is a playbook and it works. I hate to tell you it works and the US is not immune from it. And so the administration knows that they would like to win without control because they can win without it. That's just they have the public support and they did it fairly, right? But if they can't, they'll cheat. And that's not a judgment on Trump, by the way. It's a judgment on politicians and power since the beginning of time. It's like saying that we judged Augustus and Caesar poorly, people in power want power and for lots of reasons. And Trump is no different. Actually, if anything, he's one of the bigger more. He thinks he thinks for what they are and says things for what they are. But he does it with a bluster and a lack of reference for the institutions that came before him. And so my answer to you is, I think the original plan, as I understood it, from people I know on the inside, for a structural kind of, overtake a power to control the ballot box later for the eventual election. But the wave partially driven by the Epstein stuff, partially driven by the acceleration of AI and the K economy, a lot of these things are leading to incredible unpopularity historically. So of the president in the US and it shouldn't be a surprise that the response to that is an acceleration of the things that they need to do for the midterms. Because if he were to lose both houses, he will have already essentially lost the final election in the years following, 'cause he would lose full control. And so the inability to control the presidency and two and a half years in that outcome is a function of the midterms going completely against him and that is unacceptable to him. So we are seeing an acceleration of internal control, which will then accelerate the response. So this is all again, all about incentives. You just have to understand what the goals are and what the realities are. And then within that, what's happening to the economy and the realities, they will then respond to. And this is a closed loop in a sense. So there is a clear, and we just kind of saw some announcements from the administration that there's likely to be full-fledged control the ballot box in response to what is now being announced as a 2020 stealing of the election by China. While we're talking about that six years later and while all of some we need to control the ballot box is I think you know the reason for that. - And what specifically does that mean control the ballot box? - So they're declaring, I mean, if you go read the headlines, there is a, and again, I recommend everybody go take a look at the actual shortage, but it's a group of pro-Trump attorneys had drafted an executive order, aiming to give President Trump's, you know, unprecedented powers over election. And it's a full on control-to-ballot box. Deciding who can vote, who can't vote, what is required to vote. And even though this is actually, you know, not legal, this is the power, this power comes down to the states. Trump's model has been very clear, just think about tariffs. What he did with tariffs is illegal. Does that mean it didn't matter over a year and a half? No, the forces, the courts to respond. And if you do enough things, and enough ways, and you do them fast and hard enough, it overwhelms the system and you get what you want anyway, at least for some period of time. And all that matters is that he has that control now for, you know, for nine months, eight months, right? And so they are intent to do whatever, the can of legal or legal or any other way to change the course of this outcome. And they will layer in whatever they'd have to do to do that. Now, will they be successful? Hard to say, historically, the answer is yes, they will, unfortunately. And at least in swaying the results to some extent. So again, this is not, you know, people will, this is we live in a, by a political world where people will see what I'm saying as somehow politically anti-Trump or anti-whatever. This is not anti-Trump, it is anti, not anti-even. It is a discussion of the realities of what has happened in every, you know, it happens in Russia, it happens in Turkey, it happens all over the world. And it's not just in today's age that it happens, it literally happens, it happens since the beginning of time. And it is an attempt to control the outcomes of the election. And those that support the administration will gladly look past that. And, you know, this administration will look past that because it serves what they want. But the reality is as a structural reality, this is the truth. And so, that is more what we're trying to talk about to help judge future outcomes and plan accordingly. And equally, I mean, there is the market reaction to something like that, you know, historically you might have expected an adverse reaction to something like that. But it hasn't necessarily been the case with a whole range of kind of, honestly, it never really has been. I mean, more so than ever, there's a delay, I guess. But again, and the short-term markets are a voting machine and the long-term they're weighing machine. Yes, these things bend the realities of markets eventually. Yeah, but that eventually can happen in five years now. And then it can be after things have already passed, and other things have kind of melted over and there's been a reflex of effect. News and effects matter, they go into the equation. But the things we know more are the voting machine. And the voting machine ultimately affects the weighing machine longer and as well. Actually, it's the biggest effects. Markets are the biggest driver of liquidity in the world. And so you have to, you cannot as part of a process of predicting what happens to markets, think of dot news and say, dry linear line to your result in markets. Actually, you need to start with markets and voted the voting machine first, put these ingredients in, model what's going to happen in the short-term and see how that might affect the long-term outcomes for those macro effects. It is a much more complex, multi-dimensional system. But the reality of the situation is actually, I think we do people at disservice by painting a picture of the X macros happening. So you need to sell. It is, they both are true. And I know that is complicated for people and confusing. But I hate to tell you, markets are actually reflexively and credibly important, especially at this point, to all the outcomes that play in what drives markets in the short-term is primarily not the macros itself. We've talked about this reflexive process in the past. And we've talked about it as a positive aspect of the market dynamic, in a sense of we've had the wealth effect of sedication. The economy has been much discussed. And we've talked about in the past that the market rises, that improves collateral values, etc. and with leverage, people then have to buy more. It sounds like you're saying we're at that point now, maybe because we're seeing some cracks in certain asset values, that that reflexive process is posing or maybe even starting to go into effect. So you asked me questions for about why do I feel confident that this is becoming a topping process, right? I mentioned the leadership and all the rotation, etc. Probably the simpler point that I didn't make is when markets stop going up. The momentum liquidity effect that you're mentioning, which is that releveraging effect, which is by far the biggest driver of liquidity in the world. Again, we've painted the numbers. We'll do it again here, $500 trillion dollars, along assets. They go up 20%. That's $100 trillion of new collateral that then can be leveraged for new investment in one year. How do you compare that to the liquidity of the Federal Reserve or the Treasury? The other things are, you know, never mind the wealth effects and the other things that are happening under the hood. Otherwise, markets are the biggest driver of the economy now, the biggest driver of markets themselves in the world. So I know it's kind of a loop and it's hard to think about it, but if markets slowed down and stopped going up all of a sudden, you remove this counterbalance to other things that may have been already kind of drawing and the economy has been drawing on liquidity at the bottom. We have also kind of reached our natural kind of ending point for now of how much issuance we can do in the short end. So how much like soft QE we can do, which we've been doing as well. So that's slowed. We have a, we're reaching the five year, We've reached the five-year anniversary of the Boston University. and interest rates and then refinancing a debt that is a two through your draw massive on liquidity because everybody now needs to refinance from to higher interest rates. All of these things are draws on liquidity structurally and the administration is trying to do things like the SLR ratios and the stable coin acts etc. trying to counterweight that but the reality is those overhangs are strong and then they the only real way they can counteract that and they can do that they can counteract that that's the reality and they could keep this going but they need the market to keep going up to do that and if they're not it gives out under its own way and so that's where we are and so that the simple fact is the more this hits against a ceiling and can't keep going up and they can't get the momentum moving for all the structural reasons I have eventually the even worse part happens which is the negative draw that's happening across the market now gets drawn from a decalateralization and the negative effect that comes from that and so the risk to the downside are significant at this point if the market can't keep going and it has stopped going. Good stuff always good to get a whirlwind tour of all the big macro factors and also what are the true drivers of the short-term equanimarital movement so fascinating to hear all of that and so thanks for for joining us again and Neil's will be back next week I'm not sure who's with him but Neil's will be back to to anchor next week's episode so get your questions in for Neil's and for all of us here from all of us here at Toppidder's thanks for joining and we'll be back soon with more content. Thanks for listening to the Systematic Investor Podcast series if you enjoy this series go on over to iTunes and leave an honest rating and review and be sure to listen to all the other episodes from Top Traders Unplugged. If you have questions about Systematic Investing send us an email with the word "Questing" in the subject line to info at Top Traders Unplugged.com and we'll try to get it on the show and remember all the discussion that we have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance also understand that there's a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Thanks for spending some of your valuable time with us and we'll see you on the next episode of the Systematic Investor. [Music]