Cem Karsan on the Market’s Quiet Fragility | Systematic Investor | Ep.379

Summary

• Precious Metals: Strong case for gold and silver as prime beneficiaries of a structural inflation/populist regime, with emphasis on call optionality and favorable implied vol dynamics.
• Long Volatility: Advocacy for right-tail, longer-dated calls as superior stock replacement in bubble-like conditions, citing improved risk-adjusted outcomes.
• Rising Rates Beneficiaries: Focus on negative working capital and select financials (e.g., insurers, transactional finance) that expand margins and benefit from curve steepening.
• Energy Geopolitics: Heightened geopolitical tensions (Russia/Ukraine, Venezuela embargo, tankers) create interconnected risks and potential opportunities in the energy complex.
• Non Correlated Assets: Rapid growth in diversifying strategies (hedge funds, options-based ETFs, structured products) as investors seek resilience beyond traditional 60/40.
• FX and Bond Volatility: Preference for FX vol and bond vol in inflationary regimes, noting historically superior distributional characteristics versus equities.
• Election Year Returns: Populist-cycle framework highlights historically strong presidential election-year equity returns and weak midterm periods, informing tactical risk posture.
• Key Companies: Buffett’s concentration in Apple (AAPL), American Express (AXP), Bank of America (BAC), Coca-Cola (KO), and Chevron (CVX) is analyzed through a rising-rate, margin-resilience lens.

Transcript

Imagine [music] spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their [music] failures. Imagine no more. Welcome to Top Traders Unplugged, [music] the place where you can learn from the best hedge fund managers in the world, so you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, [music] remember to keep two things in mind. All the discussion we will have about investment performance is about the past [music] and past performance does not guarantee or even infer anything about future performance. Also understand [music] that there's a significant risk of financial loss with all investment strategies and you need to request and understand [music] the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran [music] hedge fund manager Neil's Castro Larson. Welcome or welcome back to this week's edition of the systematic investor series with Jim Kasang and I Neils Castro Larsen where we each week take the pulse of the global market through the lens of a rules-based investor. Jim, it's great to be back with you this week even though it's only been 24 hours since we last spoke. Um, but it's great. >> Yeah. Yeah. Not even 24 hours. No, it's wonderful to be to be back. Uh, I feel like we could talk every day and I always think of something new and exciting that's going on in the world. >> I know. people will already be curious about why did they record something yesterday, but we'll come to that um later in the conversation. Um we've got uh as usual when you're on a great list of topics. It'll be a little bit fluent today, I think. Um but something that people will definitely be interested in hearing. U now I know it's been a very busy time for you uh leading up to year end. Um, so I just wanted to throw out um if there's something that's been on your radar that we're not going to be talking about um that has caught your attention, otherwise I'll be happy to throw in a few uh curve balls on my own. Well, I think uh you know I've been talking on social media for those are who don't follow there but uh really about um kind of the geopolitical moves uh the connection between kind of what's happening Russia Ukraine and oil tankers and then what's happening with the embargo uh you know that's now happening in Venezuela and the seizure of a tanker. I think there's some really interesting geopolitical dynamics if you dug dig under the uh kind of the surface about how all these things are interconnected and and how we're having a really kind of geopolitical kind of um war underneath the surface and it really is war. It's not just economic anymore. It's becoming really um a hot war on several fronts and I think that's really uh uh interesting and important. >> Yeah. No, I couldn't agree more. Um now my um the things I noticed this uh morning actually when I was looking for some some interesting stories um actually the first one um was Blackstone. They have created a really funny Christmas video this year. It's also a 40th anniversary for them. Um and for those who have not watched it because I think it came out today uh which is um Thursday we're recording on the 18th. Um you can find it on YouTube but I would recommend it. It's um three or four minutes. Um and it's um it's really fun. Well done to them for for being a little bit out there and doing something very different. Um the other thing I noticed was maybe a little bit more on the serious side was the Bank of American investor survey that uh came out I think yesterday. There's some interesting stats I can give you. Um and then maybe we can uh talk a little bit about it. Uh, one of the things that caught my eye was there is now a net 81% of respondents expect near-term gains for European equities. Uh, while a net 92% see upside over the next 12 months. So both of those are the highest readings on record. So clearly lot of bullishness even at these levels. Valuation perceptions has also improved. Now, a net 32% of respondents see European equities as undervalued. Interesting. And that's actually close to a 5-year high. Um, average cash allocations among European investors has fallen to now only 2.8%. That's the lowest in 12 years. And uh at the same time the concern of missing out on further gains has eased with fewer investors citing that fear uh of reducing equity exposure too much. Um so um and by the way in terms of interest rates 57% expect a higher for longer rate environment um and higher yielding bonds over the next uh year. Uh but that has not dampened the enthusiasm for for equity. So I thought >> yeah you're seeing that in several other things as well. I mean uh sentiment is can always be kind of quick moving. >> Um but what tends to not be as quick moving is actual positioning cash positioning. It tends to move a little slower and just like anything where people bet with their money you know it's real. Um so cash positioning is uh for for uh your average investor is at the lowest ever >> um below 3%. and margin uh uh for investing is also at record highs. >> So you put those two together and some of this uh you know it's a lot a lot of polyianish kind of stuff out there um and pair that with record valuations. Uh it's kind of confusing to me. I don't know, you know, how people can't see the forest from the trees a little bit, but um but yeah, it's a it's an interesting setup. Yeah, we can certainly say that people are all in at this stage in the institutional world. Um, the other thing and this I read from the same survey, but it came up on a Danish website. It talked about that the exposure to equities and commodities um are actually and and these are obviously asset classes that tend to do well when the economy is doing well. That is now at it its highest since February of 2022. And of course also uh to a point that you've been talking about namely the uh crowding um the exposure to tech stocks is at the highest level uh as well and AI stocks now I think is something like 40% of the US equity markets or something like that. So all in all concentrated um and not a lot of fear um to be to be had is by the way fear that reminds me straight about your your specialty volatility. Is there any fear to be seen in in in in volatility VIX so to speak? >> So so um so first of all I don't love the VIX as a fear indicator. Okay. Uh and again to remind people why that is is uh the VIX measures at the money uh implied volatility and naturally low the lower the market goes you slide to a higher implied volatility. So >> you know people look at the VIX going up and the market goes down and say oh my gosh people are scared it's not about whether it goes up or not it's about how much it goes up relative to where the skew is which is a very nuance difficult thing for your average person to understand. So, so I don't love that as an indicator on fear. Um, if you had the ability to go take the implied volatilities of all the options, let's say in the S&P and then see how they were moving on implied V relative to their strike or in other words, fix strike V. That is the the best fear indicator out there. So, I think V can be a great indicator of fear um and and risk. Um it actually is the best and but but the VIX unfortunately is is a very poor um version of that. Um so what am I seeing? Um the so one uh when you go into these DE opex these big quarterly opexes particularly at the end of the year there is so much structure product issuance that's tied to these and so much options positioning that there is a natural as you go into the expiration and opex uh compression evolved during these quarterly OPEX weeks the week leading into it and the week of um >> and and usually we reach a nater involve um in that period uh particularly if you're at some kind of a turning point uh in terms of potential risk and other things it's a it's a you participants understand that the supply of volume will now diminish dramatically and they're willing to step in and buy it and generally that supply demand balance then gets to a point where it it is much more likely to see higher uh prices on a fixed strike basis again don't slot the VIX this is just ball in general And so um naturally you know this is what we've been seeing. Um I will say um now you know since we really called um a broader not just a week by week or month by month uh low in implied volatility in August um uh in terms of fixed strike we have seen significant support to longerterm vault. Um, you know, one of the best trades in when I started in the business in '98, 99, 2000, 2001, 2002 for a f four or five year period was really to be uh long out of the money uh calls >> um uh as opposed to long stock or this idea of stock replacement. Most people think do that with at the money >> uh really out of the money. So, think a 25 delta type call. Um uh and again three month plus out. You don't want to be playing with something that's very shortdated. >> That type of trade worked incredibly well. Um uh again even hedge the short stock net long a little delta. >> Um because it it we saw a lot of market up during that period. Um usually in bubbles we've talked about this on here or you know again I believe this is a bubble. We've talked about why I can go into that. um you know the the bigger moves happen at the end um and then eventually it's a bubble and it ends. So you're better off on a probabilistic basis over these years to be um playing uh for for bigger faster moves and more increasing volatility by the way. 98 99 were very volatile years. Not just up moves but they had big pullbacks, big rallies and coming from the environment we were in which was a very stable rally. A lot of volression the summer driven by structural factors um that was a natural buying point involve and and and um and we are seeing that. So structurally we believe this curve is you know the the outcomes are becoming more leptocritic here >> um not just on the left tail but on the right tail and when that happens uh why own the whole asset when you can just own the right tail which is by by the way the cheapest thing and implied v basis on the curve. um you can buy a 25 delta call for let's say a 12 delta in the S&P. The long-term average of at the money v is about a 17 uh v. So at a discount to long-term average while you're in a bubble and the distribution itself is uh much more leptocritic. It's a no-brainer. Uh, you know, negative risk premia in general and then add to that um uh you know the the change in the distribution here give that's likely as we move forward. Um and it really represents an incredible relative value opportunity. Um so we've been doing that to answer your question I guess more directly not I got kind of technical there. We we um we we have seen some great opportunities evolve broadly for 3 months. Uh we are definitely playing from the long Vall side on the right tail. Um and um and we we uh even though you've seen a bit of V compression last two weeks which is what you would expect. Um uh you know the opportunities we're getting you know we got a 5% pullback then a rally then we got another 5% pullback. So, we've had opportunities to also monetize that. Um, despite that and and uh and again, increasingly as we head into and out of uh the new year, out of the old year into the new year, you're going to see more opportunities involved and a bit of unpinning due to inlife fall itself likely going higher from here. >> Yeah. Very cool. Very cool. [snorts] Now, I know we're going to talk about sort of portfolio construction diversification later on, but just before we head into uh a little bit of a trend following update, um I did see a different take on diversification uh namely how Warren Buffett sees it. Um because uh today I was reading on on Bloomberg that uh he now has and this is probably not any news, but he has now 58% of his portfolio in just five stocks. uh despite having sold an enormous amount of Apple uh he still has 21% of his portfolio in Apple, 17.8% in American Express, 9.8% in Bank of America, Coca-Cola 9.3 and Chevron 5.9%. So obviously that kind of uh diversification has done very well for him even though we may not see it quite the same. >> There are lots of we we talk about diversification a ton right on our wealth advisory side. we it is a core focus. We're optimizing to risk adjusted returns. Like that's the way we um we we think about the world something the idea of risk is something that is not actually oddly talked about in an investment advisory. >> Uh and and uh again most people don't know the sharp ratio or of the S&P 500 or the or 6040 when this is what 95% of people do. >> Um but the reality is there's tremendous benefit of diversification. We know that. That said, there are other incredibly well doumented academic research that shows that there are other great things that you can also do to help reduce risk of a of a of a portfolio. And one of them uh is is focusing on stocks that are not just in the Warren Buffett model value quality focused over the long term because that reduces volatility even though long-term returns are similar to growth uh things. So that's a significant and easy way to improve riskadjusted returns, >> but also to focus on companies that have increase their profit margins as interest rates go higher because we know that as interest rates go higher, multiple contraction is an issue for equities. And the majority of stocks actually do the opposite. Their profit margins, you know, get worse >> as interest rates go higher. Why? because interest rates are generally tied to inflation. Higher inflation means higher costs which reduces profit margins. So most companies operate that way. There are a sub subset about 25% a significant minority um that that do the opposite. What are those companies? Think about companies with negative working capital. What do I mean by that? Uh Warren Buffett and insurance comes to mind, right? Insurance is incredible negative working capital business. Why does it do well when interest rates go up? Well, they get the money up front at scale. They get the inflation on that money and then they pay out afterwards. Okay? There's no increase in cost by the way of inflation to them in any other way. Lastly, they also it's a capital intensive business. So, if the cost of money goes up, there are less participants and risk risk premium tend to go up and they tend to collect more margin as well. So, it's a very good business in this environment. Right? a lot of financials that's fairly true for as well not all financials but a lot of them so it doesn't surprise me the top five he has Bank of America and American Express those are transactional businesses the more volumes go up even if their costs go up more than their volumes they are going to benefit um so he he is focused on companies when you look at this that that that generally do that other commodity businesses do very well Chevron I I also think the Venezuela thing if there's one company that's a major that will benefit is Chevron actually they're they're they're plugged into Venezuela and had that was one of their biggest markets before. Um and then uh the Coca-Cola company people think that that is a product business. It's not. It's a they they are a a um a distributor. They they're the middleman. Middleman businesses don't have more cost. Volume goes up. They do well. Um and so all of these except for maybe Apple >> um are are um are in that breed. So he is in a sense managing risk to a uh and actually trying to benefit from what he believes if I look at this portfolio is a rising long end of the curve and and importantly a steepening curve. Uh financials do really well obviously for those reasons and um and I think that's what this tells me and I think that's a good risk man at the very least it's a riskmanagement play on that >> um even though he's not doing the diversification thing uh as much. No, no. And I think we often I mean, first of all, let me say that um you know, he's done very well for someone who who said by his own words that he was not a tech investor. I think investing in Apple was a pretty uh pretty good move. But and and people often get sort of um blinded and and rightfully so by the 19% compound rate of return that he's had for I don't know 50 years or however long it is. It's amazing. Um but when you do look at the track record, there are pretty steep draw downs along the way. That's one thing. And also I think people forget that he does use leverage. I don't know the exact number but I think it's somewhere between one and a half and two times le took the words out of my mouth. >> Okay. >> So if you manage risk, this is these are the big ideas that everybody misses. And this is in our words of in the words of David Drudge. I'm going to keep using his metaphor, you know, >> uh because it's such a good one. If you can get your risk adjust adjusted returns to a better place, if you have more control in the car, you got the brakes, you got it's a stable controlled vehicle, it's not just one lever gas, um if you can get to that place where your vehicle is much more into control, you can use the brakes to go around the turns, you can accelerate, then you're in control, there's less risk and you can go faster on average. You can add leverage, you could add speed because the the machine is more under control. And and that's the critical idea. Most people think of risk management as oh I have to take less risk. And that's why 60/40 exists. Bonds are not a diversifier to stocks. They do not reduce your risk. It is just a matter of taking the speed down of the portfolio. And uh uh and fortunately that that speed taking down means your long-term returns are going to be lower. Um, and by the way, you still have more risk. You still haven't really, I mean, you've just taken your, you know, the sharp ratio is the same. You've just you've just lowered the total risk with your total return. So, so yeah, at the end of the day, what what Warren Buffett has done just to put a bow on that is is he is an expert at managing risk relative to return for a long portfolio. M >> he thinks about risk and he does that through quality and understanding what like only investing what he knows because if you know what your risks are and you understand it you have less risk. >> Um and by doing that he can then deploy leverage which he does which then gets him to a better place on a risk you know on a return basis. >> Um if he just managed risk and didn't deploy leverage he wouldn't outperform the market. He would outperform riskadjusted returns. His risk would be dramatically lower. Mhm. >> Um and and again when you this is what hedge funds do when you when you get to a two sharp by diversification or other measures of managing risk um then you lose use leverage and that's how you get outsized returns. >> Yeah. What what's interesting a lot of people of course they look at sharp ratio as being uh you know the the best measure of of these things even though I think all professionals will say and use that as the most commonly understood because if I start talking about casinos and >> I'm going to lose people. But one thing one thing I was just going to say to that is that something that um that we've done a little bit just to get a different perspective of things is actually just take people's annualized volatility and I mean people so investment strategies and divide it by their maximum draw down. That gives people sometimes a lot of surprise to see that even though something looks smooth from a sharp ratio point of view or looks safe from a sharp ratio point of view, the ratio of max draw down to that uh annualized volatility can sometimes be a lot bigger than what you uh expect >> 100%. And actually because draw downs are rarer, you have less data on draw downs and people can have five 10 year track records with great sharps, right? >> But have tremendous tales in the portfolio. You wouldn't know it until it hits. >> So yeah, sharp is even sortino is not is not uh you know sortino is way better because it's just downside volatility to be clear as opposed to total volatility. Sharp really makes no sense. Um uh but but um but but agree uh understanding the tail um structurally what is your max loss um and these things is is critical to risk management as well. You really want area under the curve with some measure adjusting for um you know amount of size as well that that that that punishes uh in the equation um bigger losses and that's really the best measure of risk in my opinion. All right, quick update for for the people who are interested in a little bit of trend following. Um, it has, you know, we are in the final stretch of the year. Um, with many trend followers actually having posted now consecutive monthly gains uh all the way through the second half of 2025. Um, so a good finish to the year. Of course, we hope that this will continue for the next couple of weeks. Uh so at least we have a chance getting and finishing the year in the black for the major indices. But the jury is still out. Uh the month looks pretty quiet so far except of course for those who are focused on things like silver and other precious metals because but I mean this has been a an amazing year. Silver is up more than 100% this year. Uh even though most people talk about gold which is still doing well up 55% so far this year. But anyways, um it's it's very interesting. My own trend barometer finished yesterday at 48. So that's kind of neutral, reflecting well what uh the data suggests at the moment. Um as of Tuesday evening this week uh and I will say by the way I think Wednesday was an up day for most uh CTAs. But anyways, as of Tuesday uh down a quarter% for the Btop 50, up 1.5% for the year. Stock gen index down 21 basis points but still down 1.5% for the year. the trend index uh up 12 basis points and up 59 basis points for the year. Um and finally the short-term traders index down 14 basis points and down 5.34% so far this year definitely been the hardest place to be uh in uh in in the CTA space uh in 2025. Uh the traditional world MEI world equity index down 1% uh thereabouts as of last night but still up 19.4% for the year. uh S&P aggregate bond index down 32 basis points but up 6.87% for the year and the S&P 500 down as of yesterday 1.78% uh and up 15.71% um year to date but is being helped by a better thanex expected uh inflation report [music] that came out just before we started recording. [music] Anyways, let's move on. Before we get to our topics, uh Jim, we have uh three questions that came in from uh Rick from Offsides Macro. He writes, [music] "Jim, you often emphasize that today's markets are shaped more by positioning and reflexive feedback loops than fundamentals. How should systematic allocators quantify and integrate the understanding of positioning into models to anticipate regime shifts rather than react to price signals? Oh, that is the greatest question of all. Honestly, if you're talking about trading, maybe not investing. Um, look, um, there are structural changes that you need to understand. At the end of the day, markets are are just a voting machine in the short term. They are a how many buyers are there versus how many sellers. Um, that's always been the case. I think the difference is nowadays the structural flows of buyers versus sellers is just much bigger than it's ever been relative to other flows. And so they are more dominant and luckily a lot of them are more measurable because they're structural as opposed to based on an opinion or a data point or etc. Um so uh so it actually favors uh those that understand market micro structure and these concepts of reflexivity etc. positioning again going back to uh you know Soros uh at the end of the day right um and others you know are the biggest understood and countable right measurable uh you know supply and demand and weight and so the more you understand that across the board whether it's in options or uh whether it's an an underlying stock or or whatever it is um is is the most important thing. So understand that positioning, understand the effects that that positioning will have as it is either unwound or as as hedging to those positioning uh kind of are done. Um and then from there I think you end up understanding reflexivity itself much better. Um you know again reflexivity at the end of the day is is a function of what are how are people currently positioned? how are they what are their needs and demands and how will they then reflect uh respond uh as a function um of of moves and occurrences in um in the marketplace. So so I guess to answer the question uh you know reflexivity is the key understanding positioning um is is instrumental if you're going to to play in in these markets uh particularly on a short-term basis. um some of those structural things lead to changes in the distribution more broadly. So it can also help for more medium-term meaning one-year even two-year type outcomes as well. So, so um that said we're looking at 5 10 years there's a much bigger uh uh story that eventually will you know will play out as a function of those flows uh generally mean reverting to some some reality and that generally happens as liquidity comes out of the system at some point which is hard to predict when >> and and the actual quantification of these things is that kind of the secret source the IP of each manager how they do it it's not like something you can look up in a specific report. I guess >> um yes, although the process is not rocket science. Okay. In a sense, it is if you can get to the positioning itself, if you can collect that data and have a good sense of what some positioning is or broad positioning, you don't have to know everything. Then just simply understanding the the reaction function, >> okay, >> of those positions is really what you're solving for. You can call it secret sauce. It may sound technical but depending on the products there are pretty clear >> results. You just have to kind of work backwards from there. Um which you know in the case of options I happen to be an expert in so you call it secret sauce but I'm not the only person who understands how options work. Um you know if time passes and volatility implied volatility changes and the market moves these all have effects on the options and based on that positioning that'll tell you then what the reactionary flows should be. That's the case for options which are a little bit more multi-dimensional, less complicated when it comes to stock and less complicated when it comes to to other other products as well. >> Sure. Great. Next question is in environments where traditional hedges become harder, eg compressed volatility, crowded hedges, what positioning adjustments do you consider before volatility spikes, especially when positioning data suggest convexity traps? Now again I don't know if this gives the full uh meaning or if this is too close to to answer in terms of IP. So >> feel free to answer how you want. >> No it's fine. I I think look uh the the broad answer is um you have to think about with options in particular which seems to be the inquiry. Um you need to both think about real the reflexive effects effects on realized positioning which is you know what what is likely to happen to the underlying but then you also have to think about supply and demand to the implied vault itself which is the secondary >> part which is critical. Um generally speaking the reflexive effects on implied volatility are much stronger. >> Mhm. >> Um uh and and because they're less liquid and uh there other there are less flows other than this relative to the effects of the reflexivity if that makes sense. So one of the easier things to do is to predict based on positioning the path the likely path of implied ball itself. Now that has itself reflects effects to the underlying as well as uh like so like the vulma and veta these effects that are that are tied to the v have effects of the distribution of the underlying but they're not necessarily the delta effects the delta effects are part of like those are the va and charm effects I talk about a much broader bigger group of of flows that that move markets they're important for for the move the direction but they uh during some periods are significantly smaller and even when they're bigger are maybe 40% at at the best. Everybody likes to think about direction specifically and the effects of the options and they started with gamma. I've added in von and charm and people have largely now absorbed that in the last four or five years and are talking about it more. But I I do think the distributional effects of implied vault compression and the those are much more predictable and uh much more powerful uh and easier easy to use. So um so I I really uh like that angle even more. I think that's something that very few people focus on that I'm trying to talk about a little bit more so people um understand. So again, there's a lot of details in there. We could probably do a whole episode on this, but um [laughter] but those are just general views that that might help. Final question. Uh, and I do remember this uh call uh a number of years ago. Um, you deserve credit for a call you made on Gold V a while back. If memory serves me, I believe gold was at 2500ish. You suggested looking at 3,000 calls. Both FX and Treasure Vault remain low. If not there, where else are you smelling asymmetry? >> Yeah, we um we don't always get it right. um hard to have called that better. I think we [clears throat] called almost to the week the low in in gold and the low and gold V simultaneously. Um uh we did that on here. You can go back and listen to it. It was again over three years ago, three and a half years ago, maybe four almost. Um h how do we do that? like what what was the um you know we've had this very clear broad thesis about structural inflation and populism right and uh again once you have that view and that's not a straight line it's going to take time to play out um the best asset to have in that type of a regime which we haven't seen for 40 40 years plus is gold and the way it was performing relative to all other ass commodities was completely out of line with that and we actually to be clear it wasn't a broad call on commodities it was a call on precious metal specifically >> and actually we said look you want to sell V in oil >> um you want to sell puts and and oil uh collect that premium and go plow it into as many long calls in gold as you can >> and and I think that education there is it's not just about direction which is what most people focus on you had a z bet in doing that actually probably collected premium in that process and got dramatic exponential convex convexity to gold and just continue to collect it in oil for four or five years. I mean, I cannot think of a better I wish I'd launched an ETF doing that. It'd be up like 10,000% and, you know, would have 10 billion dollars in assets. Um, but but um but the reality is that trade should is not going to work every week, not every year even, but structurally that that is what you want to do. and and we did a lot of data analysis of the 60s and 70s at the time. You'll remember we talked about it then >> and and the volatility dynamics again hard to predict direction general dynamics apply but predicting distribution given some very basic assumptions can be uh can be very predictable can you can make these big calls that can last decades and that can make you inordinately wealthy. Again, if you just knew that interest rates were going top left to bottom right for 40 years, which is what happened for 40 years, if that if you understood that one dynamic, >> one thing, you are probably one of the wealthiest people, you know, um because it it really drove everything. And so um and again if you believe what I believe and I have believed for four or five years I think fairly accurately um because you can see it all happening under the hood um I think you're going to be inordinately wealthy in 15 years and you've already made a tremendous I think we've already made people a tremendous amount of money with that view in the last four or five years. Um and that is that there's inflation is structural and it's not going away. It can go away for uh 6 months a year. Uh again the inflation of the 60s and 70s had four different bouts. So it was not one secular move. Uh uh there are cyclical effects and if you look and understand what's driving it and you have that view you um you are going to make a tremendous amount of money. Uh during 60s and 70s precious metal was were not only the best performing asset most people know that but it was the most volatile asset. um and with implied V with that asset at its lows relative to other things and its implied V simultaneously at the lows on a riskadjusted basis that was one of the most ridiculous trades. And again uh uh if you look at stock V um equity V because it's a nominal asset over that decade 14 years 68 to82 it went nowhere in nominal terms. So talk about implied vault compression. It's not that volatility will be higher and under all time frames for all assets. There is really a dramatic distributional difference between assets in these regimes. Uh if FX fall is the way to go. I've been saying for four or five years. Think about how much money's been made in FX fall. You're seeing you know yen carry trades blow out. You're seeing uh all these other FX moves. Um so FXVA this is why precious metals fall into that category because they are more FX >> um and then uh importantly um bondvall obviously um is is uh much much better during these periods uh so those three categories precious metals FX uh bonv dramatically higher on all time frames and then you go look at equity va long-term va equities dramatically lower short-term fairly in line so you still get a lot of uh geop like stress and geopolitical but over time as you head through these periods it actually that compresses as well because valuation should come down as structurally as inflation occurs uh multiples should contract because as interest rates go higher multiples uh need to contract to stay in line with that. And then lastly, um, uh, industrial commodities have a push pull that happens both from inflation pushing it higher, but general deglobalization and things generally putting a cap on it with minor spikes in between like we saw during, uh, the OPEC crisis in the 60s and 70s, but generally speaking, um, you know, structurally, if you're selling out of the money puts, a much safer play. I wouldn't go solid money calls per se and in oil, right? But but uh but structurally selling puts is is a much better play for industrial commodities like uh energy or things like that. >> Hearing you talk about this and I do remember all our conversations and I do remember your kind of steadfast conviction about the playbook, but I am actually kind of curious because one could say well he's been absolutely right and and it's playing out exactly as he said. But you're comparing to a period where uh statisticians might say, well that's a that's a sample size of one. It's one environment. What made you so certain actually or maybe you did go back further to see if there were other um periods like this? But but what made you so certain that actually yeah this is exactly what we're looking at? >> Well, we we've done a lot of conversations here. I can go through the deep deep kind of structural underpinnings. It comes down to this is not just a sample of one to be clear >> right >> this is uh this is a structural cycle uh the populist is populism is which is a function of inequality >> and inequality is is inevitable at some point right the system uh structurally like animal like not just humankind the way the world works is it's a The way evolution works is it's a survivor, you know, uh like it's bias. It's it's win or take absolute power corrupts. Absolutely. If we did not have government, if we did not have man-made structures to help make things more fair, that's really the role of government broadly. >> Some some governments, >> yeah, it's that's what it's supposed to be, I guess I should say, right? um is is supposed to take um you know uh you know without that I apologize we would we would have a winner or take all system. We've talked about this before the the impulse towards fairness only happens in response to eventual absolute power corrupting. Absolutely. in a democracy that happens more smoothly because you have a voting mechanism that doesn't allow it to go I mean it goes it can go very far as we've seen >> but at least uh in theory it it allows for um a transition back uh and what we've seen in the United States is a very clear cycle and others talk about this from other dynamics that we our view is complimentary to these fourth turning type dynamics that you talk about they're they're different they have underpinnings that really look at a much I think broader picture of the why and not just that it exists but that like what drives it. Um but importantly it's not just a matter of inequality expanding and and and uh you know compressing. I think one of the key takeaways is when that expansion happens that it's not equally felt across generations. It is felt unequally because when you are young you are labor and when you retire and you're old you're capital. And so what happens through inequality expansion is during the times when it happens which are the majority of the time by the way it's probably 40 out of you know 60 out of 80 years um the the the younger generation becomes disenfranchised angry. They're also young and have that revolutionary spirit and want change at at baseline. And as that generation then moves to political dominance and the older generation dies, then the tide turns. This is why the machine works the way it does. And it's not a it's not good for predicting one year, two-year outcomes or fiveyear outcomes, but if you're looking at 80year, 40year, 20 year, decade outcomes, it's incredibly valuable to understand those dynamics. Uh and again, you want to be able to do things that you measure. Those are the things that are the best for prediction that can give you great conviction. Go back to the Warren Buffett thing, right? >> These are things that you can measure. You can understand the generation, what the inequality has been for that generation, what that's likely to mean for their political views and and how that's likely to play out. Um and so that's the base underpinning. there's a lot more detail and and we can dive into all the dynamics that that are are driving it. >> But why was the 1960s7s a better metaphor um given than others? And by the way, because you could see outcomes that are not as inflationary that could become deflationary ultimately as a function breakdown. We could get into that because the Federal Reserve uh in starting in 1971 uh became the most powerful entity in the world when gold was unpinned from the dollar. >> Um and when you have a there is like world is about incentives. If you have a a government um that is forced in the situation to a political problem and there's only there's there's only a couple ways out. They are not they're going to avoid crisis >> for long-term pain. >> And that's what inflation is. It's a says a puzzle time. Peeling the silver off coins, right, is an easier way to deal with a crisis than it is to actually, you know, have the crisis occur. Um and so uh it is in government's best interest in this environment to take its pain through nominal um you know uh pain as it is to the market to have massive market declines. Uh again 68 to82 market drop at its peak uh after a 14-year window in real terms um you know 60% 55 60%. But normally it went nowhere. And that is a much more politically palatable even though nobody likes inflation. You can hide the inflation a little bit. People feel it. But you can use your talking points and look the market >> you know just rally back 75%. Well okay. >> Um and and so the incentive structures are such that uh avoid crisis, avoid uh nominal volatility and and so inflation is is really the only way out unless you're willing to accept a crisis. in these environments. [music] >> We've got three things left I'd love to talk about. Um I'd love to end up with kind of you maybe giving your [music] sort of key takeaways from uh this year. Uh I'd love to follow that with your um following the road we just talked about. You know, what do you see for next year? Uh I know people love to hear that. But before we do so, I'd like to touch on a topic that you talk a lot about at the moment, you think a lot about, and it's super important, and that is kind of how do we build a portfolio for this future or this regime um that we are in um and I just happened to come across a paper, I mentioned it to you before we we clicked record um that uh I think it was done by the future fund, which is a large uh Australian sovereign wealth fund and they did a paper about you know what portfolio resilience uh really mean and I don't know if you necessarily think about building portfolios just to be resilient because obviously people also want them to to uh compound but they as far as I understand the future fund has done very well and beaten its uh own uh target which very few pension funds I would they have done in the last in the last few years. Um they talk about when they talk about resilience and I think this is actually quite critical because in in my world we talk about building robust trend following strategies but nobody really puts words on what does robustness really means? How do you measure it? when they talk about resilience, their definition, if they were just going to say it in in a couple of lines, is um a collection of exposures that achieve target returns through a wide range of future scenarios. That's kind of how they they they put it into words. But in that they talk about achieving diversification that it needs to be able to absorb shocks. It needs to increase the predictability. It needs to guard against sustained underperformance, severe losses. And then comes this word robustness. I mean with all the work you do right now, with all the conversations you're having right now, I'd love to hear your thoughts about um how you think uh in in your uh wealth management business think about uh building um kind of the portfolio for the future or for this regime. I'm going to say something that is going to fly in the face of what 95 to 99% I'm not sure what the exact number of investors think is what investing is until 1982 really the mid80s 6040 and also passive investing did not exist. >> It is sold to the world. And by the way, everyone does it. It's group think. Everybody on the planet thinks investing is buying stuff. They think of it like shopping. I like that thing. I think that thing is going to appreciate. I want that thing that did not exist as a concept investing broadly as like a a way to invest until the mid1 1980s. Most people think that's just an innovation. People have become more sophisticated. We're going to lower the costs and we're just going to do this thing and that's what investing is. I'm telling you that didn't exist until mid191 1980s because it didn't work before that. It did not work. If you look at 1900 to 1982, I draw 82 because that's the peak of interest rates there. It's not a random number. 82 years to compare to the 40 years that were that have been sins. 60 of those 82 years in decades in in consecutive decades made no money in 6040 in real terms. I want to be clear. 1900 to 1920 in real inflationadjusted terms 6040 made zero for 20 years. >> 1929 to 1949. 20 years two decades >> made 0% in inflation adjusted terms in real terms. Zero with a ton of volatility. Both of these with tremendous volatility. Zero. And then 1962 or 63 to 1983 depending on where you draw the line 20 years again zero two decades real returns for 6040. Why in the world if 60 out of 80 years in decades you make 0% in real terms with a strategy would anybody do it? They didn't because it didn't work. This indoctrination that 6040 is how we invest is an artifact of recency bias. 1982 is the peak of interest rates and it went in a diagonal line for 40 years to zero which created over 400% multiple expansion in equities alone. >> Mhm. Never mind the the profit margins, as we talked about on here before, are highly correlated to that. And so we've gone from record low profit margins in 1982 to record high profit margins. The correlation of stocks and bonds over the long run is more positively correlated than negative. There is zero, I want to reiterate, zero diversification benefit over 125 years of stocks versus bonds. 35 sharp ratio for stocks.35 >> 37 for 6040 and the 80 years that I talked about those numbers are 27 and 26 you actually lose your sharp ratio the reason it's been adopted because it's easy it's broadly worked for 40 years right and because the sharp ratio for the last 40 years for S&P is 0.52 and 6040 is 62 you have gotten some diversification benefit but that's simply a function of interest rates going down and being used as a tool once you see this big picture and you understand what's going on again if you got this interest rates top left to bottom right right then yeah do 6040 I I get it I agree I it worked great you're really wealthy do it with leverage do it you know buy the dip and know that it's coming but if we don't know where interest rates are going. It is an incredibly poor way to invest. It's dramatically suboptimal. There is no risk management, right? And on top of that, uh you know, if if we think they might be going the other way, which we've talked about for four or five years, I'm inaccurate. It is a death wish. >> And so I'm not saying interest rates are going up. I have said that separately. I think that's a high probability over like structurally at the very base if they go nowhere if this is we're still below by the way the 60-year average the 60-year average 10-year bond is 5.8%. And can I just add one thing which people may not notice that is that since the first rate cut in this cycle long-term interest rates are actually up. They're not down. >> Correct. Which again we've talked about. We've said by again for for many years the steepener is the best trade you can put on blah blah blah blah when it was inverted. >> Talk about in that gold trade the steepener trade has been just as good. It's important to note that if we stop and think about what drives risk and what drives returns and we take a completely agnostic view just agnostic this is not a bet on where we are going from now you can achieve riskadjusted returns and I am not exaggerating relatively straightforward with diversification with a little bit of longvall and and and improving your geometric returns some value investing like Warren Buffett. These are all concepts. By the way, academic research screams it's not even a question. Simple concepts. This is not alpha in the sense of, oh, I have a gutter ching trading strategy. With these concepts, you can construct a robust, resilient portfolio relatively straightforward that does not outperform a.35 sharp by 50% by by 100% not by 200%. Not by 400%. >> Most products in this world, if you do something 25% better, you take over the whole market share. We're talking about four times the risk of adjusted returns over 125 years. Yet, nobody's doing it. >> They will do it when the things go the other way and it'll probably be too late because people just chase whatever worked the last 5 10 years and 40 years is forever for people. So to look at a big picture and understand risk is a a bridge too far. But I'm telling you if if this next 20 years does not look like the last 40 the biggest business in the world the to biggest total accessible market of any business in the world which is asset management and advisory will look dramatically different dramatically >> than what it looks like right now. And so this conversation we're having arguably is the most important conversation in business period. Um, and it's one that's well documented and understood. That's the wild part. What I'm what we're talking about is not a new idea. It's just a little harder. In the words of Warren Buffett, you have to swim with a swimsuit at the risk the tide might go out. And nobody's been swimming with a swimsuit for 40 years because it's uncomfortable. It slows you down. >> Yeah. [snorts] So, um but yeah, simple replicable ideas. This is not rocket science. Um and if you do it, you can achieve dramatically better outcomes. >> Well, I'm sure we'll talk more about that in the new year. Maybe more specific what what you are doing, but I do want to take the opportunity in the last uh 10 minutes or so that we're together today. um as we come to an end of a year that I think could be said or described as a year with a lot of noise and maybe not so much signal uh at least from a quantitative uh trend following point of view. Um what are your key takeaways from 2025 and how how do you set yourself up um for for the new year? What are you what are your um I know I know calling the future is as we in our world would say impossible but I know you sometimes venture into that >> well we've called a few things over a time um yeah let's look back briefly um a couple of really interesting uh big picture things um one uh we highlighted this in our conversation actually yesterday um but I I think it's so important is is the rise of non-correl related assets for exactly the reason I just highlighted. Um you have a $500 trillion long asset world including stocks, bonds, real estate, all the things, right? Again, how the whole world manages money to draw those two things together. And then you have this non-correlated diversifying things or not just things strategies a lot of them some of them are things and those are precious metals say call it crypto which you can argue are device diversifiers or not you know people believe it is um which is all that really matters um and then we have hedge fund type strategies right um which I think we all fall in in some form or another and then you have structured products or or I would use the the use options whether it's ETFs things to position in a much more non-correlated way >> that pool of assets has tripled in two years >> two and a half years >> and tripling consistently all of those different things for the same exact reasons which is a drive towards non-correlation but again going from a very low level of you know $5 trillion to 15 And this is why markets are going up and even though interest rates went up in 20 you know to four and a half relatively in the last year or so >> uh more stable right so um the big question is uh uh you know is this the the first inning uh second inning where are we and and you know I I would argue again based on what I just argued that that if we are happening to go into a period where interest rates do trend higher and there is worse returns for assets than we've seen the last 40 years and and and not just for a year or two. I'm talking about for a decade. >> Um you should see a dramatic continuation of that. Um I would argue a lot of these people who are moving to this are early adopters who listen to our show and who think about these things more broadly. Most people don't react until they're punched in the face. Um and so I think that's um incredible and probably the most important thing that's happening. It's it's again if you understand these one these little things they can be tremendous um uh drivers of wealth in in so many ways um the the onslaught of ETFs uh particularly non-correlated ETFs uh in the option space the uh the growth of of again structured products the the effects of those structured products and this growth uh uh both uh on on the underlying this would be kind of my second point so you now have this thing now the other big takeaway is we saw some dramatic and and important changes to how uh underlying assets move as a function of some of these moves. There is an interaction we talked about on here of hedge fund long short equity which is growing dramatically because of the demand for hedge fund assets with vault compression which is a function of rise of structural products and then those types of ETFs that are driving that vault compression. Now these things are reflexively affect affecting the underlying. And this summer there was a tremendous set of uh in particular and really uh uh interacting with policy and allowing policy makers themselves to make decisions that help drive their goals. I I would argue a lot of whether they realized it or not. Um you know the the Treasury and Fed had a much easier time with the Treasury uh and in driving a positive outcome out of Liberation Day in this year as a function of the stability that was driven uh and and some of the pain that was uh forced in in hedge funds that were underweight >> during this window. there's a a massive part of the structural demand that pushed this market higher was the underweight of equities of institutions having to buy back in and the vault compression that was strong and stable that allowed for risk-taking throughout this period. So that would be my kind of second takeaway is these reflexive effects and the importance of of this shift uh that that that's driving. And then I guess as a third takeaway um uh we talked about uh you know late last year early this year um about how uh almost to the day that FEB opex was a risky place. >> Oh yeah. >> Uh we almost called that again within a week of of of the decline. We thought it'd be a 15-ish percent type decline and then a rally. We got 20 we got 25. Um but sure enough turned in April. uh we you know uh bought that dip and were were aggressive on the rally. So those things all made sense based on the the the approach the administration was taking. I do think that um what what became clear though is um the exuberance and this is where we get into kind of future looking right to next year that we felt I think we all felt it even people who weren't proTrump were like okay well change you know this could be really rah rah you know boom boom let's go and there was a real sense of exuberance with uh with Trump coming in he was the change agent as every change agent is felt like okay we're g this is going to change things and as I've said what's happening here is is not political, it's structural. >> Um, and as I highlight in the 60s and 70s again as a as a metaphorical, you know, that that we had a 60 to 62 to 82 period, 20 years where we had five presidents, the turnover was every four years on average in some form or another. Whereas last 48's average is 7.1 years. >> Um, that is because of this populist uh impulse and the political upheaval that's coming as a result of it. Uh, and I said very clearly, loud and clear, I'm like, just wait. The pitchforks are going to be on his lawn. Give it six to nine months. Uh, and sure enough, you know, it started with the Elon getting kicked out of the administration and and pitchforks and literal pitchforks and fires and and his dealerships and then moved to uh now Trump and his approval ratings um and broad um, you know, kind of move and sent sentiment uh against Trump. Um I I want to be clear and I think you're seeing that by the way with the the Epstein releases and and his base uh kind of moving away as well. Uh this is why again structurally now we go look at the 67 60s and 70s and look at psych political cycles elections matter more in this period dramatically more than they do during other periods to highlight some data we talked about uh in 2020 early 2024 uh heading into the presidential election with great success uh made a made a great call there um you know we have these election cycles during populist periods let's start with presidential elections to Just to rewind to that, not the midterm. We're going to get to the midterm. >> This is now looking forward. Presidential elections during that 62 to 82 period, we have five of them. All five are double digit positive with an average return of 21 a.5%. >> Now, okay, people like, well, presidential elections years are positive in general. Not true. If you take out that five out of the 25 for a 100 years, >> the average return is closer to 67, which is meaningfully under the long-term average. >> So, ironically, presidential election years aren't posit like relative to normal are not positive except for during populist periods. >> Which is where they're consistent and very positive. >> So, that's a big underlying uh thing to understand and important kind of that highlights how important it period is. And then also if you take those five election years out of the 20 years that 62 to 82, we've already talked about how poor that period is. >> Right. True. >> So the other 15 years combined have an average uh nominal performance uh of of negative 3%. That's nominal, not even real, >> right? >> And that's 15 of the 20 years. >> Yeah. >> So it's black and white. If you look at it other elections, you look at in its data set and it makes sense. Most importantly, we didn't go mining data to find this. We had this big qualitative idea. We went and looked at data and it screams at you. >> And guess what? And we've been saying we're in a populist period since at least 2020. You know what the return is of the presidential election into 2020 or in 2020? 18.5%. Do you know what the the the 2024 election year return was? >> 25%. You know what the average is? 21.5%. Yeah, >> coincidence. >> I mean, maybe >> maybe >> pretty black and white. That is what the data screams. You better listen. And then lastly, now let's look forward into midterms. >> Midterms. You're right. >> We hadn't talked about this at the time. Um, >> midterms. I I kind of took those other 15 years of that data set and said, "Oh, they're all bad." But if you dive into those other three years of the of the data set, >> it again screams at you. >> S every single one of those midterm years, four of them. There are actually five. I'm not counting the um >> the 82 period or sorry uh 78. So if you go look at 62, 66, 70,74, >> okay, >> all of them um were massive down years. And particularly if you start uh in the October so like Q3 of the year prior so let's say we take a 15-month period leading into the midterm those periods if I popped up a chart here that again I could do it it is uh again just screams that you have these peaks that come out of this exuberance and uh oh we're going to change things and the great the world's going to be great to oh no our polling is at the worst numbers ever things are not working out as great same old, same big problems, nothing's changed, and you get this >> dramatic draw down. Uh the biggest draw down of those four is 42%. Um and they get bigger. They start uh at 24 25, they go to like 30 uh you know, and they build, they get bigger as time goes on. And that also kind of makes sense in the sense that they start to people start to recognize the pattern. People start to recognize they actually start earlier too as you go. It's a really interesting they they start earlier they become bigger um and and again the pressures as they build through this populist period right political dominance become more incontrovertible. So um again qualitative idea underpinned by uh big ideas dive into the data and when they both scream uh with the way they do you you probably should listen. It's not the only thing that matters, but I do think the populism and the uh is is a political reality and it's what's driving the poor outcome. Um, but it's it's unavoidable in a sense unless we head to pure authoritarianism and circumvent the whole system, which is possible. Anything's possible. >> Sure, anything. >> Um, but but that's that's the reality. Um, and the political pressures and again, by the way, I'll draw draw a parallel here. Take on 70s. Nixon >> came in who was the one I compare the most to Trump here. And what was the first thing that Nixon did? Nixon did massive tax cuts for the rich. Tried to roll back the Great Society program. It was his first policy. And by the middle of the midterm year, he was in price controls as inflation picked up. M and so the move to fiscal spending which we moved away from this year and people like oh change is coming is likely and I've said this now for a while to come right back as the political >> upheaval to these policies right the pitchforks show up on his lawn and those political pressures are are are cannot be destroyed or or or or turned away is the big idea and those pressures with the problem >> ultimately for equity markets even though they may be fixing >> underlying bigger >> will be for dead market as well. And uh what will be interesting uh with that analysis uh is also um should it play out as it has done in the past um add to that uh the the rise of passive uh investments um which we did >> effect to our point. So the last that's a very good point you know last year there were things that helped >> admin uh you know the administration >> uh fight against uh these pressures to some extent and so could it be a situation where that's those pressures which are relatively new and reflexive >> could overwhelm some of these bigger structural political things. Yes. But these are factors we should both be thinking about that are important to that analysis. >> Absolutely. >> Jim, we're coming up to the hour. This was again as always uh wonderful, so insightful. Really really appreciate uh the time not just today but actually all the weekly and monthly conversations you have with me or with other guests. Uh I know there's some really exciting uh guests coming up on your series. Uh you got options uh in the new year. So can't wait for that to be released. Um, but I would encourage everyone listening to the conversation here today, if you want to show some appreciation for all the time and energy that uh, Jim puts into this, um, follow him on Twitter, of course, but in addition to that, go and find your favorite podcast platform, iTunes, Spotify, wherever you, uh, listen to your podcast and leave a nice, uh, uh, rating and review for uh, for the work uh, that Jim does. Next week, we will be releasing part one of our year- end conversation. Um, and since we recorded it yesterday, I can assure you it will be worth your time. And part two will be the following week. I think it's very hard for me to put words on the amount of brain power and experience in that group of nine co-hosts that we have uh and in all kind of slightly different fields. But uh sitting uh and just mainly just orchestrating things yesterday and listening to all of you uh was just uh incredible. There's so many uh takeaways from that from those conversations. So can't wait to release them in the coming uh couple of weeks. From Jim and me, thanks ever so much for listening. We look forward to being back with you uh next week. And until that time, of course, uh, happy holidays, merry Christmas, and take care of yourself and take care of [music] each other. Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the [music] best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the [music] new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues [music] to grow, please leave us an honest rating and review in iTunes. It only takes a minute and it's the best way to show us you love the podcast. We'll see you next time on Top [music] Traders Unplugged. >> [music]