Market Structure, Liquidity, and Reflexivity in 2025 | Systematic Investor | Ep.368
Summary
Market Outlook: The podcast discusses the potential structural effects of governmental changes on markets, with an emphasis on the upcoming midterms and how these could influence market dynamics.
Investment Performance: There is a current "everything rally" with positive trends across equities, gold, and managed futures, highlighting a significant rise in gold by nearly 12% over the month.
Valuation and Bubbles: Valuations are not a reliable timing mechanism for market corrections, and the current market dynamics resemble the late '90s bubble, driven by liquidity and structural product issuance.
Liquidity and Reflexivity: The podcast emphasizes the role of liquidity and reflexivity in market movements, noting that structured products and hedge fund growth have significantly increased, impacting market stability and potential energy for shifts.
Non-Correlated Assets: There is a growing trend towards non-correlated assets like structured products, hedge funds, precious metals, and crypto, driven by diversification needs and concerns over traditional asset valuations.
AI and Market Impact: AI is expected to revolutionize trading and investment strategies, particularly through enhanced accessibility and understanding of options, with significant implications for market structure and investment opportunities.
Future Market Dynamics: The podcast outlines a bullish outlook for the end of the year, driven by structural product issuance, institutional positioning, and liquidity dynamics, with potential volatility increases and inflationary pressures as key risks.
Transcript
Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their failures. Imagine no more. Welcome to Top Traders Unplugged, 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, remember to keep two things in mind. All the discussion we will 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 product before you make investment decisions. Here's your host, veteran hedge fund manager Neil's Krup Larson. Welcome back to the latest edition of Top Traders Unplugged where each week we take the pulse of the markets from the perspective of a rules-based investor. It's Alan Dunn here sitting in from Pneilles this week who's away. Delighted to be joined by Jem. Jem, how are you? How's all in Chicago? Doing great. Uh, fall in Chicago is always beautiful. So, the leaves are changing colors and the kids are back to school. So, yeah, things are good. Good stuff. Noticing any impact from the shutdown or not yet? Uh, not really. Not really. I mean, uh, I, uh, more more like here in Chicago, the ICE agents and, uh, you know, those, those things don't seem to have shut down at all. Uh, okay. I went to Wrigleyfield yesterday and there were helicopters circling from ICE agents. Uh, it's really kind of a bizarre situation. Okay. Wow. Interesting. Um, we like to kick off with u asking what what's on your radar since you've been last been on. What's I mean, plenty going on. There's no shortage of things to talk about. Anything standing out? Oh, I mean, um, obviously you can't really ignore kind of, uh, some of this the the political I I I hate the word political because it's not really political, but the the governmental changes that we're we're seeing. So, I think that's starting to, you know, markets don't care about that uh, till they kind of do. And I think those are starting to have structural effects. And I think that's all going to really accelerate here into the midterms next year. And I think uh people will markets will increasingly probably focus on what's going on there. Okay. Well, I think that's definitely part of what we will get to as we go through the conversation. But maybe just to kick off, set the scene, give a quick uh recap on performance. Um it's kind of positive month for pretty much everything. We're seem to be in the midst of a of a bit of an everything rally and and uh fortunately managed features CJ is participating as well. So terms of trend following and managed futures performance on the month. Sockchen CTA was up 3.82% uh leaving it down 2.66 on the year. Sockchen trend up 5.66 on the month leaving it down 2.32 on the year. Uh BTO50 up three and a half% on the month and actually positive on the year uh 66 basis points. And the short-term traders index was up 1.4 but still down 5% on the year. I mean, outside of that, as I say, it's the uh it's the relentless uh ongoing rally in equities. The MCI world up 3.3% and the S&P 500 up 3.6%. The real standout I guess on the month was gold up close to 12% and it's been a obviously a phenomenal run in gold and I have a feeling that's also something we'll get on to. But I know one of the topics, you know, very very uh timely you wanted to talk about was was bubbles. And when you look at those numbers, I mean, okay, maybe the the equity numbers this month are strong, not exceptional, but they are just we're just seeing relentless gains in equities. Um, we do hear talk of a bubble from time to time. Maybe not as much as we might have in the past, but but I mean, how do you characterize where we're at in this bull market now? Yeah. So I've I've always used the analogy that you know to be for to be clear that valuations are first of all valuations are not a a good timing mechanism right uh there's a lot of research that says fundamentals have zero predictive value uh over any period less than 10 years and that's like that blows people's minds whenever I say that but now over 10 years it does it starts to become much more predictive um and the way that operates is is um you know markets are a function of liquidity. I've used the analogy that, you know, you're on an airplane, how far off the ground are you? Uh, that's the fundamentals. Uh, you know, so if you're at 60,000 ft, that doesn't mean you're going down, but it does mean that when the gas stops going, right, that there's a long way down. And um, and eventually, you know, if you wait 10 years long enough, the gas runs out at some point, something happens. And generally when that happens is when the mean reversion to fun like fundamental values happen. I I I really really think of valuation as a riskmanagement tool. Okay. So bubbles happen and they're going to happen and you're going to go to crazy heights because it doesn't it's not what drives fundamentals is not what drives the outcome. And so we shouldn't be surprised that we're here again. you know uh I think uh I I will say a naive me uh in 2001 2002 again I started in '98 uh after the bubble burst in 99 2000 uh would have never have thought we could get back there um uh because uh because quite simply it seemed so obvious the valuations were crazy and then you saw you know over 90% correction in the NASDAQ right how can that happen how can markets be that inefficient make the same mistake again here we are and it's not a really a mistake right I want to be clear just the way m markets work you know I've learned a lot in the last 20 25 years um uh and and and the reality is you know you've heard all the the you know the the sayings like you know markets can stay rational longer you can stay solvent it's because it's not really irrational it's it is markets are rational in the sense they just operate based on supply and demand and supply and demand and often actually most of the time has little or nothing to do with fundamentals. Um and so here we are right um you know and what's driving the supply and demand record uh structured product issuance uh short interest um so that that structure product is compresses volatility and allows for a lot of these other flows to move forward. short interest. A lot of that from the size and growth of hedge funds. Um and and uh a lot of uh lot more kind of uh relative value investing out there. Um on top of that, uh you know, we've talked about this before, but there's a momentum releveraging effect, not only from passive investing, um but but from all investors who operate with massive leverage, and that leverage has to means reinvestment on a on a ongoing basis. Um, you can add these all together and uh, if the market stays under control with the V compression gizmo, but we're just going to apply it higher. Lastly, I talked about the top, you have an administration that isn't super incentivized to keep pushing that gas and providing that plane with fuel. And so, um, at some point, uh, they may not be able to u, and we'll get to what those instances are and what drives the final end the of of a of a of a bubble. But um you know this in my mind is 98 99 and uh and you have to play accordingly and the way you play that you know I was fortunate enough to get that experience early in my career is incredibly different than any other market and there is a ton of real edge by playing the distribution which is really mispriced as a function of of those realities that supply and demand imbalance um at the end um of this bubble. So, uh, we can dive into that if you'd like, but there is. Yeah. Well, good starting point. I mean, the 90 the late '90s analogy is always interesting and it, you know, obviously fairly obvious in some respects, you know, in terms of the magnitude of the gains in technology stocks. Um, you know, and the I guess the late '9s the um the the the annual gains were probably even greater. you didn't, you know, we had a pullback in 98 of the LTCM, but we've had a correction this time around in 2020. We've had another one in 2022, obviously, uh, dips in 24, 25. So, we've probably this rally has been punctuated even more even though has been more resilient. Um, I mean, there are differences from a macro perspective as well. I was talking to somebody this week about it. You know, the deficit is one big difference. You know, we the US hit a surplus I think in just around 99 or 2000. So, so that's and we've got tariffs in the mix this time. So, that's another thing. And we I mean what came with the um with the IT spend in the late 90s was that productivity boom. It was for real. I mean growth was much stronger. Um this time around growth is solid but it's not not as strong and productivity has been kind of up and down. Um so definite parallels but some differences. I guess you're zeroing in on the market dynamics as the major parallels I guess. Is that fair to say? Yeah. Yes. I mean I'll I'll add to what you said. Uh so the same and yet different you know the the the inputs for um for a bubble to really get to these heights right is a liquidity push and in 96 you know we had uh the lowering of the natural rate of unemployment and Greenspan coming in and really changing the liquidity dynamics. Here we again we have a historic change in in how we provide liquidity. We're getting a a loss of Fed independence and a takeover of the Fed and a willingness to do um to do something bigger and different and do it proactively regardless of the inflationary kind of outlook as well. Um so those two are parallel. Another thing you obviously need is a narrative. You need a narrative that is by the the broad mass people are able to at least suspend some historical reality are able to say this time may just be different. You know the internet was big enough for people to say well this time this may just be different. Well guess what AI is big enough for people to say you know what AI is different this is going to change you cannot use the same rules. Okay. Uh we have those things and that's why that's a big part of of why we're here at at the core. Um but you also this time to your point have actually more risks uh well-known risks uh that some of which you mentioned a deficit again we were in a budget surplus in in ' 989 um uh too uh we had just become meaning the United States and the west probably had begun become the world hgeimon you know the USSR had just fallen apart there was no rival in terms of economic strength military strength, anything. Um, so the US had absolute control in a sense. I think it's safe to say that's not where we are today, right? Um, so there are some big differences. So given those risks, it's actually even more um I won't say concerning, but uh, you know, you have to look at this and say, how do we get here? Um and the answer is more absolute control from government than we had back then. An ability despite those risks to yield a much bigger um uh you know set of tools to keep things going. And lastly, they have the help of a very different and changing market structure because of those risk and and those things we can get into. I think they're very important but they are again uh you know the structure product issuance and the the move to other um other vehicles and more non-correlated things a lot of things that you and I talk about Allan that are driving actually ironically reflexively a market support as well um so um so yes very similar the things that drive it at its core are the same but the risks and the things counteracting those risks are bigger I often talk about a sumo market, right? A market where uh you could have two tectonic plates or two sumos pushing against each other. That doesn't mean you're go there, you know, there either is going to yield or something is going to happen right away. But it means the potential energy for when something does shift is dramatically bigger. And that's the environment I think we're in. Yeah. Just I mean you mentioned the word reflexivity or reflexive which I think is really important in these scenarios because obviously we know we know about bubbles and feedback loops and you know Soros had this reflexive theory about in which encapsulated the the idea of feedback loops but even more than that that the market participants have make an error in their judgment and be because they they they misinterpret or don't see um a kind of a fundamental flow in the argument the market continues higher and and and and by and that improves the fundamentals until they see the flow. I mean do you see something here is the flow the AI spend or what do you think 100%. So, so the idea of reflexivity, we could probably do a whole episode on that. It's so important. Um, you know, Soros talks about it in real generalities, but there is a practical measurable, that's a lot of what we do with the dealer flow stuff we talk about, right? There's a measurable um reflexivity. If you think about it, it's actually very logical, right? Um, the biggest provider of liquidity in markets and we we know markets are about supply and demand. So if you really want to predict where markets are going, try and understand the supply and demand dynamics, right? And the biggest and most predictable thing in supply and demand the market is the potential buyers and the potential sellers and weight, which is positioning, right? So if the world is long, guess what that means? You have a bunch of sellers and not very many buyers left to buy, right? And if the world is short, you have the opposite. But the same applies to options. So, if everybody is hedged for a 3% decline, but not a 7% decline, guess what? The 3% decline is probably not going to come. And if it does, you're not going 3%. You're probably going 12%. Right? There the the realities of positioning are by definition um potential energy for the opposite. And that's what reflexivity is at its core. We can talk about ideology and philosophy and all these other things but if you want to actually understand the mechanics of it it's whatever the way people are positioned and that's what a wall of worry is right again if people are worried that means they're underweight the market which a lot of just recently happened right they're worried because of the risk and I not surprisingly that can lead to people being forced back in and that's exactly what's happened throughout the summer and and it's likely to happen into the end of the year here as Well, so that concept reflects when you really boil it down is actually quite simple. Um, you know, something swings one way, guess what? It has better odds of swinging back the other way. Um, and and it's not just because of the swing, but now you have potential energy, right? Because it's also another direction as well. So, so um so critical um and and in this environment um I can give you one really interesting example of reflexivity that's really driving. We've talked about structured products and this really ties into you know may take us over to precious metals and crypto and stuff as well but there's this massive thing happening which is uh there is a uh you know $500 trillion long market which has expanded in in in um you know dramatically as the markets have gone up that expanded and we've gone into this bubble right we get uh we get long and and we get uh increases in these valuations as we go. Um but while everybody's getting to a valuation where they're starting to look around and they're starting to see the risks and say how do I diversify and that's a lot of what we talk about here, right? Um but that's been happening for three or so years since 22 and people because people saw that correlation breakdown stocks and bonds are like well we don't have any diversification. What do we do? And you tell me Allan how do you diversify away? I mean we what are the ways right? That's a lot of what we do and there are small doors. The reason people do stocks and bonds is because they are very liquid and very easy to implement. But in our world, right, you you need uh you need tools, you need uh you know, it's it's harder to to deploy diversification. And what that's led to is a boom in the last three years in our broad business, which is uh you know, non-correlated strategies. Um uh hedge fund assets have gone from two and a half to four and a half trillion dollars in just three years. Um by the way is very stable at two to two and a half for quite a while before that. Yeah. Um you've seen a growth in structured products again non-correlation. It's the use of options to get some type of other positioning other than just long the market and you know and short bonds uh and long bonds. Um and ultimately that has gone from 500 billion to two trillion as well. And so wow okay these are ball growing in in structure products is in structure products quadrupling of size of annual issuance in three years. Where where is where is the is that just as you say a diversification flow or where is that money coming from? 100% it's a diversification flow. I mean it's coming from uh primarily a retail world uh through RAAS through the RA channel. Um but uh but these have been huge uh you know investments in Asia as you know for a long long time and those flows from Asia continue to increase but now the west is waking up to them and the west is waking up to them because again how do I manage I mean it's the big question everybody's asking how do I manage a bubble how do I manage when valuations are like this and and and by the way at the same time that interest rates may not help me you know bonds may not help me how do I manage it um you know and the answer is you can use options right I talk about a lot in different ways to structure more capital efficiently and more non-correlated and that's what a structured product is it's taking options positioning making it an easily translatable kind of oh this is my payout which is different than just long right and it's allowing people and raas to kind of diversify so 100% that's where it's coming from and again it's the same thing that's getting people into hedge funds right but generally but generally on the search product side they are kind of autocolable type structures are more selling volatility than buying is that that's very correct. Correct. Yeah. Um and uh and by the way in that two trillion people a lot of people are like where are you getting that number? It also includes ETFs uh that are issuing similar structures. It I'm also including like buffer uh products all kinds of things that are essentially the same thing in different rappers. Um and so those are each growing. And I want to now tie this into another dynamic which is similar but different which is it's also what's driving precious metals. It's also what's driving crypto at this point. And so and it's not a coincidence that how much increase of assets have we seen in hedge funds? Okay about almost a doubling. How much have we seen an increase in structure products? Almost a quadrupling. How much have we seen in the increase in the valuations of precious metals? A three-fold increase. How much of a valuation increase have we seen in crypto last three years? About a three-fold increase. If you take all of those assets, by the way, and you sum them all together, all of these non-correlated, whatever you, you know, however you want to look at them, assets, some type of a way to offset risk and concerns about your long positioning. How much do you have? Four and a half trillion? two trillion. Uh gold is now about four and a half of uh there's seven and a half uh out there, but most of it's in vaults. Let's call it four and a half is is what the liquidly available is, right? Um you know, that's 11 and then crypto is another four and a half or so as well. So about $15 trillion if we kind of generally throw our hands around it versus 500 trillion on the other side. And people keep asking me, well, is the precious metal kind of thing, the crypto thing, like where are we? Are we almost like, look, this is a tripling. This is crazy. How could this possibly go further? You tell me. How are people when they really, and by the way, this is that market with markets at all-time highs and everybody saying, well, you know, um, what happens when the real kind of we see a 22 but worse in some ways in one way or another, right? you know, uh, and so, so the the move towards more non-correlation is, um, is upon us. Uh, it's happening. I would say we're in the second or third inning. Um, uh, and, uh, you know, likely a decade from now, all of those assets will have much more. Now, the 500 trillion also might be lower. Hard to say, and you also have to look at nominal versus real and all these things as we move forward. But but um but I think you know uh the reality on on those products um you know obviously two of those are assets you can buy and benefit from that and that's why those things are are also and they're more liquid and easier to access in some ways. Um but I think as hedge fund also strategies become more liquid and available which is happening I think those will continue to expand as well and then structured products will become also much more available. uh you know I have a I have a deep thesis that uh AI is going to unlock and make a lot of options access uh much easier and easier for people to understand which we can get into a bit and as that happens I think access for them and the growth of those are going to continue to go exponential um and so I think uh again Robin Hood is doing some of this stuff now a bunch of other platforms are starting to really uh accelerate um uh some of those offerings and simplifying kind of structures that allow people to be more noncorrelated. So I think the move towards there is one of the biggest themes you can focus on and importantly back full circle to your reflexivity argument they question they two of those you know and eventually I think crypto as well will have dramatic reflexive effects and uh and are on the actual movement of markets themselves. Um, and so if you want clues on to how this is going to end, it's not just about the bubble, and we have a lot of clues about how those operate and why and how they end. But, uh, you have to also look at this secular move that's that's exponential and pretty dramatic into some of these non-correlate products. And I think if you look at those two things together, there are some major major themes and clues to how this might um might end up the next several years and really the next decade. as you're speaking there, if you think about it, you're talking about the growth in the size of structure products, hedge funds, gold, equities, and I mean over the last 5 years, say since the end of 2019, you you might be able to approximate it, but but how much in kind of paper wealth has been created from just this revaluation of all these assets? I mean I suppose the question is how much is it just people getting more optimistic bidding up the price of the assets and how much of of it has it been driven by just liquidity injection probably impossible to differentiate between the two but I mean part of it is kind of a real phenomenon and part of it is just more optimistic asset valuations. Yeah. So the reality is uh the biggest provider of liquidity we've talked about the gas and the airplane right is actually markets themselves. So this is where the need initial injection to get it going you know. Yeah. Once markets go higher they actually create more collateral right. So it's a loop. Um, if I buy a piece of real estate worth $100,000, um, and it goes, uh, you know, and I and I, uh, let's say I put $25,000 down and get 75% mortgage on it. Well, guess what? If that property goes to a million dollar, how much collateral do I have? I have $925,000 uh, in collateral. And if I want to make the same type of bets or make the same type of money, um, I need to put that money back to work because I'm not at the same leverage level. I was 4 to1 leverage. Now I'm basically went back to one to one. And, um, and so the machine creates more collateral, which creates more uh, ability to get leverage. Uh, and this whole system is leverage by the way. I mean, people like ah, you know, most average investors like I just buy stocks. There's no leverage in my portfolio. The whole system is built on leverage. You have to understand banks themselves like 10 to1 levered you know from the Federal Reserve and assets. So the whole thing is is um it's leverage all the way down. And so every time markets go up and more collaterals increase the amount of money supply increases dramatically. Um and I just mentioned the $500 trillion in assets. Well guess what? The market goes up 20%. uh you know that's a hundred trillion dollars more in assets. Uh QE's got nothing on the liquidity that market markets can or take and also you know take away. Um and and that's why as much as the Fed and people say oh we don't manage the market. We don't manage the market you know um well if you manage liquidity you manage the market because that's actually the greatest source of liquidity in the world. Um, it's also why you often, you know, it's it's silly the market, you know, you often hear from CNBC or, you know, Fox News or wherever you get your your financial media like, uh, oh, the market is down because of X or Y. But you know why? You know, you know, the reality is we had a, as you mentioned late 90s, a boom, right, economically on the back of the liquidity driven by markets themselves. And what happened the second the market went down? The second the market went down, 95% of tech businesses went bankrupt. Uh, you know, and had a massive recession, right? Um, people think the market is a a result or or shows the the net effect of what's happening under the hood. The reality is it is more the dog than the tail. Yeah. Yeah. So, I mean it it begs the question, you know, when does the supply and demand imbalance normalize or when does supply start to outweigh demand and or are there catalysts? Is it just um liquidity tightening? Is it market dynamics, market microstructure? How do you think about what what are the signposts? Yeah. So this time um you know because of the amount usually uh if you know if you have the Fed involved historically and the and the Fed is let's say independent you know the Fed is more likely to react to an inflationary outcome withdrawing liquidity or markets going too far too fast and the perceived potential risks of what could come on the other side of that, right? Um and and those are often what force a removal of liquidity to start. Um and then you got to slow down the economy which pulls some liquidity out and then the big part is the market you know reaction eventually can undo the whole thing. Um uh volatility products play a huge role and increasingly more than ever now but have always been important in the sense that um you know when VA is very well supplied to the market despite liquidity being pulled from the market it could it stabilizes things and can allow for other liquidity to come back in and and keep supporting things. Um the thing that tends to happen at the end of a bubble and we're starting to see it now and it's actually a big thesis for me in an options land and what we're doing in the next year is you start to see volatility increase into a rally and you see that structurally and that happens because the moves up just start getting so big right um a right tail event you know if you're going to do as we saw with Arthur Burns and Richard Nixon in the 1970s if you're going to provide liquidity without care over the inflation ary setup um and uh without care for the potential risks of of the outcome on the other side. Um markets will provide more liquidity and eventually you get in a loop. Um and so the ultimate check on that environment is inflation. It's the only real place that government can't fully control if they choose to make a decision. That is they take themselves out of a rules-based or some type of forward-looking smoothing mechanism, which is what the Fed is put there to do. And what we're seeing is seems to be a removal uh away from long-term worrying about risks uh for financial markets, worrying about inflation. If we're not going to we're going to no longer use those rules to concern ourselves in the short term eventually they will come back and bite you bite you in a much worse way in the long term. So, so my view is that this ends and if we are going to go down this path which we've seen like we are from uh you know US liquidity perspective um it ends somewhere on the other side with much higher markets uh which create more potential energy as I mentioned higher volatility into the rally which loosens some of the the holding mechanisms cause uh you know that the people are short on the upside will continue to go higher and ball will go higher which will eventually make it easy for buyers of all to come and say, "Well, if we're going to make money uh on ball on the upside, then well, pretty much a no-brainer to start buying these to protect, you know, and replace stock." Um, and so that mechanism, which always happens at the end, again, 98.99 was one of the best times in history to be long longdated calls. You made money all the way up and you made money all the way down. And so that will unpin markets and then ultimately rise inflation, raise inflation. And I think we also know just to be clear people like that why does inflation matter? We can f you know the the Fed can do project twist and keep the long and low without inflation. What's the big deal? Like that's that's the real liquidity. Inflation doesn't really draw itself that much liquidity. And I think we you know those that are in markets know you can't keep real interest rates that negative or negative really at all for quite a time or that drives even more inflation. That's how you get to hyperinflation. I don't care if you're in the US government or anywhere else. You know, if we can if people can borrow money at 3%. And inflation is, let's say, 5%. And give a Yeah. You know, everybody on the planet who has half a brain, every institution, every investor is going to go borrow money at three and buy the thing that's going to appreciate at five and they're going to do it with leverage. And guess what? That doesn't mean the thing goes up 5%. Now it goes up 7%. And now we go in a loop the other way. And this is what happened in the 70s. We've seen this throughout history in lots of other places. This is why the Fed is so sensitive to inflation um and why they have the mandates they do. And so we can whistle by the graveyard and ignore those realities, but at some point that you know that is uh that is the ultimate check. Um and so my guess is that that's uh one of the best hedges you can do out here right now and to manage this is you know is to buy you know the you know the problem with break evens is they no longer you know the inflation numbers themselves are controlled but buy by things that are actually going to hedge against inflation again that's why we're also seeing the the basement trade and precious metals and crypto as well because it's interesting a lot of people out there might say oh end of Fed independence or Fed independence in their mind that's not good for the US I don't want to be in the US market. But actually, as you say, in the short term, that means acid reflation as a means of priming the economy and and boosting asset returns in, you know, heading into year of of the midterms. But that goes for only so long and you see inflation as being the thing that breaks that. Correct. That's exactly right. in the short term um control full control right of the administration who is incentivized for you know for a number go up um especially into a midterm and a uh and then eventually also presidential presidential cycle um you they are short-term focused they don't what happens in 10 20 years may or may not be their problem and they'll deal with that problem when they get there um And so the incentive is very short term and you know guess what they have absolute control or increasingly so and if they do then they get the outcome they want. It's that simple. Um until they can't control it anymore and they're getting to an increasing they will eventually get to an increasingly uncontrollable situation. Yeah. Well that's the that's the kind of irony about all of this. It's just the the cycle how you get these broad structural shifts because of what's happened in the previous kind of regime. you know, we had central bank independence that central banks fought hard to achieve. Um, which resulted in the great moderation um and low interest rates came down and they came down so far that central banks and government started to borrow excessively and now now people are happy to give up that central bank independence and the impatient floating credibility, but it's it's hard once you lose it. It's it's so hard to get it back, isn't it? That's exactly right. It's it's short shortsighted short- termism, you know, and again, it's all about incentives. Like uh guess what? The administration itself doesn't benefit from any the difference of the what where things are going to be in 30 40 years. They benefit from what's how things are going to be now. Um and uh and and so that short- termism is probably the biggest problem that faces the world in general. Uh it's true for corporations. It's true for so many things. Uh um and uh and candidly, yes, if you're predicting markets, as we said, it's not about fundamentals. It's about supply and demand. And control tells you who the big bully in the room who can push demand is. And and and you can have confidence that's going to be the case regardless of the long-term realities. Um that said, to your point, trust, right? You know, I I tell my son all the time, you know, takes a long time to build trust. It takes very little to lose trust. And uh you know, we're entering a world where we've taken a long time to become, you know, a bit more kind of the almost we can almost all laugh when we say shining city on a hill, but there was a point, right? Like that was at least a view that democracy and all these things were you know um were something special and and then people you know came and throat you know came in in large amount amounts to come and work and build a life and do things in what that was generally considered a fairer nothing's life is not fair but fairer place and way and you know not to wax poetic but like I think it's fair to say people you know myself are a bit cynical about that these days and that's I think just the beginning. Um people lose that faith. the you know the whole uh breakdown and the thesis for for why it works um breaks down both and from from an options market perspective I mean you talked about the right tail you talk about the upside um obviously people are everybody's thinking about the downside from a hedging perspective but as you say we could see higher markets higher volatility what is the market showing in terms of how what what suppose what skew has been correctly priced and is not. So, we started talking about this a couple months ago as being the next big trade, meaning year, multi-year trade. Um, and the last month, it has exploded higher. And I think we get first inning on this one. And this is again longdated calls are dramatically underpriced relative to the risks on the right tail. I mean, take the debasement trade I just told you, right? Just from an inflationary perspective, the right tail is underpriced. Now take the supply and demand dynamics I just talked about and institutions are net short and uh you know liquidity is coming in and squeezing kind of all that not to mention the growth of structured products where in the end of the year and or institutions are underperforming I mean there is I could name 12 things that mean the supply and demand imbalance the right you know is you know dramatically underpriced meanwhile we're entering a bubble and a bubble by definition is leptocritic not just a right tail eventually it leads to a left tail And so if you want to manage your risk with the world massively long and try and diversify uh not know we could argue gold and and precious metals and crypto are no longer cheap, right? We can argue hedge fund strategies have their problems. Uh what I can tell you is uh you know an S&P call uh a year out or or four six months out with on a on an 112 uh given historic uh you know long-term volatility in markets is average of 17. Um you know and given the risk we're talking on the right tail is is it you're getting that hedge for a credit and you don't get hedges for credit for very long. Um so you know the answer pretty clear to me is you replace any stock. Why would you own the whole distribution right? Uh you know be be short all that downside left tail right be underweight by the way the right tail. Um when you can just go replace that with the cheapest part of the distribution in general and particularly in this environment which is the right tail. Um, so add on the money calls and you don't have to do it in the S&P, but there's a million other there's million other equity ways to do this, but calls are underpriced. And that's what we're seeing, by the way. We are seeing market up, volume up, market up, volume up. Most people have played in the space who have not been around for the, you know, the 27 years I've been around haven't, you know, think if you came around in 2001 2, you haven't seen this in, you know, 25 years. It hasn't happened. uh you've seen market evol for a week uh which generally leads to an unpinning and a down move and it's a good indicator for nobody I don't think so has you know it hasn't been here that long has seen a continuous long-standing move meaning a year or so of of that type of general action and uh it's actually in the v space one of the easiest ways to make money. So you are uh you are fortunate to be at a time where you're getting a credit in a way to hedge and improve your outcomes. Um and if you don't take it, I think you know that's on you. Um but but uh yeah why at this point you know I'd much rather have a 12 it's been very profitable already and will continue to be a 12v out of the money call with leverage to outcomes and and and not only that left tail at this point. Um so stock replacement uh you know easier way for people who are you know if this sounds too complicated you know replace your stock with calls it's a much much better way to play this in the next year or two not financial what about I I know we've talked about this before with respect to gold but that was probably probably about 50% lower from here now that we've had this phenomenal rally this year how is that market looking in terms of the distribution so the I've said this in other formats other places but the was from 19 to 1965 68 um all the way to 1982 for you know 15 plus years. Um the best performing asset by far it's not even close was was gold. Um this is before crypto so you could argue some of this you know is going to be somehow distributed across the two. Um, but it wasn't even close a but most people don't realize it was also the most volatile asset during that period. And not just because it was upside volatile. It had a two-way volatility to it. Um, and that's logical. We've been talking about this for several years. You and I might have talked about it, but the but you know, everybody's focused on equity, the best performing asset, you know, in a debasement era or a period of bigger structural inflation. Yeah. is not equities. You know, equities went nowhere 19682 because they're measured nominally, but that the inflation forces valuation multiple risk. So, you have a pushpull on a nominal basis that drive net less volatility, more long in a long-term basis. You have crisises, so there's a role for people, but the things that did incredibly well were FX, obviously interest rate fall, but FX and precious metal, and they're the same thing. If you think about FX and precious metal are integrally related like you know precious metals are a currency is currency. Yeah. Yeah. And so um yeah if you want to if you really want to find hedges or find secular opportunities in this environment that's where you should be looking precious metal crypto. So I bring that full circle to what's what's crypto going to do. Um crypto is going to continue to perform well but it is not going to be a straight line and it has been a straight line you know. Um so uh and in the short term it could still very much go vertical and that volatility could continue. Um but similar to me how I was talking about the equity upside in the short term. I think uh you know calls are a lot more expensive in gold now but there the I would say volatility broadly is is still cheap relative to what we've seen historic. I mean relative to we've seen in other periods like this. Again, if you look at over past 40 years, you'll say, "Jim, you're telling me to buy this gold vault, crazy ball, but the dynamics that are in play are going to make this a very wild ride. I know you had a couple of thoughts around AI and a couple of themes related to that. Obviously it's topic that everybody's focused on in terms of a major driver of the market and thinking about is the spend going to be justified I suppose has been a big theme in relation to the hyperscalers and technology firms I mean I know you see it having some impacts both kind of on a trading perspective that could be quite meaningful is it going to be a gamecher that's going to add value do you think on the trading side 100% but in ways people are not betting I mean that's an opportunity. I think the way people are betting on AI is very one-dimensional. It's very kind of first order thinking. And by the way, the same thing that happened in the n late 90s the the you know the first order thinking in uh in late 99 or 99 was well you know the internet's going to change the world. So go buy the companies who do all the real world things on the internet. you know, like, uh, go buy socks.com because you know what? They're going to take over the sock business. Um, and guess what? You know, all those companies are bankrupt and and lasted only a year or two after the bubble, right? Um, and that's not who ultimately ended up winning. actually the who the winners would end up being. We had no idea how that evol that would evolve and from you know search and then eventually right uh we were we were ISPs were were trading at crazy multiples that I don't even exist anymore. Um so the point here is there's a lot that we do not know yet in terms of the evolution of AI itself and honestly we don't need to play that game because a lot of that will get commoditized. Um I would argue um that that you know the value of AI and the profits of AI are actually probably not going to acrue to AI itself. Think that becomes a commodity at some point. Think about the real world. I mean we have lots of bright people all over the world. I I a lot of people are a lot brighter than me. I'll tell you that um my value that I am able to provide uh which in theory has like real value is not intelligence. It's my my history, my knowledge of my which is very unique, right? And that unique experience intelligence can can then use to create real value. So data sets, unique data sets are going to be incredibly valuable particularly in places where that data can be used to generate uh efficiency or uh more um you know uh new ideas, new uh new technologies and things there. So you know the data itself is being dramatically undervalued. And then lastly the inputs right at some point the the thing we can have great confidence in is we don't know where AI is going but we know what its inputs are and what it needs uh to succeed and and this is where kind of energy and power you know uh come in um you know and a data again is the other kind of input. So so that's a real focus for me um broadly with AI. The other the other big focus more broadly uh with with AI um is uh you know if you think about if you think about this um you know who's going to be the next platform right the the intelligence itself will be commoditized like the cell phone itself is commoditized right like but Apple is a tremendous stock because they were able to lock in kind of a platform that everybody didn't want to switch off of. Uh, and so the question is who's going to be the big AI platform and and that's that's hard to judge and there's a lot of different places. because I I have my opinions um but I my my guess it's the one who controls data again for individuals and for companies or manages a security of data right um and I think that's a again a critical theme but what areas so like let's go a step further what areas where is data uh unique data sets uh available and where are is the greatest potential for taking that data and creating um you know value and and one I think that's one of the wor ironically one of those areas is the cheapest area in markets or one of them period which is healthcare um you know it's a science it is the science um and it is the place with some of the greatest cost particularly here in the US um on the system um why is it so inefficient I don't think many people ask that question why is healthcare so inefficient it's the science and the answer is we have very strict rules around healthcare data. Data is locked up sequestered in very unique places and very hard to access. If we didn't have data privacy around healthcare, guess what? We have no data privacy really anywhere else. But we oddly really think our healthcare data is critical. And and I'm not saying it's not. Like I think privacy is super important in general, but we've, you know, we've kind of already gone over that, you know, I think we've we've skipped over that and and um and so my point is HIPPA aside here in the US and and regulations on healthcare privacy otherwise there are places where that healthcare data is does exist and can be used. United Healthcare for example is one of the greatest owners of healthcare data in the world. Um, oddly they're they're are worth uh, you know, not so much right now. And and I just I think they're again it's not necessarily people want to say AI, it has to be an AI player. It has to have AI in the name, but really what you want to start hearing is who has data in the name, who has unique data sets in their name. I think that could be a real theme that people could start to catch on to here in the next couple years. Um, but but the reality is that's also those things are cheap and have much less downside. So I think the asymmetric things like that are are really really critical. Another place and this is more my domain now is um new technologies or things that are complicated um or uh are having a hard time are better technologies but are having um a hard time with getting uh distribution to the world because they might be complicated. They need a translation. Um there's a bunch of different things like this in financial markets and this is kind of what you're alluding to. um options right options are we've talked about this at length and people about you know four or five years ago I started saying this that you know kind of got a lot of crazy looks like options are the true underlying in the sense that they are not a two-dimensional up down they're not just an expected value of a distribution they're every moment on a full distribution of any and every asset in the world it is you know like taking trading from two dimen two dimensional world to a three-dimensional world it is superior it's not like uh Now people, it's confusing to people because you're dealing with three dimensions instead of two. And guess what? That needs to be made more accessible so that our minds, it can be more logical, more easy to manipulate. Take what's in my mind and what I actually want and translate it to how to get more precise positioning based on that information. And that's happening. And that's going to happen in spades. The next year or two, I think options will become much more accessible. I kind of liken it to electricity. When electricity was first found, discovered, like people were terrified by it. This incredibly powerful thing. You're not going to bring it into your home. People still use candles at home for many, many years. And it was really hard. They had to standardize and find a way to translate this powerful thing into just a simple thing that people just plugged in something and never worried about it. And there's a million technologies that do this. Actually, most technologies need this. They need a they they're start in the raw and they're trul uh truly worth a great value but you got to hit get network effects you got to get translation mechanisms and and this is what's happening and it's already been happening options market but AI unlocks that so quickly because it really who are the winners in that it's just again it's the platforms who embrace that and and build the user interface is that it anybody who is involved in options period it is a taking over of that whole market it is also by the way accelerant to those other things I talked about to move into non-correlation. So, uh the I wouldn't say the structural product industry, but those who step in and provide those at cost, right? Or at you know, which could be the exchanges themselves, which could be the brokers themselves. Um I actually really like brokerage exchanges because they're also uh not inflation sensitive. There's no uh input increase. Profit margins increase in times of inflation because revenue increases and costs don't. So, so you know brokerages, exchanges deal particularly in the alternative space. Any uh educators, people who uh enter the space and become more involved in it uh uh more broadly um again uh technology platforms that help uh again with this trans translation. Um and importantly you could invest in the actual assets as kind of his first order but there's also market effects that are going to drive come based on the the structural changes in markets going forward too. So um those that that trade in these are market makers entities that trade in these the spaces will will benefit as a function of this. So it sounds like you know with with those types of things obviously the gains acrewing to those with the best technology who have already the resources is that a reason to think it'll be in our business that the pod shops the bigger houses that already have or the QRTs the ones investing massively in technology will just continue to get bigger. Is that the implication? Not really. there's a pushpull, right? Because you're the edges are decaying because AI takes away some of the um you know the value of of that knowledge, right? It's no longer a uh you know, like as we're talking about data set, your data set's kind of becoming commoditized. Uh that said, you know, you have a a massive early on, you're going to have a title wave of new entrance who are, you know, just using AI and less sophisticated and and entering a space and that might create more bass spread in some ways as well. Um so I think there's a push pull. I mean, it's no different than since the beginning of time and and in and in in markets and options. you know, I started in the market, we had uh, you know, dollar-wide markets and S&P options. Um, that was very profitable. But guess what? There, and by the way, that was more segmented, um, you know, marketplace because a lot of people could just go do that. You didn't have to be that sophisticated to get a bid as spread. Um, nowadays though, the volumes are through the roof, right? And the edges have come down, but there are a lot of entities that they're sophisticated enough who are making more money than ever. Uh so um but so I think the winners and losers will change that is for sure but I do think it will in some ways be be much more profitable and if you're uh playing it from a much more you know you know who's going to win is people like RAAS who are taking advantage in this trend early because that whole industry in my opinion is changing quickly and you got $500 trillion that's one of the biggest industries in the world um that's a place I'm playing in and trying to part of as a function of that. Um, so I'm kind of talking my own book here, but I do think there are tremendous opportunities for that title wave um from just two two directional world to three-dimensional and that trans transition will be made much easier through AI and other technologies. Well, definitely that's something I'm thinking about. I mean, increasingly I think we will see a blurring of the traditional and old investments. I mean absolutely it's already happening and and and over time I would expect it to accelerate and what you're talking about obviously with options trading would accelerate that I mean maybe not seems like hard to believe a lot of we get even more retail participation we've already seen plenty of retail participation in the options market but I in the US I guess we could see even more yeah and when I say retail I you know retail is actually relatively small I mean it's gotten big but relatively small relative to because when we say retail we're swap talking generally smaller traders, right? Like uh or or smaller numbers, right? Robin Hood's average account size of $4,000, right? What I'm talking about is RAAS and the big pools of assets, and that is quote unquote retail, but that is not a small pool of assets. That's the biggest pool of assets in the world. Uh and this is why again ETF issuance uh with options in it, for example, right, which is a kind of I don't think that's necessarily the final step. I think there but that is a trend that's going to just keep going exponential. We've gone from $20 billion of those just three years ago. I'm talking about the most vertical trend to 300 sorry 20 billion to 300 billion there in just three years. Um you know that's not a 3x right that's a you know 15x and and I think that type of growth there is just start getting started as well. conscious of time and I wanted to get your perspective on you know how the kind of the timeline looks from here in terms of event risk into year end obviously you know speaking to you before you'll often talk about the summer period fall compression over that period now we're gone beyond that we've got some obviously we've got the uh Supreme Court starting to take arguments on the tariffs in I think in November and there'll be a ruling sometime after that so that's obvious uh risk around that But I mean as you look kind of next number of months, have you mapped out a timeline in terms of possible risk dates? all always and it's easier to do and the reason seasonal patterns don't really care about uh you know what's happening in the government or what's happening in XYZ is um there are structural pressures that drive outcomes much more and particularly at this end of the year period then um than the headlines. Now, the headlines can affect things if they're big enough, right? A nuclear bomb goes off in New York, there's going to be a market reaction, right? China invades Taiwan, there's going to be a reaction. That said, you know, in the absence of some massive left tail event, uh, and even I would argue in the context of, you know, we've seen many situations where those happen and the market still does its thing until those flows are gone and then it reacts. Think COVID, right? like we knew about CO in December but uh you know we didn't get a decline till um until February because the flows you know flood February opex to the day because of those flows. So so I I prefer to talk about the flows and particularly here in this period as we enter October and start looking forward to the end of the year. Um I want to reiterate again it all goes full circle here the structured product issuance is dramatically bigger than it was last year. hedge fund long short equity is significantly bigger than it was last year. Um and those are also are so it's not just seasonal oh every year the XYZ happens these effects are getting bigger. Okay. And this year we also have a now beginning and heading towards the takeover of the Fed which is coming in May for in full for next year and markets already know it. Portally markets already know it. So it's already kind of put in place there. So liquidity is coming. It's already on the way and unlike let's say last year and most years institutions are caught underweight. So you have a recipe here of supply and demand dynamics that are um not in your favor. This is a bullish period in general when markets are up. Why is a bullish period uh in general when markets are up? Markets are up 15% for the year. you have five, you know, 200 trillion of equities. That's again a $30 trillion um input and about 10 or so% of that at a minimum goes to work. Gem one 30 trillion 10% $3 trillion. The average amount that moves markets on a daily basis daily is about 75 to 100 let's say hundred billion dollars. Now they got a $3 trillion buy order that's sitting there. Jan 1, is it a surprise that the Santa Claus effect and the January effect together, those four weeks are the most positive four weeks, month of the year? No. And so an up market, the more the market's up, the more that it dries up. Okay? So that's that's one. So that's sitting out there. It's still Gen One. You know, we're in October. I get it. Like that's a lot of to play that trade now, but it's sitting out there. And we know institutions are underperforming. that Jan one deadline presents a a a problem, right? They need to get end of the year. People start looking at their statements saying, "Wait, how much have I made? How much have I not made? Do I want to stay invested and those decisions come up and uh guess what? You got to start, you know, given these dynamics, people can't wait. That's why you keep seeing the consistency of this rally as we push into the end of the year." Okay? And institutional position was at the zero percentile in July in June, sorry. Now it's at the 25th. dramatic move, but you still have way to go, right? And they're under underweight, so like you can't catch up by being even weight. You need to be overweight. Um, and so you have those dynamics at play and now you have structural policments which is bigger than ever. And we saw that this summer, we saw it last summer. And what that does is that drives compression in general. But during a September, October period or maybe maybe even August when when there's more volume and things going on, it has less of effect. But what happens when volumes get cut in half and people start shutting up shop? Well, that structured product is twice as much effect. That ball compression has twice as much of effect. And that's what we see in the summers. That's what drives that summer of George effect, which itself is bullish because then we're the skew in markets, right? And it's then there's more open interest than ever out there, right? And all that open interest leads to decay as as that happens. And that's a lot of charm flow push up as well and bigger than ever because it's not just amount it's not just the amount of all compression it's the amount of these structure products out there that need to be rehedged. That's the amount of charm flows are bigger than ever. All you put all this together and then you have again historic liquidity that's like an administration who wants it higher. Do you want to be short this market? I mean could yes could we get a headline risk and by the way the reason institutions are underweight reflexivity again let's go full circle is because we're at in a bubble and the natural thought in a bubble is oh I got to be underweight this is crazy this can't keep going like this or or I'll miss the upside you know because because I I don't want that left tail risk well okay but at some point you get pushed back in um and and um and so you know reflexively this setup is is is is very bullish here as we enter the end of the year and that goes till about the middle of January after that January effect and JN OPEX comes and then things can get some mean inversion but you know we're also going into midterm year and there's all kinds of other incentives in play to keep the plate spinning so you know you want a a general road map uh and it rhymes with a lot of the years but I'd say this year it's on steroids it's uh mark it up um you know uh probably gets front run because you know markets don't wait that's what's been happening here. Uh they don't let you back in. Um and uh and then you know maybe December Jan like that normal seasonal period which people have caught kind of on to gets front run and maybe then that period is a little kind of sideways and then you know again if you look at the price action last year it was very predictable. We said that you know similar things last year with with less of these dynamics at play. My guess is that this goes uh even faster because the dynamics are more short, you know, institutional and there's more catch-up and there's more liquidity at play. Um but, you know, steep um at first, uh less steep at the end. uh eventually some type of pullback finally probably in February or January maybe it you know gets front runs at Gene OPEX you know and then you know that'll be people will want to get back in because they see the end of the year midterm thing and there'll be some support regardless of the but the whole way volatility is going to do one of these longer term you know this count owning calendar of all which is is very compelling to and that's part of why the curve is so steep but it's it works incredibly well and and so yeah, I think those are the general dynamics. Um, you know, we can talk about what happens after Feb March or whatever next year when we get there, but um, you know, for now uh, you know, as as the front say, let the good times roll. Very good. Well, that's a a good note to finish on, a very upbeat note for anybody um, heavily invested or or not. Um, well, Neils is back next week, but Jen, thanks very much for for coming along today. Uh, always a pleasure. As I said, Neils is back next week. If you have any questions, feel free to send them in. Um, and we'll be back soon here on Top Traders Unplugged with more content. Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the 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 new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues 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 Traders Unplugged. [Music]
Market Structure, Liquidity, and Reflexivity in 2025 | Systematic Investor | Ep.368
Summary
Transcript
Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their failures. Imagine no more. Welcome to Top Traders Unplugged, 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, remember to keep two things in mind. All the discussion we will 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 product before you make investment decisions. Here's your host, veteran hedge fund manager Neil's Krup Larson. Welcome back to the latest edition of Top Traders Unplugged where each week we take the pulse of the markets from the perspective of a rules-based investor. It's Alan Dunn here sitting in from Pneilles this week who's away. Delighted to be joined by Jem. Jem, how are you? How's all in Chicago? Doing great. Uh, fall in Chicago is always beautiful. So, the leaves are changing colors and the kids are back to school. So, yeah, things are good. Good stuff. Noticing any impact from the shutdown or not yet? Uh, not really. Not really. I mean, uh, I, uh, more more like here in Chicago, the ICE agents and, uh, you know, those, those things don't seem to have shut down at all. Uh, okay. I went to Wrigleyfield yesterday and there were helicopters circling from ICE agents. Uh, it's really kind of a bizarre situation. Okay. Wow. Interesting. Um, we like to kick off with u asking what what's on your radar since you've been last been on. What's I mean, plenty going on. There's no shortage of things to talk about. Anything standing out? Oh, I mean, um, obviously you can't really ignore kind of, uh, some of this the the political I I I hate the word political because it's not really political, but the the governmental changes that we're we're seeing. So, I think that's starting to, you know, markets don't care about that uh, till they kind of do. And I think those are starting to have structural effects. And I think that's all going to really accelerate here into the midterms next year. And I think uh people will markets will increasingly probably focus on what's going on there. Okay. Well, I think that's definitely part of what we will get to as we go through the conversation. But maybe just to kick off, set the scene, give a quick uh recap on performance. Um it's kind of positive month for pretty much everything. We're seem to be in the midst of a of a bit of an everything rally and and uh fortunately managed features CJ is participating as well. So terms of trend following and managed futures performance on the month. Sockchen CTA was up 3.82% uh leaving it down 2.66 on the year. Sockchen trend up 5.66 on the month leaving it down 2.32 on the year. Uh BTO50 up three and a half% on the month and actually positive on the year uh 66 basis points. And the short-term traders index was up 1.4 but still down 5% on the year. I mean, outside of that, as I say, it's the uh it's the relentless uh ongoing rally in equities. The MCI world up 3.3% and the S&P 500 up 3.6%. The real standout I guess on the month was gold up close to 12% and it's been a obviously a phenomenal run in gold and I have a feeling that's also something we'll get on to. But I know one of the topics, you know, very very uh timely you wanted to talk about was was bubbles. And when you look at those numbers, I mean, okay, maybe the the equity numbers this month are strong, not exceptional, but they are just we're just seeing relentless gains in equities. Um, we do hear talk of a bubble from time to time. Maybe not as much as we might have in the past, but but I mean, how do you characterize where we're at in this bull market now? Yeah. So I've I've always used the analogy that you know to be for to be clear that valuations are first of all valuations are not a a good timing mechanism right uh there's a lot of research that says fundamentals have zero predictive value uh over any period less than 10 years and that's like that blows people's minds whenever I say that but now over 10 years it does it starts to become much more predictive um and the way that operates is is um you know markets are a function of liquidity. I've used the analogy that, you know, you're on an airplane, how far off the ground are you? Uh, that's the fundamentals. Uh, you know, so if you're at 60,000 ft, that doesn't mean you're going down, but it does mean that when the gas stops going, right, that there's a long way down. And um, and eventually, you know, if you wait 10 years long enough, the gas runs out at some point, something happens. And generally when that happens is when the mean reversion to fun like fundamental values happen. I I I really really think of valuation as a riskmanagement tool. Okay. So bubbles happen and they're going to happen and you're going to go to crazy heights because it doesn't it's not what drives fundamentals is not what drives the outcome. And so we shouldn't be surprised that we're here again. you know uh I think uh I I will say a naive me uh in 2001 2002 again I started in '98 uh after the bubble burst in 99 2000 uh would have never have thought we could get back there um uh because uh because quite simply it seemed so obvious the valuations were crazy and then you saw you know over 90% correction in the NASDAQ right how can that happen how can markets be that inefficient make the same mistake again here we are and it's not a really a mistake right I want to be clear just the way m markets work you know I've learned a lot in the last 20 25 years um uh and and and the reality is you know you've heard all the the you know the the sayings like you know markets can stay rational longer you can stay solvent it's because it's not really irrational it's it is markets are rational in the sense they just operate based on supply and demand and supply and demand and often actually most of the time has little or nothing to do with fundamentals. Um and so here we are right um you know and what's driving the supply and demand record uh structured product issuance uh short interest um so that that structure product is compresses volatility and allows for a lot of these other flows to move forward. short interest. A lot of that from the size and growth of hedge funds. Um and and uh a lot of uh lot more kind of uh relative value investing out there. Um on top of that, uh you know, we've talked about this before, but there's a momentum releveraging effect, not only from passive investing, um but but from all investors who operate with massive leverage, and that leverage has to means reinvestment on a on a ongoing basis. Um, you can add these all together and uh, if the market stays under control with the V compression gizmo, but we're just going to apply it higher. Lastly, I talked about the top, you have an administration that isn't super incentivized to keep pushing that gas and providing that plane with fuel. And so, um, at some point, uh, they may not be able to u, and we'll get to what those instances are and what drives the final end the of of a of a of a bubble. But um you know this in my mind is 98 99 and uh and you have to play accordingly and the way you play that you know I was fortunate enough to get that experience early in my career is incredibly different than any other market and there is a ton of real edge by playing the distribution which is really mispriced as a function of of those realities that supply and demand imbalance um at the end um of this bubble. So, uh, we can dive into that if you'd like, but there is. Yeah. Well, good starting point. I mean, the 90 the late '90s analogy is always interesting and it, you know, obviously fairly obvious in some respects, you know, in terms of the magnitude of the gains in technology stocks. Um, you know, and the I guess the late '9s the um the the the annual gains were probably even greater. you didn't, you know, we had a pullback in 98 of the LTCM, but we've had a correction this time around in 2020. We've had another one in 2022, obviously, uh, dips in 24, 25. So, we've probably this rally has been punctuated even more even though has been more resilient. Um, I mean, there are differences from a macro perspective as well. I was talking to somebody this week about it. You know, the deficit is one big difference. You know, we the US hit a surplus I think in just around 99 or 2000. So, so that's and we've got tariffs in the mix this time. So, that's another thing. And we I mean what came with the um with the IT spend in the late 90s was that productivity boom. It was for real. I mean growth was much stronger. Um this time around growth is solid but it's not not as strong and productivity has been kind of up and down. Um so definite parallels but some differences. I guess you're zeroing in on the market dynamics as the major parallels I guess. Is that fair to say? Yeah. Yes. I mean I'll I'll add to what you said. Uh so the same and yet different you know the the the inputs for um for a bubble to really get to these heights right is a liquidity push and in 96 you know we had uh the lowering of the natural rate of unemployment and Greenspan coming in and really changing the liquidity dynamics. Here we again we have a historic change in in how we provide liquidity. We're getting a a loss of Fed independence and a takeover of the Fed and a willingness to do um to do something bigger and different and do it proactively regardless of the inflationary kind of outlook as well. Um so those two are parallel. Another thing you obviously need is a narrative. You need a narrative that is by the the broad mass people are able to at least suspend some historical reality are able to say this time may just be different. You know the internet was big enough for people to say well this time this may just be different. Well guess what AI is big enough for people to say you know what AI is different this is going to change you cannot use the same rules. Okay. Uh we have those things and that's why that's a big part of of why we're here at at the core. Um but you also this time to your point have actually more risks uh well-known risks uh that some of which you mentioned a deficit again we were in a budget surplus in in ' 989 um uh too uh we had just become meaning the United States and the west probably had begun become the world hgeimon you know the USSR had just fallen apart there was no rival in terms of economic strength military strength, anything. Um, so the US had absolute control in a sense. I think it's safe to say that's not where we are today, right? Um, so there are some big differences. So given those risks, it's actually even more um I won't say concerning, but uh, you know, you have to look at this and say, how do we get here? Um and the answer is more absolute control from government than we had back then. An ability despite those risks to yield a much bigger um uh you know set of tools to keep things going. And lastly, they have the help of a very different and changing market structure because of those risk and and those things we can get into. I think they're very important but they are again uh you know the structure product issuance and the the move to other um other vehicles and more non-correlated things a lot of things that you and I talk about Allan that are driving actually ironically reflexively a market support as well um so um so yes very similar the things that drive it at its core are the same but the risks and the things counteracting those risks are bigger I often talk about a sumo market, right? A market where uh you could have two tectonic plates or two sumos pushing against each other. That doesn't mean you're go there, you know, there either is going to yield or something is going to happen right away. But it means the potential energy for when something does shift is dramatically bigger. And that's the environment I think we're in. Yeah. Just I mean you mentioned the word reflexivity or reflexive which I think is really important in these scenarios because obviously we know we know about bubbles and feedback loops and you know Soros had this reflexive theory about in which encapsulated the the idea of feedback loops but even more than that that the market participants have make an error in their judgment and be because they they they misinterpret or don't see um a kind of a fundamental flow in the argument the market continues higher and and and and by and that improves the fundamentals until they see the flow. I mean do you see something here is the flow the AI spend or what do you think 100%. So, so the idea of reflexivity, we could probably do a whole episode on that. It's so important. Um, you know, Soros talks about it in real generalities, but there is a practical measurable, that's a lot of what we do with the dealer flow stuff we talk about, right? There's a measurable um reflexivity. If you think about it, it's actually very logical, right? Um, the biggest provider of liquidity in markets and we we know markets are about supply and demand. So if you really want to predict where markets are going, try and understand the supply and demand dynamics, right? And the biggest and most predictable thing in supply and demand the market is the potential buyers and the potential sellers and weight, which is positioning, right? So if the world is long, guess what that means? You have a bunch of sellers and not very many buyers left to buy, right? And if the world is short, you have the opposite. But the same applies to options. So, if everybody is hedged for a 3% decline, but not a 7% decline, guess what? The 3% decline is probably not going to come. And if it does, you're not going 3%. You're probably going 12%. Right? There the the realities of positioning are by definition um potential energy for the opposite. And that's what reflexivity is at its core. We can talk about ideology and philosophy and all these other things but if you want to actually understand the mechanics of it it's whatever the way people are positioned and that's what a wall of worry is right again if people are worried that means they're underweight the market which a lot of just recently happened right they're worried because of the risk and I not surprisingly that can lead to people being forced back in and that's exactly what's happened throughout the summer and and it's likely to happen into the end of the year here as Well, so that concept reflects when you really boil it down is actually quite simple. Um, you know, something swings one way, guess what? It has better odds of swinging back the other way. Um, and and it's not just because of the swing, but now you have potential energy, right? Because it's also another direction as well. So, so um so critical um and and in this environment um I can give you one really interesting example of reflexivity that's really driving. We've talked about structured products and this really ties into you know may take us over to precious metals and crypto and stuff as well but there's this massive thing happening which is uh there is a uh you know $500 trillion long market which has expanded in in in um you know dramatically as the markets have gone up that expanded and we've gone into this bubble right we get uh we get long and and we get uh increases in these valuations as we go. Um but while everybody's getting to a valuation where they're starting to look around and they're starting to see the risks and say how do I diversify and that's a lot of what we talk about here, right? Um but that's been happening for three or so years since 22 and people because people saw that correlation breakdown stocks and bonds are like well we don't have any diversification. What do we do? And you tell me Allan how do you diversify away? I mean we what are the ways right? That's a lot of what we do and there are small doors. The reason people do stocks and bonds is because they are very liquid and very easy to implement. But in our world, right, you you need uh you need tools, you need uh you know, it's it's harder to to deploy diversification. And what that's led to is a boom in the last three years in our broad business, which is uh you know, non-correlated strategies. Um uh hedge fund assets have gone from two and a half to four and a half trillion dollars in just three years. Um by the way is very stable at two to two and a half for quite a while before that. Yeah. Um you've seen a growth in structured products again non-correlation. It's the use of options to get some type of other positioning other than just long the market and you know and short bonds uh and long bonds. Um and ultimately that has gone from 500 billion to two trillion as well. And so wow okay these are ball growing in in structure products is in structure products quadrupling of size of annual issuance in three years. Where where is where is the is that just as you say a diversification flow or where is that money coming from? 100% it's a diversification flow. I mean it's coming from uh primarily a retail world uh through RAAS through the RA channel. Um but uh but these have been huge uh you know investments in Asia as you know for a long long time and those flows from Asia continue to increase but now the west is waking up to them and the west is waking up to them because again how do I manage I mean it's the big question everybody's asking how do I manage a bubble how do I manage when valuations are like this and and and by the way at the same time that interest rates may not help me you know bonds may not help me how do I manage it um you know and the answer is you can use options right I talk about a lot in different ways to structure more capital efficiently and more non-correlated and that's what a structured product is it's taking options positioning making it an easily translatable kind of oh this is my payout which is different than just long right and it's allowing people and raas to kind of diversify so 100% that's where it's coming from and again it's the same thing that's getting people into hedge funds right but generally but generally on the search product side they are kind of autocolable type structures are more selling volatility than buying is that that's very correct. Correct. Yeah. Um and uh and by the way in that two trillion people a lot of people are like where are you getting that number? It also includes ETFs uh that are issuing similar structures. It I'm also including like buffer uh products all kinds of things that are essentially the same thing in different rappers. Um and so those are each growing. And I want to now tie this into another dynamic which is similar but different which is it's also what's driving precious metals. It's also what's driving crypto at this point. And so and it's not a coincidence that how much increase of assets have we seen in hedge funds? Okay about almost a doubling. How much have we seen an increase in structure products? Almost a quadrupling. How much have we seen in the increase in the valuations of precious metals? A three-fold increase. How much of a valuation increase have we seen in crypto last three years? About a three-fold increase. If you take all of those assets, by the way, and you sum them all together, all of these non-correlated, whatever you, you know, however you want to look at them, assets, some type of a way to offset risk and concerns about your long positioning. How much do you have? Four and a half trillion? two trillion. Uh gold is now about four and a half of uh there's seven and a half uh out there, but most of it's in vaults. Let's call it four and a half is is what the liquidly available is, right? Um you know, that's 11 and then crypto is another four and a half or so as well. So about $15 trillion if we kind of generally throw our hands around it versus 500 trillion on the other side. And people keep asking me, well, is the precious metal kind of thing, the crypto thing, like where are we? Are we almost like, look, this is a tripling. This is crazy. How could this possibly go further? You tell me. How are people when they really, and by the way, this is that market with markets at all-time highs and everybody saying, well, you know, um, what happens when the real kind of we see a 22 but worse in some ways in one way or another, right? you know, uh, and so, so the the move towards more non-correlation is, um, is upon us. Uh, it's happening. I would say we're in the second or third inning. Um, uh, and, uh, you know, likely a decade from now, all of those assets will have much more. Now, the 500 trillion also might be lower. Hard to say, and you also have to look at nominal versus real and all these things as we move forward. But but um but I think you know uh the reality on on those products um you know obviously two of those are assets you can buy and benefit from that and that's why those things are are also and they're more liquid and easier to access in some ways. Um but I think as hedge fund also strategies become more liquid and available which is happening I think those will continue to expand as well and then structured products will become also much more available. uh you know I have a I have a deep thesis that uh AI is going to unlock and make a lot of options access uh much easier and easier for people to understand which we can get into a bit and as that happens I think access for them and the growth of those are going to continue to go exponential um and so I think uh again Robin Hood is doing some of this stuff now a bunch of other platforms are starting to really uh accelerate um uh some of those offerings and simplifying kind of structures that allow people to be more noncorrelated. So I think the move towards there is one of the biggest themes you can focus on and importantly back full circle to your reflexivity argument they question they two of those you know and eventually I think crypto as well will have dramatic reflexive effects and uh and are on the actual movement of markets themselves. Um, and so if you want clues on to how this is going to end, it's not just about the bubble, and we have a lot of clues about how those operate and why and how they end. But, uh, you have to also look at this secular move that's that's exponential and pretty dramatic into some of these non-correlate products. And I think if you look at those two things together, there are some major major themes and clues to how this might um might end up the next several years and really the next decade. as you're speaking there, if you think about it, you're talking about the growth in the size of structure products, hedge funds, gold, equities, and I mean over the last 5 years, say since the end of 2019, you you might be able to approximate it, but but how much in kind of paper wealth has been created from just this revaluation of all these assets? I mean I suppose the question is how much is it just people getting more optimistic bidding up the price of the assets and how much of of it has it been driven by just liquidity injection probably impossible to differentiate between the two but I mean part of it is kind of a real phenomenon and part of it is just more optimistic asset valuations. Yeah. So the reality is uh the biggest provider of liquidity we've talked about the gas and the airplane right is actually markets themselves. So this is where the need initial injection to get it going you know. Yeah. Once markets go higher they actually create more collateral right. So it's a loop. Um, if I buy a piece of real estate worth $100,000, um, and it goes, uh, you know, and I and I, uh, let's say I put $25,000 down and get 75% mortgage on it. Well, guess what? If that property goes to a million dollar, how much collateral do I have? I have $925,000 uh, in collateral. And if I want to make the same type of bets or make the same type of money, um, I need to put that money back to work because I'm not at the same leverage level. I was 4 to1 leverage. Now I'm basically went back to one to one. And, um, and so the machine creates more collateral, which creates more uh, ability to get leverage. Uh, and this whole system is leverage by the way. I mean, people like ah, you know, most average investors like I just buy stocks. There's no leverage in my portfolio. The whole system is built on leverage. You have to understand banks themselves like 10 to1 levered you know from the Federal Reserve and assets. So the whole thing is is um it's leverage all the way down. And so every time markets go up and more collaterals increase the amount of money supply increases dramatically. Um and I just mentioned the $500 trillion in assets. Well guess what? The market goes up 20%. uh you know that's a hundred trillion dollars more in assets. Uh QE's got nothing on the liquidity that market markets can or take and also you know take away. Um and and that's why as much as the Fed and people say oh we don't manage the market. We don't manage the market you know um well if you manage liquidity you manage the market because that's actually the greatest source of liquidity in the world. Um, it's also why you often, you know, it's it's silly the market, you know, you often hear from CNBC or, you know, Fox News or wherever you get your your financial media like, uh, oh, the market is down because of X or Y. But you know why? You know, you know, the reality is we had a, as you mentioned late 90s, a boom, right, economically on the back of the liquidity driven by markets themselves. And what happened the second the market went down? The second the market went down, 95% of tech businesses went bankrupt. Uh, you know, and had a massive recession, right? Um, people think the market is a a result or or shows the the net effect of what's happening under the hood. The reality is it is more the dog than the tail. Yeah. Yeah. So, I mean it it begs the question, you know, when does the supply and demand imbalance normalize or when does supply start to outweigh demand and or are there catalysts? Is it just um liquidity tightening? Is it market dynamics, market microstructure? How do you think about what what are the signposts? Yeah. So this time um you know because of the amount usually uh if you know if you have the Fed involved historically and the and the Fed is let's say independent you know the Fed is more likely to react to an inflationary outcome withdrawing liquidity or markets going too far too fast and the perceived potential risks of what could come on the other side of that, right? Um and and those are often what force a removal of liquidity to start. Um and then you got to slow down the economy which pulls some liquidity out and then the big part is the market you know reaction eventually can undo the whole thing. Um uh volatility products play a huge role and increasingly more than ever now but have always been important in the sense that um you know when VA is very well supplied to the market despite liquidity being pulled from the market it could it stabilizes things and can allow for other liquidity to come back in and and keep supporting things. Um the thing that tends to happen at the end of a bubble and we're starting to see it now and it's actually a big thesis for me in an options land and what we're doing in the next year is you start to see volatility increase into a rally and you see that structurally and that happens because the moves up just start getting so big right um a right tail event you know if you're going to do as we saw with Arthur Burns and Richard Nixon in the 1970s if you're going to provide liquidity without care over the inflation ary setup um and uh without care for the potential risks of of the outcome on the other side. Um markets will provide more liquidity and eventually you get in a loop. Um and so the ultimate check on that environment is inflation. It's the only real place that government can't fully control if they choose to make a decision. That is they take themselves out of a rules-based or some type of forward-looking smoothing mechanism, which is what the Fed is put there to do. And what we're seeing is seems to be a removal uh away from long-term worrying about risks uh for financial markets, worrying about inflation. If we're not going to we're going to no longer use those rules to concern ourselves in the short term eventually they will come back and bite you bite you in a much worse way in the long term. So, so my view is that this ends and if we are going to go down this path which we've seen like we are from uh you know US liquidity perspective um it ends somewhere on the other side with much higher markets uh which create more potential energy as I mentioned higher volatility into the rally which loosens some of the the holding mechanisms cause uh you know that the people are short on the upside will continue to go higher and ball will go higher which will eventually make it easy for buyers of all to come and say, "Well, if we're going to make money uh on ball on the upside, then well, pretty much a no-brainer to start buying these to protect, you know, and replace stock." Um, and so that mechanism, which always happens at the end, again, 98.99 was one of the best times in history to be long longdated calls. You made money all the way up and you made money all the way down. And so that will unpin markets and then ultimately rise inflation, raise inflation. And I think we also know just to be clear people like that why does inflation matter? We can f you know the the Fed can do project twist and keep the long and low without inflation. What's the big deal? Like that's that's the real liquidity. Inflation doesn't really draw itself that much liquidity. And I think we you know those that are in markets know you can't keep real interest rates that negative or negative really at all for quite a time or that drives even more inflation. That's how you get to hyperinflation. I don't care if you're in the US government or anywhere else. You know, if we can if people can borrow money at 3%. And inflation is, let's say, 5%. And give a Yeah. You know, everybody on the planet who has half a brain, every institution, every investor is going to go borrow money at three and buy the thing that's going to appreciate at five and they're going to do it with leverage. And guess what? That doesn't mean the thing goes up 5%. Now it goes up 7%. And now we go in a loop the other way. And this is what happened in the 70s. We've seen this throughout history in lots of other places. This is why the Fed is so sensitive to inflation um and why they have the mandates they do. And so we can whistle by the graveyard and ignore those realities, but at some point that you know that is uh that is the ultimate check. Um and so my guess is that that's uh one of the best hedges you can do out here right now and to manage this is you know is to buy you know the you know the problem with break evens is they no longer you know the inflation numbers themselves are controlled but buy by things that are actually going to hedge against inflation again that's why we're also seeing the the basement trade and precious metals and crypto as well because it's interesting a lot of people out there might say oh end of Fed independence or Fed independence in their mind that's not good for the US I don't want to be in the US market. But actually, as you say, in the short term, that means acid reflation as a means of priming the economy and and boosting asset returns in, you know, heading into year of of the midterms. But that goes for only so long and you see inflation as being the thing that breaks that. Correct. That's exactly right. in the short term um control full control right of the administration who is incentivized for you know for a number go up um especially into a midterm and a uh and then eventually also presidential presidential cycle um you they are short-term focused they don't what happens in 10 20 years may or may not be their problem and they'll deal with that problem when they get there um And so the incentive is very short term and you know guess what they have absolute control or increasingly so and if they do then they get the outcome they want. It's that simple. Um until they can't control it anymore and they're getting to an increasing they will eventually get to an increasingly uncontrollable situation. Yeah. Well that's the that's the kind of irony about all of this. It's just the the cycle how you get these broad structural shifts because of what's happened in the previous kind of regime. you know, we had central bank independence that central banks fought hard to achieve. Um, which resulted in the great moderation um and low interest rates came down and they came down so far that central banks and government started to borrow excessively and now now people are happy to give up that central bank independence and the impatient floating credibility, but it's it's hard once you lose it. It's it's so hard to get it back, isn't it? That's exactly right. It's it's short shortsighted short- termism, you know, and again, it's all about incentives. Like uh guess what? The administration itself doesn't benefit from any the difference of the what where things are going to be in 30 40 years. They benefit from what's how things are going to be now. Um and uh and and so that short- termism is probably the biggest problem that faces the world in general. Uh it's true for corporations. It's true for so many things. Uh um and uh and candidly, yes, if you're predicting markets, as we said, it's not about fundamentals. It's about supply and demand. And control tells you who the big bully in the room who can push demand is. And and and you can have confidence that's going to be the case regardless of the long-term realities. Um that said, to your point, trust, right? You know, I I tell my son all the time, you know, takes a long time to build trust. It takes very little to lose trust. And uh you know, we're entering a world where we've taken a long time to become, you know, a bit more kind of the almost we can almost all laugh when we say shining city on a hill, but there was a point, right? Like that was at least a view that democracy and all these things were you know um were something special and and then people you know came and throat you know came in in large amount amounts to come and work and build a life and do things in what that was generally considered a fairer nothing's life is not fair but fairer place and way and you know not to wax poetic but like I think it's fair to say people you know myself are a bit cynical about that these days and that's I think just the beginning. Um people lose that faith. the you know the whole uh breakdown and the thesis for for why it works um breaks down both and from from an options market perspective I mean you talked about the right tail you talk about the upside um obviously people are everybody's thinking about the downside from a hedging perspective but as you say we could see higher markets higher volatility what is the market showing in terms of how what what suppose what skew has been correctly priced and is not. So, we started talking about this a couple months ago as being the next big trade, meaning year, multi-year trade. Um, and the last month, it has exploded higher. And I think we get first inning on this one. And this is again longdated calls are dramatically underpriced relative to the risks on the right tail. I mean, take the debasement trade I just told you, right? Just from an inflationary perspective, the right tail is underpriced. Now take the supply and demand dynamics I just talked about and institutions are net short and uh you know liquidity is coming in and squeezing kind of all that not to mention the growth of structured products where in the end of the year and or institutions are underperforming I mean there is I could name 12 things that mean the supply and demand imbalance the right you know is you know dramatically underpriced meanwhile we're entering a bubble and a bubble by definition is leptocritic not just a right tail eventually it leads to a left tail And so if you want to manage your risk with the world massively long and try and diversify uh not know we could argue gold and and precious metals and crypto are no longer cheap, right? We can argue hedge fund strategies have their problems. Uh what I can tell you is uh you know an S&P call uh a year out or or four six months out with on a on an 112 uh given historic uh you know long-term volatility in markets is average of 17. Um you know and given the risk we're talking on the right tail is is it you're getting that hedge for a credit and you don't get hedges for credit for very long. Um so you know the answer pretty clear to me is you replace any stock. Why would you own the whole distribution right? Uh you know be be short all that downside left tail right be underweight by the way the right tail. Um when you can just go replace that with the cheapest part of the distribution in general and particularly in this environment which is the right tail. Um, so add on the money calls and you don't have to do it in the S&P, but there's a million other there's million other equity ways to do this, but calls are underpriced. And that's what we're seeing, by the way. We are seeing market up, volume up, market up, volume up. Most people have played in the space who have not been around for the, you know, the 27 years I've been around haven't, you know, think if you came around in 2001 2, you haven't seen this in, you know, 25 years. It hasn't happened. uh you've seen market evol for a week uh which generally leads to an unpinning and a down move and it's a good indicator for nobody I don't think so has you know it hasn't been here that long has seen a continuous long-standing move meaning a year or so of of that type of general action and uh it's actually in the v space one of the easiest ways to make money. So you are uh you are fortunate to be at a time where you're getting a credit in a way to hedge and improve your outcomes. Um and if you don't take it, I think you know that's on you. Um but but uh yeah why at this point you know I'd much rather have a 12 it's been very profitable already and will continue to be a 12v out of the money call with leverage to outcomes and and and not only that left tail at this point. Um so stock replacement uh you know easier way for people who are you know if this sounds too complicated you know replace your stock with calls it's a much much better way to play this in the next year or two not financial what about I I know we've talked about this before with respect to gold but that was probably probably about 50% lower from here now that we've had this phenomenal rally this year how is that market looking in terms of the distribution so the I've said this in other formats other places but the was from 19 to 1965 68 um all the way to 1982 for you know 15 plus years. Um the best performing asset by far it's not even close was was gold. Um this is before crypto so you could argue some of this you know is going to be somehow distributed across the two. Um, but it wasn't even close a but most people don't realize it was also the most volatile asset during that period. And not just because it was upside volatile. It had a two-way volatility to it. Um, and that's logical. We've been talking about this for several years. You and I might have talked about it, but the but you know, everybody's focused on equity, the best performing asset, you know, in a debasement era or a period of bigger structural inflation. Yeah. is not equities. You know, equities went nowhere 19682 because they're measured nominally, but that the inflation forces valuation multiple risk. So, you have a pushpull on a nominal basis that drive net less volatility, more long in a long-term basis. You have crisises, so there's a role for people, but the things that did incredibly well were FX, obviously interest rate fall, but FX and precious metal, and they're the same thing. If you think about FX and precious metal are integrally related like you know precious metals are a currency is currency. Yeah. Yeah. And so um yeah if you want to if you really want to find hedges or find secular opportunities in this environment that's where you should be looking precious metal crypto. So I bring that full circle to what's what's crypto going to do. Um crypto is going to continue to perform well but it is not going to be a straight line and it has been a straight line you know. Um so uh and in the short term it could still very much go vertical and that volatility could continue. Um but similar to me how I was talking about the equity upside in the short term. I think uh you know calls are a lot more expensive in gold now but there the I would say volatility broadly is is still cheap relative to what we've seen historic. I mean relative to we've seen in other periods like this. Again, if you look at over past 40 years, you'll say, "Jim, you're telling me to buy this gold vault, crazy ball, but the dynamics that are in play are going to make this a very wild ride. I know you had a couple of thoughts around AI and a couple of themes related to that. Obviously it's topic that everybody's focused on in terms of a major driver of the market and thinking about is the spend going to be justified I suppose has been a big theme in relation to the hyperscalers and technology firms I mean I know you see it having some impacts both kind of on a trading perspective that could be quite meaningful is it going to be a gamecher that's going to add value do you think on the trading side 100% but in ways people are not betting I mean that's an opportunity. I think the way people are betting on AI is very one-dimensional. It's very kind of first order thinking. And by the way, the same thing that happened in the n late 90s the the you know the first order thinking in uh in late 99 or 99 was well you know the internet's going to change the world. So go buy the companies who do all the real world things on the internet. you know, like, uh, go buy socks.com because you know what? They're going to take over the sock business. Um, and guess what? You know, all those companies are bankrupt and and lasted only a year or two after the bubble, right? Um, and that's not who ultimately ended up winning. actually the who the winners would end up being. We had no idea how that evol that would evolve and from you know search and then eventually right uh we were we were ISPs were were trading at crazy multiples that I don't even exist anymore. Um so the point here is there's a lot that we do not know yet in terms of the evolution of AI itself and honestly we don't need to play that game because a lot of that will get commoditized. Um I would argue um that that you know the value of AI and the profits of AI are actually probably not going to acrue to AI itself. Think that becomes a commodity at some point. Think about the real world. I mean we have lots of bright people all over the world. I I a lot of people are a lot brighter than me. I'll tell you that um my value that I am able to provide uh which in theory has like real value is not intelligence. It's my my history, my knowledge of my which is very unique, right? And that unique experience intelligence can can then use to create real value. So data sets, unique data sets are going to be incredibly valuable particularly in places where that data can be used to generate uh efficiency or uh more um you know uh new ideas, new uh new technologies and things there. So you know the data itself is being dramatically undervalued. And then lastly the inputs right at some point the the thing we can have great confidence in is we don't know where AI is going but we know what its inputs are and what it needs uh to succeed and and this is where kind of energy and power you know uh come in um you know and a data again is the other kind of input. So so that's a real focus for me um broadly with AI. The other the other big focus more broadly uh with with AI um is uh you know if you think about if you think about this um you know who's going to be the next platform right the the intelligence itself will be commoditized like the cell phone itself is commoditized right like but Apple is a tremendous stock because they were able to lock in kind of a platform that everybody didn't want to switch off of. Uh, and so the question is who's going to be the big AI platform and and that's that's hard to judge and there's a lot of different places. because I I have my opinions um but I my my guess it's the one who controls data again for individuals and for companies or manages a security of data right um and I think that's a again a critical theme but what areas so like let's go a step further what areas where is data uh unique data sets uh available and where are is the greatest potential for taking that data and creating um you know value and and one I think that's one of the wor ironically one of those areas is the cheapest area in markets or one of them period which is healthcare um you know it's a science it is the science um and it is the place with some of the greatest cost particularly here in the US um on the system um why is it so inefficient I don't think many people ask that question why is healthcare so inefficient it's the science and the answer is we have very strict rules around healthcare data. Data is locked up sequestered in very unique places and very hard to access. If we didn't have data privacy around healthcare, guess what? We have no data privacy really anywhere else. But we oddly really think our healthcare data is critical. And and I'm not saying it's not. Like I think privacy is super important in general, but we've, you know, we've kind of already gone over that, you know, I think we've we've skipped over that and and um and so my point is HIPPA aside here in the US and and regulations on healthcare privacy otherwise there are places where that healthcare data is does exist and can be used. United Healthcare for example is one of the greatest owners of healthcare data in the world. Um, oddly they're they're are worth uh, you know, not so much right now. And and I just I think they're again it's not necessarily people want to say AI, it has to be an AI player. It has to have AI in the name, but really what you want to start hearing is who has data in the name, who has unique data sets in their name. I think that could be a real theme that people could start to catch on to here in the next couple years. Um, but but the reality is that's also those things are cheap and have much less downside. So I think the asymmetric things like that are are really really critical. Another place and this is more my domain now is um new technologies or things that are complicated um or uh are having a hard time are better technologies but are having um a hard time with getting uh distribution to the world because they might be complicated. They need a translation. Um there's a bunch of different things like this in financial markets and this is kind of what you're alluding to. um options right options are we've talked about this at length and people about you know four or five years ago I started saying this that you know kind of got a lot of crazy looks like options are the true underlying in the sense that they are not a two-dimensional up down they're not just an expected value of a distribution they're every moment on a full distribution of any and every asset in the world it is you know like taking trading from two dimen two dimensional world to a three-dimensional world it is superior it's not like uh Now people, it's confusing to people because you're dealing with three dimensions instead of two. And guess what? That needs to be made more accessible so that our minds, it can be more logical, more easy to manipulate. Take what's in my mind and what I actually want and translate it to how to get more precise positioning based on that information. And that's happening. And that's going to happen in spades. The next year or two, I think options will become much more accessible. I kind of liken it to electricity. When electricity was first found, discovered, like people were terrified by it. This incredibly powerful thing. You're not going to bring it into your home. People still use candles at home for many, many years. And it was really hard. They had to standardize and find a way to translate this powerful thing into just a simple thing that people just plugged in something and never worried about it. And there's a million technologies that do this. Actually, most technologies need this. They need a they they're start in the raw and they're trul uh truly worth a great value but you got to hit get network effects you got to get translation mechanisms and and this is what's happening and it's already been happening options market but AI unlocks that so quickly because it really who are the winners in that it's just again it's the platforms who embrace that and and build the user interface is that it anybody who is involved in options period it is a taking over of that whole market it is also by the way accelerant to those other things I talked about to move into non-correlation. So, uh the I wouldn't say the structural product industry, but those who step in and provide those at cost, right? Or at you know, which could be the exchanges themselves, which could be the brokers themselves. Um I actually really like brokerage exchanges because they're also uh not inflation sensitive. There's no uh input increase. Profit margins increase in times of inflation because revenue increases and costs don't. So, so you know brokerages, exchanges deal particularly in the alternative space. Any uh educators, people who uh enter the space and become more involved in it uh uh more broadly um again uh technology platforms that help uh again with this trans translation. Um and importantly you could invest in the actual assets as kind of his first order but there's also market effects that are going to drive come based on the the structural changes in markets going forward too. So um those that that trade in these are market makers entities that trade in these the spaces will will benefit as a function of this. So it sounds like you know with with those types of things obviously the gains acrewing to those with the best technology who have already the resources is that a reason to think it'll be in our business that the pod shops the bigger houses that already have or the QRTs the ones investing massively in technology will just continue to get bigger. Is that the implication? Not really. there's a pushpull, right? Because you're the edges are decaying because AI takes away some of the um you know the value of of that knowledge, right? It's no longer a uh you know, like as we're talking about data set, your data set's kind of becoming commoditized. Uh that said, you know, you have a a massive early on, you're going to have a title wave of new entrance who are, you know, just using AI and less sophisticated and and entering a space and that might create more bass spread in some ways as well. Um so I think there's a push pull. I mean, it's no different than since the beginning of time and and in and in in markets and options. you know, I started in the market, we had uh, you know, dollar-wide markets and S&P options. Um, that was very profitable. But guess what? There, and by the way, that was more segmented, um, you know, marketplace because a lot of people could just go do that. You didn't have to be that sophisticated to get a bid as spread. Um, nowadays though, the volumes are through the roof, right? And the edges have come down, but there are a lot of entities that they're sophisticated enough who are making more money than ever. Uh so um but so I think the winners and losers will change that is for sure but I do think it will in some ways be be much more profitable and if you're uh playing it from a much more you know you know who's going to win is people like RAAS who are taking advantage in this trend early because that whole industry in my opinion is changing quickly and you got $500 trillion that's one of the biggest industries in the world um that's a place I'm playing in and trying to part of as a function of that. Um, so I'm kind of talking my own book here, but I do think there are tremendous opportunities for that title wave um from just two two directional world to three-dimensional and that trans transition will be made much easier through AI and other technologies. Well, definitely that's something I'm thinking about. I mean, increasingly I think we will see a blurring of the traditional and old investments. I mean absolutely it's already happening and and and over time I would expect it to accelerate and what you're talking about obviously with options trading would accelerate that I mean maybe not seems like hard to believe a lot of we get even more retail participation we've already seen plenty of retail participation in the options market but I in the US I guess we could see even more yeah and when I say retail I you know retail is actually relatively small I mean it's gotten big but relatively small relative to because when we say retail we're swap talking generally smaller traders, right? Like uh or or smaller numbers, right? Robin Hood's average account size of $4,000, right? What I'm talking about is RAAS and the big pools of assets, and that is quote unquote retail, but that is not a small pool of assets. That's the biggest pool of assets in the world. Uh and this is why again ETF issuance uh with options in it, for example, right, which is a kind of I don't think that's necessarily the final step. I think there but that is a trend that's going to just keep going exponential. We've gone from $20 billion of those just three years ago. I'm talking about the most vertical trend to 300 sorry 20 billion to 300 billion there in just three years. Um you know that's not a 3x right that's a you know 15x and and I think that type of growth there is just start getting started as well. conscious of time and I wanted to get your perspective on you know how the kind of the timeline looks from here in terms of event risk into year end obviously you know speaking to you before you'll often talk about the summer period fall compression over that period now we're gone beyond that we've got some obviously we've got the uh Supreme Court starting to take arguments on the tariffs in I think in November and there'll be a ruling sometime after that so that's obvious uh risk around that But I mean as you look kind of next number of months, have you mapped out a timeline in terms of possible risk dates? all always and it's easier to do and the reason seasonal patterns don't really care about uh you know what's happening in the government or what's happening in XYZ is um there are structural pressures that drive outcomes much more and particularly at this end of the year period then um than the headlines. Now, the headlines can affect things if they're big enough, right? A nuclear bomb goes off in New York, there's going to be a market reaction, right? China invades Taiwan, there's going to be a reaction. That said, you know, in the absence of some massive left tail event, uh, and even I would argue in the context of, you know, we've seen many situations where those happen and the market still does its thing until those flows are gone and then it reacts. Think COVID, right? like we knew about CO in December but uh you know we didn't get a decline till um until February because the flows you know flood February opex to the day because of those flows. So so I I prefer to talk about the flows and particularly here in this period as we enter October and start looking forward to the end of the year. Um I want to reiterate again it all goes full circle here the structured product issuance is dramatically bigger than it was last year. hedge fund long short equity is significantly bigger than it was last year. Um and those are also are so it's not just seasonal oh every year the XYZ happens these effects are getting bigger. Okay. And this year we also have a now beginning and heading towards the takeover of the Fed which is coming in May for in full for next year and markets already know it. Portally markets already know it. So it's already kind of put in place there. So liquidity is coming. It's already on the way and unlike let's say last year and most years institutions are caught underweight. So you have a recipe here of supply and demand dynamics that are um not in your favor. This is a bullish period in general when markets are up. Why is a bullish period uh in general when markets are up? Markets are up 15% for the year. you have five, you know, 200 trillion of equities. That's again a $30 trillion um input and about 10 or so% of that at a minimum goes to work. Gem one 30 trillion 10% $3 trillion. The average amount that moves markets on a daily basis daily is about 75 to 100 let's say hundred billion dollars. Now they got a $3 trillion buy order that's sitting there. Jan 1, is it a surprise that the Santa Claus effect and the January effect together, those four weeks are the most positive four weeks, month of the year? No. And so an up market, the more the market's up, the more that it dries up. Okay? So that's that's one. So that's sitting out there. It's still Gen One. You know, we're in October. I get it. Like that's a lot of to play that trade now, but it's sitting out there. And we know institutions are underperforming. that Jan one deadline presents a a a problem, right? They need to get end of the year. People start looking at their statements saying, "Wait, how much have I made? How much have I not made? Do I want to stay invested and those decisions come up and uh guess what? You got to start, you know, given these dynamics, people can't wait. That's why you keep seeing the consistency of this rally as we push into the end of the year." Okay? And institutional position was at the zero percentile in July in June, sorry. Now it's at the 25th. dramatic move, but you still have way to go, right? And they're under underweight, so like you can't catch up by being even weight. You need to be overweight. Um, and so you have those dynamics at play and now you have structural policments which is bigger than ever. And we saw that this summer, we saw it last summer. And what that does is that drives compression in general. But during a September, October period or maybe maybe even August when when there's more volume and things going on, it has less of effect. But what happens when volumes get cut in half and people start shutting up shop? Well, that structured product is twice as much effect. That ball compression has twice as much of effect. And that's what we see in the summers. That's what drives that summer of George effect, which itself is bullish because then we're the skew in markets, right? And it's then there's more open interest than ever out there, right? And all that open interest leads to decay as as that happens. And that's a lot of charm flow push up as well and bigger than ever because it's not just amount it's not just the amount of all compression it's the amount of these structure products out there that need to be rehedged. That's the amount of charm flows are bigger than ever. All you put all this together and then you have again historic liquidity that's like an administration who wants it higher. Do you want to be short this market? I mean could yes could we get a headline risk and by the way the reason institutions are underweight reflexivity again let's go full circle is because we're at in a bubble and the natural thought in a bubble is oh I got to be underweight this is crazy this can't keep going like this or or I'll miss the upside you know because because I I don't want that left tail risk well okay but at some point you get pushed back in um and and um and so you know reflexively this setup is is is is very bullish here as we enter the end of the year and that goes till about the middle of January after that January effect and JN OPEX comes and then things can get some mean inversion but you know we're also going into midterm year and there's all kinds of other incentives in play to keep the plate spinning so you know you want a a general road map uh and it rhymes with a lot of the years but I'd say this year it's on steroids it's uh mark it up um you know uh probably gets front run because you know markets don't wait that's what's been happening here. Uh they don't let you back in. Um and uh and then you know maybe December Jan like that normal seasonal period which people have caught kind of on to gets front run and maybe then that period is a little kind of sideways and then you know again if you look at the price action last year it was very predictable. We said that you know similar things last year with with less of these dynamics at play. My guess is that this goes uh even faster because the dynamics are more short, you know, institutional and there's more catch-up and there's more liquidity at play. Um but, you know, steep um at first, uh less steep at the end. uh eventually some type of pullback finally probably in February or January maybe it you know gets front runs at Gene OPEX you know and then you know that'll be people will want to get back in because they see the end of the year midterm thing and there'll be some support regardless of the but the whole way volatility is going to do one of these longer term you know this count owning calendar of all which is is very compelling to and that's part of why the curve is so steep but it's it works incredibly well and and so yeah, I think those are the general dynamics. Um, you know, we can talk about what happens after Feb March or whatever next year when we get there, but um, you know, for now uh, you know, as as the front say, let the good times roll. Very good. Well, that's a a good note to finish on, a very upbeat note for anybody um, heavily invested or or not. Um, well, Neils is back next week, but Jen, thanks very much for for coming along today. Uh, always a pleasure. As I said, Neils is back next week. If you have any questions, feel free to send them in. Um, and we'll be back soon here on Top Traders Unplugged with more content. Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the 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 new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues 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 Traders Unplugged. [Music]