Has the Equity Market Rally Run Its Course? with Cem Karsan

foreign [Music] Market rally run its course hi everyone Welcome to the Real Vision Daily Briefing with me today is Jim Carson founder of Kai volatility hey there how are you hey how are you good to be back I'm doing I'm doing well thanks so we're still waiting on the final deal on the debt ceiling but how are you thinking about the markets as we sort of work our way through this final stage oh wow that's a big question there's a lot of moving Parts here I think uh first and foremost we'd be remiss if we didn't start with kind of the biggest story which is kind of breadth right and the lack thereof um Nvidia Stan is the tip of the spear on that um and all the AI kind of excitement um exuberance right uh the the reality is I think very few people understand why breadth is important it has a direct connection to volatility um everybody thinks indexes are a constituent of the it's Parts because that's what we've all been taught right an index indexing itself takes the single stocks adds them together and it equals the index but in today's day and age um the reality is that the index is just as powerful if not more than the parts because that is where the majority of the the directional trading takes place and the hedging takes place and the index Vol is very while supplied and very compressed and when that's the case but you have fundamental pressures on liquidity as we're seeing as interest rates have gone to five percent and we can get into the TGA uh kind of refilling and all the concerns there but as that starts to happen stocks that are not ball centers that are not compressed you know take on the liquidity of the of the primary source which is you know the fed and all the other primary liquidity fundamental liquidity sources and if those start to uh decrease right if those stocks start to decrease and the index Falls pin that means whatever is not pinned which is the short Vol Center um has to go the other way to balance it just mathematically speaking it has to happen um so the ball is very compressed indexes are pinned we're at over one year lows kind of in realized Vol implied ball has followed suit um and uh and guess what uh 90 only 10 10 stocks represent uh 97 right of the increase in the market and so something has to you know as all the other stocks are declining something has to counter bounce to that and that is not surprisingly the shortfall center which is all those calls being bought in the video eight days ago we had record levels of call buying in those names that speculation is forcing dealer short wall in that complex and this is a simple dispersion trade at its finest right and this is Market microstructure at work um that's this is why breadth matters it gives you when the index is not moving but the majority of the stocks start going down that tells you something about the reality the fundamental realities of liquidity versus what might be happening just structurally under the hood and when you start to see divergences not just like that but in other parts of the market that's a clue that this is a flows flows-based phenomenon and not a fundamental phenomenon when those divergences happen that happen that's generally a very very good clue to what might be coming yeah so we'll start there yeah do you think and there's a lot in there and I know a lot of people are listening to this and totally getting it some of our viewers may not who don't sort of look under the hood like you do so we'll try to pull it apart a little bit do you think that um that that this is the the liquidity issues are kind of permanently driving now is this just sort of a moment in time or has this sort of functioning now become more about that and less about what you call the fundamentals which I presume are the kinds of things that we used to look at when we look at stocks uh it hasn't been about fundamentals for decades um uh now uh we can again that's that's the narrative you hear on CNBC right uh yeah rias will tell their clients because the truth is too complicated for your average person to really look at or care about it's not the narrative that is uh that most people have been told I've given the analogy I think on here even about the airplane right I'm not going to redo it but the reality is that that liquidity is what drives Direction uh valuation is is the elevation off the ground right um and and the reality is you can be way off the ground but if the liquidity is still firing the you know the the plane will still continue to rise in a steady solid fashion for years a stock market is at the end of the day factually a matter of buyers and sellers and it's a function of supply and demand and liquidity goes straight to Demand right and and that is what matters supply and demand so matters in the market fundamentals will matter at some point as a function you know they will affect supply and demand but how do they do that generally as a function of cash flow they are put on a business um and what do I mean by putting the business if there is no liquidity at some point when liquidity becomes gets removed from the system all that ultimately matters is can a stock itself provide the liquidity it needs to stay in business and and that's the context under which uh fundamentals matter to the extent fundamentals affect demand for stocks but we go often not just years but often a decade without um and we have gone at least that more than that since 2009 at least uh where all that's mattered is is you know not earnings but liquidity and when that's the case um donks go up yeah uh you know to use a Wall Street uh bets phrase right like that's the reality it's all that matters is is uh is there demand now that's starting to change right and when that happens uh you know if the engines go off if they start sputtering and there's no more gasoline in the tank then guess what the elevation off the ground does matter right and and uh and particularly on a stock by stock basis now this is one kind of value growth rotations and all kinds of things start to happen because that put all of a sudden becomes a lot more important that's a great great way to put it um because I think that it's very different as you say when you listen to so many people who still talk about it in terms of those sort of earnings and their sales and their you know like the the types of things that used to used to really count um that's a really good way to look at it so when this is happening now how does the whole that whole AI narrative fit in do you just think that's sort of like a red herring um right now or is it does it matter at the margin the same way those does that fit into that sort of fundamentals that matter but they're not driving necessarily until you see things evaporate because everyone was like ai's going to change our life that's why Nvidia is going to to new highs you know uh look the the big much bigger than Nvidia is is the market and the s p 500. and if the S P 500 ball is pinned and structurally uh you have a buying and selling force that is is keeping realized ball temporarily or forever long it made in 2017 it lasted a year and year and a half um at at Bay um and fundamentally certain stocks are decaying based on the lack of liquidity for them right uh and and the fundamental pressures that they're facing that means for one or two or three stocks it's a massive amount of counter you know 490 to 500 stocks are uh are going down or or you know static um that means there has to be a pressure right um on the other side that that pressure think about how much that is 10 stocks that are getting uh are having a counterbalance 490. um you know so that is a tremendous amount of buy pressure and and it is exacerbated by leverage right in a short Vol Center this is what call squeezes kind of are about right this is a meme stock uh or you know on the other side we saw it with the with the bank stocks recently but once gamma gets involved there's a tremendous amount of Leverage uh short gamma itself can be incredibly powerful and when it has a Tailwind in the force of structural flows to counterbalance what's happening in the other part of the market it could be incredibly powerful so my view is that uh yes uh the call buying the speculation in those names is driving uh you know is loosening the liquidity and increasing leverage into a system that already has massive flows and you know is trying to find a home to to uh you know to push certain Assets in a certain direction and that's like the weakest point right um and so that's where we're seeing kind of this get going and momentum it gets momentum it gets more calls it gets more short gamma um and it's a self-fulfilling prophecy the thing is this doesn't go on forever as we've already seen in several other parts of the market as these things same things have already played out in the last several years um so um you know be careful shorting it but also understand that uh when it ends it's going to end violently and uh you know uh it will be will be painful yeah it's that's exactly as you describe that I'm thinking to myself and I think we're all thinking this can never end well when there's that much that much pressure so what's 35 times what happened 35 times the revenue right um I mean listen anything can keep going up as long as liquidity is there and that's the point but it is not uh you know if if we get to a point where the liquidity in the market is truly going out right the Tide's going out um there is a point where the put matters and you know at those those valuations there is no put within 90 of that valuation so what are you looking at in terms of liquidity then if that's if that's the key and and for those of you who are on the platform you're going to see a thread here because this is what ral's been talking about I think we're going to tackle it on Friday Michael Howell's been on it this is what folks who are looking at the markets are really really underscoring right now so what are you looking at in terms of liquidity Jim um well I mean look the reality is uh we talked about breath but just to give you some stats you know we're at uh only 29 you know outperforming stocks are down to only 29 of the market that's the lowest since 1999. that's a pretty big uh year to keep in mind right people talk about how crazy valuations were there on a uh you know on a uh discount rate relative to the interest rates were more expensive than the recent Peak uh by significant margin and that's all kind of fundamental but on a from a liquidity perspective um we've also increased interest rates from zero to five right and that the lag of that is about 18 months and guess where we are right about 18 months and I think that's uh you can reference a lot of different people in terms of how those those lags work and I think we've referenced this before here but but it's really good it's you know there's a 450 trillion dollar Global asset market and uh you know about four 380 trillion sorry of that 450 trillion uh is uh and lagging assets real estate private Equity Venture Capital right a lot of uh you know loans that that really take a while right to catch up and even the mark Equity Market itself is lagging in terms of supply and demand because of BuyBacks which themselves operate on a at least a one year if not more we had almost record Buybacks in the first quarter uh that's after an increase of five percent in the year prior that's not because interest rates haven't hit the market you know or are important just because there's a lag in terms of the approval of BuyBacks and and how they enter the market um so that's happening and uh right as right uh where the the shorter acting liquidity pieces which is kind of the fed's balance sheet the qeqt part has really not worked through the pipeline and again you can look at a lot of different liquidity models people have been like where's the QT we've been talking about QT for a year and a half what happened uh and that's been counterbalanced by uh factors um like that you know draining of the treasury general account right um it's a really big one um you know by by most estimations we're going to by the end of the year at once this um this uh the deal that that ceiling gets passed uh we're gonna have to issue 1.4 trillion dollars in in debt before the end of the year um that is a massive sucking sound out of um asset markets right uh that that money's got to go you know there's got to be buyers of that debt which means that money's going to come from somewhere um and if that means interest rates go higher right uh as that demand you know that that Supply comes on the market and demand has to be met that means Equity markets or somewhere else some other risk asset has to you know has to reduce liquidity so and that's a real-time effect to be clear that's supply and demand straight into you know the veins of the market um as opposed to interest rates which is through the economy much slower acting and so you're going to get this very quick acting kind of reduction in liquidity right as kind of the lag on kind of the other things is coming down the pipe at the same time and so that's that's a pretty kind of Brew of of uh kind of uh kind of of you know liquidity issues all at once um I would pair with that liquidity issue you know the fact that the last year and a half there's been a lot of short speculation a lot of ball buying and that led to a reduced reduction in volatility reduction and downside um and realize ball as we've talked about in the last year and a half but a lot of that has also dramatically changed because it didn't work and a year and a half is a long time to be investing in ball on the long side and and uh eating Decay and on the other side it's a it's a wonderful time right uh to be speculating short and a lot of people have been you know getting calls all the time now like what hey uh I've been 30 40 you know for the last year and a half just shorting these kind of puts why wouldn't I just keep doing that like but you know so it's back this is a cycle we go through I could go through the history uh since 2015 of the sine curve of all Supply and people crowd into shorting IT Crowd into being long it and um it's uh it's dealer positioning at its core and how how these things move when things are working you know greed uh pot you know is is you know unavoidable uh it's a it's a a feature of the system not a bug and uh and so is fear right and uh you know I think we go from vacillate from one to another structurally because we have to as money managers as uh you know as entities trying to seek up you know highest returns um and so that that where are we on that curve and and I'll quite frankly say that you know we we reduced 30-day Vol hedging by 40 50 as we move to zero DT that you know nobody's talking about how much real Vega hedging has reduced everybody's talking about the increase in zero DT why because uh realized ball was working and implied wasn't right but then what happened to all the buyers of originally buyers of zero DT have now turned sellers of zero DT because guess what that wasn't working either because everybody crowded in there which compressed realized wall so now you have a broad phenomenon where it's broadly sellers across the board that's making dealers Long right which is forcing this kind of pinning but what it is uh more and more creating is an unbalanced system where institutions are not hedged um yes dealers are hedging but as soon as you break out of the general range you can get to a really unbalanced uh you know position the market so we're in a fundamental liquidity situation which is dramatically deteriorating while at the same time uh the actual flows uh you know are are pinning the market and in the short term but are structurally more and more unstable and more and more unhed so kind of again a a particularly dangerous point in Market certainly sounds like that I mean it sounds like you're really kind of setting up for uh the perfect conditions for a major event yeah I mean the reality is uh the more people know about this I'm not the only one talking about these circumstances right um the harder it is for it to transpire but it doesn't mean it won't transpire it just will transpire broadly this is what always happens in a in a in a fee as a function of time and price that makes it very difficult to shorten and um that's broadly what we're looking for it's kind of what a topping process kind of looks like generally you get a short squeeze some over extension that is fairly violent or that unpinsable or just a simple function of uh you know enough time where more and more ball speculation more and more um uh tail kind of unhedging kind of happens where eventually um you know you get a kind of 2018 type um kind of forcing of over leverage in a system and and what the the trajectory on is is the sum function of time and price you know we're looking for the stretching of a rubber band ideally the more we get that the more uh the opportunity is there we would have liked to have seen a bit more you know squeezing of those shorts into this uh period um you know that what's happening in a video is is definitely welcome so that's definitely creating an imbalance um and and getting more and more people offsides and corners of the market um uh but uh you know generally this topping process necessitates say hey kind of uh some type of path right that will that will squeeze shorts make it harder for long ball entities to be to be long but uh but the fundamental flows and the underlying flows are definitely heading quickly in that direction and so it's just a matter of in our opinion when and how um it's going to take conviction it always does if it was easy uh you know uh you know it would it would be everybody would be shorting this all the time but whether it's 2007 uh you know 2000 or even more recently uh Feb March 2020 um it it generally is very counter-intuitive before it's intuitive and and that is a function of squeezing shorts and changing narrative and really um you know shaking weekends yeah I think that's what's necessary here in this final final stage final stage um so I want to I want to throw something else out as you describe this so I mentioned that um brow has been really focused on liquidity so Ralph sat down with Jeff Snyder I'm going to play another it's an important conversation we played a clip yesterday about inflation we'll play another one for everyone today talking about the sort of uh the the the sort of mismatch that they think that there is in the market that just that this the Market's telling them M at least said something's not right let's have a listen to it now euro dollar markets are pricing in what a cut by July isn't it well there's always probabilities and I think the market right now is saying that we don't know about July we don't know about June June June's kind of up in the air July you go back a couple weeks the market was saying that there was a maybe 50 50 chance of a rate cut by July that's kind of Gone Away now because you know Ebbs and flows what the market is saying is that September by the time we get to September rates are going to be lower the short end as well as the long end so that's really something happens this summer when we get to September which only makes sense because you look at every crisis period or near every crisis period it's always September the middle of September like the middle of March that's a seasonal point which we always go through these things so if you're thinking ahead there's probably a really good chance that something happens in September if not beforehand so that full interview is on our website if you're not a member scan the QR code and join our community um so Jim we you know it's interesting we still have officials like even today Cleveland fed president Loretta Mester saying there's no compelling reason to pause U.S rate hikes and yet as Jeff points out they're looking at the global markets and the global markets are pricing in rate cuts and so that both sides can't be right how are you thinking about this yeah um so uh a general risk-off positioning has partially is partially what's responsible for the cap and rates right uh people have been flooding into the bond market um and uh but the fundamental realities of inflation have not changed and I think that's the important disconnect right um you know labor the labor Market's the strongest it's been at 3.4 percent right um you know uh we're seeing historic onshoring deglobalization uh or refilling reserves and the spr right as Opex kind of underpinning uh oil prices dollar the dollar has been relatively weak um you know long-term rates are down the back which is also itself reflexively stimulative like all of these things not to mention you know markets have been hanging in really well in terms of a wealth effect um all of these things are structurally you know inflationary um in the context of you know the Fed was much more activist uh and and uh and hawkish right three months ago before all these things happened um the difference is we had a little Bank Run in between um and that's it so structurally nothing has changed and by all accounts that's you know again you can argue whether it's going to be over or not and then we're going to force those shorts but that is a tail in the market that is not core to the central realities of inflation so yes the market is completely out of step with the bond market but I think that's more of a function of supply and demand broad macro flows and um and the FED is going to uh not just the fed the treasury as well as we talked about the TGA is going to Force those rates higher it's going to come to balance that we've already seen it I talked about this about a month ago on a I think here but also on a couple other platforms how you know the the market was dramatically underestimating the realities of June uh at the time talk about that yeah at the time it was a zero percent guess what now it's more than you know 50 right and the reality is it's is that is is likely um to continue to go that way I think the FED is is going to have to continue to push against that and again not just the FED but importantly the treasury on a short term much more kind of again right into the veins as we talked about uh you know reality is likely to have to force those higher just in terms of issuance um again just to put some numbers out there 1.4 trillion dollars in issuance before the end of 2003 by some accounts a trillion of that will have to happen by the end of August I mean how how does you know this is in a world where the Daily net liquidity which sounds crazy by the way to some people but the Daily net liquidity that drives Market direction is 50 to 75 this is for Equity markets 50 to 75 billion right uh per day so a trillion dollars is a tremendous thing to to work against and again that that should have reflexive effects on the market in in short order as soon as this you know ironically this debt ceiling is is a is a kind of a sell the news event in that regard um and so something we need to be very very thoughtful of I do think uh there is a disconnect now because liquidity matters in the short term but as soon as this reverses I would I would expect the the bond market to kind of Meet the equity Market where it is and then the equity Market itself to kind of reflexively respond to that liquidity as well so you don't think the fed's going to be cutting you think that bet is wrong in the bond market it is uh it is wrong yes the only way they will is that the equity Market has a dramatic decline and uh can we get that dramatic decline absolutely so one of the two you know the two are going to converge and my guess is that the bond market will force an increase of interest rates right as the equity Market will also have to decline somewhat to kind of meet meet somewhere in the middle um but in that one market those yields are going higher not because of because people will listen to what you described before where you have the lag effect hitting all those assets you know that 18-month lag effect and then you've got this liquidity and it's that's that sounds like it's bad news for the stock market but bad news for the economy um so then you would think that would take the pressure off the FED but you're saying that bond yields are not necessarily going to be looking at that they've got to attract buyers it's an issuance issue correct everybody's still playing the last 40 years cyclical game right the whole game was uh very clear to the uh to the average uh Watcher it was the Fed was in control of a system uh we had not had inflation for 40 years it was destructurally deflationary environment and anytime they we got a cyclically deflation all the FED had to do was come in and you know cut rates and and stimulate uh you know liquidity and we would simply push back up um that's all final well why can't the FED continue to do that well they have a dual mandate price stability and maximum employment when we're in a deflationary environment they can cyclically stimulate all day long and push against that deflationary pressure but uh that has changed um and we can we could do another three hours on why that is yeah I've talked about that ad nauseam um uh but but the reality is they're structurally inflationary pressures uh that we've seen again historically in other environments for the same reasons at the end of the day it's about balancing inequality and populism but there's other you know generational factors which tie it to this this moment but the reality is that we are in a structurally inflation environment until we decide as a people not just as a government but as a people to not make those things a priority um then you know those structural inflationary forces will continue and that puts the FED in a box that means the FED has lost control we are no longer in a two-dimensional system where the FED can just come simply pressure against the the you know the decline in in employment um and balance deflation but now if they come back into The Fray and stimulate cyclically they will exacerbate much like they did in the early 70s structural inflation and that structural inflation could be much worse than we've seen so far and likely will be if they do that and that is what its stagflation is all about and something that nobody's experienced for 40 years and and all the Algos that are looking at 40 years of History also have an experience um it is it is an added dimensionality uh to this to the system and is much more dangerous um uh you know as well not just for Equity markets but broadly for liquidity across the market um when the FED loses control and and one of the things I I love about the way you're describing this gem is that it is um it is multi-dimensional like we can see this there are all these forces at work sometimes together sometimes counterbalancing and I and I think that you really laid it out in a way that helps us understand that by the way Christopher is saying very impressive whiteboard behind you oh we know we're they're very observant our crew um so I we have some great questions I'm going to try to squeeze a couple in but I just wanted to ask you since we're on this so I and I know you just came from a conference I know people are talking about a liquidity event uh they are but but most of them are focused on the short term around the uh the general account you're also describing these longer lag effects coming in um people are talking about of all events when do you see this this liquidity event continuing through the second half of the year is this a is this a more temporary situation and then we're going to see liquidity I think that people who think that think it's going to come from the fed and QE or lower rates but if you don't think that if you think that that's wrong then do you see this this lack of liquidity continuing into the second half so let's let's go back to uh end of December 2019 um I was on the phone regularly with my biggest institutional client at the time um about covid this is the end of December 2019 um it was a known entity uh it took a rally throughout end of December early January Midway through February right um for a 30 decline in markets to begin um the reality the realities of covid were always there the fundamental liquidity concerns um were always there um I think that's a microcosm of just how markets work people knew about it they were trying to short the market they were trying to buy Hedges and broadly it took a situation where the liquidity was poor for their to be a crack right um there for for things to Break um and that that crack was s p March quarterly Structured Products and hedges were much more short for dealers there than they were in February and January and that's why they the decline started the day after February options expiration and ended the day after March Opex right it's not a coincidence it's why uh you know correlation went to Washington 1.1 right and this Center the s p itself was actually the worst hit well because that was the ball Center where the where the problems were the biggest but the liquidity had to get to a point where they the market could break it had to shake the weak hands and that can happen as a function of price so that's why we get a lot of blow-off tops that's why it often is kind of a fast move that ends at or it could happen just as a function of building uh pressure in terms of short ball or other a structured risk in the market and that's generally functional time and that is what I've talked about both before but that the path to this decline which is a structural problem right is as shaking of liquidity and if you're asking me to time that exactly um it's hard but in the back half of the year it should happen uh I would say that the the more counter Trend liquidity you know this more of a squeeze we get the sooner it will happen um so uh it's kind of like stretching a rubber band um we would have liked to have seen that already but uh also the more Talking Heads like me come on and educate people about this that also reflexively the longer it can take and that's why markets often um you know can stay irrational longer than people can stay solvent I think that's an important Point yeah it's always worth remembering that and this is invisible to a lot of people who are watching the markets and that's what's so dangerous and worries us a lot of the time you know that that people are not aware of these other Dynamics they see it through a different lens um and that and that can be really dangerous when it comes to protecting your money one quick question we're going to squeeze in um do you have an opinion on how the fed and treasury will react to the lack of liquidity is this something they're going to take into consideration they will when they have to uh I do not do not think they will be proactive about it um partially because I actually think the FED wants a little ear out of this Market they've been trying to write calls they've been trying to talk uh you know rates higher in the long end of the curve they've been trying to you know remove the wealth effect so they can you know stop raising rates ultimately themselves um so ironically you know don't fight the FED right we've the markets have been fighting the FED as you alluded to us we're all you know and and Snyder were talking about right um they want things to be more in line and so you know how how does that happen well they they let this thing breathe a little bit and they let rates go higher as as you know supply of treasuries comes on the market uh and then uh a question about thoughts on June Opex so the these big opexes matter um it's not a coincidence that um mid-august into mid-september is often a scary time it's not a coincidence that mid-February into to mid-march as we saw with uh the coveted crash is often a scary time um uh June uh there's a reason may sell may go away exists again June sits right there December is a little bit of a different animal because it's end of the year uh it's a lot the most holidays of the year there's several other dynamics that counteract some of that risk there but these other three quarterly Opex are very important to timing um it doesn't mean a crash necessarily happens there but what that means is you have a fatter tail in those windows and so now the op the reality is if expected return is the same and you have a fatter tail that means this distribution needs to be a little bit more right distributed and that also tends to be the case and this is the dynamic of all of buyback this Von and charm effect I talk about as a tail that's fat decays right the hedgers the dealers who are short those puts uh that are short that gamma ultimately have to buy back that stock and that creates a linear buyback that can reduce volatility create a a positive force um but that doesn't mean the fat tail doesn't exist and I think thinking about this more distributionally is very important everybody wants to know up down are we going up are we going down when are we going down when we're going up the reality is you need to be uh very much more cognizant of of what the potential risk and distribution of potential returns looks like in given windows and trade according to that you can do that with options more broadly but also manage risk accordingly um you know with stops and other types of of Trades well we just got a master class in some of this from you Gem and it's so important to have this conversation as we head into these what sounds like it's going to be pretty turbulent water so we we appreciate you making it um or talking about in a way that the rest of us can understand it's not easy always a pleasure thank you so much thanks for the great questions everyone um you know if you thought you were going to be able to think to to you know just sort of put your stuff in and take a few months off it sounds like you're not so we're gonna all have to be very Vigilant and we'll have Jen back on again to help us do that thanks to all of you thanks for the great questions as always take care and good luck out there foreign [Music]

Channel: Real Vision Finance

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Keywords: real vision finance, real vision tv, chinese, stocks, bitcoin, equity, equities, nasdaq, consumer sentiment, consumer prices, inflation, chinese tech, chinese tech stocks, china's tech crackdown, fed, federal reserve, the fed, taper, fed tapering, fed hikes, rate hikes, interest rates, bonds, treasuries, investing in bonds, raoul pal, 2023 markets, 2023 recession, 2023 inflation, realvision, ral pal, raoulpal, portfolio management, AMa Raoul Pal, Raoul Pal 2023, raul paul, raoul paul

Id: 7CPBWY5Jk9o

Length: 37min 4sec (2224 seconds)

Published: Wed May 31 2023