How AI and Stagflation May Impact Our Investment Decisions ft. Cem Karsan | Systematic Investor 243

you're about to join Niels kostrop Larson on a raw and honest journey into the world of systematic investing and learn about the most dependable and consistent yet often overlooked investment strategy welcome to the systematic investor series [Music] welcome or welcome back to this week's edition of the systematic investor series with Jim cassang and I Niels casablasan where each week we take the Pulse of the global market through the lens of a rule space investor if you're new to the show I hope that today's episode will trigger your curiosity enough to check out the back catalog and listen to the past episodes that you may have missed like my conversation with Mark last week where we discussed the topic of how to detect changes in Trends and whether you should use economic data in addition to just looking at price in your investment strategy also I would really encourage you to listen to the midweek episode which admittedly will not be for everyone as it is somewhat politically charged but the topic is nevertheless incredibly important as it deals with the dangers to democracy that the financial times Chief economics commentator Martin wolf lays out in his new book the crisis of democratic capitalism which he explains why in his view the marriage between democracy and capitalism is breaking down lastly I am excited to let you know that in our CTA mini series where Alan and I have been privileged to speak with some of the decision makers of the most successful ctas in the world we have another episode planned which will come out within the next couple of weeks and in the meantime if you haven't listened to the previous episodes I certainly encourage you to go and check out that Series so anyway head over and check it all out after you're done listening to Jim and me today Jim it is always great to be back with you and how are things what's going on in the winter city today it's raining it's a little Spring May showers right uh hopefully uh you know we get some flowers here I'm not sure that the market will get uh flowers here man but that's a whole other conversation I think that's a little teaser well over here um actually where I am today the sun is shining and we have a whole weekend of the Eurovision song contest lined up for us which is one of those things where the more extreme you are as an artist the better the chance is of winning or at least that's how it seems um so um I'm not sure which one is best uh Jim but anyway we do have a good lineup of topics um and we will dive into all of those but maybe just to um just to kick it off kind of your headline big views that you're focusing on and then we'll dive into all the details um plus some other important topics yeah kind of how I tease it uh this is an interesting Crossroads in the market uh we have gone through the relatively well Telegraph to my view uh spring time uh kind of Market especially given some of the Dynamics that we had been witnessing the last kind of four or five months um there's a lag to monetary policy that is continue to work through the economy and as we get to this debt ceiling I think we're also you know debate I think uh we're getting to an interesting kind of moment here as we head into a more illiquid summer uh generally speaking uh the months before corally Opex whether it's February or may or August uh mid-month tend to be a very interesting structurally and have more risks so that's something that we're looking at as we head into Opex here into a liquid summer after a particularly kind of uh study uh you know complacent rally so perhaps the old saying selling May and go away might turn out to be a good um myth this year now I completely forgot that I did want to actually just mention that there are a few interesting things I I think uh worth paying attention to this week uh of course many believe that um you know with the FED action we saw last week that the FED will be on pause but I did notice that today uh Friday fed Governor Michelle Bauman expressed concerns about high inflation and a tight labor market suggesting a need for continued interest rate hikes in fact she was speaking at a symposium at the ECB in Frankfurt today and she said that she's seeking signs of and I quote consistent evidence that inflation is on a downward path when considering future rate increases um and at what point we will have achieved a sufficiently restrictive stance uh for the policy rate which of course is an interesting comment given the fact that interest rates are at a 16-year high and you would probably argue that it is at a restrictive level uh even at that point but it does suggest that there might be a little bit of disagreement in the rate setting committee and it does raise the question about future or potential pulses at the um future meetings I also saw that the initial claims ticked up to a fresh high of 264 000 yesterday and that the four week moving average also hit a high or recent high of 445 sorry 245 000. anything you want to add to that before I dive into my little Trend falling update before we go into the Global Micro topic I mean we've talked about this a bit but I think it's important to continue to set the stage that we are not in a typical cyclical kind of are We is they is the economy slowing or is it speeding up uh and and what does that mean for the the FED action there is uh structural secular inflationary headwinds uh that are likely to remain sticky even in the face of cyclical um you know pressures so I really think that we're no longer really playing in two Dimensions with the Federal Reserve which we've really done primarily for the last 40 years um there is a increasing probability and we've been talking about this for years of stagflation and that is a very difficult situation for the FED particularly at the beginning of a stagflationary you know secularly stagflationary environment so I really think there will be continued debate and uh and again I think we'll dive into that a bit more later but but the the you know the Crux of it is we have a a situation where the FED may not be able to to fix the cyclical downturn this time I can't remember what movie it's coming from but I think there's like a movie where the quote line is something like it's complicated and I actually think it is pretty complicated at the moment I have to I have to say anyway what's not complicated is um that in the last few weeks uh and probably most of this year really from a trend following perspective it's been kind of a non-trending environment lately uh and but we did see some recovery in the last week after a soft start uh to the month of May so um you know there's been a little bit of improvement and but frankly uh it's been driven by just a few markets really it's not very broad-based pretty much like the stock markets where a handful of stocks is responsible for the gains this year uh and interestingly enough I noticed Jim that my own Trend barometer which tracks the trendiness of of a Broadband Diversified portfolio is actually at the exact same level namely 41 as it was last time we spoke on the systematic investor series which means it's completely neutral no conviction up or down so anyways um quick run through as we normally do the beat of 50 index is down 88 basis points for the month down three percent for the year stock gen CTA index down 72 basis points for May down about four percent for the year the trend index down about 45 basis points down about five percent for the year and the short-term Traders index actually struggling a bit down 1.15 for the month down 3.3 percent for the year and given its much lower volatility uh it is relatively underperforming I would say anyways stocks are down as well this month down 74 basis points for the msci world and 93 basis points for the s p index but they're still up seven and a half and eight percent uh for the year so far and bonds are just marginally up so far in May thank you all right Jim as we already alluded to um you're talking about an interesting inflection point that we are at right now I've heard you talk about that it reminds you of a recent topping process because let's not um be too um cagey about it you do think that markets will head lower later on but talk talk to me a little bit about what you're seeing in more detail and and maybe some of the underlying reasons why you take the view of the coming Market actions as you do yeah so there's as I mentioned to set the stage a a lag as we all know to the monetary policy interest rates specifically and that's working through uh the economy usually has about the 12 to 18 month lag um you know we're getting to a point uh we're about you know call it 13 14 15 you know we're getting into that that later ends of that ending we're beginning to see those effects all right um and we can walk through all of them but whether it's in uh housing and and BuyBacks for stocks um you know uh private Equity Venture Capital uh rewriting all of these things are starting to begin to work through and and those have significant uh you know effects to Collateral in the market and Broad liquidity for asset support um at the same time and I think this is important the QT and the drag on liquidity that that the FED has supposed to have been doing which has a much more you know direct effect to markets in terms of liquidity has really been counter uh acted by uh you know several things not just the the deposit insurance that we you know have recently given to Banks but also the the treasury general account um kind of stimulus that's been coming as a as a function of sending money in you know to uh during these emergency measures right uh for the debt ceiling debate and so if you look at a chart of liquidity really uh you know in that regard it really hasn't come down much given the amount of you know the the 90 billion dollars of draw that we're supposed to be seeing in terms of quantity of tightening um our estimation is that as we move forward here we'll begin to see a lot of unwinding of not only the deposit Insurance effects right but also importantly the refilling of the treasury general account once we get past this um you know this this debt ceiling so ironically everybody's worried about the debt ceiling right I think the the great irony of all this is is the resolution of the debt ceiling is ultimately what uh will be a sell the uh the event um we think um so as we move towards that those pressures are all increasing in terms of removal of liquidity all while we're moving um along a path of uh you know generally uh worse margins um you know and other you know margin compression and other issues that are hitting equities broadly at the same time positioning is actually quite short um so people know all of this right I'm not telling anybody here things that that aren't kind of publicly understood or known the question is why hasn't the market you know the market is forward looking why hasn't the market taken this to Heart yet and the answer is positioning and this is what the answer always is by the way um that if everybody expects something it doesn't happen uh exactly as one might expect and that's because of the reflexive effects of dealer positioning we talk about this all the time not just in the options markets but broadly if there's a lot of short interest in the market uh or there's a lot of put buying um you know these things ultimately lead to reflexive support for the market it's that proverbial wall of worry that people talk about and so we've really had this macro versus um you know positioning uh push and pull and the way that usually ends is one of two ways it ends uh either with time and why does time matter because uh risk increases with time people are willing to take more risk if things don't happen for some time and they're willing to whether it's self all or other forms of risk Premia they're willing to come in and uh you know and sell uh kind of risk over time and that's greed at work it's also the diminishing of fear people who are buying protection or or you know risk-averse eventually give up on that and because it's it's expensive by the way you know Market structure works not just the ball but but broadly and that that generally leads to the unwinding eventually I think uh you know think about all of the uh the selling of all that in 2017 that eventually led to the 2018 of Apocalypse as an example but there's a million examples of this um along the way generally that starts to get unpinned before a decline uh we saw that in 07 we saw it in 99 2000 uh we've seen it even in other uh such circumstances and and that's part of why things always take longer not always but generally take longer than we think right because of those reflexive effects but they do eventually come right people were talking about the housing crisis and in 0.506 uh it took till oh uh you know 08 to really unwind but it was macro realities eventually do come home to to roost um it's just a matter of shaking you know uh things building uh to a point often beyond what what you think is possible so time is always one possibility the other is um this price so you can shake a short positioning simply by a big enough rally a a a a stretching of markets you can squeeze shorts force people uh institutions back in from under performance um as well as naturally take fall higher into a rally because markets slide naturally to a lower implied volatility just at Baseline and eventually that becomes low enough where participants are willing to come in and buy it and then remove that liquidity right from dealers and and Vol naturally becomes more unpinned this is a natural process this is why we often get also blow off tops right and uh and increasing ball into those final rallies that we see so these are kind of two ways that this story kind of ends and that we shake positioning right and that's really what needs to happen at this point all of this structural liquidity factors the macro elements are place but you know you have to shake the conviction of shorts and uh and long Vol and uh in the shortfall um you know has to build in the market so this is generally the process um we saw this uh you know as recently as the the recent November into February 2022 um all the things were in place people were positioned for a decline there was a lot of talk about the FED increasing interest rates everybody knew it was coming um they started and then it took several months and it also happened to line up with a seasonally kind of positive period right that's not a coincidence uh end of year beginning of year and all those flows and that pushed us into kind of a a a very kind of big blow off top not a very big but a big blow off top that that uh that ultimately then Unwound um you know last year and so we believe again after seasonally positive period here for a lot of the reasons we've talked about in the lags we've talked about that that everybody knows what's coming here now we're in this topping type process and it really is a function of of time and distance you know for for what comes next it's actually getting something I'm there are actually two questions that comes from from your your thoughts there uh one is one thing that I've actually always as a trend follower uh been wondering because what we notice in our models is that um we we make a lot more money on our long-sided trades than our short-sighted trades and some of it can be explained by say bonds having gone up in price for so many years up until a couple of years ago and so on and so forth um but I've always myself had a little philosophy and you will probably know this much better than I do that uh tops takes a lot longer to form compared to a bottom you you often see like a one day like March 23rd 2020 now it was artif artificially induced by the FED sure um but but that's kind of just what I've been noticing how do you how do you think about the because you mentioned time and I completely agree time is important but but how do you see or do have you even thought about where the timing of topsoil and the the duration of forming a top versus a bottom is structurally different unquestionably and for one simple reason the world is long right if you if you eat sleep breathe you're long right you own a home you work a job you own it as any asset uh whatsoever you're long and so Panic is akin to death right they are they are fearful uh scary things for everybody and so that simple positioning again it's all about positioning right necessitates some type of panic and expediates panic into a decline and makes them more volatile and ultimately it is that panic in that stress selling that is beyond kind of some rational level that ultimately will turn a market quickly into a decline and ultimately we all still again need we still breathe we produce we you know create earnings Etc and so there is a natural bias up in markets now that bias to be clear is long-term and you can stretch uh again we've talked about the 68-82 period ad nauseum but the the reality is you can go decades without that upside Trend if you if you bring that forward in in other ways which we did before that period and we've done now uh for now 40 years but there is a natural um upside bias for lots of reasons that's why there's skew in markets as well which also structurally has a reflexive uh effect here too right that's all still positioning and at the end of the day they gamma's to the you know to the downside uh you know broadly in markets not just structurally whether or not people you know but also for dealers because Insurance gets bought and that also exacerbates faster you know the the elevator down escalator up reality and it's not digging it's it's structural to markets and how they work it is not a coincidence that that's the way it works because of that though um you know it's also hard uh it takes time as I mentioned to for markets uh to go down at first um because there's like steady stream I mean a great example here just structurally is you know one of the many things that kind of feeds into this is as Market evolve declines right it's easier to hedge and structurally this is kind of in some inside baseball what happens when that that happens is put SKU actually historically increases because people will still pay some price for insurance the downside when you have a structure where the fall comes down and skew is high the market has it's easier to buy insurance but there's also this buyback of Delta that happens because skew is higher in the market every day and so it's a naturally stickier better and the more put buying that happens in that scenario the more that supports uh markets in the short term so there's a structural kind of buying and and stabilization that happens during these periods and again reflexively the more worry there is the more of that there is in markets it won't stop it from happening right the macro realities eventually do play out um and often this creates bigger kind of problems that eventually are bigger crises uh because they take longer and they build in the system but but structurally uh yes it is by definition a vol event or a structural decline can't happen if if people are expecting it and preparing for it so so that actually brings me to another thing that you mentioned and I I'm sure that some people listening to us today will probably sit there wondering when you say Well it kind of reminds you of that uh period uh November 21 leading into February 22 where and you talk about both periods where investors are short right so I'm thinking okay well last time uh we we were rates were at zero and everybody was expecting rightly so um that Fed was gonna put up rates not necessarily by 500 basis points in a year but certainly so you could you you could kind of logically say yeah okay I'm gonna take some risk off I'm gonna protect myself go short whatever now we're talking about the complete opposite we're talking about the FED pausing right so why do you think people are short today as well in that sense how how does that I think people might want to hear your insights on that yeah absolutely so um my likening those two is more in terms of structurally how the market is positioning and and broadly how markets stop right I can have given many examples throughout history of that that's the most recent and Vivid in people's minds um the macro realities um are actually not as much a function in my view of again given the lag in in uh in interest rates is not as much a function of the FED raising rates it's a function of that we're heading along the same secular path that we're on and we're just further down that path and the realities are becoming more and more evident you know based on how sticky inflation was right we were in Camp transitory still right at that point uh there's there's a lot of information that we now have that we've been talking about it since back then but a lot of these things have been affirmed um at least to this point so so my view is is again the the secular realities of the more stagflationary environment that we're in that geopolitically um you know the geopolitical tensions haven't gone away if anything they've continued to ratchet up um the resource scarcity we've been talking about you know OPEC and and kind of the the battle uh you know across borders in that regard you know the economic Warfare all of that um has continued um meanwhile uh you know we've raised interest rates zero to five and guess what unemployment is at a new record right people you know and these things so that the realities of the situation are if anything more more dangerous at this point um so yeah I think uh again it's it's more the secular realities and we're bumping along kind of this this top this trend that's coming that we're seeing and uh and I think that's becoming more and more evident yeah no and and and and you know in many many ways uh Jim I if I take off my systematic hat I kind of see it the same way as you do I'm kind of thinking yeah there should be some downside maybe even a lot of downside in equity markets I hear a lot of people that I have huge respect for with that view the only thing that concerns me is I hear more and more people expecting that and that reminds me of of the rally after the global financial crisis in 2009 and people are saying well it's just a bear Market really clearly we're going to go down to new lows and all that and the market just kept going and going and going and I think it really was one of the most hated you know bull markets we've seen because too few people participated in that bull market I think with as much um exposure as they would have liked be that as it may because I've also actually heard people um that were one of them were on the podcast and he is Simon hunt I mean although he did expect the markets to go down first which hasn't really happened he was saying well and I've heard that from other people you could as you say you could have that blow off top but actually lasting a lot longer uh than a few months maybe even into 24 25 I mean Rock and Miller and I'll come to him later but he sees this and has for a long time sees 2025 to 2035 as a really troubling period but I'm Gonna Leave Dragon middle for a second because I'm going to ask you another question you talk about stagflation again I don't disagree necessarily with that view and we do see unemployment at least uh from the official numbers at at record lows and this is a little bit of a curveball but since you're from Chicago I'm sure you can handle that and that is you know AI has even since you were last on this particular series uh like five six seven weeks ago so much has happened in the AI space meaning it has become so much so much more accessible to all of us and I'm thinking it's going to have an impact and people already talk about all the things it can do but what's interesting about AI it's different from the technology Revolution where a lot of quote-unquote blue collar workers uh were suddenly obsolete because we could have machines do the work with AI it's kind of the well-educated people uh that becomes potentially obsolete because it can do things that and maybe do things better than you and I can do you know write a blog post or whatever it might be a memo and so and again I don't want to you know scare people too much on on a weekend but but I'm thinking you and I have these big picture talks about where we think things are moving in in a much bigger time frame and I'm I'm curious about what you think that the real risk is if suddenly AI does create you could say an unusual pickup in unemployment not from the usual places where you would see it coming but actually from the middle class the well-educated how from a societal point of view do you think that can impact all of the things we're talking about here yeah so great question and I get this question mind you a lot this is the new question everybody's asking is like AI as if AI just came out of nowhere right like we uh I want to be clear uh you were around in 1999 uh did you hear anything similar about the internet in 1999 it was going to change the world and guess what it did right but just because that was true did not mean that the realities of financial markets didn't play out right yes unequivocally technological advancement is deflationary right there's no question about that right we have been advancing for a hundred thousand years right this is not new and everybody again when you're sitting on the the trajectory looking up everybody always thinks we're going to keep going at this pace the problem is that the reason that AI is happening here right now and that we're at this moment of exuberance and uh the the world is going to change tomorrow is because we took rates to zero over the course of 40 years and the century invested in technology and advancement and globalization and at the same time that advancement right so everybody has been uh growth at all at all costs right and um the reality is that's this is what happens at the end of those Cycles um but now if you're pulling that money away and this takes time right it took 40 years it's not going to happen overnight you are now taking the means of investment into more future technological advancement away all right and that happens not overnight talk about lags right that's a that's a much bigger lag but the bigger structural question isn't well look now that we've done this for 40 years look at where we are technologically what does that mean it's what is happening underneath the hood and what does that mean for the coming cycle right and so in my view yes secular uh technological advancements but will continue this is part of that never-ending Trend right again we all live we all create we all grow we all create advancement but uh you better believe when the wheel was created people thought the world would never be the same right nobody will ever have to walk again uh you know uh you know when the internet was created we'll never have to uh talk again we'll just uh you know connect to the supermarket plug our brains into one another all of these things are essentially true right um but but they they don't change the simple realities of supply and demand and and uh the ability to get supercharged that advancement versus depleted over the course of decades now that is perfectly fine and I appreciate your comments there I was actually expecting a different answer Jim because I was thinking about potential civil unrest and I this is to the extreme meaning you're certainly getting unemployment in a group of people that are not usually unemployed or at least not as badly hit during recessions etc etc and so I was more thinking about the social impact because I think both you and I also share the view that although we might think that markets are going to change and that we are in a complete we are in a different regime we're in a different regime geopolitically and so on and so forth but I also think you and I believe that the um quote unquote cycles for civil unrest and War and all of those things are changing at the same time and they're obviously interlinked but I was just curious on that aspect as well whether this yeah very various two points I couldn't agree more right we've been on a three-legged deflationary stool for 40 years and all three of them are tied to monetary policy one of them is just quite simply the first base effects the cheap money makes it cheaper to do things um but but the knock-on effects of cheap money is that corporations were the ones that borrow the overwhelming amount right have a profit seeking mandate and they go find the the cheapest means of production which leads to globalization and they if you send enough money that way there's it's a competitive you know evolutionary force that just creates more technological advancement technological advancement globalization cheap Capital those things are massively deflationary things they're also uh lead to cooperation because corporations are Global uh and and uh broadly the unwinding the knocking out of that most important leg of that stool which is interest rates eventually leads to protectionism Etc populism comes out of that period right uh the the the distribution of wealth which we've talked so much about has gotten too far as a function of of that uh technological advancement globalization Ron tooth and Claw natural selection Capital Market you know uh priority and and now we have a generation and this is the key that draws Cycles right we wouldn't necessarily have Cycles if if the younger generation wasn't by definition labor when you're coming to the world you don't have assets right you you work and then you earn and and so baby boomers are the top of the stratification right broadly and and Millennials on down are the bottom of that stratification at that period and so Millennials on down have gotten a bad you know they've been at the the wrong part of the cycle over this period and that drives populism right it's it's pretty straightforward in that regard and you go talk to any Millennial on down this Rings true you know they're 40 of the household formation wealth creation the Baby Boomers at this point in the generation we've talked about this right so that ultimately right leads to a lot of frustration and anger if you're living in mommy's basement uh at the age of 35 you are not happy now this is driven again crypto and all the other things that we've talked about right but at the end of the day that's where we are in the cycle now add to that what you what you've said right that all this technological advancement um is is essentially making things worse for them uh and and likely at this point of the trajectory to continue to to make because these are the lagging effects of that 40 years right uh admin governments efforts to fix that for the populace harder um and that's basically what this is right that technological advancement will continue and as a result we'll continue to take money from the rich and move it to the poor and and people are you know become more and more unemployed in the middle um we'll have to we'll have to fix that with other governmental means as well we vacillate between trusting Capital markets implicitly as the best allocator of capital to saying well wait a second uh the that raw to the clock isn't fair and we need somebody to come set rules to make things more fair and Trust in government nobody broadly trust government ever but uh sometimes uh particularly after crises I think about 1929 think about kind of uh you know the 69 and some of the things that came after in the 70s um you know we broadly begin to trust government to fix that for us and that's where we are in the cycle um and that that at the end of the day uh you know everything is tied into this political realities of of how the voters or the people who are determining the leadership feel um and I think that's the critical backdrop to be thinking about yeah no absolutely and um if before we move on to maybe some some other topics you obviously expect at some point that markets will um you know Keel over and and start heading south um but I've heard you talk about the one of the reasons why you also expect that are one of the factors in this view is kind of your outlook for earnings can you talk about this for a little bit yeah so uh again I always hate to refer to that most recent period again and again but 68 to 82 is is the last time we had inflation so if you're looking at a data set right that's a that's a pretty important one to look at right now so GDP growth during that period was above Trend and not just above Trend nominal terms with inflation but in real terms right and I think that's pretty mind-blowing when you think about how markets did relatively right like when you really start to put your mind around the fact that like the economy grew above trend from where we have been the last 20 years the market went no we lost 70 in real terms in real terms while real growth was higher in the last call it 20 30 years we've been growing at 15 percent in the market in real terms or 13 right um while GDP growth has been much weaker so complete disconnect between the economy and the market why well one of the big things that happened was not just multiple contraction right it's not just that uh we had we were having to pay more for you know less for stocks and more for stocks recently it's that margins got crushed during that 68 to 82 period um why the same reason why they're at records now after 40 Years of monetary policy that's that three-legged stool if you uh are Empower sending cheap money to government I mean to to the stock government sorry to corporations those corporations are lowering their cost of capital by globalization right and technological advancement um so all three of those things help margins dramatically if you start to unwind all those things not surprisingly if you have to onshore all the means of production and in the developed world if we have to if the rate of technological advancement slows if the cost of capital goes through the roof guess what margins collapse Labor uh you know power as we're seeing also makes things harder and all of these Trends which we've been seeing for 40 years now go the other way nobody looks at price to sales anymore it's always just priced earnings price earnings priced earnings but price to sales is through the roof it has been for for years now it is off the charts right um and the reality is a normalization not just a price to earnings and not just normalization but you know a multiple contraction there sure that's part of the story but the margin compression that's ultimately going to drive a dramatic reduction in price to sales and a normalization of price to sales is going to play a major role in the next decade of uh stock market you know going nowhere as not only I believe that a lot of other big names as you mentioned believe it another curveball for you which I'm sure you can handle here Jim and that is there's one thing that's different I guess between previous periods and now and that is the huge amount that we have in passive managed funds versus actively managed funds and I can't work my head around how I think that that might impact the next I hate to use the word crisis because we're always it's almost like we're always in a crisis so I'm not but let's just call it the next downturn in markets now last year we did see a downtrend in markets in fact we saw a downturn in both bonds and stocks at the same time I don't know that passive versus active made a huge difference frankly I don't know is that on your radar or is that one of the factors that you do pay a little bit of attention to absolutely so you talk to most people especially up until maybe a year ago about the advancement of passive investment most people would consider the Advent of a passive investment a technological advancement or a a natural Move Along progress right to making things easier lower cost uh to to deploy and they think that you know that up until the 1980s right like they just we just weren't there yet in terms of that technological advancement the reality could not be further from the truth indexing has been around for a hundred years plus right um uh this you know the idea that you can create an index and deploy it is not a technological advancement it didn't happen before that because it didn't work it made no sense from 68 to 82 right for example and other periods before to put your money in stocks and close your eyes and wait for them to perform because if you did you experienced a tremendous amount of volatility with negative real earnings significant negative relearnings for a long period of time this was the time of the creation of hedge funds right it's also the Advent of derivatives all of these you know the publicly traded derivatives those are coincidences those are that was a period where being Dynamic and actively managing your portfolio uh finding ways it was also a great time for Value investing right the the relative fundamental evaluation things that we all talk about came about during that time people kind of forgotten about all those things for the most part because it didn't work in the last 40 years but the reality is in a period like what we're likely to go through passive investing will all of a sudden become not investable right or there will be new at least products that are active passive products right um you know which is I think what we're going to see a lot of actually I think I think you'll you know the the indexing of more active products right is probably the next big Trend something that's happened for some time but really hasn't become Central Finance um so yeah my view is that this idea that beta and broadly 60 40 is what works and everybody thinks they're an investor and everybody has been taught that that is what investing is that investing is just owning stocks for the long run you dollar cost average you close your eyes when it goes down you buy more um is the answer and you know over a very very very long time frame that works but that time frame might be 30 years um you know and and uh I would venture to say most people don't think in 30-year time frames when they're investing so my view is that yes we are going to see a significant decline in passive investing probably at the worst moment it'll probably take five to ten years and people will you know just like uh you know now in the last decade is really when passive investing has gone through the roof I'm guessing that you'll see um uh you know a decline in the next five years as it just doesn't work um and I think you'll see a significant increase in active management which has become basically dead as everybody has opined that why would you do it look at the performance relative to passive why would you pay those expenses um the reason you pay those fees for active investment is the same reason you pay those fees to a doctor or a lawyer or somebody else with a deep expertise a deep expertise yields its knowledge and leads to some type of edge some type of uh thing that will help you that you couldn't get otherwise and so real investors who have an edge whether they're hedge funds or otherwise do create non-correlated returns and that is where I think the world will have to go in the uh in the decade to come yeah no absolutely okay so let me finish off with a question about what you expect into the May Opex which is a week from now and maybe you can talk about what you what you think and then I want to finish off this this part of the conversation just with a one follow-up uh question but but just to finish off where we are because I know a lot of people follow you especially into the Opex and so you may be already starting to form your opinions about that yeah so we have pointed to May for some time right um this is not a new you know we said there was a window in at February Opex which we pretty much you know nailed that that we would get some type of decline to the day of that Wednesday of expiration into Opex that was right before you know that that eventually led to again narrative Falls price the banking crisis right but uh the answer was very clear that if that didn't have enough for us and unpin the volatility which it didn't that eventually that would lead to another rally and that we would then have to wait till May and guess what you know we've waited and bought that dip and kind of played it into here now we would have liked to have seen a new high and a bit more of a Thrust a squeeze if we were to to really get kind of a the bigger decline we're kind of looking for right and unpinning again we were talking about time or Price Right that move in price often is what um you know allows for a market to unwind and why is that again we'll review uh because it unpins Vol Supply we slide to a lower ball as we go higher and that ultimately can take kind of ball Supply away from dealers in the broad Market that squeeze takes shorts out of the market because people have to come get squeezed back in essentially uh they have to they're underperforming their benchmarks they gotta go back in as well and then just simply you're getting further off the ground you're creating more potential energy and so those three forces are what's kind of necessity to unpin kind of that positioning that we are still seeing we haven't seen that enough right and so that's you know we we go we can point on them on a calendar and say may is a great period for X Y and Z reason but it is also a conditional probability that we're looking at and we'd like to see certain things to to help increase our odds of it being the right moment and so I I we we would have liked to like I said see a bit more thrust here and we haven't seen that that said there's a lot of structural reasons as I mentioned at the top of the show that there are still this is still a a a period not to be uh long specifically for the next week and a half two weeks after starting starting the Monday Wednesday a little bit earlier than usual of of this uh Opex week it is a period to be cautious and Be watchful of price action and and uh especially given where we are heading into with the banking issues as well as more importantly the debt ceiling and the way of all structure is pricing in there again why why is this may period it's not just because Maize is on a calendar and it's a solid made phenomenon again it's because it is positioning wise there's a lot of short Vol in the June Opex because it's a quarterly Opex it's exacerbated right now because of the debt ceiling in that area um so there's less small Supply there you're in a cereal right before that think of Feb to March 2020 we've talked about this but the market rallied in the Feb depleted all the ball that people had in 2020 until all the only shorts were left in the March and then the day after Opex that 30 percent decline began and ended the day after March Opex that's not a coincidence this is a structural reality of all positioning and this makes for a dangerous window four markets especially after a rally like we've seen especially given kind of wearball and the potential energy is in some of those Dynamics so so a dangerous period as we pointed to on the the counter for some time not with quite the thrust that we'd like positioning is shorter than we would like and more prepared for it than we'd like but that doesn't mean that the realities won't and can't potentially uh kind of get get going here um so that's kind of our view again uh that this would really start uh we generally point to vickspiration as as the kind of the key point that might start a little bit earlier uh Monday the biggest thrust on some of this modern charm and support that we see is the Friday into Monday right where we are today when we're we're doing this after that it becomes less uh really uh Wednesday of Opex is is uh is an important moment now not to get down to the minutia in terms of what's gonna happen the next week or two but let's take the big let's go back to the big picture for one last time uh today and and and my question is a little bit maybe it's a little bit unfair actually when I think about it and that is what has to change or what would you look for in order to change your view what could what could change your view of this frankly pretty bearish Outlook and and yeah so I mean obviously I it's easy for me to ask this question I don't know if that's easy to answer but but I'm sure it's a it's a question I ask myself all the time if I didn't I wouldn't still be around 25 years later right um managing money we are not dogmatic as much as it may sound we are very much looking for contrary evidence and testing our thesises at all time the thesis is broadly tied to one very important secular reality which is our interest rates likely right in his liquidity uh likely to diminish and interest rates go higher broadly over over the period to come are the knock-on effects of that right which is deglobalization and other things we've mentioned likely to uh to continue and and what I would need to see right if we had a all of a sudden China and the U.S uh moved out of the trend towards Cold War back to cooperation that would change my view if I began to see um interest rates be you know if the FED would be able to lower interest rates to zero and you know back to zurp not us not see an inflationary kind of result that would change my view if populism broadly and all the fiscal kind of activity not just in the U.S globally right was to diminish and I was to see clues that that was turning around that would change my view these are the things that are all tied up together and the secular Trend that are really underpinning our video and why to be clear we started saying this two three years ago and we continued to watch and it continues to play out step by step you have little blips here and there question marks and then is there you know is there going to be a reproachment between the US and China quickly get shot down right and that's because of these structural underlying Trends they're because of the people and the populism and the effects of four years these are Big so structural things that are very hard to turn they are not one person's decision they are not one government's decision it is the effects of 40 Years of monetary policy yeah and and there are some other policies that's been going on for probably equally as long that um and I mentioned Stan draken Miller earlier in our conversation I want to get back to uh to that point uh as we wrap up our conversation today I don't know if you've heard him speak recently there's an amazing uh Speech he gave recently uh at a university and you know since you're nodding I'm hoping you've heard that I have the Sun Conference he recently had a yeah actually I did not hear that particular one but it's probably the same speech more or less he gave to uh uh I can't remember you see California or something like that where he was like on the 1st of May but in any event what he has been arguing for a while and and he was reminding the audience that he actually came to that University 10 years ago warning about the period we are almost getting to now 2025 to 2035 as long as that politicians were not willing and able to deal with the real underlying problem meaning we're right now so focused on the debt ceiling discussion but the reality is that's not what we should be focusing on we should be focusing on why we are in the situation with the debt ceiling every single year right how do we solve the huge amount of debt that has built up uh obviously he's talking about it from a U.S perspective but it's probably many countries we could say that because in reality this is something that is going to be so impactful in a negative way for the prosperity of our children our children's children etc etc it's a huge discussion and I know a lot of people like to come to podcasts to get some kind of actionable advice about what they can buy and sell but that's not really what we like to do here we like to have these bigger picture conversations because if you want to build long-term wealth you need to think about these things so this is probably more um you know just wanting to hear your thoughts about uh his his views because I encourage everyone to go and and and listen to these conversations there's no point in us regurgitating what he said you should listen to him uh he's been around for a long time he's incredibly successful and by the way he also I think a couple of years ago started to to uh like you and I talked about start the dangers of inflation building up etc etc so anyways long story short the underlying problems of debt in society which also Ray Daly has been out uh warning about the husbands that sit with you yeah so both of those uh names right are names you don't take lightly right dalio uh drunken Miller they are thoughtful very successful investors um I agree with I would say 95 of what trunken Miller says about 90 of what dalio says um I and I feel good about that right being in good company uh they you know trucker Miller has talked a lot recently about the Lost decade that we've been talking about now for some time that said I do think the debt issue at its core is not the primary issue I think he really paints it as the primary issue he completely agrees on the inflation of pressures the populism the deglobalization all the things and so does dalio right but I think there's a linear thinking that happens when you start thinking uh relating a country like the United States or Europe to a human being and an individual about oh well you've you've spent like a drunk sailor right like there will be repercussions and I don't think markets really work that way I don't think it's um I know it's not fair right like in a fair mathematical model like that's how it should work pretty simple right but in a Fiat World which is what we live in the exorbitant privilege of the primary currency of of trade right which can change I get that we you could there's definitely a a Breaking Point under which uh that is no longer the case but until that point right the the primary currency or currencies can be multiple right have the exorbitant privilege of being able to create you know and remove debt without massive repercussions I know that's a heavy thing to say but it's true we have created 10 trillion dollars of debt right in the last several years what happened to the dollar over that period tell me what have been the natural the net repercussions over that period actually has the opposite effect generally right it tends to drive money back to the main the center right and so the question is really and again I know there'll be lots of people that disagree that's what makes the market right but the question is where in a time of stress in a time of D globalization in a time of uh populism in a time of military economic resource uh conflict do you find safety and if I look around the world regardless of the amount of debt the U.S has or any other country has I can't find another alternative there's nothing that even comes close this is an island that is on the other side of the world protected by two oceans it's the biggest economy in the world the biggest military in the world it is resource heavy we have all of the food all of the Commodities that we need to produce right so most importantly though we have a rule of law and a decentralized rule of law it's not perfect there's all kinds of ugly warts and problems to this country debt being one of the major ones right but if you were going you or I are going to put our money somewhere when the wall the world is falling apart I would prefer to have it here than in China or I guess we could argue maybe the EU as well right but there are problems of the U as we know as well and again this is not just a a pro-american I live here again I want to be clear I grew up abroad I lived I've lived here I've lived in lots of other countries and this is not a pro-american statement I have the US has all kinds of major major problems I could go on and on about in a separate podcast but it does uh mean that your money is legally safe here as long as you follow the rules that the U.S you know which is a decentralized kind of system right um uh you know and there's a lot of problems with the litigious and legal systems we have here but they are decentralized and they do hold up so my view is really that the that over the very very long term if we're talking 500 years or so at some point that stuff May matter but if uh you know think about what Nixon did uh in 69 to 72 well Johnson first or the Nixon followed up on and just untied us to goal um you know from gold that ultimately was uh a maneuver to say look we're we're the big kind of powerful entity in the room and uh or Rome right we're gonna tax all of our provinces and uh until that changes until Rome Falls and it usually doesn't fall overnight right it's usually a slow death people always like to think about oh the implosion of a Empire but it usually is a slow slow Decline and I think maybe we're heading down a slow decline I I can see that the picture for that for sure but is that happening in the next 50 years I don't think so um is it happening over the next 200 years probably right and so I think the the idea here that that that debt is going to ultimately be the cause of the of the major implosion that happens in the U.S is is I think misguided I think there are other issues right that broadly are going to uh cause uh problems uh to economies globally but I think uh you know uh I don't think the US is the specific problem no and and injury I've been quiet all along because it's always interesting to hear which direction you go um it was a slightly different direction than I expected because a lot of people yeah yeah I know right yeah no no no no not not not not your view but I wasn't thinking about this as a kind of a dollar story so to speak for me it was more like what are we gonna do whatever what have our children gonna do are there children's uh or their children when there is no pensions when when we can't afford pensions when we can't afford welfare but Niels yeah so I think that it's important to understand that the dollar and the debt are intrinsically tied right um at the end of the day the FED much like Japan has right can take back all of its debt internally they can just buy the debt right they can take it off the external books and if you do that the fed and the treasure are the same thing we're just printing money at the end of the day you can print I know it sounds crazy but the US has done it we just did 10 trillion dollars of it we printed 10 trillion dollars and our currency went up there is in this environment as long as the U.S is the bully in the room or the the primary kind of means of you know we have the ability to make that debt disappear we have chosen not to to this point because we don't need to right um and I want to hit that I want to say we I hate saying we because it's not it's not us but but but uh you know the reality is they have the ability Japan did and how was Japan able to because Japan is being strong no because the U.S sits behind them right and and that's the important part so so I take I take that point and and again I want to wrap up um but uh but I will say at the same time that sitting over here in Europe and you know some of the other central banks they I mean they print money as well and and and even in the US even though you printed all that money certainly where I'm sitting from you see even a country like Denmark which a lot of people will say well that's a decently run fiscal kind of country you know the Health Care system is falling apart I mean completely apart uh obviously the UK where you hear about 65 listen to this 65 hours waiting time to get an ambulance I mean at some point I think people are just going to say we've had enough I mean this is completely unacceptable that's what I mean but let's keep that for another conversation because I do want to just one final little question uh and maybe the answer is that we've already kind of talked about it but I couldn't help noticing that gold is sitting pretty much at all-time highs any thoughts any views is it another and I got that one right uh spot on several months ago and again this is what happens during these regimes right you get significant volatility to Commodities um everybody was scratching their head at first precious metals is the one you well not all Commodities and everybody's scratching their head into that initial decline all right but it's always a function of positioning right relative to secular realities and you have to wait for people to give up well guess what the world kind of gave up on gold after it seemed like an obvious trade and here we go right now comes the squeeze and we're at um your all-time highs and about to break out I would argue that uh yes we will break out but as I've mentioned it's not just a matter of price everybody wants to know up down it's a function of volatility and the volatility has been too low in Precious Metals particularly upside calls that's how we suggested people play this from day one and that continues to be the way to play this it will not be a straight line much like it's not a straight line with long-term treasuries much like it's not a straight line with the dollar but certain Trends are very much in place here and the right way to play it in those parts is is playing the leptocurtic distribution that we're seeing there's that word um right and to really play it with parts that the Tails of the distribution here and particularly upside for goal so it took an hour and eight minutes before we heard the word glitter critic today but there we are we got it here we're done we can now end our conversation on a high note Jim as always it's been fun it's been a pleasure it's been insightful next week I am joined uh by another fun insightful person namely rich and no doubt if you have some questions he will be more than happy to tackle those you can either email them as usual to info top Traders on blog.com if you're enjoying these conversations do give us a little hand to expand our listener Base by leaving a rating in review it is a great help for us and of course we love reading your reviews as well with that said from Jim and me thanks so much for listening we look forward to being back with you next week and until next time take care of yourself and take care of each other thanks for listening to the systematic investor podcast series if you enjoy this series go on over to iTunes and leave an honest rating in review and be sure to listen to all the other episodes from Top Traders unplugged if you have questions about systematic investing send us an email with the word question in the subject line to info toptradersunplug.com and we'll try to get it on the show and remember all the discussion that we have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance also understand that there's a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions thanks for spending some of your valuable time with us and we'll see you on the next episode of the systematic investor foreign [Music]

Channel: Top Traders Unplugged

Views: 3,204

Keywords: top traders, top traders unplugged, Cem Karsan, US economy, stagflation, market risk, positioning, artificial intelligence, investors, earnings outlook, price, passive investing, bearish view, economy, markets, debt problems, society, conversation, inflection point, industry performance, timing of tops, bottoms, short positions, AI impact, middle class, upper class, economic cycle, active investing, OPEX expectations, May, debt problem, societal decline, gold, podcast discussion

Id: KqSAPyXH5UA

Length: 67min 25sec (4045 seconds)

Published: Sun May 14 2023