Cem Karsan: What’s Really Driving This Market Boom?

28:33That is a great indicator, great signal that a bigger top is coming when it happens. We haven't seen it yet. The prediction has been that you're heading in that direction, and that we'll likely see that come January of this year. There's several things culminating that are pointing to that being high probability now. Again, we've been able to call the rally. We said 20 % or so this year, starting in February. The summer doldrums, the vault compression. We've been able to talk about a wobble that was coming in the fall after that summer. We did get that in the form of August 10 % correction. And we said that this market would close on the highs somewhere between 6 ,000 and 6 ,200.

29:12And that is also what we continue to believe. Now, next couple of weeks, you can expect that we'll likely see some sideways kind of back and forth, maybe a small pullback. It'll be a viable dip again and likely close back higher into the end of the year, given the positive flows. Again, that will likely mean something in mid-January where you would want to really be cautious going into a new year. Yeah, so we're trading right now at 59.80 on the S &P. It kissed that 6 ,000 level that you just mentioned, I guess, yesterday on Monday. And that's the call that you have for January. Let's talk a little bit about these relative returns here.

29:55A 35%, almost 36 % a year to date here on the S &P, excuse me, trailing 12 month on the S &P. A year to date is actually lower. Russell 2000 trailing 12 month up 41%. Talk about those relative returns and what you think is driving that. Well, again, at the end of the day, this was an election year. We've talked about this, maybe on this show before, but I want to reiterate. rate, we are in a broadly structurally inflationary period. I won't get behind the whole thesis. That would be another hour here, but I've talked about it before. During these structurally inflationary periods, these populist periods, you tend to get very poor long-term market returns.

30:40I'm not the only one out here saying that. Again, a pretty unpopular opinion right now because market's up, again, as you mentioned, 35%, 40 % in the trailing 12-month period. But you tend to get really poor market returns, 68 % to 82%. Last time we saw interest rates go bottom left to top right, which is, again, what we believe we are now in the process of seeing for the next 10 years. We saw the market return zero in nominal terms and lose 67 % of its value. That is the type of thing that you can see. the market just goes sideways for a decade. By the way, I'm not the only one saying this. Drunken Miller is out saying something similar.

31:19BlackRock has put out some verbiage saying this is likely to be a lost decade. But these are the reasons - That negative return is in real terms. In real terms. Yeah. Which is what matters. Nominal illusion that we can talk about all day long. That's what people like to focus on. But the reality is, what is a dollar worth is all that really matters. And in real terms, again, 14 years, 67 % decline. Never mind the opportunity cost loss over that period. Bonds, obviously, the long-term bonds did incredibly poorly as well, right? Because if interest rates are going from 3 to 20, you probably don't want to own a 3%, 4 % yielding bond.

32:01But during, ironically, that same period, that last time we saw increasing interest rates, every single election year was up double digits. Every single election year was up double digits. And the average return over those elections was 21%. Pretty crazy, right, that you'd see a 14-year period of 68 to 82 of 0 % nominal return, 67 % negative real return. but with 21 % on average returns on election year. Why? The populist periods, that's when all the fiscal spending, monetary stimulus, all the liquidity comes in the market because these are contested elections and the incumbents in power are trying to juice the market to make sure it's positive returns.

32:46That's what happens. And by the way, if you pull out those populist election years out of 110 years of market data, election data, the average return of election years is 5%. It's populist years that are positive for elections. It's not all the other years, despite what people tell you. And guess what the last two elections have returned? 21%. But we're beating that right now. Yeah. So we're not going to close exactly at 21. That's the average, right? The point here is that these years and populist years are incredibly positive. every single one. That's 100 % populist year elections, 100 % double digits, average of 21%.

33:31Full amount of the data set, every other election is 5%. And in those populist periods, 14 years, markets do awful. So it's even more kind of, the contrast is incredible between those two. Jim, let me just ask you this. I don't know if you happen to know off the top of your head, you make the point that 21 % is the average. We're sitting here on a trillion 12-month basis to 35. What does that distribution look like? What does the top decile look like in terms of return? Let me see if I could actually find it. But what I can tell you is every single one is positive, and the lowest was 11%. So it's not going to be 50%, right?

34:13You're talking about somewhere between 11 and 35%, right? But you're referring to a 12-month trailer. In other words, we're at the high end of the distribution. You're referring to a 12-month trailer. I'm talking about an annual year. So we're talking about January to January, January 1 to the end of the year. And again, for that, I think we're up like 23%. What are we up for the year to date? YTD on S &P is 26%. 26%. So we're on the higher end. but the point here is that flows are structurally positive. It would make sense to push higher here into the new year. Flows are generally positive until the Monday of January expiration, that first week and a half or so, is very positive as well for the S &P.

35:04But it would not surprise me to see market up, follow up to answer your question, and a top that happens in January. We called this almost to the day in 22, six months out, by the way, if you go look at when we topped in 22. We were very kind of spot on with this. These are, again, the power of flows. By the way, from a political perspective, we want to just go into election real quick and also just not market trend, but what's likely to happen. I mean, you look at 60 from 61 to 82, sorry, 60 to 82. And what happened in elections in the last time we had a populist period, right? We saw Kennedy, two-year election, or, you know, before his assassination.

35:52LBJ got reelected for one term and got kicked out. Nixon got elected, reelected and kicked out of office. Ford was in for one term, sorry, not even one term, a half a term. Carter for one term before Reagan. So completely, it's a disadvantage to be an incumbent during these periods, whereas every other period, you see the complete opposite, that it's a huge advantage to be an incumbent. So not a surprise that we've seen turnover from one party to the other again and again. It is a difficult time. People are unhappy. People are looking for solutions, and what people don't realize is that is an effect of 40 years of monetary policy and the inequality that's been created.

36:36Politicians point the finger in opposite directions, but each party is populist. Now, everybody is trying to give people who are unhappy at the lower and middle of the distribution of wealth more money, and that is structurally inflationary, whether it's tariffs or immigration policy or fiscal spending. You can go down the line, but that is both sides are getting you the same policy. And to that end, this isn't a Trump rally. This is a market rally, and it's done much more a function of structural flows than anything. And the long-term outcomes are also much less tied to who's president, but much more the will and the trend of generational inequality and what people this generation now wants.

37:26hey i want to ask you to give a little bit more color around this idea of 40 years of monetary policy uh leading us to where we are today talk a little bit about that how we got here and what the implications are again this could be an hour-long show on its own but i'm happy to dive in because this is actually because this is a big big idea um america was founded on the principles of some level of equality and fairness, justice. Those are not natural constructs. The natural world, your mom probably told you when you were a child, life isn't fair. They're all ideals that we love, that we, as individuals, the human condition is such that we have a big frontal cortex and we see ourselves as cells much more than other animals.

38:18And by defining ourselves as cells, we look across at somebody else and say, oh, this has to be fair. We need to be equal. We're both independent individuals. Fairness is not an actual thing. It doesn't exist in the natural world. But because we as a society believe in it, we've created ideals to help underpin that and to give each other freedom and liberty and justice. We have created a structure to help support those ideals. right uh these checks and balances to help uh make sure that absolute power doesn't corrupt absolutely and at the end of the day uh those things decay they entropy because they're not natural things uh those those structures uh decay over time and our world are we our founding fathers created this system that made that made it very hard to change to corrupt the system but because there's entropy at some point eventually you get crisis And those crises were meant to be a unifying time to bring politicians together to solve problems, to pass laws, because it was really hard to pass laws.

39:27We created a Federal Reserve to help smooth the business cycle because we didn't want volatility in the business cycle anymore. But when you remove volatility from the business cycle, you remove the whole thing that allows the system to work, to burn the underbrush, to restructure the system so that things don't become structurally that break the whole thing. And so what we've done for 40 years, which is longer than ever, once we took ourselves off gold as a country in 1971, we unconstrained this Fed that we had created before to help smooth the business cycle to have almost infinite power. with the exorbitant privilege of the US dollar, the Federal Reserve has immense power to stem liquidity and to run essentially the whole economy.

40:22The problem is the Federal Reserve is a very simple thing. It has one tool, monetary policy, and it has two mandates. The very simple function, manage price stability while maximizing employment slash GDP, right? Maybe three, maybe three. Well, it doesn't have three. Oh, what's STEM volatility? Is that the other, the third? Yeah. So exactly. And that was the original, to be clear, that was the original idea is we want to smooth the business cycle. We want to slow volatility. That's the whole point of the Fed. But at the same time, it has two mandates, right? To do that in the context of maximizing growth while managing unemployment, managing, sorry, price stability.

41:04I apologize. Now, if you put that function on an academic institution, you say, go, you're in charge of the economy go, you need to control these two things. Everybody responds to incentives. What do you think happens? Well, we're going to try and find the cheat code that allows you to manage lower inflation and create growth. What is that? Well, monetary policy. If you keep doing it, keep doing it. You keep sending money to the rich. You do things like QE. You send money to capital again and again. Instead of sending money to people, you don't get inflation. Capital over labor. Yeah, capital over labor because capital is not inflationary.

41:40You send a million dollars to capital, they'll try and create more profit with it, which means they'll lower the cost of production. They'll export to China. It'll increase globalization. And at the same time, they will try and create technologies and innovation to replace their input costs, which again is primarily labor. And this is because when you send it to capital, they have a much higher marginal propensity to save and invest rather than consume, which would be what would happen if you sent it to labor where you would see that inflationary push. To invest, yeah. Save is not necessarily the – but yes, to invest.

42:17You're sending money to the top. If I send a million dollars to somebody like Elon Musk versus to send it to somebody who's homeless, what do you think – how do you think each of them spend their money? The homeless person will go buy all the things that they need to survive and to live in a meaningful way. It'll have what economists call a 100 % velocity. The velocity of that money is 100%. If I send it to Elon Musk, it's going to go right into Tesla and hiring people to build more cars, to improve the technology, to output more profits. And maybe even higher than 100 % because people will get credit against their improved credit profile and borrow more money.

42:59Right. And the theory has always been politically, at least this has been the cover for this type of policy, has been that this type of policy has trickle down effects. It trickles down to people, largely proven not to be true, because a lot of that investing replaces labor. It creates technology that replaces labor. It creates globalization where the money that the labor gets goes to the lowest place. Right. So companies can create profits. At the end of the day, monetary policy creates profits for corporations at the cost of labor. For 40 years, we've had 1.75 % GDP growth in real terms. 0.75 % is the amount that median incomes have gone up in real terms over that time.

43:46What happened to the other 1 %? That's more than 50 % of those profits. What's happened to it? It's gone to the top 1%. Now, 1 % of GDP growth to the top 1 % is equivalent to 100 % growth for that cohort. Over 40 years, compound 100 % at 40 years, the numbers just explode. The numbers become irrationally almost infinite. And that's what's happened. And the net result is dramatic inequality. You've seen the Gini coefficient, which is the distribution of wealth in the United States, go from 0.35 to 0.47. We are now in line with emerging market economies in terms of distribution. So this is the net effect.

44:33Now, again, it's a great way. If there are no humans in the system, this is the optimal system. Free market economics creates more growth, creates more technological development. It is the right way if there are no humans in the system. But guess who the profits accrue to? The profits accrue to the top. It's survival of the fittest. right? This is how the world has worked for a million years of human history, for four billion years of animal history. This is how the system's worked. In the context of that, we've had a millisecond, a 250-year period, where we've created this grand experiment of freedom and justice and liberty and equality.

45:20In order to protect this unnatural thing, it takes government intervention. It takes checks and balances. It takes a very complicated system. It is an entropy, and it is an entropy because of 40 years of no crisis, no dramatic, meaningful crisis, which has been created by the Federal Reserve. And that inequality that exists is now, much like it always does, eventually leads to a crisis. Eventually, you can't stem the bigger crisis. It just gets bigger. And that crisis is a populism and a rebalancing of that inequality, which has been coming for some time, but was released in 2020 on the back of COVID in terms of the stimulus.

46:03Trump is a vehicle of that, much like AOC and Bernie Sanders are vehicles of that. Everything has moved left. The difference is there was a right and there was a left, and Trump importantly brought the right left in terms of populism. Rusted out cities in middle America, right? Tariffs, China tariffs, immigration policy. These are populism. These are not free market economic ideals. No matter how you feel, this is not a political statement. This is just the reality. And so we as a society, and it's not just here, it's globally because the U.S. dominates the global system, are now heading through a period of populism, of protectionism.

46:46And importantly, when you're going through a period of protectionism, it's populism. Protectionism is one and the same. You care about your people, not the people of the world. So you put up boundaries, put up tariffs and immigration policy that closes borders and puts up walls. That leads to global conflict. The last time, 68 to 82, we saw this, we had a Vietnam War. We saw the Cold War kind of grow. And these are inflationary periods. These are the drivers. If you look at the inflationary period of the 60s and 70s and say, what caused this? You look it up, Google it. What is it? You're going to have three things come up.

47:17They're going to say fiscal policy, the Great Society Program. It's going to say the Vietnam War, global economy. And it's going to say the OPEC crisis. Sound familiar? Anything else? These things sound like we might be heading down that path. Not a coincidence. These things are all tied to populism. Populism itself is a function of global macro trends. So this is the thesis of why we likely have higher increasing interest rates. The generation that has experienced that 40 years are millennials on down. They are now the primary voting members of society, and they are speaking loudly with their political decisions.

47:53And those political decisions just push their policy. It is not a Trump issue. It is not a Biden issue. It is a political populist movement that is going to find its way. And trust me, it'll go from one politician to spit them out to the next politician next time. Well, folks, there's your big idea for the day, your big idea for the month. Jim, I want to coax you away from your Bloomberg terminal and convince you to write a book with me about this. This would be an incredible thesis, this broad scope of big history. I guess the first question that I have is, is there any way out of this box? How do you fight entropy?

48:31I mean, the last progressive era was consequent upon the Gilded Age, which came before it. Then we had the 20th century, which was clearly the American century. Is there a way out of this box? To be clear, we have tried to get ourselves out of the box. That's why we're here. We have tried to smooth the business cycle. We have tried to remove volatility from the system. it is not possible. If you don't burn the underbrush, you get a bigger fire down the road. That's just how the system works. Now, the good news, I don't want to sound so negative, is crisis is good because it allows for a reinvigoration of the system and a lasting of longer prosperity.

49:15If you think this is the first time we felt worried or scared, how do you think people felt in the 60s? Go talk to somebody. People felt like the world was being torn apart at its seams. Race riots, assassinations, right? We were at war in Vietnam. There was a draft. This is nothing. Go think about the greatest generation in the 1930s and 40s. World War II. These are not that long ago, right? But guess what? We owe what we have now as a function of those generations and the progress that came through the crisis of those periods, we have been amidst a time of incredible peace and prosperity as a function of smoothing the business cycle.

50:02Crises are inevitable and actually they're good. They're necessary. The fact that we've tried to get rid of them for all this time is only going to make it bigger and worse this time around. Jem, really powerful ideas we're talking about here today. Let me try and bring this back to markets here to find some way of applying this to what we're talking about. I know something that you've been talking about is the rise of this dispersion trade, how technically how we might be seeing a topping in NVIDIA right now based on some of these dispersion attributes that you see in markets. I've heard you describe this as not technical and not fundamental.

50:45I guess my question, my first question is, what is it? How do you call this thing, this idea that you're using to frame the context around what you see happening in dispersion? And second, what do you view happening in regard to that specific trade to the dispersion trade and this pattern we might be seeing topping for NVIDIA specifically, but big cap tech more generally? Yeah, this would be, again, I don't put all my eggs into this topping NVIDIA idea here, I just want to be very clear that a lot of times into these blow-off tops, the leadership that you've seen by certain groups, you start to see jaws.

51:26You start to see an underperformance way earlier. If you think about 2000, the market actually topped a bit later than tech itself. The flows continued on underneath the surface. and you began to see a really big rotation at the end, it foretold kind of what was to come. It would make a lot of sense here, given that vol is very compressed on the S &P 500 itself and is likely to be a bit more compressed in the short term to start to see a rotation, right, away from the leadership. And if we do, again, there's a lot of if-thens here, And again, calling a top rate on something that has not shown any signs of a top yet, to be clear.

52:18There's nothing out there that would say that that would be a pretty wild thing here and something that has been one of the best performing assets in the S &P 500. but to be clear it would make sense that before these final this final run that we get into much what is likely to be something more of a blow off top in my opinion that we would start to see some rotation away from what has worked for the last several years and into things that have not worked And that is what I believe we are starting to see. Again, not today specifically, but I do believe that outperformance of the Russell, the other clue there that the Russell might continue to perform better into the final legs of this rally is there's a lot of short vol positioning in the Russell broadly on the call side relative to the vol supply that exists in the S &P.

53:15there's a lot of imbalance positioning there that can really push that higher and again at the end of the day if that's going if you're going to get a rally in certain parts and the smb is going to be pinned something else has to go the other way is it nvidia is it broadly tech is the mac 7 we will see that would be my guess that would be my guess and if that were to happen that would also reconfirm some of the things that i'm thinking about in terms of going into January or February, right? In this early part of the year, there's several kind of one week windows, two week windows in there. We'd want to see some things happen there, but it would confirm that those periods are more likely possible areas for a bigger market decline.

53:56So again, calling a top, calling a big tail, particularly in kind of the hot parts of the market, you know, is always a fool's errand, very hard to do. So I hope people appreciate it. It's right that it is a threading the needle. It is not probable, but I think it could be possible. Definitely higher probability than people expect or are thinking at this moment. Yeah, and I certainly didn't want to reduce those big ideas that we've been talking about to a single trade. But it's one possible mechanism by which those ideas might play out, might express themselves in markets in terms of price action.

54:34Absolutely. I think the core fundamental view here that I have conviction in is that vol is very well supplied in the S &P, and you're likely to get some high levels of dispersion, big rotations under the hood going into the end of the year. The question is, which ones will those be? And if we start to kind of feel the winds and look at the tea leaves, that would be a really interesting one. And if that starts to happen, again, more problem than people expect. And if it starts to happen, that could really accelerate and be the beginning of something much bigger. And so I'm really just highlighting something that's really nascent and potentially interesting in the form of that trade.

55:13But again, the rotation is what's key and highly probable. Jeff, I really always enjoy these conversations. These are some of our best here on Real Vision that always makes me think, let me give you this just opportunity, final thoughts, key takeaways that you'd like to leave our listeners and our viewers with from this very deep, very detailed conversation. Yeah, I think I'll go back to bigger picture for a second. I think the election is pushing us towards a bigger change. I think most people want change. I think that change is likely to create, if it is going down the path, I believe it is in terms of broadly populism, tariffs, immigration policy, etc.

55:52it's likely to create more global conflict and it's greatly likely to create a growing feeling of change that can be disruptive. That's not necessarily bad. Again, it could feel like crisis. But at the end of the day, this is the invigoration, the rehealing and reconstituting of things that allows for longer term positive things to happen. Again, 68 to 82 is what led to 82 to 2022, 40 years of incredible market returns, prosperity, peace. And so we need this. it will be difficult. And I don't think it'll be great for markets. It's a great time to be prepared and ready for a different type of investing, really, and a different type of involvement with markets, as well as broadly thinking about life writ large.

56:58So that's something that we do here, non-correlated investment at Chi Volatility and Chi Well. And I think that's something that people need to probably be thinking about. Jim, I'm going to sneak in one additional question before we wrap here, which is this. You talk about this idea of life writ large more generally, as well as the market and economic history component. Are there any books that you would recommend readers go take for our viewers to go take a read on if they want to understand how you came to see the world the way you see it? Oh, God, that's a that's a tough one. And there's a whole library full of books.

57:38That isn't one book that I read that told me maybe I need to write that book, like you said, Ash, and put it out there. I'm a huge student of history. I think more than telling you how, I think one of the lessons I was taught from a young age is don't tell people, show people. History shows you what's happened and what's likely to happen. And so I think being a student of history, I could name a ton of books. I won't, we'll, we'll give it to you now, maybe, maybe a year or two from now, uh, we'll, we'll, we'll trot out the book, uh, for everybody to read. Well, that would be, that would be a great show to do just an hour.

58:15We just talk about books. We'll, we'll earmark it here. Yeah. I'm happy to do that sometime. Jim Carson, great conversation as always. Really a great one. Thank you so much for joining us. Thanks for having me, Ash. Thanks for watching. Thanks for listening, everyone. If you liked this episode, I'd love for you to head over to realvision.com forward slash join for a free membership. Start your journey today to unfuck your future. Just one click away.

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