Global Macro: The Hidden Force Behind Market Movements ft. Cem Karsan

30:53And ultimately it led to a very unequal world and an unquote, unquote, fair world. So if we are going to address that, we are going to have to move away from all those benefits. And now the Fed has two mandates that they must manage parallel, which is price stability and maximum employment, which are very much contradictory in the coming period of rebalancing inequality. So many deep philosophical questions, Jim, raised by what you just said. The idea of obviously oral, the moral and ethical imperatives that are caught up in those challenges that ordinary workers feel in an economy, but also the idea that the cycle, ultimately, if all the capital is allocated away from labor and toward capital, what you wind up with is that the fire eventually burns itself out because you have the people at the top of the distribution who have a very low marginal propensity to consume, a very high marginal propensity to save and invest.

31:55And ultimately, the demand side of the economy suffers because every new incremental dollar that accrues to capital doesn't get invested in demand at the worker level, at the individual level of the economy and the system burns itself out. That's true in a system without the Federal Reserve, right? And so what the Federal Reserve ultimately did, you're right, the system did burn itself out. But every time it did, that's what deflation was, right? Every time the Fed would create more artificial demand, they would send more money to corporations to drive more growth. And that would have a stimulative effect, but concentrated not at the people, because, again, we can't send money to people in that situation.

32:40They'd send it to the corporations, and that would ultimately drive a cyclical push, but then fade right back into an even more structurally deflationary environment. And all of this led to globalization, by the way, is the primary driver of globalization over this period. It's the primary driver of technological acceleration and development over this period. You know, there's so much more tied into it just than inequality. If you send unlimited money to corporations over 40 years and every time you have a slowdown economy, you stimulate and send more money to them. Corporations make the rules.

33:20Corporations, you know, created China, you know, opened up China. Corporations sent all the jobs over to, you know, through globalization to the rest of the world. They lower the cost of labor. you know, so they could make more profits. That's the natural system. It's not wrong. It's just how it is. But it also led to incredible taking on 20-year, 30-year, 40-year growth bets, which were never done before. The Amazons, the Ubers, the Teslas, none of these would have existed if it wasn't for easy money. These were entities that were able to invest in incredibly large, long-term thinking projects because they could lock in money for zero for decades.

34:06And that growth would never have been here without that. And so what happens when all of a sudden to the next Teslas, Ubers, Amazons for the next 10, 20 years, if they can't bend on 20-year outcomes or making money in 10 years, that they have to make money in the next year or two or three, the growth slows down dramatically. And so I think that's a big point that people are missing. The deflation we've seen has been a function of technological development, globalization, and cheap cost of capital. When you reverse the cost of capital, the other two fall apart as well. Not to mention that you get more global conflict, less peace, and all the other things that come along with that as well and drive more higher costs.

34:54So it's really a cyclical effect. It's also generational. The reason this happens over some generally ready kind of decade-type periods in general is because it's generational. The millennials on down for 40 years have grown up this way. That's all they know. They believe in the power of technology to change the world because that's all they've seen in dramatic ways for the last 40 years. They believe in the power of Bitcoin to change the world. But they believe it's an unfair system because they've been on the bottom. They've been labor during that period. And they have really seen a system that doesn't work for them.

35:33And again, that's the birth of Bitcoin. Those are the reasons Bitcoin came about. And it is also the reason that they are politically arguing as they come to political dominance, right? For people like Donald Trump and Bernie Sanders and AOC. And that's not a political thing, but it's, you know, populism is global and it's on both sides of the aisle at this point. Well, it sure is. They disagree dramatically about the potential prescription solution, but both sides of the aisle seem to share a common sense of what the diagnosis is, the challenges that you've just described there. And boy, how different for us, Jim, you come of age during that magic window between the fall of the Berlin Wall in 1989 and 9-11.

36:17And it was this period where the world looked like, at least for those who had been growing up in it, that progress was just ever upward. You heard great Francis Fukuyama phrase, the end of history, the idea that totalitarianism was a retreat around the world, the Washington consensus, free markets, liberal economies, freedom of speech, freedom of press, all these things were just an inevitable forward progress that humanity was going to make in a continued and inexorable way. And then the world wakes up from history and you have the challenges that you see today and the feeling that I think so many, as you point out so eloquently there, Jim, so many young people have the lack of faith in the system, the underlying system, not a cyclical impact, but a structural risk fear that they have.

37:02I mean, it's just such a deep and powerful and profound point that you make. Yeah. I mean, we are, as a people, likely to take what we have experienced and project that into the future. And it's important to also note, you know, an optimistic note, you know, when we, the highs are, the trajectory is never as high as we think, but it's also never as low, it's rarely as low as we think, right? I would, for people who are scared about where we're going and what this means for the next 10, 20, maybe even 50 years, right? I think it's important to note that we would not be where we are now if we didn't experience the 1960s, if we didn't experience the 1940s, 30s and 40s.

37:57The reality is people thought the world was coming apart at the seams during the 1960s and 70s. There were assassinations left and right. We were at war in Vietnam and people were dying. you know, race riots. I mean, think about that compared to where we are now. We think this is tumultuous because we're coming out of a time of incredible peace. But we are, we have evolved and we have grown and we have become what we are as a nation, as a country, as a developed world, as a function of that period. Times of crisis are critical periods for growth and to actually fight against the kind of the entropy that has probably built up in the system in other more peaceful times.

38:40Again, tell the greatest generation that this is a difficult time that we're entering. So again, without that period, where would we be as well? So I think this is an important period. I would not get too high, too low. Understand it's a time of crisis. It's a time that will bring us together. Ultimately, we'll be forced to come together. But ultimately, it's something that needs to happen in order to revitalize and rebuild what we believe in and continue the progress we've seen for the last 250 years. It's very well said. Obviously, it's all relative. But certainly, the times that we're going through right now compared to what Xers and Xennials experienced, New Wave, Synthpop, and Rave Clubs, it's certainly a much more challenging period.

39:31It's almost a shame to bring it back to financial markets and the price of risk assets here. But I want to touch on something you said, this idea of these 10 to 20-year time horizons, which dovetails right nicely with what we're seeing right now in U.S. Treasuries, particularly the belly of the curve, the 10-year, and the longer end of the curve, let's say 30 years. I mean, pretty dramatic increases from, call it, mid-September of 2024. I mean, 100 basis points. These are big moves. Talk a little bit what's happening there, what you interpret those moves to be about, and the impact on risk asset prices, particularly the spillover effects into US equities, to dovetail nicely with what we were talking about earlier.

40:15Yeah, I want to first again back up and look at big picture with this. When yields were at 10 years, it was at 1%, we were very vocal that it would be going to five in a matter of years. People thought they were crazy. People said, you know, I mean, it was, you should have seen the comments. We've adjusted, right? People are like more, oh, well, this is long-term, near the long-term average. Okay. It makes sense. I want to be clear. The 10 year is likely going to above six and a quarter, somewhere between six, a quarter and seven. By the end of this year, it won't be a straight line again. But I do think it will start to accelerate and you'll get less pullbacks in the near term.

41:01That will ultimately be a short-term top, I think, meaning not a secular top, but a multi-year, maybe a year top, because it will ultimately be too much for these equity markets to bear. and the liquidity that will come with a liquidation equity markets will ultimately drag down the economy as well. So we saw many cycles like this in 68 to 82. To reference the last period, we saw kind of a structural increase in yields, three different major bouts of inflation throughout that period, each one bigger than the one before it. there's a problem too. And once it starts going, the harder trade was actually for it to go from one to five because the curve was, you know, was inverted during a large part of that move.

42:03It was easy to hedge the inflation and the structural increase. You know, when I was in the last two years, when we argued for the 10-year was still going higher, every time people would say, well, look at the market. The market's telling you you're wrong. It's too easy to put the trade on. It was correct. It was too easy to put the trade on. And it was an incredibly, you know, you got paid. Think about what risk trades do you know that you get paid to put on the risk trade and the convex trade? That's what you got to do here. Now, that's no longer the case. And I think that's an important distinction.

42:36Now that the curve is upward sloping, it becomes very hard to hedge this structural long-term inflation. It becomes very hard for entities to go put the trade on because they have to pay to hedge that. And the cost of that is getting increasingly difficult. There are accelerating effects. The higher the long-term yields go, the more structural inflation you see, the more you see higher yields go higher, the longer yields go higher. That's because of, again, the higher cost of money, but also the effects that that higher cost of money has in terms of pulling forward demand, as well as on top of that, people realizing that there's structural inflation.

43:21They should borrow money and buy things pinned down, which then also accelerates that move in commodities. But our view is that this will continue. It's, again, not a straight line. We'll probably top short term, five quarter, pull back to four half. and then ultimately run again to six and a quarter. It's a similar kind of process. And if you look back at where we've been, that's the general process we'll likely see. The why, other than the protectionism and the populism, which again is at the key, it's really a moving of money from the top to the bottom. You know, wages are going up. labor, particularly on the bottom deciles.

44:07We are seeing shorter work hours, more labor rights, and those are structurally inflationary. And if we want to rebuild our middle class here in the US, which is what politically both sides are saying at this point, there's a cost to that. And that is higher yields in the back end of the curve. I also think it's particularly accelerating now because that populism, or at least the rhetoric, is a little bit more front and center now with the coming administration. I also think not only is it tariffs and immigration policy, which are going to affect labor supply dramatically and the cost of goods coming from abroad.

44:58But also, I think there's a high probability that the Federal Reserve, and I think this is an important point, is about to be operated very differently as well. I think we're likely to see a very, very hot approach, a demand-push economy on steroids the next two, three, four years. any recession in the market that will eventually come from higher yields. And it will come probably in the back half, Q4 of this year will be the beginning of it. If we do see these 6.5 % type yields and a decline in the market that's commensurate with that, which is again what we think is going to happen at this point, we will see an aggressive Federal Reserve monetary policy.

45:45We will see more liquidity coming into the market. And if Powell doesn't play nice, there will be a shadow Fed, and Trump will see to it that we are aggressive with the most powerful tool that the U.S. has at its disposal. That's our view. And I think the Federal Reserve is going to be much more aggressive in the four years ahead. Again, think of it as an Arthur Burns-type situation with Nixon. I think we know how that ends. That said, that's the most likely outcome, because at the end of the day, if forced to choose between recession and a appearing, you know, a high unemployment rate, an unpopular kind of set of policies, Trump will likely choose the lesser of two evils, which will be inflation.

46:37inflation. And that's just incentives. And again, we've seen this again and again through history. It is the most likely path. Jim, these are huge, huge calls. Just to frame this up for people who don't follow 10-year Treasury market yields, you're talking about essentially a 25-year high in U.S. Treasury yields of the 10, you're going back to 1999 before you saw those plus six rates. Yeah. But if you look at the long-term average, the long-term average, meaning 100 plus years, is about six and a half. So it's not odd. It's not weird. And by the way, 1.5 % from here, we just covered 1 % of ground in three months.

47:22So if people are sitting here saying, well, Well, that seems unlikely. You may want to examine your framework a bit. I think people are really whistling by the graveyard here. The more and more I talk about it, the more and more I get moved, talking about it for about 4 % of the market and the tenure, the more we talk about it, 1.5 % seems conservative. I do think that is the right number before it starts to hit the economy in meaningful ways. And I think it's not just the move of 1.5%, it's also the lag. This process started in 21. We are now about four years removed. Any five-year arm in real estate, any venture capital investing, private equity kind of money that has been called for five years is about nine months or so from having to come back to market.

48:23There's a dramatic amount of supply and need for liquidity that is sitting out there. And if yields continue to go higher, which, again, reflects that they likely will if people need to refinance, right? And not just for homes. That's for businesses and all kinds of other private equity and all kinds of other investment vehicles as well. That is supply and will lead to higher yields. By the way, I got to ask this question because you sparked my curiosity there, but what the hell happens to private equity and particularly private credit? If you see this. I love that. I love that question. I wish people asked it more often.

49:07One of my. Listen, I want to make sure people think private equity is something that it's not.

49:17banks, if you go say, I don't want to be in stocks and bonds anymore, can you get me an alternative? The first thing they put in front of you is private equity and private credit. It's almost like people don't know the words in there. Equity and credit. They're literally giving you the 60-40, but without the public part. They're doing it in private. And somehow making it private makes it, in people's minds, uncorrelated to the public. It makes no sense. And the greatest irony of all is by not marking these things to market, which is what the private part means. We're not going to show you the value of these things.

49:59We're going to hold your money for 10 years. By making it private and decreasing liquidity, increasing the duration, right they are somehow convincing people that it's reducing the volatility actually it's the opposite because they do that they then can take leverage and what those vehicles do and the way they make money is they double the leverage right and then charge higher fees to capture the difference so imagine you have something that makes 10%, but we're going to put twice the leverage on it, twice the risk. So it's going to make 20%. And then we're going to charge you 20 % for it. So you're going to make 16%, right?

50:46As opposed to 20%. But at the end of the day, you're taking twice the amount of risk. You're not getting, this is not an alternative to equities. Private equity is not an alternative to equities. It is equity. And actually it's way worse. It's leveraged equity. You just don't see it because it's 10 years. Now, the problem here is, and the reason it's worked incredibly well, and private equity, people in private equity made tremendous amounts of money, is because we haven't had a meaningful decline for 40 years that's lasted more than four years. So if you're dealing with a 10-year duration, the market has come back in a 10-year period every time for 40 years.

51:31But if you look back in history, that doesn't happen all the time. If you go back, actually, there's a much longer rich track record of lost decades. And when those things happen, you are then not just in equity, you are in leveraged equity that has no liquidity in a decade-long duration. So private credit, it's credit. So it's a little better in the capital stack, but otherwise the same exact thing. And so I find it really disturbing that your average bank and wealth advisor, if you go to them and you say, I need an alternative to my equity and bond exposure, the first things they show you are private debt, private credit and private equity.

52:14And the reality is 80%, I'm not exaggerating, 80 % of the alternatives space is those two things in real estate, which are all just leveraged, long duration, short liquidity, equities, and debt. And if we do go through this period, which I believe we are going into, equities and bonds won't perform well, but the leverage form of them will be worse. Jim, I'm trying to formulate the devil's advocate position here, which I'm probably not qualified to do. But I imagine if you had a private equity guy or gal on the show, what they would probably say is, look, we're concentrating our bets. We're doing a lot of effort in terms of due diligence.

53:04We're thinking this through. We're investing in great businesses. We don't have the same pressures that publicly traded companies do. We can afford to put these investments up for long periods of time where we see these returns based on our analysis where we're investing in great businesses, we're investing in great managers, we're investing in great industries, they would say. And that, you know, look, we're taking our time here and doing our due diligence. That, I imagine, would be the argument you would get. Sure, sure. And I think that's a fair argument. And to be clear, I - And we have patient capital to do it, so we're able to realize time over a longer time horizon.

53:38But you could say the same thing in public equities, Right. Like people can do pick the winners and not the losers. Right. And and they could say there's this really smart guy named Jim Carson, who's described so brilliantly all the challenges that we have in public equity markets, all the mispricing, all the concentration, all the mechanistic effects that you get from dealers rebalancing. So come invest in private equity, they would say, I imagine. I am not saying that every private equity business is going to fail or every private investment is going to fail or every private credit is going to fail in this environment.

54:13That's not what I'm saying. There'll be still some very profitable private equity investments if you pick the winners, actually. And by the way, to be clear, I'm not saying all equities on the public side are going to perform poorly. In 19, 6, 18, 2, the market went nowhere and in real terms lost 70 % of its value. But if you were in the right things, you still did very well in the equity world because we had a very strong economy. I want to be clear. We're likely to have a very strong economy for the next 14, 15 years. I'm not saying the economy is going to be weak. We'll have some recessions along the way, driven particularly by inflation and higher long-term yields.

54:54But the things that will work will be almost the exact opposite of what has worked for the last 40 years. the businesses that succeed. And if you pick the businesses that won't have their margins degraded by inflation, that are not capital intensive, that are not labor intensive, you will outperform and you will do quite well. So again, there's an argument to be made. If you pick the right businesses, you're still going to do great. But overall, statistically, equities won't do well. And I'm guessing a lot of the private equity that people are investing in is the stuff that's worked, because there's recency bias.

55:34And the stuff that's worked is likely not to be the stuff that works. And if you do that with leverage, you're probably going to find out about yourself. Very well said, Jim. I enjoy these conversations so much whenever you join us. They are deep and thought-provoking and very much tied to risk asset prices. Talking of which, I know we've gone off on these sort of amazing conversations here, but I wanted to at least give a couple of questions here to you. So we've got some great ones from our audience. First one comes to us from Doug Martin. Will SPX trade above 6K into the inauguration or BEB OPEX?

56:10If no, how high will it trade in this stair step down, I should say, right now on my screen? 58.14 right now on SPX. Yeah, I think we're likely to see a countertrend rally before we see a renewed decline. I do not think we are going to hit a new high this year. I think if we do, it'll be a very minor new high. Again, I don't think we get there. So that's a 6 ,100 kind of top in the market. market and I think this is the first place I'm saying that, that I believe that is the top and the top is in, I want to be clear, but that doesn't mean or at least there's a very small minor new high. I want to be clear that doesn't mean the market's about to crash.

57:04Don't go sell everything right now, right? I think we are going to chop and that we are going to have a decline into March OPEX, you know, with likely a counter trend rally before we go lower, but not necessarily. But I do think we will make a low somewhere around March OPEX, which will be a 10 to 15%, likely on the lower end of that 10 to 12%. But maybe the 15 decline, peak to trough, You can do the math. 15 % would put us at 51.75. And that would be a buying opportunity. And we would get a countertrend rally there that was even bigger, whatever small countertrend rally we might see in the near future.

57:53So I know he's talking specifically, or here she is talking very specifically about inauguration, which is a week away. And the next week, I think the odds are in the favor of a counter trend rally, yeah, up to somewhere 6 ,000, 60 quarter. And it wouldn't be by inauguration. That would probably be till the end of the month. So I wouldn't expect that rally that quickly by inauguration. But again, by the end of the month, early February, I could see us back to those levels after maybe slightly lower levels, maybe somewhere near here as a bottom. We'll see what CPI says tomorrow. But then again, I expect a bigger decline to come and continued stair steps till March OPEX, or maybe a week or so before March OPEX would be the bottom, depending on the path.

58:44But that's a bigger and interesting point that you make, though. 6 ,100 is a top. Essentially, you're talking about tops now, highs that are progressively becoming lower and lower percentage gains off the last percentage gain high. I think everybody will begin to appreciate that and give up on the next new high after the next two rallies. We'll have a rally here that will fail. We'll see a March bottom. People will, that'll be more cathartic, a bigger 10, like a 10 to 15 % decline, like I said. That'll be bought after March and some of the risk comes off the table, I believe. And when that rally fails, I think that's when people will really start to throw out the institutions.

59:28Others will start to throw the baby out with the bathwater. And I actually think that will coincide likely with higher push in yields, closer to 6%. And I think that's what's going to take this market down ultimately is those yields and the inflation expectations. expectations. And ultimately, again, we'll see the path. But I do think that the real decline, though, despite what I'm saying there, does not start till Q3. And again, we won't have reached new highs and vol will not perform now and shorts will get squeezed until then we'll have a lot of chop and within a wide range, essentially. But I do think that a bigger decline is coming.

1:00:12and I think it will be tied to higher interest rates. Ultimately, I think that decline when it does come will lead the economy and will slow down the economy in a way which will drive a meaningful recession and will be met with a very powerful Federal Reserve response

1:00:31that ironically this time, even though people think it will save the day, will not in my opinion. And I do think this ultimate decline, we'll see, will be somewhere between 30 % to 40 % peak to trough by early to middle of next year. Yeah, really, really interesting insight to end the show with. I know you got to jump. Maybe this is a question for next time. This is a great one. I'd love to hear a view on this, which is Frank Anthony says, Jim, what are your thoughts on housing if you see a potential 6.5 % on the 10-year treasury? Boy, that's a hell of a question that I'd love to take 20 minutes to get you.

1:01:08Yeah, there's a quick answer. There's no supply or no demand, nothing trades. And until the market declines and liquidity comes out of the system, the prices are sideways to down. The bigger issue is what happens once we go into recession, and that'll be a real correction in real estate prices. Jim Carson, another barn burner of a show. Fantastic, fantastic conversation right here on Real Vision. Thank you so much for joining us. Thanks for having me. Always a pleasure. Thanks for watching, everybody. See you in Miami.

1:02:05to trade it in just two clicks. Feel ready? You can move to real money with as little as$100 once your account is approved. And the great thing is that in addition to crypto, Plus500 gives you access to a wide range of instruments. S &P 500, NASDAQ, gas, and much more. Explore equity indices, energy, metals, forex, and beyond. With a simple and intuitive platform, you could trade anytime, anywhere. Experience the fast, accessible futures trading you've been waiting for with Plus 500. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit us.plus500.com to learn more. Trading in futures involves the risk of loss and is not suitable for everyone.

1:02:42Not all applicants will qualify. Plus 500, it's trading with a plus. If you like 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. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus 500 Futures, you can trade crypto without the hassle of opening a wallet. With just a few clicks, you can register and start practicing with their free and unlimited demo. See a trading opportunity? You'll be able to trade it in just two clicks. Feel ready? You can move to real money with as little as$100 once your account is approved.

1:03:23And the great thing is that in addition to crypto, Plus500 gives you access to a wide range of instruments, S &P 500, NASDAQ, gas, and much more. Explore equity indices, energy, metals, Forex, and beyond. With a simple and intuitive platform, you could trade anytime, anywhere. Experience the fast, accessible futures trading you've been waiting for with Plus500. With over 20 years of experience, Plus500 is your gateway to the markets. Visit us.plus500.com to learn more. Trading in futures involves the risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500. It's trading with a plus.