Navigating Markets Amid Middle East Conflict ft. Jared Dillian

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0:28Welcome to the Real Vision Daily Briefing. It's Monday, October 9, 2023. I'm Ash Bennington. War in the Middle East. Horrific weekend, obviously. Our remit, of course, is to talk about its impact on markets. Jared Dillian, what do you see happening in markets right now? Well, I was sitting on the couch last night, and I logged into my Bloomberg app to kind of see where everything was. And stocks were down about 30, 35 handles. Bonds were up. Gold was up. pretty much what you'd expect. And you had a lot of follow-through today because we had 12 Fed speakers that were pretty much all saying the same thing.

1:09And they were saying that long rates had basically done the tightening work for them. So there was no need to tighten short rates. So we had a big squeeze in stocks and twos went up a lot and gold went up and even more. So yeah, that's kind of the backdrop. So Jared, obviously we see on the screen right now, A lot of green up fractionally. I mean, I think all the major indices are up a little bit less than 1%. Dow Jones Industrial Average, S &P 500, NASDAQ, Composite, all hovering between, call it up half a percent and three quarters of a percent. So lightly positive across the board. What do you make on that in stocks?

1:48I mean, you know, I think if the layperson were to look at where stocks ended today, they'd say, gosh, that doesn't make any sense. I mean, we have basically the biggest war in the Middle East in history, and stocks are up. That doesn't make any sense. But really, the squeeze started to happen. I forget which Fed speaker it was, maybe Jefferson. But it was when we had the Fed speakers that that's when stocks started to squeeze. And if you believe that we've had our last rate hike, which I think we have, I don't think we're going to hike in November. And if you believe that usually we start cutting within six or seven months of the last rate hike, then, yeah, I mean, that perfectly explains stocks being up 1 % on a big reversal.

2:40That makes sense to me. Yeah. You mentioned to your treasuries. Tell us what you see there trading right now on a yield basis. Looks like 5.08. Well, so the bond market is closed today. So the bond markets closed because of Columbus Day. So really what's trading are futures. So I don't know where twos are in yield terms, but I can tell you that futures are up nine plus basically today. The futures are up nine plus, which is a big move in two or no futures. So, yeah, I mean, I think the bond was up like a point and a half or something like that. It was a big move in treasuries, but we'll see what happens tomorrow when cash bonds start opening up again.

3:28Hey, let's talk about this, the mechanics of what happens when you have bond markets closed with futures markets trading. Obviously, we're talking here about what's happening in futures markets implied on rates. What does that mean, and why is there a divide or a disconnect between what happens when cash bond markets open relative to what's happening in the derivatives position? Well, it's not even just the derivatives. It's also the ETFs like TLT, for example, like everybody knows TLT, like TLT is basically trading on expectations of where the bond market is going to open up tomorrow. Like if you're a market maker in TLT and you're trading TLT, like you have no means to hedge with cash bonds.

4:13Like you can hedge with bond futures, but it's not a great hedge. So liquidity in TLT and the other bond ETFs is down on a day like today. But it's basically like it's signaling where bonds are going to open tonight, basically. So why would you see a differential between what would happen in the cash market and what would happen on a proxy, whether it's on the derivative side or on the ETF side? In other words, why wouldn't those align? Is it just a question of liquidity and pricing? Yeah, it's just liquidity and pricing. That's it. Yeah. Yeah, TLT on my screen, I'm trying to get this, looks like after hours, it looks like it's up on the close about 2%, which implies bond yields down.

4:52Yep, yep. All right, I have some, I can't tell them on the air, but I have some hilarious stories of trading ETFs at Lehman, like trading the bond ETFs when the bond market is closed. And like, you know, with like equity guys, like not understanding that and it just, you know, hilarity ensues. So, yeah. What happens? How do those markets get dislocated? Well, I mean, this was back in the mid 2000s. So, you know, I think that, you know, we have a lot of quantitative trading outfits today. and I think there are some algos that will trade TLT against bond futures and stuff like that, but back then that didn't exist.

5:40So literally the price of TLT was driven entirely by supply and demand of TLT. It could go way out of whack from where yields are supposed to be. So now what you're saying is essentially the quants arbitrage those differentials away to try and bring them into alignment. So lower opportunity to profit from those. Yeah, yeah, yeah. All right. Let's talk about another thing that people are talking about here, which, of course, is oil. WTI on my screen, 86 spot 40 up about four, call it four to a third percent of the day. Yeah, I just I kind of want to talk about the conflict in general terms and kind of what this means for all asset classes, including oil.

6:26Like. I am of the personal belief that this is going to get much, much worse, much worse, and it opens up a whole new set of risks that it turns into a regional conflict that Israel attack attacks Iran, that the U.S. attacks Iran, that this turns into a prolonged war that, I mean, you know, there's, you know, a lot of times when you have some exogenous event that happens and, you know, markets move and people don't really know what to do. They don't know how to process it, but they don't really look ahead. And, you know, when I look at the VIX at 18 today, I think it opened up around 19 and a half or 20, like that is completely mispriced.

7:10That is completely mispriced. You know, I mean, if you think about the purpose of a tail risk hedge fund and what that's designed to do. It is designed for moments like this. A tail risk hedge fund buys calls and bonds. They buy calls on VIX. They buy calls on oil. They buy calls on gold. And they buy puts on the S &P. And they just wait for things to blow up. And the whole philosophy behind a tail risk hedge fund is that these exogenous events happen much more often than probability dictates. So you have these long periods of time where you're bleeding money, you're bleeding decay, and then you have this exogenous event.

7:51And look, if you're of the mind that the worst is over, that this is going to be contained, that we're not going to have any kind of contagion, then sure, go back to selling bonds, sell oil, sell gold, do all that stuff. I don't think that's the case. I don't think that's the case at all. I think this opened up a big can of worms. So why do we see then this relatively modest move on the VIX trading on my screen 17, 17.6 right now? I mean, this is a lot of a lot. The way the VIX is calculated, the VIX is actually not a great index. It's very spot dependent, you know, and what I mean by that is if stocks go up, the VIX will go down like in the calculation of VIX is a measure of spot.

8:37So like it's spot dependent. So like if stocks go up, the VIX goes down. Having said that, like I did not see today a demand for volatility. I did not see anybody buying 50 ,000 out of the money S &P puts. I did not see, you know, bottom markets closed, but I didn't see anything going up in futures. Like I think people are complacent. So what's the opportunity then based on what you see? The opportunity is in all those asset classes, like I mentioned. I think you really have to think like a tail risk hedge fund. And this is sort of the opening salvo of what could be a much longer prolonged conflict that could spread into places you don't want it to spread.

9:29So yeah, you would buy bonds, you would buy gold, you would buy oil, you would sell stocks. So let me ask you this. Of those menu of alternatives that you mentioned there that look like tail risk hedge fund options, what do you see as being the most opportunistic right now for you, and how are you thinking about it? Absolutely the front end of the yield curve. I've been beating this drum on the daily briefings for a couple of months now. I personally have built up a large position in two-year note futures. interesting looking chart I recommend you check it out of twos like basically throughout all this bond market madness where the long end was selling off relentlessly the front end was pretty much anchored and now you're getting the Fed communicating that we've had our last rate hike and we have a war which could threaten global trade oil prices stuff like that like the next move is going to be a cut and it's going to be lots of cuts that that I am pretty sure of.

10:34So where do you see this going on a yield basis and how bullish are you?

10:40So twos are at 5 % right now, probably go to three at a minimum, maybe two and a half. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision daily briefing. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus500 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.

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11:56That's a huge move. You're talking about 20 basis points here. Yep. And how are you playing that on the future side? I'm just long. Yep. Yeah. I also want to show a clip from a conversation here on Real Vision. Andreas Steno-Larsen talking about American exceptionalism more broadly and geopolitics in the energy market. Let's take a look at that clip right now. What I like about the current setup in energy is that I think there is a fundamental reason to expect the oil rally to resume due to flawed data last week on the gasoline consumption. And if you then pair that with the geopolitical risk, then you have a cocktail pulling you in the same direction, right?

12:44So I add the geopolitical layer to an already fundamental macro layer. I will never trade geopolitics on a standalone basis. So had the fundamental outlook been different in oil, then I would never have used this geopolitical excuse to reenter a position.

13:10Andreas Dino-Larsen, obviously talking about a potential rally there in oil on geopolitics and on some fundamental factors that he sees. Jared, you talked about your setup for two-year notes. Let's talk a little bit about the energy complex and oil in particular. We mentioned WTI earlier in the show. What are your thoughts? Are you as bullish there as you are in bonds as another hedge? I am bullish. Like, I mean, let me put it this way. Last week, I was bearish. Sentiment is all over the place. Sentiment is kind of a mess. You know, one thing, I'm not an oil trader. Oil trading is confusing to me.

13:47there was this was like three or four years ago there was something that happened in iran and oil futures spiked on a geopolitical event and that ended up being the high and then it traded off relentlessly for months so kind of the prevailing wisdom in the oil community is that you want to sell these geopolitical events uh and i'm not a part of that community and i see the potential for something a lot worse and i kind of want to buy the geopolitical event but this isn't really my bailiwick. Fair enough. Jared, we got a bunch of questions coming in hot right now, and I'd love to get some to you.

14:21This is an interesting one. Trillion X Macro on YouTube wants to know, Jared, did the equity melt up just start? No, I don't think so. I don't really, I don't have a position in stocks at the moment. I was short for a while and I covered. I do think that I think I think the analog here is 2000 and 2007. Typically, rate hikes, the end of rate hikes co-occurs with the top of the stock market. It happened in 2000. It happened in 2007. On the way down, when you get the rate cuts, you see these big rallies in stocks. But those are all rallies that should be faded. I guess I'm leaning bearish, but like I said, I don't have a position right now.

15:11Yeah, I was going to say, that does certainly sound like a bearish lean. By the way, you can see the logic in the question here, right? Which is, if you think that the Fed is going to start cutting, are we going to see a kind of symmetric asset reflation against the loosening of monetary policy more generally? Yeah, honestly, I'd be looking for another place to short. You know what I mean? So we topped out around 4 ,600. We traded down to about 4 ,240. We're at about 4340 right now. I think you get stocks up to 4400, 4450. That's probably be where I'd like to lay out another short. Interesting.

15:50So you're going to start to see this environment where stocks and bonds start moving in different directions again. That should happen. It's funny. I was thinking about that last night when I checked my Bloomberg app. like, you know, in times of crisis like this, because, you know, bonds are many things. And right now we have too many bonds, but bonds always are a safe haven asset. You know what I mean? And actually, I want to dive into this a little bit more because this is kind of like a pet peeve of mine. So all the bearish rates people have been talking about supply for months, all the issuance, all the supply.

16:29And the thing about supply is that you can very easily measure supply. We know exactly what the government is issuing. We know how big the auctions are going to be. And we also know how much China is selling and we know how much Japan is selling. So you can figure out supply. Demand, you have no freaking idea. You have no idea if demand will rise to meet supply. And what I've said on other daily briefings is that, look, you can't predict what is going to turn bonds into a safe haven asset again. Back in 2008, 2009, when we were running equally large deficits, people were super bearish on rates.

17:08They were buying these CMS caps on rates. People thought rates would go to like 4 % or 5%, and it didn't happen. People showed up at the auctions. We had these huge auctions,$60 billion,$80 billion worth of 10s, and people showed up, and the bid to cover was like 3%. Like there was massive demand because the stock market was melting down and people wanted bonds as a safe haven asset. Could happen again this time. That's such a good point, Jared. And, you know, we've heard so much about the 60-40 portfolio being dead. We've heard all of this sort of secular bearishness on the bond market. But you make this point in the times of geopolitical crisis.

17:44If there is just a bid for safe haven assets, you could, in fact, see exactly that. You could see a meltdown in equities, theoretically, where a fight to quality happens in U.S. treasuries. Yeah, I think it's going to happen. I do. Yeah, well, that's the case. Is this it on YouTube? Can we get Jared's sentiment analysis on gold? It was pretty bad before this conflict occurred. Great question. So have you heard of the literary device called Deus Ex Machina? I sure have. God from the machine. So basically, Deus Ex Machina in a story or a novel is when everything's going really, really bad, and then some exogenous event happens and like bails everybody out at the end and you have a happy ending, right?

18:29So it's a terrible device. It's not a good way to write a story. This is what I call Diabolus Ex Machina, right? Something really bad happened that bailed people out of these losing trades, including me, right? My two biggest positions were bonds and gold and I was getting crushed, right? And this exogenous event happened and it bailed me out. The funny thing about these exogenous events is that they always seem to happen right at the moment that the market is at maximum stress. Maximum stress. Interesting. Here's a question from Simon Wickberg on YouTube. Do we see oil going to$100 a barrel on the new escalation?

19:20Yeah, it could happen. I don't know I don't have a strong opinion I think it's probably going to go higher But If we have an all-out war In the Middle East I think 100 is a given I think 120 is a given If this gets much worse Over the course of weeks Here's Trillion X Playing devil's advocate On the last question If inflation rises because of another war You don't want to be in bonds So he's talking about this differential in rates, potentially seeing inflation wipe out those yields as they drop, particularly, I would assume. Well, not necessarily. I'm trying to think of what the bond market did in World War II.

20:11I think the government was able to issue bonds at pretty attractive yields. You know, there's all kinds of weird stuff that happens during war, you know, like just for an example, during World War Two, we had war bonds and the government had this huge marketing campaign to get people to buy bonds and people bought bonds in support of the war effort. You know, so the government was able to finance that war basically internally, you know, so like I don't think you can say that, you know, OK, we're going to get inflation during a war and that's going to destroy the. Like, I don't I think some of those relationships kind of break down.

20:54Yeah, you know, Jared, you've made some very nuanced points here about these markets. But if I had to sum up what we've talked about in the last 20 minutes, I could say one of the overarching themes here that you've started to unpack is that in times of geopolitical crisis, all bets are off. You could see a significant reversal of some of the longer term durable correlations that we've seen. And some of the sort of truths that we assume to be the case may not be. Is that fair to say that you could see just a major reversal of a lot of these broader trends? Yeah, it's not even really like a reversal of trends.

21:25It's like a regime shift. You know what I mean? Like, basically, the thing that gets people in trouble in markets is correlations, right? Because you have these periods of time where correlations are stable, and then something happens and the correlations are unstable and the relationship between all the asset classes changes. that's how people get murdered in markets is when the correlations break down. And I think, I mean, today is, you know, T equals one, but, you know, I think today was an example of that. We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

22:06Here's one from TC. Question for Jared. Does he think TLT is being used in ARB with futures? If you look at the call, oh, I open interest, it's bonkers and I don't see another explanation. So he's seeing the size of the open interest gap up and asking the question about is this an arbitrage opportunity in terms of the relationship of TLT to the cash bond market? No, I don't think so. I mean, the the S the AUM of TLT, I want to say, is like 40 or 60 billion or something like that. And the open interest in treasuries is hundreds of billions. so I don't think that's what and plus like you know having traded TLT against bond futures like the duration of bond futures is very short the duration of TLT is very long it's a terrible hedge like I don't think that's happening so there really are a lot of terrible hedges in terms of the bleed out on uh you know attempting to compensate yourself uh for the risk that you see in the future and the price you pay in the present yeah yeah yeah for sure I mean We were talking about that with VIX as well.

23:12Yeah. Yeah. Is there any way to capitalize on VIX mispricing? I don't trade VIX. It's my belief that the only people who make money in VIX are the VIX market makers. You know what I mean? You know, every time I think about trading VIX, I just want to tase myself. because, you know, I look at the VIX options and I'm like, oh, I should buy like the 40 calls and well, they're too expensive. I'm like, oh, I should sell the puts. Well, they're worth 10 cents. Like, it's like, you know, I got to tell you, like when VIX, when VIX options first started trading in like 2006, there were huge opportunities, huge opportunities.

23:57And now it's all perfectly priced. So. Yeah, I guess that's a, that's a, that's a broader theme we can talk about in markets. So you mentioned earlier, you didn't have a strong conviction around any particular number on oil. Do you see anything there in terms of resistance or support levels, or do you just feel like this is a broader secular trend higher based on geopolitics, and you're not really sort of in the weeds in terms of the price action based on the futures markets? I mean, the most recent high was up around 92, so you'd probably have resistance there. and above that you don't really have resistance until 120 so you know just from just from a technical standpoint I mean those would be your resistance levels and support would be around 68 I think so got a long way to go to the upside then yeah yeah Jared what are you thinking about in terms of the macroeconomic variables around employment and inflation um you know I I wish I had an answer.

25:02You know, what's interesting is that we were operating under the assumption that the Fed would not pause rate hikes or the Fed would not pause rate hikes until we had some kind of uptick in unemployment. Right. And yet we never got an uptick in unemployment. And now the Fed is pausing rate hikes. Right. So like getting back to correlations, breaking down weird stuff happening. Like that's, you know, that's kind of an example of it. You know, I don't really have an ax to say that there's going to be layoffs, that unemployment is go up. I'm not really sure. Like, I think that economic activity is slowing down.

25:46I think we're headed into a recession. Usually when you have recessions, unemployment goes up. Hasn't happened yet. And I don't think I have an explanation for it, just like anybody else. Well, here's a topic we haven't hit on coming through. It's from Steve. Jared, do you have a view on USD, DXY, I should say, US dollar index over 106 right now on my screen? Yeah, I got to look over at it at my screen. Yeah, the dollar's up as a result of this, which is yet another example of correlations breaking down because the dollar's up and bonds are up and gold is up. Yeah, I mean, the dollar should get strong.

26:30If this conflict continues, then dollars should get stronger, absolutely. But I don't really have a strong opinion on that. SBD758 from YouTube. What does Jared think about industrial metals like aluminum, copper, et cetera? These are all quite cheap, but are we going to sit here and go lower until rate cuts? I gotta tell you, so typically the, the industrial metals, all metals, but industrial metals in particular start to do really, really well during a rate cutting cycle. And also industrial metals do really, really well in times of war. Right. So I, this is actually an interesting comment and it's funny because I hadn't thought about this, but you know, with, you know, it was funny.

27:17I pulled up the chart of Alcoa last week. It's a horror show. I think it's a terrible chart. You know, the stock is down like 60, 70 % from the highs. Like if you think we're heading into an easing cycle and you think we're heading into war, man, that's an opportunity for sure. I totally agree with that. Any base metals in particular or commodities that you see being particularly well positioned to benefit? it i mean copper aluminum tin lead all that type of stuff yeah for sure there's basically everything across the board yep yep yeah jared anything i've missed what else are you thinking about what else are you interested in right now what's got your attention uh gosh i think we covered everything um yeah i mean it's it would be you know it's funny i'm i think i might actually tune into the daily briefings the rest of this week and see what people say about what they think what's going to happen with the war and stuff.

28:17I'm very pessimistic.