What’s Driving Both Stocks and Yields Higher? With Cem Karsan

0:02Hey, everyone. If you like this podcast, go behind the paywall to get privileged access to the smartest minds in finance. Visit realvision.com slash RVpod and use the promo code podcast10. That's podcast10 to get 10 % off our essential membership for the first year. Join the Real Vision community and learn how to become a better investor. And now to the top analysis of today's markets. Why are stocks and bond yields both moving higher? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Jem Carson, founder of Kai Volatility. Hey there, welcome back. Great to be here. Good to see you, Maggie.

0:39Same here. Same here. Before we jump in, and we already have questions, which I love. Before we jump in, though, I want to welcome many of you to the new platform. We migrated over another big batch of members yesterday. If you haven't made the move, check your email. The invitation might be sitting in your emails. You'll get the instructions step-by-step how to do it. There are two things to be aware of. You have to create a new account, and for a short period, you're going to need to make sure that you are signing on to the correct site. There are actually two running simultaneously while we're in the process of rolling everyone over.

1:12So make sure you're on the right one. If you have any problems, email Milton, despite my best efforts, he's still there. So somebody from the team will help you walk through it all. And if you're not a member, what are you waiting for? We have a great deal. Brian will put him in the chats, But I believe it's www.realvision.com forward slash birthday. Okay. So, Jim, really interesting market action today. We saw that 10-year yield briefly, touch a 15-year high. Some people were tweeting about the volume. What's your sense of what's happening with the Treasury market? Well, we've been talking about this for a couple of years, right?

1:54And the reality is the amount of issuance that needs to happen from the Treasury, and it's never a straight line, is increasing dramatically. We had a reprieve from it for a little while because of the debt ceiling and the bank run that we had, right? And everything that came with that, which extended the liquidity draw out a bit. But eventually, liquidity, all you have to do is go look at the correlation between liquidity and the markets over the long run. And it's pretty clear that liquidity is a direct input to supply and demand to assets. and when we withdraw liquidity in some form or another, in this case,$1.6 trillion of issuance that's happening over the next six months, that comes from somewhere.

2:51And I think very few people have the context. We've talked about this on here, about how much money that is,$1.6 trillion. We've lost track of zeros in this economy, but the average daily amount of volume that is a net difference that moves markets is about$75 billion. So 1.6 trillion of issuance is a tremendous amount, especially over a six-month period. And so that is a structural headwind to markets. We've known that. That doesn't mean markets are going down because there's other structural tailwinds and supportive structural flows. So we've had this push and pull going on for a while. While that overhang was not there, the other structural supportive flows, which have been significant, have overwhelmed the others.

3:34But here we are in this structurally weak flows period. And guess what takes over? It's the macro structural flows. That will not be the case as you get into the end of the last quarter of the year into the first two weeks. This time around, we can talk about seasonality and why that exists. It's not a magical construct. But that macro liquidity matters, and it's a major input to the equation of supply and demand. And so that's what we've been seeing. What is clear is that that's pushing Treasury yields higher. And again, that's something that we've known for some time. It's never a straight line.

4:11We had that head fake back in March of this year with the bank run and positioning. Last time we were, treasuries were starting to break out, was too bearish in the bond market. And that really led to kind of the boat getting pushed to the other side very quickly. But then we shook a lot of that positioning. and positioning is very different this time around. People are very unprepared. And that really happened not just because of the bank run, but also because of the narrative of recession coming, right, and all of the cyclical realities that people are used to playing in the last 40 years with the Fed policy.

4:55So this is a different market. The Fed is in a box. We've talked about this for years. They have a dual mandate, which are no longer in concert. with one another, and they have a challenge, and they have to fight inflation as long, regardless of growth, as long as that inflation is sticky. Yeah. So when you say that the positioning is very different this time around, are bond investors positioned incorrectly for what's coming in the economy and inflation? So I think the reality is most people think that there is a direct one-to-one correlation with cyclical demand and yields. And the reason they think that, and most algorithms actually think that as well, is because for the last 40 years until recent history, it was all about cyclical dynamics because we didn't have structural inflation.

5:49And we've talked about that on here, why. I'm not going to dive into all that right now. But there's structural inflation, which is really a function of not cyclically how the economy is doing, but where money is going from wealthy to poor, right? The redistribution of wealth piece. And that part, which is coming through labor rights, we're seeing a new strike every week in some area of the market or another. We're at near all-time lows for unemployment. We don't have to go very far to see what's happening there. Protectionism is on the rise, right? And that's causing a lot of these things as well.

6:23Those structurally secular inflationary pressures are happening regardless of the cyclical pressures. And so that cyclical versus secular dynamic is not something people have had to think about. That's why demand has been way stickier than people have expected, why this recession hasn't come as quickly as expected, and why inflation has been hotter. And that will continue. If anything, you can argue that has a lag in it and will continue to accelerate on a secular basis. That's what happened in the 70s. So the cyclical, we're trying to fight a secular story with a cyclical set of tools, and that can only do so much.

7:01And I think the long end of the curve is waking up to that. That's what we talked about for a couple of years. We're starting to see it happen. Yeah, it's interesting. So we have a question from someone I think maybe has the opposite thought from you, but stocks, let's just thread why stocks. So stocks have been reacting to that idea that maybe we have higher for longer, maybe we're going to see volatility higher rates, the rate reset, all of that. They've been selling off on that. Today, they rose. Should we read anything into that? Is that meaningful in any way, or is it just a reaction to the fact that we're bouncing off?

7:37We had four out of five sessions down up until today, right? And those were a function of a window of particularly weak flows, structural flows in the market. We can talk about those and what those mean. We are transitioning away from that, those structural flows being weak. Those positive flows are coming back, and there's also even more of it sitting in front of us as a function of an event ball that, you know, the September 29th and October 2nd, those expirations are priced particularly high across the board because of a fear of extra hedging that's happening in those expirations. So there's a coming kind of VANA charm flow that's coming as a result of that.

8:16And that can, you know, potentially even front run what's coming behind that, which is more structural positive flows into the more cyclically positive period of the expiration cycle, then back into November, shortened holiday time, and then back into December and January, where we start getting the effects from reinvestment and recollateralization of the market being up 15 % for the year. It's about$15 trillion of new collateral in a$100 trillion market equity world. And that doesn't all go to work on the first of the month, but there is a significant amount that does. First of the year, I mean.

8:55And so this is why we get the most positive four weeks of the year, the two weeks before the beginning of the year, Santa Claus rally, and the two weeks after the January effect. That, again, is not a magical construct. People assign psychological dynamics to it. It has very little to do with psychology. It's really a function of pluses and minus, buying and selling. And there's just a lot more buying and an up year into that period. and it's dramatic relative to liquidity. And so as you now are in an oversold market with November and December and those effects, plus the, again, like I said, the significantly lower volume weighted time, a lot more holiday season and acceleration of the decay of skew, those bond and charm effects will also kick in that period.

9:40So that's coming. That's sitting back there in November and December. Here we are going into October and there's an event ball and some seasonally more positive micro-weekly flows coming. Take those now against this macro overhang. And those are the pluses and minuses and the parts of the equation when you're looking at supply and demand. Yeah, which is so important to layer on. So Bo asking this question, the latest GDP revision printed at eight-tenths, down 80 % from Q1, a nine-sigma miss. Does this put to bed thoughts of the resilient U.S. consumer and the services sector propping up the economy?

10:18Again, I want to reiterate, cyclical is only part of the story. GDP growth is only part of the equation. Everybody is used to, for the last 30, 40 years, it's a very simple equation. What is the economy doing and what does that mean in terms of output? What you're getting is margin compression broadly in the market, but also significant increases to balance sheets and demand via rebalancing of income. So yes, to be clear, we're getting a slowing. I'm not saying that the economy is going to be gangbusters, but is that the only input that matters to equity market performance? No. Is that the only input that matters to bond yield performance?

11:02Absolutely not. But you can have a downturn in the economy and likely get higher yields on top of that. We believe that will be the case this time around, particularly in the long end of the curve. We do think there will be an actually steepener happening into this time around, which is very, very counter what we've seen more in the decades more recently. So, yes, we're not dismissing that there's a slowing. I think it's hard to dismiss that it's taken way longer than people expected. I think it's hard to dismiss that the consumer is hung in there way longer than expected, given what's going on.

11:40And yes, it is slowing, but that is only, you know, the question is at what speed and how important is that relative to the other structurally, secularly inflationary pressures? And how much does that cyclical slowdown matter for inflation ultimately? So that would be my response. Yeah. So, so, so important, you know, again, to sort of like anchor in the time we're in now, right? Some of the models that we used before, if they were just relying on that, are not going to work. So, government shutdown. another let's throw another factor in that is kind of hard for some people to to figure out and i think adding to that is the fact that when we've mentioned in this in the past and it's you know outrageous to many that we just keep you know it's like being on uh in groundhog day the movie we just keep replaying this it's a hard way to govern but uh when when it's happened before or as frustrating as it may be to watch, analysts would say, oh, I'm not paying attention to it because it's a mess, it's a hot mess.

12:46But at the end of the day, at the 11th hour, they get it done, doesn't matter. It's not gonna be a market factor. Is that the same sentiment this time around? A hundred percent, in my opinion, the odds are very, very, very slim that this becomes some structural, stressful event for the market. There's several reasons for that. One, there is a positive demand coming out of the market at this event, no matter what happens in the short term. That's short-term supportive. Even if we get a situation where in the short term it's not resolved, it is a nobody in either side of the political aisles best interest if you're an incumbent.

13:28If you're an incumbent, you're on the same side at the end of the day. You don't want a default from the U.S. government. That is a good way to lose your job. So everybody's incentivized to reach a deal eventually. This is all horse trading and nothing gets done until the final pressure comes in. So, yes, something will happen. This will be resolved. There may be some volatility between now and then per usual. But, yes, if you're betting on a crash based on a government shutdown, good luck. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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15:11Question on some of the seasonalities that you mentioned before. Nugget heads, I love some of these names. You mentioned October 6th on X Twitter. It's hard for me to call it X. Bear with me. Is that when you see Vavana and Charm flows returning as the window of non-strength closes? Thank you. Yes. October 6th is a Friday into Monday before the beginning of the strongest week of the options expiration cycle. You know, strongest week and a half. There's a lot of positive flows, you know, left in the market, particularly. So, you know, going into there because of this event vol that exists in front of it as well.

16:01So it could be front run here, you know, because, again, the event vol falls September 29th, October 2nd. And we're already seeing some support underneath the market. But that is when you'd expect there to start to be more structurally positive flows. Does that mean the market's going up in that window? Not necessarily. Are we talking positive flows into equities, into treasury fees? We're talking about equities specifically here, yeah. And does that mean markets are going up in that window? Not necessarily. What it means is there's going to be more positive flows. In the context of an overhang of structural negative flows coming from the Treasury, you could just get a vol dampening effect and a slight kind of mean reversion.

16:42But it's still a bit early to start kind of betting on the NovDs kind of positivity that's out there a month later. but I will say we're moving you know there's two positive things there's a short-term positive set of flows coming in the context of an oversold market already and then you have behind it like I said very positive structural even more positive structural seasonal flows coming in November and December so you know with this sell-off and us being kind of two standard deviations or close to it below the 20-day, very oversold RSI is kind of in a spot. You know, I think most entities are not out there kind of trying to bet against this thing here now.

17:24You might be looking for an opportunity to short it higher. But yes, coming into this window into October 6th after that is a period where it'd be, you know, time is not a bear's friend is what I like to say in this window as we approach that. So we got the decline you'd expect after quarterly OPEX. It came pretty steep right after that OPEX, which is, again, what we're used to seeing. You kind of rode that support into that sub-quarterly OPEX. You took your shorts. That worked out pretty well. You don't want to stick around too long, you know, would be my opinion as we get closer and closer, you know, into that AUK6 and behind window.

18:02So, again, if you get to 18th or so, 17th or Wednesday of OPEX and the flows aren't rebalancing, they're repairing technical damage. If they're not by that point, you probably want to start leaning short again for a little bit. But for now, this is a period to kind of take your winners, rebalance, and then start looking for longs. A lot of people, when they're talking about seasonalities too, just always worry about this time of year because it tends to be when we see something break, right? You see some turmoil in the market, something happens. Is there anything on the horizon that worries you in respect to that?

18:42Yeah, I want to keep hammering on this. It's not like the month of September is a bad month. There are very specific micro effects that fall within this period that are themselves very important. And you can tie them much closer than to the month. Right. It's there's a reason the back half of September is dangerous. It's not just September. It's because it's post a quarterly opex. Right. Like we saw. And that after that, those positive flows in that quarterly opex. Now you have a lack of support. You have very few holidays, actually no holidays during during this period, post Labor Day for quite some time, which means there's people are coming back in the market.

19:24Volume is also increasing, which can be a significant factor. All of these happen generally after a summer that has been very low liquidity, where the demand, structural demand forces have been kind of at work. So you tend to get give back from a higher level that's starting in the back half of September. It's a period without those positive flows. When you have a down month in September, the end of the month also tends to be negative because, again, there's a momentum factor to the end of month for each month. And then you can get some trouble in there. That said, once you get that nine times out of ten, there's something else coming on the other side and a chase into the end of the year.

20:08So this has been very orderly under the hood. Vol has been very well supplied. There's a structural – from structured product issuance, there's massive vol supply still on the market. Vol is still very compressed. This is not what a tail event is made of. It doesn't mean a decline can't happen. But it's going to be well-supported more and more, like I said, in the weeks to come. And I wouldn't be betting on a crash from here. Yeah, we absolutely love having you on for this very reason because you're giving us a peek into this other world that a lot of people sort of don't know or watch as closely that obviously has huge effect on what's going on.

20:48and makes a lot more sense when you layer it on and you can sort of see what's happening as opposed to looking at it in this sort of very, you know, one month fall is when the crash happens. And it's much more nuanced and you can sort of dig in for anyone who wants to get a better understanding. Imran Laka, I know you were on Gem Together. Imran has an entire course on options on the academy, on our website. I think Brian can pull up on the news site and you can see there the two of you are together. And if you're afraid, you're not going to understand it. We now have an AI tool that's embedded, the little green button that you can see right on the side.

21:24So you can ask it questions in real time. You can take notes on what they're saying. The sort of education part of it is so important. And I know, Jim, you try to do that all the time and translate this world. So does Imran. But it's really important because I feel like without it, we're all kind of flying blind. Yeah, I mean, at the end of the day, this stuff, as much as people like to talk about qualitative, you know, who's feeling what and animal sentiments, markets are a function of buyers and sellers and supply and demand. And the more you can measure that supply and demand, the better off you're going to be.

21:58That's how we approach things. It's very mathematical. And you can explain the overwhelming majority of seasonality and a lot of these things that, again, to most people are magical by simply understanding buying forces and selling forces and why they happen during different periods. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

22:24yeah and we've been hearing from those of you who are on the news site by the way like the note-taking part of it and being able to do that in real time and have it right there keep it on hand is amazing like we're all playing with it and we absolutely love it and i really need the ai part for some of these conversations um for sure and speaking of before i get to more questions You briefly mentioned structured products. And I know that this is something that you're watching really closely. In addition to something new the CBOE has, bring us up to date on what you're looking at. Because there's definitely many of us have not wrapped our head around this.

23:05Yeah, this is such a big thing. Both of them are actually. Let's start with the bigger current thing that's going on. And that's structured product issuance. There is a massive wave, right? Historically, whenever interest rates get higher in the bond market, that serves as a reverse Tina effect. Now there is an alternative to equities. You can go put your money in a 10-year bond now for 4.65%. That is a significant alternative to what it was just a year and a half ago. And that means less demand for stocks. The reason the price to earnings multiple in the S &P 500 in 1982 was 4.5, 4.5 PE. People were like, how is that possible?

23:50Because you could get a 10-year bond for 20%. So why would you go invest in the stock market? There is an alternative. So it's a function of interest rates. Price to earnings multiples are a function of interest rates. And the reality is that has always been the case, that markets have gone into bonds as interest rates go higher, and it sucks not money at a risk premium. This time, though, last time during the last inflation push in the 70s, we didn't have something called derivatives. We didn't have the ability to layer on top of bonds other structured yields to enhance our yields. And so there's a big demand, not just for that 4.65 % 10-year or that 5.7 % one-year or whatever you're doing.

24:35You can now put stack selling kind of way out of the money puts, way out of the money calls, all kinds of different structures to enhance that yield, have very low leverage on your portfolio, non-correlated, and get something closer to 7.5%, 8%. And so banks are issuing these en masse and have all kinds of demand for them. The thing is, what does that do? That ultimately leaves the dealers, the banks, the issuers with a bunch of long volatility, right? Because these entities - Oh my gosh, wait, we've been here before, haven't we? It's a little different this time, and I'll tell you why. Is it better?

25:08It is better. Let me tell you why. Because this is very, people are de-risking by coming out of the equity market and very low leverage broadly products. This is not a leverage bet. And that was important. So wait, I just want to put a pin in this and just underscore the humongous importance of what you just said. So the reverse, Tina, right? The idea that now that you're getting yield in bonds for the first time in decades, it's sucking funds out of stocks, which is, A, super interesting. And another one of these things you have to be aware of instead of just paying attention to the earnings.

25:44and they're issuing all the structured products, derivative products, and they have them on their books. The reason I said, oh no, we're not because it made me think of back in the housing, in the great financial crisis, in the lead up to that, all of these derivatives that people evidently didn't understand and were bundled and then kind of led to the blow up. And Warren Buffett used to warn about derivatives being like a nuclear bomb, right? So you're saying it's different. To be clear, This will eventually lead to more and more vol compression, and it already is, leading to entities taking more risk than they normally would because they feel that this is a sure thing.

26:25Eventually, the more crowded and profitable this becomes, just think 2017, and lower and lower vol and more and more compression led to what? The proliferation of all the risk-taking XIV that eventually imploded led to the volpocalypse, right? So this stuff eventually will undo itself. I don't think it's the structured products themselves that are going to cause directly, but somebody is going to get out over their skis and over leveraged. And the more concentrated that becomes in one vehicle or one entity, think long-term capital management, think XIV, that's when things go wrong. and eventually will get there.

27:04But the structured products themselves aren't the kind of the problem. They are eventually going to cause more and more and they already are significant vol compression at the index level. But to just take this one more step, I think this is the important part I wanted to make is all of the structured product issuance, which is again, trillions of dollars in the context of a market that the daily flows are 75 billion or so that net move markets. So that is causing massive compression, but it's in a specific place. It's in the S &P 500 where all these structured products are issued. And so the vol compression is happening on the index level.