You're about to join Niels Kaastrup-Larsen on a raw and honest journey into the world of systematic investing and learn about the most dependable and consistent yet often overlooked investment strategy. Welcome to the Systematic Investor Series. Welcome and welcome back to this week's edition of the Systematic Investor series with Cem Karsan and I, Niels Kaastrup-Larsen, where each week we take the pulse of the global market through the lens of a rules-based investor.
Cem, wonderful to be back with you. I was just going to say how have you been? But we actually, we spoke not very many days ago. So how are you? Doing well, doing well. Chicago in the spring, my son got into boarding school and he's getting ready, so, a moment of change and renewal. So, things are good. That's good to hear. That's great to hear. Well, we've got a (I always say this), we've got a great lineup of topics. I think we do.
They may be a little bit different to what people hear us talk about. I think this will be influenced by an episode that we will refer to a little later in our conversation that we just released a few days ago, a very, very deep conversation with Demetri Kofinas. Butbefore we get into all of that stuff, I always love to hear kind of things that we're not really going to dive into today, but just things that you may have come across your radar.
Something that you think is interesting, could be funny, you know, anything, or is it just spinning with all the stuff you have going on? There’s so much going on. It's like, I don't even know. Let me throw a couple of things to you then if, if you don't mind, then you can see where this lands. Obviously, there are a couple of things that I just noticed, it's just like a kind of WOW thing. Imean,obviously Warren Buffett stepping down after all these decades.
I thought that was interesting, probably a good time. Certainly, he's done incredibly well. Not a lot to that, but I do think it's worth recognizing. Onething I did pay attention to is the more and more the narrative about how some of the US, let's call them elite universities, seems to be asset rich but cash poor at the moment and they're tapping the bond market to basically get liquidity.
And I'm just wondering, is this something we should be paying attention to or is this something private equity investors should be paying attention to? Because that's obviously where a lot of their money has been invested. These are two great Important ideas. I'll take the last one first. There is a way (we will talk about this on the show) of liquidity is coming off the system. It's getting pulled off the system. We are reaching the five year anniversary of the refinancing of debt.
And that's not just debt, by the way, that's equity, that's venture capital, that's everything. And I don't think it's a coincidence that they also are at that point where they need those things. Peoplehave a notorious… we are notorious for our short sightedness or needing to satiate and take care of the things we need now and not worrying about the future. That's usually out one year, usually that's less than 10 years though. And guess what?
Five years is a big kind of milestone for lots of reasons. So, I think that has something to do with it. Inthe same vein, the rhyming piece, I think this is interesting. I don't think Warren Buffett's retiring at this moment... It's perfect, right? It's perfect. Why is it so perfect? And it kind of feels that way for a lot of people, like the end of an era. The beginning of an era. Why? Wetalked about the Fourth Turning all the time.
Guess when Warren Buffett started, he started in the ‘60s and ‘70s. And that was, you know, at that 40, 50 year mark. Right? And the principles that he believed in, the value investing, kind of also protecting your margins and increasing interest rate inflation, he started during an inflation environment. Insurance, the one thing he started with, by definition, is a negative working capital business that excels during times of inflation. That's part of why he excelled. Andwhy?
Because he understood that their profit margins increased, and that would offset multiple contraction in a world of higher inflation, lower multiples. And he dramatically outperformed in his first 20 years. So,those things happen, again, yet much like the Fourth Turning does because of these generational things. And he started, and he's passing, and now a new generation who has not experienced this will now begin to experience it. So, there will be a new Warren Buffett. You can hear me here.
We'll talk about in 40 years. We'll say who that is at that point. Yeah, absolutely. And, of course, it is very interesting to see that he's passing on the baton, so to speak, at a time where he's got so much cash that needs to be invested. So, it'll be interesting to follow. Thelast thing… two last things I had on my little radar that I found was interesting, something that we will talk to but in a different way, but did you notice the move in the Taiwanese dollar? Yes. Hard to not note that.
Okay. That was, you know, that was a... Not a currency I normally follow. That was a standard deviation move. There's definitely something there. I'm not going to sit here and try to pine on it and sound like an idiot in the face of people who have much, probably better views on that. I know when to kind of draw the line. I could speculate.
Butif there's a listener, by the way, who has a deep, deep understanding, believes they understand all of the reasons behind that, we're happy to get known on that. Yeah, absolutely. Andthe final thing I just noticed, over here in Europe, of course, you may be also paying attention to what's going on in Europe, of course, with your roots, it's just once again we see this swing to the right.
Romania, this time also being influenced, let's call it that, by the Trump family with Donald Trump Jr. Going to Romania just before the election last week or the week before. So,yeah, interesting developments from a political point of view and also because if it goes in that direction, it'll be someone who is not necessarily that keen on the EU. Guess what? Trump is not very keen on the EU either. So interesting developments. Trump is lots of things, but he's most of all a magnet.
Magnets are implied that they push/pull things forward. The other side of the magnet also pushes things away. If you look at what happened in Canada and Australia, he's actually pushed people away. So, he is unequivocally a powerful force. But that unity/disunity part, which we may talk about later, is a critical, critical thing. Absolutely. Allright, a quick run through of the sort of trend following part, where we are right now. Obviously, May is off to a quiet start.
I would say we're seven, eight days in. Compared to April, of course, which was kind of a wild ride, May seems pretty calm right now. Some of the same themes are continuing. Goldis doing well, you know, even some of the agricultural markets, like live cattle, are doing well. Equities are still being supportive. We'll come to that towards the end of our conversation - your views on that. And also, the dollar has gained, regained a little bit of the ground, you know, after a tough month of April.
But as I said, it’s reasonably quiet. My own trend barometer stands at 50, and has been around that level for a while. So, it's a little bit positive and there has been a recovery in performance the last couple of weeks, but it's not, you know, that strong. Asof Tuesday this week, since we're recording on Thursday, BTOP 50 down 70 basis points in May, down 4.22% for the year. SocGen CTA index down 73 basis points, down 7 1/2% so far this year.
SocGen Trend down 87 basis points, down about 10% for the year. And the Short-Term Traders Index doing, obviously, better in this environment. It's flat for the month of May. It's down about 1% so far this year. Lookingat the traditional indices, obviously you wouldn't really believe that there had been a big crisis this year already. But MSCI world is up 1.15% as of last night in May, down quarter percent for the year.
The S&P Aggregate Bond index down 44 basis points but still up 2.5% for the year. And the S&P 500 up 1.13% in May so far, down only 3.85% so far this year. Cem,we've got, as I mentioned, kind of a long list of topics. I'm going to start out with some of the ones that you sent over and then we will interchange with a few things I thought about and then we'll finish up with kind of your view of the equity world right now. I know people love to hear your thoughts on all of that.
But just let's start with kind of the macro side of things and, in particular, you have a few thoughts on something that I think a lot of people are very familiar with but also very interested in finding out, and that is what about inflation, what about recession, what's coming, what's not coming? So, let's start with that. Yeah, just to put a shape around this, I think it's important because people talk about this much like they talk about everything, in two directions.
Is inflation coming or is it not coming? Is the recession coming or is it not coming? Well, let's actually add some texture to that. Ihavean ongoing strong belief (you've heard me say this), and I think this, if anything, is just an acceleration of those longer-term trends that you and I have been talking about for three years at least, if not four, which is the populism, the protections, et cetera. What do those movements, those policies do?
And I just want to be clear, just to reiterate for listeners. Thattakes money from the top 10%, tries to move it down to the bottom, let's say, 40%. Moving it to the bottom 40% then creates inflation because the velocity of that money, there's a lot more velocity if everybody who's on the bottom has to spend pretty much everything that they get. Whereas, the people at the top put it into assets.
So, the net effect though (and if you accelerate it at its extreme, it can be pretty dramatic), is actually, ironically, more job but with lower pay. That makes sense. And,that, at the same time, you get more inflation but the net result (particularly under a protectionist type scenario where things become more inefficient), is less profits for corporations. And importantly, it can be, for certain periods, recessionary, but in a very kind of counterintuitive, slow recessionary way.
Not a recession we've been used to. Ifyou look at 1969, 1970 as our most recent example of something like this, you saw a very, very shallow kind of one and a half, two year recession (about one and a half years) where, actually, earnings did very poorly in that period, markets did poorly. But to be clear, it's not some deep recession that everybody thinks about in recessions in recent history. We'reso used to these V's, and these big implosions.
And by the way, it wasn't a time when the 10-year bond kind of came down and helped with poor equity performance because inflation was sticky. And so, I think that's more the shape that I'm talking about. Everybody'sso focused right now on the recessionary part. Are we having a recession, are we not? Everybody assumes a long bond will kind of help people into an equity kind of decline.
And my view is we will probably go into recession because, and primarily because, we have gone so far in creating the top 10% that is now 50% of retail spending in the United States. The top 10% has become such a big part of consumption that pulling money from there, the wealth effect will ultimately be much more painful on a total consumption level. But that doesn't mean the employment numbers will be bad. Andby the way, the employment number was a bit warmer.
I mean it's the first number since tariffs, et cetera. And I'm not saying that those numbers can't come down either. But I think you can take money from the whole, bring down consumption barely, if that makes sense, while still adding jobs or keeping jobs stable and get this really weird recession where it's more of an earnings recession, margins compress and yet inflation stays hot. So it's a stagflation, right?
Yeah, it's stagflation, but it's stagflation in a way that's like, I think people assume… There's all kind of range of stagflation that could be hot inflation with low growth. It can be no inflation with recession - like deep recession. Sure. And I think people are more like, people are thinking we're going to no inflation with a deep recession. Right. And I'm here to tell you I think it's actually more inflationary.
I think the one thing we can say confidently, and this is what the Fed is telling you, is that we know inflation is coming, or at least the supportive effects of inflation are coming. What's less clear and uncertain, as the Fed is saying, is what the taking from the wealth effect and putting down to the bottom will do, over what time period, to growth. And if there's a reason they're staying pat is because they know one thing and they're not sure about the other.
Andthe timing, by the way, is a bit uncertain. Think about it, if you put a tariff up (and this is the last thing I'll say about this before we move on), is if you put a tariff up, one thing we know for certain is that those jobs have to be replaced by entities that are more local or that don't have those tariffs, or the price of goods, that needs to go up. Thosesupply chains will have to be repopulated. Somebody has to take those jobs.
That is massive demand for jobs not a subtraction for jobs locally. Think about how many jobs have been shipped overseas. Okay, yes, it's inflationary for sure if we bring them back. The question is, at what point do those jobs get recreated? You know, over what interval? How do they get recreated? Andso is that a three, six, nine month, one year recession before, you know, the, the power of all that job creation here, creates GDP growth, but ultimately over that period hits margins?
My point is, it's a much more nuanced thing than people are painting. And I think you really have to think about in that nuanced way. Otherwise, you totally miss the forest for the trees. Yeah, yeah, and as you say, I think it's pretty difficult actually to know exactly how this will play out even in how. I mean, you can think about some jobs being replaced by robots. Obviously, that's not necessarily inflationary, but.
And at the same time, obviously, the US is hitting hard on, or clamping down hard on immigrants who may, historically, have taken some of the lower paid jobs. Yep, absolutely. And I think, you know, a couple of other interesting things that happened this week. Microsoft's earnings I thought was very interesting. Why? Imeanthat was the one question mark. How will Microsoft do? And Zala came out and said, you know what, inflation's good for software. And he's right.
He's right on our basket of stocks that will outperform in periods of structural inflation. It's not just companies like insurance businesses like I mentioned, but it's in it's value - good discounted cash flow software businesses and telecom. Everybodyshould increase revenue during these structural periods. That'll be great. Growth will be great. Whose margins will increase during that period and who will get excess demand over that period? Software, to your point.
Soagain, if you're growth software and you're looking for venture money, good luck. But if you're Microsoft, that's pretty awesome. Yeah, so, we know that Jerome Powell has been out saying that they're going to take a wait and see approach. They don't feel certain about moving rates right now, either way. I thought that was interesting, actually, what he said in his latest press conference. He didn't just say when to cut, he also said, if maybe we need to go the other way with rates.
I thought that was interesting. Anyways,we also know that the biggest expense, now, for the US in its budget is interest rates - payments on debt. How do you think about just in the issuance of debt, so to speak, we've talked (you and I have talked) in the past about, did Yellen miss the big opportunity to go long in terms of financing? She didn't do it. It's all pretty short-dated paper. But how do you think about all of that?
Because that's another challenge I guess for the… Yeah, there's like four questions there and I'll try and address all of them. They're all very important. One, the first, the easy one, Yellen, that was politically motivated. I'm not a Trump supporter, a Biden supporter, I don't really care. People are people, and people respond to incentives, no more than in politics.
Butif you think Janet Yellen, who worked directly as the Treasury Secretary for Biden, wasn't doing what they were doing in the election period, or in a… you know, you got it all wrong. By the way, it's not an accusation of Biden, the same damn things happening with Trump. Trump's trying to influence the Fed and, you know, this is just how it works, from the beginning of time. So that's my view there.
Yeah,the short sightedness versus long, and I don't know what president since FDR has been long sighted. Right. And guess what? It takes a crisis, and we've talked about that. So that's that piece. Interms of the Federal Reserve, they're in a box. We've talked about this for some time. The box is getting smaller, and smaller, and smaller, and I don't envy Powell. Everybody's kind of, he's becoming the fool. He's not the fool.
He's just in a… you know, it's like how Arthur Burns… I mean Arthur Burns another story… But people during those periods, they're going to be made the fool. They're the fall guy. It's not their fault. Justlike, you know, Volker seems like a hero. Volker was not a hero. He had the ability to do a big thing at a big important time. It's a very different situation. But the Fed, at the end of the day, is stuck. And by the way, the politics isn't helping as populism is kind of the force.
It makes sense that that's the biggest issue. Iwantto highlight. I don't think enough people are talking about this. Actually, this is one of the biggest things politically, and it's just crazy to me that this is not on any media platform more highlighted as just a big picture thing. And I don't think it’s a coincidence is that Elon got kicked out of the administration. I want to say that loud and clear. Thatwas not like Elon deciding. I mean yes, he had incentives to leave as well.
But you know, Elon was used to… They both used each other. But like used his voice, his media presence was used to get the administration in.
As part of that they were like, let's try this grand deal where we take the supply side… richest man in the world… you know, we're talking about corporate interests at their core, and try and bring them into a big grand tent with all this populist protection side, which is who we really are, which is Lutnick, and Navarro, and Bannon, and all those other guys. It was always an unstable equilibrium. Andright away there was an effort and a belief by everyone, by the way, it was palatable.
The excitement, “Oh, my God, this Trump administration is different.” These guys are business friendly.” Isaid(I was very, very public with this), good luck. Good luck. I didn't think it ended one month, by the way. But, yeah, why did that happen? Well,yeah, if at the end of the day, you try and do supply side economics… The first budget they put out, by the way, had massive fiscal cuts.
We had Doge cutting massive jobs, cuts to the poorest of the poor, and tax cuts to the rich, and a hope that if they push the market down enough that the Fed would react and get the 10-year down and they’d get a supply side response from that too. Withina month, that whole idea explode, like, imploded, imploded. And not just imploded, like from a, “Hey, it didn't work. It didn't get the 10-year down. The Fed didn't respond.” Sure, that didn't work.
But politically, in the first hundred days, is the worst approval rating since 1940. Well,Trump is a political animal. He's a marketer. That's how he got here. And importantly, since the 1980s, he is a populist. He has talked about what he's like. The one thing you got to give him credit for is he has had this belief. You know, he's like a broken clock. He has this one belief. It wasn't the right belief then, but right now it sure is. And now people are like, he was right all along. Okay, sure.
But that's where he, he really is. That's his base. That's what got him here. Heknows that, the Bannons, the Lutnicks, the Navarros, and guess who's now running the show. And so, they've abandoned the supply side, old school Republican corporate interest, supply side economic model. By the way, the only way out, and it was always doomed to fail, in my opinion, but the only way out of the stagflationary mess like we're in is to go back to where, that was working for X number of years.
TheProblem is inequality. And so, populism is what's trying to fix that inequality. It's the political forces and Trump knows, if he's going to survive in the midterms in a year and a half, he's got to get back on that. And he pivoted so fast back towards that side. Nobody'stalking about this. The administration is not the same administration we had two months ago or three months ago. Right. It is a different administration. By the way, when I say he got kicked out everybody's like, proof.
It was literally yelling (this is well documented by the Wall Street Journal) by others, at the top of their lungs, between Bessent and Elon, in the halls of the White House right before he started to part. And,well, what was being said very much accusationary like not just about Doge. And guess what? I said there’d be pitchforks, and literally had massive fires at Tesla dealerships. I mean, what a bad political idea.
Again, to bring the richest man in the world in and try and do supply side economics during a populist period. Whodo you think is going to be the focus of the ire, of the anger? And so, convenient for Trump to just cut the cord and set it off to sea. And so that's what he's done. Again, nobody's talking about that. Acouplepolicy changes that have happened very quickly since then, which I think are very, very important. One, the Congress is now trying to pass no taxes on any tips.
That is a huge deal. Again, something nobody is talking about. That is massive fiscal spending to the bottom. Yeah. But not the opposite of what they were talking about. Well, they talked about no tax on tips during the campaign, as far as I understand. Yes, yes, but in terms of the actual policies that got pushed through in Congress. Right.
And what was being driven by the Elon's and the Bessents, in terms of supply side economics which is that original budget proposal, that was a cut to the poor, give the rich. It was very clear. It was not close. Right. And by the way, the key there was that we're going to get spending down dramatically and that's going to help the 10-year. And then we're going to respond with market friendly forces. No tax on tips. Also, a 20% increase in national defense. $150 billion a year increase.
That's also new. So, spending cuts, that didn't last very long. And so yeah, cutting government, Doge, okay, we cut some but we just now increasing it back to government spending just in a different sector. So,my point is, I think that's an incredibly important thing and that's if we're talking about the one thing that we were concerned about (and I mentioned it here in, in January), in the short-term - in terms of short-term meaning one year, two year path, versus let's say ten year.
And it was well, would this administration succeed for some short period with doing supply side economics? AndI said they might be able to, but the backlash will be dramatic. I just didn't think it would be in a month or two. And so now that's off the table is my point. And, and now we're just seeing acceleration, which is what we saw during Nixon. We talked about this.
They tried, with the supply side economics (you probably remember me saying this), they tried, it didn't last long before it got to price controls and Watergate. We talked about the Fed, we talked about this new spending coming in. There's something that's kind of interesting that I saw that the good people over at Odd Lots had written about recently and that was what had happened to CDS on US debt.
Idon'tknow if you follow that, but it actually picked up, which is kind of as I think Tracy Alloway said, something like it's kind of a weird thing that you have, even the CDS on US debt, because if US debt defaults what's left kind of thing. But yeah, yeah. So, you have to understand those things are always, by definition, going to… There's a risk premium to the tail and it's dramatic. It's the one thing that everybody's short is the tail.
Whether you're thinking about this is the ultimate tail. A default, the US dollar would be the ultimate tail, right? Butit's the one thing that will cause even the hint, it doesn't have to even happen. Right? Andthat's why when we see things that are clearly like .01% probabilities, it can still freak out the bond market because the risk or the magnitude of the risk is so big and it's the one thing that nobody can hedge, or if they can, this is the only place they can.
Andso, you see some crazy bumps and things and that's just risk premia and it's not risk premia like volatility risk, it's skew risk, tail risk premia, which sometimes it's crazy, but it's like, well, if it happens, there's no way to hedge it into the distribution. Yeah. And I think I might come back to this, as far as I remember from some of the other things I want to talk to you about today.
But I guess the change is, and maybe that's what you were referring to, that if we went back six months, the probability of this, people would say zero. But now that zero is not zero. I mean that probability is not zero. It might be small, but it's not zero anymore. Yeah, yeah, and by the way, it was never zero. We can call it risk free. It was never zero. The perception or fear or… And yes, it is likely higher than it was, but it's still approaching zero.
I mean at the end of the day, you tell me if there's a situation where things got so out of hand, what would happen? Would we default, in terms of a literal default, or would we just print money and monetize? So, the same thing. Yeah. And, by the way, I do think that's going to happen. Sure. There's only one way out. Look at where the exits are and that's where, ultimately, everybody's going to leave the party.
So yeah, I don't want to focus too much on it in the sense that… But, I do think that, look, there's been. It's not just… That's the tail on the distribution. In a vol environment, when the whole volatility goes up, the amount that the tail goes up is even more than let's say the after money, or whatever, because it has a multiplier. It's the tail. Andso similar thing here, CDS in general have more risk. There's a bigger risky environment and that tail is part of that.
Yeah. There are a couple of other asset classes that you wanted to bring up which I will set up now. We've kind of hinted at it already, but there is the US dollar. And I mentioned earlier that we had seen, you know, some moves in the Taiwanese currency. You know, we've seen a lot in April in terms of movement in the major currencies against the dollar. So, I'd love to hear your, you know… Yeah. I'm going to start a little bit bigger and work my way down to those which I think will be great.
Which is that I mentioned this before, but I want to reiterate. The other major thing that I don't think enough people talk about, which I've already talked about a bit, but I want to reiterate, is that five year anniversary of the low in interest rates. We've talked about how there's a lag to interest rates. People have often said, well, look, you know, interest rates have been going up since 2021. You know, that's almost three and a half years or three years.
Why haven't we seen a significant decline in markets yet? If this multiple that you speak of, Cem, is the most, you know, the 10-year, the discount rate is the most important thing. Like why? Well,there's a reason, by the way, that Schiller does a ten year tape, and smooths interest rates over a long period because of variable lags and how those interest rates hit the market. There's always a lag. To be clear, the question is, how long is that lag?
Andyou can't look, without some intelligence, at the whole picture and determine what that lag is because it's different during different periods. Why is that lag different during different periods? If you have a significant decline to historically low interest rates, like zero, guess what? There is a massive amount of refinancing and capital that gets stored away for the winter. And if you store it all away for the winter, for long enough, it'll delay that even longer. But guess what?
When the thing comes, it'll be worse than it ever was. That's just how it works. Andso, yeah, the lag here is, and we've talked about this for years, is there's going to be a meaningful lag. The question is, how long is it? Well,anecdotally, I have at least two or three stories, I won't tell all of them, but of people who have taken money, in some form or another, for about five years. Why?
It's just logical as we were mentioning, nobody's going to take money when it's super cheap for one year. Butalso, you know, there's a cost to taking money for 10 years in some situations. Think about venture capital. I have a family member who is the CEO that, you know, once was close to Unicorn. Guess how long there is money for. Gave up 20% equity valuation. This was Spectown. Like there was just so much money flying around. Of course you're going to take money.
They didn’t take enough money to last them 10 years to survive. It took five years. Guess what? A year from now they’ve got to raise money. Guesswhere valuations are, 25% of where they were or 30% or 40%, whatever they are. And that's going to be hard. And that's going to be, importantly, a draw on liquidity from somewhere else. Somebody's got to do that. Andif everybody's doing at the same time, guess what? Those prices go down. Not just on the equity side, but same as with sovereign debt.
Talked about rolling over a debt, you know, short termism. You think it applies to the government too? Janet Yellen, same thing. So,this overhang is dramatic and it's just getting started and you know, it doesn't keep increasing but it does increase until it levels out and then there will be a consistent amount from there. And there's actually a period where it slows down a bit and then kicks up again. And by then, if interest rates are even higher, then we have an even bigger problem.
And this is how this kind of goes. So,the reason I start there, though, is that's overhang for particular asset classes in particular. When you start pulling liquidity from the system, that affects all assets. And this is the thing I've talked about, I don't want to go too deep down this rabbit hole today because we just don't have enough time to cover everything today. But that's why 60/40 is so dangerous at the end of the day.
Andthat's why, also, the alternatives that are sold to people are also dangerous which are private equity, private credit, private real estate. Because people are taught that investing is just owning assets. And we learn about diversification. But the idea that we need to diversify away from just owning assets is not part of the vernacular. People don't understand that. That'swhat trend following is, by the way. That's what hedge funds and multi strategy non-correlated assets are.
I’m not here to pump my book, but that's the reality. If the 10-year goes up, the earnings yield of what you need to make in any asset, that has to go up. Which means price has to go down. It is the most important thing period. It’s not about earnings. It's not about other things. It's not even about supply. It's about the discount rate. Shocking. It said, you know, Finance 101 like, but nobody seems to understand that. Andso, that diversification is key particularly during periods like this.
But to that note, all assets are correlated and that's to that one important item. And if we think there's a high probability of that going higher or there are risks of inflation going higher, people think assets are a protection against inflation. See the contrary thing here. The problem with this, yes, if you want to hold value, yes, an asset in theory will protect you against inflation.
But if it's an earnings yield or some type of appreciation you're trying to achieve, your multiple has to go down if inflation goes up. Andthis is why equities, despite people thinking they're a hedge to inflation, are not and have not historically been. There’s plenty of data that shows that. So, to that end, let's get to the other asset class you talked about. So, how will oil do in this type of environment? Maybe it'll hold its value relative to inflation. It is a good inflationary hedge.
It is at least a core real asset. Its margins aren't going to compress. It can actually improve margins over time if we're talking about longer term, but it is still an asset. Andif we have a liquidity suck coming out of the market, you can actually have a situation, by the way, with demand it will be maybe a mild recession. It may not be as deep a deep recession as people think. But the number will go down. That's not the only reason it's going down now.
I think it'll be less than everything else eventually. There are the forces we'll get to. We'll talk to oil here. Butwe're also alienating international buyers from some of these developed world assets at the exact same time we have the supply. I think this is one of the biggest, most important things happening. You know, we are injecting volatility and uncertainty into a system. We're removing buyers right when the selling is coming on the market.
Can you imagine a more kind of dangerous environment for the next year, year and a half? Soyeah, not a surprise that we get dollar weakness into that. And then guess what? Dollar weakness has a reflexive effect of causing more inflation. Because we've had the benefit of not getting that much inflation. Part of the way we've managed it, particularly on the import side, Is by lower goods. So, lower dollar.
Rightat that time where we were putting up tariffs and creating more inflation, we are now getting a weaker dollar and creating more inflation in terms of other imported goods. So, it's already kind of a tariff upon a tariff. I don't hear anybody talking about that either. That's a pretty big deal if that continues. So yeah, we want to be more productive on the world stage and export. Be careful what you wish for. It won’t be cheaper.
Just that's going to take a while and in the meantime that's going to be painful. Andthen lastly let's talk about that oil. Let's have a little bit deeper… I think this is actually an interesting little topic and we can get into this in a later conversation maybe. But the one tool that Trump has in this inflationary mess are things that are less liquid and that he can control a lever over maybe that the markets can't necessarily control on their own. And oil is the biggest one.
That's very important. People who saw this again this year made a lot of money on shorting oil. Thisis the important point for now. Incentives always rule the day. Trump has a problem, he has an inflationary problem. And the only lever that he can pull, the only lever he can pull, and he can pull that a couple different ways, by the way. A, the US is a big oil producer. Guess what? We're opening up as much pumping as we can anywhere, no matter how you feel about where and how, that's for sure.
Drill, baby, drill. Yeah. The other lover is our friends in Saudi Arabia - friends in Saudi Arabia. That doesn't cost them anything. Doing what they're doing in the short term may cost them something, but every time the Saudis do this, we've done it 20 times the last hundred years, maybe more. It's a big winner for them. Why?
There'sone thing we understand, if you don't understand it like, one of the easiest ways to make money in the long run is when oil gets really cheap to buy it and when oil gets really expensive to sell it, it takes a while. It's not a one week, one month, one year trade. Why? It’s one of those reflexive assets on the planet. If oil goes to 10, guess what? People aren't going to pump. We're going to shut down stuff. Five years from now there's not going to be enough supply.
Andif it goes to 150, guess what? We're going to be pulling it out of the ground any way we can. The price is going to go down. And so, the Saudis know this. They play the long game. They got up the asset. So, if for some period they’ve got to pull supply off the market and force the price down for a year, that's a short term pain. But they're Going to make a lot more money on that in the long run. So. the question is short term versus long term for the Saudis.
Theyhave, you know, the long-term button down. Maybe not long, long term anymore and so, it doesn't really cost them anything. At the end of the day they ingratiate themselves in an important time to Trump. So, you think, just for me to understand your point of view. So, you think the surprise from OPEC, in terms of increased production, was a favor to Trump? Yeah, I'll be very explicit. Yeah, I think it's one of the factors. I don't think that's the only reason they do it.
Sure. But again this is a game that this OPEC (I don't just say Saudis because that's very specific) has done forever. This is not… I'm not saying something that is controversial. This is the game. They can do it again, and again, and again. They can remove supply, they can put on supply. And why do they do it? Because when they worry (they explicitly say this) that there's too much. They did counter the US for some time.
Because they thought too much supply was coming on the market from the US and they said, well you know, FU, we're going to squeeze all your producers out. Okay. So, point is Trump wants lower oil. They're willing to do it. Doesn't cost them anything. Thereare plenty of… I don't know what the favor is on the back end but trust me, that's ingratiating themselves to Trump at this point at a very important time. And that is a lever.
My point is that he can pull that is not controlled by the bigger forces of supply and demand that he can't control. Andso, oil, notoriously, is kind of not only mean reverting, but it can make moves like this because of exactly that reason. Doesn't mean, by the way, it's a bad long term investment. Keep that in mind. But it does make sense from incentive perspective that, right now, that that would be the one way that they try and keep inflation down.
Nowquestion is if we do get an asset deflationary period across the board, and right now it's pretty easy for the Saudis to do that because, things are not bad. What happens when their budgets start to be a problem and assets go down and there's more risk and you know, are they going to continue? Are they going to need that money? And then, also, what's going to happen, as I said reflexively, to all the, the entities that, that don't make money below 40?
Yeah. So, so again, I actually, I'll say this now, you can highlight it. This will be hopefully another one of those ones that we come back to and say, told you so, a year from now it’s going to be, or so, maybe it's nine months, maybe it's a year and three months, I don't know. But there's going to be a generational buy opportunity in oil. Okay. In oil names Okay, cool.
Youknow, I'm not sure this is the favor they're getting, but I did notice today that it was announced that Disney is building a new theme park and it's going to be in the Middle East. It's not going to be in Saudi, though. I don't know how much Trump had control over that, but anything is possible. I've got a few things and we'll see how many we get to.
But I do want you to talk a little bit about the conversation we just released a couple of days ago with Demetri Kofinas, because I did notice that you very kindly on your Twitter feed that everyone should follow, of course, said that it was the most meaningful and big picture conversation you've had in years. Andfor those who may not have listened to it yet, and hopefully they will after having listened to conversation today, tell me a little bit about why.
I also felt this was, it was a very profound conversation, but tell me why you felt so strongly about the conversation and where that's leading you in your thoughts. Andthen we'll see if I can tie in a couple of other guests we've spoken to in the past before we get to your current market outlook for the stocks, which I know a lot of people are interested in hearing.
So, some people think I've built my mental model on where this world is going, which I've been talking about for five plus years publicly on Fourth Turning. I'll be clear embarrassed to say I read the Fourth Turning two years ago. Thatsaid, it is so complementary to my thesis that when I read it and I started thinking about these things, I'm like, wow, the picture becomes clear.
And by the way, I I think we have some different views that explain some things tied to the Fourth Turning that are more than just generational demographics. We have a lot of things that we talk about that kind of tie in. Partof what I loved about this conversation with Demetri, and by the way, my first real conversation with him. And, you know, I've heard him on his own Hidden Forces pod, but very thoughtful. We definitely align in different ways.
I have come about something, again, from a different perspective, but complimentary perspective. And I just think that when that happens, really some magical things happen for me, at least in terms of maybe some thought bubbles and things coming together that unite and make the picture clear. I think Demetri probably had some of the same.
Andso we had, in particular, we had a lot of great parts of that conversation, but in particular, there was this part where we talk about Joseph Campbell's hero's journey. And I never really tied in, although I'm very familiar with that, obviously, I never really tied that into this bigger kind of where we are as a society, and this idea of crisis that you and I have talked about, and a need for a crisis in order to kind of resolve these problems.
And the conversation took on that track, and it was really meaningful in a lot of different ways that I think are very powerful. Youknow, Plato had the Republic. A book about kind of the individual and then modeling it over society. And it's no coincidence, that we're a microcosm as individuals of what society is on the whole, I think that's a very productive way to kind of think about certain things. Not exactly to a T. There are differences, but in this context, we did that.
AndI think the hero's journey, which if people aren't familiar, I'll be give a very basic kind of example. Star Wars is modeled, George Lucas took Joseph Campbell's work and modeled over the story and is part of why the Star Wars trilogy was so successful. Homer'sIliad. This goes back to the beginning of time. And that story is about basically a hero.
You know, I won't go through all the steps, but a hero essentially facing having to leave society, having to face some challenge, having the free will and the courage to overcome that obstacle, and then coming out, on the other hand, with success and conquering that challenge. Andas I mentioned, the US Is that hero. That is that we'll see. We'll see if they'll be the hero. But they are on a journey.
Ultimately, we are on a journey here in the US and the developed world and its challenges are significant and are being forced to rise to the challenge and a crisis will come. Thequestion (I think this Is the part that's interesting) is will the West be able to rise to the challenge? It did during World War II. It has during other turnings. Will it this time? And eventually it won't, to be clear, the hero doesn't always succeed.
In fairy tales and stories it does, but the hero doesn't always rise to the challenge. And why doesn't it rise to the challenge? Maybe it's not strong enough, can't conjure the courage to do it. And being scared or unwilling, it fails. Andso, the question is what is courage as a society and an individual, what is courage? It's conjuring up the strength. It's like this idea of taking every cell of your being and being devoted full heartedly and doing whatever it takes to make it happen.
Inthe case of a society, how do we bring those individuals together? This idea of courage and laying it over as this idea of unity and bringing entities, people and groups together to rise to the challenge I think is a critically important idea. And I find it very interesting that we're facing, if you compare let's say to the ‘60s and ‘70s, you know, I've talked about that period and the challenges we face then.
But we did rise to the challenges of the time in our own ways at that time, as well. And we did it through music and movies, and leaders like JFK, and inspirational ideas. We look all back and feel like that we look at the ‘60s and ‘70s and that's the one thing that stays, that it was a powerful time of emotion and art and renaissance, in a way, to conquer those feelings of crisis. Wefeel so disunified right now. And are we going to be able to conjure the courage or to unite?
And the question really is one that I think is incredibly important. Where are our musicians? Where are artists? Where are our leaders? Who will those people be? Will they rise to the challenge? And what can we do to encourage that? Andwhat are people doing to discourage that I think is important too. And I think there are entities who understand this much, from a bigger perspective. I don't want to go all conspiratorial, but I think there is a concerted effort to disunify the West.
This is actually quite explicit. It's well stated. This isn't a conspiracy. Thequestion, and I believe actually that they really understand this idea that the one thing at this time of coming crisis that is critical is unity or the ability to unify. Do you remember our conversation with General Robert Spalding? And if people haven't listened to that, we did this in June of 2024. And I completely agree with what you say.
I also share the concern that you raise and this concerted effort, although he talks about it from a Chinese perspective, the playbook that they put in place back in the late ‘90s, which includes, and probably we see that, which is also why I still can't believe that we still allow Tick Tock on our children's phone and all of that stuff. But, that's certainly part of that. And you could say that what was different back in the ‘60s and to now? Well, social media for sure is different.
It’s a tool to disunify. Exactly. By the way, it can be a tool to unify as well. I want to be clear. Clear. It can be a powerful tool. It's a magnifier. But they now have this powerful magnifying tool, which we do as well. Yeah. And you brought this up, (Sorry to interrupt here), but you brought this up earlier before we got on here, which I think was very important, which is at the end of the day is this unification being also disunification being done from the inside?
Yeah. And you know, again, this will be very unpopular to say, and nobody wants to say, something that nobody wants to say. But you know, what, for the heck of unity, you know, like the problem is nobody wants to say these things. And again, I am not political at all. I want to be very clear. People will take this as political. But is there a disunification going on from the inside in the US, meaning, you know, tariffs.
And again, it's fine to put tariffs against the counterparty, but if you're doing it against your allies. This is the West. This isn't just the US this is the West versus… Why are we disunifying the West? Andthat's a big, big question that we should all be asking ourselves. By the way, this is the same administration which has shown a desire to be very close to Russia. Yeah, right. So that is an important question.
If here's one tell that I have that that Trump might be a useful fool, you know, that is probably it. And so again, very unpopular. I'm going to get some hate mail on that. But this is not anti-Trump. Look, we look at incentives, we look at what's happening and try and opine on what that might mean. This is not an emotional lot. I want to pivot a little bit in the interest of time.
I just want to bring up a couple of things for you before we go to the market update, so to speak, and we'll have to continue down these paths for sure. But there are a couple of things I mentioned to you before we pressed record. Justa couple of things that I'm reminded about after our conversation with Demetri, as you and I speak right now. It's our conversation, actually, that we had with Ben Hunt a while back.
It's conversations we've had with Peter Atwater about confidence and how that ties into what's going on right now. And by the way, Peter Atwater actually talks about, that when you lack confidence, your time horizon gets short. Interestingly enough, in many of the things we've seen, including the issuance maybe of Treasury bonds, that it became very short term. So, there are a lot of things in there.
Butif I should just pick a couple of things that I'm thinking about at the moment, and I don't know exactly how to tie it altogether. One of the things I've noticed that Ben writes about at the moment is this thing about, do we really know who the real enemy is yet? Andhe ties it back to the great financial crisis or the subprime crisis, where I guess most of our listeners will still remember what that is. And he ties it back to how people were talking about what was going on back then.
You know, people were talking about recession fears. They weren't talking about systemic failures. They were debating whether we were getting a soft landing or a kind of mid cycle slowdown or whatever. But the real danger turned out to be kind of a structural rot of mortgage securitization that, you know, was spreading already.
Andmaybe we see a little bit of that in his mind today where, again, we talk about recession, we talk about jobs, we talk about inflation, all the things you and I have just talked about. Meanwhile, maybe the true structural threat is already largely, you know, undiscussed. And that could well be this thing about when we hear about, oh, the treasury markets are dysfunctional and it's a little bit… But maybe there's a lot more going on beneath the surface. And it comes back to this thing.
Could we see some real cracks in that one risk free asset that we all think about as being the safest of all? Yeah, I totally agree. By the way. Ben Hunt has become a friend. He comes to Chicago every once in a while and does a book club with us. So, I think incredibly highly of him. What an independent thinker. There aren't many out there these days. Just want to sing his praises. ButI've talked about the sumo market for ever.
And there's so much pressure in this system, so much potential energy, so hard to predict the actual tail. But the distribution is easier. And this is a wide distribution with fat tails everywhere - Leptokurtic market (haven't used that word in a while). And the reality is we are now unleashing unconventional policy with entities all over the world. Thisis not one node of uncertainty. We talk about it as tariffs. This is an infinite opening of release of things that were assumed to be static.
And when you release one thing that's assumed to be static, okay, that creates some volatility area. When you increase all of these things that were assumed to be static and now they become dynamic, and they play on one another. Like one affects the other. Yeah. It's unpredictable. It is the definition of uncertainty. But the one thing we know is we now have a catalyst to increase uncertainty in the world of a high potential energy situation. And I think that is the big idea. Yeah, absolutely.
So, we'll see if we, at some point, get a collapse of belief in America's ability and willingness to stand behind its own debt. I won't have time to go into Peter Atwater's points, but I do remember this whole, you know, the whole point about confidence, I think, and our conversation about it and the book he wrote about it. I think it's probably more relevant today than it was when we spoke to him a while back. So, I just encourage people to go back and listen to it.
Maybeyou and I need to revisit this also at some point. And also, this whole, as you already talked about, this thing about diversification, you mentioned it briefly kind of thing. But I think this is really, really important now because I think people have forgotten what diversification is all about. Diversification is not about making more money. It's about actually building something that's resilient.
And that hasn't paid off for a while because you only had to buy seven stocks, essentially, or one index. And kind of this change from passive back to active management again, I think, is also something we're going to have to revisit at some point. Butas I promised, I do know that lots of people follow very closely what you say about your expectations about the markets Even though this is not investment advice. Let me just, just stress that.
But we talked about some softness, let's put it that way, that you were expecting. Wecertainly got some softness for sure. We also got a big bounce. Manipulated to some extent people might say. But anyways, where are we in your framework and has something maybe changed more structurally after what's happened? Because yes, we did see weakness, but we also just had a meaningful recovery. So, one hour in the people get their crumbs. Let's give them their crumbs.
So, we were very clear that after a Feb to March cycle drop of close to 15% was bigger than that, for reasons we've discussed, that we would get a rally back. We said it would be steep, initially, before all the tariff stuff. We said that might get back to 6000 or new highs. After the drop to 21%. Thenew news of the tariff, Elon getting kicked out. All the things that have changed. We have been very clear that that ceiling has come down.
And our most recent kind of predictions were somewhere between 5,700 and 6,000. Likely 5,700, 5,900 is where would we get back to. Sorry, I finished that thought. Guess where we got to this week - 5720 again this morning. Just go and retouch those levels again. There are a lot of important levels here. Go ahead. I was just going to say that. I mean are you familiar? I don't know whether you follow that, but that is around the area of the 200 day single moving average. Absolutely, absolutely.
But there's a confluence. I can name probably seven things that line up there. It's not a coincidence that I name those levels as important levels. It's not the 200 day alone. But when there's a confluence of different things and that usually matters a lot. I'm not the only one who looks at them and that's important. So,now the question is path. And I never thought, you know, we would get there and it just would be an automatic point to point and then we turn.
Particularly on tops it's more of a process. It always is. Right. And I would see this bigger move as again a process. Yes, we had a big dive and a big, you know, and everybody's watching it. But like this is a topping process. Yeah. It doesn't mean, by the way, that we haven't hit the high. I think we've hit that high. But it doesn't mean we couldn't go again another 300 points higher or whatever. But why do I think, that, A, the ceiling has come down significantly?
I already mentioned the alienation of buyers of assets. We already knew the supply piece was bad. Now we know the demand part's bad. And we've injected volatility. That's not good. So, that's the big reason. Ontop of that, importantly, we have an options expiration cycle. So, now we talk kind of more short term and flows. You've heard me talk again, and again over years, if people haven't learned this, they should about flows. Quarterly options and expirations are important. Pay attention.
It is not just, again, Covid. We've highlighted this. Nobodyelse ever talked about this until we brought it up is that Covid started the day after Feb. OpEx. It ended the day after March OpEx. That is not a coincidence. The recent decline that we called for, when did it start? The day after Feb OpEx. It didn't decline end on March OpEx, partially because people A, get it. And so, it kind of makes it harder to bottom.
B, everything we just talked about, things are going on in late March or middle of March. Butguess what? Here we are. Next week is May OpEx, and you get a next quarterly OpEx, which is June. And June tends to be less bad than a March. And there are reasons for that because we usually get a big ramp into end of the year January. Which then, if we can hang on through Feb, then that kind of creates potential energy for March.
June tends to be after kind of a spring push, which we're kind of getting. This is why sell in May, Bythe way, we should have an episode. We just do all the adages, and explain how these flows that I talk about literally lead to these outcomes. Because all of them, basically, are confluence of these structural flows. That's why they repeat. But May to June is also a dangerous cycle, less historically volatile, but we'll see. But yeah, I think we've reached our, you know, near our ceiling.
Okay. And to be clear, it's May 8th. We could push higher before Monday, Tuesday. Ithinkthere's another couple of important things I want to throw in that aren't just the option cycle. I always got to look at all the different parts. Itdoesn't help that this administration, all of a sudden, actually brings risk forward, and is trying to juice the market, clearly, and trying to push a deal through and show some positive momentum to support this market.
That's been part of this whole rally the whole time. And it happens to be, “We're going to announce it over the weekend.” Well,okay, but what about when they announce it? And then it's not a deal that's nearly as big as people hoped. That's another one. And by the way, we juiced volatility a bit. Not incredibly juicy, but there's a little bit more risk premium put in now because of uncertainty. And lastly, guess what's on Tuesday?
Full circle for this conversation was the first thing we talked about, Inflation. What's the most important thing for this market right now? The 10-year and inflation. What's on the 13th? CPI. So,when you get a confluence of events, and things, and potential energy, and you start to understand these option cycles and the flows, and then we're hitting a level, you make your own determination. And this is why people come back to listen to you and all these conversations.
Cem, thank you so much for all of that. Iwillplug one thing before we end, and that is if people can't get enough of Cem, actually, they can just tune in again next week because we have episode two of U Got Options with Cem and, well, I won't reveal who the guest is. Let's keep that a little bit of a secret. It's a great conversation. I've listened to it, it's really wonderful, and so lots of good stuff coming out to our listeners in the next week or so.
Andof course, if you want to show your appreciation for Cem and all the work that he does to prepare for this, do go to your favorite podcast platform, leave a rating and review and that's the best way to show your support. Ifyou have any questions for upcoming episodes, you can send them to [email protected]. Next week I'm back with Andrew, this time without Tom, actually. So, I'm sure going to talk about some replication and how that handled the April tariff turmoil.
So, all good stuff to come. Anyways,from Cem and me, thanks ever so much for listening. We look forward to being back with you next week. And until next time, take care of yourself and take care of each other. Thanks for listening to the Systematic Investor podcast series. If you enjoy this series, go on over to iTunes and leave an honest rating and review and be sure to listen to all the other episodes from Top Traders Unplugged.
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Also, understand that there's a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Thanks for spending some of your valuable time with us, and we'll see you on the next episode of the Systematic Investor.