Global Macro: The Hidden Force Behind Market Movements ft. Cem Karsan
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Hi, everyone. I'm Raoul Pal, the CEO and co-founder of Real Vision. Here at Real Vision, we're committed to give you the best knowledge, tools, and network to help you succeed in your financial future. If you're enjoying this podcast, please take a moment to give it a five-star rating. It truly helps us continue to bring top-tier content. Thank you so much.

Welcome back to Real Vision. I'm Ash Bennington. Today, I have the pleasure of speaking to a true fan favorite here at Real Vision, Jem Carson, founder of Kai Volatility and Kai Wealth. But before we get started, just a quick reminder, tickets for our upcoming in-person

Crypto Gathering in Miami are now up for sale. Head over to realvision.com forward slash CG 2025. That's realvision.com CG 2025 to get yours. I will be there. Hope to see you in Miami. With that said, Jem, let's jump right in. Let's start it off, man. Let's kick it off with the tweet.

The call. Let's bring it up on screen. Take a look at this. Jim, walk us through the tweet. We're going to show you the chart in just a second. And you can explain exactly what the call was, how you made it back in November and why you saw it coming. Yeah. So I guess, you know, a month and a half ago, I

you know, we had, we knew there's positive flows going into the end of the year. And people read that as, oh, the market is going to go up, right? And all that means is there's a steady flow of demand in the market. There's other things other than that. Those aren't the only flows. And we highlight them here on the show. And so knowing that, you know, we knew we had a likely lot of support and that would really go till

go till the end of the year. So that takes about a month of that time off the table. The question is, would we ever fill it? And I had, you know, we had a lot of conviction here that the, all the indicators were that we were, there was too much over positioning in the marketplace that we had run, you know, very powerfully in election year, that a lot of the support that we had seen was based on structural flows. And we've been talking about this for some time.

And the more we started seeing that, we had great confidence that in early January, we would have a pullback. Now, was that going to be, was the pullback going to come in January 2nd, 3rd?

beginning of the year, January 6th or January 13th, we weren't sure. But what we were confident of is that the extension of it would happen during the most likely time would come during the expiration week. And the Monday of OPEX is always a very, very important date. Why is it such an important date? Because

If there is a stressful event, there's a ton of open interest sitting out there in that exploration. It exacerbates volatility, exacerbates tail moves. If you look at crashes in history, if you're a student of understanding big vol moves, they tend to happen on the Monday of OPEX, Friday into the Monday of OPEX, right? And so it would make sense as the most likely outcome to fill a gap between

on that day, um, you know, out in the, in the future. So we had great confidence that we would get a decline, uh, in January, uh, uh, from the peak, it would make sense to fill it, uh, or to start filling, um, kind of in that early January, uh, window with an extension on that day. So, uh,

It seems like magic, but it's a function of the flows, right? There is a ton of Vana charm flows, which we've talked about on this show, a ton in that December window. There is a ton of end of year rebalancing, re-leveraging flows that would take us a month.

And then you needed some time and room to get down. You still had enough positive flows to to stem the tide until that date. So, yeah, that was kind of the most likely outcome in terms of the day if we were going to get it. And we had great conviction that we were. So I think that's the big picture. Obviously, unemployment that Friday was a big, big thing we're looking at as well. We don't just look at the flows, you know, the unemployment.

given the breakout of bonds, which we've also been calling for, and the importance of both the unemployment dates and the CPI dates as we head forward, given the breakout in the 10-year and the uncertainty around Federal Reserve policy, particularly going into an election year, also led for a catalyst, which we were very aware of when we kind of made that call as well. Because if you get a catalyst on that Friday into Monday,

it is particularly vulnerable as well, given the state of flow. So that Friday was a catalyst. We knew it even back in November, that was an important date. And there you go. That's how we nailed the probability.

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So let's talk a little bit about the Greeks that you just mentioned there, VANA and CHARM and their significance, because I think it's important for people to try and visualize what's happening here to understand what are some of the metrics that you look at when you look at options positioning. Yeah, so if you look at VANA and CHARM, those two in particular in the indexes are a function or in general, they're a function of skew.

SKU being the downside options relative to the upside options. If you have a lot of positioning in SKU and dealers are short it, meaning short put, long call, which almost always is the case in the indexes, but particularly in big quarterly expirations and particularly into the end of the year is particularly so. So there's a lot of short positioning in that SKU

by dealers. And on top of that, that skew is very steep, right? You have a large amount of positioning and it's priced very highly. So it has a lot of potential energy to come down. And that means there's a ton of Delta short against that position. It leads it's a, it's potential demand in weight basically. And so that demand has to hit the market unless those puts relative to those calls, unless those positions become in the money.

for the market, which would take a really fast move by the way, because there's a constant rebalancing, right? Dealers are trying to keep their positions out of the money and try and manage that carry trade, if you will, for a profit. And so the majority of times that's the case,

And when that is the case, the Vaughan and charm flows do come in. Now the rate at which they come in is not linear. It's more concentrated towards expiration. So as you reach those big expirations with big positioning, you, you, you get an acceleration of these flows and they can be, they're very measurable. You can take, you know,

Measure the quantity that it's out there. Take the size of the delta positioning relative to it. Take the time move and the vol move. The vol move gives you the VANA effect, and the time move gives you the charm effect. And ultimately, you understand how much supply and demand is coming on the market. And in the case of these VANA charm flows, generally that means demand.

Um, uh, and then you can measure that relative to liquidity and supply in the marketplace and the other factors that you may be looking at in terms of supply and demand. But these are, um, anywhere from, uh, 20 to 60% of, uh, daily, uh, flows in the market. So they are a huge, huge portion of the flows, um, uh,

in the underlying markets in this day and age. So something that if you're not watching it, you're kind of missing the big picture. - 20 to 60% of the flows in the market are dealers repositioning to hedge for their book? - In the indexes, correct. - Hi, Raoul here.

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Yeah, I mean, it is a massive amount of volume. And as you say, it is, I don't know what the right word is. It's essentially kind of like mechanistic, right, that they have to make these moves in order to balance. Yeah, I mean, a market maker, by definition, or a bank is not looking to hold risk on their books. They're not taking a bet. They're looking to, I mean, they're taking a bet in the sense they are warehousing risk and holding a carry trade. But

But the whole point of making money off this carry trade is to rebalance it. It is a profitable trade at its core. It is a carry trade. It has a structural mispricing that is very profitable over time. Short put, long call, you're selling a very high vol to buy a very low vol. There is a cost. It's not free money. That is, you are short the tail.

And you have to manage your risk. It's just like an insurance company, right? You have to diversify your risk. You have to manage it. And you need to offset and reinsure catastrophic losses.

But it is a very profitable trade. And the way that gets locked in is through structural flows. And the same is true for, by the way, a yen dollar carry trade. They blow up. And eventually, you have problems with it if you don't manage your risk right. And you don't know what you're doing. But it is a very profitable trade, obviously. And over the long run, makes a lot of money. And those flows dominate at times. Like December, which is the biggest period, dominate the flows.

Yeah, and perhaps an especially poignant risk here today when you talk about catastrophic loss in insurance companies and giving you a sense of what can happen when you see what happens when tomorrow does not look like the day before and you see these potentially catastrophic impacts as we see obviously right now. Terrible, terrible events happening at a human scale in California as we film this here today on January 14th. But it does...

provide a little bit of a metaphor, Jim, which I think you're so good at doing when we talk about this, which can get very abstract. It's great to find a way to explain that and break it down for people in a way that is not so mathematized. Yeah, appreciate that. At the end of the day, the market is a three-dimensional system.

kind of thing. It's not just a buy or sell. It doesn't just go up or down. It has different texture, different areas of risk, and those are constantly moving. And the important thing to understand is the world universally has a structure position, which is long,

which leads to a very big structured tail to the market. And that is hedged and concentrated and warehoused across the market. And that those effects ultimately lead to a certain time involved, structural mechanistic set of set of flows. And I think that,

Most people think it's just a function of the valuation of a company that leads to supply and demand or some other very kind of linear thought process. It is a much bigger set of risks and information that make up the total expected return of an asset. And those are constantly being hedged in the marketplace.

And there's nobody better at explaining exactly that point. That to me is the foundational core idea that underlies everything that you do. Everything else builds on top of that. And by the way, we should talk about why that structural long position exists. And you correct me if I don't express this as elegantly as I'm sure you can. But it's just this idea that you, as somebody who's just the massive growth of passive indexation, you have people who are investing in

for the long term in U.S. equities through this rather undifferentiated vehicle of indexation. And as a consequence, it forces the buying of those underlying constituents of the equity index. But you do a better job of explaining this than I am. I'm just trying to break it down into the simplest possible. Yeah, I think you make a good point that the positioning has been very concentrated in the last 20, 30 years.

This has always existed, but concentrated into a specific 500 stocks, into an index, into a very specific market. And the whole world is trying to hedge long exposure, we'll call it, from this index. Prior to that,

Not that indexing wasn't a thing, but everybody was always long. We're long since time incarnate. If you live, if you breathe, you're long. We are creating the value over time. We grow, we build, we live. And that means we build businesses, we build homes, we go to work and create output. And all of that is long-term.

At the end of the day, if you live, you're long. And so ultimately, death or entropy is the end, is the thing we all try to hedge. And that is why the whole world, everything, the biggest character in the world is to hedge that, that tail, the tail. It's all the same tail.

But increasingly, all of that output, all of the economic GDP output, everything that's tied to that is expressed in the form of an index, the S&P 500. And so it shouldn't come as a huge shock to people that these carry trades are as big as they are. They are everything. They are the exposure of the world's output. And so...

That is not a new exposure. You know, 25 years ago when I started in this business, this existed. You know, it has become more concentrated, more predictable. The hedging that's going on is bigger as markets have become more financialized. But the indexes weren't the beginning. They are a concentration and a more distinct representation of something that's been there all along.

Yeah, finance, physics, and philosophy. But to your point, the indexes, and we've had indexes for long periods of time, but the idea that you can invest directly into the indexes,

passively at very, very low costs. And the fact that you have this just now enormous base of people who are doing it through 401ks, 403bs, through all of these other vehicles that have been intended to allow workers to participate in the economic upside and growth of the country. It's just it's layering on by no means the cause, but an expansion of and a concentration thereof all of the underlying factors that you've talked about. Yeah.

Yeah, and I think we'll kind of switch from options to a little bit bigger picture here as well. I do think that it's interesting that if you ask your average person in today's day and age, is passive investing...

You know, what led to passive investing? People would say, oh, it's a technological innovation. We have evolved to a better, cheaper way of investing. I think that's what most people would say. I actually take a very different view. Indexing was created about 200 years ago.

It is not a new idea. Indexing was around, obviously, the 1929 crash. We've seen things well before that. The important idea here, and so why did it take so long for us to get this idea of just putting money into an index? The reality is it didn't work very well until 40 years ago.

It was actually a very poor investment. You could argue over the long-term history of index investing, it's actually still quite a poor strategy. The S&P 500 has over its 125-year history, a 0.35 Sharpe ratio. It's a very volatile asset.

that loses about 40% of its value every eight and a half years on average. And it loses 10%, has a 10% drawdown twice on average a year over that period. If you brought a strategy like that to most people and said, hey, you can make 9% in the strategy they tell you to get out of their office, yet 60% of asset allocation, we are told that 60% of asset allocation should be in these passive vehicles.

Um, the reason is it's in, uh, you know, equities have had an incredible outlier positive return for the last 30, 40 years in the, in the bigger set of history. And that's a function of interest rates going from the top left to the bottom right over that 40 year period. Uh, that really juiced, uh, multiples, uh, and profit margins, um, and has dramatically benefited, uh, corporations, um,

If you look at a longer data set, passive investing doesn't work all that well. And I would argue that, you know, I think we're going to move away from passive in the coming 10, 20 years. I think people will see that it simply doesn't work. And in the 15 to 20 years prior to this 40 year period, if you passively invested in the S&P 500, you lost 70% of your money over 50 years.

15, sorry, won five years. You lost 70% of the real value of your money. Markets went nowhere and inflation

the value of your money over that 14, 15 year period. That is, if you go through that period, people will abandon passive. And the crazy part that people don't realize with passive investing is there's so much structural reflexive support in a system that is built to consistently invest that way. And if you start to remove that, now people begin to abandon that form of investing. It actually has the exact opposite effect.

So I would caution people who believe passive investing is the future. And the only way to invest is to passively invest because it is a low cost way to do things. We have not seen a drawdown in a market.

That lasted over four years in the last 40 in a meaningful way. And I think we should be open to that, especially as interest rates work their way higher, which is what we've really expected for the last two, three years and talked about very, very openly.

Well, these are sort of deep philosophical questions about the underlying nature of markets and investing. I'd love to talk a little bit about this and touch, uh, obviously on what's been happening in fixed income in the bond markets now, because we've seen some price action there. We've seen what appear to be some spillovers to us equities. Uh, but I want to, I want to talk a little bit about, about this point that you just mentioned here, uh, because many people who look at these markets say, well, you know, ultimately, uh, sure there's volatility over shorter time horizons. Uh,

But ultimately, this school of thought would say there's mean reversion because of the underlying economic growth that those equities represent. But the point that you're making, or one of them at least, is this idea of, hey, look, if you throw up that 40-year chart of US interest rates of, for example, if you look at 10-year treasuries, and you see it go from the top left down to the bottom right, that has a material impact on what

you see in terms of the returns of U.S. equities. And obviously, that period, when you look at that period from Reagan's first term down to where we hit lows, let's say pandemic lows, in U.S. Treasury yields, prices obviously moving in the opposite direction, you see some of that effect being baked into equity markets in terms of the potent positive upside. And I want to be clear, it's not just some of them. It's

That is the most important thing by far. If you ask, again, your average investor, what is the most important thing to equity market performance? They would say the economy. That's wrong. That's very wrong. I can prove it. 1968 to 82, you have a 14-year period where real GDP growth was much higher, significantly higher, almost a percent higher than it was in the last 30, 40 years.

The economy in real terms adjusted for inflation with gangbusters inflation. So nominally incredibly high growth. Yet over that period in real terms, the S&P 500 lost 70% of its volume. Real to real.

Real, you know, incredible real GDP growth, incredible real S&P market losses, whereas we've had much lower GDP growth in the last 20, 30 years, but with dramatic, you know, performance in the real market. How could that be? Why would that happen? That doesn't make sense. That's confusing because the market is not just representative of growth.

It is more importantly relative to growth, the discount on that growth. And so if you have a 20% yielding 10-year bond, which is what you could get in 1982, a 20% yielding 10-year bond, what should your multiple in the S&P be? It was four because four is an earnings yield of 25%.

It's actually four and a half, so 20% or so, 22%, which is rational. This is not a weird thing, right? Why would you go take the risk on a market with all the uncertainty if you didn't have an earnings yield that could compete with bonds? So that's just one of the effects. The other big effect to higher interest rates is it dramatically reduces margins. Profit margins are at records. They were at records in 1968.

By the way, the PE of the S&P 500 in 1968 was 24. It's now 2526, right? Sounds pretty similar, right? If interest rates go to 20, the multiple of the S&P will go to 4.

That's just how it will work. And so multiples are just part of the story, but the profit margins are also at records like they were in 1968 because of the globalization, the lower cost, labor costs, lower commodity costs because of global trade, technological innovation, et cetera, that were going on at the time. If you have

protectionism, higher cost of goods, those profit margins eventually degrade too. And it doesn't happen in a straight line. It happens with a lag. And that's why we haven't seen it all happen yet. But it is on the way. And if interest rates, particularly long-term yields, continue to break evens, continue to go higher, which we believe they will and have been pounding the table on for several years as it's continuing to happen,

secularly, that will lead to a much bigger structural decline in markets, regardless of what will likely be strong growth over that period.

Jim, let me ask you this, because you've just described the relationship between interest rates, discount rates, these sorts of very sort of key ideas that we've talked about here on Real Vision before, equity, risk, premium, et cetera. But I'm curious if during that period, what role you think financialization of the US economy has played in some public policy choices that have been made over decades by both parties, particularly

to create the effect that we have seen in terms of the preference for U.S. equities? Yeah, I think there is a there's all kinds of fiscal tax incentives to be passively invested. Right. There are, you know, the the the Federal Reserve, you know, in particular, is is it

is put in a place where it is their preference to keep equity markets and liquidity well provided to the market. The Fed was created to smooth the business cycle. And you and I have talked about this here. I don't want to go through the long history and the bigger picture too far back.

But it was really Bretton Woods that gave the Fed infinite strength. It allowed it to take advantage of the reserve currency of the United States and to print unlimited amounts of money. They were no longer constrained by gold. And that power and the mandate is

with a mandate of lowering volatility and smoothing the business cycle with infinite power in one tool leads to very specific outcomes. Because monetary policy isn't fiscal policy. Monetary policy goes straight to the top. It goes to capital and it funds corporations. So it really turned the US into a corporately ruled entity, right? Because all money would go straight to the, not to the people, but to the corporations.

And that's not a political argument. That's just the fact. And that worked really well because with interest rates at 20%, the Fed had an incredible amount of potential energy that it could use to push this policy through over decades.

The problem is, ultimately, that causes a lot of inequality. It's actually the perfect tool if you're not worried about people. If you're just maximizing GDP and technological output and productivity, you would send money to the top all day. Socrates said,

do you give the best violin players the best violins or do you give the worst violin players the best violins? What is the right approach? And Socrates' view was you give it to the best violin players because you can make infinite music. The way of the world is survival of the fittest. The strongest get the best. And in that way, they create new and innovative things and they change the world.

That leaves a lot of people to starve and die in a natural system.

But if we're going to live in a fair world, which is what kind of America, democracy, all these ideals are about, they're not natural structures. At some point, that inequality becomes a problem. That's what we're dealing with. And that's why we go through these cycles. That's why we're working our way through this cycle now is because we've only gone for a survival of this capitalistic approach, which lowered the cost of, you know, lowered inflation, maximized GDP relative to it, created global peace and did all the things. But there was a cost.

which is that it's a natural system. And ultimately, it led to a very unequal world and an unquote, unquote, fair world. So if we are going to address that, we are going to have to move away from all those benefits. And now the Fed has two mandates that they must manage parallel, which is price stability and maximum employment, which are very much contradictory in the coming period of rebalancing inequality.

So many deep philosophical questions, Jim, raised by what you just said. The idea of obviously oral, the moral and ethical imperatives that are caught up in those challenges that ordinary workers feel in an economy, but also the idea that the cycle, it

Ultimately, if all the capital is allocated away from labor and toward capital, what you wind up with is that the fire eventually burns itself out because you have the people at the top of the distribution who have a very low marginal propensity to consume, a very high marginal propensity to save and invest, and ultimately the demand side overflows.

of the economy suffers because every new incremental dollar that accrues to capital doesn't get invested in demand at the worker level, at the individual level of the economy, and the system burns itself out.

That's true in a system without the Federal Reserve. And so what the Federal Reserve ultimately did, you're right, the system did burn itself out. But every time it did, that's what deflation was. Every time, the Fed would create more artificial demand. They would send more money to corporations to drive more growth. And that would have a stimulative effect.

but concentrated, not at the people. Because again, we can't send money to people in that situation. They'd send it to the corporations and that would ultimately drive a cyclical push, but then fade right back into an even more structurally deflationary environment. And all of this led to, well,

Globalization, by the way, is the primary driver of globalization over this period. It's the primary driver of technological acceleration and development over this period. There's so much more tied into it just than inequality. If you send unlimited money to corporations over 40 years and every time you have a slowdown economy, you stimulate and send more money to them,

Corporations make the rules. Corporations created China, opened up China. Corporations sent all the jobs over through globalization to the rest of the world. They lowered the cost of labor so they could make more profits. That's the natural system. It's not wrong. It's just how it is.

But it also led to incredible taking on 20-year, 30-year, 40-year growth bets, which were never done before. The Amazons, the Ubers, the Teslas, none of these would have existed if it wasn't for easy money. These were entities that were able to invest in incredibly large, long-term thinking projects because they could lock in money for zero for decades.

And that growth would never have been here without that. And so what happens when all of a sudden to the next Teslas, Ubers, Amazons for the next 10, 20 years, if they can't bet on 20-year outcomes or making money in 10 years, that they have to make money in the next year or two or three?

the growth slows down dramatically. And so I think that's a big point that people are missing. The deflation we've seen has been a function of technological development, globalization, and cheap cost of capital. When you reverse the cost of capital, the other two fall apart as well. Not to mention then you get more global conflict, less peace, and all the other things that come along with that as well and drive more

higher costs. So it's really a cyclical effect. It's also generational. The reason this happens over some generally ready kind of decade type periods in general is because it's generational. The millennials on down for 40 years have grown up this way. That's all they know. They believe in the power of technology to change the world because that's all they've seen in dramatic ways for the last 40 years. They believe, you know, in, in, in,

And the power of Bitcoin to change the world. But they believe it's an unfair system because they've been on the bottom. They've been labor during that period. And they have really seen a system that doesn't work for them.

And again, that's the birth of Bitcoin. Those are the reasons Bitcoin came about. And it is also the reason that they are politically arguing as they come to political dominance. Right. For people like Donald Trump and Bernie Sanders and AOC. And that's not a political thing, but it's populism is global and it's on both sides of the aisle at this point.

Well, it sure is. They disagree dramatically about the potential prescription solution, but both sides of the aisle seem to...

share a common sense of what the diagnosis is, the challenges that you've just described there. And boy, how different for us, Gemma, you know, you come of age during that magic window between the fall of the Berlin Wall in 1989 and 9-11. And it was this period where the world looked like, at least for those who had been growing up in it, that progress was just ever upward. You heard great Francis Fukuyama phrase, the end of history, the idea that, you know, totalitarianism was a retreat, uh,

around the world, the Washington consensus, free markets, liberal economies, freedom of speech, freedom of press, all these things were just an inevitable forward progress that humanity was going to make in a continued and inexorable way. And then the world wakes up from history and you have the challenges that you see

today and the feeling that I think so many, as you point out so eloquently there, Jim, so many young people have the lack of faith in the system, the underlying system, not a cyclical impact, but a structural risk fear that they have. I mean, it's just such a deep and powerful and profound point that you make. Yeah, I mean, we are, as a people, likely to take what we have experienced and project that into the future.

And it's important to also note, you know, an optimistic note, you know, when we the highs are the trajectory is never as high as we think, but it's also never as rarely as low as we think. Right. I would for people who are scared about where we're going and what this means for the next 10, 20, maybe even 50 years. Right.

I think it's important to note that we would not be where we are now if we didn't experience the 1960s, if we didn't experience the 1940s, you know, 30s and 40s.

The reality is people thought the world was coming apart at the seams during the 1960s and 70s. There were assassinations left and right. We were at war in Vietnam and people were dying. Race riots. I mean, think about that compared to where we are now. We think this is tumultuous because we're coming out of a time of incredible peace.

But we have evolved and we have grown and we have become what we are as a nation, as a country, as a developed world, as a function of that period. Times of crisis are critical periods for growth and to actually fight against the kind of the entropy that has probably built up in the system in other more peaceful times.

Again, tell the greatest generation that this is a difficult time that we're entering. So again, without that period, where would we be as well? So I think this is an important period. I would not get too high, too low. Understand it's a time of crisis. It's a time that will bring us together. Ultimately, we'll be forced to come together. But ultimately, it's something that needs to happen

in order to revitalize and rebuild what we believe is, you know, what we believe in and continue the progress we've seen for the last 250 years.

It's very well said. Obviously, it's all relative. But certainly the times that we're going through right now compared to what Xers and Xennials experienced, New Wave, Synthpop, and Rave Clubs, it's certainly a much more challenging period. It's almost a shame to bring it back to financial markets and the price of risk assets here. But I want to touch on something you said, this idea of these 10 to 20-year time horizons, which dovetails right

nicely with what we're seeing right now in US Treasuries, particularly the belly of the curve, the 10-year and the longer end of the curve, let's say 30 years. I mean, pretty dramatic increases from call it mid-September of 2024. I mean, 100 basis points. These are big moves. Talk a little bit what's happening there.

what you interpret those moves to be about and the impact on risk asset prices, particularly the spillover effects into U.S. equities, to dovetail nicely with what we were talking about earlier. Yeah, I want to first, again, back up and look at big picture with this. When yields were at 10 years, it was at 1%. We were very vocal that it would be going to 5 in a matter of years. People thought we were crazy. People said, you know, I mean, it was...

You should have seen the comments. We've adjusted, right? People are like more, oh, well, this is long-term, near the long-term average. Okay, it makes sense. I want to be clear, the 10-year is likely going to above six and a quarter, somewhere between six and a quarter and seven by the end of this year. It won't be a straight line again, but I do think it will start to accelerate and you'll get less pullbacks in the near term. Okay.

That will ultimately be a short-term top, I think, meaning not a secular top, but a multi-year, maybe a year top, because it will ultimately be too much for these equity markets to bear. And the liquidity that will come with a liquidation equity markets will ultimately drag down the economy as well. So-

We saw many cycles like this in 68 to 82. To reference the last period, we saw kind of a structural increase in yields, three different major bouts of inflation throughout that period, each one bigger than the one before it. There's a problem too. And once it starts going, the harder trade was actually for it to go from one to five because the curve was, you know, was...

was inverted during a large part of that move. It was easy to hedge the inflation and the structural increase. When I was in the last two years, when we argued for the 10-year was still going higher,

Every time people would say, well, look at the market, the market's telling you you're wrong. It's too easy to put the trade on. It was correct. It was too easy to put the trade on. And it was an incredibly, you know, you got paid. Think about what risk trades do you know that you get paid to put on the risk trade and the convex trade? That's what you got to do here. Now, that's no longer the case. And I think that's an important distinction. Now that the curve is upward sloping, it becomes very hard to hedge this structural long-term inflation trend.

It becomes very hard for entities to go put the trade on because they have to pay to hedge that. And the cost of that is getting increasingly difficult. There are accelerating effects. The higher the long-term yields go, the more structural inflation you see, the more you see higher yields go higher, the longer yields go higher. That's because of, again, the higher cost of money.

but also the effects that that higher cost of money has in terms of pulling forward demand, as well as on top of that, people realizing that there's structural inflation, they should borrow money and buy things pinned down, which then also accelerates that move in commodities.

But our view is that this will continue. It's, again, not a straight line. We'll probably top short-term five-quarter, pull back to four-half, and then ultimately run again to six and a quarter. It's a similar kind of process. And if you look back at where we've been, that's the general process we'll likely see. The why, other than the protectionism and the populism, which, again, is at the key, it's really a...

a moving of money from the top to the bottom. Wages are going up, labor, particularly on the bottom deciles. We are seeing shorter work hours, more labor rights, and those are structurally inflationary. And if we want to rebuild our middle class here in the US, which is what politically both sides are saying at this point,

There's a cost to that, and that is higher yields in the back end of the curve. I also think it's particularly accelerating now because that populism, or at least the rhetoric, is a little bit more front and center now with the coming administration.

I also think not only is it tariffs and immigration policy, which are going to affect labor supply dramatically and the cost of goods coming from abroad, but also I think there's a high probability that the Federal Reserve, and I think this is an important point, is about to be operated very differently as well. I think we're likely to see a very, very hot

a demand push economy on steroids the next two, three, four years. Any recession in the market that will eventually come from higher yields, and it will come probably in the back half, Q4 of this year will be the beginning of it if we do see these 6.5% type yields and a decline in the market that's commensurate with that, which is again what we think is going to happen.

At this point, we will see an aggressive Federal Reserve monetary policy. We will see more liquidity coming into the market. And if Powell doesn't play nice, there will be a shadow Fed, and Trump will see to it that we are aggressive with the most powerful tool that the U.S. has.

you know, that the U.S. has at its disposal. That's our view. And I think the Federal Reserve is going to be much more aggressive in the four years ahead. Again, think of it as an Arthur Burns type situation with Nixon. I think we know how that ends. That said, that's the most likely outcome because at the end of the day, if forced to choose between recession and a

appearing a high unemployment rate and unpopular kind of set of policies, Trump will likely choose the lesser of two evils, which will be inflation. And that's just incentives. And again, we've seen this again and again through history. It is the most likely path.

Jim, these are huge, huge calls. Just to frame this up for people who don't follow 10-year treasury market yields, you're talking about essentially a 25-year high in U.S. treasury yields of the 10. You're going back to 1999 before you saw those plus six rates. Yeah, but if you look at the long-term average, the long-term average, meaning 100 plus years, is about six and a half.

So it's not, it's not odd. It's not a weird, you know, and by the way, one and a half percent from here, we just covered a 1% of ground in three months. So, you know, if people are sitting here saying, well, that seems unlikely, uh,

I may want to examine, uh, you know, your framework a bit. Um, I think people are, are, are really whistling by the graveyard here. Um, the more and more I talk about it, the more and more I got moved, talking about it for about 4% of the market, uh, and, and the tenure, uh, the more we talk about it, one and a half percent seems, uh, conservative. Uh,

I do think that is the right number before it starts to hit the economy in meaningful ways. And I think it's not just the move of 1.5%, it's also the lag. This process started in 21%.

We are now about four years removed. Any five-year arm in real estate, any venture capital investing, private equity kind of money that has been called for five years is removed.

is about nine months or so from having to come back to market. There's a dramatic amount of supply and need for liquidity that is sitting out there. And if yields continue to go higher, which again, reflects that they likely will if people need to refinance, right?

And not just for homes, that's for businesses and all kinds of other private equity and all kinds of other investment vehicles as well. That is supply and will lead to higher yields.

By the way, I got to ask this question because you sparked my curiosity there. But what the hell happens to private equity and particularly private credit if you see this? I love that question. I wish people asked it more often. Listen, I want to make sure people think private equity is something that it's not. Banks, if you go say, I don't want to be in stocks and bonds anymore. Can you get me an alternative? The first thing they put in front of you.

is private equity and private credit. It's almost like people don't know the words in there, equity and credit. They're literally giving you the 60-40, but without the public part. They're doing it in private. And somehow making it private makes it, in people's minds, uncorrelated to the public. It makes no sense.

And the greatest irony of all is by not marking these things to market, which is what the private part means. We're not going to show you the value of these things. We're going to hold your money for 10 years. By making it private and decreasing liquidity, increasing the duration, they are somehow convincing people that it's reducing the volatility.

Actually, it's the opposite. Because they do that, they then can take leverage. And what those vehicles do and the way they make money is they double the leverage, right? And then charge higher fees to capture the difference. So imagine you have something that makes 10%. Well, we're going to put twice the leverage on it, twice the risk. So it's going to make 20%. And then we're going to charge you 20% for it. So you're going to make 16%, right? As opposed to 20%.

But at the end of the day, you're taking twice the amount of risk. This is not an alternative to equities. Private equity is not an alternative to equities. It is equity. And actually, it's way worse. It's leveraged equity. You just don't see it because it's 10 years. Now, the problem here is, and the reason it's worked incredibly well, people in private equity made tremendous amounts of money.

is because we haven't had a meaningful decline for 40 years that's lasted more than four years. So if you're dealing with a 10-year duration, the market has come back in a 10-year period every time for 40 years.

But if you look back in history, that doesn't happen all the time. If you go back, actually, there's a much longer rich track record of lost decades. And when those things happen, you are then not just in equity, you are in leveraged equity that has no liquidity and a decade-long duration. So private credit, it's credit. So it's a little bit better in the capital stack, but otherwise the same exact thing.

And so I find it really disturbing that your average bank and wealth advisor, if you go to them and you say, I need an alternative to my equity and bond exposure, the first things they show you are private credit and private equity. And the reality is 80%, I'm not exaggerating, 80% of the alternatives space is those two things in real estate, which are all just leveraged, long duration, short liquidity equities,

And if we do go through this period, which I believe we are going into, equities and bonds won't perform well, but the leverage form of them will be even worse.

Jim, I'm trying to formulate the devil's advocate position here, which I'm probably not qualified to do. But I imagine if you had a private equity guy or gal on the show, what they would probably say is, look, we're concentrating our bets. We're doing a lot of effort in terms of due diligence. We're thinking this through. We're investing in great businesses. We don't have the same pressures that publicly traded companies do. We can afford to put

put these investments up for long periods of time where we see these returns based on our analysis, where we were investing in great businesses, we're investing in great managers, we're investing in great industries, they would say. And that, you know, look, we're taking our time here and doing our due diligence. That I imagine would be the argument you would guess. Sure, sure. And I think that's a fair argument. And to be clear, I- And we have patient capital to do it. So we're able to realize time over longer time horizon. But you could say the same thing in public equities, right?

Like people can do, pick the winners and not the losers, right? And-

Well, they could say there's this really smart guy named Jim Carson who's described so brilliantly all the challenges that we have in public equity markets, all the mispricing, all the concentration, all the mechanistic effects that you get from dealers rebalancing. So come invest in private equity, they would say, I imagine. I am not saying that every private equity business is going to fail or every private investment is going to fail or every private credit is going to fail in this environment. That's not what I'm saying.

There'll be still some very profitable private equity investments.

If you pick the winners, actually. And by the way, to be clear, I'm not saying all equities on the public side are going to perform poorly. In 19, 16, 18, the market went nowhere and real terms lost 70% of its value. But if you were in the right things, you still did very well in the equity world because we had a very strong economy. I want to be clear. We are likely to have a very strong economy for the next 14, 15 years.

I'm not saying the economy is going to be weak. We'll have some recessions along the way, driven particularly by inflation and higher long-term yields. But the things that will work will be almost the exact opposite of what has worked for the last 40 years, the businesses that succeed. And if you pick the businesses that won't have their margins degraded by inflation,

uh, you know, that are not capital intensive, uh, that are not labor intensive, um, you will, uh, you will outperform and you will do quite well. So, so again, uh, there's an argument to be made. If you pick the right businesses, you're still going to do great, but, uh,

statistically equities won't do well. And I'm guessing a lot of the private equity that people are investing in is the stuff that's worked because there's recency bias and the stuff that's worked is likely not to be the stuff that works. And if you do that with leverage, you're probably going to find out about yourself. Very well said, uh, Jim, I enjoy these conversations so much. Whenever you join us, uh, they are deep and thought provoking. Uh,

and very much tied to risk asset prices, talking of which, I know we've gone off on these sort of amazing conversations here, but I wanted to at least give a couple of questions here to you. So we've got some great ones from our audience. First one comes to us from Doug Martin. Will SPX trade above 6K into the inauguration or FebOpX? If no, how high will it trade in this stair step down? I should say right now on my screen, 58.14%.

right now on SPX? Yeah, I think we're likely to see a counter trend rally before we see a renewed decline. I do not think we are going to hit a new high this year. I think if we do, it'll be a very minor new high. Again, I don't think we'd get there.

So that's a 6,100 kind of top in the market. And I think this is the first place I'm saying that, that I believe that is the top and the top is in. I want to be clear, but that doesn't mean, or at least there's a very small minor new high. I want to be clear that doesn't mean the market's about to crash. Don't go sell everything right now. Right. I think we are going to chop and that we are going to have a decline into March OPEX and

You know, with likely a counter trend rally before we go lower, but not necessarily. But I do think we will make a low somewhere around March OPEX, which will be a 10 to 15%, likely on the lower end of that 10 to 12%. But maybe the 15 decline peak to trough. You can do the math. 15% would put us at 51.75%. And yeah,

That would be a buying opportunity, and we would get a countertrend rally there that was even bigger, whatever small countertrend rally we might see in the near future. So I know he's talking specifically, or she is talking very specifically about inauguration, which is a week away. And the next week, I think the odds are in the favor of a countertrend rally, yeah, up to somewhere 6,000, 6.65%.

And it wouldn't be by inauguration. That would probably be till the end of the month. So I wouldn't expect that rally that quickly by inauguration. But again, by the end of the month, early February, I could see us back to those levels after, you know, maybe slightly lower levels, maybe somewhere near here as a bottom. We'll see what CPI says tomorrow.

But then again, I expect a bigger decline to come and continued stair steps till March OPEX or maybe a week or so before March OPEX would be the bottom, depending on the path.

But that's a bigger and interesting point that you make, though. 6,100 is a top. Essentially, you're talking about tops now, highs that are progressively becoming lower and lower percentage gains off the last percentage gain high. I think everybody will begin to appreciate that and give up on the next new high after the next two rallies. We'll have a rally here that will fail. We'll see a March bottom. That'll be more cathartic, a

a bigger 10 call, like a 10 to 15% decline. Like I said, that'll be bought after March and some of the risk comes off the table, I believe. Um, and when that, when that rally fails, um,

I think that's when people will really start to throw out the institutions. Others will start to throw the baby out with the bathwater. And I actually think that will coincide likely with higher push and yields closer to 6%. And I think that's what's going to take this market down ultimately is those yields and the inflation expectations down.

And ultimately, again, we'll see the path. But I do think that the real decline, though, despite what I'm saying there, does not start till Q3. And again, we won't have reached new highs and vol will not perform now and shorts will get squeezed until then. We'll have a lot of chop and within a wide range, essentially. But I do think that a bigger decline is coming.

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

Ironically, this time, even though people think it will save the day, will not, in my opinion. And I do think this ultimate decline we'll see will be somewhere between 30% to 40% peak to trough by early to middle of next year.

Yeah, really, really interesting insight to end the show with. I know you got to jump. Maybe this is a question for next time. This is a great one. I'd love to hear your view on this, which is Frank Anthony says, Jim, what are your thoughts on housing if you see a potential six and a half percent on the 10-year treasury? Boy, that's a hell of a question that I'd love to take 20 minutes to get you to go through. Yeah, there's a quick answer. There's no supply or no demand. Nothing trades.

And until the market declines and liquidity comes out of the system, you know, the prices are sideways to down. The bigger issue is what happens, you know, once we go into recession. And that'll be a real correction in real estate prices.

Jim Carson, another barn burner of a show. Fantastic, fantastic conversation right here on Real Vision. Thank you so much for joining us. Thanks for having me. Always a pleasure. Thanks for watching, everybody. See you in Miami. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus 500 Futures, you can trade crypto without the hassle of opening a wallet. With just a few clicks, you can register and start practicing with their free and unlimited demo. See a trading opportunity? You'll be able to trade it in just two clicks. Feel ready?

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