Together with Cem Karsan we explore the current investment landscape, with a particular emphasis on the volatility and dispersion of market correlations as we approach the end of the year. We discuss how a compression of volatility at the index level can lead to increased idiosyncratic risk for individual stocks, creating opportunities for savvy investors. We explore the implications of regime shifts and how geopolitical factors, particularly related to the new U.S. administration, could influence market dynamics. The conversation also touches on the historical context of populism in politics and its potential impact on financial markets, suggesting that upcoming months may reveal significant volatility, particularly in fixed income and currency markets. With insights into sectors like gold and evolving trends in cryptocurrencies, we provide a comprehensive overview of what investors should keep an eye on as they navigate this complex environment.

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Episode TimeStamps:

02:22 - What has caught our attention recently?

05:50 - Industry performance update

07:58 - Q1, Adam: What are your thoughts about trading efficiency in VIX futures trading?

09:30 - How volatility compression evolves going into 2025

17:42 - How you take advantage of the volatility compression

26:14 - How Cem acurately forecasted this year's market rallys and his predictions for 2025

39:34 - When does Cem think the current populist period began?

48:22 - How inflation and interest rates have impacted the rise of populism

55:31 - How the gold market has evolved over the recent years

59:12 - Cem's outlook for Bitcoin and crypto currencies

01:03:59 - Is Donald Trump a threat to populism?

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Intro: 00:00:01

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.

Niels: 00:00:23

Welcome or 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. Jim, it is wonderful to be back with you this week. It's been a while. How are you doing? Is Chicago all dressed up for Christmas?

Cem: 00:00:40

Yeah, I got my flannel on here. We got our first snow of the year last night. So nothing, nothing that really stuck too much. But it has been unseasonably warm throughout the year.

And Chicago, global warming is a thing. Come to Chicago. It's been beautiful here. But.

But no, we got our first snow so we're getting ready for the holidays, family coming in, all the good stuff.

Niels: 00:01:05

Well, that sounds very nice actually. Yeah. You know, it was actually snowing when I drove down to my office just a little while ago.

But I will say I was in Singapore last week and it is really interesting. They really go all in on Christmas. I've never been there at this time of year before actually.

And not only do they have all these decorations in the streets, I mean it's insane.

But they also play loud Christmas music in the streets and then you walk around and as a European, of course, you're doing this while you're sweating at 33 degrees Celsius and massive humidity. Right. So it's such an un. Surreal experience.

Cem: 00:01:46

But I often go down to Arizona to my in laws for the, for Christmas and it's like inflatable cactuses with like Santa Claus hats on. It is talk about surreal. Yeah, it's.

But yeah, here in the US that we do America, we do Christmas big, you know, in Chicago I'm going to a tree lighting ceremony along Michigan Avenue and there's like a hole. We're going, you know that there's a whole to do and this is like literally the day after Thanksgiving. So it'll be fantastic.

It's quite a, quite a scene.

Niels: 00:02:20

Absolutely. Absolutely. Okay, well, we've got a list of really important topics that we're going to be tackling today.

But as you know, I always, especially at a time like this where it's been a little while since we spoke on this series at least I would love to hear kind of what's on your radar outside the topics we're going to be addressing later on today, it's.

Cem: 00:02:45

A, it's a moment. It's a trajectory moment. Right. And not just in the year, but really kind of in history.

And I think it's hard to not be aware of that and thinking about those effects.

We've been talking about regime change like, you know, here, broadly like that, that we are broadly in a very different environment than we have been to the last 40 years. And I think we've seen that as we've taught for the last two, three years, we continue to go down that path.

And those things are not linear when they happen. Sometimes it goes very slowly and then all at once.

And I think you have to be prepared for the fact that things have gone slowly in that direction, but really had the possibility of accelerating all at once here pretty quickly. So I really do feel in many ways that this is a calm before a bigger storm.

That storm doesn't mean a crash necessarily or but a bigger acceleration into a broader regime changes. So there's a lot of questions about that. That's what's on my mind as we head into the holidays.

Niels: 00:03:51

Yeah, no, absolutely. And we'll touch on some of those topics for sure today. I think as a, you know, for me, I was thinking about what's really been on my radar.

I mean, one is, was just the experience of being in West Palm beach the day before the US Election. That was also an interesting experience, I have to say. Luckily, it was very peaceful.

But then now that I'm back in Europe, as a European, I obviously are thinking about what will this new Trump administration really mean for Europe.

And of course, as a starting point, it's the Ukrainian situation, because if you go by what was discussed during the election campaign, the support for Ukraine can go away very quickly. And I just don't think Europe is ready for that. And so a lot of that has to do with Russia.

But of course, then I'm thinking a little bit further down the road and I'm thinking, well, hang on, I don't know if you followed the news.

It's maybe not world news, but in my birth country of birth, Denmark, in the last 48, 72 hours, we have been holding back a Chinese ship that they are. The suspicion is that it has caught another two fiber cables in the Baltic Sea in the last week or so.

So if it's the Chinese now doing this, I'm not saying it is, but if it is, it just opens a whole can of worm. And I know we're going to be talking about all these geopolitical issues as we have done in many of our conversations over the years.

But it is, it's just super interesting time and I think your wording of regime shift covers it so well because it's going to be different on so many levels that we can't imagine, I think.

Cem: 00:05:47

Absolutely. And agree more.

Niels: 00:05:49

All right, good stuff. All right, quick trend following update before we dive into all the juicy topics.

You know, it's not always that trend followers on the right side of an event, especially if it's one and one of these events that you know is going to happen, like the election in the U.S. but so far at least, the U.S. election has in large part been in line with the overall exposures of trend followers in the aftermath of the election.

Long equities and the dollar has certainly been profitable. Avoiding long exposure in bonds has also helped.

But as far as I can tell, perhaps an even better sector for trend followers so far in November has been soft commodities like coffee, like cocoa, both of which are up about 20% so far this month. So that shows you the power of being truly diversified.

What seems to have hurt Trend follows a little bit following the election is being long precious metals and I think we're going to be talking about gold a little bit later on today. My own Trend Barometer stood at 41 last night. That's a neutral reading.

It does look like longer term strategies are doing a little bit a bit better than what the readings suggest. As of Tuesday. Beta 50 up 1.72% in November, up 3.67 for the year. Soc Gen CTA Index up about a percent only up about 20 basis points for the year.

Soc Gen Trend up about 2% and just slightly positive for the year now. And the Soc Gen Short Term Traders Index up about quarter percent and up about 14 basis points so far this year.

% so far in: 2024

And the S&P 500 of course still powering away as Jim by the way has forecasted for a long time, up 3.8% this month and up 25.6% thereabouts so far this year. Now before Jim, we dive into the topics, we did have a question in from Adam. Adam wrote, I have a question for you.

Not sure whether you trade or know who does VIX futures. Well, I certainly know someone who does trade VIX futures. But here's my question. I'm trying to gain exposure to VIX as a daily swing trade.

Now for a two and a half, $3 million trade, would it be more efficient to gain exposure directly to the futures for a daily holding period or by the etp? Vxx.

Curious about your thoughts on this around trading efficiency given there are futures and ETPs that holds futures and PS he says I'm a retail investor. All right, any thoughts?

Cem: 00:08:44

Always better to go to the direct Source. Right. These ETPs are sitting on top of the DIX futures. Right.

So at the end of the day there's, there's, you're paying market makers extra edge, you know, in, in these ETPs to, because they have to rebalance. There's all kinds of other costs on top of that to the etp. So if you're talking about just pure efficiency, VIX futures are more efficient.

They're also more capital efficient. Right.

For their margin as opposed to, you know, you're talking to a derivatives guy like capital efficiency matters, especially in a world where interest rates are 5%. So yeah, not even a question for me. I'd go straight to the futures and I think it's a pretty simple answer.

Niels: 00:09:28

Okay, cool. Well done.

All right, so now we're into your topics and you gave me a few headlines and then I'll try and follow along and also follow up with some thoughts and comments and questions for you, Jim.

But the first thing, not surprising I guess that we are going to talk about is volatility and the volatility compression and dispersion into the end of this year. You mentioned specifically just Nvidia. So I'm excited to hear where we're going to go with this.

Cem: 00:10:00

Yeah, so one of the big concepts that we've kind of, we've talked about on the show, but if you haven't tuned in for some time, is how correlation of constituents and stocks in the market are tied to volatility to break it down in a very simple sense, if volatility is compressed, is offered on the index level, if it's very well supplied and dealers and market makers are long, that pins the index. Right. But the counterintuitive part is that the underlying constituents actually get pushed away from each other.

Think of it as a magnet with a positive and a negative. If, if the volume is really well supplied at the index level, that means the index can't move, it's stuck. Right.

But there's still something called IDIOSYNCRATIC risk. Right. Things still have to move.

At the end of the day, a positive set of news comes out in a name or something very bad happens, there will be a reaction to that single stock, especially if it's not a big ball center itself. Right? Right. If that's not, there aren't major other effects. If that happens, that means something has to go the opposite direction.

Like by arbitrage constraints. If the index is pinned and something moves in one direction and another thing has to move in the other direction.

And so what that does is that actually exacerbates volatility in the constituents. If you think about it, maybe not as a whole. Right. Because again, the index isn't moving, but the what that does is it breaks down. Correlation.

We've seen this at scale more and more. If you look at a chart of correlation, correlation is actually breaking down.

At the end of the day, there's been less correlation between constituents than ever. And it's been secularly that way. And people point to, well, we live in a world of regime change, et cetera. Yes, that's true. That is happening.

happening was also happening.: 2017

I think this is the most important data set for, for this, we had 30% lower implied and realized volatility than any other time in history. 120 years. You do a chart, a scatter plot. It's like a massive outlier, Right. Usually massive outliers like that don't happen without a reason. Right.

The other interesting part, right. This is not coincidence. The odds of this being coincidence are essentially zero.

You had 25% lower correlation between underlying constituents than any other time in 125 years. Again, look at the scatter plot. Massive out. Those two things are intrinsically tied.

And again, they're tied for this reason, particularly in this scenario where the index itself is pinned by something, it's the index that's being forced to be pinned. Idiosyncratic risk you're never going to eliminate. Right. That's the definition of idiosyncratic risk.

And if you have idiosyncratic risk and the index is pinned, that means things have to move. That concept is incredibly powerful, incredibly important. And it is an edge. It is a source of alpha for people.

If you understand that and you understand what's happening in the volatility and you have an edge, you understand that things are going to move away from each other. It's not a directional edge per se, but I Think so.

So so few people understand that most of the edges truly true alpha, it's generally not directional, right? It's generally market structure dynamics that lead to different dynamics and distribution outcomes. And this is a critical one.

So having said that, now drilling down to now and what's happening, volume is very well supplied. Why is that? Often after a big event this happens, right?

We had the election and the election has passed that event, volume has come out and that was a very high volume and the vols behind it were lower. So there was this great opportunity to sell higher volume, to buy lower volume.

And as long as you could manage the gamma, which was relatively manageable all things considered, you have now been delivered longer volume at a much lower level. And that brings the whole curve down. And this is a. You get into a circle, right? Because the more it comes down, the more dealers are long.

The more dealers are long, the more they are having to be on the offer. And until there's a buyer to help relieve that pressure, it cycles down, it compresses realize which compresses imply, et cetera.

Eventually this gets to a low enough level and markets, the way this generally, generally resolves is on the upside, the market rallies enough that the market slides to a lower implied volatility because calls are priced in a lower wall and eventually becomes so low that there is a impetus. You know, the realized volatility on the upside tends to outpace it. And there's an impetus for people to come in and buy volume.

Also entities are short call, they write calls against their positions, they have to buy back their calls, they're making money. So they usually go buy puts to hedge as well. So there's a general.

As you rally and you slide to a low enough volume, there is a, there is an impulse for the market to kind of come back and buy back that ball eventually.

And so until that happens, volumes compressed and we are seeing a massive amount of all compression across the board in the shorter data, meaning 1, 2 month etc. Vol. That's likely to lead to dispersion. And that's what we're starting to see. And again people will point to regime change and regiment.

You know, like all these things that are happening, new administration, those are true, those are true. But understand there's a structural reason. There's a wind at the back of, of those dynamics as well. It's likely to push things away from each other.

So this is. These tend to be times of rotation. We're likely to get increased rotation into the end of the year for the next Several months.

And that vodka brush is only going to be exacerbated, by the way, by Thanksgiving and Christmas.

And all the positive flows that don't just come out of these bond and charm flows from the skew, which I've talked about at length here, right, in December and all the structured products at the end of the year.

But also that releveraging effect that we've talked about at nauseum that comes into the end of the year, these next, this next month and a half to two months, really call it two months, because it's really through early January, is likely to continue to not only push the market higher, but compress volatility at the short end of the curve and lead to dispersion. So that's the big takeaway.

Niels: 00:16:15

Can I ask maybe a silly, naive question, but I just want to try and understand this. So as markets move higher, we know that volatility often come down, right?

And then at the same time you're saying, well, dispersion is growing, so correlation is breaking down. So intuitively you would think, well, if markets move higher, it means that all stocks must be going higher.

What you're saying, that's not necessarily the case.

And is this then, if I'm understanding this correctly, is then this kind of also related to the fact that the rally is narrow, meaning there's not a lot of breadth?

Cem: 00:16:54

Okay, yes, yes, it is a major driver of the breakdown of breadth. There are other drivers which are also exacerbating, like passive flows, which other people have talked about and are definitely true as well.

But 100% Vol compression into rallies is leading to correlation breakdown, which is also by definition hurting the rut. And again, it's multivariate. All of these things are. It's not everybody would say, well, this is, this is what matters, or is this what matters?

You can, it can all be true. And this is a major force. It's an important one that people need to be aware of. Passive flows are also important.

But 100%, the breadth breakdown and the breakdown of correlation are intrinsically tight.

Niels: 00:17:44

So maybe as a follow up, and I know we're not giving investment advice here, but I'm just curious about the mechanics of this. If fund managers out there are seeing this, how do they take advantage of it? But also at the same time, how do they know when it's coming to an end?

I mean, is it just saying, well, we have to wait for the markets to turn to see this reversal?

Because you would think that maybe if markets really sell off, that could also Well, I don't know about how breath would be affected by that, frankly. But. So how do people who want to, who's observing this? How would you take advantage of that?

Cem: 00:18:22

Yeah, the way we take advantage of it is we watch very closely what's happening in the ball markets. Right. That volume supply is the key. Right. You know, in terms of how do you watch that? There's several ways.

Niels: 00:18:36

Oh no, sure, sure, sure, sure.

Cem: 00:18:37

No, no, yeah. So at the end of the day, but, but to be clear, I want to make sure I also am clear.

Most people, and I really try and dispel this, this is so critical and it's easier than people think. The VIX is not what you should be looking at to understand fully. I mean, yeah, it's correlated, right?

It's volume, but, but it is not a pure representation of what is happening in the volume market. Because there is skew in options, right? There's a downside, much higher volatility, implied volatility on downside options versus upside.

So naturally if you go down, the VIX will show upside like the VIX is. You know, if the market goes down, the VIX will pop. But often more times than not, actually the actual underlying volume is coming down.

And so understanding what that volume, those volume dynamics are. Price, as most people know in other products matters. It's a reflection of what supply and demand is telling you. Right.

Price is, is a great way to understand what's happening to supply and demand in the volume market. You can know the actual what the dealers hold or they don't hold, that's the best.

But if you're a retail player or don't know those things or can't track it, price is also very helpful. And that's kind of a little crumb like people should be watching price on the underlying options, not the VIX onto the underlying options.

And what's happening to the fixed strike volume of the surface. And again, that's not as hard. It's not a two dimensional thing. You have to look at a lot of options.

But in this day and age, you know, getting options prep balls in and then taking one price, you know, set them looking for the price. Like you can do that. Those are things that even retail can do. Yeah, that's what I would recommend.

Niels: 00:20:27

Yeah, no, that's amazing. You mentioned in your topic line Nvidia, for example.

Cem: 00:20:35

Well, rotation, right.

So now the next step is we know this dynamic is in play here into the end of the year and I know people always say no, we know this dynamics in Play now, things can change. You can have other factors. Vol could go bid and that dynamic may change. But this is a high, high probability factor. Probability though. Watch.

So given that, what rotations are we likely to see? So that's the next step. Right? And that's a harder question and again not one that we have to say 100% this is going to happen.

That said, you know, if you want to start trying to look for places where things can rotate, one good place to look is shortfall areas in the market because the long volume areas of the market are likely to stay pinned with the, with the rest of the market and not be the places where correlation breaks down. Nvidia clearly is one of those. Interestingly, the Russell has become one of those. It didn't used to be because of so much upside call buying.

It started last July. We talked about some of those dynamics that led to the like that helped exacerbate at least the August decline dynamics.

And so there's, there's a really interesting kind of bifurcation in the market of different short volume areas and the rotation that we're likely to see is likely to involve those, those, those entities. Not only those entities, but those things are likely counterweight to one another. Now what's likely in between those two?

And now next question to go up versus down. Well, let's, let's kind of, we can go through the analysis of that and there's no right answer here by the way.

But if you look at Nvidia, you know, it's, it's flagging in a lot of ways. It, it's tried to push up, it's had incredible momentum and that momentum is slowing.

The earnings yesterday were, as I would have expected, good but not great. Right. There are some worries, you know, we're not going to get into all the names about accounting issues and all kinds of things. Right.

That I think are legitimate. They're not just kind of narratives and you know, they're, they're serious potential issues.

Now that doesn't mean, by the way we're talking trading, that doesn't mean a high is not going to be the future or that, you know, I think people come after me right away like how could you bet against AI? That's not what. I'm not betting against AI. Right.

Like please don't come after me on social media about any of this is simply factors and likely probability. So.

And meanwhile we're talking about America first policy and you know, things that largely are more likely to benefit kind of smaller cap domestic stocks and so there are other pressures and narratives and things that have a wind at create a wind at the back of the Russell as a, as opposed to a headwind in my opinion, to Nvidia at this point. And again happens slowly and then all at once.

But it would not surprise me if we continue to have pressure like volume compression, steady grind higher in the S and P. Meanwhile, things like Nvidia start to lag and then continue to do not as well while things like the Russell broadly do better.

Now go pick your favorite names in there. I also think I mentioned this elsewhere, like meme names, you know, have a tailwind in the form of the new pumper retreat.

You know, Elon, get to that one. Elon Musk and you know, you think the bully pulpit is important normally.

Now take, you know, Twitter as a microphone and add that to Donald Trump and Elon himself. It's not just Twitter. Elon himself is, you know, we no matter how you feel about him. Right.

He's done an incredible job pumping Tesla stock over the years. You could argue that Tesla would have gone bankrupt years ago if he didn't wasn't able to get the call squeeze and things going on in Tesla early on.

He is a narrative genius. He's been able to kind of push investment into his names at low cost and go through years of with lacks of lack of profits and successfully.

Again, this is not a negative commentary on Elon. He's done an incredible job of that. It's genius. But he is going to use those tools again and yeah, and that's what he did politically, by the way.

He helped Trump politically. There's no doubt about it among the younger cohort that his support of Donald Trump was incredibly powerful. Well, so.

So, you know, heed that and think about again, if we're getting rotation short vol areas again, narrative names are one of them. So, you know, running of the memes is likely to be a thing again.

Niels: 00:25:35

Sure, yeah, we'll get to. I'll come back to Elon in a slightly different way a little bit later. I just want to mention also that I mean, it's interesting you mentioned this.

I was listening to professor, actually a previous guest of ours, Professor Ashworth, the Motoran, and he was talking about specifically what he thinks about AI and the Max 7. But he basically felt that these things were overvalued in his view.

And he also mentioned that he had sold half his Nvidia position probably a little bit earlier than now, but there we are. So it's a fascinating area before we Go on to the next thing.

While we are on the topic of kind of stocks in general, first of all, I want to acknowledge you for being so consistently right for many, many months. Talking about and guiding people through the ups and the downs, really through the equity market.

And I wouldn't mind if you could just very briefly recap kind of why you kept that view and whether something surprised you or it really just played out as you expected. Because it's going to set us up to when we get to the point about what happens next.

Cem: 00:26:55

I think yeah, a good time to talk about the year. The whole year. And I think it's good to self reflect at this time of year. We came into the year cautious. We were a little wrong. I want to be clear.

I was very, very precise in the wording for a reason coming into this year. The Fed pivoted in December of last year and they really surprised us and everybody else. We priced in six cuts last summer.

People forget year's move very quickly.

Niels: 00:27:38

Yeah.

Cem: 00:27:38

And then all of a sudden they had to pivot. We got, we said when that happened, like the Fed's, like this is crazy. Like the Fed, there's no way the Fed is going to be able to stick to this.

Like inflation's gonna be stickier than people expect. You know, the economy will be stronger than people expect.

And part of that was reflexive because you lower the rates and I think they know that actually they lower out the long term rates and guess what, it's stimulus and it's a quarter forward, all the demand comes back. Right.

We saw a massive amount of sequestered demand in the real estate market here in the US be unleashed because people, Malayal Zadan have been waiting for an interest rate break and they got one early in the year and going into the spring that was brilliant. I think the Fed is on to something here.

If they every end of the year start, you know, reflecting that they're going to cut aggressively and they can bring down the long end of the curve. Not able to do this time. Interesting. Which we can get to. They are going to push a spring push and get the economy going in the beginning of the year.

It works. It's not and by the way, it's just a narrative play. And then they can not do the six cuts and it doesn't matter.

And then things kind of work themselves.

Niels: 00:28:57

Out and can I interrupt you here just because we may not remember this. You were also very early, I remember from our early conversations.

You were also very early out talking about be aware this is an election year and I've done my study on that. So just want to mention that.

Cem: 00:29:15

Exactly. And I was going to get to that.

Niels: 00:29:16

So okay.

Cem: 00:29:17

So absolutely. So in January we said look, there are these windows where after a big run at the end of the year you have to be cautious. Right.

And we're talking about that again next for next year. That's consistent and particularly consistent in in up years. And guess what, 23 was up year. We had a good rally at the end of the year.

Again, not as up as this year. Right. That's a whole another story. We've talked about that in his election year. So there's more volume dynamics, et cetera.

It's even more powerful this year. But you know, especially with the Fed simulating late Last year starting no.

1 we called like a rotation massive rally, got all that spot on, made a ton of money. No one till January that we're like okay, time to take a break, see if things kind of we get a pullback here in June.

And, and and we were very tailored with the trade. We said there's a 1 1/2 to 2 week window here where you got to start seeing something. Or this is because this is election year.

You know, you got to be careful. We took that short kind of look in early mid January briefly and February didn't happen literally mid February.

We said you gotta go long, you gotta go aggressively long and you're gonna be good long the rest this year. And we were very adamantly pat on the table literally from February till August right along.

So we were incredibly right during that period obviously and right before we had a couple of tailored. You know this is the be water thing. Like you gotta sometimes betting not long the market by the way is the hardest thing you can do.

And it's what where we have real edge honestly. Because if you do it in a tailored way and you're very specific, you can, you can really add great risk adjusted returns and improve your short.

Anyway, so we get to the summer and we were very clear similar to what we're talking about now Summer of George Vol compression you're likely to see a much more of a grind. It's a good time to sell short dated Vol. Buy long dated volume. Right.

So important we're not just Evan right Just on dynamics of direction of the market. You know made a ton of money being we didn't have anything greater than a 2 1/2% pullback for three months.

May, June, July, we were very clear volume compression was this plays into your question when do you know? How does it. You know, because when it breaks, it breaks spectacularly.

By the way, that: 2017

And this again ties into the end of the year, which we'll get to in January, February now, but, but you know, we said it will, it will.

We will get a volume in the fall and that Volt will be a wobble 10% or so we said we targeted likely September, it happened in August, it happened early. So that was again something we didn't get perfect right. Again, getting every point and pivot exactly right is essentially impossible. Exactly right.

But if you step back and look at what we said every single quarter with I'd say the exception with that, like that Jan Feb, with a couple of weeks in there, spot on. Not just what happened directionally, but what happened to volume.

And the dynamics and the characteristics and distribution of the period have been 100% spot on. And again, we got massive volume compression. Then we got a volume release 10, 11%.

And we said, we're screaming from the rooftops, this is your opportunity, this is what you've been waiting for to get back in.

The end of the year is going to be a massive rally and that we should hit 6,000 to 6,200 and the year and that will be, you know, you know, not just end of the year, but mid. By mid January, maybe even higher. And that, that should be a period again to hedge and to be careful. Now we may not get the decline in jam Feb.

Tell you people right now, by the way, we called it 22 beginning of a decline to the day. And go back, we were onto the show, we were on other shows literally call that six months out.

So these dynamics are real and they are periods to be very, very careful and look for convexity in those periods and be hedged.

But this year in particular, part of the reason we had such confidence in the rally throughout the year, not just the volume dynamics, but the election year dynamics. And you and I talked about that at depth. The long and short of that was the data speaks very loudly about election years.

case. If you look back to the: 1920

Everybody's like, wow, those are 11 half percent. Those are great numbers. But what people don't realize is if they look at the data.

If you, if you take 64, 68, 70, 72, 76, 80, those five years out of that data set, just five election elections, all of those together were up an average of 21 and a half percent. None of them were down. All of them were up double digits. So incredibly consistent.

And if you take those out of the data set, the number for the 100 years of history is actually 5%. So election years outside of that period are not positive.

And what makes it so impressive, again, you can kind of look at the data and pull whatever data and get whatever results. What makes it so impressive is that if you look at that same period, that's the period where the market went nowhere.

That 68 to 82 period, which we've highlighted ad nauseam here, the market went nowhere for 14 years and lost 70% of Italian real terms. Yet all the election years during that period were up double digits and the average was 21 and a half.

So what do you think that that data period looks like when you pull those election years out? And okay, this is data. Let's not talk about qualitative, you know, all right, let's dive into the qualitative. Why? Pretty obvious, right?

You're in this populist period that we've talked about in depth. Actually, before I looked at this data, I had this thesis and I looked at the data and I was like, holy cow, it's right there in the numbers, right?

So it's not like I looked at the numbers and said, I came up with this thesis. It's very clear. Populist periods, they, these are contested elections. You have massive turnover.

Again, data wise, if you go look at those, all those elections, the average period that somebody stayed in office during that period was four years. Either by getting kicked out of office, assassinations or getting kicked out of office, the average these days is seven, right?

So contested period, people are not happy. People want change populace, and guess what?

They're feeding money to people, feeding money through Federal Reserve policy, and they're pumping the market to get elected. We're about tomorrow, later, get the voters what they want, right?

But eventually you got to pay that bill and it ends up getting paid in the years prior. So here's your big picture kind of idea.

And by the way, also probably not a coincidence, the last two elections, right, Which I've also defined as populist elections that were in this populist period, the Last one was 21% and this one, we're now at 25%, right? So again, maybe Not a coincidence. Maybe we should look at the data. So again, you can't put all your eggs in one basket and go all in for that reason.

But then you take that as part of a bigger picture.

Look at the flows, understand the micro what's happening and you know, and this is where you end up in a good predictive kind of position and end up getting it right. So that said, I think you can insinuate what I think you know is likely to happen in early next year.

Again, I see this end of year period as more positive, with more positive flows than the summer. But volume compressed similar to the summer. I see the.

Again, we already talked about the dispersion and everything else, but I see this giving way ultimately to a bout of volatility and a decline and something that's much more than a wobble, that's to be aggressively bought. So a word of caution come January, it doesn't mean be cautious now because many, many times, most times the best returns happen at the end.

And again a lot of tailwinds until mid January. And again we've, we can call. People love it when I call dates because when it ends up being right, people are.

It's the precision that's important, right? Sometimes. But again I would focus on a January 13th to 15th window as being your first shot. Again, tailored trade, it's a hedge.

Look for convexity in that portfolio. As we play it time off there's going to be a lot of really important indicators.

Again we've talked about blow off tops and, and what unpinning of volume looks like and how important that is. I think it's something you look for those things at that moment in those windows. It will never be easy. Right.

So something much like the 10% wobble came in August, not September. Look for some variation off of this. That's not going to be exact in terms of timing or path, but the trend still holds.

And if it doesn't happen in January, I would be very much looking at February as well. January is better, is a better window in some ways because it comes sooner after the rally and more likely to get that blow off and then a decline.

But sometimes it happens in February expiration because March is a quarterly opex and creates much more dynamic kind of stress potential in the market as we saw during the COVID crash. Right.

We continue to rally despite knowing about COVID into Feb Opex and then saw a Feb to March cycle to the day that represented an over 30% decline in the market. And again, not a coincidence, which we've highlighted before as well.

Niels: 00:39:33

Quick question for you. In your mind, in your analysis, when do you think the current populous period really began in this cycle?

Cem: 00:39:44

So that's an interesting question. And obviously that assumes that it's like has a start date and an end date.

Niels: 00:39:49

Right, of course, yeah.

Cem: 00:39:51

Which it doesn't.

Niels: 00:39:52

No. I'll tell you why I asked and you can think about it.

The reason is I'm kind of curious because your analysis has been so accurate and the fact that you very, very early on this year started to talk about. Be aware it's election year. Here's the analysis.

This is what the data tells us you just pointed out before that through that populist period, 68 to 82 or whenever, equities overall didn't move, but they moved a lot during the election years. The question for me is I'm trying to. And of course there's no guarantees here.

So far it looks like election years have been following that pattern at least. My question is, do the years in between follow the same pattern as they did in the last populist period?

That's kind of what I was trying to think about.

Cem: 00:40:43

Yeah. So in terms of timing, populism, again, these are. When you're talking about big cycles, they rhyme.

But it's not like something starts at one place and it ends at the other. The reason is because you need something idiosyncratic to happen to unleash what is a secular trend.

Niels: 00:41:05

Right.

Cem: 00:41:07

In our last data set that we talk about the 60s and 70s, Kennedy was assassinated in 63. Kennedy had a. He was, he captured the imagination, the beginning of a young populist feeling. His policies were incredibly populous.

He was the originator of the Great Society program idea. The reason it got instituted was his passing. His passing was a unification of the country that allowed LBJ to pass that.

That fiscal policy was the beginning. Right. Of the fiscal push that started the inflation. But if you look, it was happening well before Kennedy. Kennedy was a vehicle. Kennedy was a.

Much like Trump is. Right. He was a vehicle for this sentiment. The Vietnam War and all of the protectionism and things that were going on were going on before Kennedy.

But that. That swell was starting. I would argue that the populist pressure would have taken longer if Kennedy had not been assassinated.

Like it wouldn't have started. This policies would have started in 64. They might have taken to 68 and they may have taken another.

Something else would have had to have happened to kick it off. That's that one.

ht here in the US starting in: 2009

The personality of those, of those were a young population who was disgruntled, but yet not quite to political dominance yet. And there was still an era of political conservatism and worrying about spending. Right. That was involved in that.

Ultimately that was the beginning of kind of, or you could see it already coming at that point. But these cycles are tied to ages and demographics. The baby boomers had to start, you know, again, to think about this. We've had 15 years.

Think about how many baby boomers have passed and think about how far and retired or you know, are no longer voting in some form or another or applying pressure to the political system. And meanwhile those, those kids who are doing Occupy Wall street and 18 year olds, 18 year old are now 33. Right.

So the political winds have shifted as a function of demographics because again, this is a critical thing that people don't understand. People think demographics is rich versus poor. It is, but it's also old versus young because it's capital versus labor.

And as you get older, you are more generally capital. And when you're younger, you're labor. And so the entities that have lived through this period of being disadvantaged because of inequality are young.

And as they grow to political dominance, the zeitgeist, the political winds shift. That's a critical thing that people don't really appreciate. And so it took, you know, every year's four, every election is four years.

It took several election cycles. And we started to see it. People wanted change. That's what Obama was about, because that was populism, right? Change. Why do we want change?

Why did they want. People didn't understand fully. There wasn't.

It wasn't as refined, but it was tied to this inequality and this feeling of the system does not work for me. Well, that created more frustration by a lot of the entities and the labor, the real labor, which is more rural. Right.

Because it didn't represent them. It didn't represent them. It wasn't male focused, it wasn't white focused. It wasn't all the things that we know about. Right.

And that created a backlash by the same, by the way, people who have been you know, by the people who are also being disadvantaged, whether you're poor white in West Virginia or you're poor black in Chicago, like it's the same effect that is, that is making you disgruntled.

The problem is people start pointing at each other and at the end of the day, the most disgruntled are probably the rusted out cities in middle America because male white have been.

Even though the primary reason that, that all of them are performing have been hurt probably more because more female engagement in the last 40 years in the workforce, more minority involvement in the workforce.

ams that were promised in the: 1960

And the key unleashing here was, was two things. One, bringing the right left.

So Donald Trump brought the conservative side, the non populist side of politics, kicking and screaming to the left because he is a marketer and he saw he's really good at giving people or telling people he's going to give them what they want.

And he saw Trent and he told him, I don't know that he even realized it at first, but once he realized that he went headlong into it, he told them what they want, which is popular. And bringing the right left. Wow, that's a, you know, now the whole thing's left.

And whether you're AOC or Bernie Sanders who have all seen again upsurge in their interest or, or Donald Trump, you're populist now. And that paired with a catalyst which was Covid.

You know, our, our assassination of Kennedy was Covid and that released a massive amount of fiscal spending.

And by the way, those policies were not just focused on, on that, that period and during COVID it was a crisis that was very much taken advantage of by politicians to, to institute populist policy and populist policy that, that will stretch 10, 20 years.

To be clear, like we're still, we're just starting to see some of the fiscal populous impulses from COVID So anyway, so that, that's, that's how it's played out now. So you asked, you asked me a simple question, give you a long line to answer. I tend to do that.

Niels: 00:47:53

I just wanted a year. I thought like this going to take five seconds.

Cem: 00:47:58

So the answer is: 2020

So if you, if you want to just kind of look at a rhyme and see what the verse may look like, which is, I think what you're going for. You know, there's, there's 18 years in there, 64 to 82. This probably goes to 20, 38 or so.

Niels: 00:48:23

haved. So let's just say it's: 2020

So for now you could say, well, it's a little bit different from last time, or maybe it's not. I don't even know exactly what the equity markets were doing. But what I'm trying to get to, because I think it might be a nice segue to.

One of the topics that I wanted to touch on with you is the role of inflation.

Because you can have the populist in society, but the question is in my mind is does that impact performance of equities or is it really what happens to inflation that is the one that drives the return during these periods? That's what I was trying to figure out and I wanted your thoughts on that.

Cem: 00:49:22

Yes, inflation or interest rates. Right. And the two things are intrinsically tied, are critical.

Like that is where the rubber meets the road, that is the supply and demand that drives the market outcomes.

But those are affected by the populism to such an extent that I would argue that this period, and I don't want to dive too deep into this because this could be another two hour show. But the. We had populist periods before the 60s and 70s and they weren't inflationary by the way. Right.

Like Great Depression was a very different world, very populous period. Interestingly, when you put markets in real terms, they have the same exact performance metrics. Literally the exact.

If you just took markets to real terms and you looked at charts, literally that period, which is dramatically different because it was a deflationary environment, had very, you know, again, in real terms, the same dynamics and nominal, completely different. So important to note that in real terms this populism and the dynamic effects we're talking about will likely play out this way.

But in nominal terms, you'll have very different outcomes. And even the interest rate and inflationary dynamics will create slightly different supply and demand dynamics as a function and change path.

But the difference now and the reason we're more likely to be Inflationary, as opposed to something like the Great Depression is because of the Federal Reserve and the power, you know, the Fed was not around at that time or at least dominant enough.

Niels: 00:51:02

Just.

Cem: 00:51:03

Yeah.

And their mandate is very clearly to avoid a Great Depressionary kind of volatile environment and to use nominal illusion, for lack of a better term, to manage the volatility of a cycle like this much better politically, you could argue.

Not just politically, in terms of real outcomes too, to manage market volatility through these periods and, and have used the shaving of coins, for lack of a better term, to manage the loss of real wealth than through something like the Great Depression.

Niels: 00:51:41

But I get the impression that you are expecting some changes, if nothing else, certainly in the volatility of fixed income markets in currencies which are obviously related to fixed income. How do you see this play out or interlink with some of the other things we've talked about?

Cem: 00:52:02

Yeah. So the Federal Reserve is in an incredibly tricky situation here. Take politics out of it. Take the, I mean take Donald Trump not to do.

Niels: 00:52:14

But we can try.

Cem: 00:52:15

Right. Not out of it, but like take, take Donald Trump and his willingness to kind of take over the reins and do. We can talk about that as well.

But you know, they have a dual mandate.

They have one tool and they are being asked to do essentially an impossible task which is control both an environment that we borrowed from the future and created structural inflation. Right. And that structural inflation is likely to hurt both Right. At the same time. So they had an incredibly easy task the last 40 years.

They, you know, they were able to create price stability with excess growth through essentially infinite monetary policy because they didn't have a mandate on inequality. And they kept saying not a problem, our mandate.

But of course, if you're managing until you're removing crisis from the system, the political system, the political system is set up to not be able to pass laws unless you do have a crisis. You're by definition, it may not be your mandate, but you're by definition structure creating massive inequality.

And you will until it I think is ultimately break. And so now if we're going to deal with inequality and that not political issue now it's the political side problem.

We're going to deal with it now the Fed is completely has our hands tied.

So given that the Fed is going to be forced to try and manage two sides of the equation and when there's more inconsistency and less ability to control. Right. Volatility. We've talked about the fed put for 40 years. If the Fed Put is no longer truly valid or clear what they can or cannot do.

What do you think that does to volatility and where does that volatility express itself the most? And the answer is historically. You can look at the data and we've talked about this for some time.

We talked about a year, a year and a half, two years ago. Historically the greatest volatility during these populist periods does not come in equity markets.

It does not come in commodity market like precious metals. Yes. Because those are more of a currency. But does not come in energy markets or whatever. People would naturally think that that would be the case.

It actually comes in FX yield bonds, which makes sense. Right. And precious metals, you have a time of deglobalization, a time of great global strife and global conflict.

And on top of that you have a time of Fed lack of control over economic outcomes. And so, so that's where you should be playing. We've had a relative to, to.

I mean generally it's been increasing the volatility broadly over the last two, three, four years in those areas. But a relative time implicitity there. And, and I think the coming of the election of Trump again is an acceleration point to that volatility.

And, and those assets will be. It'll be pretty wild. And actually that dovetails into our gold conversation. I don't know if you want to go there.

Niels: 00:55:33

I was just going to say because that's the other thing I really wanted to acknowledge you for because a long time ago, probably more than a year ago, you first started talking about the opportunities you saw in a gold volume in particular long dated gold vault and in particular gold coal long dated gold option. So congrats on that. But also what now?

Cem: 00:56:00

Yeah, in: 2021

And an oil volume was through the roof. We said look, this is a massive structural secular opportunity. And that was, you know, very unpopular opinion at the time.

Now, now it's not so unpopular, which is a reason why it's going to be more volatile. But, but yeah, we've obviously seen a massive surge in gold and gold upside called ball.

You know, the calls importantly, it's not just volume in general.

Like the calls were massively, like the curve was flat and gold calls absolutely exploded historically actually the oddest, not the oddest, the thing that I would most highlight to people.

And recently with the gold decline, you know, after Trump's election, people have been like all of a sudden, you know, never mind that we call this in 22, you know, on so many different levels. Like got this just right. People are also losing some confidence in the rally.

And the thing that's odd actually is that we actually haven't seen much realized volatility in gold in this rally. I want to be clear when I say massive volatility, the best performing asset from the 68 to 82 period, not even close, is gold.

But it was also the most volatile asset. Remember we untied ourselves from gold, you know, like in the US there it's a massive like 50% type declines. So. So be prepared for volatility.

And if you think it's going to be a straight line and you're going to sell it as soon as it starts moving down or, you know, like you're doing it wrong, this is going to be. There's a reason we own calls and not stock. Right. Or not the underlying asset. So anyway, prepare for volatility.

Would it surprise me if it dropped another 20%? No. Would it surprise me if it rallied 50%? No, it wouldn't. The secular trend is up.

It will continue to and actually by the way, most likely time to get some volatility.

The other way, not surprisingly, is when everybody's all in and these things cool down and get volatile when everybody has is on one side of the boat and it's been a very popular trade, whereas it wasn't when I first started talking about it.

And so yeah, expect when you start hearing people turn negative on it, that's when you start buying it with two hands again and again focus on volatility in the calls. There's still, even though it's a lot higher, still cheap, because it got me. And we're not talking short data calls.

Niels: 00:59:09

We'Re talking long dated calls maybe to round things off. Talking about things that is linked to volatility in many people's mind.

It's also linked to gold in many people's mind, but it's not real gold, it's virtual gold. It's Bitcoin 100,000 pretty close to that level. There's new Bitcoin ETF options coming. What are your thoughts about bitcoin?

I don't even know whether we want to go further than bitcoin because maybe it is different to the world of crypto.

Cem: 00:59:49

Yeah. So more long term, meaning this period we've talked about. Right. That we're in not long term, 50 years. Right. You know, next decade.

Bitcoin is millennial on down gold. Gold is not a commodity in the sense that it's valued because of its industrial capabilities. Yes.

There's some portion of that that's not what's important. It is store l. And it has value because people believe in it. Right.

This is part of why it's so volatile, because it can also, all of a sudden people can lose belief. Right. Bitcoin has captured the belief of this, these generations.

And if they are the ones that are coming to political dominance, the ones we want to be looking at, like what, what they want is what's likely to happen. Probably don't want to bet against Bitcoin. And then maybe it takes some of gold's upside off the table because people are buying bitcoin as well now.

The difference is gold's been around for, you know, 100,000 years, right? This has been around for, you know, 20 years. And so we start talking about 20, 30 years.

There are bigger questions, I think until sovereign entities start adopting it as a currency, I think their concerns longer term, I've talked about this, but I think you have to have a situation where the entities in power don't see it as a threat. There's a reason the US unpinned itself from gold, because it constrained the US's power.

And Nixon, Nixon's untying of the dollar from gold gave the US infinite power, essentially.

And to be clear, if the US ever lost the exorbitant privilege of the US dollar, like, you know, incredibly, you know, never mind the size of the military or anything else, that's by far the biggest power. But that's not going to happen overnight.

And you better believe, whether you're China, which has already showed that, you know, this ban bitcoin, right. Or the us, at some point, if it gets big enough and it becomes a threat to the exorbitant privilege of the US dollar, that's a problem.

And so there is a cap on. Is it 13 million, which I think Michael Saylor is calling for in bitcoin?

Maybe I'm skeptical of that high, you know, because again, at some point there's gravity to this in the sense that it does not have a sponsor. Now, to be clear, world, these big things work in mysterious ways.

And, and I want to be clear, like Donald Trump and Elon Musk, you know, bringing Elon into this picture and, and, and the talk of adoption of bitcoin, again, I think it's completely and not in the long term best interests of the United States, but maybe it's in the short term best interest for, for them politically and for centralizing their own power.

And so, yeah, short term, you know, don't get in the way of Bitcoin if the one big overhang is regulatory and long term kind of, you know, access and openness. You know, Bitcoin's been worried about the sec, Right. And regulatory over, overarching kind of Federal Reserve control over it, et cetera.

That's the main headwind for it. Right. But if, you know, that's why after Donald Trump and Elon victory, this, this is just taking off. It's not just a narrative, by the way.

Narrative matters, but it's truth. You're taking the biggest risk off the table for Bitcoin in the next four years.

Niels: 01:04:01

One last thing I'm curious to know about, and I would phrase it as a kind of a neutral question, even though it may have certain feelings attached to it, because it is about Elon Musk, but I'm curious about your thoughts about having someone like him.

Whether you like him or hate him doesn't really matter, but someone with that mindset giving at least some kind of job description to make government more efficient, and then he's being joined, obviously by another Silicon Valley person for that, Vivek.

And I'm curious because for so many years, I think we probably all feel that government is just growing and growing and it's not as efficient as you would think, whether I look at Denmark, whether I look at whatever country.

So the experiment, as I would call it, having two people like that influencing efficiencies is interesting to me because if it works, maybe that's something the rest of the world should pay attention to. So, politics aside, what do you think about that experiment?

Cem: 01:05:30

It's a big question. We don't know. We don't know.

But I find it really, really, really interesting that at the same time that we are amidst this populous period that it is popular to gut government. I think that's probably not going to end well. Those two things are in almost diametric opposition to one another.

e are facts, came on board in: 2016

He, again, everybody likes tax cuts, so. And everybody felt like, oh, we're getting something, but 95% of the benefit of that went to corporations and wealthy individuals.

And you can do those things and co wool over people's eyes. But at some point that just exacerbates populism and makes things worse. Now, Donald Trump might be able to gain more control.

He's done through the Supreme Court and through other pathways. Now Trump versus US Legally he has more ability to pull levers and secure more power in the system.

And trust me, he's going to try and do even more in the next four years. And so he might be able to overcome what's likely to become pushback over time.

And again, I'd like to highlight that whether it was Nixon or Kennedy or LBJ or Ford or Carter or, you know, none of them lasted long enough as transplant. It is a tough time to be president. Is a.

Niels: 01:07:44

We know already he's only going to last four years, right?

Cem: 01:07:46

Well, yeah, that's what, that's what Erdogan said in Turkey. Right. So, you know, you don't know again, people think it's impossible but you know.

Niels: 01:07:53

There are, you mean if he changes the law and he could do another.

Cem: 01:07:56

There's all kinds of interesting things that can happen. I would not.

And you can pin that look of having talked about that and saying that's a higher problem than people expect doesn't mean he's going to change the laws and make it, you know, that could be it. But you know, he could put his child in office and blah, blah, blah and yada yada. Right. Like he's at some point he's got pass. Right.

But the point is the, the impulse and what he stands for. And the point is that is likely to become his policy as well, is likely to become unpopular in four years.

Now, again, he can manage that with power and other things and potentially done that now.

But I'm saying that in the sense that, you know, Donald Trump could very well gut the system and which is really good for business and wealthy individuals and corporations, not good for the populist, you know, giving populists what they want and at the same time kind of give do tariffs and do stuff which are much more marketing wise, oh, look, I'm doing populist things.

And so if he takes this kind of dual pronged approach, which is not necessarily what happened during the 60s and 70s, my guess is it'll extend the populous cycle a bit and the path will be a bit different and it might actually make it so that the kind of, the poor performance may extend the cycle a bit in terms of equity performance and other things. And Then this kind of more dead kind of cycle may get pushed out or be more volatile down the road. But, you know, something to watch for.

The impulse is the impulse, the political wins and the demographic realities are not going anywhere. That's not going to change. And if you don't give the people what they want, it's going to, you know, stick around and get worse.

And so I would watch the policy, you know, pretty confident he will do some of the things like immigration policy and tariffs to some extent, and those things will continue to be populous. But I would look under the hood and see, you know, what is happening on the other end. And the regulatory end is a big piece of that.

If they completely do what they're saying, which it's going to be hard for them to do, by the way, and just start gutting, you know, different parts of the government and restructuring, I don't think it'll make people happy in the long run. Again, if you gut Social Security, people happy, if you gut, you know, Housing and Urban Development, people are going to be unhappy.

If you, if you got, you know, go to the budget, you know, there's a reason government exists.

Government exists because, you know, without it, you know, rich people get richer and poor people get poorer and it's survival of fitness and you get a, you know, system. And that's what we're trying to fix.

So there is a populist impulse he can do it to kind of gutting the system and like burn it all down is a feeling, right? But I'm guessing if they don't burn it down and build it back up the right way, if they just burn it down, I won't be pretty.

I don't think politically for them in.

Niels: 01:11:08

The long run, it will certainly gives us lots to talk about the next four years. Jim, this was, this was an awesome conversation. I really appreciate all of your insight.

It was wonderful to review some of the old things and see how they played out. So well. Obviously now people have come to expect just to listen to you, Jim, and know what to do with the portfolio. So stay tuned.

There'll be a lot more of that coming.

If you want to show your appreciation for all the work that Jim puts into this, please go to your favorite podcast player, leave a nice message, rating and review. We so appreciate that. Next week I'm back with Rich and a surprise guest, I think. So that's going to be super fun.

And if you have any questions you want us to tackle, feel free to send them to infotoptradersonplock.com from Germany. Thanks ever so much for listening. We look forward to being back with you next week and until next time.

As usual, take care of yourself and take care of each other.

Niels Kostrup Larsen: 01:12:12

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.

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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.