WEBVTT - The Market's Big Bet on Low Volatility 0:00:10.640 --> 0:00:14.040 Hello, and welcome to another episode of the Odd Thoughts Podcast. 0:00:14.120 --> 0:00:18.840 I'm Tracy Alloway and I'm Joe wisn't so, Joe. It's 0:00:19.120 --> 0:00:21.560 that time of year again. You know, we're getting close 0:00:21.600 --> 0:00:25.640 to the end of and that means everyone is starting 0:00:25.680 --> 0:00:30.400 to talk about what nineteen might have in store for markets. Truly, 0:00:30.560 --> 0:00:34.080 the most wonderful time of year, I think is the 0:00:34.200 --> 0:00:37.720 season right about now. It always warms my heart and 0:00:37.760 --> 0:00:41.160 that's when you start getting analyst notes from sell side 0:00:41.479 --> 0:00:47.120 shops talking about what the forecasts are for all asset classes, uh, 0:00:47.159 --> 0:00:50.160 stocks and bonds and currencies. I truly think it's really 0:00:50.200 --> 0:00:54.639 like the most heartwarming time of year for right, Okay, Um, 0:00:54.680 --> 0:00:59.720 don't you absolutely the most wonderful time of the year. Indeed. Uh, 0:01:00.040 --> 0:01:02.880 But there's there's a little bit of a difference this year, 0:01:03.000 --> 0:01:07.000 I feel, and probably it's because December is coming off 0:01:07.040 --> 0:01:11.319 the back of November and October, which, as we've discussed 0:01:11.360 --> 0:01:15.160 on the All Thoughts Podcast before, have been pretty painful 0:01:15.319 --> 0:01:18.560 months for a lot of investors. Yeah, that's true, and 0:01:18.600 --> 0:01:24.800 of course people always update their forecasts basically to some extent, 0:01:25.040 --> 0:01:28.560 extrapolating on what happened in the recent past. So I 0:01:28.600 --> 0:01:31.080 think the fact that we got this sort of October 0:01:31.200 --> 0:01:35.680 November intense about of volatility has caused people to say, oh, suddenly, 0:01:35.720 --> 0:01:38.440 we see all these new risks on the horizon, Whereas 0:01:38.440 --> 0:01:40.760 if you had asked them at the end of September, 0:01:40.920 --> 0:01:43.000 they would have been much more sanguine about what the 0:01:43.040 --> 0:01:46.720 future had in store. Yeah, everyone's sort of rushing to 0:01:46.920 --> 0:01:51.240 retool their risk forecast for next year. But there's one 0:01:51.400 --> 0:01:56.280 person who has been consistent in forecasting a very similar 0:01:56.520 --> 0:01:59.840 set of risks for many years now, and that person 0:02:00.080 --> 0:02:02.240 is going to be our guest on the show today. 0:02:02.600 --> 0:02:04.680 That's great. I'm looking forward to this because a it'll 0:02:04.720 --> 0:02:08.680 be nice to get an alternative viewpoint from the always 0:02:08.720 --> 0:02:12.720 sort of, you know, somewhat rosy outlook of the mainstream 0:02:12.800 --> 0:02:16.040 investing class. But it's also interesting to talk to people 0:02:16.080 --> 0:02:19.520 who are contrarians, because while it's true that you know, 0:02:19.840 --> 0:02:22.560 it can pay to have a different view, in the 0:02:22.639 --> 0:02:25.240 meantime when markets aren't blowing up, it can be a 0:02:25.320 --> 0:02:31.400 costly view. So how you reconcile that is always very interesting. Yeah, absolutely, 0:02:31.440 --> 0:02:33.320 And I have to say I've been a fan of 0:02:33.320 --> 0:02:36.200 this particular person's work for a very, very long time. 0:02:36.360 --> 0:02:38.880 So I'm quite happy that we're going to have him 0:02:38.880 --> 0:02:40.320 on the show and that we'll get to put these 0:02:40.400 --> 0:02:43.760 questions to him. So, without further ado, our guest for 0:02:43.840 --> 0:02:49.320 this episode is Chris Cole over Artemis Capital Management. Chris 0:02:49.560 --> 0:02:53.760 is the founder and c IO of Artemis Capital and 0:02:53.880 --> 0:02:58.760 he's been writing about the markets and specifically volatility for many, 0:02:58.800 --> 0:03:01.760 many years now. Chris, welcome to the show. Thank you 0:03:01.800 --> 0:03:04.400 for a pleasure to be here. So Chris, maybe just 0:03:04.440 --> 0:03:06.239 to get started, you can give us a little bit 0:03:06.360 --> 0:03:10.520 about your background and how you got to Artemis and 0:03:10.680 --> 0:03:14.200 what exactly it does, because it's a little bit unusual, 0:03:14.280 --> 0:03:17.959 I feel sure. Well, I think the mission of Artemis 0:03:18.720 --> 0:03:23.880 is to really create opportunity out of chaos. Normally, when 0:03:23.880 --> 0:03:27.919 there's volatility in the marketplace, that's a bad thing, big 0:03:27.960 --> 0:03:31.359 equity draw downs, it impacts people's portfolio in a negative way. 0:03:31.960 --> 0:03:35.760 Our job is to turn that volatility into something that's positive. 0:03:36.640 --> 0:03:39.440 And the history of the firm actually comes out of 0:03:39.640 --> 0:03:42.560 an old school hedge fund story. I used to I 0:03:42.600 --> 0:03:45.400 was trading my own proprietary capital throughout the period of 0:03:45.400 --> 0:03:49.320 two thousand seven to two thousand ten, and really turned 0:03:49.360 --> 0:03:52.880 two thousand eight into something that was quite profitable and 0:03:53.240 --> 0:03:57.280 try to develop strategies that paid off in the event 0:03:57.320 --> 0:04:00.280 that there was a tremendous amount of volatility, but it 0:04:00.360 --> 0:04:04.000 didn't bleed uncontrollably or lose a tremendous amount of capital. 0:04:04.240 --> 0:04:07.680 Uh if the market continue to do well. And that 0:04:07.800 --> 0:04:09.640 that was how Artemis was founded. It was founded out 0:04:09.680 --> 0:04:11.520 of a bedroom um and you know today we have 0:04:11.560 --> 0:04:15.280 institutional clients all over the world. So is the goal 0:04:15.560 --> 0:04:20.000 of Artemis to be or even the goal of their 0:04:20.080 --> 0:04:24.159 sort of framework, to be profitable over the long term, 0:04:24.360 --> 0:04:28.200 or is it as some other funds are positioned, to 0:04:28.440 --> 0:04:32.799 essentially allow people to take more risks during the good 0:04:32.800 --> 0:04:37.200 times while ensuring that when the bad times hit unexpectedly 0:04:37.640 --> 0:04:42.120 that they don't suffer a massive negative shock. Basically, the 0:04:42.160 --> 0:04:44.719 answer is both actually depends how you want to use 0:04:45.080 --> 0:04:47.040 the uh. You know where a hammer, you can use 0:04:47.040 --> 0:04:49.839 this whatever we like to. I think we have clients 0:04:49.839 --> 0:04:52.120 to look at it in both ways. But the goal 0:04:52.160 --> 0:04:54.040 at the end of the day is is that throughout 0:04:54.040 --> 0:04:57.680 the business cycle we want to deliver returns that show 0:04:57.760 --> 0:05:00.919 excess alpha that are on par with what you'd expect 0:05:01.000 --> 0:05:03.880 from an alpha generating hedge fund. But The difference is 0:05:03.880 --> 0:05:06.640 that we want to create most of our returns when 0:05:07.120 --> 0:05:09.560 the overall market is suffering the most and when there's 0:05:09.560 --> 0:05:13.600 the most volatility. So instead of where most the classic 0:05:13.600 --> 0:05:18.120 hedge fund structure of the classic portfolio has these long 0:05:18.200 --> 0:05:20.520 periods when there's a bolt market and people are doing really, 0:05:20.520 --> 0:05:23.159 really well. But that's when we're just trying to stay 0:05:23.160 --> 0:05:26.360 static and not not really make or lose a lot 0:05:26.400 --> 0:05:28.640 of money. Um. But when we end up having that 0:05:28.800 --> 0:05:33.640 twenty brought down draw down a market crash, that's when 0:05:33.640 --> 0:05:36.560 we want to really shine and do do particularly well. 0:05:37.120 --> 0:05:39.720 And uh So, to that effect, you can you can 0:05:39.720 --> 0:05:42.560 think of us as a hedge, but we we like 0:05:42.640 --> 0:05:45.080 to look at ourselves as a hedge that pays you 0:05:45.120 --> 0:05:47.960 to own it through the business stuffle. Right, So you 0:05:48.000 --> 0:05:51.560 mentioned creating value out of chaos, and I'm trying to 0:05:51.560 --> 0:05:55.479 think how to phrase this question. But why did chaos 0:05:55.600 --> 0:06:00.919 or volatility become your thing or your area of expertise 0:06:01.000 --> 0:06:06.400 or focus a long time ago? Uh Now, I train 0:06:06.520 --> 0:06:08.839 myself with the c s A, I PAS the CFA program. 0:06:08.880 --> 0:06:12.440 I worked at Merrill Lynch in my early days, and I, 0:06:12.600 --> 0:06:16.000 like most people, began starting out and value investing and 0:06:16.040 --> 0:06:18.640 I looked at all these different strategies like like value 0:06:18.680 --> 0:06:23.839 and momentum and all these different financial products, and I 0:06:23.880 --> 0:06:25.200 really kind of looked at them the way that an 0:06:25.200 --> 0:06:28.839 alien would looking look at different looking at different return streams, 0:06:29.640 --> 0:06:32.520 whether you're talking about credit or value investing. These are 0:06:32.600 --> 0:06:35.680 mean reversion strategies. And then there are strategies like global 0:06:35.720 --> 0:06:37.640 macro and c t A s that make money off 0:06:37.680 --> 0:06:42.280 of prend or divergencies, divergences and change. So I came 0:06:42.320 --> 0:06:44.479 to this conclusion that really there were only two at 0:06:44.520 --> 0:06:49.640 A classes in actuality, long and short volatility. There's people 0:06:49.680 --> 0:06:52.680 that say is volatility asset classes, saying volatility is the 0:06:52.720 --> 0:06:58.280 only ethic class because in a crisis, people have all 0:06:58.320 --> 0:07:01.760 of these these different strategies in their portfolio. But in 0:07:01.760 --> 0:07:04.960 a crisis, these strategies end up looking a lot like 0:07:05.000 --> 0:07:08.720 a short volatility strategy, a strategy that is that ends 0:07:08.760 --> 0:07:12.160 up doing particularly bad during draw downs, and all of 0:07:12.200 --> 0:07:15.120 these different diversification ends up being correlated with one another, 0:07:15.560 --> 0:07:17.480 and then you end up having a strategy that is 0:07:17.480 --> 0:07:24.680 particularly fragile to change. So institutional investors, individual investors in essence, 0:07:25.440 --> 0:07:27.960 kid themselves into believing that they have all these different 0:07:27.960 --> 0:07:32.120 asset classes when n actuality, they're just crowding into strategies 0:07:32.160 --> 0:07:34.320 that are that are fragile to change in the market, 0:07:34.880 --> 0:07:38.440 and that the true diversification is actually finding strategies that 0:07:38.480 --> 0:07:41.480 are long volatility or strategies that that make money from change, 0:07:42.080 --> 0:07:44.600 and that when you look at the world in this lens, 0:07:45.000 --> 0:07:47.480 there there are really there's really only one asset class, 0:07:47.520 --> 0:07:51.160 and volatility is the only real asset class in a 0:07:51.200 --> 0:07:56.320 sense of replicating returns chris In theory, this idea of 0:07:56.360 --> 0:08:00.440 having assets or having diversification that could pay off in 0:08:00.520 --> 0:08:05.440 both long, heightened and reduced volatility is the premise behind 0:08:05.680 --> 0:08:09.360 a lot of sort of do it yourself at home portfolios, 0:08:09.440 --> 0:08:11.680 like buying a lot of stocks and buying a lot 0:08:11.720 --> 0:08:15.000 of bonds, buying treasuries that you know, maybe pay off 0:08:15.040 --> 0:08:17.440 a little bit a little bit extra money during the 0:08:17.480 --> 0:08:20.240 good times button bad times bit up and are a 0:08:20.320 --> 0:08:24.560 safe haven asset class when we get a surgeon volatility. 0:08:24.680 --> 0:08:27.800 This arguably has worked well for the last few decades. 0:08:28.240 --> 0:08:30.880 Do you think there's a reason that that won't work 0:08:30.920 --> 0:08:33.840 in the future, and that the assets that seem to 0:08:33.880 --> 0:08:37.240 have thrived in the past during heightened volatility won't do 0:08:37.320 --> 0:08:40.199 so in the future. You know, it's a wonderful topic 0:08:40.240 --> 0:08:44.200 to bring up because for the greater part of thirty years, 0:08:44.440 --> 0:08:47.200 people have looked at the stock bond anti correlation and 0:08:47.200 --> 0:08:49.000 have said, you know, why do I need to be 0:08:49.080 --> 0:08:51.880 invested in something like long volatility or something that that 0:08:52.000 --> 0:08:54.800 is exposed to change when I can just be invested 0:08:54.840 --> 0:08:57.800 in fixed income because I know that bonds will go 0:08:57.880 --> 0:09:01.240 up when stocks go down, and that has been true 0:09:01.280 --> 0:09:05.960 for my entire life. But if we take a longer 0:09:06.000 --> 0:09:10.240 history and look out one one hundred twenty years, and 0:09:10.240 --> 0:09:13.120 I presented this evidence as far back, it's become a 0:09:13.160 --> 0:09:15.400 popular thing to talk about now. But if you look 0:09:15.400 --> 0:09:18.160 at some of Artemiss research dating back to two thousand fifteen. 0:09:18.200 --> 0:09:21.600 Two fourteen, we talked about this at length, stocks and 0:09:21.679 --> 0:09:26.760 bonds have actually spent more time correlated with them one another, 0:09:26.920 --> 0:09:30.880 and they've spent anti correlated. There's been multiple periods in 0:09:31.120 --> 0:09:36.400 history where stocks and bonds have dropped together for two 0:09:36.440 --> 0:09:39.920 to three years at a time. This includes the early 0:09:40.000 --> 0:09:43.440 nine hundreds, periods like in the fifties, and periods like 0:09:43.480 --> 0:09:46.760 in the late seventies. So if I go to an 0:09:46.800 --> 0:09:51.360 average financial advisor, out on the street and I say, what, 0:09:51.600 --> 0:09:53.720 you know, I have a hundred thousand dollars. What should 0:09:53.720 --> 0:09:55.839 I do with my money? That person is likely to say, well, 0:09:55.920 --> 0:09:58.760 you put it in sixty stock bond split and then 0:09:58.760 --> 0:10:01.520 the bonds will protect you when you're stocks too badly. 0:10:02.040 --> 0:10:03.680 And if I have a little bit more money, I 0:10:03.679 --> 0:10:06.280 can go to a very expensive financial advisor and they'll say, 0:10:06.280 --> 0:10:09.840 you know what, we want you to lever the bonds 0:10:09.880 --> 0:10:13.320 against the stocks because that's better on a market with 0:10:13.480 --> 0:10:17.360 risk reward framework efficient frontier. That's something called risk perry. 0:10:17.440 --> 0:10:19.760 But if you look at these portfolios, they performed very 0:10:19.880 --> 0:10:23.439 very well over the last thirty years. But if we 0:10:23.480 --> 0:10:27.120 look out over a hundred years, there are multiple free 0:10:27.160 --> 0:10:30.760 year periods where these portfolios would have had massive drawdowns, 0:10:31.360 --> 0:10:35.280 massive drawdowns in some instances for risk parity, even even 0:10:35.960 --> 0:10:39.960 career ending drawdowns. So this assumption that stocks and bonds 0:10:39.960 --> 0:10:43.880 will always be anti correlated is a very very dangerous assumption. 0:10:44.679 --> 0:10:47.680 And I think all one has to do to prove 0:10:47.720 --> 0:10:52.040 this is look look across history. Now, if yields were 0:10:52.080 --> 0:10:55.000 all the way up at you know, ten, as they 0:10:55.000 --> 0:10:57.720 were in the late seventies, you could sit back and say, well, 0:10:57.720 --> 0:11:01.040 there's room for bonds to perform uh in the event 0:11:01.120 --> 0:11:03.960 stocks drop. But if we think about what it would 0:11:03.960 --> 0:11:07.600 take for treasury bonds to perform as well as they 0:11:07.600 --> 0:11:10.360 did during the last recession, we'd have to have treasury 0:11:10.440 --> 0:11:14.559 yields go all the way down to negative two. I'm 0:11:14.600 --> 0:11:17.600 not saying that that's not possible, but I'm just saying 0:11:17.600 --> 0:11:22.760 that's highly improbable. And if you're this is the baseline 0:11:22.760 --> 0:11:27.439 assumption from which trillions of dollars of asset allocation decisions 0:11:27.440 --> 0:11:30.880 are made upon this, this assumption on the stock bond 0:11:30.880 --> 0:11:35.440 at a correlation. So this this makes alternative forms of 0:11:35.480 --> 0:11:40.160 defense like volatility, like smart global mackerel very very important 0:11:40.200 --> 0:11:42.880 at this particular juncture in the cycle. I think it's 0:11:42.960 --> 0:11:45.560 very important that people understand that the stock bond, the 0:11:45.600 --> 0:11:48.600 assumption that bonds can be a form of defense for you, 0:11:48.960 --> 0:11:52.520 is particularly dangerous at this stage of the market cycle, 0:11:53.000 --> 0:11:56.640 when most yields are at their zero bound. Right. So 0:11:56.679 --> 0:12:00.640 the argument here is that when most people talk about 0:12:00.679 --> 0:12:05.439 being short volatility, there's an assumption that they're explicitly short 0:12:05.520 --> 0:12:11.040 volatility by for instance, you know, buying VIX related exchange 0:12:11.080 --> 0:12:14.439 traded products or something like that. But you're saying that 0:12:14.480 --> 0:12:17.840 there are big parts of the market that are implicitly 0:12:18.120 --> 0:12:23.400 short vall through an assumption of existing relationships like the 0:12:23.440 --> 0:12:28.680 correlation between bonds and stocks. Are there other things that 0:12:28.800 --> 0:12:33.240 you think are implicitly short vall in the market. Absolutely. 0:12:33.640 --> 0:12:35.560 One of my papers I talked a little bit about 0:12:35.600 --> 0:12:38.920 the short ball trade as being like an oboros or 0:12:38.960 --> 0:12:42.120 the classic image of a snake devouring its own tail 0:12:43.120 --> 0:12:44.800 um And this is this is how I like to 0:12:44.920 --> 0:12:51.280 visualize modern markets today, this financial outcomy driving markets higher 0:12:51.280 --> 0:12:55.760 and volatility lower. The global short vall trade now represents 0:12:55.760 --> 0:13:00.480 an estimated to trillion dollars in financial engineering strategies. And 0:13:00.679 --> 0:13:05.080 these strategies that I deem as short volatility simultaneous exert 0:13:05.160 --> 0:13:10.320 influence and are influenced by volatility. This includes what I 0:13:10.320 --> 0:13:14.280 would deem about sixty billion dollars of explicit short fall 0:13:14.320 --> 0:13:18.880 exposure and another one point four trillion dollars worth of 0:13:18.920 --> 0:13:21.920 implicit So what do I mean by the difference between 0:13:21.960 --> 0:13:26.240 explicit and implicit short fall? Well s, Explicit short fall 0:13:26.760 --> 0:13:29.800 tends to be the weak hands at the table. These 0:13:29.920 --> 0:13:33.280 are These are traitors or their institutions that are actually 0:13:33.280 --> 0:13:36.480 shorting volatively This is where you're actually going out and 0:13:36.559 --> 0:13:39.560 shorting a vixed future, where you're actually going out and 0:13:39.600 --> 0:13:42.640 you're rolling. Are you doing a by right overwrite program. 0:13:42.679 --> 0:13:45.880 You're actually shorting your shorting calls or your shorting puts 0:13:46.360 --> 0:13:49.640 to earn extra income UM. It involves actually selling a 0:13:49.679 --> 0:13:52.920 derivative UM. I think most people are aware of this, 0:13:53.000 --> 0:13:55.560 but this is actually the smallest component of the short 0:13:55.600 --> 0:13:59.920 alter rate. The much much bigger component of the short 0:14:00.000 --> 0:14:04.960 all trade, the trillion dollar plus component of it, is 0:14:05.000 --> 0:14:09.520 what I call implicit short fall. When you are when 0:14:09.559 --> 0:14:13.800 you are sorting an option, you are taking on the 0:14:13.840 --> 0:14:18.840 assumption of stability, and that assumption of stability expresses itself 0:14:18.880 --> 0:14:23.480 through various risk profiles that can be expressed in uh 0:14:23.520 --> 0:14:28.920 these esoteric Greek terms that we use. But long story short, 0:14:29.520 --> 0:14:33.520 you're taking the assumption of that volatility and markets will 0:14:33.560 --> 0:14:36.520 be stable. You're taking the assumption that there's not going 0:14:36.600 --> 0:14:38.800 to be any jump risk. This is something we've option 0:14:38.840 --> 0:14:42.080 traders are called gamma. You're taking the assumption that there's 0:14:42.080 --> 0:14:44.840 not going to be rising interest rates UM, and you're 0:14:45.480 --> 0:14:49.800 taking assumption that there will be stable cross asset correlations. 0:14:49.840 --> 0:14:55.040 These implicit short fall strategies replicate the payoff of a 0:14:55.120 --> 0:15:00.720 portfolio of short options by creating these similar exposures. So 0:15:00.760 --> 0:15:04.680 these would include strategies like ball targeting funds, which are 0:15:04.840 --> 0:15:07.680 a short gamma in the market, their short volatility and 0:15:07.680 --> 0:15:11.000 their short gamma. These would include strategies like risk parity 0:15:11.040 --> 0:15:14.760 which are implicitly short gamma and short correlation. So even 0:15:14.760 --> 0:15:19.720 though these strategies may not be directly selling volatility, they 0:15:19.760 --> 0:15:25.240 are implicitly replicating the exposure of a portfolio of short options. 0:15:26.120 --> 0:15:28.800 And you know what, one of the greatest examples of 0:15:28.920 --> 0:15:33.080 an implicit short ball trade in history was actually was 0:15:33.200 --> 0:15:40.680 the portfolio insurance debacle of portfolio insurance was implicitly um 0:15:40.880 --> 0:15:44.400 short some of these exposures of a short option portfolio, 0:15:44.480 --> 0:15:47.720 even though it was never actually shorting a put or 0:15:47.720 --> 0:15:51.760 a call option. Um So, I think many of these strategies, 0:15:51.880 --> 0:15:55.120 ranging from the the financial engineering of share by backs, 0:15:55.600 --> 0:15:59.320 to certain risk premious strategies, to certain ball targeting strategies, 0:15:59.560 --> 0:16:04.440 to certain risk parity strategies, which are comprising a very 0:16:04.560 --> 0:16:09.960 large portion of the institutional flows in equity markets today, 0:16:10.440 --> 0:16:14.720 are replicating the payoffs of a short straddle. And this 0:16:14.840 --> 0:16:18.520 presents a layer of embedded and very hidden risk that 0:16:18.560 --> 0:16:36.320 people aren't fully taking into consideration. Chris, I don't want 0:16:36.360 --> 0:16:40.960 to get too philosophical here, but whenever I think about this, 0:16:41.120 --> 0:16:45.080 I start my mind starts to drift beyond mere financial markets, 0:16:45.160 --> 0:16:48.480 and I always think about like, isn't life and living 0:16:48.720 --> 0:16:54.320 in a society implicitly short volatility? I take a job, 0:16:55.120 --> 0:16:57.880 there's no guarantee that that job will last. But as 0:16:57.920 --> 0:17:00.800 long as sort of things more or less function as 0:17:00.800 --> 0:17:03.240 they are, I keep my job, I buy a house. 0:17:03.640 --> 0:17:06.000 There's no guarantee that there's not going to be some 0:17:06.119 --> 0:17:09.320 freak fire or war in the area. But if there is, 0:17:09.440 --> 0:17:14.400 then of course that's completely potentially destroyed. Like isn't aren't 0:17:14.440 --> 0:17:17.240 we all always going to be as long as we're 0:17:17.240 --> 0:17:24.479 functioning members of society sort of all implicitly short volatility? Well, 0:17:24.480 --> 0:17:26.040 you know, Joe, it's it's funny you mentioned this, and 0:17:26.080 --> 0:17:29.480 I could ask this question a lot because I actually 0:17:29.520 --> 0:17:32.000 wear a watch that counts time backwards to my to 0:17:32.080 --> 0:17:36.600 my death, So so that gets some perspective on the 0:17:36.720 --> 0:17:40.280 issue the world. I guess that's right. I look at 0:17:40.320 --> 0:17:43.640 myself as a call option, you know, and I by 0:17:43.760 --> 0:17:47.320 there's an element of of time exposure. That's ticking off. 0:17:47.560 --> 0:17:50.120 We are a short time and that's that's a form 0:17:50.160 --> 0:17:54.120 of short fall. There are ways in our lives that 0:17:54.200 --> 0:17:59.160 we make ourselves and I fragile and in less exposed 0:17:59.240 --> 0:18:03.240 to the whims change. You know, certainly, if by by 0:18:03.280 --> 0:18:07.479 a process of self education and by learning, learning, um 0:18:07.560 --> 0:18:12.320 and reading and continually educating yourself, you are making a 0:18:12.359 --> 0:18:15.600 long volatility trade. By meditating and taking care of your health, 0:18:15.640 --> 0:18:18.720 you're making a long volatility trade. By having lots of 0:18:18.920 --> 0:18:22.040 meaningful connections in your life and knowing a lot of 0:18:22.080 --> 0:18:26.840 individuals um that that can provide good contexts and good 0:18:26.840 --> 0:18:31.880 healthy relationships. These are these are ways to be long volatility. 0:18:31.920 --> 0:18:34.320 But almost certainly most of what we do in life 0:18:34.359 --> 0:18:37.960 has an element of of of short vall exposure, and 0:18:38.200 --> 0:18:41.159 the biggest one of course being time that is the 0:18:41.560 --> 0:18:45.600 only true currency and the most fragile one. So is 0:18:45.640 --> 0:18:49.720 the implication here that overall people should think about the 0:18:49.840 --> 0:18:53.520 role of financial markets and investing sort of differently than 0:18:53.560 --> 0:18:57.080 they do, because I think like basically people see, they 0:18:57.119 --> 0:18:59.560 go about their lives and they make money from their jobs, 0:19:00.040 --> 0:19:03.479 and then to some extent, the role of investing in 0:19:03.520 --> 0:19:06.400 the market is to augment that and to turn their 0:19:06.440 --> 0:19:08.879 savings into even more and to make even more money 0:19:08.880 --> 0:19:12.399 than they would just get from labor income. It sounds 0:19:12.440 --> 0:19:16.320 like the implication is that, for you, since most of 0:19:16.320 --> 0:19:19.919 our lives are going about being short vall that to 0:19:20.000 --> 0:19:23.239 some extent, we should really rethink what the purpose of 0:19:23.280 --> 0:19:26.160 investing money is and that it should be more like 0:19:26.680 --> 0:19:31.000 a general lifeheage. I absolutely think that one of the 0:19:31.000 --> 0:19:34.480 ways to look at savings is to to make yourself 0:19:34.840 --> 0:19:39.920 and I fragile to turbulence, to give yourself options. So 0:19:40.160 --> 0:19:43.720 you know, it's amazing that the US is probably one 0:19:43.720 --> 0:19:48.040 of the only cultures in the world where we assume growth. 0:19:48.800 --> 0:19:50.720 I think my friend Jared Dillian has made this point 0:19:50.760 --> 0:19:54.000 really well, that it's it's always assumed that the stock 0:19:54.040 --> 0:19:57.600 market should always be going up, it's always assumed that 0:19:57.720 --> 0:19:59.720 earnings per share should always be going up. Now, that's 0:19:59.720 --> 0:20:04.120 been a fantastic assumption to bet on over the last 0:20:04.119 --> 0:20:07.080 fifty years, um and maybe a wonderful assumption to been 0:20:07.119 --> 0:20:09.840 on the next fifty years. But it's actually important to 0:20:09.880 --> 0:20:13.320 understand it's it's it's quite unusual in the history of 0:20:13.400 --> 0:20:17.160 most most nations. Most people don't have that philosophy. So 0:20:17.240 --> 0:20:20.159 the concept of being able to provide a sense of 0:20:20.160 --> 0:20:24.800 savings is not necessarily to to lever up your lifestyle, 0:20:24.880 --> 0:20:28.200 but it should be too to give you an ability 0:20:28.320 --> 0:20:31.119 to to be your highest self. The money and saving 0:20:31.119 --> 0:20:35.560 should be a form of of antifragility. Um Cash itself 0:20:35.600 --> 0:20:39.119 provides optionality, So I want to be an in the 0:20:39.160 --> 0:20:42.200 money call option. That's how I'm going to start thinking 0:20:42.240 --> 0:20:46.000 of myself. So I want to get back to that 0:20:46.200 --> 0:20:50.359 short volatility idea, because of course, in February we had 0:20:50.720 --> 0:20:54.439 this volumit getting occurrence where we saw a lot of 0:20:54.520 --> 0:20:59.880 explicitly short voll strategies like VIX related exchange traded notes 0:21:00.040 --> 0:21:03.960 and products blow up, and there was a theory that 0:21:04.040 --> 0:21:06.639 when they blew up, they basically had to hedge, and 0:21:06.720 --> 0:21:11.040 so they started pushing up the VIX index itself, and 0:21:11.119 --> 0:21:14.639 that kind of caused investors to get even more nervous, 0:21:14.680 --> 0:21:17.159 and then the VIX would go up even more and 0:21:17.320 --> 0:21:20.480 the exchange traded notes would have to hedge even more. 0:21:20.560 --> 0:21:23.280 So you have this feedback loop that ended up making 0:21:23.280 --> 0:21:26.320 the whole thing really really painful for a lot of people. 0:21:27.200 --> 0:21:30.639 I think you mentioned one point for trillion dollars for 0:21:30.800 --> 0:21:37.280 your implicit shortfall strategies. So I'm wondering, could we get 0:21:37.320 --> 0:21:41.960 a sort of self reflexive feedback loop in implicit shortfall 0:21:42.000 --> 0:21:45.600 strategies And if we did, how bad would that be 0:21:45.880 --> 0:21:49.720 for the overall market? Well, if we look at the 0:21:49.760 --> 0:21:54.080 cause of this main problem. So today trillions of dollars 0:21:54.080 --> 0:21:57.159 in central bank stimulus share by back systematic strategies are 0:21:57.200 --> 0:22:01.320 based on market volatility as a key decision metork for leverage. 0:22:02.320 --> 0:22:06.160 So what we think we know about volatility is pretty 0:22:06.240 --> 0:22:09.720 much all wrong. Uh you know the MARKO it's modern 0:22:09.760 --> 0:22:13.760 portfolio theory conceives volatility as some external measurement of the 0:22:13.800 --> 0:22:18.360 intrinsic risk and asset. And this is a highly flawed concept, 0:22:18.400 --> 0:22:21.959 even though it's wildly taught in MBA and financial engineering programs, 0:22:22.680 --> 0:22:27.400 because it views volatility as an exogenous measurement of risk. 0:22:27.960 --> 0:22:29.760 So this is extended sort of like the way a 0:22:29.800 --> 0:22:33.880 sports commentator sees strikeouts and shots on goal. It's sort 0:22:33.880 --> 0:22:37.000 of a statistic measuring past outcomes of a game to 0:22:37.040 --> 0:22:41.800 keep score, but that somehow exists externally from the game. 0:22:42.840 --> 0:22:45.240 But the problem is that volatility isn't just keeping score. 0:22:46.320 --> 0:22:48.920 It's a player on the field now massively affecting the 0:22:48.960 --> 0:22:50.960 outcome of the game itself in real time at a 0:22:51.080 --> 0:22:55.000 level that's never been seen before. The last time we 0:22:55.000 --> 0:23:00.760 we saw something like this was leading into and back 0:23:00.800 --> 0:23:05.680 then the short volatility dynamic of portfolio insurance. What's really 0:23:05.680 --> 0:23:10.360 only about two percent of the market today. Today, these 0:23:10.359 --> 0:23:15.640 short volatility strategies comprise upboards of ten of the overall market. Now, 0:23:15.680 --> 0:23:20.720 that doesn't mean that we're likely to have another type 0:23:20.720 --> 0:23:25.119 of crash in a day, but it does make the 0:23:25.160 --> 0:23:29.720 probability of some event like that much much greater. These 0:23:29.760 --> 0:23:33.639 short volatility strategies are like a barrel of nitro glycerin 0:23:34.840 --> 0:23:38.280 sitting in your offices. Now I can walk over to 0:23:38.320 --> 0:23:42.560 your offices in Bloomberg and I can sit back and say, hey, guys, 0:23:42.800 --> 0:23:45.720 you know Joe Tracy, what's what's in that barrel? And 0:23:45.840 --> 0:23:49.919 be like, Oh, it's, uh, just some nitroglycerin. Be like, 0:23:50.040 --> 0:23:53.119 isn't that highly explosive? Could it blow up several city blocks? 0:23:54.080 --> 0:23:55.479 Oh no, it's it's not a big deal. It's been 0:23:55.480 --> 0:23:57.479 there for for years. It's been in factually, we've been 0:23:57.480 --> 0:23:59.919 adding to the stockpile of it for years. The banks 0:24:00.040 --> 0:24:04.560 pay off a healthy yield to store it here, and 0:24:04.600 --> 0:24:07.119 I'm like, my god, this is scary, this could this 0:24:07.160 --> 0:24:10.480 could blow up. And then you just say, well, haven't 0:24:10.480 --> 0:24:12.679 blown up for years on end, and you know what, 0:24:12.800 --> 0:24:16.200 it may never blow up. Risk does not necessariate outcome. 0:24:17.160 --> 0:24:20.439 But if you have a fire that starts somewhere else, 0:24:21.280 --> 0:24:24.000 and that fire gets larger and larger and larger, it 0:24:24.040 --> 0:24:27.040 may touch that barrel of nitricglysra in and what starts 0:24:27.080 --> 0:24:30.440 out as a as a regular fire could explode outwards 0:24:30.880 --> 0:24:33.960 into something that blows up several city blocks. That's what 0:24:34.000 --> 0:24:38.800 happened in where we had a routine market correction. Market 0:24:38.880 --> 0:24:42.760 was down, and then that caused the barrel of nitric 0:24:42.800 --> 0:24:46.159 glycerim known as portfolio in, starts to blow up and 0:24:46.240 --> 0:24:50.760 drop the market. One day, we could see something very similar. 0:24:51.640 --> 0:24:56.800 It's a fundamental credit crunch. Liquidity and leverage crunch intercedes 0:24:57.080 --> 0:24:59.959 with these short volatility strategies the way that they're currently 0:25:00.000 --> 0:25:03.080 composed in the market. Chris, I just want to point 0:25:03.119 --> 0:25:07.320 out that your theoretical story about us having nitroglycer and 0:25:07.359 --> 0:25:10.520 barrels in the office is not as ridiculous as it sounds. 0:25:10.520 --> 0:25:13.040 Because I used to sit next to Tracy and she 0:25:13.200 --> 0:25:15.800