Cem Karsan Called the May Rotation. Now He Sees 30% Down After the Midterms.

0:00 Jeb's bringing up a lot of interesting points when he's been here on the network about August OPEC spinning and ultimately the risk that the market may carry heading into and after midterms here. Perhaps we got some clarification or at least a catalyst in that chain of events today with July CPI. Jim, uh let's just break it down from here. July CPI came right in line for markets. We're seeing a little bit of a V compression here on the other side of it. I saw the VIX flashing below 15 again. Why is the market so unconcerned right now? Yeah, I want to be clear. CPI is not to be fully trusted for a while now. I don't put a lot of weight on CPI on its own, but from what we can read through on it, um uh demand is weak. Uh you know, there the core inflationary parts

0:46 are um are relatively, you know, well well held. This is a supply story. The inflation story we're talking about is really a hormones and commodities story. I just want to be clear. Um, everybody's so used to thinking about it. But look, demand's weak. Like, you know, core inflation. Listen, um, if we do not solve the issue in the straight of horses, there is no ambiguity here, uh, inflation gets worse. It's that simple. Unless we have a massive, uh, draw down in in GDP and and growth, right? One of the two have to happen. Um, and it's not linear. uh growth in inflation and commodities is not something that's just going to slowly tick up. It's going to get to a point where we hit bottom uh barrel uh and and all of a sudden we're

1:32 going to start seeing asymmetric kind of upside. We already see it by the way. If you look at the price of diesel, if you look at the price crack spreads, it's already there, right? These are things that are um that are already started to explode higher. Um, and my big point to everybody is that the straight up form is, as I've been saying since March, people are starting to finally listen. It's not going to reopen. Everybody's like, we got another end of understanding. There's a deal. Like literally a month ago, people are still trying to argue with me. This is not opening. And there's a reason. You have to understand why. This is not just an opinion. Okay? This is all about dollar dominance. It's all about making sure trade happens in dollars. It's about the most

2:19 important thing in the world when it comes to power, which is the exorbitant privilege of the dollar being the reserve currency of the world. What is at threat and what China and Russia are trying to undermine with trade originally with Venezuela and with Iran, right, is the exorbit of the dollar. So everything we have done from the very beginning with Trump with the pan Panama Canal with uh Venezuela with Straight of Hormuz uh all of these things the deal in Indonesia right on this on the street there is to control trade and control that trade is done in dollars and so once you realize that that's what China and uh Russia are trying to convert and what the US is trying to uh make sure is is a moat

3:05 bill, you begin to understand that the only way that the straight of horn moves uh is ends up being is through war is through somebody forcing another person out and controlling it. And the US is not willing to let China, Iran by extension, who is, you know, just a proxy >> proxy. Yeah. >> Control straight for it's that simple. This is the battle. This is not a battle. This is not just another war. This is a battle over the exorbitant privilege of the US dollar. And once you begin to realize that, you realize why this cannot be resolved with just a handshake or an agreement. This is not about Iran. It's not about nuclear weapons. It never was. We've been talking about nuclear weapons in Iran for 50 years. Okay. >> Yeah. We have >> 50 years.

3:51 Yeah. Exactly. So, I want to be clear and the second we understand that and we start to see that for what it is, inflation is about to get a lot worse. They have been trying to manage it because they have an election a midterm coming and they've also been very clear vocally uh whether it's Hank Pollson or Bent himself that the solution to this is to hold down the long end of the curve. We all know the way the math works when you take real rates negative on a supply shock that drives more and more inflation >> unless you you solve the supply shock. Well, I mean, that's one of the >> this is just the reality of history since the beginning of time, >> but that's that's one of the interesting knock on effects today of the inflation report, right? The market tells you on

4:37 one hand, oh, the Fed's not going to need to cut or rather hike in in September. Those odds drop a little bit at the margins, but what happens to the long end of the curve? They were rallying this morning and yields have started to creep up over the course of the day again. The Fed CP not going to hike >> right now. It's irrelevant. Now, it's gone. is you're you're backward looking and you're focusing on core when the structural inflation on commodities and everything lies ahead of you with a lag. >> Yeah. >> Um and so so the point here is watch the long end of the curve. It is telling you exactly this but they are also that Japan the yen intervention is not about the yen. It is about making sure Japan does not sell more odds. Right? So it is holding down the long end of the curve. It is explicitly the beginning of QE to

5:25 support and hold hold at bay the long end of the curve. We have been talking about everything here and everything is continuing to march down this curve. And now what do we get? Now we also get some proposal because they're trying to hold things at bay with all these things going wrong. What can we do now as an administration to make sure markets continue and the capex continues into the midterms? This is what a capital gains tax. It also is something they're going to need to if they're going to drive massive inflation, if we are going to get >> Do you mind if I set the table here real quick? Just so I maybe people don't know the background. So just yesterday, Trump reportedly starts looking at a capital gains tax cut and a larger home exclusion sale as part of a a midterm policy pitch for voters. It clearly comes across as a market friendly headline. Who wants to pay more taxes? But I mean, Jim, you were tweeting about

6:11 this yesterday. Uh some folks are arguing it's progrowth policy here. Everyone loves progrowth policy. I see it as just another way that they're trying to juice asset prices between now and the first week of November. >> QE is progrowth policy. Uh printing money is progrowth policy. Uh yeah, it's progrowth. Let's cut taxes to zero. Let's get rid of government. That'll be great for growth. For certain people, the top.1% maybe the top 1%. What about the other 99%. Right? That is not progrowth for those people. And so growth of for who is the question. And this is the difference between a supply side policy of just lower interest rates, small government. Uh yeah, that's great. But there's an ex the truth, the best thing is in the

6:57 middle. We don't have to live on the extremes. We don't have to live in in in you know fascism. We don't have to live in communism. We can live in a world where we use supply side policies and use free markets but institute a level of uh of of fairness for median outcomes to improve median outcomes and that's what people want. Okay. So uh the point here is is markets are everything. Everything depends on markets. The only way we avoid inflation from a demand perspective is to drive more of of the QE and the money to capital markets capex businessto business. Um and and the second we start to take money from them uh from that top part and somehow deploy it to people that drives more and more structural inflation. So they know that's coming the supply side issue with straightforward moves is is going to

7:42 make it worse. They are preparing for inflation. I have been saying this for about two years. It is the structure and not just preparing for it. they are helping promote it even right um they know they can't do anything but let it happen and in some ways it's not a bad thing because we can't manage our debt without monetizing it >> to the point where it's unsustainable and the only way out is inflation >> the only way out of of the debt spiral that we are in is massive inflation you got to monetize the debt and so what >> destroy the currency monetize the debt And you got to put the destroy the currency destroy the currency would be if you are not the exorbitant

8:28 the the reserve currency of the world. The question is will you destroy the reserve currency which brings us for full circle to why we are in the street of hormone. You have to draw a moat around the reserve currency. You have to this is power. This is this is not like uh US history power. This is power since the beginning of time. You must, you know, the golden rule. He who has the gold makes the rules. >> Right. Right. Right. >> Um and and so the greatest power in the world is not the commodities and and the military of the US. It is controlling the actual form of money itself. We can print unlimited dollars if we remain the

9:13 reserve currency. Now the question is to your point, will that threaten the reserve currency status of the of the US? And that's what this battle in Iran is about and that's why it's not finishing anytime soon. >> So we have we have an anchor for the midterms, right? And I feel like Iran is just going to kick this ball down to the midterms as much as they can here. But now that we're through CPI and we've had this little bit of, you know, move here. I'm thinking about OPEX next week and I'm thinking about the tendency for markets in the second half of August and September to see higher volatility for whatever rhyme or reason here. What's changed in your view? I know you had the summer of George thing going on which I think is quite funny. Um but what do you view now about opex in the wake of what we've seen over the past two weeks to start this month? >> This is exactly what we would expect during uh during uh OPEX. This is

10:00 sideways V compression um uh on a realized basis. But if you look under the hood, what's happening is actually the long end of V is starting to go up right as realized V is compressing. And what we've been telling people for now a couple weeks is you want to be long calendars. Longer date of V meaning 60-day V, 90-day V, 120day V will continue to work its way higher as we come out of the summer. Um and that V compression which really has another you know two to two to four week really one to I guess two to four weeks one and a half to to three and a half weeks. Um and it is going to start is going to start dissipating as the long end of the curve um starts you know going higher hanging in um as the front kind of collapses and the reason we have

10:48 confidence that not only again we've introduced this idea but but the amount of volumes are cut in half during the summer and the amount of v compression is the same. So the effect of all compression doubles during the summer, but importantly, this is also in a a another election year. And election years, this isn't just regular midterm year. It really matters. It's a real coin flip about who wins both sides. And the the the effects of who wins are are dramatic. So this midterm, that ball in November and December and January is going to stay boo. If anything, it's going to as an event ball is going to continue to be supported uh and go higher. And that is going to drive less v supply as we come out of the summer as well. So not only has volumes come back with the effects of vault compression from structured products relative dissipate, that's the summer of George

11:33 uh reality, but in a midterm year where the uh the election by the way event is actually quite cheap at this point, you're likely to see uh higher ball pressure and demand um going into that as well as we come out of the summer. So those things will increase the price of insurance. And what's the net effect if if the price of insurance goes up? If implied vault goes up, well, people can't hedge as easily, which means realized vault starts to go up as well. >> Realized vault starts to go up, then we have a little bit more of a problem on our hand. But maybe these two things run in contrast to one another. It feels like the administration is trying to force a little bit of a meltup now for the next 3 months. And then you do have this potential for the markets to start to bid volatility higher as we get into the fall here. So, which ultimately wins out? I mean, are they in contrast to one

12:19 another? No, no. You can get a volatile trade that is still net net higher or at least supported. And you know what does that look like? Uh 10% pullback. Uh maybe maybe even a little bit more. Um but something in that range uh that feels scary. uh VA initially early V expands administration comes in as it has learned to do and is very you know again whether it was uh April 25 uh or April 26 or March 26 you know take it down and take it up is is a policy that is what they're doing you know end of a civilization is near next day we have a deal in two weeks 150% tariffs uh you know oh never mind 10% on some zero on others like never mind uh we'll do it

13:06 six months that is a a feature, not a bug. This is how the administration works. Uh volatility will expand that volatility expansion and letting it kind of kind of work through early on. Uh think of it August, September to to to squeeze it back up in October, November or you know, something along those lines would not surprise me in the slightest. And given the natural flow and structure of things, that is more likely than not if they can't continue to get a squeeze going. They're trying to get a squeeze going. The Japanese yen intervention, that was an attempt to get things going. the new new kind of announced uh capital gains tax whether it happens you know or not is a um you know is an attempt to get market squeezing but they are I mean look at the market is it squeezing right

13:51 now has it squeezed the last several weeks despite all the policy announcements despite everything no and so my my point to you is at some point uh they know if they can't keep going in besides a hedge fund manager he gets this this is what they're doing this is a very concerted effort to get markets moving uh for political reasons for also economic reasons. If they keep it going, that's what's driving the capex. The whole capex cycle is because markets are going up. Without markets going up, the capex cycle goes away. It is they're they're two the same. The whole economy and the growth in the economy is being driven by the market. And so this is um this is a circle. And so they yes, their intent absolutely is to take it higher. Will they likely win? Yes. Will they win from here uh at this moment? Uh probably

14:39 not. Uh once they win, the question is post midterm, are they as motivated to keep it going uh aggressively higher when they have other things they want to deploy, which is sovereign wealth fund, Trump accounts, uh backs stop the other curve and right as the straight of horses is getting going to get significantly worse. So the goal here is to keep the plates spending the midterms, do whatever they can to keep it going and keep things as good as they can till early November, which is not that far away. But after that the natural structural decay uh in the straight of Hormuz and the inflation problems are going to increase the flows are no longer be as supportive as they are now >> as volatility expands and then the third leg of the stool the administration becomes less aggressive because the midterms are over whatever happened happened. Heaven forbid they lose. they

15:25 lose then you have they have lost a significant control as well which makes it come January very hard to maybe deploy some of the things they're doing and that opens the window for potentially something way worse but u I think at baseline even even if they do win uh the the Senate which they likely will um you know they will still want to take it down to take it up and that's not a 10% decline expect 20 to 25 maybe even 30% uh next year after post midterms um and I think people are starting to see that that's the other thing and markets have a also way as you're starting to see at the bond market. The bond market tends to be early have a um once the markets start to see something generally tend to front run it a bit. So that's something to be cautious of. >> So the biggest volatility risk comes for you still after the midterms with everything that we've seen play out over

16:11 the past two weeks. Just to put a >> chart probability is post midterms. Three legs of the stool right now. Two of them are very supportive and uh uh you know which is the admin as you're seeing with all the things they're trying to do. the VA which is compressed in summer George as we get to September right um post August opex really getting into September uh that flows part the the the start to expand uh less supportive and you're really stuck with the administration uh without the benefits of the summer George of all compression all the things on their side and in that situation if they can't get things going I think you're um you know with markets starting to see through what what the plan is post midterms they're going to be in a battle royale the administration is till the midterms but that leg the stool has been buttress but a smart guy he knows everything that I'm saying he's preparing for all these

16:58 things and it's not just him understand they have a thousand plus people working uh at the treasury a thousand plus at the fed everybody AI models they are doing everything they can and they got the privilege of the US dollar and and they can do all kinds of things right so the point here is that leg of the stool can do a lot uh it will be you know as the bond market really starts to fight back as inflation does start to take off it will again a battle royale, but I would not understand that leg of the stool can still support things and likely will to the midterm. Um, so best odds are yes, post midterm when when they really actually will be incentivized, if anything, to let it go to take it back up. Okay, so I want to just put this together for everyone here. CPI today gives the Fed a little bit more room to pause. August opex is pinning the tape. VIX seasonality says

17:43 that this may be calm fragility. Uh, we have capital gains tax cuts giving investors maybe a reason to hold risk for the next few weeks and months with that carrot dangling out there. And the midterms are going to give policy makers a reason to keep asset prices elevated. I don't even need to ask the question, are we in a political volatility control regime? We've already arrived at that yes or answer being yes right now. But if the administration is trying to buy the midterms with pushing asset prices higher, what do traders do? Do they ride that wave for the next two months? Do they buy crash protection on the other side? Do they just ignore the game and go to a different corner of the market? I mean, how do you avoid it? Then >> the beauty of these scenarios is actually um you know, implied V is incredibly cheap and so you can um buy longerdated V uh you can replace your

18:30 stock with calls right on a longer data wave protect uh in the meantime. Uh and honestly, I think any move up from here should be market up on the longer end of the curve. uh we started to see that already in the last move. Um and as as we slide to lower and lower uh fixed rate VS 5% higher from here implied VS are even lower than they are now right those VSS are very cheap and don't buy the thing that's going to decay in the next month or two right buy the thing that is going to have very little decay and that is a incredible riskreward opportunity. be long, you know, be long delta, but definitely be playing it from that side because uh you're going to get a lot more realized volatility as we come out of this uh 2 3 week period where it's still compressed and you have the

19:16 benefit of implied vault likely heading higher. It's a 1479 here on the VIX. Uh the low close for the year I believe comes on July 10th at 150. No, that's not true. It's 1490. So yeah, we are we're right around the corner around another low close here right now. Uh just to circle back on opex as a pending mechanism here, you know, that only really works as long as dealer positioning is one-sided. Um what does it tell that opex is no longer a floor but more of a ceiling for asset prices? >> Um so you have to separate where the flows are. So at the um at the index level which is generally what we're talking about here it is one-sided you know these are call calls are offered puts are uh bid always the positioning

20:04 wise uh so the von and charm at the index level the supportive flows the vault compression at the index level going to opex uh particularly right now with the summer of George kind of dynamics I've explained are are very firm and in place the part that you are seeing a lot of other people are beginning to seeing is Because in the Momo space, call buying has become so big and implied VSS and the call uh call skew has been introduced to that part of the market. It's driven this rotation, this counter rotation that we saw this summer, right under the hood while index vault is compressed. This is we called for this in May before we saw that massive Momo kind of rotation away. That is still an overhang and is strongest if you go look at it throughout the summer. Um heading into opexes. So the next week is actually very uh poor from a flow

20:50 perspective for the Momo names while being very very strong at the index level. And so that pushpull which is what I think you're referring to is driving a a bit of a cap as well as a floor. We're more used to being primarily at floor and supportive. But what we're seeing is really this push pull because momentum is really weak but there's support of flows on the index level and as we talked about momentum is the the key to op uh to to capital flows and capex and all the things right uh how do we buy the market at all-time highs with momentum rolling over. So this is the the challenge that you're having and why if anything it's forcing compression. So for the next week, expect more of the same a lot of push pull. Uh but V compression at the uh index level, but again unlike most of the summer, that doesn't mean implied V

21:36 at 6090 days is also a sale. Early in the summer, that was definitely the case. Now that we're coming out of it, this should be beginning of the end of the summer compression in the last two to four weeks of that story. You and I have been talking about a whole bunch of things here, but if I could distill us into maybe something that's in the zeitgeist right now. Uh the Bank of America bull bear spread and that indicator has become quite a talking point I've heard at least because it's sitting at a such a high level. It's graded from 0 to 10. It's sitting basically at like a 9.7 right now. Things have never been more bullish. Um is that your feeling when you take a look at the tape in all the ways that you examine this market? Does it feel like we are, you know, doing the wy coyote? We've already run off the cliff and uh we don't even realize it yet. >> Yeah. Uh there is a I would say explicit at this point. It's no longer implicit

22:22 put from the US administration. They are being incredibly proactive. Uh I would say every other day there's a we got a deal in two weeks. Everything's good administrative news. That starts fading off. We have a new tax capital gains tax deal. We're going to buy proactively support the yen and do QE. uh it is incredibly aggressive uh support and explicit support for the and and that is what is forcing a very explicit kind of right tail positioning and uh long positioning and so my answer is yes uh positioning is incredibly long everybody's definitely out of their skis but as long as the admin's going to continue push on it that that's relatively protected especially in the summer when v compression is there um as

23:07 all expands as the inflation story gets worse in the street of horrorism actually affects prices on bonds etc. Uh yes to answer your question you need to be worried but it's about timing. It's about understanding how that positioning on the long uh you know how long are people how short are people that is one of of of many important factors as you're looking through the timing of a potential decline or rally. >> Uh pleasure to have you here on the network. Of course we're going to see more of you. This is uh a little tasty crumbs in the middle of day edition. Uh do you have any final thoughts on this market today? It feels like it's a just a third day in a row. We're we're doing nothing. 570,000 ES traded. That's This market's asleep. >> Summer of George continues. It is sleep for a reason. This is not just uh

23:53 everybody likes to paint it as sentiment or people are feeling uh you know bullish people feel bearish. No, there's structural uh structural products. There's fall compression. The stuff is from a flows basis. people are at the beach and the net of that doesn't mean that things are liquid so things go everywhere that means the de facto is all these structural ball compression compressing things are overwhelmingly positive so right now yeah summer George uh it will continue uh through this um you know through this period right now for another two weeks through opex and then uh you know potentially even another two to three weeks till till the the end of August