Language: English

[Music]

Market Rally Run Its Course

Jim Carson, founder of Kai Volatility, discusses the importance of breadth in the market and how it affects volatility. He explains that indexes are just as powerful as individual stocks and that when there is a lack of breadth, it has a direct connection to volatility.

The Importance of Breadth

• Breadth is important because it has a direct connection to volatility.

• Indexes are just as powerful as individual stocks.

• The index is where the majority of directional trading and hedging takes place.

• When fundamental pressures on liquidity occur, stocks that are not ball centers take on the liquidity of the primary source which is the fed and other primary liquidity sources.

Shortfall Center

• Shortfall center refers to all those calls being bought in Nvidia Stan complex.

• Shortfall center is forced by speculation which forces dealer short wall in that complex.

• This is a simple dispersion trade at its finest.

Divergences Happen

• Divergences happen when flows-based phenomenon occurs rather than fundamental phenomenon.

• Divergences generally give clues about what might be coming.

Liquidity Issues

• Liquidity issues have been driving for decades now and have become more about liquidity than fundamentals.

The Importance of Liquidity and Demand in the Stock Market

In this section, the speaker explains that the stock market is a function of supply and demand, with liquidity going straight to demand. Fundamentals matter as a function of cash flow affecting supply and demand, but ultimately what matters is whether a stock can provide the liquidity it needs to stay in business.

Supply and Demand in the Stock Market

• The stock market is factually a matter of buyers and sellers, with supply and demand being key factors.

• Liquidity goes straight to demand, making it an important factor in the market.

• Fundamentals affect supply and demand through cash flow put on a business.

Importance of Liquidity for Stocks

• When liquidity gets removed from the system, all that matters is whether a stock can provide its own liquidity to stay in business.

• Since 2009, all that has mattered is liquidity rather than earnings or fundamentals.

• However, this is starting to change as fundamentals are becoming more important again.

The Role of Value Growth Rotations in Stock Market Shifts

In this section, the speaker discusses how value growth rotations start to happen when stocks need to provide their own liquidity. This puts pressure on certain stocks while others experience massive buy pressure due to structural flows.

Impact on Individual Stocks

• When stocks need to provide their own liquidity, value growth rotations start happening.

• Certain stocks face fundamental pressures due to lack of liquidity while others experience massive buy pressure due to structural flows.

• This means that a few stocks experience a massive amount of counterbalance while the majority go down or remain static.

The Role of AI in the Stock Market

In this section, the speaker discusses whether the AI narrative is relevant to the current stock market situation. They explain that it is not driving fundamentals but may matter at the margin.

Impact of AI on Fundamentals

• The AI narrative does not drive fundamentals but may matter at the margin.

• The S&P 500 and market forces are much bigger than individual companies like Nvidia.

• Certain stocks are decaying due to lack of liquidity and fundamental pressures.

Short Gamma and Leverage in Stock Market Shifts

In this section, the speaker explains how short gamma and leverage can be incredibly powerful when structural flows counterbalance what's happening in other parts of the market. They caution that while speculation and call buying may increase leverage into an already massive flow system, it doesn't go on forever.

Impact of Short Gamma and Leverage

• Short gamma can be incredibly powerful when structural flows counterbalance what's happening in other parts of the market.

• Speculation and call buying increase leverage into an already massive flow system.

• However, this doesn't go on forever as seen in several other parts of the market where these things have played out before.

liquidity in the market

Jim discusses the liquidity issues in the market and how it is affecting valuations.

Liquidity Issues

• Michael Howell has been discussing this issue, which is becoming a thread on the platform.

• Only 29 outperforming stocks are down to only 29 of the market, which is the lowest since 1999.

• Interest rates have increased from zero to five, and there is an 18-month lag before they take effect.

• The Fed's balance sheet has not worked through the pipeline yet.

• There has been a lot of short speculation and ball buying over the last year and a half that led to a reduction in volatility.

Impact on Asset Markets

• By the end of this year, we will have to issue $1.4 trillion dollars in debt, which will suck money out of asset markets.

• This will lead to higher interest rates as demand for debt increases.

• This will cause a quick reduction in liquidity straight into "the veins" of the market.

Conclusion

• There are many liquidity issues happening all at once, making it difficult for investors to navigate these uncertain times.

Shorting IT Crowd

The speaker discusses the dynamics of shorting and long positions in the market, how they move, and how greed and fear are inherent features of the system. They also talk about how money managers have to vacillate between different positions to seek higher returns.

Market Dynamics

• Money managers have reduced 30-day Vol hedging by 40-50 as they move to zero DT.

• Real Vega hedging has reduced while everyone is talking about the increase in zero DT.

• Broadly sellers across the board are making dealers Long, which is forcing pinning but creating an unbalanced system where institutions are not hedged.

• Fundamental liquidity situation is deteriorating while actual flows pin the market in the short term but become structurally more unstable.

Topping Process

• The topping process necessitates a path that will squeeze shorts and make it harder for long ball entities to be long.

• A topping process generally involves a short squeeze, overextension, or tail unhedging that leads to over-leverage in a system.

• The trajectory of this process is a function of time and price.

Final Stage

• Ralph has been focused on liquidity and believes there is a mismatch in the market.

• It's just a matter of when and how this will happen; conviction is necessary as it always does.

• Squeezing shorts, changing narrative, and shaking weekends are necessary for this final stage.

Liquidity Mismatch

Ralph and Jeff Snyder discuss the liquidity mismatch in the market.

Liquidity Mismatch

• There is a liquidity mismatch in the market.

• The Fed has been providing liquidity, but it's not getting to where it needs to go.

• The problem is that there are too many intermediaries between the Fed and the end-users of credit.

• This creates a bottleneck that prevents liquidity from reaching those who need it most.

Market Expectations for Rate Cuts

The market is predicting that rates will be lower by September, but officials like Cleveland Fed President Loretta Mester are saying there's no compelling reason to pause US rate hikes.

Market Predictions

• The market was previously predicting a 50/50 chance of a rate cut by July.

• However, the market is now predicting that rates will be lower by September.

• Historically, crisis periods tend to occur in September or March.

Discrepancy Between Global Markets and Officials' Predictions

While officials like Cleveland Fed President Loretta Mester are saying there's no compelling reason to pause US rate hikes, global markets are pricing in rate cuts.

Risk-off Positioning and Fundamental Realities of Inflation

• A general risk-off positioning has partially contributed to the cap on rates as people have been flooding into the bond market.

• However, the fundamental realities of inflation have not changed.

• Labor markets are strong at 3.4 percent and historic onshoring deglobalization is occurring.

• Long-term rates are down which is reflexively stimulative.

• Markets have been hanging in well in terms of a wealth effect which is structurally inflationary.

Structural Disconnect Between Bond Market and Central Realities of Inflation

• The Fed was much more activist and hawkish three months ago before all these things happened.

• Structurally nothing has changed with regards to inflation despite the discrepancy between global markets and officials' predictions.

• Supply and demand broad macro flows contribute to this disconnect between the bond market and central realities of inflation.

Forcing Rates Higher

• The Treasury as well as the Fed will force those rates higher due to issuance before the end of 2003.

• A trillion dollars of issuance will have to happen by the end of August.

• Daily net liquidity that drives market direction is 50 to 75 billion for equity markets per day.

• The debt ceiling is a sell the news event in this regard.

Conclusion

The Fed and Treasury will force rates higher due to issuance before the end of 2003.

Continued Push Against Rates

• The Fed is going to have to continue pushing against rates.

• The Treasury on a short term basis will also push against rates.

• Reflexive effects on the market are likely as soon as this debt ceiling is a sell the news event.

The Bond Market and Equity Market Convergence

In this section, the speaker discusses the convergence of the bond market and equity market. He explains that the bet on cutting is wrong in the bond market, and it will only be right if there is a dramatic decline in the equity market.

The Two Markets Will Converge

• The speaker believes that one of two things will happen - either the equity market will have to decline somewhat to meet somewhere in the middle with the bond market or there will be an increase of interest rates.

• The yields are going higher not because people listen to what was described before but because of an 18-month lag effect hitting all those assets.

• Bond yields are not necessarily going to be looking at bad news for the economy; they've got to attract buyers. It's an issuance issue.

Structural Inflationary Pressures

In this section, the speaker talks about structural inflationary pressures and how they affect the FED's control over inflation.

FED's Control Over Inflation

• For 40 years, we had not had inflation; it was destructurally deflationary environment. Anytime we got a cyclically deflation, all FED had to do was come in and cut rates and stimulate liquidity.

• However, now we are in a structurally inflation environment until we decide as a people not just as a government but as a people to not make those things a priority.

• There are structurally inflationary pressures that we've seen historically in other environments for balancing inequality and populism.

• The FED has lost control, and we are no longer in a two-dimensional system where the FED can just come simply pressure against the decline in employment and balance deflation.

Stagflation

In this section, the speaker talks about stagflation and how it is much more dangerous for liquidity across the market.

Stagflation

• When the FED loses control, it is much more dangerous not just for equity markets but broadly for liquidity across the market.

• We are in an added dimensionality to this system that nobody's experienced for 40 years. It is called stagflation.

• All the Algos that are looking at 40 years of history also have no experience with stagflation.

The Path to the Decline

In this section, the speaker discusses how the decline in markets began due to liquidity concerns and how it was a structural problem. They also talk about how markets work and why they can stay irrational longer than people can stay solvent.

Liquidity Concerns

• People were trying to short the market and buy hedges, but it took poor liquidity for there to be a crack.

• The decline started after February options expiration and ended after March Opex because of short ball or other structured risk in the market.

• The liquidity had to get to a point where the market could break; it had to shake weak hands.

Structural Problem

• The path to this decline is a structural problem that requires shaking of liquidity.

• It's hard to time exactly when this will happen, but it should occur in the back half of the year.

• Markets often stay irrational longer than people can stay solvent.

Fed and Treasury Reaction

In this section, the speaker talks about whether or not they think the Fed and Treasury will react proactively to the lack of liquidity.

Lack of Proactive Action

• The speaker does not think that Fed and Treasury will be proactive about reacting to lack of liquidity.

• The Fed wants a little air out of this market; they've been trying to write calls, talk rates higher in long end curve, remove wealth effect so they can stop raising rates themselves.

Thoughts on June Opex

In this section, the speaker talks about why big opexes matter and how they are important to timing.

Quarterly Opex

• Big opexes matter; mid-August into mid-September is often a scary time, as is mid-February into mid-March.

• June Opex has a fatter tail in those windows, which means the distribution needs to be more right distributed.

Distributional Thinking and Risk Management

In this section, the speaker emphasizes the importance of thinking distributionally when it comes to potential risk and returns. It is crucial to be aware of the distribution of potential returns in given windows and trade accordingly with options or manage risk with stops.

Importance of Distributional Thinking

• The fat tail still exists despite positive forces.

• Need to be more cognizant of potential risks and distribution of potential returns.

• Trade according to the distribution of potential returns in given windows.

• Manage risk with stops and other types of trades.

Conclusion

• As we head into turbulent waters, it is important to be vigilant about managing risk.