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Excess Returns
It Only Happens at Bottoms | Andy Constan on the Options Extreme That Showed Up at the Highs
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- [00:01]
Podcast Host 1
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Andy Constan
this episode is brought to you by Google Chrome. You think you know a browser, but Gemini and Chrome?
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Podcast Host 1
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Andy Constan
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Podcast Host 1
Various 18
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Podcast Host 2
we are excited to announce the launch of a new podcast, First Principles with Andy Conston. There are a lot of shows out there that give you opinions on what is going on in markets, but the goal of this show is to go deeper. We want to focus on the lessons and frameworks behind what is happening so we can all develop a better understanding of what actually drives markets and the economy. In this episode we discuss the extremes in the options market before the latest sharp pullback in semis, why the AI boom has a pie problem, what could change at the Fed under WARSH and the tariff deadline. Almost no one is watching. If you would like to continue receiving new episodes of First Principles, you can subscribe on all major podcast platforms using the links in this episode. Description thank you for listening. We hope you enjoy the new show. This is our fourth episode of First Principles where we sit down with our good friend Andy Constant of Dance Spring Advisors to talk about what he's paying attention to in the markets, what investors can learn from it, and why it matters. We don't have all the answers. He doesn't have all the answers, but he puts out a lot of interesting, thoughtful research that I think investors can can learn from. And I think Jack, I know you know you wanted to start. One of the key things that jumped out to you was some of the data that Andy was highlighting around the option market. So I think that's probably a good place to start and I'll let you kind of get into it.
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Podcast Host 3
Yeah, you know one of our goals here is to educate people and I learned a lot from reading this analysis from Andy. Was it about a few weeks ago Andy, you put it out?
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Andy Constan
Yeah. On the 28th I think.
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Podcast Host 3
Okay, yeah. And you would flag something that was going on behind the scenes in the option market in terms of the AI infrastructure stocks and the pricing of call options. And it's proved to be pretty prescient in terms of what's happened since then. So I was wondering if we could maybe take a step back to then and you could just talk about what you were seeing when you wrote that report.
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Andy Constan
Yeah, sure. I mean just we've talked about this on prior episodes and I think it's all part of the same discussion, which is we have this potentially transformative technology that is we're dealing with in the world. It is heavily impacting stocks, it's heavily impacting all businesses. It requires a tremendous, tremendous amount of compute, which to get compute you need chips and a bunch of other peripherals around that. And so that's been the big story. And my way of thinking about that is we know the capex is massive, there's been massive promises of CapEx, it's driving the economy, other things are as well. But it's a unusual driver of the economy. It needs to be financed. Meaning the companies that are buying all this, building all this compute, need money and so they need to go to markets to get that money because their own cash flow no longer allows for that. And all that money is being plowed into a handful of companies. That's three or so companies that sell memory, three or four companies that sell chips that can be used for compute. One or two ish, really just one company that makes raw silicon and a bunch of companies that will one day allow the people that make raw silicon to make more of it. And that's what I call the Fab 5, which is five or so companies that are really necessary for clean room builds. And all that money's being plowed into those companies and so they're experiencing parabolic moves. Intel, I think it's 3x, was 4x a while back then. And so all of this is happening
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Podcast Host 2
and
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Andy Constan
I think we're in a bubble. I've described this as a bubble. And I also think that there is simply not enough GDP to earn money from all the investment that's being made and have the regular economy thrive. So those have been my high, high level things. I went old school with this report. I've spent all my career, or the first 18 years of my career as a. Actually more like 20 or 20, 22, 23 years of my career as an option an equity options, equity derivatives, fixed income derivatives, professional. And so I decided to look at what was happening in the options market because I thought that was a. There was something very, very unusual happening. And really it's happening in two very specific things are occurring. One is we look at the stock market every day and it doesn't go anywhere but some stocks go up a lot and some stocks go down a lot. And so the, what we call the dispersion of single name stocks, lots of rotation, lots of, lots of moves under the, under the, the sea. But the relatively stable overall stock market and that's very unusual. The level of correlation amongst individual stocks is very, very low. And that's just very unusual. And it's consistent with a world in which there are some clear winners that are getting going up parabolically they're the people that are spending all the money to hand to those people hyperscalers and then they're the rest of the economy that doesn't know what it's going to deal with as it deals with AI. So it makes a lot of sense that there's a lot of winners and losers being decided within the market. At the same time, index volatility is relatively elevated. Realized volatility on the index is well under the realized volatility of the implied volatility in index option. So while all this is going on, what that really means is single stock volatility has exploded higher. And in these particular companies you should probably put up one of the charts I have from the DSR about that. But in the when you look at individual companies and even the broader indexes of those, you know, those semiconductors, you'll see that volatility has realized volatility has doubled, tripled in some case. Implied volatility has doubled or tripled in some cases. And that's very unusual for single stock options to be single stocks to be so volatile to won't be is one thing. And for the implied volatility of those things to be so high. So the one big thing that happened over the last really since the war is single name volatility exploded higher. The other thing that happened is that usually equities are sort of slow, have a slow climb on the upside and they say take the escalator up and the elevator down. And so typically out of the money puts which are something people use to hedge and protect their investment are extremely are much higher bid than out of the money calls. That also has reversed where many of these companies have calls that are significantly have significantly higher implied volatility than at the money volume and out of the money volume puts and that's very, very unusual. It happens, but it almost always happens at a bottom where you have elevated volatility because everyone's panicking and suddenly a bottom where then everybody needs calls, they want to sell their puts, they want to buy calls and off we go. That often happens at a bottom. It just doesn't happen at tops or, or really it doesn't. I don't know if this is the top. It doesn't happen at very high prices. After a long rally. You don't see calls bid and high implied volatilities. You see calls offered because people are overriding their position. You see vols low because everyone's comfortable. No one really is worried about it. But this is a very unusual time.
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Podcast Host 3
Did you see uniquely around then? Because one of the things with these types of situations is they can, at least for a period of time, they can continue. But in this case you saw something that it has reversed since you put this out. And I'm so. And this is probably a lot of what you learned throughout your whole career. But like how did you see that it was such an extreme level that it probably couldn't continue?
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Andy Constan
Yeah, I mean, I think that's mostly luck. I wish it was. I wish I could say there was like this bell ringing signal. I've told you in past episodes and in my writing that I think we're in a bubble. And in a bubble you see parabolic prices and then you see the end of the bubble. And I don't. We certainly, I certainly got lucky and the parabolic prices stopped going parabolic and have reversed substantially. But that doesn't mean the bubble has popped. So I think it's possible I got lucky. I think that's the more likely explanation. But I'll tell you what I do. I keep an eye on the individual implied volatilities of all stocks relative to themselves, relative to an index over the decades. There are two things that people who focus on options care about a lot. One is, are the premiums in options rich or cheap? Meaning should you be a buyer of options or a seller of options? And I don't mean directionally, like it doesn't matter if you want to buy calls or puts. You may just expect volatility without any direction. So that's what an options specialist is trying, is spending their life's work. And I've been spending my life work trying to determine whether an option is rich or cheap. And then the second thing, which is the other sort of holy grail that we all seek in, in looking at options is whether the options market provides some insight on the direction of stocks. And we can cover both of those topics. But those are the two big things that I look for. And so I have many, many, many different ways of doing that. And none of them give me the answer. It is a holy grail search. So it's a set of these things all brought together. And then you say, okay, well, is this a good chance that we're going to have some sort of event around this, given all the things coming together? Turned out I got lucky in this case. But it could be because the set of things that I look at all came together at once. And that was in this case, parabolic stock price moves of the biggest companies in the world. Very, very high single stock volatility, flat skew, meaning calls, bid relative to puts. Those three things were, you know, sort of very elevated at all at the same time. And so when I look at that, I say, hmm, there must be a bull market for calls and a bear market for puts. And when you have all those things happening at the same time, you have parabolic price movements, extremely bid calls, extremely high level of volatility in general. I think it's one of the things I'd weight fairly heavily to say a speculative frenzy is reaching its peak. And it turned out it was. But I don't think it was enough to say I didn't take any directional bet based on this. I didn't say, oh God, I'm going to call the top here, because I don't think you can. But it did give me enough to say there are trades to do that don't have to be directional in nature that can be useful for your portfolio.
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Podcast Host 3
So instead of basically betting the market was going to go down, what you were doing was selling volatility, right?
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Andy Constan
Well, in two ways. One, I was. So there's an old story about Mark Cuban from the 2000 time period. And I was sitting at the running global equity derivatives at Solomon Brothers at the time. And our clients, our high net worth clients, our investment banking clients, we were part of Citigroup at the time. Well, still, this firm still is, had a high net worth private bank. And all of these wealthy founders wanted to hedge their Internet stocks. And so we were marketing the hell out of the following trade. You're long the stock, you don't want to sell it. One, you'll pay taxes. Two, you'll forego upside. So sell a call that's far enough out of the money that you're happy if it goes in the money. And Use the proceeds to buy a put, which protects you from downside, from losing some of the fortune that you've made. And Mark Cuban did that at the absolute top on his portfolio. He had just gotten a whole bunch of Yahoo stock when he sold his company, I think it was called Broadcast.com, an Internet radio company. And that trade saved him. He walked away with billions of dollars, a couple of billion dollars, because he did that trade. And what it would normally be if the whole market was hedging, they would be selling calls, pushing down implied volatility, buying puts, pushing up skew. And they weren't doing it. I noticed no one's doing it. And so to me it said the market is completely unhedged and the opportunity to hedge is just extraordinarily good. And so that was the big thing I noticed a few weeks ago.
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Podcast Host 3
Just one more for me before I hand it back to Justin. Do you look at this as kind of a short term thing? So in other words, obviously these stocks have come down a lot. I'm assuming implied volatility has come down a lot. Is this something where now the situation is kind of back to normal and it's over, or do you look at it as kind of like it has more long term implications?
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Andy Constan
Well, I would say the implied volatility hasn't come down as much as you might think. And I think that's partly because realized volatility has been extraordinary. You know, two of the stocks I don't actually use, well now I can because they've IPO'd. But two of the stocks in the semiconductor space that are most comparable to Micron are Hynix and Samsung Electric. And if you look at what's happening in Korea every night, you know, they're doing limit up, limit down every day. And that's not. When you have a 10% daily move, chances are implied volatilities are going to stay pretty darn high. But they have come down because the speculative demand for calls has disappeared now. Speculative demand for puts has come in and so Q has started to lift while call volatility, which is the thing I sold, has started to fall. So it's a good combination and it fit my trade well.
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Podcast Host 2
Does it tell us anything about. You mentioned just a few minutes ago, like, kind of the way that you look at this in the context of like the overall market and maybe thinking about it in terms of like where we are in the bubble regime that, you know, we've talked to you about. So how do you kind of read this in terms of overall like market or bubble regime?
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Andy Constan
Well, again, I think it's one of those things where so a bubble regime doesn't happen very often. So you can't point to something and say, well look, we're in a bubble regime because of every bubble that's ever happened. Looks like this because statistically it's not significant. There's only been a handful of bubbles. Similar thing with implied volatility on options. There has been another time when markets were near their highs and implied volatilities were very high. But they're not enough to really point to say, what's next for stocks. I think it's just support to the whole idea that there's a bubble regime and simply put, there's a bull market for calls. If there's a bull market for calls, retail investors have a bull market for calls and no one's hedging. So there's a bear market for puts. Chances are that supports the idea that we're in a bubble. If everyone was hedged up, if nobody wanted to buy calls, chances are we're not in a bubble.
- [19:14]
Podcast Host 1
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Podcast Host 2
You know, you had mentioned intel earlier. It just got me thinking. Like I remember intel went nowhere for so long and then, I mean, maybe it was a year ago, I don't know when it started to move and the move was just crazy. And you know, you, you think of these, the size of these companies and the types of move moves that they're making. It's just in some ways, you know, you see it. And maybe as investors, we get like a little callous to it, you know, thinking, oh, that's just, that's just one. But to your point, it was happening with a lot of different companies.
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Andy Constan
Yeah. I mean, this is. Again, while the DSR that I'm writing now, the damp spring report that I'm writing now talks about this topic, people look and say, well, the multiples aren't extraordinarily high, and some companies, like these chip companies, actually have fairly low multiples. And so people will say, well, it's not a bubble because of that. But what is a bubble is earnings expectation. The earnings have been unbelievable. Companies doubling, tripling their earning year over year. That is an extraordinary and unusual thing. And the people expect it to continue. And that is also those sort of very enthusiastic expectations for the future of companies is part of a bubble.
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Podcast Host 2
Talk about the idea to like, you know, this idea of like the pie that you talk about. And, you know, if all the money is going into certain areas, you know, that has to come from somewhere, so it's going to be taken from someplace else. That. And there's only so much sort of pie to go around as you explain it.
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Andy Constan
Right. So
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Podcast Host 3
all the.
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Andy Constan
Economy is the gdp. That's all the economy. It's every. The GDP just sums up every transaction that's done.
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Podcast Host 3
Right.
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Andy Constan
The pie. And that pie really depends on how much stuff we make. How much stuff we make depends on the number of hours we spend making stuff and how good we're at. We are at making stuff. And if we become better at making stuff, we can make more stuff in the same number of hours. And so that tends to be good for gdp, real gdp. There's an inflationary aspect. I think we'll lose the point if we talk about that. That's part of it, though. In order to make more stuff than we, than we have humans to make it and tools to make it with, we have to work harder. And that tends not to be sustainable. Or we have to invent better tools, which can be a temporary boost. And that's what's happening. Though it's unclear that there's significant productivity gains yet from AI, There is certainly significant money being spent on goods and services to build the compute. And so the GDP is expanding, the pie is expanding. So then you say, okay, who gets the pie? Because every transaction, every purchase has a sale and every seller gets the money from those purchases. And the seller can get them, can, can be a person Or a company, if it's a company, it can split the proceeds of that sale, pay its suppliers, but then split the proceeds between its shareholders and its workers. And so that is where the pie goes. And so we know that workers are not seeing significant growth in their real wages. So they're getting less of this pie growth. Pie's growing. They're getting less of the pie growth than capital is getting, than shareholders are getting. And so then you say, okay, fine. So that's so shareholders are getting more of the pie, the pie is growing, and the piece of the pie that the shareholders are getting is getting larger too. They get a bigger. It's a bigger pie and they get a bigger piece. Great. So that can support a stock market rally. My thesis, I think it's starting to play out, is that equity prices reflect the growth of the pie and the slice that the company is going to get of that pie. And if you total all of the slices of every company that they expect to get or that their shareholders expect based on what they priced in, in terms of earnings expectations, you can't cover the amount of promises of pie. Company A says, I'm going to get a slice of pie. Company B says, I'm going to slice everybody, saying they're going to get a certain slice. There's not enough pie for everyone. In fact, I think there's not even close to enough pie. And so some people are going to be left without pie, where everyone is going to be have less pie than they've promised their investors. So I think that's the big story regarding the overall market, even the most like, I've made some extremely aggressive. I've assumed population isn't going to grow because I don't think in the next few years we're going to have a change in the immigration policies in this country. And that's the only way to turbocharge population productivity. I've made some very aggressive expectations for population growth. And so I've made the pie grow in a quite aggressive way. And then I've made some extremely aggressive. This is in prior work, we share extremely aggressive expectations of how much companies are going to take of the pie, leaving the consumer, the employees, not getting much in a pie. And even then I can't get to the current earnings expectations for what's built into companies. So I think that's the big bear thesis I have regarding the AI boom. And I think we're going to have spectacular outcomes for AI. If we don't, it's a disaster. But I'm not Even don't even need to make that claim to say there's not enough pieces.
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Podcast Host 2
It's, it's, it's funny, it's not exactly to what you're saying, but it's kind of the way that I use AI in the sense that like I'm not just using ChatGPT and I'm just not using Claude and I'm just not using that. And so, you know, no one is getting all of Justin's AI PI usage. It's being spread out across different models, different days, what I'm looking for. So it's just the way. But yet these companies are being valued at whatever they're being valued at.
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Andy Constan
And some of them are going to listen if somebody wins, like I pick your, pick your model. If that model gets a monopoly, that company that owns that model is going to make a fortune, no doubt about it. But the other four companies are fucked. So, you know, that's the, that's the thing. And this doesn't even deal with the fact that the real profit from productivity is reducing the labor force. If you reduce the labor force, Justin isn't going to be able to pay if he's out of a job, isn't going to be able to pay for his Claude subscription. And the company who has to fire people because they can't compete with the AI company that's turning their business into a, you know, a vibe coded app, They are not going to be able to buy any more compute. So ignoring the idea that the people who don't that, that are displaced, disrupted by AI are part, are significant part of the economy, it's super hard to get there. So you have to have this perfect world where no one loses a job, wage gains continue to be decent, they don't have to be great and productivity blows through the roof and the GDP blows through the roof without population growth. That Perfect Storm is the one I modeled. And we don't get there. There's still not enough pie. That Perfect Storm model, there's not enough pie. And so not surprisingly, when you have this under the surface war between who's spending money, who's receiving the money, who's winning, who's losing. Single name volatility gets very, very elevated because the payoff to win and the downside of losing is so severe that you have to pay. People who are willing to sell you insurance for those events are charging a lot.
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Podcast Host 3
It was interesting, I was listening to a tech podcast the other day and I was thinking about your pie thing because they were debating this whole idea of how much usage and how much revenue will go to the frontier models versus the cheaper the open source models. And it seems like that will reallocate the pie. I mean, if most of it goes the frontier models, the OpenAI and the Anthropic win, and counterintuitively, it's actually a great thing for the semiconductor companies if it goes to the cheaper models. Right. Because you get more AI usage potentially. So you may end up like that may end up benefiting them. It was just interesting. Maybe I'm thinking about it wrong, but I was just thinking about your pie thing when I was hearing him talk about that. Right.
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Andy Constan
I mean, now you're in the war of who gets what slice. You know, the music stopped. The pie thing also works with musical chairs. The music stops and everyone needs scrambles for a chair. And some people don't get a chair. And the people that do win. And I'm saying there's probably half as many chairs as are needed.
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Podcast Host 3
On the thing you referenced about the labor force, I just want to ask you quickly about that because we did a podcast with Eric Pakman recently, and he's like, dug deeply into the data and one of the things he was arguing is like, the unemployment rate really doesn't tell you much these days because the labor force keeps going down. I mean, I mean, do you think that's fair based on what we're seeing?
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Andy Constan
Yeah, I mean, the, the. So that's a philosophical discussion regarding data. And it's maybe not for another time, but I think there are people that really understand deeply every bit of data. And I've been one of those people over the years, and I think what you just said is an example of that. If your business is trying to predict a reported piece of data, you have to be really in the weeds to understand what's going on. I'm more at the. I've realized over time that that data is useful and gives you a window into what has happened. Hard to extrapolate often to what will happen. But what I care more about is the general conditions of the labor force and their leverage. In particular, their leverage, their ability to demand higher wages. And I don't think the labor situation is in a particularly good place. There are plenty of people have all the jobs they want and all the jobs they need. Their labor participation is okay. The unemployment rate, which is the one you're talking about, has a denominator that is impacted by immigration, which is stopped. So it's going to be. It's going to appear with immigration turned off it's going to appear that the unemployment rate is attractive relative to when there was influx of people. The problem is that people who have jobs, even if it means the unemployment rate rises if more people have jobs in total, meaning the denominator rises but of course the numerator doesn't rise quite as much so they the rate changes. That's good for growth, that's good for humans. So it's, it's a little tricky to sort of isolate one thing. So I tend not to get deeply involved in those type of things. But it is true that immigration is impacting growth, inflation and the reported numbers.
- [34:06]
Podcast Host 3
How about we take a step back to the overall economy? When we've talked about this in the past, you've talked about Capex obviously is a big driver of the economy right now. We've talked about deceiving, we've gotten to the point where consumers are deceiving which for right now you kind of said the economy is okay. But I think longer term that is some degree of a warning sign. How are you thinking about where the overall economy is right now?
- [34:24]
Andy Constan
Just what you said, it's okay. It's being driven by capex and dis saving. Dis saving depends on. You know there's the classic thing about this savings, it can only go so far. You know, once you've sold all your assets and you're living based on your wages and your consumption offsetting, you can borrow, but you have to be pretty darn optimistic. If you've used all your assets, you've either levered against all your assets to continue to lever. So it has a natural end point where the economy just is un unwilling to dissave. We're not there yet, we're not in that situation. And asset prices continue to stay relatively elevated, quite elevated. So I don't worry about the DIS saving ending anytime soon. It's just not as big a factor as it was two years ago. First we've got all the government handouts which created an income driven consumption. Now the last few years have been a substantial desaving stimulus. There's nothing left in the tank but the tank is still pretty full. So to me it's not a short term major issue. So I guess that's what I'd say on that part of the economy. The other big factor is the capital expenditures and those will depend on the ability to fund them. And so far so good. Maybe not as good as people would hope, but so far so good. SpaceX is it IPO'd and is below currently trading below its IPO price. Google did an $80 billion issuance. Everybody who bought that is out money. Every corporate bond that's been issued to fund data centers is trading below par or depends on when they issued at the date. But their spread to Treasuries is wider than it's been. There's a fair amount of indigestion regarding the absorption of by the financial financial markets of the issuance required to pay for the Capex, which the entire economy depends on. So there's a question of whether that turns over or not and so far it hasn't. Trading at Schwab is now powered by Ameritrade, giving you even more specialized support than ever before, like access to the trade desk. Our team of passionate traders ready to tackle anything from the most complex trading questions to a simple strategy gut check. Need assistance? No problem. Get 24. 7 professional answers and live help and ask. Access support by phone, email and in platform chat. That's how Schwab is here for you to help you trade brilliantly. Learn more@schwab.com trading wishing you could be there. Live for the big game, soaking up the atmosphere of the crowd. But too often life gets busy or the price holds you back. Priceline is here to help you make it happen. With millions of deals on flights, hotels and rental cars. You can go see the game live. Don't just dream about the trip. Book it with Priceline, download the Priceline app or visit priceline.com Actual prices may vary. Limited time offer and I don't have
- [38:14]
Podcast Host 3
an opinion whether this is good or bad but I am thinking about like sort of the end user ROI of this capex and I'm wondering when that becomes a factor because you could argue the end user will get a massive ROI out of this or you can argue maybe they won't relative to spending. But we've, we were putting out the money in advance of that and I'm kind of wondering when that becomes an issue that we're going to be focused on.
- [38:33]
Andy Constan
Yeah, I mean it will be, it will be in both ways. It's been largely ignored to date though you'd certainly look at companies like Oracle or the hyperscalers more broadly the some of the data center neo neo cloud data center companies and you'd say people are wondering where the ROI of all this investment is coming from. So that's one thing. But when you look at the real economy, when you look at everybody else, there's no ROI yet. There's very limited investment because tokens are largely being subsidized and so end users as you define them which is nobody in the AI provider token providing chain but the token consuming chain are getting a subsidized good. Justin, I'm sure you use 5 or 6 4, 5, 6 AI models as we all do. The question is how much do you pay for them? Are they free? Do you lean on the free stuff? How many do you pay for? Are you still paying or have you canceled any of your. The same thing applies to companies who are finding they are paying more for their AI bill than they are for the human that would have done the work. So there's going to be some stuff When I look at throughout all history the one that I spent the most time in my history was obviously during the Internet boom. Long term I think it's great. I think there is a that the workforce will adjust, will find different jobs than they have now and frankly there'll be different people. A younger generation will replace an older generation who gets pushed out. That'll be disruptive and difficult. Medium term, short term everyone's doing great because people are just buying chips. Longer term I think it's a good situation. I think we're going to be have tools that, that allow us to be more productive. I, you know there's, I'm not a doomer as it relates to, you know, the robots taking over. Maybe they will, I'll be dead by then but I'm not playing that. I, I actually pretty optimistic about the 10 year outcome but it's going to and the fir and the one year two year outcome. You can't be anything but optimistic because until the capex either investors say no mas on companies making capex directly or the companies overwhelm us with supply to fund that sort of the same thing. It's coming so it's the medium term that I'm more concerned about.
- [41:28]
Podcast Host 2
I'm going to pivot here to I mean it relates to this but this is a quote from Eric Balchunas of Bloomberg and the title of the piece is is is Is the US stock market too big to fail? And then he, he goes on to say could the Fed buy stocks the case for the next major crisis? The Federal Reserve could break decades of precedent and buy equity ETFs during the next bear market. The rationale the stock market increasingly functioned as America's de facto retirement system with roughly 58% of Americans now owning stocks, a figure that could approach 70% as the Trump accounts add millions of investors as equities become more Central to household wealth, voter behavior and financial stability. The political and economic cost of a prolonged bear market has rarely been higher. So I'm just wondering the two things that do sort of jump out to me is, you know, I do think because the market has done so well here in the last really 10 years, you know, there's a lot of people's wealth is, is obviously in the market. And I do wonder, you know, you go into a bear markets are painful in general. But I wonder if the next because more and more people own stocks, if it's going to be even more painful than typically they've been in the past. And then number two is, you know, is there a possibility that the Fed could step in and maybe buy equities?
- [42:51]
Andy Constan
Simple answer is we don't know. I think it's all the things that quote describe are roughly true. We have a tremendous amount of wealth that comes from our stock holdings. Stocks falling would hurt. People would have a. Just like stocks rallying is a virtuous circle. Stocks falling would be a vicious circle. That's not particularly new. It is true that the U.S. economy is more financialized primarily because we have $39 trillion of debt, which has amplified stock prices. There's quite a bit of concern regarding the economy and what could happen. And so the question becomes. Does the financial system have and the policymakers have the tools necessary to offset a crisis? And the answer is they do. And there are just consequences to using those tools in various ways. We offset Covid. We offset Covid by spending across two administrations. $6 trillion financed by the Fed buying bonds. What we got is inflation. It's a choice. We made it, we got it. There have been many times throughout history where economies have had significant amount of debt. And they're the way that that plays out when you have a downturn requires nimble, thoughtful balance actions by policymakers. And the challenge will be probably a bit more complicated in the next downturn. I think there's an expectation amongst a variety of people who are in the business of selling financial assets that the Fed is going to step in before the crisis. And maybe, maybe they're right. Maybe the gold bugs and the big print guys and all the guys that are saying, you know, we can't the no, nobody stops this train. There are a million every day I look on my feed and somebody says the Trump put the Besson put the you tell me who what put it is that you can buy stocks on leverage because there's no downside. Maybe if so simple thing will happen. Our cost of interest will stay very high, our national debt will continue to grow and inflation will be well above target for the rest of our lives. Those are all choices. And by the way, eventually our taxes will go up. The spending we do on the government spending that we do will buy less stuff and so our people will experience a lower standard of living. But there's a world in which we just make choices so that investors never feel the pain. You can do that. You can make choices so that investors never feel the pain. I don't think that's what the choices that are going to be made because I think the consequences for non investors are very, very high. So I would say if you think that there's going to be QE or what Eric was talking about buying ETFs. No, talk to me. When stocks are 80% lower, then the Fed may buy some ETFs. But I certainly wouldn't buy today based on. There's lots of good reasons. There's lots and lots of good reasons to be bullish financial assets. Lots of them. I'm long financial assets in my personal account for my whole life. I'll always be long Lots of good reasons to buy financial assets. The reason you described that we're too big to fail so it will be that there's a. At the money put at all times is not a good reason.
- [47:56]
Podcast Host 3
Do you think? I'm just curious because you brought up the put thing. Is this less under worship? I mean a lot of people argue that he is going to be less likely to do this kind of stuff than Powell did.
- [48:05]
Andy Constan
I have. That's what he says. I have no idea. And let me tell you something. If stocks are down 30% and unemployment's at 10%, that fucking guy is cutting rates to zero and doing QE and buying ETFs. Don't kid yourself. So maybe he does it a little slower, maybe he does it a little later. But every central their job is to make sure that there is financial stability and full employment and the economy doesn't go to hell. And this has nothing to do with Trump, who would obviously be screaming bloody murder if such a thing were to occur. He's a central banker. That's what they do. And by the way, I approve of that. I approve of that. But get the crisis before we. He's not, he's, he, he has not been tested. He may not be tested in the near term, but when he is tested he will ease when needed in a mate and in a size that will blow your mind.
- [49:18]
Podcast Host 3
It's this idea, like none of us know what we're doing when there's a gun to our head until there's a
- [49:22]
Andy Constan
gun to our head, right?
- [49:23]
Podcast Host 3
We're all like, I'll be buying like crazy in 2009 at the bottom or whatever.
- [49:26]
Andy Constan
And by the way, every central bank always, or every central banker always does the same thing.
- [49:34]
Podcast Host 3
Do you think there's anything like, I mean, we've had wars, first press conference now, I mean, he's talked about, I mean, it seems like maybe there's going to be less use of forward guidance. But again, who knows until they actually do it? Like, is there anything significant you take from any of this that you think will change or that we can have high confidence will change?
- [49:53]
Andy Constan
I hope so. I've written a lot of things about the balance sheet and its interaction as a monetary policy tool and its interaction with short rates. He actually speaks my language as it relates to that. I think we can, assuming, assuming inflation's been killed and we don't need to tighten financial or even just assuming. We just want to keep this, what's happening today as is like we don't want to make a monetary policy decision. I like the idea of a smaller balance sheet and lower short term rates. A smaller balance sheet is a tightening short term rates, lower is an easing. I like that twist relative to what we have in place right now. I think it's a better way to run monetary policy and I think it does a little bit toward to rebalance asset prices relative to. Income inequality and 1% sort of populism issues. I wouldn't mind to see stocks down 10, 15% and people able to fund overnight a little cheaper. I wouldn't mind that. I'd sort of think that would be an okay outcome in terms of helping Main street relative to Wall Street. It's not a big, not a big thing. But I think that what he wants to do is lower interest rates and shrink the balance sheet in tandem. And I think that's a better thing than where we are today.
- [51:34]
Podcast Host 3
Can you explain the mechanism of that? How would that work to maybe reduce inequality or benefit Main street relative to Wall Street?
- [51:41]
Andy Constan
Well, it's complicated, right? I mean, at some level, if stock prices fall, companies cut workers and so it's not great. It's not a great monetary policy tool to lower stock prices. So but the primary person who's hurt is the person who owns the stock. The secondary person is the person whose job may get cut, but his job may be saved by lower short term interest rates. So the mechanics Are he. They stop increasing the size of their balance sheet. They change their investment policy toward not owning mortgages, not selling them, but as they run off, not replacing them or their long term Treasuries and they cut interest rates, cut fed funds rates. That's the mechanics and how it affects the economy versus today. Lower stock prices, lower short term interest rates, lower housing prices, lower short term interest rates, lower gold prices. Every asset falls a little bit which becomes more affordable for the people who don't have assets. And that is I think a little. That's how it impacts the inequality issues. A huge balance sheet has for. Without a doubt. Listen, I think a huge, I think the monetary and fiscal policies have been great for everyone but greater for certain people. For asset holders. It's not like I think that the monetary policy has just been great for asset holders and bad and bad for non asset holders. No, it's been good for everyone. It's just been more good for certain set and so I think Warsh's policies, which I happen to agree with, would restore some of that balance a bit.
- [53:44]
Podcast Host 3
How about the less forward guidance thing? Do you think that matters a lot? Like I remember early in my career there was such a thing as like the Fed did a surprise, you know, there was a surprise announcement at the Fed meeting and they did something people didn't expect. It doesn't seem like that happens much anymore. What do you, what do you think about that?
- [53:56]
Andy Constan
Yeah, so, so what is forward guidance? Forward guidance is something you use when you don't have any more tools left. It was used when interest rates were at zero and you couldn't cut, so you couldn't cut interest rates. So all you said is hey, we're not going to cut. We're not only not going to cut, we're not going to hike today, but we're also not going to hike for three years. Well that has an impact. That says that's what forward guidance is and it's useful and they're going to use it again. They're going to use it in a similar circumstance when their other tools are no longer effective. Today you look at the economy, you look at the Fed itself, half the people want to hike, the other half have wanted a cut. Now they're sort of neutral. People don't know. The market doesn't know which way the to go, whether we're going to cut or hike. We might just be about right. And so if we're about right, why would you have what's forward guidance good for you say we're going to stay about right? No, we're. We just don't have any guidance. So I think it's actually a good thing. Some people say it's going to increase volatility. I don't think so. I don't think so. I don't think. You know, if you were to. One of the things that the Trump administration is floating is canceling quarterly corporate earnings. Make it semiannual. I think that's bad. I think that will increase volatility of companies and lower their stock price because we need an update every once in a while and that's useful. The Fed talks to us every six weeks. They don't have to also tell us what their future plans are and it'll be okay.
- [56:00]
Podcast Host 1
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- [56:44]
Podcast Host 3
Just one more topic here before we wrap up. I wanted to ask you about tariffs. I mean, it doesn't seem like you hear about them too much anymore, but I believe they have to be replaced fairly shortly. So I'm wondering what your thoughts are and where we are with that.
- [56:55]
Andy Constan
Yeah, I mean, I'm laser focused on that. I've been saying that for a couple of weeks now, which is. No one's talking about it, but July 24, the Section 122 tariffs go off the board. They have to be replaced with something or there are no tariffs. I mean, there are some, but there are nowhere near as many as there used to be. And so we have a lot of very short term, over the very short term, it's. What is it, the 17th already next week? We have a week for the Trump administration to completely outline its new tariffs. And so I would expect lots of news on that. And so the big picture is which way are we going? Are we going? So where we started, we had Liberation Day, in which a huge amount of terrorists were threatened. We had TACO Whatever, the 9th or whatever that was where. Nope, it's not going to be quite as bad or we're going to delay. Then we had deals and deals and deals. Then we had the Supreme Court declare all of them are illegal. They get replaced, but not fully replaced by 122. So there's a level. And by the way, all the tariffs are getting repaid. So all the collected tariffs are actually being repaid at a faster rate than the tariffs are. The new tariffs are being collected. So there's flows of money to people. So we have to see where we settle. And if we have less tariffs than the day before. The Trump administration has said that they expect the new regime of 301 tariffs to be essentially where they were before the Supreme Court Act. Okay, well that would be a big change. That would be a big increase in tariffs. Tariffs are a tax. They have a one time increase in prices that's probably already flowed through like the oil. All this tariff stuff has probably gotten the price level up. But it's a tax and people pay the tax and it's going to be a slight hit to growth but we don't know how much it's going to be. That's assuming it just gets back to where it was. The Trump administration could say, hey, Elections are coming up, we're going to slow play this. Here's half of the tariffs that we plan on doing but we're going to do deals and blah, blah, blah. We've already said that the U.S. mexico, Canada trade Agreement is going to be renegotiated. That's going to take years. And so I think there's a decent chance and it would certainly be consistent with a run it hot economy that we hear less tariffs over the next week than we might have expected then. I don't know about market expectation. That's always tricky, but certainly less than what had been in place and that would be stimulative and disinflationary. And so yeah, I'm looking very carefully about adding all those up. Now. Is it as big a deal as Liberation Day? Nah, it's nowhere near as big a deal. But it's something worth, you know, $100 billion change in the deficit and that would have a, you know, a 25 to 30 basis point change in GDP. So worth paying attention to and we should get a lot of news in the next week.
- [60:30]
Podcast Host 3
Andy, thank you so much for doing this again. This is, this has been great. I know you've posted the damp spring report we talked about here. You've now posted publicly. People can get on your Twitter account, but for people who want to get them when they actually come out, then go to damspring.com. you've got some awesome research there. Thank you again. This has been great.
- [60:44]
Andy Constan
Thanks guys. Good to see you all.
- [60:46]
Podcast Host 2
Thank you for tuning into this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform or on YouTube. You can also follow all the podcasts in the Excess Returns network@excessreturnspod.com. if you have any feedback or questions, you can contact us@excess returnspodmail.com no information
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Podcast Host 1
on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the firms of the host
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