I mean, if you wanna go and play Robin Hood and do options, be my guest, but most of you should be constructing longer term portfolios where you're not gonna trade that often. Structure it right, size it right, and the end of the day, I can assure you, you'll be better off. You won't be as much fun in a party, but you will be smiling at the end of the day.

Okay. Good morning, good afternoon, good evening. wherever it is your time, I'm here with Convexity Maven, Harley Bassman, who's back on as a guest after two or three years. Harley, we had you on in, oh, it was probably, you know, 2019. 2020 now is sort of pre pandemic, I think. And, I know it was interesting, Dan, you were, you had a really neat trade set up that you were working on, that you were deploying as an ETF, which worked out really well. I wanna get into that a little bit later. Harley, you're currently what, a managing partner at Simplify ETFs and also invented the MOVE Index. Harley, let's start with what is the MOVE index and how did that come about?

Well, I, I, I suspect, well, thank you for having me back. Fun to be here. the VIX came out, I think in 90, I think it was 94. I, and at the time I was running bond options at Merrill Lynch and I saw the VIX and go, wow, that is a darn clever idea, ma'am, because the problem you had with, with options is how do you explain it to people? How do you level set what's high, what's low? And the VIX basically does that, in a very, you know, easy kind of way, that's easy to calculate. And I said, geez, I, I'll do it for bonds. It's a good way for me to go and sell, you know, options to people, you know, clients at the time. It was 30 years ago. Um, and I actually, the move actually, goes before the VIX because I have data going back to, 1988 already in my system. So I could populate six years just to the drop of the hat. So actually the move is, if you pull it up, we'll go longer. The vix, it's just very simply a blend of one month implied volatility options on the two year, five year, 10 year, 30 year. Waited 20, 20, 40, 20. Double waiting on the tenure because that's the benchmark for most trading. And that's it. And it's always a one month option. You gotta be a little careful about it because since it's always one month, sometimes you'll get two payrolls in it, or you'll get, you'll pick up, you know, an extra, business day. That's interesting. And so it'll jump for one day. So you gotta be a little careful about that. Same thing with the vix, by the way. but, um, uh, that's it. And, and, you know, the old rule was you buy 80, you sell one 20. this changed after the financial crisis when, when Val really got drilled on down, when, in the fifties and sixties, four years ago before they started hiking. and the problem you have with the strategy of you buy it low and sell it high, is that when it's trading 60, 70, 80, nothing's happening. And, you know, nothing's ever gonna happen ever again. And why would you possibly buy this ticking, decaying, you know, asset where you're burning theta? So no one buys at the bottom and what's up at one 40? You're at your desk crying for your mother. No one sells options up there. They're all out of their gut minds. So it, it gives you a sense of what's happening, but people, reallyt make any money off of it. Oh,

That's the same thing with the vix, right? You know, you just spend so long with the VIX hovering kind of between. You know, 10 and 15, and it just feels like nothing's ever gonna happen again. And the term structure is so steep that that to, to buy puts against something happening is just so expensive. Like you say, you're burning so much data and, um, then by the time it, it pays off, it pays off. So suddenly that, you know, no one's actually able to capitalize on it. And then once it's, you know, once you're in full panic mode, the last thing anybody's thinking about is, I, I wanna sell vol. So, so,

Oh, when the VIX is over 40, no one's selling vol,

yeah, exactly. Yeah.

which is why I said 40.

right? Right. So then, so who were the natural buyers of this when you created it? You were reaching out and you're pitching this buy at 80, sell at one 20. was, was this a structural trade that some institutions put on, or was it tactical?

You know, all option trading, is basically the same when you think about it. And this is for equities also. when you sell an option also, so a stock's trading at a hundred, you sell the one oh five call for three points. What are you doing there? What you're really doing is you're, you're taking potential possible future gains. I stock was above 1 0 5. You're taking as income right now. You're taking in the income. And, and so the most you can make is that three points. You, you could, I won't say lose because it's a covered call, but I mean, it's really a conversion process. Kinda like this mathematical idea of converting capital gains into income back and forth, and people have various needs at various times to go and do that. I mean if you really look at, we were hiring in the nineties, all physics PhDs. That's who we hired, uh, under the training desk. And the reason why is at the end of the day, derivative financial trading, financial engineering is just the physics of money. That's it. And when you look at like delta, gamma, theta, all delta is is velocity. All gamma is acceleration. It's the exact same thing. If you took, you know, ninth grade high school stat and 10th grade physics, you could do my job. We just changed the names around, make 'em Greek. So it sounds sexier, but there's no difference. It's all the same formulas.

That's right. If you know, you know, grade 12 ballistics right. VT plus one half at squared, then, then you can do most, most, most options math. So yeah, that's, that's a good insight. Um, alright, and so as convexity maven though, you were, you sort of migrated to, I identifying or, or, or monitoring markets primarily sort of fixed income markets, looking for highly asymmetric mispriced trades. Right? So what that often meant, presumably, is that you were oftentimes really like quite early to the game, right. which meant that by its very nature you ended up sort of burning some theta before the, the trade, actually paid off. Can you gimme any, any good stories or examples of Yeah.

Well, you know, for the first part of my career I was an option market maker basically like three, six months on in. That is very heavy lifting and why I lost most of my hair. Um, after I, when I became more of a prop hedge fund trader, uh, later in my career, I pushed my trading out to like, you know, three to five to 10 year trading. where I, I have an idea. I think I'm right. I'm pretty sure I'm right. I start the timing of it. and where the opportunities arise is when you get these weird discontinuities and, and the biggest one being the shape of the yield curve. So simple, some simple math here. you're advising grandma, okay? She has, has $10,000. She wants to invest it. Uh, the one year CD is trading at 3%, the two year CDs trading at 4%. What do you tell grandma to do with her money? Very simple. Actually. You can create a situation of I can earn 4% for two years. Or I can earn 3% for the first year. What do I have to earn the second year, the second one year period? So those two one year periods equal 4%. That's called the forward rate. And in this case, ignoring, compounding, it's five, right? I get TH five, I get three. That's 4%. So the question is, do I think the one year rate will be above or below five one year from now? That's all there is to it. People will talk about forward rates as being a prediction. That's false. It is not a prediction. In fact, people, people say, that kinda gets me angry. It's not a prediction, but it is the back end of an arbitrage free process. And if you remember the book, um, Liar's Poker, what Sawn Brothers did in the early eighties was they figured out how to trade forward rates before anybody else did. And they basically created free money by buying and selling this one year, one year forward rate. Okay. What happened, you know, in, in the last cycle here was, um, we had interest rates go down to zero, five years ago. And we had the move go to like 55. And I said, well, I'm, I'm, I'm a U Chicago, NBA, kind of think I believe that you print money, you get inflation, not right away, but that's kind of it. If I have, you know, $10 and 10 loaves of bread, then it's a dollar a piece. If I go and print five more dollars out of nothing, at some point I make no more bread. The bread goes up in price. Okay? And so I said I wanna go and buy a, an an option, a put option on like the 30 year treasury, but I wanted to be way out there. So I bought a seven year option on the 30 year treasury basically. And we put that into an ETF. And this is the magic of why I kind of came out of retirement. Is it simplify what we do. There was a rule change five years ago. SEC allowed people to put IVs, futures options, swaps, everything else into ETFs that became legal. And at my firm we did this. And so what we do is we take professional investment products that the big hedge funds, the Citadels use the state of California Prudential Insurance, and we use exact same products from Morgan Stanley, Goldman Sachs, JP Morgan, and put them into ETFs. And so I was able to go and buy a seven year option. Believe it or not, they exist and they trade rather easily on the, you know, not the exchange, but dealer to dealer. And I put it through ET tf. And this thing went from, you know, 37 up to one 14, you know, two years ago when the Fed started hiking rates. Yeah. Pretty good deal there. That's all it was.

a great pass. Yeah. I remember watching that whole story. We interviewed you during the evolution of the thought process. The execution was brilliant, the payoff was amazing. and yeah, that rule change. Has just enabled such a, proliferation of incredible new tools for advisors. The ability to stack sort of derivative based or, or levered or option based type strategies on top of other types of core exposures create very specific, uh, you know, types of payoff functions. We do the same thing at Return Stack ETFs, stacking managed futures style strategies on top of, you know, core S&P or bond, exposures. And, I mean, just the tools available to advisors right now are, are truly incredible. but I, I'm, I'm wondering why you chose the 30 year there instead of like, if the bet was that that, some combination of monetary and fiscal was going to. Inevitably create inflation. Obviously the bet was you're gonna create inflation in the next seven years. why not go, like to take a a, a bet on the, on shorter rates on two years or five years, betting that the Fed was gonna have to react to that and you'd get a, you know, just a higher, you know, the 30 year wasn't a treasury, but the two year was, sorry, it wasn't at zero, but the two year was pretty close. Right. So would you have not gotten a, a larger payoff on that? Or what was the premium on those options on the two year is just so much larger than the 30 year. Like how did you come about that specific

There were, it was a somewhat technical in terms of the shape of the yield curve, and this gets really into the weeds that I'm not gonna do here. but also there's the, there's the, if I'm trading the front end, so basically zero to five years, I'm really talking to the Fed and certainly zero to two is all the Fed.

Right.

Do I know what the Fed's gonna go and do? No, I don't. I know what they should do. I know what they should not have done, which is they shouldn't have, you know, kept doing QE in 2013. I mean, that, that, that, that mean, if the Fed had just done the zero rate thing in 2013, stopped it, I don't think it would've had, you know, all the problems we've, we've, we've had since then. but I'm not the fed, but the backend that's gonna be more market controlled and so the fed printing money will go to the backend and also the shape of the yield curve back then and the, uh, implied volatility, it gave me a lot more leverage. I had to go put fewer dollars to work to get the payoff I wanted. and, and, and that's very important for people to understand is there's, there's different ways to get leverage. usually people hear the word leverage and think margin, margin call, they think bad, which is kind of true. There's other ways to get leverage. Buying an option is a way to give you leverage without be exposed to a margin call. Um. You, you've taken the leverage and embedded it into the actual structure of the, of the security as opposed to something like buying futures contracts and, you know, levering that up. so I I, I mean, it's once again a little complicated. I suspect your, your listeners here understand what I'm talking about. and, and, you know, return stacking is just adding leverage. but when, when, when, when the return stacks are, negative correlations, it actually reduces risk as opposed to increasing it. so, uh, and, and by this is what Bill Gross did, you know, we're basically, we, we, we are basically PIMCO jr. bill Gross was the first guy to put to Rives into a 40 ACT fund in, uh, 85, 86, where he started buying futures contracts as opposed to buying the cash tenure. And then with the conserved cash, he bought floaters. And, um. You know, you, you go and you beat the index by 50 basis points for 10 years. They call you the bond king.

The Bond King. Yeah, for sure. Yeah, he sort of unitized Portable Alpha, right? Obviously Portable Alpha had been around for a lot longer than that. And then he sort of put it in a Unitized Forti Act product and, and you know, to be fair, really delivered for investors too, using structural Alpha. but. Still, it was a, it was a real innovation. so this actually dovetails, well, this, the, the, the bet that you had sort of made several years ago, which you wrapped into the ETF, the, the bet that it was inevitable we were gonna get inflation. And what, how can I create this highest convexity, payoff structure betting on this inflation? we were chatting before our, you know, we, before we went live about the fact that, you know, at resolve, we focus on really diversification, like global diversified risk parity portfolios, trying to account for the major muscle movements that. Dominate, dominate asset class movements, changes in expectations for growth and inflation. And so, you know, depending on the sources of growth, the sources of inflation, you got kind of disinflationary growth or inflationary growth or, or disinflationary contraction or an inflationary contracts or stagflation, these types of, of regimes. And you, you try to put assets together in balance so that they generally hedge one another against these different types of risks and environments. And let's call this kind of an all weather portfolio or a global risk portfolio. We, certain risk parity portfolio, we certainly didn't invent it goes all the way back to Harry Brown and, and further back than that. But one of the things we noticed about the Harry Brown permanent portfolio or all weather or global risk parity, and even when you start to stack on, you know, more sophisticated managed future style strategies. Is that there are still these periods in, you know, we identified kind of 19 91, 94, 2004, 2006, 20 13, 16 17, which just seemed to take the wind out of the sails of all of the different asset classes at once. They all kind of go down together, bonds, gold, commodities, equities, they all kind of tend to fall in concert. There's this systematic risk factor that is just not, not in a typical kind of global risk parity portfolio, but which is a, a major vulnerability of all of these types of portfolios. And I I thi I thought that you would be a really good one to have some thoughts on what might be missing there. Right. I think you've come at the market and were raised in the ecosystem that it might be right in the sweet spot in kind of helping to discover what's missing there. Uh, we'll just walk through how, an investor might be able to patch this, this potential hole in, in the portfolio diversification equation. What are your initial thoughts on that, given those specific time periods?

Okay. So Ray Dalio became a billionaire for risk parity. Okay. an idea that may have been already out there, but he just took at times, you know, a hundred billion. Um, and, the idea would be you, you have a hundred dollars, maybe you put, you know, a hundred into stocks and, and 40 into bonds, but via futures, and you kinda lever it up that way. and, and as long as stocks and bonds go in different directions, you actually reduce your volatility of the portfolio, even though you're levered up. the problem is this, you are looking at a correlation looking backwards. You're adjusting the sizing based on that correlation, but that all assumes that the sign is negative. That one up, one down. Where did they both go together? And I've written about this for many, many years. You go to my website and find all my stuff writing about this. Yeah.

But just let me, let me just, let me pause because I wanna make sure that we're, we're discussing the, the complete picture here. So I wanna expand the canvas a little bit, but beyond stocks and bonds here, because we agree on this, right? That, that just inverse vol weighting stocks and bonds leaves a massive hole in your portfolio from a risk perspective, which is the inflation risk, right? Where stock and bond correlation converges on, on one, all of the divers diversification benefit that you expect between stocks and bonds is expected to go away mechanically during an unexpected inflation spike. Which is why you wanna also add things like commodities and gold and tips or, you know, breakevens, for example, to the portfolio to try and hedge against. The, the convergence in, in correlations between stocks and bonds, during inflation spikes, right? So just to expand the canvas and set the, and set the table. Even a portfolio that contains all of the elements that I just described still has these weird air pockets, right? So I just wanted to make sure we sort of started there instead of starting at the gap with just the stock bond risk parity. 'cause I think we'd all be kind of in agreement on that one.

Well, I mean, you hit the nail on the head. I mean, data shows that when inflation goes above two and a half or tens, 10 year rates go above four and a half. The, uh, sign on the correlation flips and they both go positive. Both go negative as far as everything else. What happens is, because people tend to use these strategies very commonly when the sign flips, so they're both go up and down together. They have to de-lever. What they do is they sell everything. So you've seen gold and tips and everything else go, go down the tubes. I wouldn't say, but that tends to be temporary. but can you, which is why I always say sizing is more important than entry level. Trying to time it, you're gonna fail. Okay? You gotta size it so you could take a, a rattling of the markets and not get stopped out, because that's what happens with these markets is, is everything goes south. Correlation one, people get stopped out, they don't get back in again, and then the whole thing, you know, un

But let's go back to like, let's go back to like 91 and 94 and even oh four. I think the amount of these kind of lever diversified kind of permanent portfolio weather portfolios, they were still pretty small relative to the size of the overall markets, and yet you still do have these periods when kind of everything goes down together. So maybe if we sort of sidestep this whole discussion of kind of risk parity and just talk more about these strange environments where diversification kind of fails, right? Where you're a typical kinda long only portfolio that's trying to diversify between inflation and growth sensitive assets. Well, all of those inflation and growth sensitive assets all kind of flop together, right? And my, my supposition, which I, I I mentioned before and which could be totally wrong, which is what I wanted to kind of grind through with you, was that, it might be due to an unexpected increase in the expected cash rate, right? The Fed comes in and either. Jawbones a potential unexpected rate hike that the market had not been pricing or expecting, or they actually come in and sort of do a surprise rate hike. Maybe the market was expecting 25 and they came in with 50 or 75. Right? Or, or, or, but something happened that, right? Yeah. So I'm just wondering, so first of all, am I right in my intuition that that many of the time periods that I highlighted may have had that, that draw down in everything partly, or mainly for that reason? Are there other things at play? And then we could talk about how can a long only investor best diversify against that kind of, everything falls together kind of outcome?

I, I don't think it's the surprise factor that you mentioned. Um, well, I guess you could be. Everything's a surprise nowadays. I think it's the inflection points on the yield curve or really the inflection point of the Fed, which kind of dries it. So if the Fed's hiking rates and they hike and they hike and they hike, that's not quite a surprise. You kinda know what they're doing. It's when do they come, when do they get a reverse course? When when's the first cut coming? And that's what we saw happen over here. That's when the markets ran and, and when the first hike happened, rates were zero for a long time. When they hiked well, then everything blew off the map. I think identifying these inflection points in the Fed and thus, more importantly in the yield curve is, is important. And if you go look back, the curve was Max was max inverted in, uh, you know, late 23, 24. and it's now positive and it might go and it's probably gonna go a lot more positive. and so I think, I think it's the yield curve, that's driving it. And, and that's been driven by the Fed. So it's not the actual, if they're in a hiking process and you're 20 fives and toss in a 50, like you might call it a surprise, I would say it's going the same direction. It's, it's, it's, and stopping is also not a big deal

right. So it's more this sort of inflection point.

when, when they turn

when the market has been going along as if the Fed is gonna stay loose forever and the Fed makes the first noises, or takes the first steps on the tightening cycle is that's kind of when you, you get these big downdrafts.

Or the, or the easing, actually, I mean, easing in theory is helpful because, you know, you lower the, the, the present value of cash flow changes. But when they're cutting rates, that's a signal. Probably they're worried about the economy and that could be a challenge. and also the back end of the curve often goes up, which we saw this time, ev everyone thought when the fed cut rates were gonna see, you know, everything come down. It didn't, you know, twos came down by a hundred and bonds went up by 50. Right.

yeah, yeah. But it's not so much always that the backend goes up. It is that the, what is it again? It's a, it's a bull steepening, right? It's like the, the, the, the short-term rates come down faster than the long-term rates.

but this time here, we actually had the backend go up and the

Right, right. In the, in the modern context. Yeah.

Yeah. And th this, this is not, we have not invented tragedy here. This has, this has happened before.

Gotcha. Okay. So like in the 91, 94. So, so there's, it's not just one type of situation. It's not just the Fed is, is unexpectedly hiking. It's also where is the yield curve when the Fed pivots? That's also a really important, context,

Yeah. But I mean, look, up until now, at least, what has been the best predictor of recession? Invert Curve.

right?

two tens, but actually three month to 10 year treasury, not swaps, that has, that has the best historical 40 year record of part, particularly, a recession. which we, we have this, you know, a while ago and it, we came out recently, where it finally flipped over. so in theory, we're supposed to get a recession in, you know, six to 18 months. So theoretically we should get a recession between December of this year and June of next year. Will that happen? I don't know, but I mean, that is the best historical, correlation of recessions.

Right, and, and you know, it's for, for a global, like for a, a portfolio that's, that's risk balanced between, between, treasuries and equities and gold and commodities. A recession, you know, a recession is painful because the equities and the commodities obviously drop, but the equities and commodities, they don't have a huge amount of weight. Gold can kind of go either way, right? It, gold can, can drop typically early in a recession and then it begins to, to rise once the fed drops into negative real rates territory in order to stimulate growth or fiscal kicks in or what have you. But treasuries can be relied upon typically too. Rates are gonna fall and treasury are gonna rise, and you've got a, a risk appropriate allocation to treasury. So as long as you've got sort of, you know, one or one and a half or two pistons in the diversified portfolio working, you're typically okay. But these, these, the situations that I'm really trying to narrow down to that sort of 91, 94, 0 4 type situations, treasuries, drop stocks, drop gold drops, come outta these drop tips, you know, break evens, don't do much. Like it's, it's those particular periods that I'm, you know, I'm mostly trying to really keen in on, I'm, I'm wondering whether you got, you know, any particular intuition on, on, on that particular situation.

If you're trying to get me to predict the next

No, I'm not. I'm not, I'm not, I'm really, I'm really trying to, to narrow in on like what is the systematic risk factor. Not like what's gonna happen in the next few months, but rather what is the systematic risk factor in common? With those incidents and, and is there a, a strategic allocation that one could add to like a, a, a diversified portfolio that's trying to manage against, you know, inflation and, and growth shocks that would help to mediate those, those specific types of experiences? By the way, I'm now like hammering you and I, I feel, but I do feel like you've got some ins insight. Like what, let me, let me, let me back it up. What does do well when the fed, when the fed does pivot from, from loose, loose, loose to, to beginning to reset market expectations for a tightening cycle, what does well in that period?

I think there's been a systematic change, a paradigm shift over this last, you know, 30, 40 years that you, you're kind of kinda looking at. And as I think we went from a value active manager proposition to a passive flow situation, my partner, Michael Green, has done excellent, excellent work on this entire topic. And although he is been wrong on interest rates and inflation, I think he is right on, on passive what's driving it. And I think what's going on over here is this, the millennial cohort, they have jobs, big companies, they do matching 4 0 1 Ks. I've told all my kids just max out those 4 0 1 Ks, put, you know, 70, 80% into, into an equity, you know, passive, uh, I'm not gonna mention a ticker. SSPX put 2030 into some IG five year. Corporate bond fund reinvested, divs called me in 30 years. and I think what's happening is these flows just from this bulging demographic of the, uh, millennials. Remember, millennials are actually bigger than the boomers by number now. The boomers were bigger by percent of, of, of the country, which is why we drove everything, um, and took everyone's money. but, but I mean, one, they're, they're, they're pretty big out there. And if this money keeps going into passive, it value doesn't matter. I mean, we have all the, I mean, Cape and everything, every other value metric is off the charts right now. And I don't see it changing until we see unemployment go above 5%. And I'm picking the number kind of outta the hat. I'm saying that is what will stop the passive flow is people not having jobs. 'cause if you don't have a job, you're not getting a 401k, you know, coming a matching coming at you. I think that's, I think that's gonna be what's gonna turn the market. I think value has no meaning. 'Cause I can guarantee you, my kids have no idea what the PE is of the S&P. They don't even care. They said they, they said, they said, we're gonna do this in 30 years. It all kind of balances out. And truth be told, they're right. And inflation and equities are a great inflation hedge over the very long term because a company can raise prices. By definition, inflation is raising prices and therefore the nominal return of stocks is always going higher with inflation. The PE might be lower or higher, but the, but if the company doubles their prices, they're gonna make twice as much money and the stock price is gonna double basically with the same pe. So over the long period of time, average will go up as long as you think there's gonna be population growth and inflation.

so I mean, I think if you, my sense anyways is looking historically that. In general, equities do well in an inflationary boom up until a certain threshold,

When? When tens get above four and a half or inflation above two and a half, yeah,

yeah, right. At which point, you know, the market tends to get skittish about inflation expectations. The inflation genie kind of, you know, escaping the bottle and, and,

forget that. Just the pure bond math of it. I mean, I know Amazon will make a trillion dollars in 30 years. Question is, what do I discount that trillion dollars back to today? And discounting that NPV at 2% versus 5% is a very different animal.

I know, I hear you. But then we had two point a half percent tips yields, out out 30 years a year ago, you know, and, and, and

it's crazy

here, we're at, at, you know, at 22 times forward pe on the, on the S&P. Right. So, I'm, I, I, I know Mike and I've, I've, we've chatted extensively about the passive flows and, and I agree. And, you know, I wonder how I, I've had this hypothesis about, so there's, there's a lot of, there's a lot in the news lately about AI displacing jobs. You know, I think in a way it's a little bit overblown. I think some parts of parts of it are, are almost under blown a little bit. But, but the irony is you've got a, you've got a market that's pricing AI companies as though there's going to be a massive proliferation of AI and robotics. What are they going to do? Who's gonna buy them if they're not gonna massively increase productivity? How do you increase productivity by displacing lower productivity workers? Right? So the unemployment rate is going to tick higher in the, at least in the short, intermediate term while this takes place. If that's true and the passive flows argument is also true, then I wonder if these companies are not sowing the seeds of their own destruction because you know, once you've got a certain threshold of unemployment, like you say, then those passive flows turn from at the margin positive to at the margin negative and multiples begin to contract even while profit margins at companies may be, may continue to expand and you, so you may have like the market kind of treading water or even dropping while profit margins. Continue to expand and, and earnings grow nicely. Is that something you guys have, have contemplated internally?

My job is not to go predict the market. My job is to, is to give you products that you can use to, to predict the market. That said, what you're describing is, um, fiber optic cable 30 years ago. I mean, all, we all have these predictions of it. We laid, laid, you know, gazillion miles of cable under the sea. and then we discovered, oh, with all this cable out there, the price per foot is, you know, pretty small, not what we thought it was. And it's because it all went bankrupt. AI will be the same thing. The price, the, the monopoly prof profits that if it is getting will stop at some point. and, we'll, we'll find out what happens as far as job displacement. Look, they cars came out and all the guys were making saddles and buggy whips. They all, they, they all got jobs eventually. we had the same thing with nafta, out shoring to China and Vietnam and everywhere else. I, I would say that the grand political problem. Which is why we have our current situation, not assassinations by the way, is that we, the government did a lousy job of transferring, re retraining, helping to move around, people who were doing, making furniture in North Carolina. They should have learned how to go and do welding and plumbing. 'cause those jobs pay a bloody fortune. You know, any, any qualified welders are making, uh, over a hundred KA year. We, the government should have been involved in there in this transition. And I think our current politics is basically that we didn't do that, thus we widened out the, the income gap. Um, and that, that's so,

Yeah, I mean, the American Society of Engineers says that there's a $3.6 trillion infrastructure gap in the us. We desperately need to replace, you know, pipes and bridges and, and all manner of other types of infrastructure. There could have been massive investment in retraining and deploying these to rebuilding. America. But, instead, the choice was to drive all of those profits to a narrow group of companies who benefited most from, you know, hollowing out America's industrial base and then redeploying all those excess profits to buybacks and, and, and dividends into the, into capital coffers. Right? So, I mean, we're, we're definitely on the same page there.

Yeah, I mean, look, but once again, what I'm saying is over my horizon, I'll all, all will be fine. You are saying over the next year or two, how am I gonna trade this thing? You're right. Also, I mean, there will be bumps along the road. I just don't think that AI is gonna go and destroy civilization. I think, we'll, we'll just do different things. The computers aren't gonna go and, and, and, and, you know, weld pipes or build robots, you know, someone's gonna go and, and just, and those other stuff for it. It's just bumpy. And I, I, I expect our politics will adjust at some point, for, for that rational idea. I mean, we, we, and I don't believe China is gonna overtake us ever, at least not in my kids' lifetime.

Yeah, it's just funny because, you know, you either are betting you, you've got all this money in market cap indices, the vast majority of which is, is effectively betting on AI at the moment. I mean, AI and data center, investment is kind of propping up the economy and AI market caps and, and expectations are propping up the cap weighted indices. That obviously is predicated on the fact or the expectation that AI and robotics is going to be broadly embraced by the global enterprise market, right? which, if it's true and happens on the timeline, that might justify the valuations and the investment that we're seeing would result in massive job displacement. So you've got, you know, you've got that kind of bet already happening, but if it plays out like that, I think you're gonna get unemployment that would then undermine the valuation expansion or multiple expansion that we've had through passive flows. So you've just got this weird kind of reflexive bet on at the moment. I think that, that, I think it's kind of fun to sort of toy with everybody's expectations and if everybody gets what they want, will they actually get what they want? Or will something very different happen at, at a a market cap investment level?

Well look, not to go and shill my, my, my, my, my own products, but, we just came out with a new product six months ago. that is the opposite of the bet of rates going higher. It's a bet that rates are gonna go lower. It's a seven year option. On the 10 year rates. You should be happier. It's a 10 year, not a, not the 20 year. and this, option because of dynamics, and you go to my website, I've written about this. Actually earns a positive 2% yield. You're long an option. Limited loss, unlimited gain. Okay. With a positive yield.

Okay, so what's the bet on, what's the bet you're you're making here, Harley. And why? So this is sort of like the next, version of your other bet, the, the PFI bet, right?

it's the opposite. Yes. and

yeah. So, so why, why this and why now? And, and why is it structured this way?

I kind of felt that up at, uh, 5% on bonds we're getting to the higher end of the range. Could it go higher? Yeah. Could inflation keep going? I think it will, but we're getting up to where that's starting to be a, an impact on, you know, society. And so now it's, will we get that transition? Will the Fed start to cut? Maybe even more than just a little. Because they have to, because actually we do have that recession coming as the curve kind of indicates. And if that happens and you get like those power windows down rate environment, having a 40 duration instrument with positive carry, think of what you can do with that. You only got a, I mean, the, the ag is a six, six and a half duration. I could put a dollar to work and get a 40 duration, so I only gotta buy, you know, 15% to get the same duration exposure. And the other 80% can go to any, get the gold to this, to that and do your return stacking idea. That's pretty clever. the trades I like, I mean there's been some of these, um, I'm, I'm not gonna mention tickers, but you know, floating rate, loans that yield, you know, seven, 8% or some of the, um, BDC equities, you know, they are, they yield eight, nine, 10%. that, that's, that, that, I mean, if you get eight, 9% compounded, that's equity returns forever. You have credit risk in there. What's gonna cause the credit risk to go and go south? It's gonna be a recession. We got a recession rates, it's gonna go down hard, it's gonna hard. I got a 40 duration asset in my pocket. I'm looking pretty good. and, and that's the clever idea of getting leverage via this option as opposed to buying, you know, five futures contracts. You have five futures contracts, all of a sudden you, you, you lose five to one on the way down. Also, you buy an option, you lose one for one, make three to one, four to one. That, that sets a different, that, that's pretty clever. And, and once again, it's, it's, these are professional instruments that are available. Only the pros and putting them into ETFs is a clever idea. So that would be my best idea right now is to go and buy this long dated call option. You don't go buy a lot of it and then put some income producing investments in there. And I'll say one thing that's very important is when, if you go look at anything that's not like ultra high grade, in fact even IG also has a negative duration. High yield's a negative duration. You can have rates go down by a hundred and have high yield bonds go south because that spread can widen more than the, uh, bond, the, the treasury goes down. Um, that's why you gotta go and, and buy over, buy, duration. So if you go use this option ETF, you could get 12 duration in that by buying twice as many of it. Right. And that'll offset you put that with a high yield product. Well, not, there you go. You got a high yield instrument portfolio with a, an embedded insurance policy.

Right. I mean, high yield spreads are pretty grim at the moment too. Right? What do, what do you see as the sort of ideal pairing like between the the trade that has the, the best current, carry, but that is most vulnerable to the type of risk that the new product that you've constructed is best designed to hedge?

I like buying, the, the, the loan products or the BDC products. and then pairing that with my, you know, levered call option product.

leveraged loan? ETF plus A.

You know who they are?

Yeah,

Or, or, or, or, or, or the BDCs. I like them also, you know, and, and, and, and the big, there's like four name brand ones. there's one that's really big. I mean, I own them. Okay. and, and, They're, they're not gonna blow up. I, I would say that, you know, sometimes if the yield's too good to be true, it is okay. You're better off sometimes taking a little lesser yield and having a, a, a, a product that's just not gonna blow on you. and there's a lot of people who look at these very, very high returns. If, if you're looking, it's like it's yielding 12%, you know, there's a reason for that. Man. Junk bonds yield six, seven, right? Eight. I mean, if I'm getting 12, I'm, I'm taking a risk. And now it might be risk you want to take, and I'm fine with that. I will tell you, likely you don't, you've not looked under the hood to see what risk you're taking.

Yeah, no, I hear you. So you're able to get a 2% carry. Is that because the yield on the underlying is, is higher than the the carry on the option?

It has to do with the fact that, when I buy the op ordinary options that you buy and sell on the exchange, you have a suitcase full of cash and you give it to someone, they give you an option or vice versa. They give you a suitcase full of cash and trades right there. In the Pros market, we don't trade options by giving you cash back and forth. We say, I will pay you. So a seven year option on the 10 year rate that I do with Morgan Stanley or Goldman Sachs, we agree upon a price and I'll pay you at x expiry. I'll pay you in seven years. And we do all the calculations. And when we do that, we solve a lot of problems. because we don't know what, what the, the rate that Goldman Sachs borrows short term money at is different than where Morgan Stanley, worse than that. Think about, company in Switzerland, company in Japan, company in Germany. The Euro with the yen, the, the short term rates are everywhere. It's very hard to agree upon what a future, what, what a thousand dollars a year from now is worth. We all agree it's worth a thousand next year, but what's worth today, we don't know. So we, what we've done is we trade forward and everyone's happy. so I buy these options forward. So I have all the cash, I put the cash in. The treasuries are earning four point quarter percent. The option itself decays very slowly 'cause it decays at the square root of time. So going from route seven to route six, not that big a number. Whereas going from route three to route two is a very big number. So that going that long day option, time decay, kind of goes up and flattens as opposed to interest rate, which goes linearly. And so when you have this versus that, that little triangle out there is positive carry. Um, and that's, uh, and once again, that's why I like dealing with these long-term options. because they allowed me to go and do something. I mean, usually people wanna go and they wanna make money right now, they wanna go to the party and brag what they did. I mean, I guess I, I saw in the, in the, you know, news, some Twitter thing yesterday, some guy bought an Oracle option for, for a penny, and it was ended up being worth $8. End of the day, it's like, fine, the guy's a hero, okay? but away from that small detail over there, I mean, you should not, I mean, if you wanna go and play Robin Hood and do options, be my guest, but most of you should be constructing longer term portfolios where you're not gonna trade that often. Structure it, right size it, right. And the end of the day, I can assure you, you'll be better off, you won't be as much fun in a party, but you will be smiling at the end of the day.

I love it. Alright, well I, I wanna talk about, your letter about Fannie Freddie, but before we do, any other low hanging fruit kind of opportunities that are, that you feel are kind of page 16 could move to page three and, and eventually to kind of page one over the next three to six months.

Look, I mean, mortgage bonds are still the, uh, cheapest, the, the best risk return out there. They were trading 1 75 over, they're now a hundred over. That's still, well more than their long-term average. And it's still more than credit bonds. They're trading only 50 over, so you won't get rich. But new issue mortgage bonds, you know, yielding five and change. I've done dumber trades than that to go put money at 5% with no credit risk. it's, it's not a big winner, but that's what's part your money. other than that, things are, I mean, we are in this transition period now, the Fed kind of. Turning over and the curve going positive. It's plus 50 right now. Twos, tens. it, it, I mean, it's gonna go back to a hundred. I could promise you that. The question is, how's it get there? Front end, down back, end up. The most important thing from a macro standpoint, from my view, is this. It's not tariffs, it's not tax, it's not regulation. Okay? They're important. That's not where the rubber hits the road. It is immigration policy. I'm telling you right now, this is the big one. There's the, the government not withstanding them being fired all, all the time has calculated there's 75,000 illegal immigrants who were bad guys, bad girls also. They, they, they, they have tickets. They, they do, they do bad things. We go and deport them. God, I'll, I'll go, I'll go buy the ticket and pay for the gas. That's ship outta here. We start going up to a million people. That's a whole different animal. because GDP is people, times, hours has productivity. That's it. Nothing more, nothing less people, hours. Productivity. Productivity ain't gonna get that much better. I guess you could say AI maybe, but not really. Hours. How much more can you work? It's people, it's population. We have negative net immigration right now. We have a birth rate in this country under 2.1. Theoretically we have negative population growth right now. That is not good. and Jim Bianco in his last, Macro Voices said that because of this calculation where we used to need like 1 20, 1 31 40 payroll every month to break even, he thinks it might be only 20 or 30 now, break even because population growth is negative. if he, if we really go to the screws here and kick out a million people or more. that's, that's gonna be really bad. I, I promise you thi this will end in tears. And I'm not making a comment whether it's good or bad. If you believe that we have an immigration problem and you sincerely believe that we should deport a million people, I will say, that's your opinion. You're welcome to it. I have no problem. Just know there is a cost to that. If you're willing to pay that cost, God bless you.

Yeah, I mean, if, if you want to deport people and you understand that GDP is number of people times, times, hours, worked times, you know the amount that you're paid, then you just, I guess you need to have a policy that is, that is ready to, to provide enough fiscal to offset the negative shock from, from these private sector, employment deportations, I

It's stagflation man. We're gonna have lower GDP and higher inflation because you know what? If we lose the immigrants who are working in the chicken plucking factories and send 'em back to Mexico, we have to raise the wage, the marginal wage to bring in different people into that job. Or we're not gonna be eating chicken. So it is inflationary and negative GDP. This is a, this, this is the big one. If we go through this policy, by the way, we, he might stop. We might, we might stop doing it. Um, I'm just saying that that's to watch out for is, is the immigration policy.

Yeah. Great insight. Alright, let's, um, let's pivot to your recent letters. You said you had a longer letter, which I read, a few weeks back and you've now condensed it, I guess, and, and submitted it to some, some popular, newspapers, journals, et cetera. What's your, what's your main thesis here?

Look, Fannie and Freddie Jenny, they were created by the government to go and support the housing market. If you remember the, the, the movie, it's a wonderful life. there's the SNL, they make loans, to people to buy houses. And let's say they have a hundred dollars, they make loans for a hundred bucks. Once they loan all the money out, that's it. They can't loan any more money. What the government did was say, okay, we're gonna securitize these loans. So the, so the bank could take that a hundred dollars in loans, give it a Fannie, Freddie Ginny, they'd securitize it, make it basically government guaranteed bonds, sell 'em to the market, a hundred dollars comes back to the bank, they could lend money again. And it's a way to go and massively increase the available funds for housing. Housing is 18% of the economy. And

You, you did a really good job in your letter, Harley of, explaining the, the public good. The creation of Ginny and Fannie and Freddie did in the economy. What, what was the initial motivation for, so you, you talked about it, but I just wanna make it really cr really explicit that this was policy that was, that was brought in by the government expressly to allow every American to own a home at the time, was sort of the ambition, Right.

Help, by lowering, by significantly lowering interest rates, you made housing more available. Remember, nobody buys a house, okay? A rich guy buys a house, or they don't buy a house. They sign up for a payment plan. The payment plan is driven by the price of the house. More importantly, by the interest rates, you bring that rate down by two, three points. All of a sudden, that massively changes the ability to go buy a home because your payments come down by a lot.

Yep.

That's what Fannie and Freddie and Ginny have done is massively lowered it because now people who buy these mortgage bonds, it's government guaranteed money. So they have no risk. A a bank, I mean, would you, would you take out a, would you give a loan to your next door neighbor? I kind of doubt it. I mean, you charge him 15% probably. You have no idea who this guy is. Take it out government money. Ah, fine. So they radically changed the availability of housing to do that. They, they lowered the price and increase the availability. And the problem we had here was that, Fannie Mae went public and IPO in, in 68. and what you did was you created this bifurcation of risk where the stockholders got the upside and the government got the downside. And so what the guys at Fannie Mae did was they said, Hey, good idea. Let's go and juice it up. They bought $750 billion of their own mortgage bonds. Hedged them out. So they thought, took those profits and they took a, they went into the stock and the value of Fannie Mae went up eight x and they got options on those stock and they got, I mean, the CEO made $90 million over the course of six years. Okay? he's supposed to be a government employee as far as I'm concerned. He's cleared up 90 million bucks and then financial crisis hits, the whole thing blows up, and the government goes and owns the bag. this was always a bad idea. Okay. This is called moral hazard. It's classic moral hazard where the gains and losses go different places. We're back to a world where the government has the whole thing kind of sorta. We did conservancy as opposed to pure bankruptcy. What they should have done, the reason they didn't do it is at the time there was about $5 trillion of Fannie Freddie to ventures and mortgage bonds out there. If the government took it onto their books. Then we would've seen total national government debt, not liabilities. This actual debt go from 10 trillion to 15 trillion and that would've taken the debt to GDP ratio from 65 to a hundred. And Reinhard Roff, as you know, they've written about once you go over 90%, you tend to have a dulled economy, which where we are now, we're like, I think we're 110, 20% right now, which is why growth is also lousy. and someday we'll have to deal with that different topic entirely. they should just take the thing over. They're thinking of re privatizing this, like, who wins? I mean, there's a few guys that own a lot of this stock and they, and they might make billions of dollars for what purpose to go. And once again, bifurcate the risk and return. The stockholders are gonna go and I presume get money. They have to take, if they get, if they earn more than treasuries, that means they're taking on risk. But the risk is the government's risk once again. So, I mean, we're paying people from the government's risk, and if we actually really do privatize, which we won't, but if we really did well, those mortgage bonds are gonna trade to a wider spread 'cause there's more risk than them. Now

Yeah. The cost of capital to all homeowners goes up dramatically.

if we, we, if we only had a quarter percent, just a quarter percent increase in the mortgage rate nationally, that would take up the average or the median mortgage payment by $800. That's about people pay for Christmas presents, man, we're gonna suck out, you know, Christmas cheer and give it to a few rich guys. Like, this is public policy, you know, gone upside down. It's a horrible idea.

statement in your, in your original letter. I remember reading that.

Yeah. So, I mean, I'm totally against this. I hope they don't do it. Hopefully it's, it is just talk, but

How do people still own shares in Fannie and Freddie? Um, oh, they're like listed, right?

No, they are, they trade on their stock exchange, but they, they never went bankrupt. They traded for 25 cents, 50 cents a share. You know, five years ago, 10 years ago,

So what does it mean to them to, to re privatize it if they're already trading private shares?

I think, well, the government owns most of these shares and the government

So there's some small float that, that the government doesn't own, and they're gonna

So the government will go, yeah, so the government will go sell these things, fine. They'll go and make, you know, $50 billion or whatever it is. Like, really, they're gonna do a one shot deal of, of an amount of money that's, you know, they're barber at the club and basically screw all the American homeowners. This is upside down public policy.

Well, they're basically selling another $50 billion put option, right?

I suppose, but I, it, it, it's, it, look, it's a bad idea in so many ways. I mean, look, if they really wanna do it, then really privatize the whole thing. Then the buyers of the stock, well, they're not gonna be quite as happy if they think that stock is really gonna zero this time. But we can't do that. We, I mean, we just can't go and beg the same reason why. When they talk about they're gonna shut the government down, you know, in, in a month or so, really, they can't do that. I mean, you can talk and talk and talk, but the US government is not going to default. We can't just can't. So it, it is just, just more talk to go and have trading ideas. It, it is bothersome that we even have this kind of conversation.

yeah. So what, what kind of, investors or you know, are, are agitating for this privatization, do you think? Without naming any names?

Look, it's all public information. You just go to Bloomberg and type it on in HDS to give you all the names of who, who owns the shares. It's real easy

Right, right. Obviously people with, with, with a, a serious profit motive and, and without naming names, some of them have been very public supporters of the, of, of the current administration. So

I kind of gotta go there. All I'll say is this. You go to HDS, the top line is 115 million shares. It was trading at a buck 50 before the election, trading at 14 bucks. Now the math okay.

Yep. Say no more. Awesome. Well, I hope you find a, someone who will print it. Maybe the Financial Times will print it, like you say. That'd be great. or, you know, one of the American, newspapers would ev be even better. But, let's hope it gets some publicity. 'cause I think it's a really important message to get out there and I appreciate you writing it. and I appreciate you sharing all of your wisdom and, and all your ideas again here with me today. And, it's always just an unbelievable pleasure. I know you're traveling to Italy next week. Are you?

Indeed I am. We leave on Saturday, my third grandchild is arriving. Then my, daughter has a postdoc, physics PhD in Pisa, Italy. She's working on quantum thermodynamics. and, uh, she's been there longer than I thought she was, and she might be there even longer than I think. but, but there, she's doing very well. And someday you might go and see, uh, she might start a company someday you'll be, be, uh, dealing with her.

That's exciting and I can't think of a better reason to visit Italy. you'd want to go anyway, but to be able to visit new grandchildren and spend time with family even

I, I'll say that, that this, everyone says, oh, Italy, Tuscany. It's incredible. Thank you. It's wonderful. I said yes. If you go for a week, you're gonna love it. Ma'am. I was there for six weeks for the first baby after about week three. You know, it's pizza, it's pasta, and that's kind of it. Ya and sushi or Chinese or Mexican or anything else. So, um, it is affordable though. You get a great pizza for $8, a good pasta for $9. It is very affordable. so, so that's good.

found the same.

six weeks is kind, is, is a little long.

Yeah. We went for three weeks and found the same that you, you end up craving diversity palate diversity matters a lot. You don't realize it until it's missing.

Yep.

Awesome. Alright, well thanks again, Harley. Really appreciate it. And you know, I'm sure we'll have you back on in a year or two to, to to reflect on what's happened and, and I'm sure the environment will be completely different. We'll have lots wanna talk about, but until then, save travels and, chat soon.

Excellent. Thank you.