What's Next for the Market? (w/ Matt Rowe & Jared Dillian)
MATT ROWE: And I guess that's the ultimate question, to the point of your article-- is you can be offended. You can be outraged by certain things. And you can write about it. Or you can refuse to participate in the market. But that's futile. So what do you think? What rules do you think are going to get changed now outside of the fed buying high-yield bonds? If we had a crystal ball and we could say, OK, these rules are going to get changed, and that'll make all the difference, do you have any conceptual or specific ideas of what rules you think are going to be changed? If you could tell me first before we put it in the interview, that would be awesome. [LAUGHTER] JARED DILLIAN: I don't know about the federal government. But I can tell you that the Fed has two things left that they haven't done. And they're saving that for when things really get bad. And one is negative interest rates, and one is buying equities. And the Fed has said that they don't want negative interest rates. But they have left it open as a possibility. And everybody says they're against negative interest rates until they're for it. So I think that's a possibility at some point maybe to steepen the yield curve. And the other possibility is buying stocks, which I think if we had-- let's just pretend we had a second wave of infections. Things get worse. We have another lockdown-- a 100% chance we'll retest the lows. And that's probably when you actually have the Fed buying stocks just like the BOJ does in Japan. So those are the two things that I think could happen at some point the future. MATT ROWE: Yeah. It seems like, to your earlier point of the upcoming wave of auctions, that we have-- the classically trained supply-demand thought would be, well, that's a lot. So the yield is going to have to be higher. But the cynic in me is often coming back to, well, whatever the pain trade is probably what's going to happen. So similar to crude oil trading negative recently, wouldn't it just floor everybody if the massive size in the 10-year auction went off at a 0 yield or slightly negative? I don't necessarily think that that's going to happen. But at this point, I guess I'm conditioned to not being surprised by anything. What do you think? For the Real Vision viewers and for myself, what's your take on covering the markets going forward for your newsletter and for the things that you see as being important to pay attention to? I've got a few that I can share in a couple of minutes, too. But I'd be curious to hear what you think the next chapter looks like. What's the summer look like? JARED DILLIAN: I'm actually working on that right now. I'm really good at investing in a crisis. So during the period we just had, I've actually done pretty well. But one of the things I actually-- in my newsletter on Monday, the title was "Out of Ideas." [LAUGHTER] We're kind of in this no man's land where stocks are overvalued, but the Fed is supporting them. The upside is gone for a lot of stocks. But the downside is truncated. So I'm trying to figure out what that next big opportunity is. And honestly, I haven't come up with it yet. MATT ROWE: I would love to see-- to your point of airlines, number one, I think you're right that the upside is constrained. There's been a revolving door for bankruptcy for airlines as long as I can remember. And I often come back conceptually to, what's the difference between keeping a revolving door open for bankruptcy for airlines and Amtrak? Amtrak exists because private entities couldn't run it at a profit. But the government decided it was important enough to the economy and to the infrastructure to maintain it. So it's now run like the Postal Service without concern about profitability. A revolving door in bankruptcy is similar, I guess, from a funding standpoint other than you get equity investors to routinely throw money in it again. And then they get restructured every 7 and 1/2 to 8 years or something like that. But it seems to me that if you're going to give people a put-- just coming back to my volatility strategy and my background, if you're going to give people a put in the form of supporting the equity market, you should demand something in return for it. So the idea of companies issuing warrants to the US government which would cap the upside in exchange for some form of downside protection seems like a logical spread trade. Do you think, even just outside of the airlines, that we'll see other companies issuing warrants again to the taxpayers, to the Treasury, or to the Fed? Do you think that's the type of structure that we're going to see more of? Or do you think that we just see continued support of high yield and equity pricing with no requirement on the upside? JARED DILLIAN: I think that depends on the political environment. I think you're unlikely to see that if Trump is president. You might see that in a different administration. But I will say that one of the things I fear about the airlines-- I've been flying for a long time. I've been flying since I was a little kid, and my parents were divorced. And I used to go back and forth across the country. And in 1981, a plane ticket from New York to LA round trip cost $700 in 1981 dollars. In 2013, it cost $250 in 2013 dollars. So costs were very high in a regulated environment. And then we deregulated the airlines, and prices came down for everybody. And my concern is that we're going to return to previous levels of intervention in air travel. And it's going to get expensive again. We're going to reregulate the airlines. That's my concern. MATT ROWE: Yeah. It seems that way. Anecdotally, the immediate response seems that way. And I think just this morning, Virgin just announced that they're going to no longer fly out of Gatwick, I believe, and that they're cutting 25% of their staff. And United is laying off a number of people and forcing a lot of reduction. So if that's happening in the airline industry, I find it hard conceptually. This is where I get on the verge of. I have a great idea. But will the government actually let it happen? Why wouldn't that happen in energy? Why don't we let the free market take over in energy? Or is the energy industry in the US crucial enough to our independence and to the national identity that we save it? Do you have an opinion on energy as a sector? JARED DILLIAN: Yeah. Once again, I think that depends on the political environment. I think under the Trump administration, energy is considered to be of strategic importance. I think under a different administration, it might be considered to be sort of an ESG problem. So again, I think it's just due to the political environment. MATT ROWE: Interesting. Well, one of the things that I have come back to-- early on in my career, there was a story that went around about an interview question where the question was posed to the potential job candidate. There's a button on your desk. And if you hit that button, a million dollars is going to fall out of the ceiling onto your desk. But a random person somewhere in the world is going to drop dead. Would you push that button? And if so, how many times? And the read through to this was, obviously, how much of a savage is the person sitting in front of you? How do they think about risk and reward? And maybe this is the early days of ESG. And we're really taking a blunt force idea to it. But how do you cross the chasm of what you're writing about here and a big problem for the market of-- there are things that offend us and get to a point where, well, that seems impossible and not likely to happen, versus, well, you might not like it. But it's going to happen anyway. So stop complaining about it or run for Congress. What do you think the most important confluence is of that moral hazard and being offended versus pragmatism and the reality of it? How do you wrap that up and decide what falls on which side of that? JARED DILLIAN: I look at this from a standpoint of-- I actually look at it from a psychological standpoint and things that you can control. And you have to figure out the things that you can control and the things that you can't control. And if you spend a lot of time worrying or stressing about things you can't control, then it's psychologically unhealthy. I see people on Facebook with 500 friends. And they're posting about politics constantly. And it's obvious that they're very upset about what's going on in the country. They're extremely upset. But you just have to say, what is in my power to change? What things can I do? And me personally, I write a newsletter. And I do some other things. I send my newsletter to a few thousand people. And I have the ability to influence their thought process. And that's the extent of my influence. Just like you said, if you don't like it, run for Congress. That's absolutely true. MATT ROWE: Yeah. Well, I think one of the mantras that I was taught early on in my career was, know your risk and get paid for it. And that's actually-- it sounds simplistic. But it's very hard these days, from my perspective. Headwaters Volatility runs long-vol overlays for family offices and institutional investors. And one of the hardest things to do is to know your risk and to decide whether you're being compensated for taking that risk. And to your point of don't do irrational things, if somebody came to you and said, I'd like to buy a put on the S&P struck at 1,500, what would you say? JARED DILLIAN: So if somebody came to me and they wanted to buy a put on the S&P at 1,500? MATT ROWE: Yeah. Would you tell them that they're-- that's ludicrous, that they shouldn't waste their money? Or what do you think the effective strike-- the put spread strikes are for? If you were going to reverse engineer the perfect put spread, where you are long a strike that has some semblance of possibility of getting hit and short a lower strike that would never get touched, what would you guess? JARED DILLIAN: Probably the 22, 2,500 put spread-- 2,200, 2,500 put spread. 22 is the previous lows. You buy the 25's. You sell the 22's. Last I checked, that was trading for around 60 or 70 points, pays off 5 to 1. I think that's the right-- now, that's a hedge. That's absolutely a hedge. But I think that's the right trade. MATT ROWE: Interesting. I would tend to agree with you. I look at it as-- I constantly think about the high-yield market as being a form of a put. Back to the idea of know your risk and get paid for it, most of risk taking is a short-vol trade. So owning equities is technically and theoretically a short-vol trade. Certainly buying a high-yield bond is very similar to selling puts on the same company. You're being compensated for taking a risk on the company. And the worst-case scenario is failure. So I think one of the biggest challenges here in my mind is there aren't many people who are paid to do nothing. And right now, being patient and not getting overextended in either direction seems like the most prudent thing to do. But back to the initial point of the discussion, not many people in our business are compensated for doing nothing. So what do you think the best course of action is, from your perspective? Is the best form of being proactive sitting still and being patient for a little while? Or do you think that if somebody said to you, I have $100 million and I'm 50% invested, would you-- what would you say to them about that? JARED DILLIAN: Well, the second question-- I would try to put somebody in an asset allocation. Again, it depends on your time horizon. But if this is long-term money, I would put you in an asset allocation. That makes sense over a long term. I've thought about this concept that there's not a lot to do right now. And I've actually thought about short-vol trades at this particular point in time. You're kind of getting paid to do it. It's not easy for me to execute on the fancy stuff. But I'm actually considering selling a strangle at this point in time, which is something I never do. But just the fact that I'm considering it, I think, is kind of interesting. MATT ROWE: I think that's right. And people ask me frequently, what do you think of the VIX at 32 versus 40? A VIX of 32-- I tend to turn this into practical terms of, well, what does that really mean? It's sort of a weird barometer, where people don't necessarily often think through. Well, what is that really telling me? And one of the most easy-to-understand, practical touch points is, OK, the VIX looks at roughly 30 days forward implied volatility on the S&P. And it has some sensitivity to put skew and others. But in practical terms, if you look 30 days forward and you say, OK, the VIX is where it is. What are the other conditions of volatility that I can observe, one of them is at-the-money straddle. You have no opinion if the market goes up or down. And you buy both the call and the put at the money. How much does that cost you in dollar terms? And then what type of a move do you need in the S&P to break even? So in sports gambling terms, what's the over-under on the move? And so right now, the over-under on the move for the S&P with the VIX sitting here, going from memory, is roughly 7%, maybe a little bit over 7%. And if I think 30 days forward-- considering what we've been doing in the market routinely here, I have a hard time selling that. I don't necessarily know if the market's going to go up or down 7%. But if I had to take the over or the under on displacement or distribution of the S&P in 30 days, I would bet it's going to move more than 7%. But I'm a long-vol guy. So that's my predisposition, I suppose. I think that's sort of the crux of it. Do you do nothing? Do you hedge? Do you don't bother hedging and remain underinvested? And I think that's probably the biggest challenge for everybody to try to pick through is how to make sense of this and get compensated in the long term. And I will say one thing I hear frequently from people, particularly the large pension schemes around the world, is that the enemy of long-term compounding success is short-term drawdowns. And your point of knowing the time horizon is a crucial one. If you have a decade-plus, you can weather some downturns and stay invested. If you're closing in on retirement, you need that money for bills that are going to need to be paid in the next couple of years, have a different tolerance for taking risk. And I think to me, that's the big moral hazard of the Fed-- is if the policy pushes a bunch of people into risk positions that don't match up with their own time horizon, but they have no other choice, that to me is probably the biggest moral hazard in a lot of this. Well, I think we could talk for hours on this, and we do. And I look forward to continuing the conversation, Jared. Anything else you want to close with before we wrap it up? JARED DILLIAN: No, I don't think so. This is obviously a pretty exciting time. And I'm definitely glad to be talking with you today. It's good to reconnect, so appreciate it. MATT ROWE: Yeah, likewise. Well, look, we have to have something outside of a market contagion or blow-up to bring us back together to share ideas and talk more often. But thanks to Real Vision for having us on. And we'd love to do it again sometime in the future. And maybe in the doldrums of summer when we're trying to figure out how things are going to shape up coming into the next flu season, we'll have reason to get together on TV again. But thanks, Jared. And thanks, Real Vision, for having us on. Be safe, know your risk, and get paid for it. And hedging is not an enemy. But sometimes you should just not own the underlying asset instead of paying to hedge it, I guess, would be my advice.