What Bessent Is Really Doing in the Bond Market | Mike Green

0:00For the first time ever, Yamavar Resort and Casino at San Manuel is giving away a new Rolex watch for every Club Serrano card deer. Play with your Club Serrano card and on September 20th, you could be one of five winners of a Rolex watch. Plus, all winners will advance to the finale at Palm's Casino Resort Las Vegas for a chance to take home a rarity. The second Mustang Dark Horse ever produced on September 26th. Two properties. Six winners. Only at Yamavar Resort and Casino, your California to Vegas connection. Details at Yamavar.com must be 21 or older to enter participate. Please gamble responsibly. Star Wars. The Mandalorian and Grogu is now streaming on Disney Plus. What are you waiting for? Hop on. The Must See Galactic Adventure comes home on Disney Plus. This is the way. Our only chance is to work together. On the life of this game, always wear your seatbelt. Star Wars. The Mandalorian and Grogu, now streaming on Disney Plus.

1:26In the work mode, available on plus and pro plants. This is a very dangerous wound in situation that we have. You need to take this very seriously. The treasury is going to be forced to address this. This is just debt management and it makes perfect sense. It's exactly what you should do. The sky is sitting there with the turnip at saying, do you want me to put it on or not? Hello and welcome to Welltheon, a Maggie Lake. Joining me to discuss the outlook for bonds. What it means for your portfolio is Michael Green, the CEO and CIO of the newly formed tier one Alpha Asset Management. Hey, Mike. Hey, Maggie, it's great to be here. Thanks. You're great to have you congrats on the new venture. This is super exciting. It is exciting. It's an awful lot of work and congratulations is not the appropriate sentiment. Good luck is a much better sentiment. Once dollars start coming in the door on a sustainable basis, then you can say congratulations. We know that's going to happen and it's really interesting, exciting stuff.

2:28We're going to talk a little bit more about what you're doing and why now because it's a really interesting story. But first, there's a lot happening in market. Let's talk a little bit about what's happening in the bond market and excited to have you for this conversation because you and I have been talking throughout the year. You wrote an open letter to treasury secretary Scott Besson earlier this year. You've been vocal about policy and policy decisions and potential pass forward. In August, Besson intervened in the Forex market and announced a treasury buyback plan, which sends a lot of ripples through markets. What's your take on these policy moves? Well, unfortunately, as you and I have talked over and over again about the passive influence on equity markets, unfortunately, what I think we're largely seeing right now is a global phenomenon in which duration is selling off because there is an absence of the marginal buyer of the longer dated bond. I actually don't think that that buyer is missing the way other people do. I think they have simply assumed a different approach to how to manage their portfolios

3:30than traditional participants would. So if you think about a long dated bond, it would have historically been purchased by somebody like an insurance company that was looking to match assets and liabilities. In that framework, you're looking at the value of that bond relative to the value of your liabilities and matching the two on a duration basis and on a required income basis. No other type of buyer is what's called the levered buyer. This is somebody who's going to finance the long end by selling the short end. They will short a three-month treasury, obtain financing and then buy a longer end treasury. The marginal buyer today is actually a passive bond fund. And that passive bond fund ironically doesn't care about any of that. It's simply trying to match its exposure on a notional basis. And this is really critical to the underlying index. And perversely, what that means is when you have an environment like we have today in which there was roughly a decade of very low interest rate, very low coupon issuance.

4:32And the Federal Reserve then hiked interest rates. We've seen this in the banking system as these bonds are deeply underwater, meaning they are trading well below their face value. Basically that means that a passively weighted bond index fund is going to buy them in proportion to their market capitalization. That price times the notion of outstanding. And so as that price has fallen, their demand for those bonds has decreased on a relative basis. This creates the perception that nobody wants the bond. But the players at the game are behaving somewhat irrationally. Equity investors will remember this time as roughly around 2016 where we began to refer to the Costanzo market, the market, the opposite of what you thought it should. And unfortunately that's now come to bonds because your largest marginal player at this point looks at a bond that's trading at 150 and says, wow, that's much more attractive than a bond that's trading at 50. And that is absolutely absurd. It makes no sense in bond language.

5:34But that is the algorithm under which they are programmed and the markets are now playing that out. They are going to be those long dated low coupon bonds which actually offer a tremendous feature in bond land called convexity. They have positive convexity to the top side. Your money can literally double in many of these long dated bonds. You're looking at a situation which they are being ignored. And so I think unfortunately the treasury is going to be forced to address this through a combination of issuance and market involvement. In fact, it's like buying back those low price bonds because the current participants are ignoring it. Ironically that's an opportunity set for the treasury. And I think the treasury has started to recognize that saying, wait a second, we can issue one dollar of current coupon paper and retire two dollars of low coupon paper that has a modest increase in our cash interest expense. But in aggregate we are significantly shrinking the debt. And that is a great strategy for any debt manager to pursue.

6:37And at the end of the day that's exactly what the treasury is. So I believe that Scott Besson has now recognized that he has an opportunity to shrink US national debt at the same time that he begins driving the prices of that national debt higher and attracting that marginal buyer with greater intensity. So there's a lot of important stuff in there. And I will say this is why we like to catch up with you. We don't expect everyone who's listening to this to understand every single thing you set, right? You've spent your, you know the bond market inside and out. You know all these mechanics. But the important thing about it is that it's, this is not being driven by rational actors. This is sort of algorithmic patterns that are happening that have kind of skewed markets. And if you really understand the bond market like you do and you really understand the bond market like Scott Besson does. This is sort of what he's doing sounds like a rational actually smart thing to do. But I think for folks listening who may have exposure to bonds, who may not have exposure

7:39to bonds who are listening to the narrative out there, they are hearing something that's much scarier. And I saw a post that I think kind of sums it up. And it was, it was the unsustainable fiscal conditions in the US and other major countries are going to lead to yield curve control, high inflation, hyperinflation, monetary crisis, you know, move away from the dollar and this all means soaring, precious metals and commodity prices. You need to rebalance your portfolio immediately. I'm hearing you say, and so tell me if you agree or disagree with that, but I'm hearing you say this is actually somebody who really understands the bond market, he's making changes that are wise. And I think this sounds totally different than the narrative that's out there. Well the narrative out there that you're reading is obviously under selling it because the primary concern is the potential extinction of polar bears and penguins in result of Scott's fiscal policy. We have to really understand it. Like it is absolutely absurd that this was treated as the financial crime of the century.

8:44It gives you some idea how milk toast we have become as a society. If we think the Scott Bessons announcing that he's going to increase purchases of low price bonds on an existing program in a voluntary exchange. If this is a financial crime, like I can't even imagine what these people think when they see real crime, this is just debt management and it makes perfect sense. It's exactly what you should do. The thing that I find most frustrating about these discussions is that they are directed at Secretary Bessons saying you've got to get the fiscal house in order. He doesn't control tax policy. He doesn't control spending policy. In fact the only spending policy he controls is how much the US government pays on its interest, given interest rates that are set by the market and the federal reserve. So what else is he's supposed to do? I understand how people can disagree with the way he is comporting himself and the way that he is perceived as having to address the needs of his boss. But my God people, he has a job.

9:46What is he supposed to do? The fact that people are out there screaming about this, what they're really saying is like, look, this is serious. This is a very dangerous wound and situation that we have. You need to take this very seriously. And Scott is sitting there with the tourniquet saying, do you want me to put it on or not? And the answer is, of course, yes. And now we need everybody else to get their fiscal house in order and we need Congress to do what it's supposed to do. When you're the president to do what they're supposed to do, but those are not his job. So he's doing, he's using the tools he can to best deal with the situation at hand. The root cause is on the fiscal side that needs to be. Absolutely, absolutely. If you as a household were given the opportunity to consolidate your credit card debt into the lowest interest rate debt that you possibly could, you would be foolish not to do so. Turn on Dave Ramsey or any of those programs. It's the very first step they tell you to engage in. That's all Scott's doing.

10:46Is this is the treasure department on a path to yield curve control? Is that what this is? Well, when you say yield curve control, again, it becomes a question of, are I am engaged in yield curve control when I minimize my interest expense on my credit card payments? Yes, I am engaged in yield curve control. I am removing the interest from those who would charge me the most for it. If that's your idea of yield curve control, then I'm not entirely sure what else to do. Yield curve control in the classic sense of the Federal Reserve and the Treasury conspire in order to keep rates artificially at a certain level, there's no sign that that's what we're engaged in at this point. If Worsh decides to join the game with Scott and recognizes that his current interest rate policy, which everyone from John Cochran to myself to totally blanking on his name right now, ex credit Swiss guy, Sultan Pazar, right? We are all saying the same thing.

11:47Your interest rate policy at this point is actually creating inflationary conditions. By keeping interest rates high in an attempt to forestall inflation, you are preventing new homes from being built. Those new homes mean that there will be a relative shortage of homes available and home prices and rents will be higher than they otherwise would be. Likewise, fewer cars are being sold into the system. That means that used car prices are going to be supported on a relative basis. We may enter into distress because of the high interest rate policy and that would create a catastrophic slow down economic activity that the Fed would then be forced to respond to by rapidly lowering interest rates, which appears to be the policy, but that appears to be a very unsensable policy. That's the equivalent of saying, you know, well, I'm going to keep feeding my teenager drinks until they feel responsible enough to hand me the keys to the car. That's just not a good policy whatsoever. So we're living in a situation, I think, unfortunately, where people who are being thoughtful about market structure are saying this is actually the best policy to pursue.

12:51It can be claimed that that is a function of yield curve control, the minute that Fed steps in to assist the treasury in that process. But as Jerome Powell told us over and over and over again, they are the Fed. It's a fiscal agent of the US treasure. At the end of the day, they need to be paying attention to these things. So why do you think it's become such a dirty word and there's so much sort of panic about the fact that they may be going down that road and that somehow it's going to create a crisis? Where is that narrative coming from? I think that narrative is broadly coming from a loss of faith in the institutions of government and other institutions in the United States to allow people to achieve their objectives. That's trapped in a cage being randomly subjected to shocks from their perspective and they're looking for somebody to blame. Well, we've talked a lot about the problem of the loss of trust. There's a cost to that. There is. Absolutely. And I think we are seeing this in very clear terms. I think, unfortunately, as I've written about in some of my recent pieces, we have chosen

13:53as market participants to discard the soft data, to discard the consumer sentiment data. The reason we do that is it doesn't appear to have significant impact on economic activity, which ostensibly is what we are supposed to be tracking. Reason why that's occurring is because there are two different types of votes. There's a vote with dollars. It depends on how many I have in my wallet, my bank account, and it's coming in and my income. Those at the top end of the spectrum are still doing extraordinarily well. And in fact, interest rate policy from the Federal Reserve to keep interest rates high is giving that group a significant net stimulus. So on a dollar's basis, the economy appears to be doing fine. In the soft data, we're getting the picture of what the median person gets. Like a democracy, it is one person or one household and one vote. As a result, we're getting a clear picture in the soft data of what people are experiencing. Because we as a profession have largely chosen to ignore that bottom portion of the portfolio,

14:54to the point that many pod shops and investors now say we only invest in stuff that is sold to the top of the K. I've actually heard that used repeatedly as a rationale for investment strategies. It's understandable, but it's what's causing that decay and trust. Because people are increasingly looking at the institutions that are meant to serve their interests in a democracy and a more accurately Republican form of government in which we elect leaders that are supposed to pay attention to our aggregate concerns and represent us on that basis in Washington. They are increasingly throwing up their hands and saying we don't have a clue either. Let's just do what these special interests tell us to do. Yeah. If you had a line in one of your recent sub-stucks that I thought was great, the macro economy sees resilience, which is a word I hear a lot when I talk to analysts and strategists, while the household experience is depletion. I think that really sums up what I then see in the comments from people about how they're

15:56not doing well. I just spoke to a copy Harris Copperman who called it economic feudalism because he's been sort of looking at this for a long time and thinking, why are certain trades not working that should be working and anything connected to the lower part of the K. And the real economy has been struggling. Well, a pretty interesting way of putting it. Yeah. I mean, perversely, if you think about the economic voting, right? The higher the price level gets, the more necessities rise in price, which creates a sense of stress and lack of well-being for that household. If it is truly a necessity, you have to buy it. And as a result, you will deplete your savings and you will go into debt in order to obtain that resource that is a requirement. And that shows up as increased economic activity that shows up as spending. And the reality is you're saying, I'm slipping beneath the surface. And your next step is a catastrophic reduction in expenses we call consolidating households, right?

16:57Moving back in with your parents. You eliminate the rent expense. You eliminate a fraction of the waste associated with your consumption. You eliminate the energy required to heat your place separately from your parents' place. All right? That is a catastrophic reduction of spending that has created once people hit a breaking point and more and more people are telling us they're getting closer and closer to that breaking point. I know, which I think just it's so hard to hear that and to see that. And it's why you're seeing the results in elections. We haven't gotten to the big midterms yet, but you're seeing some unusual and unthinkable in some cases. Election results in states that we thought we understood or that the political class thought that they understood or labeled red or blue. And that seems to be getting upended in small places, but maybe it will increasingly move up the food chain. So in this scenario, if essence managing, doing his job to manage the debt, the best he

18:00can, and the Fed may also, if it's looking at the lower K, join in, is there a market cost to that? Is there a problem if there's a loss of confidence in the Treasury market? Do you see those two things? You can think he's doing a good job as manager and it can still have negative outcomes. Do you see that happening or do you believe the market once they start doing this, we'll sort of see the wisdom in it? Well, I don't think anything is guarded by wisdom per se. Right? Everything is driven by exigent circumstances. Very few people plan proactively. And while I think what Scott is doing is relatively proactive in terms of recognizing that this is indeed an effect and Treasury has gone far enough to know that this is indeed a legitimate effect that they are now playing with, that's a net positive. There's no such thing as a quote unquote free market price. Prices are always established in regulatory frameworks.

19:02And so if you go to a Moroccan suit, I guarantee you that there are rules around how you get to set up a stall in that Moroccan suit. You can look at the most free market things that you imagine. There are rules behind that. It unfortunately turns out that one arm of the government, the Department of Labor, decided to bless a particularly bad approach towards investing in bonds. And the Treasury cannot change that. That is another cabinet-level decision. It needs to go through the regulatory process and realistically given the lobbying that's in place, it will require an accession by Congress that is against the interests of the largest lobbyists in Wall Street. They don't want to change the methodology that they're using because it works. It has attracted assets. It's simple to explain. We buy things in proportion to their market capitalization. That means that we are not making any sort of credit assessment. And theoretically, we are not causing any distortion to the market if all liquidities, if all assets traded with similar liquidity. We know that last statement is not true, but it's convenient at a top level for a theoretical

20:07thought process and certainly for explaining it to a member of Congress who has no interest in going to a PhD level finance course. And even in that PhD finance course, you'd have to move into an area that is still disputed and not accepted as fact. So it is not realistic to expect people to change these behaviors and to understand what's really going on. But the reality is the way we chose to construct our retirement system in which we forced every individual to ensure themselves against that long tail outcome of, oh my god, the worst possible thing is I live a long time. From a retirement standpoint, that's a terrible good. That means that you have to ensure against that right tail outcome that everybody else says, oh my god, isn't that awesome and amazing? And you look at it with mild terror. When you do that, you structurally advantage equities over debt and you raise the relative real cost of debt and debt and the cost for debt issuers.

21:07This was a mistake that was made in 1978. It is not something that's got any role in and it's going to require a lot of steps to undo the mistakes that were made in the past, but we are living with them today. And the only option that we have is to address the market that we have, not the market we like to have. This is the 401, right? Well, the choice of the move to self-insured, define contributions that have defined benefit meant that we lost the statistical sampling properties of a large population, a pension that is spread across 100,000 participants has very different cash flow characteristics than those individual 100,000 people. But some of those 100,000 people are going to be lived to be 110 years old. Their cash flow patterns are going to have absolutely no resemblance to those who unfortunately passed away at 65. The insurance that is blended together in the form of a pension is able to treat that as an actual or a statistical property.

22:08The individual who experiences that has to treat it as insurance and they have to protect themselves against the unfortunate and then putting them in air quotes, you know, result that they live to be 110 years old. I personally don't, that would sound terrible to me. But I do understand that like most people want to live a long retirement. That sounds like it should be a really good thing, but from a financial planning perspective it's disastrous. Everything we do on this channel has one goal, to make you a sharper, better informed investor, someone who understands the macro forces shaping your money before the mainstream catches on. But information is only half of it. The other half is acting on it. And that's what wealthy on membership is for. It's how you go from watching these conversations to putting them to work in your own portfolio. Membership opens three doors, access to advisors, helping build real assets into your portfolio and for accredited investors access to specialized funds. To learn more, the link to become a member is in the description box below.

23:08So who, when you were talking about the buyer, I want to get back to this point, I think it's really important that this isn't a decision that people don't like treasuries or they're making a bet against treasuries. It's more that the composition of the buyer of treasuries is changing. I think that's a big, that's not, that's not really discussed. It's more, this sounds like a voting machine. Treasuries are bad. U.S. says too much that they're losing the ability to manage it. What do we need to understand about who the buyer was and who they are? What does that mean now? Well, well, first let's actually address those. So if you're going to make a series of assertions and I'm not accusing you of this, I just won't be clear. But if you're going to say, well, it's because we think the U.S. is credit quality is declined. There's actually a financial instrument called CDS contract that's available on the United States and that will actually tell you what people think the risks are that the United States defaults in a Euro-related currency, for example. So a massive depreciation of the dollar would show up as an increase in U.S. CDS that has failed to materialize. In fact, U.S. CDS is contracted over the past several months.

24:12Likewise, if it was fears of inflation, there is a market-traded instrument called an inflation swap or an inflation break even that should reflect those fears. They do not. Likewise, if we thought that this was a U.S. centric problem, somehow tied to the fiscal unsustainability of our debt to GDP being in excess of 100%. Well, then we'd have to look over to Australia, which has debt to GDP of 25% and is experiencing the exact same bond market sell-off. So is the market suddenly assessing that Australia, 25% debt to GDP has an unsustainable fiscal outlook? These are just silly and unthoughtful characterizations because they are not reflected in what we're seeing in the markets more broadly. What we are seeing is a global phenomenon unique in Western markets in which the long end of the curve after a decade of issuance at low coupon is now priced well below par and the marginal buyer. So when you think about passive in bond indices, you hear me refer to equities.

25:15Typically, you'll hear me say equities are around 55% passive. Bought markets are only about 15% passive, but that understates the influence that they have on the marginal activity where there is something closer to 50% of the marginal buying activity. And so because they don't have any interest in quote unquote value, that value is being ignored now in the fixed income markets in the exact same manner that it is being ignored in the equity markets. As it relates to the changing buyer, because buyers typically are managing for totally different reasons and pure price appreciation or yield maximization, there's what's called threshold characteristics. And so for Japanese life insurers, they don't care that bond yields are 5%. What they actually care is that they have an actual requirement to meet their obligations and the threshold for that was somewhere around 2%. When interest rates were zero in Japan, they forced them to go around the world and figure

26:16out ways to obtain that 2%. The minute interest rates are 2% in Japan, why would they do that? They're protecting against risks in their own currency. They don't care what's happening around the rest of the world. The minute their needs are met, internal to Japan. And that means the rest of the world is now searching for that marginal buyer. That marginal buyer unfortunately has the world's dumbest algorithm. You can at least make the case that a stock trading at 150 versus a stock trading at 50 reflects underlying expectations about where it's going to end up at its 10 years. But in a bond, in a high quality bond, what we know about the bond trading at 50 and the bond trading at 150 is they're both going to end up at par. And so to treat the bond that is trading at 150 as somehow more attractive than the bond that's trading at 50, which perversely means you're skewing yourself to lose roughly one third of your capital as compared to doubling your capital, is absolutely insane.

27:19But we have blessed this system as the marginal source of funds for US retirements. And again, it is outside the purview of the treasury to change that. They could speak up about it, or they could do what I would do in the situation, which is recognized. People made a choice. Yes, it was government sponsored, but it is uniquely dumb. And so I as a trader have to take advantage of that. I as the debt issuer should take advantage of that for the benefit of the aggregate American population is compared to bond index investors, who I couldn't care less about candidly. They are my opponent in this game. So is there, it's so interesting to hear you talk about this because it makes perfect sense what you're saying. And yet you that sort of other narrative that is much more critical of US, US policy worried about debt is so attractive and powerful to people. Do you, is it more just that they're directing it?

28:20Do you think that's flawed or do you think more that they're directing it at the wrong department? They're directing it at treasury where it should be directed at Congress for the fiscal behavior of the US, which is worrying and carries risk for the US bond market. Do you see a risk to the US treasury market? If I saw a risk to the US treasury market, I expected it would be reflected in CDS contracts and flash inswops, etc. I'm not seeing that. And I also understand the mathematics behind how easy it is for us to actually address the challenges that we face. We simply lack the will to do it. And more importantly, we lack the will to ask people who have benefited from the system to benefit a little bit less. That's what progressive taxes are. Several people have pointed out that the US has an unsustainable deficit. Well, you know what you do with an unsustainable deficit. You marginally increase your revenue and you marginally decrease your spending. And guess what? That unsustainable deficit will disappear or at least fall below the nominal growth rate of the US economy, which means it begins to shrink as a percentage, which is what Scott

29:22is highlighting. Unfortunately, the policy of the Federal Reserve at this point to keep interest rates high in an attempt to prevent inflation, which is seriously diluted, but is certainly accepted in monetary policy, is creating conditions that are making that order to achieve. So if you are all, if you're listening and you are not following Mike's substock, yes, I give a fig. This is where you've kind of laid out the possible solutions in a path forward, which is, has incredibly, you have a ton of people have responded, but you also have a fair amount of pushback, which you're bravely waiting through every day. But it's sort of incredible how much controversy there is around because most of what you hear is we would love of way forward. We would love a solution. And you say there is one. It's just that we don't have the will. Yeah, I think we like the will and candidly, I don't think we really want to way forward. We want to way to complain and we want to way to see other people suffer because we are at that stage where we are so angry about our personal situation that we would rather see

30:24effectively inflict pain on others before we want to make things better for ourselves. This is the stage in which traditional mythology requires the scapegoat. Somebody has to be sacrificed. I'm not offering myself to be totally clear. But the simple reality is that people need blood at this point and they're going to take it in one form or another. Does that, we're going to get to sort of, we're going to pivot back to sort of what you're doing because I think it's connected to some of the sort of misconceptions out there. Do you think that blood comes in the form of some sort of crisis? And I'll be more specific. Do we need to see a market crisis or a correction in order for people to feel like somebody, there was some justice done? Well, when you say need, we never need anything, right? They make it easier that you're talking about. Yeah, it makes it easier for things to change, right? So a market crisis exposes false beliefs, right? The idea that the Federal Reserve can always step in and say everything that it's simply

31:28a function of printing money. There is some truth to that. And we lived through a very real example of that. We're incredibly bad policy. Let's treat a novel infectious virus as if it's the end of the world and we all have to stand six feet apart because it will just because, right? That sort of behavior of shutting the economy was just unbelievably stupid. It was unbelievably stupid. And monetary policy and fiscal policy in concert by and large, papered over those stupid mistakes by giving people money to address their immediate needs. That was the sin. The Federal Reserve accommodating it for too long was also a mistake, right? It is totally predictable. As has happened in every pandemic in history, the desire for increased living space would occur to finance that, to make it easier for people to follow through on stupid policy prescriptions. It was a mistake and they should not have done it.

32:31They should not have made it as easy to buy homes as they did in 2020 and 2021. They shouldn't have made it as easy as they did for people to stay in their existing housing units without moving out and therefore creating artificial demand. These are all things that we should not have done, right? I also should have been kindler and gentler with my children. I should have been more patient, right? I can't undo that that was done. And so I have to make policy going forward. Do you, so this idea that you see, the warnings that you've put in for passive and we've been talking about this for a long time about what it's done to the stock market and the dangers that are kind of getting embedded there. And now you say it's an even dumber algorithm that's sort of having an impact on the bond market. Is that sort of understanding part of why you're launching your new firm? Like why now?

33:31Why are you doing that? Well, the real answer is because I can, right? I spent roughly a decade doing research in this and my initial implementation, I will be candid with you. I got very lucky, right? So the initial trades that I did is I began my work around systematic investing and the risks that I created were tied to the XIV year or the Volumogetten event. What I didn't realize when I executed that trade, although I mean, I understood it, but I didn't fully appreciate the importance of it, was that was a fund that had a single security underlying it. And so the fund and the security itself were the same thing. They behaved in the same way. If I understood the underlying and I understood the flow associated with the fund, it became very predictable in its behavior. What I didn't understand until almost exactly a year ago, it was truly a year ago that breakthrough on an intellectual framework occurred. And in my defense, this is still a major mistake that sits out there in the financial literature. I had not understood that the fund was distinct from the underlying securities.

34:34I had not understood the characteristics of a fund that you need to appreciate in order to understand how this influences behavior. And in the academic financial literature, there is almost no discussion of the fund. It doesn't exist in the literature. We always talk about securities as if they themselves are end recipients, well in the world in which the vast majority of people's purchases are funds like ETFs that actually takes on very, very different characteristics. So in September of last year, I approached my team at Tier 1 and I said, let's try something different. Instead of tracking at the fund level, let's aggregate the information that we get from all of the funds into each individual's security. And that initially was an incredibly time consuming task. It took us about 45 minutes per security. So you can understand that we were very limited in our capacity to do analysis, as we improved our capability to do that. And in January, we got it down to about 45 seconds.

35:34We're now sub one second on each security. So we're able to radically expand the number of securities we're observing as well as run repeated models with different sources of flow. We're able to suddenly start building portfolios themselves that take advantage of the insights that are derived from the analysis on each individual's security. That's something we simply put an end done before. And now, what does that tell you? What is it that you're, what whole or what problem are you solving for? Because I sense it's connected to the passive flows that you see having such an impact that others are just not really kind of recognizing. Well, the way we're doing it, the way I describe it is the we're engaged in an entirely different process of fundamental acquisition. So if you think about fundamentals, they're traditionally like, how much is the company earning? What do I expect their next earnings report to be? What is their cash balance? How much debt do they have? That are these are all things that are characteristics of the company that we're searching out on the fundamental basis.

36:35The reason we search those out though is not because they themselves create demand, but because they create demand from other people who are trained similarly to us. If I correctly intuit that people respond to an increase in earnings by increasing their buying of the security, then that becomes a positive predictor of future expected returns because I'm identifying buying activity. When the majority of the buying activity shifts to an index vehicle, they don't pay attention to those fundamentals. I'm increasingly watching a marginal pool of the population that actually in aggregate is experiencing outflows. And so all of those insights have actually negative loading factors. They mean net selling behavior that's going to occur. And so when you have those conditions and you're monitoring the fundamentals, people traditionally approach, you're actually going to get what looks like as I've referred to before, the Costanza market. It does the opposite of what you think makes sense. What we've done instead is build basically a stop motion photograph that takes a picture

37:40of the crowd of 500 stocks in the S&P at every point in time and says, a wall of liquidity is about to hit these individuals, similar to crowd control with a fire hose being directed at them. They're out there collecting fundamentals like what are the FICO scores of the crowd? What are their incomes? Are they married? What town are they from? These are all really important from a fundamental behavior standpoint. They tell me absolutely nothing about how that crowd is going to react when hit with a wall of liquidity. What I actually want to know is how much do they weigh? Are they standing on two feet? Do they have a history as alignment in the NFL? Are they afraid of water? These are characteristics that actually matter for that. We're tracking an entirely different set of fundamentals, which interestingly enough has possibly its most powerful applications when we then re-merge it with those traditional fundamentals because we find very intriguing evidence that those actually continue to work for that very shrinking crowd.

38:42It's like watching the pop-up and table. Heat map of flows. Exactly what it is. That's exactly what it is. It is a heat map of flows that looks like a continuous picture but is really a stop motion photography. It sort of indicates that we're going to talk about CPI later this week and it's going to be a big market mover. You're saying not all of the traditional models because the nature of the system has changed so much with passive flows and with algorithms dictating it. It's not that they don't matter but they're not the indicators that they were. We're all driving around looking at faulty signposts. Yeah, I think unfortunately that's correct. That is what the opportunity set for us is. It's what I describe as passive aware investing. Our objective is not to do better than the fundamental guys and it's not to do better than the passive guys per se. It's simply to take the reality that the passive players are now the marginal source of flows and shift our analysis to better understanding what they're going to have to buy and what

39:44they buy and what they buy reacts to those purchases. That's all we're really doing. We are to my knowledge unique at doing this at the time skills that we're talking about. One of the other factors that plays through is the size of that traditional asset management business. The active management business can broadly be thought of as shaperones at the ball. They are the people in charge of saying that behavior is not okay. I'm going to force it back into norms of behavior. When you enter into an environment in which the shaperones start coming in only a predictable intervals. That actually perversely creates conditions under which the party appears totally tame and then it goes totally crazy and totally tame and totally crazy. Eventually the party goes lose control and the shaperones are then tasked with the can-we engage in riot control. Oftentimes they'll just shut the gym doors and say there's nothing we can do about it at this point. That's where we stand. There's just not for a person to cross. That's a really good description of how it feels I think to people, especially when we

40:47have so much momentum coming in and for folks who are listening, a lot of our audience, they just want to protect their portfolio. They just want to try to do the right thing. It feels increasingly hard to do that in this kind of environment right now. Are you going to apply this to the bond market or the stock market? Do you still worry about stocks facing a crisis and a reverse of passive flows? Is that still consistent for you or have you changed that? No, no. I still think that ultimately this is going to end very badly. We've actually embedded that insight into our products. We're looking at effectively isolating what we refer to as the passive factor, which we think is the single most important factor in market price behavior today. In general, we think it explains about 50% of the price move of any individual security at this point. That's an extraordinary edge to bring to the table. It means we can take a very small, what's called active bet versus the underlying US

41:48large cap equity indices and deliver out performance with that very small bet. Rather than deciding that we're going to put this on full force on day one, which would involve adding leverage to it and identifying securities, we're both going long and securities we're going short identifying sectors that look particularly attractive. If you want to go max active in this type of approach, you can generate. It's a very extraordinary return and we will continue to explore that. The most important thing at this point is to actually demonstrate that it works and to do so in a manner that it takes that offers low relative risk exposure to the end audience. Our target market is actually people who own the S&P 500 and who are looking to generate a little bit better return but more importantly, actually, to look at their portfolio and saying, wait a second, it's worth taking a fraction of that large allocation and putting it towards a little bit of experimenting to see if this guy green actually has some idea

42:48of what he's talking about. If he is right, then we've got an entirely different set of issues. That really is our objective. It is to take the easy sale. It is to say in your portfolio, you already have a 35% to 40% allocation to this thing called US large cap equities. We take a fraction of that and try and approach that we think is actually driving that. We can demonstrate exactly why it works that way. It takes what could be a very complicated sales force. Do you trust Mike Green's Black Box, which is making all sorts of crazy calculations and running at 60 times leverage to deliver a 30% return with zero volatility? That would be an absurd sale. I can do it with my personal capital and many people in the industry actually do that sort of behavior. But the simple reality is there's a product out there that is crying for the center of the battlefield, which is really what the active management world is just completely abandoned. Eric Buckland has nailed this almost five years ago where he observed the more vanguardian

43:51in the center of the portfolio gets. The more money that goes to vanguard and the like and low cost indexing, the more you're going to see the active management community create hot sauce products to try to attract attention on the edges. That is exactly what's happening. The active management community has basically focused itself on a tiny sliver of about a trillion and a half dollars of possible assets where they're all running around and saying, look at my latest greatest creation on a back test it does X. Almost nobody is saying, hey, instead of the S&P you should try this. In fact, perversely, those same individuals that you highlight that are seeking safety and could obtain it in things like a 30-year tip, currently offering a 3% real yield, which is extraordinary. The stop and think about a 4% withdrawal yield, a 4% withdrawal rule, you can accomplish almost all of that in an inflation protected security for the next 30 years with no principal risk whatsoever. And nobody wants it.

44:52Because the argument for that is that you're going to see the dollar devalued, right? That may be true, but it will be worthless because the dollar is... Well, this is again an inflation protected security. So you've gone a step further. You're saying, not only do I think the dollar will be worthless. I think the US government is going to lie to me every step of the way. I can point to the inflation that we've experienced in the last five years. And the Federal Reserve obviously is terrible at its job because it hasn't got it down to the arbitrary 2% target. Despite the fact that all the methodology around CPI was set up to address the fact that the Federal Reserve in the early 1980s, under Volper, behaved in a terribly irresponsible manner in which they created their own inflation because they did not understand how mortgage rates passed through to the CPI itself. That is where the owner's equivalent rent came in. It basically was created to prevent the Federal Reserve from doing something as stupid as

45:53it did. And yet here we are again with people encouraging the same behavior from the Federal Reserve tied to a formula that now increasingly shows a lagged 3, 4, 5-year average on CPI. It's just absurd. But it is what happens when people don't understand the systems that they build. Do you... When you're concerned about stocks and if you're looking at it with the understanding of the expectation that there is a sort of crisis coming because of the passive reverse flows, are you fighting the US government? If so much of the US economy relies on asset wealth and the feed-through to spending and growth, although from a sliver, you know, the upper K, is it becoming too important for the government not to continue to make sure asset prices climb? Well, I mean, again, we're now making a choice about what is too important, what's not too important without considering the alternatives, right? The high cost of assets is creating conditions for the next generation that are causing

46:55many of the problems that we are identifying at the same time it preserves the purchasing power of the older generation, which seems to be what we're mostly focused on, right? People wonder, boomers often wonder why the younger generation is so angry at them. It's not that we're saying you actively came into my crib and stole the lollipop. It's just you consistently have made the choice at every step in the process to protect your circumstances without considering how that's affecting other people's circumstances through time. Yeah, over, over mine. Ed, Ed, Ed, Ed, your journey was on the channel. He called it, he said, it's a K economy, but it's also the G economy, generational decisions have been made that benefit the older generation over the younger generation. Yeah, and then we can see that explicitly, right? And we also know that this is bad policy. And one of my older sub-status posts I actually shared analysis that the US government has done itself on the return on investment for various social programs, right?

47:57What do you actually think the economic return associated with giving 95-year-old's hip replacements is? It's not very high, right? What do you think the- That's the high start. As compared to head start. Yeah. Right? Yeah, I get to encourage everyone to go look at Mike's posts on this and just challenge yourself to have an open mind because there is a lot of- and I think Mike, the pushback is more emotive because it comes from a lack of trust, because there's lots of reasons that- to take issue with the behavior of the government and the lack of trust that it's created in order to execute on any of this. People feel like they want to try to provide for younger people themselves, their direct people, as opposed to, societally, because there's been a breakdown of, I think, trust. And that's where that- that hits home for people. I think there's a lot of truths to that. I think we also have to recognize that, you know, the vast majority of people understandably are going to choose the evolutionarily appropriate choice of minimum and caloric expenditure. Right? You do not get up and go look for food unless you need food.

49:01You do not get up and engage in activity unless you absolutely have to. Right? And so we create all sorts of reasons why we don't do things. I'm not religious, so I don't go to church, but I respect people who do because they are making an effort to commune with their neighbors. Right? They are saying it is worthwhile. You have to ask yourself, really, am I not getting up and going to church on Sunday because I don't believe in God? Or are you not getting up and going to church on Sunday because you don't believe in the teachings of that particular church and you don't want to go through the effort of finding another one in which you share a common environment that is both physical, which is the vast majority of our experience and social and emotional, which we increasingly turn online for those communities. Right? The lack of teaching. The lack of teaching is the process. Yeah. The reality is most people are going to actually do something like say, you know, I'm not going to church because those priests are a bunch of, you know, debeants. And instead, I'm going to stay home on Sunday morning and watch porn, though. Yeah.

50:01Um, I guarantee you that is actually happening far more than people want to admit. Yeah. There, there, there is a lot. And I hope you'll continue to push on those threads. A lot of, um, sort of, you know, societal ethical conversations that we need to be having in the next few years that are, that are completely connected to economic, by the way, and financial. I got to ask you before we go about gold in all of this, uh, because the solution to the problem for overexposure to equities for a lot of people is a bigger move into commodities into gold. How does that fit in with your thinking? Um, well, I mean, look, first commodities are a tiny portion of people's consumption expenditures. Um, if you stop and think about how much you actually spend on porn or grain or even oil for that matter, it is a very small fraction of your expenditures relative to childcare. Or, um, you know, the actual depreciation of your automobile relative to the gasoline

51:03expenditures, even at today's elevated gasoline expenditures, you are spending far more on the depreciation of the vehicle than you are on the actual gas that you're consuming. Um, and so when people make the decision that suddenly they're very worried about commodities and they decided to take a portion of their investment portfolio and allocated to commodities, that is an outward shift in aggregate demand that it's effectively borrowed from the future and it will push prices higher in the immediate turn. That in turn is supposed to engender a production response that reduces the conditions that I saw in the future. Uh, if the central bank is artificially keeping interest rates too high because it doesn't understand what it's actually doing, it then retards that development. And so you need prices even higher to spur that. And if that of course then causes the federal reserve to hike interest rates, well, guess what? You're going to need an even higher number. And so these patterns that play through, unfortunately, are very predictable and when a society becomes very wealthy relative to the underlying asset, it becomes very possible

52:07for it to have large swings. As it relates very specifically to gold, gold is kind of that negative trust asset. It's the one that you can look at and you can say, well, if I own this, it's always going to be gold. There's nothing that anyone else has to do for it to remain gold. All right. Ironically, if you get wheat, for example, first of all, the quantity of gold that you have wheat that you would have to store in order to store a similar quantity of monetary value is absurd, right? You're thinking, you know, storage facilities versus a shoebox for the gold. Likewise, you then have to have, you know, somebody guard that wheat and that wheat is actually not particularly valuable until it's been processed into something we call bread or grain, you know, grain alcohol of some sort or another, right? All of those require other people to engage in them and gold doesn't require any of that. And so gold is the ultimate asset that people say, this is where I put my money or my resources when I don't trust anyone else in the process and I actually am most interested in making

53:08sure that I don't have a hidden obligation from somebody else. That means it tends to move in line with real interest rates. There are also events like the U.S. policy in 22 with Russia that caused many of our counterparties to say, hey, wait a second, we can no longer hold treasuries because they are no longer a safe asset. The U.S. government is indicated they will seize them. And so we're going to redirect into gold. Most gold participants looked at that and said, wait a second, now gold is not behaving in line with real interest rates. That relationship must have disappeared just like our discussion around passive investing. It just means that a marginal buyer appeared for a period of time who behaved in a certain fashion, right? All right, once war breaks out in the Middle East, which is one of those marginal buyers of gold and saying, hey, we want to reduce our reliance on the U.S. government relative to the wealth that we are suddenly creating, they suddenly were forced into a very dangerous situation. We have to increase our expenditures on defense and social needs and we simultaneously

54:08don't benefit nearly as much from high oil prices because our own production is restrained. So what do we have to do? We have to sell some gold. We've seen that pattern playing out that relatively suppresses the price of gold alongside the rise in real interest rates. And people are waiting for it to break out. And I think ultimately it probably will because they do think that the Federal Reserve will get its act together and recognize that they need to cut interest rates. So it has a role, but what be where the buyer? I just look, I think we live in a world right now in which the level of lack of trust, right? I think still has the best definition of gold as one over n where n is faith in central bankers. And so as that faith falls, the multiple of gold rises. Gold is expensive relative to everything else on almost any reasonable metric, right? People will point to the fact that gold announced a gold to buy a fine-man suit. I buy fine-man suits. I get custom made suits. Those custom made suits cost somewhere around 1200 bucks.

55:10Right. Gold is somewhere around 400 percent overvalued on that metric. Somebody was trying to point out the other day on Twitter that historically gold was valued at one ounce of gold per cow. Well, now of course that means that you should have one ounce of gold, one cow per suit. And as somebody correctly pointed out, the price of cow is relative to suits has exploded. That's largely because suits are indeed an endangered species. But when you do all that math, you basically realize that gold is benefiting from this period of lack of trust. And it is somewhat priced in. Do I think it will continue to respond yes because I don't think our policy makers are yet at the point where they start making really good policy? But as I wrote about my last piece, I also think that there's a quiet change that's happening. And I think it's happening in exactly those elections that you were highlighting. When you see that sort of switching and unexplained behavior, it tells you the tails aren't nearly as strong as you think. What there actually is is a relatively homogenous center.

56:12And that homogenous center can flip 50-50 in either direction with disturbing frequency on this type of framework. I think that's what we're seeing. I think America is actually a much more unified country than we give ourselves credit for. I think AI as distinct from search. Search, remember you type in is crypto a good investment. It's going to serve you ads from crypto providers. You type in is crypto a good investment into an AI. And yes, it's going to be influenced by the narrative that is out there. But it's going to try to give you a more holistic answer. That naturally forces people towards the center. And I'm seeing more and more evidence that people are exhausted with the shenanigans on both sides. And starting to think, okay, what do I actually do that makes sure that my grandchildren have food in their mouths? That is such a keen observation, Mike. And it's not one I've heard a lot of, but it's really, really fascinating as we move forward. Especially if you, as I just had some young people, because we both have kids that are kind

57:12of the same age or a little ahead of mine. And also another person who was showing me their AI prompts and what people are putting in now is don't delude me. Don't try to complement me. Challenge me. I want you to check. So they're giving both sides. That's a fascinating, fascinating observation. It probably applies to markets as well in terms of what influence interests will have. That will be one to watch. Yeah, no, that's what I said. I come across, depending on how you want to listen to me, as insanely bearish or insanely optimistic. And the answer is both, the current behaviors that were engaged in, the choices that we're making as a society are creating the conditions that we're unhappy in. The first rule to, to improving your happiness is to diagnose why you're unhappy and what's actually occurring and what choices you're making that are contributing to that unhappiness. I think we're getting painfully close to the realization that this is largely not outside

58:15forces that are acting on us, but choices that we make and that we influence that are affecting all of us in very predictable ways. From a social standpoint, I still think that we are going to need to find that scapegoat. And I don't know who it is and I don't know exactly why it will occur again. Are you more likely to die or you more likely to die of a shark attack? You're obviously more likely to die. So I don't know why this will happen. I cannot point to the specific examples of it, but I do, my strong hunch is that market events will actually force us at some point to make the harder choices that we have been avoiding up to this point. Fascinating conversation. Mike, thank you for taking so much time when I know you're working like eight at 18 hours a day. You always say, you're the hardest working man. You always say you're going to not be. And somehow you have yourself back in a situation where you are, but it's so needed. I love that you're building something for the center. It's been totally ignored for too long, both financially and politically. So I think that's amazing. And please come back and give us an update on how the research is going because I think

59:18they're going to be amazing insights that come out of it. Thank you.