Fiscal Dominance, Dollar Power, and the Politics Driving Markets ft. Lyn Alden

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Welcome to U Got Options, an exciting series right here on Top Traders Unplugged, hosted by none other than Cem Karsan, one of the sharpest minds when it comes to understanding what’s really driving market moves beneath the surface. In this series, Cem brings his deep expertise and unique perspective, honed from years of experience on the trading floor, to candid conversations with some of the brightest minds in the industry. Together, they unpack the shifting tides and underlying forces that move markets and the opportunities they create.

A quick reminder before we dive in, U Got Options is for informational and educational purposes only. None of the discussions you’re about to hear should be considered investment advice. As always, please do your own research and consult with a professional advisor before making any investment decisions.

Now, what makes this series truly special is that it’s recorded right from the heart of the action on the trading floor of the Cboe. That means you might catch a little background buzz. Phones ringing, traders shouting as Cem and his guests unpack real world insights in real time.

We wouldn’t have it any other way because this is as authentic as it gets. And with that, it’s time to hear from those who live and breathe this complex corner of the markets. Here is your host, Cem Karsan.

[00:01:28] Cem

Hello and welcome back to U Got Options from the Cboe floor, brought to you by Kai Media and Top Traders Unplugged. Today we get to talk to no other than Neil Howe. The seminal author of the Fourth Turning I’ve talked about it a lot of times. Obviously, Neil is well known for it, but we are in a regime change, and in a regime change we talk about how distributions change dramatically, the value of options in that type of an environment, as well as how to invest and allocate assets in a dramatically different environment. You’re going to love this one. Enjoy.

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[00:02:24] Cem

Hey, welcome back to U Got Options. I’m here with no other than the man himself, Neil Howe, author of the Fourth Turning. Neil and I have an incredible, you know, personal connection, which is pretty cool. A really good friend of mine, recent friend of mine and investor, I won’t name his name here for confidentiality, is a really good friend of Neil’s. They’ve known each other for, I think, 40 years or some amazing amount of time.

I believe Neil wrote some of the Fourth Turning, you know, on his couch at times, I’ve heard. But yeah, we’ve got to have dinner together a bunch of times. So, wonderful to finally kind of get you here in person so the rest of the world can hear some of the awesome conversations we’ve had in person.

So, Neil, I want to have you start off. You don’t mind. A lot of people are familiar with your work, you know, some foundational work on generations and kind of how they affect outcomes in markets. But if you don’t mind giving us an update about, I know you put a newer book out in the last several years, update on kind of how you see the timeline of kind of Fourth Turning, where you think we are in it, and speak a little bit about more generally what the Fourth Turning is for those that aren’t as familiar with the issues.

[00:03:37] Neil

Yeah, Cem, great to be here. It’s very nice to be able to follow up, you know, after meeting you and talking to you at length in person. And I enjoy your show, by the way. I learn from it, you know, being gradually becoming a little bit more market practitioner than I used to be.

But, you know, this whole idea of the Fourth Turning, I mean, it started out many, many years ago actually, with a co-author, Bill Strauss, and myself. We started writing books on generational differences. We didn’t start writing about historical cycles at all.

We were just interested in why it was that different generations, when they come to power, behave so totally differently than other generations. In other words, we’re just interested in history, and we were particularly interested in how some generations leave behind such different endowments. Some generations are very much civic builders and doers, team players like the parents of the baby boomers who took the nation through the Great Depression as coming of age young adults; World War II, built up the Pax Americana, the whole infrastructure of post war America. And then their kids, boomers, who were famously a generation of vision and values, and I’m sure, tore down more dams than they built. You know what I mean? Who always had a very different sense of themselves.

And what interested us is how these differences, and clashes, and these patterns, go back all the way back to the 17th century. I mean, they go back to the very first colonists in America. And in fact, they go back in Anglo American history. I mean, they go back, way back in Europe. And we think a lot of the world, now, is manifesting some of these basic generational archetypes and contrasts.

Now, that led to the idea that certain generations always follow other generations, and that these kinds of things are related to some of the broader patterns we see in American history. So, for example, this country has seen, certainly since our colonial experience, huge, almost cataclysmic upheavals in the public sphere when we rebuild our political constitution, our economy, our infrastructure, our whole outward community life about once every long human lifetime.

I mean, we did it in the last quarter century of the 1600s with the glorious Revolution and all the various rebellions and, you know, Bacon’s Rebellion, King Philip’s. It was a very violent and very civically constructive period in colonial history. We did it again with the American Revolution. We did it again with the Civil War. We did it again with the Great Depression, the New Deal and World War II. This is part of the grand cycle.

And considering this, a long human lifetime is seasonal. You know, about one generation per 20 years or so, that leads to almost a seasonal idea that we go through this spring, the summer, the fall, and the winter. The winter is the Fourth Turning, and the Fourth Turning is the season we are now in.

And it’s no accident, Cem, that we have so many comparisons today, to our experience today, to the 1930s. In fact, there is no other decade (I mean, you can just check it out on n-gram) to which parallels are more often drawn today than in the 1930s. This is no accident. That was the last Fourth Turning.

We’re in the new Fourth Turning. And so, it is a vision of cyclical motion, of social moods in which one mood always drives the next with the coming of age of a new generation, with the new socialization experience, and ultimately gives us different kinds of trials to live through. One of the most momentous in terms of public history, certainly political history and the history of great conflicts, is the Fourth Turning. And that was released, actually, in a book we wrote in 1991 called Generations.

And I think that book, re-brought generations back into parlance. It had been gone for a while since the 1960s. In the late ‘60s everyone talked about generations. That was a generation gap and the boomers and, you know, Dean Rusk, and LBJ, and all those people who took us into the Vietnam War and all that stuff. But I think we brought it back.

And it was in that book, by the way, that we identified and first talked about the millennial generation. So that’s our term. And then later on we wrote other books about generations. And, particularly in 1997, we wrote the Fourth Turning, which really turned this idea of sequence of generations into more of what we think of a cycle of history. We’re a cycle of historical tendencies in modern societies which tend to think of themselves as progressive.

And very recently, Cem, I wrote a book. My co-author, Bill Strauss, passed away about 10 years ago. But I did write a book back in 2023 called the Fourth Turning is here. That book did very well. That was a New York Times bestseller for more than the summer, summer and fall. And this idea, which originally was considered really out there, has really [gained] a much wider [following in the] mainstream.

And I will say that leads me to the final thing, we can talk more about it if you want, Simon Schuster has now asked me to write another book in response to the single biggest question that I get from the Fourth Turning is Here. And that is, “Neil, I believe you, I think history is going in that way. What the hell can I do about it? How do I prepare my family? Where do I live? What do I do in markets?”

In other words, that’s kind of my day job being a financial advisor. But what do I do in my market behavior? How do I manage my wealth? In other words, there are all kinds of questions, practical questions which people want to know.

[00:10:27] Cem

Yeah, I think I mentioned this to you at some point, but I actually came late to your work. I actually didn’t read the Fourth Turning ‘till 2022. And in ‘23 I read your new book. But I had come to a lot of these same conclusions from a different perspective, which were really from a markets history perspective, not a generational perspective, but also taking politics and mixing politics in.

And it was so amazing when I read your book. It’s like I found myself at points almost being like, yes, 100%, yes, he gets it. It’s such an elegant solution, in reality, when you see things that fit so cleanly into the real world and the why, you know at that moment how real and true that is. And I think that’s why you’ve had such great success and it’s hard to deny, I think, what we’re seeing at this point.

[00:11:26] Neil

I think another person who’s looked at a little bit from market perspective is Ray Dalio. You know, I mean, he’s talked a lot about the long debt cycle and God knows how many books he’s come out with. But, Ray, he talks about the same 80 to 90 year cyclicality. And I think though, when you look at the roots of it, I mean, debt itself has no periodicity. You know what I mean? Debt itself is just an abstraction. It’s just a dollar amount. But what gives history an actual periodicity, a tangible periodicity, and that has to be related to the human life cycle. You know what I mean? It has to be.

[00:12:04] Cem

I couldn’t agree more. I couldn’t agree more. And that’s what connects everything. At the end of the day, generations, as you state, have their own learned history, right? And that learned history, their relativism is based on their experience.

[00:12:21] Neil

Totally.

[00:12:22] Cem

Their generational experience is very different than the other generations around them. And because of the human life cycle, I couldn’t agree with you more, we keep repeating the same political realities.

Now, the reality is, as you know, why do we constantly shift from one to the other? And I have a theory, and we’ve talked about it, that at the end of the day, there is a kind of this almost animal survival of the fittest, driving force in humanity that’s like an animal reality. It’s nature, if you will.

And then there’s the truly unique human thing, that is not natural, which is the pursuit of fairness, and justice, and the human contract with one another. And I think those two things are the two forces that are kind of pushing us and pulling us. And there’s a constant debate about which one is more important, how far one should be treated, and this is the left and the right. Socrates talked about this.

Do you give the best violin players the best violins or do you give the worst violin players the violins? And I think that is the driving kind of animus that drives this. And I think you speak about this so eloquently.

[00:13:38] Neil

You know, Cem, it’s interesting, that very duality that you mentioned, between survival of the fittest and, you know, kind of reality show Survivor, all of that, versus high ideals, making life kinder and nicer, is itself a generational archetype. And today we find, coming of age (I would say not coming of age), but coming into midlife is generation X, who was always, from the time they were throwing kids, back in the late ‘60s and’ 70s, when no one had any time to pay attention to them, because family life was going to hell basically back then, these notions of reality and survivor became building blocks of their pop culture. And later on, I mean, the whole idea of, you know, just do it, you know, and it works for me…

I think that’s my favorite Gen X motto. It works for me. Meaning I really don’t care if it works for the rest of you, but it works fine for me, right? It is atomizing in some ways. It is very pragmatic, obviously. And these are the people who are now the members of cabinets. I mean, they are the people who are senators and congressmen now. They are beginning to set the tone for this highly pragmatic age in which there are no rules. What are you talking about? Collective security, international law, all this stuff.

But many of these Xers had parents who were the children of World War II. And they were all believers in those high ideals. They believed in the UN, they believed in the peace marches. You know, many of them went down to Selma. They believed in the system.

And you know, even when we saw the recent valedictory to Dick Cheney, we forget that generation, of which he was a member and most of his career people forget, he was the ultimate systems guy, you know what I mean? He was just the ultimate nerd. He always kind of went along with, you know, the CIA or the State Department decided this, of course we have to do it. We got all these things. But my point is, these are generational contrasts.

And it’s shocking because we don’t think about the fact that we all live on a generational diagonal. We should have known that that generation was going to replace boomers and they would be the dominant generation. Their way of speaking, their way of thinking would inevitably take its place in the sun.

[00:16:42] Cem

So, I actually think of, and what I love about this conversation is, the way I came to the same conclusions was really looking at interest rate cycles. And these things are connected, right? Basically, anybody who was born, let’s say, heading into 1982 has only now, for 40 years, experienced one thing which is decreasing interest rates, supply side economics, increasing inequality, globalization, expansion, technological development as a function of lower interest rates. And this 40-year experience is very unique, at least to this 80 year period, right? And not surprisingly, those people are having a reaction to it, which is, this isn’t fair, this is unjust.

They’ve been labor, you’re born, and as you know, you go to the workforce after high school, college, you’ve been labor. And the older generation has been capital.

And so, you’re more likely to feel, well, this isn’t fair. I’ve been on the front end of this. The system is broken. It’s all gone one way. And so, this idea of fairness and reinforcing populism, if you will, has really come to fruition as a function of those generations coming, in my opinion, to political dominance, or coming towards political dominance. Does that jive with your thinking at this point?

The core driver right now, like, I guess the thing that will ultimately drive and kick off what we’re beginning to see, which is a more market change, I’d love to hear kind of like if that’s tangential or how you think about it.

[00:18:26] Neil

Look, I mean, I think, you know, this is when the investors idea was… You know, the investors, they go to a financial advisor and the financial advisor says, oh, invest your money with me. I’ve looked at the last 40 years. I figured out all the correlations. I figured it out, we have mastered everything, we know how it works. And their fear is, wait a second. I don’t think the next 10 years are going to be like the last 40 years. And I think their suspicion is absolutely correct.

All of these trends we’ve seen over the last 40 years, toward greater inequality, toward democratization around the world, toward freer trade, toward free flow of capital, toward disarmament, I mean, you could also say collective security. All these things are all now moving in another direction toward autocracy, toward tariffs, toward industrial policy, and toward higher interest rates.

And I will say this, and we can get into this because this has monumental implications for investing. And that is, I think toward a trend of from lower interest rates and lower inflation instead to higher interest rates, higher inflation.

And a point I make is that the climax of Fourth Turnings always results in higher inflation. And why? Because inflation is a great means. And leaders may not think that at first, but when they’re in power, it comes upon them like an epiphany. Inflation is not a problem in a crisis, it’s a solution. It’s a wonderful way to rearrange the card decks, you know what I mean? To absolutely reallocate wealth and income.

[00:20:17] Cem

It always comes in these scenarios…

[00:20:19] Neil

Exactly, but it always happens. And in a crisis, every country raises resources, it needs to reallocate resources suddenly. It tries to do it through debt, it tries to do it through taxes, but inevitably it has to do a lot. And I think this time we’ll have to do more because of the amount of indebtedness, not just public sector indebtedness, but indebtedness to the world that America has.

So, I think here we have it, part of the solution. And also, to follow up on your other point, these younger generations today, if you look at just attitudes toward democracy, they don’t care as much about democracy as older people. Because when people say democracy, older people think, oh my God, you know, a great system, it’s beautiful, it worked well for me. But what younger people see are leaders who talk about everything and never do anything.

It’s basically a vetocracy. You get to keep your high prices on your homes, you get to keep markets super high, overvalued, so that when I invest I’m not going to earn anything in the long run. But he reiterated his belief once again, he says, yeah, yeah, it’s terrible the young people can’t get mortgages for their houses, housing is so expensive. But he says, on the other hand, I’m not going to do anything to undermine all these Americans who have high priced homes.

You know, but here’s the thing, at some point that becomes a zero-sum game, right? So, I don’t know, your reaction?

[00:21:56] Cem

Yeah, yeah, I completely agree with you.

Look, the connection between markets and inflation, I think it’s important that everybody understands this because it’s the most important thing in finance. If money gets spent in a demand/push economy, if we’re spending money, if government is transferring money from the rich to the poor, or we’re sending now the flow of money instead of the capital now to people, the velocity of that money, as economists would call it, or the entry into the economy is 100% whereas the velocity of money that goes to capital approaches zero.

The reason we haven’t had inflation despite all of the spending that we’ve done, is because it has been driven by Federal Reserve monetary policy, which by definition is just sending money to capital. It is sending money to investments that are owned by the rich. And as those that money flows to them, what do they do? Do they spend their money? No, they already have the minimum they need. Yeah, they’ll spend it on luxury goods. And yes, we’ve seen that for 40 years.

[00:22:59] Neil

That’s keeping economy going right now, by the way.

[00:23:02] Cem

Yeah, 100%. But the reality is, once populism takes hold, and is a political structure, assuming (and this is a big assumption that I think we’ll get to a little bit later) that the political will is ultimately, you know, seen through. Which, in a democracy, historically, it has been right. We could go, in theory, to an authoritarian situation where we could suppress the will of the people for much longer and that will build. Okay, that’s my, my thoughts on that. We’ll get to that later.

[00:23:35] Neil

Bookmark that one.

[00:23:38] Cem

It’s important, it’s important in this regime, but importantly the will of the people, broadly, if it is going to be politically fulfilled, that means those people are going to get more money, which means they’re going to spend more money, which is a demand side economy. It can create a lot of real growth, like not real in inflation terms, but like actual demand growth like we saw in other periods.

But at the end of the day, it drives dramatic inflation. And the discount rate, the price of the long-term bond, which is driven by inflation, is not even close the most important thing to finance. Most people think it’s economic growth. It’s not 1968-‘82, great example. Inflation happens, right? What happens to equities? We actually have greater GDP growth in real terms, adjusted for inflation, 3.8% per year for 14 years. What happened to the market in real terms for the 14 years? Down 4% per year on average, for 14 years. The GDP growth in real terms, in the last 40 years, has been 2.3%, 1 1/2% lower, yet we’ve seen 9% real per year, you know, growth of market.

So, assets are much more sensitive to the discount rate, what people are willing to pay for the earnings, the liquidity that’s driven by lower interest rates is what drives outcome for investments. Most people don’t understand this. People have moved away from the bond market because they understand the connection between interest rates, the long bond, and bonds. Obviously, they just experienced that initial pain in ‘22. But very few people understand that the dominant force in the value of equities and assets is not growth. It’s not GDP growth, It’s actually interest rates. And we can get into the whole piece of it.

It’s important to note that is intrinsically tied to inequality and generational political demands, are we prioritizing one thing: median outcomes or mean outcomes? And it sounds like a small thing. It’s everything.

Are we prioritizing to the greatest GDP growth of the whole thing or to technological advancement and outcomes? Are we giving the best violin players the best violins, or are we thinking about the weak violin players and them all having a little bit more fairness in the system? And that really is how these markets interconnect. It’s through that interest rate mechanism and through that inflation that is so critical.

[00:26:05] Neil

Well, inflation really is… You know, there’s been a lot of increased discussion recently about ergodicity. You know what I mean? I’m sure that it’s the whole idea that the sum of all possible trajectories may be perfectly fair, but most Americans are on one trajectory, and a few are on another, right? The whole idea that how the process takes place. It’s also a fundamental point about, you know, investing in bets which the expectational value is positive, but the geometric outcome, as you know, is negative.

[00:26:43] Cem

Now you, now you just brought up my favorite topic, which is volatility and options. That is a perfect segue into we are so fortunate, in this Fourth Turning, because in Fourth Turnings we didn’t have this great fortune to make bets in nonlinear ways. The public can actually position, and investors can position, with much more liquidity in ways that take advantage of this ergodicity, that take advantage of this non-linearity.

And this is why 60/40 may have worked okay the last 40 years. There’s been a controlled system. We’re kind of a natural free market system where we’re optimizing to one thing that’s deflationary and we can just respond with more and more monetary policy. Great. We’re all cogs in a wheel.

But as your generational work talks about the politics of each generation matter, and when we prioritize fairness, or equality, or some level of fairness, then there’s less control and there’s more nonlinear outcomes. And things can change, not just very quickly, but for long periods of time, in dramatic ways that seem impossible to imagine given a 40 years of one.

[00:28:02] Neil

Well, I, you know, there are so many different ways the conversation can go from here. I kind of hesitate. My first question is, and I’m just going to shoot out some questions here because you can go with different ones, but one is, to whom are these option strategies available? You know, there are all kinds of… You know, you can go down the list of all the kinds of stuff that’s out there being offered, right? All of these buffered outcome funds, you know what I mean?

All of these different kinds of funds which, basically, give you a guarantee on the downside, and kind of, you know, sell the upside, right? And we know what that does. In fact, now that I am in (but we’ll talk about that later)… Now, I’m actually in the business of investing and trading, the first thing I look at in the morning is to look at where’s the gamma and the overall market?

You can now, with all these different kind of systems out there, you can kind of see what’s going to happen if the market goes up a little bit or goes down a little bit. Are we in a stable zone or are we in an unstable zone? This did not used to be true, but now that we have this machine in place, Cem, it’s doing what I just suggested. I mean, it’s selling when you go up, it’s buying when you go down. But, it lends itself to this discontinuity.

You can add too much and the whole thing falls away. And of course, then what have you got? The Fed, you’ve got the treasury, you’ve got all of your other things in place. That’s one question I wanted to ask you.

The other question, I think, had to do with the political side, because I think you were getting at it. Let me just add, by the way, an economist who wrote nearly a century before Adam Smith… And I’m a huge fan of Adam Smith. I mean, the history of economic thought actually was my specialty in graduate school. So, I worked on all of them. I went to the marginalists, and I read all of that stuff.

But there was one genius who wrote nearly a century before Adam Smith, Richard Cantillon. He was a Frenchman, and he wrote the definitive work on the impact of inflation. As you know, Smith and all the classical economists never wanted to talk about inflation. This is why Keynes later blamed them. He said, you know, they never actually understood the importance of price changes on the market.

Cantillon talked about it all, and he talked about it back in the 1600s. He was the one who said, it’s like honey pouring out of a jar. He said, first you have to look at where the inflation is coming from. Who gets advantage first? And he was the one, for instance, to notice, why is there always a lot of money in urban places and in rural places there’s never any money?

I live out in West Virginia, and I’m telling you, there’s no money out here and no one here cares about the S&P 500. But you see these enormous discontinuities, they really haven’t changed since Cantillon’s time. But he actually… And I urge you, Cem, if you have not revisited it… It’s not a long book. It’s much shorter than the Wealth of Nations.

[00:31:24] Cem

Yeah, definitely read the Wealth of Nations. Cantillon is in my parlance. I definitely haven’t read Cantillon and should. But I love the elevation of it and it just speaks to that what we’re talking about is a tale as old as time. Even though it’s not as well understood by most, and hopefully you and I are helping educate, and bring this, and stand on the shoulder of giants, you know, elevate and bring those things to, to the broader public.

But, like I said, do things still also change? Like we’re. It’s a tales as old as time, but now we have reflexive instruments, like options, to affect and bet on these outcomes in a much more precise way. And whether it’s here, at the Cboe, or whether you’re doing on commodities elsewhere, using those options allows for incredible impact for relatively low risk in multi-dimensional space.

But you do highlight that they also have reflexive effects. And so, they can make some of these cycles and these things go on for longer, play out in very unique kind of paths, if you will, maybe in different speeds and different, again, path in a sense. I don’t think it necessarily means we’re not going to get to a similar place eventually.

But, I do think that they are playing increasingly important roles. I think we’re living a really important moment right now, in these four or five years. Most people don’t realize this is critical. You and I talked about this, but I want to highlight this for the audience. We have seen a tripling to quadrupling, in the last three years, of AUM money invested, in a series of things. Most people don’t draw them together and see the connection, and I’m going to highlight what those are. But they’re all correlated. And how are they correlated? They’re correlated in the sense that they are non-correlated assets.

[00:33:32] Neil

Yeah.

[00:33:33] Cem

Who’s getting those assets? Precious metals tripling to quadrupling in value in three years. Who’s getting those? Hedge funds have a two and a half X at AUM, by the way, from almost a steady state – US$2 trillion, they’re now UE$5. And by the way, gold itself was at a pretty steady state until they took off.

Structured products or things like structured products, like ETFs, and buffers, and all these other things that do these same things, have gone from US$500 billion to US$2.3 trillion. A 4x to 5x, in 3 years, from, again, a relatively steady state of growth. And then crypto, you could argue, or things again seen as non-correlated. Now whether they are correlated or not, we could talk about that. But the big idea here is that there is a perception of a need.

And these are early adopters, these are people listening to you and I, thinking about these things, saying, oh no, we need to do something. But this is with markets at all-time highs. People who saw ‘22 happen and like oh my God, bonds aren’t going to help me anymore. I need something else that maybe is going to help me. But these are people who have not yet seen what I believe, and I think you believe, is a broader regime shift and that equity is not going to work either. Not the way we’ve seen in the way we think about it.

So, it’s critical to see what’s happening. Boots on the ground, three years, and know that this is an area and the growth of these things that are working are all correlated in that sense. And that you also, by the way, just if you look at markets, the ultimate driver outcomes of supply and demand. We have gone from a, call it US$6 trillion. All those things I talked about were US$6, maybe US$7 trillion, that’s it in 2022. And here, in 2026, how much is all of that? Maybe about US$20, US$23, depending on how you look at precious metals and what’s above the ground and who owns it.

Yeah, well, the total assets, last thing I was going to say, US$500 trillion, Neil, US$500 trillion? Yeah, you’ve seen a tripling from, from US$7.5 to US$23. But, US$23 relative US$500, what happens when the US$500 really is at risk and the 95% of allocation, which is stocks, bonds, private equity, private credit, real estate, all the same stuff really, assets, what happens when those things are finally at risk?

Well, the door that… The amount of available things to invest in, that are non-correlated, are much smaller, and a lot of them are still developing, and some of them (sorry if I cut you off) like hedge funds and structured products (the evolved stuff we’re talking about that is so critical in this positioning) has reflexive effects.

And so, we’re looking at a complete market transformation as part of this Fourth Turning. And it’s happening at the same time because we’ve developed a lot of these things that didn’t exist amidst this time, and now the adoption’s happening. We’re hitting a bit of a tipping point for what I would consider new technology and new products and things, not just hedge funds (which have started, by the way, in 1970), and options (that were starting around 1970), and that are now coming, kind of, for broad adoption.

[00:36:45] Neil

Look, very often the things you mentioned… Obviously the market itself has gone up. This has been a great time for markets. And this is when we’re talking about and complaining, you see the multiple expansion. I mean, by any… Well, let’s not get into Shiller’s CAPE and all that. But we all know that it’s very expensive markets, now, overall, I mean, in terms of not global equities especially, but US equities. I mean, honestly, the rest of the world’s a lot cheaper, you know, relative to earnings or anything like that, but it’s very expensive.

So naturally people are going to gravitate toward these other things that are regarded as tail hedges. I mean, that’s what people are going to want. And the ultimate tail hedge is political, and you have a very optimistic outlook. I see something that could be a little bit more of a discontinuity than you do.

In other words, let me come back to what Four Turnings always climax in – conflict. I mean, real conflict. I’m talking about real conflict. Which is all of the ones in our history and most other modern nations, Fourth Turnings always involved an internal war, external war, and a huge devaluation, at least temporary, of markets. In extremis, they resulted in just the closing of markets. Just closing.

People don’t remember what happened in World War I. A day or two after armies started marching, the markets just closed everywhere. And you’d be lucky, at the end, if markets reopened because you might be a member of a different country. Right? I mean, if you’re part of the Austrian Empire, it didn’t exist. If you were part of czarist Russia, it was no longer there. I mean, what happened to your assets?

Interestingly enough, in the early 1990s, many Eastern Europeans who had come to the United States had lost all of their assets During World War II. The Warsaw Pact fell. These new democratic governments took power. And there were all these people writing back to these new regimes, because they set up markets again – free markets. And they say, my great grandfather owned a piece of property near Budapest. Do I have a…? Think of how pathetic that is?

Maybe the people who own stuff today, maybe it will be your grandchildren writing letters to some new regime. I mean, I don’t want to be an alarmist, Cem, but you need to realize that it’s not always just – everything doesn’t end and buy the dip.

[00:39:38] Cem

Yeah, and by the way, nobody’s called me the greatest optimist. So, I think we know where we are here. I love that you’re highlighting, again, the big idea here is we are embedded in this recency bias. Nobody looks at a track record longer than 10, 20 years.

[00:39:58] Neil

Well, also survivor bias. We’re the most prosperous economy on earth. So, of course we’re talking about connected.

[00:40:05] Cem

Yeah, 100%. I 100% agree. 60/40 people don’t realize this didn’t exist in 1980, ‘82. It came about because it worked for 40 years. But why did it work? Does anybody ask that question?

It didn’t work… If you look at 60/40 for 120, just 125 years, never mind the 250, 500 the 1,000s of years we’re talking about, it doesn’t work. There’s no diversification benefit. Literally the Sharpe ratio over the last 125 years of stocks is 0.35. And a 60/40 portfolio is 0.37.

There was zero diversification benefit of a stocks and bonds. And importantly, this idea that this is how you invest, which is just conventional wisdom, at this point, for what is the most important (other than maybe your health), the most important thing that everybody does. People are just following the lemmings, following something that only worked because of recency bias.

So, I think it’s critical to understand that what you’re highlighting is not just that this is recency bias, but what is possible, as opposed to this controlled little system we’ve been in, is dramatically different than what most people are willing to come to terms with.

[00:41:16] Neil

Well, and the impact of policies which nations will enact when the people demand them. You know, it’s funny, whenever I talk to people about the long-term success record of equities, you know, I take them through US history, sort of inflation adjusted total returns – total real returns, inflation adjusted. You had these crashes and long periods of nothing happening.

[00:41:45] Cem

I’m going to give you a statistic here because…

[00:41:46] Neil

Hold on, hold on a second… 1929 to 1949, it’d be one. First of all, you had to undo 77% decline in real terms. And then you had to go 20 years before you got your money back. But it’s interesting, so, as I go through them, there was another one, World War I, there’s another great one that started in the late ‘60s, lasted through to the ‘80s.

But here’s the thing. And then all these people getting really nervous and I say, but I’m not just dissing equities. Take a look at bonds. If you had bought a bond portfolio, sort of 10-year maturity, US treasuries, just before Pearl Harbor, when the interest rate was down around one point something, you know, we still had deflation right up there. We were still in the Great Depression, really up until Pearl Harbor.

If you had bought that, my question is, how many years would you have to wait before you just got your money back with inflation? You would have to wait till 1987 – that’s 47 years. And I talk about that. Imagine a real stagnation for 47 years. And by the way, I think a lot of economists would say that when you look at Jeremy Siegel’s wonderful thing about, you know, stocks do so much better than bonds. A lot of that was due to the half century of financial repression that we had in place in America.

[00:43:09] Cem

To reiterate what you’re saying, I love that you know those numbers because most people don’t. The reason passive investing and 60/40 exists, by the way, it’s gospel. It’s like blasphemy to say this is not the way to invest, but the reason that it is adopted fully, and it didn’t exist before 1980 (and you highlight these), I want to like reiterate, is because from 1900 to 1982, actually, where interest rate peaked (that’s why I’m drawing that line there.)

[00:43:43] Neil

Yeah.

[00:43:44] Cem

From 1938, 1982, 82 years, you had three (I want to reiterate three) 20 year (two decade periods), where 60/40 (what’s considered the way to invest now) made 0% – 0% for 20 years. Three of them, 60 of the 82 years, if you invested in each one of them, you made 0%. 1900 to 1920, 1929 to 1949, 1962 to 1980.

[00:44:20] Neil

Yeah. The ‘70s would have been terrible.

[00:44:22] Cem

How in the world, if you’re sitting in 1982 (we’re talk about recency bias, now), if you’re sitting in 1982, how in the world is anybody going to say yes, you buy and hold for the long run? Or better yet, we’re going to buy and hold stocks and we’re going to pair it with bonds. Nobody did it. The Dow Jones was created a hundred years ago, sixty years before that. So, we had passive investing as a concept. Why do you think nobody did it? It didn’t work.

[00:44:51] Neil

So, Cem, one new idea, this is something we’re doing with our fund, and that is getting rid of that pairing to the extent that we’re long net equities, we’re not pairing it with bonds. If anything, we’re short in certain kinds of bonds. What we’re doing is pairing it with commodities and commodity futures.

So, this is the missing great leg that has always been there, by the way. And people looked at the behavior of commodity futures, since the late 19th century. This is something that I’m trying to revivify, bring back to life.

But anyway, go ahead.

[00:45:28] Cem

Yeah, I couldn’t agree more. Three years ago we very publicly… Actually four, almost four years ago now, we said gold is going to be the best performing asset for the next 10, 15 years. This is when it was literally… And buy it with calls…

[00:45:44] Neil

Not just precious metals. I’m just saying.

[00:45:49] Cem

Commodities writ large and strategic assets things of true value… I couldn’t agree more. The thing I would add to that though, or maybe kind of to be polemical, it’s a great diversifier. But the thing that’s also true anymore is diversify. They don’t think about risk because they haven’t had to. It’s controlled system. But there are ways. We talked about a 0.35, 0.37 Sharpe for 60/40 over 125 years.

There are ways that are not that complicated that are basic academic research. Diversification using long vol, convexity to rebalance to prove geometric returns, value investing versus growth. All of these things are well known, well documented ways to improve risk adjusted returns.

You can get 2 Sharpes and higher, which seems almost crazy to people, by following these principles, not by having just some incredible alpha. Commodities, broadly, do need to be part of that stool. They need to be one of the legs. It is a diversifier.

I will highlight though precious metals themselves have a ton of volatility. In the ‘60s and ‘70s the best performing asset was precious metals, gold in particular. But it was also the most volatile asset and so agreed.

It should be part of your…

[00:47:00] Neil

But here’s the thing. It doesn’t matter how volatile it is. If you have a lot of volatile assets and they’re not correlated with each other, it doesn’t matter. What you need to do is to, is to make sure you have enough of each. You need to do something to reduce the volatility drag on your portfolio, and if you hold enough of them, you’re good. You know what I’m talking about.

[00:47:22] Cem

I agree but diversification, which everybody talks about but they’re like then diversify to 500 stocks and 500 bonds, is a thing that I think is going to become more a part of broad parlance, risk management, people throw it around but nobody even knows what the Sharpe ratio is of the assets they own or the portfolios they own.

So, that is the key. And at the core of that, and this is what I do and what I think a big part of what you’re doing, is using also things that are nonlinear like options to really help shape a portfolio that takes advantage of that nonlinearity and that non-correlation that’s so critical.

As we approach the end here Neil, tell me a little bit more about what you’re doing within your ETF. I’d love to give you time to talk about, other than the commodity piece which you already highlighted, what are the other things you’re doing? Do you use options, and how? So, what are the other things that you use and what do you do?

[00:48:12] Neil

So, remember, the answer to the question that I said is, people said what should I do? So, one of the things is, I’m writing a new book. The other thing is with Hedgeye, that I worked for, I started an ETF

It’s called the Hedgeye Fourth Turning, so, HEFT, and, you know, the great thing about what I love about ETFs is anyone can invest in it. You know what I mean? You don’t have to be qualified this or…

Okay so, it’s basically three basic premises. One is, I just talked about. Instead of pairing our net equity position with… By the way, it’s a 150/50 fund, so, we can go short as well as long, but we pair our net long equities with commodities commodity futures rather than bonds. So, the number one difference, right?

[00:48:59] Cem

Yep.

[00:49:00] Neil

The second is that all of our actual equity investments are Fourth Turning themes, things that we think will do good. I mean, this would be, obviously, national defense, personal security, energy, a lot of industry, robotics, completely retooling a health care system. To some extent, when it comes to more things like a lot of the weirder highly leveraged consumers and financials, we’re probably short.

Here’s one thing you have to understand, Cem, is that for the last five quarters, America has had a net national savings rate of exactly zero. Outside of a severe recession, that’s never happened to us before, America simply has to move to saving more and consuming less. And every time there’s pressure on the dollar, this just comes again, this reality back. America has got to fundamentally change its orientation.

I think, in a weird way, Donald Trump may be actually part of that in its own strange fashion. But, I do think, you know, I say strange fashion because obviously we’ve got the deficit to worry about when it comes to saving too. But, I do think this is inevitable. It doesn’t matter who our leadership is. We’re going to have to move that direction, and then that influences the kind of sectors we’re in.

And then finally, and this is the part that I think you’d be interested in, and that is we’re built for heavy weather, meaning that we strongly believe in the optionality of cash, along with Warren Buffett. So we are, you know, to some extent cash, but valuations remain very high.

We do tail hedging. That’s where the options come in. And that is very carefully calibrated according to the Kelly criterion. So, you’d be familiar with that. So, we wage our bets very carefully. And we optimize them. And it has really helped us, I mean, it helped us two days ago. I mean it was wonderful. So, we do that and we also keep our beta low. I mean, we’re low beta on our lot.

[00:51:16] Cem

Yep. And again, I’ve talked about this in other venues here, with David Dredge on the same podcast, but that vol, people look at it, as they have in the past, and say, well this thing makes 0% over the long run, why would I own it? And they’re missing the big point, which is it’s like taking the brakes on your car and saying, man, these brakes make me go slow. Gotta throw’ ‘em out of the car.

[00:51:35] Neil

No, no…

[00:51:37] Cem

You don’t sit on the brakes and gas at the same time either. That’s not how brakes work. It’s brakes, gas, it’s control around the turns that allows you to be aggressive at the right times, allows you to not only not fly off the tracks, but allows you to take risk when risk and opportunities present themselves in different ways.

[00:51:52] Neil

Yeah, absolutely.

[00:51:54] Cem

That’s what using options and hedges are all about.

Two last things. And we’re running out of time here, so we’re going to hit it quick. But these are big ideas, so let’s dive in.

One, it’s one thing to say, okay, the Fourth Turning is here and the big ideas which are so valuable over a decade, but do you have signal? How will we know that it’s imminent, or this year, or next year? The tough part here is the timing.

Historically, since you have such a lens on, maybe it’s not one year or six months, but how do you gauge where we are? Because again, it’s not just a life cycle per se, there’s some other effects and things playing in. And how would we know or how would we have a good sense when the probabilities start really drifting to our favor, and how close are we?

[00:52:45] Neil

You know, it’s funny. I’ve actually been thinking about that a lot because I’m writing about it now, because I’m now getting into practicalities. I do think that an extremely overvalued market is obviously a dangerous signal. It’s not… No one should time their trades on that, let me be clear. But you need to be aware that we are looking, you know, when I look at RATF, for instance, I’m looking at a 10 to 15 year horizon.

So, you know, I’m looking for something that’s going to carry you through. But you should be aware of what the historical record is at these valuations or what your likely 10-year return is on just equities long. It’s probably not going to be terribly good. And I would say, if I were to be a little bit more dramatic about it, it may not be very good and it may include some huge declines.

I mean, if you look at these plateaus in the past, they’re not plateaus, they’re plateaus that include huge declines and recovery. So, I would say… But obviously the market is unpredictable. At any given time, and you know this better than anyone, Cem, there are an equal number of people who think the market is going to go higher, as go lower. So, the market is, to that extent, unpredictable.

I would say that when it comes to the other elements of the Fourth Turning, that we talk about, such as conflict, I would actually say that, particularly in terms of geopolitics, when America seems to be at the point that it’s really repairing stuff and getting stuff back in order, I think that becomes a forcing moment for adversaries. I’m serious about that. When it looks like things are still going to hell, there’s no window closing for China, no window closing for Putin. Just let it keep going to hell.

[00:54:37] Cem

Almost like a caged, you know, cornered animal is when things really…

[00:54:40] Neil

Well, we’ve seen this in the past and I like to bring up historical examples of when this happened. I think that the success of coming out of this very often depends upon the investments we make early. You know, the classic one I like to talk about is, right after the fall of France, is when the mood in America began to change hugely. You know, we were no longer an isolationist nation. The Republican Party, instead of running someone like Lindbergh, they ran Wendell Wilke, who was an internationalist who actually agreed with FDR. It was important. We had to resupply the arsenal of democracy. That’s how much the mood had suddenly changed.

And FDR went to Congress in July, the next month, and he proposed more than doubling the size of the U.S. navy. And this included, you know, the Iowa class battleships and included all the Essex class aircraft carriers that would later dominate in the Pacific in 1943 and 1944. That bill, which is, by far, the largest weapons appropriations in American history as a sheer of GDP, went through Congress with not one opposing vote. Remember, that was in July of 1940. That was more than a year before Pearl Harbor. But here’s the thing, Cem. If we had not made that investment, the war in the Pacific would have gone on for at least another couple of years.

We don’t think about this, and there are other great examples I like to bring up of this, but these are moments, actually in our history, we really have to think ahead. We’re so much into the headlines right now. We’re not thinking of where these things are likely to go.

[00:56:33] Cem

I couldn’t agree more. Two quick thoughts. And then I want to ask you one last quick question, but these are the thoughts I have on what you’re saying. You know how you said I’m not being bearish enough or whatever. I think I’m going to say the same thing back to you now.

So, one to your thought of market valuations and historic forward, and you kind of were like, yeah, CAPE Shiller, whatever. The reason Shiller matters, and why he ultimately will be proven correct, most people don’t understand. People are like, oh, but there’s such a lag, and it’s so indecisive on when. The reason there’s a lag, the reason we haven’t seen adjustment as interest rates have gone higher yet is because people obviously, when interest rates are zero, everyone is going to refinance. Markets operate on supply and demand. Until people need to refinance at higher rates, the higher rates don’t matter.

[00:57:25] Neil

Right.

[00:57:26] Cem

And Everybody refinanced in 2020, 2021. Do you know what the average duration is of the debt taken in Jan. 2021? Five to eight years.

[00:57:38] Neil

Yeah. So, it’s beginning to roll over.

[00:57:40] Cem

So, the interest rate and its effect on the total valuation has a lag for that reason. And guess what? Here we are on the doorstep. So, you want signals? That’s a signal for me.

[00:57:50] Neil

Yeah, I agree. By the way, I will say this, just in defense of Bob Shiller and that is Burton Malkiel. You know, I think they’re both getting on. I think, you know, he’s in his late 80s. But Burton Malkiel, who’s very famous, along with Eugene Fama, is one of the great titans of efficient market theory. Which is that you can never predict anything. What was his book, A Random Walk Down Wall Street, 1973. It was a long time ago, but a classic, a classic on the markets.

So, he wrote, just last fall, in the New York Times, and this is his admission, he says, you know, it actually is true, at times when the valuations are elevated, investors tend not to do well over the next several years. And I consider that to be, my God, why didn’t you say that years ago?

[00:58:49] Cem

But the reason too, that it’s going to be worse than you said, is not just because the interest rate effect and how… I do believe CAPE Shiller or the Shiller indexes are correct, by the way. And most people like oh, it can’t be, whatever.

I think the other part that people also poo poo, price to sales, like, oh, come on, profit margins have changed forever. I think what a lot of people don’t realize is profit margins themselves are highly correlated, over long periods of time, to interest rates. So, not only are we… If you look at it, price to earnings ratio, yes, it’s records or close to records, relative to interest rates, even worse. But when you really connect it to price to sales, it is so far off the charts.

And the reason is because profit margins are at records at exactly the time, not surprisingly, that interest rates are starting to kind of break out the other way. And that’s a critical thing for people to understand. So, from a markets perspective, I know I’m out in the fringe. And if you’re out on the tail, I’m even further out in the tail in that regard. So, I think it’s important to note that.

And then, last thing again, we gotta button this up. I could go for two hours with you, Neil. this is wonderful. The big question for me, and I don’t know how we can do this service in like two or three minutes, but we have to. Is it possible that this could lead to pure authoritarianism? That the will of the people, which is what the generational part is kind of the thing I alluded to earlier in the conversation, can be circumvented by power? And is that something, in your view, that could be, in theory, despite it being an unlikely outcome?

[01:00:29] Neil

Well, in my most recent book, I do talk about the threat of civil war. And that would just include conflict that just simply brings down the politics in America, makes us just dysfunctional, a failed state in some way, as well as something that would really involve two sides ultimately through escalation and threats. You know how these things happen. And just to remind people, just historically, no one ever thinks civil war is going to happen in their own country.

Barbara Walters, who is actually one of the world’s experts on civil wars, has actually interviewed survivors of civil wars all over the countries, you know, from Myanmar to Rwanda. And she says, she interviews these people and they all say the same thing. We never saw it coming.

And Henry James, who wrote his autobiography late in life, he was 21, 22 years old in Washington D.C. in 1861. He was right there in the Capitol. He knew everything. I mean, his father was a diplomat after all. And he later wrote in his biography, said absolutely no one saw it coming. I mean this was after the election of Lincoln. He said no one saw it coming. He said, and anyone who did is lying.

But my point is simply that this will be a conflict. Now, your question is, could authoritarianism… In other words, could you simply move from being a republic to an empire with no conflict in between? And I actually, in my new book, I actually address that question.

[01:02:13] Cem

Oh, interesting. I love the little cliffhanger. You’ll have to go read the book.

[01:02:18] Neil

Well, I do, and I go through all the examples, but let me just give you the quick answer. Every republic, and I’m talking about Venice, and Carthage, and Rome, and you just go through all the great names, the Dutch Republic, all of the great republics of history, including those that the founding fathers thought about when they were designing a constitution, they all fell in either two ways, foreign conquest or civil war. None of them simply died with a signature. You know what I mean? It never happens that way.

[01:02:53] Cem

Well, Neil, what a wonderful… Again, we could do two hours. Maybe we’ll do it again with you and revisit it in a year or so. But incredible having you on here. No better environment to trade in distributions and look for kind of tail convex instruments. And hopefully we’ve been, again, like I said, on the shoulders of other giants to help kind of spread the word about kind of where we are and where we’re going.

Neil, thank you so much for your time today and look forward to talking again.

[01:03:23] Neil

Thanks.

[01:03:24] Cem

Take care.

[01:03:30] Ending

(Music)

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