The Fed Rapidly Changing the Rules of the Game (w/ Matt Rowe & Jared Dillian)

Video Transcription:

  The Fed Rapidly Changing the Rules of the Game (w/ Matt Rowe & Jared Dillian)

MATT ROWE: Good morning to the Real Vision viewers. I'm Matt Rowe from Headwaters Volatility. And I have the pleasure of interviewing Jared Dillian of Daily Dirtnap. Jared and I have known each other for a number of years. And we seem to have bonded over contagion. And we tend to compare notes when things get weird. So he's a great touchpoint in that regard. Jared has a long career which started off at the Coast Guard and has extended into working with Lehman Brothers and the ETF index arbitrage desk, if I remember correctly, Jared. And he has now made a career and a name for himself in commentating on how ridiculous things get often in our industry. So I'm happy to be able to follow up on our conversation that we had stemming from Jared's recent article that he wrote for Bloomberg and do it live here in front of the viewers for your benefit and entertainment to some degree. But I hope it's enlightening. I'm certainly looking forward to it. I find that Jared challenges my thinking and gets me to come to some pretty good conclusions as we work through things over time. So thanks, Jared, for joining me. JARED DILLIAN: Yeah. Thanks for having me. Thanks for the introduction. MATT ROWE: Yeah, of course. So one of the things just right off the bat to dive into it that you mentioned in your article is about the collision of what people-- what investors do and how there's a bit of self-loathing or a conflict between what they do and negative commentary. How do you think about that? What's your view on that at this point as far as investors' behavior goes? JARED DILLIAN: Well, I think that there's-- I think money managers are greatly influenced by their personal feelings about things. We're all human beings. We all have a sense of right and wrong. And a lot of people who have worked in the industry for a long time and have seen the evolution of the Fed over the years-- they look at what the Fed is doing with unlimited quantitative easing and stimulus and buying junk ETFs and everything. And they say that this is socialism. This is bad. And what they kind of lose sight of is the idea that their job isn't really to have an opinion on these sorts of things. Their job is to make money for their clients. And oftentimes that involves doing things which they might find distasteful. And if the Fed is buying high-yield credit, then you should be buying high-yield credit. It doesn't matter about your personal feelings about it. But if there's explicit support for an asset class, then it pays to play along with the Fed. And that's what you should be doing. But there's a bunch of examples over the years where people get caught up with their personal feelings about something. They say, well, I'm not investing in this because it's a bubble, whatever. This is a bad stock. And you try to divorce those feelings from what your actual investment thesis is. MATT ROWE: Yeah. I mean, I can remember in years past running convertible bond portfolios looking at things like issues that had no takeover protection built into them and making a loud protest to the underwriters that that's ridiculous. You shouldn't remove that protection for bond holders. We shouldn't buy it if it's not in there. And then the new issue pricing is 102 bid in the gray market. And you have a choice of going in at par or not. And you know what? You probably participate at par. So I think that's an interesting topic, though, in a ESG-type world and even where we stand right now with the Sarbanes-Oxley and such. What do you think about things like the zone of insolvency for companies, where executives have- - publicly traded companies under Sarbanes-Oxley have a fiduciary duty or a legal requirement to do everything that they can to maximize shareholder value? But in times of distress, there's a legal concept called the "zone of insolvency," where the requirement of the executives of the publicly traded companies and other shifts towards defending assets of the company to benefit or to preserve value for debt holders. What do you see or think about that notion in a world where we've become so accustomed to the benefit of buybacks and other shareholder-friendly things? Do you think that there's a possibility for people to think about cap structures more broadly? Or are we still more in everything is good for equity, you should do it, and follow and chase? JARED DILLIAN: I still think we're at the point where everything is good for equity. And you should follow and chase. You know, it's funny. I haven't really thought about the zone of insolvency until you mentioned it and this idea that you would do things that are preferential for bondholders. But I don't think we're at that point yet, although I will say that now that buybacks are probably going to be mostly disappearing and that S&P dividends are probably going to be down about 40% that these are shareholder-unfriendly actions. But these considerations don't really have anything to do with capital structure. They have to do with, really, politics and the perception that companies would be rewarding shareholders during a time of crisis. So it's really about perception and politics. But for sure, that's definitely not benefiting shareholders. MATT ROWE: Yeah. I often have thought in the last couple of weeks that the answer to this situation, barring any influence or outside intervention from the government, that the right thing to do for companies is to do things that are dilutive. Because I've classically trained in cap structure that I view equity as a call option on the assets of a company above and beyond that the debt holders have a claim to. And it seems as though the behavior of the pricing is different for many reasons. But taken to its extreme, one thing where buybacks are concerned that seems ridiculous to me is, can you imagine if a company refuses to give guidance, yet they continue buying back their own shares? That seems to me to be a very risky move for companies. Because if you're spending shareholder capital to buy back stock and you can't even issue guidance, there seems to be some sort of new level of ludicrousness. But I'm sure it'll happen. I'm sure there is. As we sit here today, there are some companies with that. JARED DILLIAN: It's funny that you mention buybacks because buybacks are an example of what I was talking about with portfolio managers with their personal feelings about things. If you go back to 2017, '18, '19, there was plenty of data out there that showed that buybacks were responsible for most of the returns in the S&P 500. And as a money manager, you can sit there. And you can say, OK, we're doing a trillion in buybacks a year. This is rewarding people who are just long. But that's not really what happened. People complained about it. They thought it. They said, I don't want to participate in this. And they severely underperformed the market for a period of about 3 or 4 years as the buybacks were running about $800, $900 trillion a year. MATT ROWE: Yeah, I think you're right. And it's hard to argue that if times are good and executives of particularly publicly traded companies in this regard are doing what's best to maximize shareholder value, there's a pretty strong case to say that you should be doing buybacks even over dividends. I know that the dividend versus buyback case studies are an oftendebated point of business school theoretical and engineering process. But to me, the buyback wave has been the most recent chapter. And it's getting further and further out on the risk spectrum from '08. And I guess if we walk it back to, Jared, where you and I were in more constant conversation while you were at Lehman and I was running a highly levered convertible arbitrage firm, we saw things get fractured for various reasons in '08. And then we've been working back from that, in my opinion, since, where in '08, there was-- secured debt was trading at a significant discount to liquidation value. Then you've got preferred equity. And then you had various forms of other risk premia, as they're now defined, that were at different levels of cheap. And now it's about creating cheapness. And the buybacks are creating scarcity value or cheapness and equity as we've moved further out here. And it seems that the step one of getting back to more normal times, I guess, you maybe could say-- I don't know what normal is anymore. But stopping buybacks seems like a very rational thing to do. But at the same time, it seems like the US government, Treasury, Fed is starting in a slowmotion LBO of the market. So to your point, if you don't like it, you could get a job doing something else. If you continue to manage money, you should probably play along. What do you think about the government buying high yield and us moving into that part of the market? JARED DILLIAN: Well, I think you and I are about the same age. And when I first got my job in the capital markets on the Florida [INAUDIBLE], it was 1999. And back then, interest rates were-- Fed funds were 6 and 1/2%. There was no QE. There was no asset purchases. There was nothing like that. It was a very different environment. Fast forward to today, and we're talking about-- one of the things I've been doing work on is we're about to issue $3 trillion in treasuries over a 3-month period. You're going to have auctions in 10's that are $100, $150 $200 billion worth of 10's at the same time at 0.66% interest rates. And there's the possibility that people show up at these auctions because we have the only debt that is positive on a nominal basis. And the dollar has been strong. And it's just-- the progression that we've had over the last 20 years to this new era in finance, I guess, has just been unbelievable to watch. MATT ROWE: I would agree with you. And actually, I think when I worked-- you and I have the Pacific options exchange in common as well when I worked on the floor straight out of college. One of the things I did was to walk around and ask people what their strategy is. How do you think about this? What do you do? How do you manage risk? And I quickly learned that there were a lot of gamblers on the floor. Even outside of running a sports book, there were a lot of people who were not running delta-neutral vol risk. It was more various forms of directional bets. But probably the most shocking conversation that I had was a guy who told me that his secret-- and it still probably took me a couple weeks for him to trust me well enough to open up on his trading secret. But his trading secret was to get short gamma and trade it as if he's long. And I thought to myself, now, that makes absolutely no sense. Why in the world would somebody do this, right? But the reality of the situation that I didn't really understand or appreciate at the time is that he was basically identifying that his clearing firm had all the risk. And if he could leverage himself to the put that he's long by the clearing firm, he can only lose as much money as he has on deposit at the clearing firm. And if he loses more than that, it's on them. So it kind of feels that way now. I feel like we're back to a point where in order to really maximize the benefit or to understand the risk framework, you have to understand where the risks lie and where you have backstops and things like that. And here comes the Fed with buying high yield again, to your point. And you should probably just, at the very least, understand that that mechanism is in place if you're trading high yield or equity volatility and at best figure out a way to get ahead of it. And I think that's really what the market has done to date, although I will say, when I look back on the last month since the low right around mid March to today, I believe that the S&P and the NASDAQ are up somewhere around 24%, 25%, 26% since the lows in mid March. But the highyield spread is roughly the same. I find that to be strange. What's your take on that? JARED DILLIAN: Yeah. High yield is kind of in a funny place right now. The market is kind of divided in two. The Fed isn't buying all bonds. They're buying some bonds. And the bonds that the Fed is buying have yields of 4%. And the bonds that the Fed is not buying have yields of 10%. And what's interesting is that people are piling into the bonds that are supported by the Fed, but it's totally bifurcated. And there's a lot of opportunity in some of these issues that-- I don't invest in credit on a daily basis. I jump into credit in times of crisis. I jumped into credit in 2002. I jumped into credit in 2009. Any time you start getting nominal yields out to double digits, I started to get interested. So obviously, there's an economic bet here about the virus and how quick we're going to recover and stuff like that and how long the recession is going to be. But I think there's some opportunity in the stuff that the Fed is not buying. MATT ROWE: Yeah. Well, that's a good point. I think it seems very-- I don't know if "alarming" is the right word. But to your point of your article, there are certain points in my career where I've become either irritated or personally offended by certain things that have been done or haven't been done. In the GM, bankruptcy is something that I was intimately involved with that reminds me of that. And I continually think about what could come out of left field and just shock everybody. Crude oil trading negative is one. To your point about treasury auctions coming up, what would shock the world? If we had a 10-year auction that went off with such massive demand for some reason that it traded at a shocking rate or flat-- things like that, I think, will just cause people to be offended, shocked, otherwise caught off guard. But I think when thinking about things like the General Motors bankruptcy, I come back to this notion that the government is almost doing a slow-motion LBO of equity in the US markets and how to play along with that. I have a hard time making sense of which companies are going to be allowed to fail and which ones aren't. I think that's probably the question that I have the fewest answers for. What do you think? If you were going to tell somebody your thought on which companies are going to be allowed to fail and which ones aren't, what are the characteristics or the criteria of what goes into the "friend of the government" bucket versus the "not friend of the government" bucket? JARED DILLIAN: Well, I want to answer this question in sort of a roundabout way. You talked about ESG a couple of minutes ago. And I think ESG is a pretty good framework for how to talk about this. So under an ESG framework, you say, OK, this is a tobacco company. This is a bad company. And we are going to exclude it. Or this is an energy company or whatever. And if you think about this in terms of constraints, an ESG manager has explicit constraints. There are things that they simply cannot buy, refuse to buy. And then you have-- on the other hand, you have somebody who's an unconstrained manager. They can buy anything they want. How can you expect a constrained investor to outperform an unconstrained investor? So if you think about a portfolio manager today, and they say, I disagree with what the Fed is doing. I find it offensive, whatever. So I'm not going to participate in this. I'm not going to buy these bonds, in effect, what happens to them is that they become a constrained investor. They don't have explicit constraints. They don't have rules that they have to follow where they exclude certain bonds. But they say, there are implicit constraints. These are things that I will not buy. And then they become constrained investors. And then you can't expect them to outperform unconstrained investors. MATT ROWE: Right. I think that's-- it's funny. When we talk about the moral hazard or that topic, which you just illustrated well, it then sort of begs the conversation or argument of, well, isn't this how we got into covenant-lite loans? Or isn't this how we got into-- people would say, well, why in the world would you buy a basket of fixed income that didn't have these protections built in? Or the market pushed this far. And it's like, well, if you're being paid to manage money for people and you are personally offended or morally offended to a point where you're handicapped to a degree where you can't do your job, you really have to choose. Well, do I play along? Or do sit over here and hope that somebody is going to pay me to do nothing? So I think that maybe is a good segue to talking about what I think is the agency risk and the business in the asset management and hedge fund business these days and something that I've observed for years. The people managing portfolios, managing assets for investors definitely have a different time horizon than the end pool of money that they're managing. So most of the people in our business have some sort of an incentive fee alignment and are expected to take action, to make changes, to buy things that are on new issue, to identify things that are uniquely cheap and buy them quickly. There's not much reward for being patient or being uninvested. And what I hear from Sam Zell and Warren Buffett today-- not that I'm a disciple of Warren Buffett, but I pay attention-- is that they haven't seen anything that has caused them to get excited to buy, even in the middle of March. So if you have a bunch of portfolio managers and hedge funds, if you didn't buy something in March, you're probably out of a job. And then you have a lot of bigger, more patient money that didn't touch anything in March. What do you think about the agency risk or the personal compensation risk that drives a lot of market behavior in this? Is it a misalignment of interests? Or what do you think? JARED DILLIAN: Well, I think it all comes down to time horizons. And I think people have different time horizons. One of the things I've talked about in my newsletter is the performance of private equity versus hedge funds and how private equity has had this outperformance. But private equity doesn't really mark to market. But the reason that private equity outperforms is because they have a 10-year lockup. They say, we'll lock up your money for 10 years. You can't get it. And now everybody's time horizon is aligned. But if you're a hedge fund and you're providing people with quarterly liquidity, then what that does is it prevents you from taking positions which could be illiquid, which could be hard to sell that you would like to hold for a long period of time. But you may be forced to liquidate those positions if somebody redeems your fund. MATT ROWE: Yeah. I think you're right. I've often thought of-- you really need the vehicle to match the liquidity of the asset class that you're going to be trading. And part of the post-'08 story in my mind was that there was a premium for things that were liquid at the beginning. And then out to today, even as we sit here today, there's a premium paid for opacity in private equity. If you don't have to own up to the mark-to-market shifts in private equity, if you can pave over-- if this truly is a quick one-quarter interruption to the economy, which I don't necessarily believe in myself-- but if it were, your mark-to-market experience in private equity would be pretty much zero. I don't think that's going to be the case. I actually think that that's going to be a pocket of significant pain as we come out of this. And maybe that's a good segue way to talking about emerging from the coronavirus stall or coronavirus halt to the world's business. My contention is that once things reopen or things restart, it's not going to be a magic grand opening of an amusement park. It's more going to be like walking past the yellow tape of a crime scene and seeing just how bad it is on the inside. What do you think about where we go from here? What do you think people are going to be surprised by? Or what do you think is going to be the reaction to reopening the economy? JARED DILLIAN: Well, I think that we have the possibility to have a pretty deep 12- to 18-month recession. From a policy standpoint, I think we made it worse through unemployment benefits. We also did this in the financial crisis. We extended unemployment benefits to like 96 weeks or something like that. And there's a lot of research that shows that people don't look for work until their unemployment benefits are starting to run out. And in this particular case, we're paying unemployment benefits that are well in excess of what they were making at their jobs. So it's going to take a really, really long time to hire back those people. It's going to be a slow process. Yeah. I think we could have negative GDP out to the middle of 2021. MATT ROWE: And with that in mind-- here we go, me trying to get an investment angle out of this. With that in mind, how does anybody make sense of current valuation on stocks? I guess from my perspective, to the point of your article, you can be offended. You can be morally challenged with what the government is actually doing. But they're doing things. And our job as money managers is to take advantage of that and to make the best risk-adjusted decision we can. But I think about and I agree largely with what you said about the impairment on growth. But I also consider one of the greatest potentials for a positive equity market is a surprising level of growth. What do you think about equity valuations here? Or does it even matter? JARED DILLIAN: I think they're high. But I don't think it matters a lot. One of the things I learned very early in my career is that the stock market is not the economy, and the economy is not the stock market. And I think that statement is more true now than it ever has been in history. MATT ROWE: I agree with that. JARED DILLIAN: I think that in a Fed-free world, S&P would probably be below 2,000. And I think valuations would be a lot more reasonable, speaking of which, one of the things I wanted to mention was I wanted to talk a little bit about market commentary and how it pertains to this. Because getting back to the original point, people complaining about the Fed, there's a whole genre of financial commentary out there that talks about what the Fed should do. And instead we should be focused on what the Fed will do. And they have a very predictable reaction function. The government operates differently from the private sector. And I worked in the government, so I know this. The government is motivated by different things. They don't have P&L. What the government tries to do at all costs is to avoid being embarrassed. That is the Fed's reaction function. They act in a way so that they try to minimize embarrassment. And if you knew that going into this crisis, you knew that the most embarrassing thing that would have happened to the Fed is if they actually allowed the markets to fail at this particular point in time. So for the Fed buying credit, I think that was fairly easy to predict. And I think you could have made money off of that. MATT ROWE: Yeah. I think about it-- Powell is pretty transparent. And he has spoken about, in very direct terms, that the Fed's position is a short vol position, that they've effectively shorted puts to risk-takers across the market, and that the market has responded accordingly. And there's no reason to think that they're going to do anything different. So people have asked me, well, what do you think about the Fed's reaction, the Fed's action? Is it vol dampening? And the answer is absolutely. Most certainly it is. It doesn't mean that the jump to 0 probability for certain companies, to our earlier conversation, is removed entirely. It's not going to stem insolvency from certain companies. We're even today talking about hurts, potentially filing for bankruptcy and accessing that path. But I think you're right. I think it does. It lops off a significant bit of what I would refer to in the classic trinomial tree analysis of up node, down node, jump to 0. The jump to 0 for the market is effectively not there. It's funny when you're talking about the government, me being raised in a government household as well, that avoiding embarrassment at all costs-- maybe this is why the whole contention between or nasty relationship between the US Postal Service and Amazon exists because Amazon is killing it on doing this and effectively arbitraging the Postal Service right in front of a lot of people's face. And people don't like it. And maybe the biggest difference is retirement benefits and legacy liabilities. But that's a whole 'nother conversation. JARED DILLIAN: I think the best way to understand this-- a light bulb went off for me about a week ago. Somebody mentioned this to me in an email. I've been semi-unsuccessfully trying to short Canadian housing for the last 7 years. It's just been this ongoing saga. And I haven't gotten killed, but hasn't exactly been fun. MATT ROWE: So that's actually-- sorry to interrupt, though. That's amazing because number one, it's a hard thing to short. And number two, it sounds like you have some personal angle why you think that the valuations are ridiculous. What led you to wanting to enter into this? I'm just curious. JARED DILLIAN: Yeah. This was about 2013. And I started reading anecdotes about construction in Toronto and what was going on in Vancouver. And there's a lot of wiseguy US investors that said, OK, we just had a housing crash in the US. The same thing is going to happen in Canada. So this was a very popular short in the hedge fund community. And the thing that I literally just figured out last week is that culturally, Canada is the same with houses as we are with stocks in the US. In the US, we do not allow stocks to fail. It is in our DNA. We support the stock market. And in Canada, their savings are in houses. And the government cannot allow the housing market to fail. So just as pointless as it is to try to short housing in Canada, it's equally pointless to try to short stocks in the US. It's like a cultural thing. MATT ROWE: Yeah. Yeah. And I think you're right. Short alpha in the hedge fund world is something that is very hard to come by because you can be right academically, and you can be right theoretically. But if you don't get the timing perfect, the cost of financing a short or riding against the beta wave has largely made it impossible. It's like the rainbow unicorn to be able to generate short alpha consistently over time. One of the things that we were talking about before the interview on a phone conversation, too, coming back to the idea about General Motors and my experience with GM, I was personally offended by the fact that the US government threw out all bankruptcy precedent with General Motors coming out of '08. And it seemed to me that the reason they did that was because the VEBA at GM was effectively long General Motors stock. And they made a number of tactical errors and a number of managerial errors. But when the story was getting towards its conclusion, it seemed that the real crux of the problem was that General Motors had 250,000 pensioners that, without GM and the VEBA remaining intact, were going to become obligations of the US government. And so they opted to keep the company alive and to prop them up in ways that legal precedent wouldn't have dictated prior to that simply because it was cheaper and easier to keep the pensioners serviced, if you will, by the pension plan of GM. Do you see that system-wide right now, keeping companies intact and functioning supported by the government as a way of managing the population because it becomes a bigger problem if we get a series of failures? Or what do you think-- to your point of Americans loving the stock market like Canadians love housing, what do you think drives the desire to prop things up? JARED DILLIAN: Yeah. There's a whole lot to talk about there. I think we're there-- I think the parallel today with GM in 2008 is the airlines. And I think the airlines are going to have explicit government support for a long time. It's interesting because I was reading this morning that there's a whole bunch of retail investors that are piling into JETS, which is the airline ETF. Apparently Robinhood has gone from 300 accounts with JETS to 20,000 accounts with JETS in a week. And they've had like $480 million of assets go into that ETF. So people are trying to pick a bottom in airlines. I guess what I would say to that is the airlines are going to trade away a significant amount of upside in exchange for this support. And buying airlines at these valuations-- I mean, yeah, the airlines are not going to be allowed to fail. But all the upside is gone. All the upside is absolutely gone. And what happens in times of crisis is that people change the rules. People change the rules in times of crisis. And just like your experience with GM in 2008, this is what bankruptcy law says is supposed to happen. All the rules went out the window. We changed some other rules back then. We banned short selling of financials. So that's just what happens in times of crisis. MATT ROWE: Yeah. And I guess that's the ultimate question, to the point of your article-- is you can be offended. You can be outraged by certain things. And you can write about it. Or you can refuse to participate in the market. But that's futile. So what do you think? What rules do you think are going to get changed now outside of the fed buying high-yield bonds? If we had a crystal ball and we could say, OK, these rules are going to get changed, and that'll make all the difference, do you have any conceptual or specific ideas of what rules you think are going to be changed? If you could tell me first before we put it in the interview, that would be awesome. [LAUGHTER] JARED DILLIAN: I don't know about the federal government. But I can tell you that the Fed has two things left that they haven't done. And they're saving that for when things really get bad. And one is negative interest rates, and one is buying equities. And the Fed has said that they don't want negative interest rates. But they have left it open as a possibility. And everybody says they're against negative interest rates until they're for it. So I think that's a possibility at some point maybe to steepen the yield curve. And the other possibility is buying stocks, which I think if we had-- let's just pretend we had a second wave of infections. Things get worse. We have another lockdown-- a 100% chance we'll retest the lows. And that's probably when you actually have the Fed buying stocks just like the BOJ does in Japan. So those are the two things that I think could happen at some point the future. MATT ROWE: Yeah. It seems like, to your earlier point of the upcoming wave of auctions, that we have-- the classically trained supply-demand thought would be, well, that's a lot. So the yield is going to have to be higher. But the cynic in me is often coming back to, well, whatever the pain trade is probably what's going to happen. So similar to crude oil trading negative recently, wouldn't it just floor everybody if the massive size in the 10-year auction went off at a 0 yield or slightly negative? I don't necessarily think that that's going to happen. But at this point, I guess I'm conditioned to not being surprised by anything. What do you think? For the Real Vision viewers and for myself, what's your take on covering the markets going forward for your newsletter and for the things that you see as being important to pay attention to? I've got a few that I can share in a couple of minutes, too. But I'd be curious to hear what you think the next chapter looks like. What's the summer look like? JARED DILLIAN: I'm actually working on that right now. I'm really good at investing in a crisis. So during the period we just had, I've actually done pretty well. But one of the things I actually-- in my newsletter on Monday, the title was "Out of Ideas." [LAUGHTER] We're kind of in this no man's land where stocks are overvalued, but the Fed is supporting them. The upside is gone for a lot of stocks. But the downside is truncated. So I'm trying to figure out what that next big opportunity is. And honestly, I haven't come up with it yet. MATT ROWE: I would love to see-- to your point of airlines, number one, I think you're right that the upside is constrained. There's been a revolving door for bankruptcy for airlines as long as I can remember. And I often come back conceptually to, what's the difference between keeping a revolving door open for bankruptcy for airlines and Amtrak? Amtrak exists because private entities couldn't run it at a profit. But the government decided it was important enough to the economy and to the infrastructure to maintain it. So it's now run like the Postal Service without concern about profitability. A revolving door in bankruptcy is similar, I guess, from a funding standpoint other than you get equity investors to routinely throw money in it again. And then they get restructured every 7 and 1/2 to 8 years or something like that. But it seems to me that if you're going to give people a put-- just coming back to my volatility strategy and my background, if you're going to give people a put in the form of supporting the equity market, you should demand something in return for it. So the idea of companies issuing warrants to the US government which would cap the upside in exchange for some form of downside protection seems like a logical spread trade. Do you think, even just outside of the airlines, that we'll see other companies issuing warrants again to the taxpayers, to the Treasury, or to the Fed? Do you think that's the type of structure that we're going to see more of? Or do you think that we just see continued support of high yield and equity pricing with no requirement on the upside? JARED DILLIAN: I think that depends on the political environment. I think you're unlikely to see that if Trump is president. You might see that in a different administration. But I will say that one of the things I fear about the airlines-- I've been flying for a long time. I've been flying since I was a little kid, and my parents were divorced. And I used to go back and forth across the country. And in 1981, a plane ticket from New York to LA round trip cost $700 in 1981 dollars. In 2013, it cost $250 in 2013 dollars. So costs were very high in a regulated environment. And then we deregulated the airlines, and prices came down for everybody. And my concern is that we're going to return to previous levels of intervention in air travel. And it's going to get expensive again. We're going to reregulate the airlines. That's my concern. MATT ROWE: Yeah. It seems that way. Anecdotally, the immediate response seems that way. And I think just this morning, Virgin just announced that they're going to no longer fly out of Gatwick, I believe, and that they're cutting 25% of their staff. And United is laying off a number of people and forcing a lot of reduction. So if that's happening in the airline industry, I find it hard conceptually. This is where I get on the verge of. I have a great idea. But will the government actually let it happen? Why wouldn't that happen in energy? Why don't we let the free market take over in energy? Or is the energy industry in the US crucial enough to our independence and to the national identity that we save it? Do you have an opinion on energy as a sector? JARED DILLIAN: Yeah. Once again, I think that depends on the political environment. I think under the Trump administration, energy is considered to be of strategic importance. I think under a different administration, it might be considered to be sort of an ESG problem. So again, I think it's just due to the political environment. MATT ROWE: Interesting. Well, one of the things that I have come back to-- early on in my career, there was a story that went around about an interview question where the question was posed to the potential job candidate. There's a button on your desk. And if you hit that button, a million dollars is going to fall out of the ceiling onto your desk. But a random person somewhere in the world is going to drop dead. Would you push that button? And if so, how many times? And the read through to this was, obviously, how much of a savage is the person sitting in front of you? How do they think about risk and reward? And maybe this is the early days of ESG. And we're really taking a blunt force idea to it. But how do you cross the chasm of what you're writing about here and a big problem for the market of-- there are things that offend us and get to a point where, well, that seems impossible and not likely to happen, versus, well, you might not like it. But it's going to happen anyway. So stop complaining about it or run for Congress. What do you think the most important confluence is of that moral hazard and being offended versus pragmatism and the reality of it? How do you wrap that up and decide what falls on which side of that? JARED DILLIAN: I look at this from a standpoint of-- I actually look at it from a psychological standpoint and things that you can control. And you have to figure out the things that you can control and the things that you can't control. And if you spend a lot of time worrying or stressing about things you can't control, then it's psychologically unhealthy. I see people on Facebook with 500 friends. And they're posting about politics constantly. And it's obvious that they're very upset about what's going on in the country. They're extremely upset. But you just have to say, what is in my power to change? What things can I do? And me personally, I write a newsletter. And I do some other things. I send my newsletter to a few thousand people. And I have the ability to influence their thought process. And that's the extent of my influence. Just like you said, if you don't like it, run for Congress. That's absolutely true. MATT ROWE: Yeah. Well, I think one of the mantras that I was taught early on in my career was, know your risk and get paid for it. And that's actually-- it sounds simplistic. But it's very hard these days, from my perspective. Headwaters Volatility runs long-vol overlays for family offices and institutional investors. And one of the hardest things to do is to know your risk and to decide whether you're being compensated for taking that risk. And to your point of don't do irrational things, if somebody came to you and said, I'd like to buy a put on the S&P struck at 1,500, what would you say? JARED DILLIAN: So if somebody came to me and they wanted to buy a put on the S&P at 1,500? MATT ROWE: Yeah. Would you tell them that they're-- that's ludicrous, that they shouldn't waste their money? Or what do you think the effective strike-- the put spread strikes are for? If you were going to reverse engineer the perfect put spread, where you are long a strike that has some semblance of possibility of getting hit and short a lower strike that would never get touched, what would you guess? JARED DILLIAN: Probably the 22, 2,500 put spread-- 2,200, 2,500 put spread. 22 is the previous lows. You buy the 25's. You sell the 22's. Last I checked, that was trading for around 60 or 70 points, pays off 5 to 1. I think that's the right-- now, that's a hedge. That's absolutely a hedge. But I think that's the right trade. MATT ROWE: Interesting. I would tend to agree with you. I look at it as-- I constantly think about the high-yield market as being a form of a put. Back to the idea of know your risk and get paid for it, most of risk taking is a short-vol trade. So owning equities is technically and theoretically a short-vol trade. Certainly buying a high-yield bond is very similar to selling puts on the same company. You're being compensated for taking a risk on the company. And the worst-case scenario is failure. So I think one of the biggest challenges here in my mind is there aren't many people who are paid to do nothing. And right now, being patient and not getting overextended in either direction seems like the most prudent thing to do. But back to the initial point of the discussion, not many people in our business are compensated for doing nothing. So what do you think the best course of action is, from your perspective? Is the best form of being proactive sitting still and being patient for a little while? Or do you think that if somebody said to you, I have $100 million and I'm 50% invested, would you-- what would you say to them about that? JARED DILLIAN: Well, the second question-- I would try to put somebody in an asset allocation. Again, it depends on your time horizon. But if this is long-term money, I would put you in an asset allocation. That makes sense over a long term. I've thought about this concept that there's not a lot to do right now. And I've actually thought about short-vol trades at this particular point in time. You're kind of getting paid to do it. It's not easy for me to execute on the fancy stuff. But I'm actually considering selling a strangle at this point in time, which is something I never do. But just the fact that I'm considering it, I think, is kind of interesting. MATT ROWE: I think that's right. And people ask me frequently, what do you think of the VIX at 32 versus 40? A VIX of 32-- I tend to turn this into practical terms of, well, what does that really mean? It's sort of a weird barometer, where people don't necessarily often think through. Well, what is that really telling me? And one of the most easy-to-understand, practical touch points is, OK, the VIX looks at roughly 30 days forward implied volatility on the S&P. And it has some sensitivity to put skew and others. But in practical terms, if you look 30 days forward and you say, OK, the VIX is where it is. What are the other conditions of volatility that I can observe, one of them is at-the-money straddle. You have no opinion if the market goes up or down. And you buy both the call and the put at the money. How much does that cost you in dollar terms? And then what type of a move do you need in the S&P to break even? So in sports gambling terms, what's the over-under on the move? And so right now, the over-under on the move for the S&P with the VIX sitting here, going from memory, is roughly 7%, maybe a little bit over 7%. And if I think 30 days forward-- considering what we've been doing in the market routinely here, I have a hard time selling that. I don't necessarily know if the market's going to go up or down 7%. But if I had to take the over or the under on displacement or distribution of the S&P in 30 days, I would bet it's going to move more than 7%. But I'm a long-vol guy. So that's my predisposition, I suppose. I think that's sort of the crux of it. Do you do nothing? Do you hedge? Do you don't bother hedging and remain underinvested? And I think that's probably the biggest challenge for everybody to try to pick through is how to make sense of this and get compensated in the long term. And I will say one thing I hear frequently from people, particularly the large pension schemes around the world, is that the enemy of long-term compounding success is short-term drawdowns. And your point of knowing the time horizon is a crucial one. If you have a decade-plus, you can weather some downturns and stay invested. If you're closing in on retirement, you need that money for bills that are going to need to be paid in the next couple of years, have a different tolerance for taking risk. And I think to me, that's the big moral hazard of the Fed-- is if the policy pushes a bunch of people into risk positions that don't match up with their own time horizon, but they have no other choice, that to me is probably the biggest moral hazard in a lot of this. Well, I think we could talk for hours on this, and we do. And I look forward to continuing the conversation, Jared. Anything else you want to close with before we wrap it up? JARED DILLIAN: No, I don't think so. This is obviously a pretty exciting time. And I'm definitely glad to be talking with you today. It's good to reconnect, so appreciate it. MATT ROWE: Yeah, likewise. Well, look, we have to have something outside of a market contagion or blow-up to bring us back together to share ideas and talk more often. But thanks to Real Vision for having us on. And we'd love to do it again sometime in the future. And maybe in the doldrums of summer when we're trying to figure out how things are going to shape up coming into the next flu season, we'll have reason to get together on TV again. But thanks, Jared. And thanks, Real Vision, for having us on. Be safe, know your risk, and get paid for it. And hedging is not an enemy. But sometimes you should just not own the underlying asset instead of paying to hedge it, I guess, would be my advice. JUSTINE: If you're ready to go beyond the interview, make sure to visit realvision.com where you can try real vision plus for 30 days for just $1. We'll see you next time right here on real vision.