The Korean Levered ETFs Shaking Markets All Around the World

Retail participation in the stock market is booming. And of course the biggest story in markets is the AI trade, which has created an incredible amount of demand for chips and memory. These two broad themes have come together in the form of leveraged, single-stock ETFs. And while these products are popular in the US, the scale coming out of Korea is enormous. It's a good week to talk about this intersection, because some of the biggest stories of the week include Samsung's earnings and SK Hynix's new US listing. Barclays's Global Head of Equities Tactical Strategies Alexander Altmann has used the word “terrifying” to describe the amount of notional exposure coming from these levered ETFs. He explains to us why that is and we talk to him about why, in such a short period of time, the world of levered ETFs has gotten to be so large, with AUM increasing threefold in Asia alone. He also us gets into how he is thinking through risk management and how we as society — and retail investors in particular — got to be overexposed on equities and why that keeps him up at night. Read: SK Hynix’s $26.5 Billion Listing Reopens Asia Route to US Market https://bloom.bg/4f68KA5 Only Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox, plus unlimited access to the site and app. Sign up: bloomberg.com/subscriptions/oddlots https://www.bloomberg.com/subscriptions/oddlots?in_source=oddlotspodcast See omnystudio.com/listener https://omnystudio.com/listener for privacy information.

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• 0:00Tracy Alloway?

  There are some market stories where you want every detail. Joe and I have made quite a few podcasts on that basis. But sometimes you've only got 10 minutes and just want to know what's moving markets fast. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and Research get you up to speed on what's happening and what to watch next. Concise, focused, and brief. Search Barclays Brief wherever you get your podcasts.

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• 2:02Tracy Alloway?

  Hello and welcome to another episode of the All Lots Podcast. I'm Tracy Alloway.

• 2:06Joe Weisenthal?

  And I'm Joe Weisenthal.

• 2:08Tracy Alloway?

  Joe, when I think about the big market events this week.

• 2:11Joe Weisenthal?

  This week, we're recording this July 9th.

• 2:13Tracy Alloway?

  July 9th. Macro doesn't feel like it matters that much anymore. Like, so we had renewed hostilities between Iran and the US. Markets, at least as of Thursday morning, don't seem to care too much. You know, we've had some Fed minutes. They didn't really change things that much. The big stories this week, unusually for the US market, have all stemmed from Korea.

• 2:39Joe Weisenthal?

  Yeah, no, it's true. I mean, look, the chips trade, which then becomes the Korea trade and all of these things, is like the big thing in the entire world. And I agree. I do not think people are going to focus on much of this other stuff. As long as this thing is so crazy and, you know, the Korean market, like, we've just come to get used to this major, you know, pretty big market in the grand scheme of things, moving 5% a day. And we've suddenly all become sort of normalized to it. Yeah, this is the big thing.

• 3:12Tracy Alloway?

  Yeah. So the two big Korea events this week, we had Samsung earnings already. And then today, which means we're recording this podcast either at the best or the worst time because we don't know how things are going to shake out. But we have a US listing from S K Hynix. And the reason Korean stocks are so interesting right now is it's not just that the US market is kind of like playing off of them as well, but it's because you have all these new products in the Korean market, all these things called single-stock levered ETFs, which seem to be having an impact on the overall movement of the underlying shares.

• 3:47Joe Weisenthal?

  It's so funny to me. You look at, again, the performance of some of these chip companies, some of them up like 10x.

• 3:55Tracy Alloway?

  Forty percent is not enough. We need like 86%.

• 3:58Joe Weisenthal?

  You know what? I look at this chart. You know what? The one thing I'm missing is some leverage here. This is always also funny to me when people were like trading crypto on leverage. It's like, what? You're not getting enough? You need like 20x it. But people love it. And so.

• 4:10Tracy Alloway?

  Yeah, but even, here's the thing, even if you personally don't love leverage, leverage has an impact on you.

• 4:16Joe Weisenthal?

  Totally.

• 4:17Tracy Alloway?

  If you're in that market.

• 4:18Joe Weisenthal?

  You may not be interested in leverage, but leverage is interested in you.

• 4:21Tracy Alloway?

  Exactly.

• 4:22Joe Weisenthal?

  One of those guys said.

• 4:23Tracy Alloway?

  All right. So we should talk about all these products. You know, I can't resist a product tail wagging underlying share price dogs. So we really do have the perfect guest. We're going to be speaking with Alex Altman, AKA Alty. He is, of course, the Global Head of Equities Tactical Strategies over at Barclays. So, Alty, Alex, thanks so much for coming on.

• 4:45Speaker 05

  Thank you very much for having me.

• 4:46Tracy Alloway?

  So I believe in one note I read from you, and the reason I wanted to get you on is you specifically use the word terrifying to describe the amount of notional exposure coming from levered ETFs. Can you give us a little bit of context about how big this market actually is now?

• 5:05Speaker 05

  I think that the, well, I'll give you the numbers straight away. And as you highlighted, markets are moving really quickly. So these numbers change a lot every day. And I think at the time when we wrote about that, it was the local highs of the AUM. And it was globally around about $250, $270 billion. The number itself is actually not enormously terrifying at all. I would just say the asymptotic growth of the AUM over the past few months has been somewhat sensational or just, it's just meteoric. So just to put some numbers behind that.

• 5:41Joe Weisenthal?

  Yeah.

• 5:42Speaker 05

  If we look at, say, the Korean market, which you guys highlighted, at the beginning of the year, APAC AUM, so Asia Pacific AUM, was somewhere around about 12 or 13 billion. That's now around about 50.

• 5:54Joe Weisenthal?

  Sorry, just sorry, the AUM within these levered ETFs?

• 5:56Tracy Alloway?

  Of levered products.

• 5:57Speaker 05

  Of levered products in Asia. They are, they are now around about 50 to 55 billion dollars. So talking about a threefold increase or plus over a relatively short period of time. And here in the US, if you take the beginning of April, excuse me, yeah, beginning of April, which was, of course, the local lows for the market, we were talking around about 120-odd billion here in the US. And that's now increased, I think, at its peak. It was north of, just north of 200 billion. So, so these numbers can move extremely quickly. And what's really interesting is that if you look at the US market, it's not like you've actually seen significant inflows and share creation in that space. Most of it of that AUM growth has been because of price performance.

• 6:42Joe Weisenthal?

  Oh, interesting.

• 6:42Speaker 05

  Whereas in Korea, you've actually seen the opposite, not the opposite, but you've seen huge share creation on top of meteoric rises in the share prices as well.

• 6:50Joe Weisenthal?

  That's super interesting.

• 6:51Tracy Alloway?

  But just to be clear, for the Korean products, as the underlying share price goes up, the AUM also tends to go up, right? So that, and then when the underlying goes down, it collapses. And so that's why you get these big spikes in AUM.

• 7:05Speaker 05

  Yes. So I think it's worth just like expanding on the mechanics of it just for a second. So I think that's really important to debunk and why they've become such a relevant product in the market. So if you just take, we just actually put some numbers behind this. Let's say you had one underlier, whatever it was, and it was an AUM of, call it, $30 billion, just to make the numbers simple. And let's say it was triple levered. So now they're going to basically go out and get a load of exposure for another $60 billion. That exposure is typically done through swap agreements, right? So, so they can actually sort of have this synthetic exposure through prime brokerages and so on and so forth. And so now you've got $90 billion exposure. Now, let's say the stock goes down 10%.

• 7:50Speaker 05

  So $90 billion, 10% drop. So that's going to be a $9 billion drop. So you're down to an $81 billion of exposure now. But you've lost $9 billion of your AUM, which was only, remember, 30 billion. So the 30 goes down to 21. And then if you multiply that back by three to maintain your triple-levered exposure, you're going to be at 63, but you've got 81. So you need to reduce down your exposure mechanically by over $10 billion in order to sort of maintain what you've kind of put in your prospectors as of, you know, your, your triple leverage against that underlie. And that's what's creating these mechanical

• 8:31Speaker 05

  adjustments on a daily basis, whether it's down, obviously, on, on down days and then up on up days. So effectively, you're creating a new short gamma dimension in the market that was relatively small only a couple of years ago. And I think really importantly is that there's a lot of dynamics that are moving non-discretionary flows in the market. So obviously, in the ETF world, you've got a lot of overriding ETFs that are doing the opposite. They're effectively selling voluntary to the market, which is creating a long gamma process. And that would typically have netted off against a lot of these levered ETFs. But because these levered ETFs have become so large and they're rebalancing, that now net gamma profile is effectively becoming more negative.

• 9:14Tracy Alloway?

  Yeah, a bigger role in the market.

• 9:16Speaker 05

  Yes, exactly.

• 9:17Joe Weisenthal?

  Can you actually just maybe take a step backwards? Can you just walk us through the basic, I don't know if it's like the business or the simple mechanics of setting up a levered ETF? So I have a company, I want to, okay, I'm a upstart ETF provider. I want to.

• 9:35Tracy Alloway?

  Do the odd lots three times.

• 9:36Joe Weisenthal?

  Yeah, the odd lots, the odd lots three times micron ETF, whatever it is. So it's like, who's providing the leverage? Just talk to us about how this product, you know, it was originally conceived of setting aside market impact and all that stuff for now.

• 9:51Speaker 05

  Sure.

• 9:51Joe Weisenthal?

  How the product works.

• 9:52Speaker 05

  The product, I mean, the product is very straightforward. It's really no different to any other fund provider in the ETF space. So effectively, if you're creating an ETF and you typically go and get some kind of anchor investor or some kind of co-sponsor who's effectively going to create the initial amount of AUM for you. And then obviously, because you need critical mass.

• 10:11Joe Weisenthal?

  Yeah.

• 10:12Speaker 05

  There are, as I'm sure you guys have talked about, there's more ETFs in the world than there are single securities here in the US. So creating the ETF and the fund is not complicated. It all obviously has to go through SEC regulation. And I think that's an important point to highlight when it comes to all these levered ETFs is whatever your opinion on them may be, the fact is, is that the SEC, the regulator, has approved all of these. So in the same way, this, these funds will then get approved. And from there, of course, the question is, where do you get the leverage? So typically, the leverage will come from a banking partner. So through a prime channel that they will effectively seek to get that exposure synthetically through the bank.

• 10:53Speaker 05

  And that in turn, obviously, will effectively create the balance of, of their notional exposure. Now, from a bank's perspective, that goes through the prime balance. And the interesting thing about, about that is, is that.

• 11:09Speaker 05

  Some of market participants have been talking about an increase in financing rates.

• 11:13Joe Weisenthal?

  Yeah.

• 11:13Speaker 05

  That has been driven by

• 11:15Joe Weisenthal?

  Yeah.

• 11:15Speaker 05

  by these levered ETFs. I think we need to debunk that for a hot second.

• 11:18Joe Weisenthal?

  Okay.

• 11:19Speaker 05

  Because I know I've kind of a little bit off topic, but it is still very much.

• 11:22Joe Weisenthal?

  No, I actually had a request recently. Someone wanted us to talk about equity financing costs. So I'm glad you brought that up.

• 11:29Speaker 05

  So it is perhaps a contributor. You have to acknowledge the fact that if you've got north of $200 billion of AUM that has materialized in relatively short order or grown exponentially recently. And you're obviously putting over two times leverage on that. So you're creating additional 400 billion plus of stuff that's been bought and put on balance sheets in swap format. It's going to create a degree of tightness within bank balance sheets. That's not in isolation true. The fact of the matter is, is that bank balance sheets have become tighter because my primary reason is markets have gone up. And as markets gone up, the price of stuff has gone up.

• 12:09Speaker 05

  And so that has been without a doubt, the biggest reason for financing rates rocketing is, is the fact that spot levels are higher. This is, has been a contributing factor, but we shouldn't overlook the fact that if you just look at the biggest driver of AUM growth within the hedge fund community, it's the multi-manager platform. We're talking about those guys are effectively a trillion dollars of AUM now. That's essentially tripled since COVID. And obviously those guys are deploying a huge amount of risk on a long and a short side. So again, that's using balance sheet as well. So it's not really so much just the levered ETFs that are going out and asking the banks for balance sheet that's causing financing rates to squeeze higher. It's a, it's one of many.

• 12:49Joe Weisenthal?

  But balance, but balance sheet capacity is scarce.

• 12:52Speaker 05

  Balance sheet's capacity is scarce and it will remain scarce so long as S and P's trading at 75, 7600.

• 12:59Tracy Alloway?

  Yeah. Well, just on a related note, okay, balance sheet is scarce from the dealers. And it is true that like, if a levered ETF comes to you and says, I have two times leverage. And now I need like $40 billion worth of exposure. You're not going to want to extend like that much credit to a single counterparty if you're a dealer. And so one of the things I've heard in the market is that maybe some of the levered ETFs are going out and sourcing leverage, not just through swaps with dealers, but through the options market. Have you heard this?

• 13:28Speaker 05

  So that, that was documented, I believe in the press as well. And I believe that was specific to one particular fund out in Asia, rather than specifically anything that's happened here in the US. So I think that you can open a bit of a can of worms when you start talking about the availability of this leverage and to certain counterparties. And, and I don't think that's specific necessarily even just to, just to the levered ETF market. I think you can really open that up in, in any counterparty risk. When you think about, does a bank really want to have, so what, you know, bank will be very careful. And Barclays, I would say are pretty conservative and extremely diligent about how they choose their

• 14:11Speaker 05

  counterparties, who they want to, who they want to partner with. And so as a general rule of thumb, you have to always keep that in mind. Just, we're in the, we're in the, we're in the business of risk management at the end of the day. And so yes, this is sort of a, I wouldn't even say a new tool. It's not a new shiny part of the market, but it's, we would treat it exactly the same way as we would any other counterparty.

• 14:48Joe Weisenthal?

  There are some market stories where you want every detail. Tracy and I have made quite a few podcasts on that basis, but sometimes you've only got 10 minutes and need to know what's moving markets and why. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and Research get you up to speed on what matters and what to watch next, about the time it takes to grab a coffee. So search Barclays Brief wherever you get your podcasts.

• 15:13Speaker 01

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• 16:48Joe Weisenthal?

  So you mentioned in the beginning that there's levered single stock ETFs in Korea. There's levered single stock ETFs in the US. The difference is that in Korea, so much more of the AUM growth has come in through new money rather than the underlying asset values going up. So one thing I, I think about the Korean market, people talk about incredible retail interest that probably dwarfs the US on some sort of per capita basis. How does that matter? Does that have implications in terms of the tail wagging the dog, the spillover effect? This fact that there is just a lot of interest in these products beyond just the products going up?

• 17:30Speaker 05

  I think that the retail channel in general is one of the most important dynamics for global equities in the world today, right? Could we make the case that Korea in particular is kind of ground zero for that retail cohort? Probably.

• 17:48Joe Weisenthal?

  Okay.

• 17:49Speaker 05

  You know, so for example, 93% of levered ETFs in Korea are owned by the retail investor. Whereas that number is lower in the US, it's approximately 75%. Still, still high, but, but, but not as high, right? And some may say, well, only 75% of why is it not high? And also I think we should probably just be very clear, like levered ETFs have made retail an awful lot of money.

• 18:14Joe Weisenthal?

  Yeah, yeah.

• 18:14Speaker 05

  Right? So, you know, there are plenty of guys driving around in McLarens.

• 18:17Joe Weisenthal?

  Yeah.

• 18:18Speaker 05

  Because of their returns that they've generated in levered ETFs. So, you know, I think we sort of need to balance out and sort of.

• 18:24Joe Weisenthal?

  No judgment here.

• 18:25Speaker 05

  Yeah.

• 18:25Joe Weisenthal?

  We're just trying to, we're just trying to learn how it works, but I don't judge anyone for making money.

• 18:29Speaker 05

  And on balance, a lot of money has, I actually got asked this morning, you know, have you actually calculated how much money has been made? And I said, no, but on balance, a lot.

• 18:37Joe Weisenthal?

  Quite a bit.

• 18:37Speaker 05

  Yeah, quite a bit. So going back to the, the point on retail, take the US for example, the US, it's a phenomenon of our lifetimes. 34% of US household wealth is now in equities, right? It's the highest on record. It's higher than dot com. I think what's even more amazing about that stat is if you take the next largest component of household wealth in the US is real estate, and that is around about 26%. So the eight percentage point difference between those two sort of assets, so to speak, is also the widest on record. We as a society have never been this over indexed or over exposed to, to equities. And so I think that what you've seen within, say, the levered ETF space is really just another

• 19:20Speaker 05

  small part of that broader ecosystem that has contributed to this enormous wealth creation. And one of the things that we think about a lot as a team, people ask us, what keeps you awake at night? It's not levered ETFs that keep me awake at night. What keeps you awake at night is that you have a structural impairment to equities.

• 19:37Tracy Alloway?

  Yeah.

• 19:37Speaker 05

  That, that effectively no economist on the planet has a cell in their econometric model that says 20% impairment to the S and P that basically destroys, let's just call it around about $16 trillion of wealth. So let's just say that's half of US GDP, right? And that is an instant impairment to US consumption. It's your recession straight out the gate. I don't want to get all sort of bearish or anything, but I think it's just important to highlight. Within the broader context that that retail investors have a huge amount of exposure and therefore in turn, the US government has a huge amount of incentive to try and not do anything too disorderly that could that could completely derail.

• 20:19Speaker 05

  I mean, my, my, my big stat is, is that people used to say the economy is not the stock market or the stock market is not the economy.

• 20:25Tracy Alloway?

  This has been said many times on the podcast.

• 20:27Speaker 05

  Yeah, I just think the stock market is the economy now.

• 20:29Joe Weisenthal?

  Yeah.

• 20:29Speaker 05

  Not in the traditional sense of like, oh, the stock market is going up, therefore the economy is doing great.

• 20:33Joe Weisenthal?

  No, yeah, yeah.

• 20:34Speaker 05

  Yeah, a 20% impairment to the stock market is kind of, I think, it will trigger a meaningful downturn in US consumption.

• 20:40Tracy Alloway?

  The thing that worries me now is it's not just the stock market is the economy. It's like AI is the stock market and therefore AI is the economy as well. Like, we know it's been driving not just macro growth, but if it's also driving stocks and we're getting a wealth effect and it's also driving consumption, then, I don't know, it's like an AI impact squared.

• 20:59Speaker 05

  Right, and look, again, just to talk about facts, the bulk of levered ETF AUM has grown within that cohort as well. The largest AUMs are all within either NASDAQ rated products or semis, conductors or single names, most of which are, I mean, the largest, the largest single name levered ETF in the US is Micron, right? So that kind of tells you the largest, largest single name levered ETF in the world is, is Heinecks. So these dynamics do play an important role and especially when you start thinking about tail wagging the dog and price dictates narrative, right? So people see prices going up, that gives them a confirmation bias about, oh, that means we, maybe we can spend more money on capex or that means that the AI story is alive and well.

• 21:42Speaker 05

  And that's not necessarily not true, but how much of that is getting distorted by these sort of these non discretionary flows that are pushing prices up or indeed down?

• 21:51Tracy Alloway?

  Or just general momentum, right? Like momentum attracting more flows.

• 21:54Speaker 05

  Correct. I mean, let's face it, momentum is the

• 21:57Tracy Alloway?

  Everything.

• 21:58Speaker 05

  It's, it's the most successful factor, strategy in history, right? You know, S and P goes up 78% of the time, therefore by definition, investors generally want to be long momentum. They want to be long stuff that goes up and they want to be short the stuff that goes down if they do indeed short.

• 22:13Joe Weisenthal?

  The MUU, the triple levered, I think it's triple levered, whatever it is, that was trading at 23 a year ago and it recently hit a peak of over 1,200. So that'll get you a lot of McLarens, won't it?

• 22:25Speaker 05

  Oh, yeah, look, I mean, again, this is the thing for, as a team, our main mantra

• 22:29Joe Weisenthal?

  Oh, sorry, it's 2X, it's a 2X ETF.

• 22:31Speaker 05

  It's a 2X ETF, but that's, that's okay.

• 22:33Joe Weisenthal?

  But actually, can I ask you a question about this? So you mentioned that all of these products, like they go through the regulatory process and, you know, we have the SEC, I don't know what Korea's equivalent is, but I assume they have some sort of similar body. What is like the SEC's bar? Is it just like?

• 22:50Tracy Alloway?

  They have a hundred times levered ETF.

• 22:52Joe Weisenthal?

  Yeah, like what is, like, what, no, seriously, or like, you know, 10X, like, what is the point? Is it just like, okay, this checks a certain set of boxes? Cause clearly it's not about like, I doubt it should be, you know, it's like, oh, is this product good or bad, right? That's not really the question. Does this product meet a criteria or doesn't? What is the criteria and why don't we have 10X ETF?

• 23:12Speaker 05

  So there's actually an anecdote. There was a time, if I'm not mistaken, relatively recently during the government shutdown, where there was an attempt to try and list and shelf some, I don't think it was 10X, but there was, I believe, some 5X levered ETFs. And effectively the regulator, I believe at that point, just kind of made it abundantly clear that, that there are limitations to, to leverage just from a, to your beginning point, you know, you may not be interested in leverage.

• 23:43Joe Weisenthal?

  Yeah.

• 23:43Speaker 05

  Leverage is probably interested in you.

• 23:45Joe Weisenthal?

  Yeah.

• 23:45Speaker 05

  And again, I'm not privy to those conversations in any way, shape or form, but I, I do know and understand that there are limitations to what a regulator would deem acceptable.

• 23:55Joe Weisenthal?

  Okay.

• 23:56Speaker 05

  From a leverage perspective, quite reasonably as well.

• 23:59Joe Weisenthal?

  Sure.

• 24:00Tracy Alloway?

  Just going back to the momentum trade more broadly, so Barclays, you have this index product, I can't remember the exact name, but it's like the market timing product.

• 24:10Speaker 05

  Betty, yeah, Betty. Barclays Equity Timing Indicator.

• 24:13Tracy Alloway?

  Yeah, and that has been like in, I don't know if, if you use the specific term overbought, but like, it's basically been in sort of bubbly, speculative territory for some time now, like a record amount of time, right?

• 24:26Speaker 05

  Yep, that's right, yeah.

• 24:27Tracy Alloway?

  Okay. What should investors do with this information?

• 24:31Speaker 05

  Sure.

• 24:31Tracy Alloway?

  Cause I feel like all the surveys right now show everyone's super bullish, everyone thinks stocks are overvalued and it's like, so what? If the trade is momentum, then you just keep going.

• 24:39Speaker 05

  Yeah, so, so Betty, yeah, we love Betty. So this index was created shortly after I joined Barclays, but it was, the first iteration was created back in 2018. So there's, there's a reasonable amount of out of sample data around this framework. It's got 19 inputs, none of those inputs, we have a mantra on my team, I tell everyone this in my team every week, which is if you can't quantify, you don't have the right to talk about it and using the word feels and seams are banned. If you use the word feels and seams, you're fired.

• 25:07Tracy Alloway?

  I think we'd be in trouble, Joe.

• 25:09Joe Weisenthal?

  Yeah, but it's a good rule.

• 25:10Speaker 05

  It's, it's, but the, the idea is it's a very simple rule, which is we just want to try and really deep root the team in quantifiable data, right? You know, and just to take a step back, when Scott and Ronnie, who run the equity business, when they sort of effectively were hired into Barclays to kind of really revamp as an ascendant equity business, one of their main priorities was like, we need content at the center of the mind share in order to sort of like really partner and hold hands with our clients. And so that's when they brought me in and because we wanted to focus on quantifiable content as opposed to it. So that's the backstory as to why Betty was created, because we wanted to have a market timing model that removed feels and seams.

• 25:51Speaker 05

  And, and, and so it's got 19 inputs, it's got everything ranging from real yields to spot vol correlation to looking at discretionary flows, like what are mutual fund beaters? What are hedge fund beaters? What are CTA's doing? What are vol control doing? What are levered ETFs doing? What, so everything from the discretionary and non discretionary vertical, from the vol vertical, from the, from positioning, we just, the only thing we didn't include was sentiment indicators. We weren't interested in feels and seams, so we, there's no AI bull bear index or anything like that. And so your question was, it's been in this record sort of warning territory now. Yes, it has been in record warning territory and effectively that's been driven by primarily momentum crowding. Now, as you know, at the time of recording, we had a big momentum pullback over the past

• 26:36Speaker 05

  couple of weeks. So that's actually sort of been a relatively healthy and reselling that. Real yields, problematic. If you're competing for capital at the same time as the, between the equity market, obviously record year for issuance possibly this year, government going to be record year of issuance, IG, record year of issuance.

• 26:54Tracy Alloway?

  Yeah, this is the other big market story is like a blockbuster summer for IG bond issuance.

• 26:59Speaker 05

  Absolutely. So if you think about what real yields effectively represent, that dynamic of that competition of capital versus equities, if you just generally look at where real yields are today in say a post GFC environment or a post COVID environment and benchmark it against where equity multiples are, equity multiples shouldn't be this high, right? So we can get into a bigger debate about, oh, dot com, real yields were very high and equity multiples skyrocketed. I'm like, yeah, but the government wasn't asking you cap in hand for tons of money.

• 27:29Joe Weisenthal?

  So that didn't end great.

• 27:31Speaker 05

  Yes, but, but, but hell of a ride it was in the build up to that. So, but, so Betty effectively is taking all of these inputs and what is it telling you right now? It's just telling you that the forward return profile of the S and P from an asymmetry perspective on a tactical two month time horizon is just not great right now. We're looking at, if you were to pick a random day in time and say, all right, I'm going to buy the S and P and I'll hold it for two months, 42 trading days, the average return would be around about 190 bips, not bad, right? And your hit rate of making money is about 73%. So Betty, when it is in this kind of territory, so six, seven, it was high as sort of 10 or 11, it was telling you that you only had around about a 35% chance or even lower of

• 28:14Speaker 05

  making money in the S and P over that same time horizon and your average return was basically negative. So it's not so much necessarily that it's telling you, oh my gosh, the market's going to crater. It's really just an illustration of a bunch of quantitative inputs that are telling you, actually the asymmetry is not great. And that's exactly what we've seen. The model first flashed as a warning signal late May. S and P's kind of gone enough, done nothing since then. And so maybe in anticipation of some big correction in the equity market isn't forthcoming and that's okay. I still take a lot of validation in the model that is kind of telling you that to just sort of pump the brakes a bit, let some of this froth in the equity market come out and actually get a reset, which then actually sets us up better. I mean, ultimately earnings are still good, right?

• 28:59Speaker 05

  We're still driving AI in the economy and we can get into a debate about whether that's sustainable or not. And then we've also got to, you know, work off the assumption, we're still running a massive fiscal deficit and whilst that environment is happening, it's quite hard to create any kind of fundamental economic downturn.

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• 31:36Joe Weisenthal?

  Setting aside market timing and what's going to happen in the next two or three months, et cetera, just on the sort of like bigger question, the combination of market valuations, however you want to measure them, all the classical ratios that people like versus the increase in real yields. Like, how historically expensive is this market right now?

• 32:00Speaker 05

  All right, so if we take the post-GFC environment, the challenge is always going to be that S and P margins were much lower for a long period after the GFC than where they are today.

• 32:14Joe Weisenthal?

  Okay.

• 32:14Speaker 05

  And we have to acknowledge that higher margins should map into higher multiples. So, but we'll do the full comparison. So post-GFC, because there's not that many periods where real yields are this high. Real yields today on a 10-year basis are running about the 95th percentile. And they're around about, I think, 230, give or take. So with that being said, if you take what the average S and P multiple when real yields were this high or higher, it's a scary low number. The S and P multiple would be around about 14 to 15 times. And we're currently trading on around about 20.2, 20.3. If you take the post-COVID environment, which I think is probably a better representation of what S and P operating margins look like today, we're still low. It's around about 18 and a half times.

• 32:59Speaker 05

  So you're still talking about basically a 10% multiple contraction versus where the...

• 33:07Joe Weisenthal?

  Just a very simple question. Why are margins a more important factor here than expected growth or expected earnings growth? I mean, like, in my mind, I would pay higher multiples because I think that the earnings are going to have a faster growth rate than they used to have. That seems intuitive to me. Why is margins the lever here that we're looking at?

• 33:27Speaker 05

  It's a good question. Well, it's not exclusively just margins. You can sort of measure it as ROE as well. You know, there's, there's different ways you can do it. But effectively, businesses are becoming more profitable. If it's a more profitable business, it's going to be working off the assumption, to a degree, it may not necessarily be accurate, but that effectively that has a bigger moat. It's more, it's a more

• 33:47Joe Weisenthal?

  All right.

• 33:48Speaker 05

  high-quality business, and therefore you'll put that on a higher premium, so to speak.

• 33:53Tracy Alloway?

  Can I ask a slightly personal question? Which is, I used to joke that I wanted to be reincarnated as an equity derivative strategist because then I could just find a number to like justify anything that's happening in markets. But does it feel like people take you more seriously now versus, say, 20 years ago when people were still talking about like fundamentals and stocks? Now you have this environment where flows are super important. You have all these mechanical things happening. You have the multi-strats, as you pointed out, vol targeting, CTA's, all of this stuff is getting bigger. Does it feel like equity derivatives are more important now?

• 34:29Speaker 05

  Oh, I thought you were going to say, well, it's my British accent that makes me sound more, more...

• 34:33Tracy Alloway?

  Well, that too.

• 34:33Speaker 05

  People take me more seriously because I'm, because I'm...

• 34:35Tracy Alloway?

  I will say, we get higher listenership on episodes when our guests have a British accent.

• 34:40Joe Weisenthal?

  It's crazy because like, everyone knows how much Americans love a British accent. But what's annoying is the Brits know it too and exploit that. Like, you're not just like, you like, know, like, you know what you're doing.

• 34:50Speaker 05

  It's a reason why I stayed here for 10 years. Married in America, you know, living, living the American dream. Sorry.

• 34:56Joe Weisenthal?

  You know what you're doing.

• 34:57Speaker 05

  I'll, I'll get, I'll get back to the, the actual question at hand. So is there increased validation from having a more quantifiable world that we operate in? Yes, but, but on a person, if you're asking a personal question, I don't think that's a personal question. If I was to give a personal answer, my career wasn't always like that. I started my career as a fundamental single stock analyst. And I actually started my career actually as a generalist sales on at JP Morgan in 2004. But I then became a general, generalist analyst, so to speak, on the buy side. And I did that within the venture-driven world for several years. And then when I went to the, back to the sell side, I had to pivot. I had to change my investment approach because of the

• 35:42Speaker 05

  fact that the industry was becoming increasingly specialized.

• 35:45Tracy Alloway?

  Yeah.

• 35:46Speaker 05

  And as a generalist, I was struggling to make an impact on clients that were becoming much more sophisticated in the weeds on their particular sectors and areas of granularity that I just couldn't compete with. And so at the time, I was working at Citi and Citi has a very good, had a very good quant business. And I was like, what's all this quant and factor stuff? What is all that? And I genuinely didn't know. And this is 2012, to be clear, 2013. And so I took on a personal crusade to understand the post-mortem of my portfolio management experience prior, understanding why was my P and L doing certain things, which I didn't understand at the time. And as it turned out, I was just a value investor.

• 36:29Speaker 05

  But the concept of being a value investor, other than sort of the Ben Graham or Warren Buffett model, was a bit, as in value from a factor perspective. Now it's ubiquitous, which is sort of 14 years ago. But back then, it was really novel

• 36:42Tracy Alloway?

  Yeah.

• 36:42Speaker 05

  that you were going to customers, discretionary customers, generalists or, or just long, short guys who weren't quant guys, and explaining to them this quant phenomenon in layman parlance, basically. And that was the start of a pivot into a much more sort of quanti derivative-y knowledge experiment. And it just ballooned from there.

• 37:02Tracy Alloway?

  Yeah, this is kind of what I'm getting at, right? Like, it has become more important in the market. I remember, speaking of 2012, do you remember, Joe, the headlines where like people would talk about CTA flows or something like that?

• 37:14Joe Weisenthal?

  Oh, yeah, of course.

• 37:14Tracy Alloway?

  And it would be like a mysterious force

• 37:16Joe Weisenthal?

  Yeah, yeah, yeah.

• 37:17Tracy Alloway?

  in markets. Now everyone knows what CTA is.

• 37:18Joe Weisenthal?

  Now that's what it's become. Yeah, and it's interesting to think too, like, if you, if I just think in my mind about one of these platform shops, multi-strategy, whatever, the understanding of the, of, you know, the companies that they, that pod invests in, like they must, on the buy side, must be orders of magnitude greater than it was in the sort of heyday of like the sell side analysts who would like, oh, we're going to issue a buy rating on GE or Nova or whatever, like that. Those, those investors know GE, that company insanely well.

• 37:52Speaker 05

  Oh, totally. And look, to put some anecdote around that, Barclays as a bank, as an equity business, as a research house, again, ascendant equity business, we've been working really hard over the past three years to sort of hold our clients' hands and make them aware that we are a really prime and tier one equity franchise. A lot of that is about corporate access, right? So actually having more research coverage and having more access to more companies, which in turn we can roadshow and actually give our customers access to those companies because it is that important to them. To your point, exactly, Joe, like they, they have so much granularity and detail in their forensic modeling now that if you're a generalist, it's very, very hard to compete on, on such a granular level.

• 38:36Speaker 05

  So yes, I pivoted away completely and focused on, the different mantra was, if you think about the verticals of equity investment, the way I see it is that you've got fundamentals, which is obviously what we talked about. You've got economics, you've got cross-asset/macro. You've got quant, which I would include factors. You've got derivatives. You've got positioning, right? And then you've probably got some other stuff as well. But my, my view is, the way that I, I run the tactical strategies team is that we don't need to be a 10 out of 10 in all of these. I'd love to be, but it's just, I just don't think it's possible. In a world of AI, we can obviously augment some of our game in certain verticals. But the aim of, of our game is if we can be like a seven

• 39:20Speaker 05

  or an eight in all of these, and some of them we, we know will be less and some of them will be more. Some of them will be in nines or tens and others will be like fives or sixes. It basically means that what we can do is we can go into any customer, any client, any investor and say, hey, there's something about the market that I'm sure I can help you on that you're not as aware of. And that's where I think that the evolution of that kind of education, investor education has come to now, rather than just focusing on just one vertical.

• 39:49Tracy Alloway?

  Yeah, I, I don't mean to get all media navel gazy here, but I think we are seeing, seeing a similar story in media where like the niche subject matter experts are becoming much more important, much more popular versus the sort of generalized news platforms.

• 40:05Speaker 05

  I think that-

• 40:06Tracy Alloway?

  You don't have to comment on that, by the way.

• 40:07Speaker 05

  No, but it does parlay back into the world of finance and the world of AI. Because in the world of AI, everyone can have an army of quants in their pockets now of questionable accuracy. But the point is, you can crunch orders of magnitude more data. So where's the real value? I'm a big believer that the value, I see it kind of, think about it as knowledge and wisdom. Right? Everyone can now have access, infinite knowledge. But it doesn't necessarily mean-

• 40:34Joe Weisenthal?

  Yeah.

• 40:35Speaker 05

  -that they've got wisdom. I mean, the old saying is, is that knowledge is knowing that tomato is a fruit. But wisdom is knowing that-

• 40:41Joe Weisenthal?

  You know, this came up on another episode. And by the way, Tracy, I just want to say, I meant to send you this. I saw someone with one of these viral Froyo places that are like-

• 40:51Tracy Alloway?

  No.

• 40:52Joe Weisenthal?

  They put little cherry tomatoes.

• 40:54Tracy Alloway?

  Actually, that could be good.

• 40:55Joe Weisenthal?

  Yeah, that's what I'm saying. Tomato is a fruit in the, in it-

• 40:58Tracy Alloway?

  Not to get wildly off topic, but my tomatoes so far this year are freaking amazing.

• 41:03Joe Weisenthal?

  Yeah.

• 41:04Tracy Alloway?

  And come later this month, in August, you're gonna have like-

• 41:07Joe Weisenthal?

  No, this is my take, actually. I love the, the saying, knowledge, wisdom, tomatoes, et cetera. But I actually think some tomatoes actually do make a cut to make it into a fruit salad. This is my only point. But I understand, I understand the point.

• 41:20Speaker 05

  Yeah. And so I think it's the same when it comes to sort of data and the world of finance. Yeah, you can be incredibly granular and specialized, but sometimes you're gonna miss the forest for the trees.

• 41:29Joe Weisenthal?

  Can I just ask not to turn this into just another AI conversation? But you must actually have some insight on the question. On some of these things, let's say like you wanna construct an index or some new thing. Like, how good are the models right now at like really reliably being able to do quantitative work? I know it's like you can get a lot of the way there and even someone like me can like hack together or something. But like to the standards that you have, like, how much do they still like? No, this is not, nowhere near something that I would like then be ready to turn into a chart and send to a client.

• 42:07Speaker 05

  Yeah, I think that's a great question because we're doing that all the time. So, you know, we'll have a customer come in and let's say they've got a particular security, a single name item. They wanna hedge that item and they wanna hedge it with a basket, right? That's, that's one of our most common kind of business-

• 42:24Joe Weisenthal?

  Yep.

• 42:24Speaker 05

  -problems that we face off with. And so we need to build a universe of securities that effectively replicates that particular instrument without using that instrument, of course. And as a consequence of that, we're effectively running a, what is essentially a giant pairwise correlation model. And then we've got to optimize the inputs depending on what individual correlations against that underlying instrument are. It's relatively straightforward if you've got a really cool optimizer. If you ask AI to do it, what it's okay at is selecting what instruments you should. So let's say you're like, I need, all right, this is a household consumer product. Actually, you know what? Let's do it in AI, let's make it more new economy. So we've got, all right, we've got a particular AI vertical. Let's say it's a NeoCloud.

• 43:09Speaker 05

  All right, we need to hedge that NeoCloud with something else. All right, so AI is quite good at selecting, let's go and get all the other NeoClouds that are listed. And then let's find a whole bunch of other companies that most of which you'll be aware of, maybe some you're not aware of, that actually have a reasonably high correlation to that instrument that you're trying to hedge. That's kind of where it ends. It's not very good at telling you, all right, what about the liquidity considerations?

• 43:35Joe Weisenthal?

  But it can roughly sort of determine the first, the ingredients, right? Like you're making, Emmanuel Derman in his book talked about like the job of the trade, it's make a- It's, we were going back to the fruit salad question. But you have a bunch of wholesale fruit and then you slice it up in a certain way. It could, it can identify the ingredients and then it's your job to figure out the optimal, like, you can't do the proper slicing and allocation.

• 43:58Speaker 05

  Exactly. So it's, it's, yeah, it's pretty good at, it's pretty good at identifying what my universe is meant to look like.

• 44:04Joe Weisenthal?

  Cause I get the, sometimes I see these notes and I have never tried this, but like from, I don't know, somehow I get, I got on like JP Morgan's like trading desk thing. And they're like, oh, buy that, we think it's time to go long this basket of, you know, energy related companies and short this basket of like whatever it is. And I've been curious, I've never tried it, it's like, could I get a model to like back out what these ingredients are? If, if I gave the model a line and a theme?

• 44:30Speaker 05

  Yeah, so again, I would, I mean, get this real credit to Barclays, just in terms of, we've been pretty leading edge in experimenting and adopting as much AI as we can. And so we have Copilot, we've got Claude licenses, we are, we're working with other, other partners to sort of build in-house stuff, either using external models or our own internal models. But the point being is, is that we've had plenty of time to operate in the sandbox now. And I'd say where AI is without a doubt most powerful is when you're giving it very identifiable data parameters.

• 45:06Joe Weisenthal?

  Okay.

• 45:07Speaker 05

  Right? So whether it's structured or unstructured data and say, hey, I need to try and figure out whatever my parameters are. That's the data. Where it's still less good is if you're basically giving it unstructured parameters to say, just can you think about an ethereal topic and sort of come back to me with an answer? And it will come back with a pretty comprehensive answer. But most of the time it needs to be fact-checked and or annotated or just tested and scrutinized.

• 45:37Tracy Alloway?

  Joe, you've successfully turned this into another AI conversation.

• 45:41Joe Weisenthal?

  Well, how can you talk about quantitative identi-, you know, how can you talk about this?

• 45:45Tracy Alloway?

  Yeah, we were doing pretty good for 40 minutes, so. All right, Alex, thank you so much for coming on Odd Lots, really appreciate it. Truly the perfect guest.

• 45:53Speaker 05

  Thank you so much.

• 46:07Tracy Alloway?

  So Joe, that was a fantastic conversation. Couple of things stand out. So first of all, it does seem like with the growth of all these products, the explosion, especially in Asia, that we, we have products who are sort of like more important marginal buyers and sellers-

• 46:23Joe Weisenthal?

  Yeah.

• 46:23Tracy Alloway?

  -in the market at a minimum. The other thing I was thinking about is like, okay, a regulator isn't necessarily gonna approve a five times levered product or a hundred times levered product. But is there a point at which like the aggregate number of all these products actually becomes more of a concern?

• 46:42Joe Weisenthal?

  Totally. I mean, there's two things. One, you have to take seriously like where we are in terms of balance sheet capacity and how much balance sheet is being allocated to this leverage and what happens to bank balance sheets in the event of like some major downturn. And then I thought like the, just the idea of like, I had not realized how big that gap has grown between household equity exposure- and household real estate exposure. I still feel like that's probably like a pretty, at least to me, like a pretty eye-opening stat because they're just, I know there's a lot of equity exposure and it's become important and no one needs to like argue with me, it's like the stock market is the economy.

• 47:23Joe Weisenthal?

  But in my mind, I'm like, oh, it's still like real estate is the core of like people's holdings. And not only is it not the core, at least in the aggregate, I'm sure the median household is still way more exposed to their house than the stock market. But in overall, it's pretty staggering how much we're a-

• 47:39Tracy Alloway?

  And then you start wondering-

• 47:40Joe Weisenthal?

  -geared to the stock market.

• 47:42Tracy Alloway?

  Geared to the stock market? How much of the stock market is now geared towards leverage? And then how much of it is also geared towards AI? It's, yeah, it's a lot.

• 47:50Joe Weisenthal?

  No, it's a lot. And he really spelled it out well.

• 47:52Tracy Alloway?

  Yeah, we have to have him back on.

• 47:54Joe Weisenthal?

  Definitely.

• 47:54Tracy Alloway?

  Shall we leave it there for now?

• 47:55Joe Weisenthal?

  Yeah, let's leave it there.

• 47:56Tracy Alloway?

  This has been another episode of the Odd Lots Podcast. I'm Tracy Alloway, you can follow me at Tracy Alloway.

• 48:02Joe Weisenthal?

  And I'm Joe Weisenthal, you can follow me at TheStewart. Follow our producers, Carmen Rodriguez at Carmen Armin, Dashil Bennett at Dashbot, Kale Brooks at Kale Brooks, and Kevin Lozano at Kevin Lloyd Lozano. And for more Odd Lots content, go to Bloomberg.com/oddlots, we have a daily newsletter and all of our episodes. And you could chat about all of these topics 24/7 in our Discord, discord.gg/oddlots.

• 48:26Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we talk about single stock levered ETFs, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

• 49:18Speaker 08

  If you enjoy Bloomberg podcasts, you'll love listening to Bloomberg 991 FM in the DMV. Hi, this is Joe Matthew. Here in the DC area, the story is always changing. From the White House, Capitol Hill, to K Street, Wall Street, and the Fed, Bloomberg 991 keeps you connected to the news that's driving decisions in the nation's capital and around the globe. Check us out at 991 FM or stream us anytime on the Bloomberg Business app.