Structural Flows Will Support Stocks Until the U.S. Treasury Crisis in 2027 | Cem Karsan & Noel Smith | Kai Asset Management

Invesco QQQ Trust (Nasdaq-100 ETF)

Across the shows: 4 speakers in other episodes, 2 bullish and 1 bearish calls, past 30 days

• Noel Smith · Kai Volatility AdvisorsBearish

  Higher rates favor value over growth, so QQQ should underperform SPY on a relative basis.

  Smith restates Cem's view that higher interest rates punish duration. He says growth stocks need cash flow to pay ongoing bills, and value stocks that generate cash flow now will outperform on a risk-adjusted basis. He frames this as a relative-value trade: short QQQ, which is growth-heavy, against long SPY, which holds more value. He says this is only partly a joke, so the view is less firm than a fully argued position.

  “That's why I gave my smart aleck answer, which is short Qs, long SPY as a relative value trade.”at 41:31

Market sentiment, positioning & volatility

• Cem Karsan · Kai Volatility Advisors

  Index-level volatility compression from structured-product flows is massive and is propping up the index.

  Cem argues the amount of volatility compression at the index level is enormous. The main driver is structured products, whose growth has been 100% year over year for four years. Flows of this kind are very hard to break, and he says it would take a lot of negative macro headwinds to do so. Those headwinds are only starting to show.

  “The amount of flows of [vol] compression that exists at the index level is tremendous. The growth of structured products, which is the primary driver of that [vol] compression, has been a 100% year over year now for four years. It is something that's very hard to break.”at 1:54

• Cem Karsan · Kai Volatility Advisors

  Single-stock dispersion is at historic extremes and could itself break, forcing volatility under the hood.

  Compressing volatility at the index level pushes individual stocks away from each other, creating historic dispersion. Cem says dispersion has reached an extreme level beyond an already high baseline. He argues that extreme level can itself break, and that idiosyncratic moves will push volatility higher underneath the index.

  “It has created historic, really historic dispersion. We've reached a higher dispersion level in general, but even from there, we've gone to a really extreme level. And my opinion is at some point that itself can break.”at 2:42

• Cem Karsan · Kai Volatility Advisors

  Index has a very fat left tail; a crash needs a continuation move within days, currently unlikely.

  Cem says the index is pinned by flows and that the left tail is very fat, like tectonic plates building pressure. A single move big enough to trigger gamma effects is needed to activate that tail. Yesterday's move was not big enough, and it needed to continue in the next several days. Because dealers had already managed the move and people had rebalanced, he calls a tail activation low probability, even lower than the previous day.

  “I cannot emphasize this enough. The tail on this market is tremendous. ...if we had woken up this morning the market was down two, it would have been down probably five.”at 6:16

• Noel Smith · Kai Volatility Advisors

  Buying volatility at current prices is a terrible trade; he sold most of his hedges.

  Noel sold some VIX options from inventory after the volatility spike. He says the current prices are not ones at which he wants to buy volatility. He monetized most of the hedges he had been carrying, which had more than paid for themselves. He would not put them back on unless forced or unless the setup became much more favourable. He acknowledges that the VIX could go much higher, so this is judgment rather than certainty.

  “These prices are definitely not a price that I want to be buying volatility.”at 7:35

• Cem Karsan · Kai Volatility Advisors

  Likeliest macro catalyst is year-end into early next year; stay long convexity for now.

  Cem says the highest-probability timing for the macro catalyst that could unlock the fat tail is the end of the year and early next year. Until then, he and his team want to be long convexity. Later, as the options expiry window passes and the flow support fades, they want to add exposure to implied volatility more broadly. The December options open interest is large and the December expiry will be very big, so flows matter in the meantime.

  “those things I'm telling you are highest probability comes at the end of the year and into early next year. Okay. So we really want to be long convexity here, but also looking for opportunities to go more along vol broadly.”at 10:55

• Cem Karsan · Kai Volatility Advisors

  Very high index skew has preceded major declines about six months later, three times in a decade.

  Cem says index skew has been this high only three times in about ten years: late 2019, mid-2021 and now. Each time it preceded a major decline by about six months, with the skew marking the start of the decline rather than a day or week before it. He links this to reflexive hedging by institutions that worry for good reason. He also argues downside protection is overpriced relative to realized moves, so the premium is a carry trade that is one-sided and leaves a fat tail.

  “We see very high skew in the last call it ten years. We've had three periods of skew that have been this high, three... They all preceded, then let's say six months, a decline, the beginning of a major decline.”at 11:28

• Noel Smith · Kai Volatility Advisors

  Call flies and spreads give better asymmetry than buying outright calls in this volatility regime.

  Noel says call spreads and call flies are superior to buying deltas or outright calls on the index or ETFs. Buying calls at around 32 vol loses money if the market rises only 60 basis points, because implied vol falls. Structuring the position with a fly gives asymmetry, so the team wants to make more than it loses in any scenario. He says this is what Kai is looking at doing.

  “I think call spreads, call flies... is a superior trade than just closing your eyes and buying Deltas... So there are ways that you can structure the vol into your favor so that you have asymmetry.”at 20:06

• Noel Smith · Kai Volatility Advisors

  Market unlikely to bounce straight back; vol-control signals stay in-sample for about a month.

  Noel argues that a sharp fall in a volatility-control strategy's signals creates mechanical selling. Those signals will remain in the sample for roughly twenty more days, so they will not return robustly for about a month. Hedge-fund deleveraging and redemptions are transitory. He says this is structural rather than opinion, so a full rebound to Monday's levels does not seem likely.

  “So the idea that we bounce back, you know, right back to where everything was on Monday, man, I'm very circumspect of something like that. That just does not seem likely to me.”at 21:36

• Noel Smith · Kai Volatility Advisors

  Clustered expiries and events in Nov-Dec will clear options positioning and open a volatility window.

  Smith points to a dense calendar: Nvidia earnings, VIX expiration, November opex, the December 9 Fed decision and December opex. He argues that these events will clear options from the board and free up trading afterwards, opening a window for volatility. Kai plans to take advantage of this asymmetrically with options structures, while acknowledging that timing the exit is hard.

  “All of those things are going to take a lot of options and just kind of wipe them off the board. And what that means is that all the activity that can commence more freely afterwards does open up a window of opportunity for volatility.”at 54:54

US stock market outlook

• Cem Karsan · Kai Volatility Advisors

  Weak market areas keep weakening as new leadership emerges; the index could stay pinned into year-end.

  Cem expects dispersion to continue, with what is weak getting worse while other areas start to lead. He says the market can flip between tech and other sectors, as it did in the summer, though a full flip is less likely. He points to 2000, when the Nasdaq fell 50% while the S&P 500 fell only 15% and half of the market rose 20 to 30%, as an example of how much rotation can occur under a pinned index. He expects the stress to continue through year-end even if the index holds up.

  “And if anything, would argue that's probably going to continue with the what's weak, continuing to get worse while you start to see other leadership.”at 31:02

• Noel Smith · Kai Volatility Advisors

  Rotation is real: healthcare and homebuilders are holding up while tech looks stretched.

  Noel argues that things can move under the surface even when the index is pinned. He points to healthcare and homebuilders doing fine, skew dynamics in gold, and utilities as not especially expensive relative to tech, which is well above them. He says the dispersion amplifies this under-the-hood activity, with macro reasons helping drive it.

  “Look at healthcare, you know, it's been doing fine. Look at home builders doing fine... Utilities, they're not that expensive. Relative to tech, they're on the moon.”at 31:45

• Cem Karsan · Kai Volatility Advisors

  Value will outperform growth for twenty years if the populist policy wave unlocks.

  Cem notes that growth has outperformed for about 40 years under supply-side economics, with interest rates cut from 20% to zero and every crisis met with easing. He says the 2000 to 2006 value outperformance was a narrow window within a long history of alternating regimes. He argues the answer depends on whether the post-2020 populist wave, now reflected in Trump's second term as a supply-side version, is unlocked again. If populist policy returns, value should outperform for the next twenty years.

  “And if it does, the value factor will outperform for the next twenty years.”at 35:46

• Cem Karsan · Kai Volatility Advisors

  Value will outperform growth as rates rise and demand-side populism takes hold, since higher rates punish duration.

  Cem argues higher rates raise the price of money, which hurts long-duration growth companies that depend on cheap borrowing to fund years of losses. Cash-generating value businesses can fund their own growth and are not dependent on capital markets. He ties this to a demand-side populist wave that pushes rates up and says the value factor will stay weak until demand-side economics returns. He calls this a multi-decade shift.

  “So at the end of the day, why will value outperform if that's the case? Because if interest rates go higher, if the price of money goes up, that's really bad for duration.”at 38:22

• Cem Karsan · Kai Volatility Advisors

  Government intervention, including state equity buying and money printing, will be needed to support a market that is too big to fail.

  Cem argues the US is moving toward state-run intervention, including massive buying of equities and money printing, as Japan did for two decades. He says the debt burden and populist politics leave no exit without buying stocks on behalf of the public, through sovereign wealth funds and Trump accounts. He points to equities at about $2.3 quadrillion, with about $50 trillion of new collateral added in April and May, against $10 trillion of COVID-era QE, as proof the market is too big to fail and that officials know it.

  “The US is moving to communism with American characteristics. We are going to meet them in the middle. We are going to push massive state run, buying of equities and printing of money.”at 51:18

• Cem Karsan · Kai Volatility Advisors

  A market decline is coming before June next year, then resolved by December; equities may rise 5-10% by year-end if reflated.

  Cem says the needed decline, which the rate-support plan requires and which would happen without intervention, is likely before June next year and resolved by December next year. Kai is positioned for this with put calendar flies and risk reversals that have little premium and pay off if the decline comes later than expected, with a possible Nasdaq rally. He also says that if the government can reflate the market, it could rise another 5-10% from now to year-end, which would add liquidity and keep the plate spinning for a while.

  “The decline that's going to come that is necessitated to roll out this plan, and naturally would happen without this response, is, in our opinion, coming sometime before June of next year. And will be resolved by December of next year.”at 55:53

AI infrastructure & data centers

• Noel Smith · Kai Volatility Advisors

  A blue wave could make data center funding harder, compressing IPO valuations and delaying listings.

  Noel suggests a Democratic midterm win could make some political actors less favourable to data centers. That would make funding for them more difficult, which could compress IPO valuations and push a listing back a date or two. He frames it as a possible catalyst among several, including Nvidia earnings ahead of VIX expiry. The argument is speculative and hedged.

  “the idea that there is a blue wave and maybe some of those people are going to be less favorable to data centers and the funding for that is going to be a little bit more difficult and that's going to compress IPO valuations, maybe push back a date or two.”at 28:45

• Cem Karsan · Kai Volatility Advisors

  Hyperscaler capex has been funded with debt after cash ran out, so it will need a government backstop.

  Cem says the government pushed hyperscalers to commit massive capex through industrial policy in September, and they have now burned through their cash and moved to heavy debt. CDS spreads are blowing out and crowding out sovereign borrowers. He argues the earnings growth and capex built on that debt cannot continue without a backstop, which he expects the government to provide.

  “What happened? They burned through all their cash and now gone to massive debt. And at somebody, at some point, you can't just encourage these companies to do this. You have to backstop them.”at 47:51

US elections & politics

• Cem Karsan · Kai Volatility Advisors

  Populist taxes-and-transfers drive demand; supply-side policy is deflationary and forces more monetary easing.

  Cem contrasts two policy approaches. Populist policy taxes the rich and gives to the poor, and the poor spend the money. Supply-side policy sends money to capital through lower rates or QE, and the companies receiving it return investment such as Uber, Amazon and Tesla rather than demand. In his view that demand shortfall is deflationary, and the next response is more monetary policy. This is the mechanism behind his argument that demand-side populism favours value.

  “Because populist policies mean you're taxing the rich and giving to the poor. When you give money to the poor, people spend money... They don't send us back demand, which is deflationary. To which our next response is more monetary policy.”at 35:58

• Cem Karsan · Kai Volatility Advisors

  A populist, demand-side political wave will reach dominance by 2036, after roughly a decade of growing pressure.

  Cem argues that 40 years of supply-side policy produced inequality, and that younger generations who cannot afford homes or pay off college debt are pushing for policies that prioritize median outcomes. He points to the populist shifts in France, Brazil and the US midterms as evidence. He expects millennials to take political dominance around 2036 and says the trend will get worse, bringing protectionism, higher rates and higher commodity prices.

  “Millennials will get to political dominance in '36.”at 40:41

US Treasuries & yields

• Cem Karsan · Kai Volatility Advisors

  Long-run interest rates are structurally headed higher, though they may rise further in the next month or two.

  Cem says the old driver of rates, the business cycle, has been joined by a supply-side versus demand-side force that bond traders have largely missed. Structural inflation, weaker foreign demand for US debt, and the refinancing of 2020-21 debt at 1-2% into a 6-7% market all push rates up. He expects a cash crunch at year-end and a near-term rise as the market reflates, but his base case is that the structural path is higher.

  “The answer is higher. And the base case is structurally higher. That doesn't mean over the next month or two.”at 48:23

• Cem Karsan · Kai Volatility Advisors

  A Treasury refinancing crisis will force the Fed into long-end QE, and a decline comes first.

  Cem argues 2020-21 debt, with 5-7 year average duration across sovereign, corporate and municipal borrowers, must now be refinanced at much higher rates. Corporate CDS are widening and sovereign issuance is crowding out other borrowers, which he says cannot continue without support. He cites Hank Paulson's April warning of a coming Treasury crisis and the Fed's recent interventions (buybacks along the curve, yen intervention) as signs of a backstop. He concludes the only way out is Fed QE at the long end, and the needed adjustment, which he expects before June next year, will be resolved by December next year.

  “The only way out of this mess, point blank period... there's only one way out, QE. The Federal Reserve has to get on board and start printing money at the long end the curve or backstopping”at 49:45

US rates & the Fed

• Cem Karsan · Kai Volatility Advisors

  Fed will need quantitative easing to backstop an impending Treasury crisis and support equities.

  Cem says a coming Treasury crisis means the Fed must prepare a facility to backstop it, and that the Fed is no longer purely reactive. Given current interest rates and market structure, he argues QE is the only way to keep supporting growth and the stock market. He presents this as the only path out.

  “The only way out of this mess, point blank period, the only way to continue the growth that we want, that's supporting this market at this point, ... there's only one way out. QE.”at 0:22

Middle East & Iran

• Cem Karsan · Kai Volatility Advisors

  Probability of US military action against Iran is about 1-2%, well above normal, a market risk.

  Cem says a strike on Iran is not that improbable given current signals. He puts the probability at roughly 1 to 2%, against a normal baseline of about 0.01%. He says such an event would act as a market surprise that could reactivate the volatility stress and push the tail further.

  “[Not] an actual nuclear [bomb]. By the way, it's not that improbable based on what we're hearing... That's maybe a one or 2% probability where normally that would be a point zero zero one.”at 27:44

AI: overall outlook

• Noel Smith · Kai Volatility Advisors

  AI trade won't be abandoned; money seeks path of least resistance, not a verdict on AI.

  Noel rejects the idea that investors are abandoning the AI trade because they dislike AI. He says money always seeks the path of least resistance, and that selling is driven by specific catalysts rather than a rejection of the theme. He says the idea that people are bored of making money in Nvidia is a very small probability, and that the most likely case is that some catalyst has driven the moves.

  “The idea that people just abandon the AI trade because they decide they don't like AI. I just don't agree with that.”at 28:45

AI chips & semiconductors

• Cem Karsan · Kai Volatility Advisors

  Parts of the market, especially semis, have crashed repeatedly this year while the index went nowhere.

  Cem argues that this year has already seen several real crashes in parts of the market, even while the index went nowhere. He points to semiconductors as an example now, with the market flat. He distinguishes the index-level vol compression from what is happening in individual areas like the AI complex, and says these are not the same thing.

  “We have seen multiple times this year crashes, literally crashes... Look at the semis right now, right? With the market going absolutely nowhere.”at 30:23

US inflation

• Cem Karsan · Kai Volatility Advisors

  Inflation is structurally elevated and will stay high, driven by fiscal spending, conflict, protectionism and commodity sequestration.

  Cem argues inflation has not been below 2% for 68 months and that this reflects a structural shift, not just the business cycle. He cites infrastructure-type inflation from fiscal spending, inflation from a global conflict and its spending, protectionism and supply-chain breakdowns, and commodities being sequestered as trade stops expanding. He adds that foreign buyers of US debt are declining as the US turns toward protectionism and populism, which keeps structural inflation in place.

  “Structural inflation. We have not been below 2% inflation in sixty eight months.”at 45:07

US growth & recession risk

• Cem Karsan · Kai Volatility Advisors

  The Strait of Hormuz disruption is cutting consumer demand through gas prices, and the economy is already rolling over.

  Cem says the Strait of Hormuz disruption is structurally reducing consumer demand because gas prices are high. He adds that the rest of the economy is already rolling over. He treats this as a macro pressure alongside the bond-market funding cap, which limits growth without government support.

  “Strait Of Hormuz issue is structurally causing less demand from consumers because of price of gas and the rest of the economy is already rolling over.”at 58:42