Lots More on Solving the Mystery of the Big Market Selloff

SPEAKER_1 (0:03)

Bloomberg Audio Studios, podcasts, radio, news.

Charlie McElligott (0:10)

Hi.

Tracy Alloway (0:10)

How are you?

Charlie McElligott (0:11)

Great to see you again.

Joe Weisenthal (0:11)

How are you doing?

Charlie McElligott (0:12)

How's life?

Joe Weisenthal (0:13)

Nice to see you.

Charlie McElligott (0:14)

Good to see you. Thank you guys for having me.

Tracy Alloway (0:16)

No, thank you for coming.

Joe Weisenthal (0:16)

Thanks for, anything going on this week? Big week.

Charlie McElligott (0:19)

Holy moly.

Joe Weisenthal (0:20)

Yeah.

Charlie McElligott (0:21)

You know, we've been feeling stuff, seeing stuff for a while, but you know, by end of last week, it was like, this is getting pretty hectic. And I had to drive like eight hours each way up to New Hampshire. I got back Sunday. I was like, I gotta start this right now.

Joe Weisenthal (0:37)

I did a deadlift. One, two, three. Okay, go.

Tracy Alloway (0:44)

Barges.

Joe Weisenthal (0:45)

This is an after school special, except.

Tracy Alloway (0:46)

I've decided, I'm gonna base my entire personality going forward on campaigning for a strategic pork reserve in the US.

Joe Weisenthal (0:52)

Where's the best squid in pasta?

Tracy Alloway (0:54)

These are the important questions. Is it robots taking over the world?

Joe Weisenthal (0:57)

No, I think that, like, in a couple of years, the AI will do a really good job of making the Odd Lots podcast. And people will say, I don't really need to listen to Joe and Tracy anymore. We do have.

Tracy Alloway (1:09)

Cha-ching. The perfect guest.

Joe Weisenthal (1:12)

Welcome to Lots More, where we catch up with friends about what's going on right now.

Tracy Alloway (1:17)

Because even when Odd Lots is over, there's always lots more.

Joe Weisenthal (1:21)

And we really do have the perfect guest. So when you say that like stuff was already getting a little hairy last, like what were those early signs? Was it just Wednesday during the Fed decision? Or what were you starting to see?

Charlie McElligott (1:35)

Well, there's different time horizons for sure. And I think one of the things that we absolutely have to discuss is the signal from skew, right? Skew is this relative measure of kind of demand for downside versus demand for upside. Which is something that we can come back to later. But without a doubt, when you began to see skew relentlessly stay bid, when you began to see the volatility of volatility stay so bid, even as stocks were trying to kind of stabilize after some of the recent death by paper cut of geopolitical and kind of earnings disappointments.

So, obviously, the growth dynamic is a big part of this too, as far as the labor data finally catching down. But it told you that there was this grab into tails, and a big part of the messaging that I've been giving since March, April period was that we had been living in this really interesting world where in the end of April skew was extremely, extremely historically all-time kind of flat levels. Meaning that it was really representative of two things, extremely low demand for downside, extremely high demand for upside.

Joe Weisenthal (2:55)

Downside protection.

Charlie McElligott (2:57)

Right.

Joe Weisenthal (2:57)

All right. Just for listeners to make sure.

Charlie McElligott (2:59)

Right. When you look at the forwards, and in my view is this, skew really on a longer horizon, like decades type horizon, to me is representative of what's the actual risk taking, risk appetite backdrop. Meaning, it's heavily related to central bank policy. So for instance, in the kind of QE era, where the Fed was trying to incentivize a wealth effect, right? They wanted you to be leveraged long assets, and in that, because that's economically virtuous, right? Consumption, paper wealth effect, all those things. You were leveraged long risk assets, skew is steep, because you had something to hedge. But after the events that created that idiosyncratic stacking of stuff from the Fed's inflation rethink in 2019, the flexible average inflation targeting, the tariffs impact into COVID, into the supply chain disruption, into the stimulus plus the tectonic stimulus, which had never been tried before, in addition to the unprecedented quantitative easing, you finally had this escape velocity inflation event, which then forced the Fed behind the ball, and it forced them to have to tighten in a place that we've never seen before. And QT, as opposed to QE, they needed to create a negative wealth effect because they could only impact demand side inflation. And with demand side inflation being the only lever that they could pull, they had to create a negative wealth effect.

And in that environment, SKU went extremely flat. You didn't own underlying. They were telling you to get out of risk assets. They were telling you to park in cash. Cash isn't at the money put, right? It's a hedge there. You were able to sleep at night, collect 3%, 4%, 5% at times. The only tail that you were afraid of was no left tail, was no crash downside event. It was about missing the right tail. It was about missing the rally.