Episodes

Dan Ferris: Hello, and welcome to the Stansberry Investor Hour. I'm Dan Ferris. I'm the editor of Extreme Value and The Ferris Report, both published by Stansberry Research.

Corey McLaughlin: And I'm Corey McLaughlin, editor of the Stansberry Digest. Today, we'll talk to Harley Bassman, the convexity maven and a managing partner at Simplify Asset Management.

Dan Ferris: And Corey and I are going to talk about S&P 500 at $5,000 for the first time ever, and what is a little bit wrong with one of the bitcoin arguments?

Corey McLaughlin: And remember, if you want to ask us a question or tell us what's on your mind, email us at [email protected].

Dan Ferris: That and more right now in the Stansberry Investor Hour.

OK, let's talk about bitcoin, man. Bitcoin's fun. You like bitcoin, don't you?

Corey McLaughlin: I love bitcoin. I really do. And it's making new highs again, back to where it was when all the ETFs launched a couple weeks ago. Had a little sell off after that, but now it's climbing once again.

Dan Ferris: Love it. Of course, I'm not holding any, but I'll get in right when it hits the next hop, I'm sure.

Corey McLaughlin: But you have some interesting thoughts we were just talking about on bitcoin.

Dan Ferris: Yeah, well, actually, it was because you had listened to a podcast featuring a guy named George Gammon, who I think we should try to get on the show. He's a smart guy, I follow him on Twitter. But it sounded like he was on a Twitter Spaces event and someone was telling him, was trying to get him to say that the dollar is going to basically collapse tomorrow and that we're all going to have to start using bitcoin. And he wasn't having any of it. And you know, I'm not having any of it. And I don't think you are either, much as you like bitcoin, right?

Corey McLaughlin: Correct. Yeah, yeah, yeah. I'm bullish on bitcoin as you know, for a trade and that sort of thing, and it may be its use case in the future. But yes, to paraphrase, I might have been saying it a little, I was paraphrasing that conversation that I that I heard on that Twitter Spaces. But yes, that's the general thought, like the dollar is going to lose its reserve currency status sooner rather than later.

Dan Ferris: Right. So even if even if we've misrepresented the conversation, we know that in the minds of many a bitcoin bull the bull case is the end of the world. It's the end of – the collapse of the U.S. dollar. Let me tell you, if the dollar collapses, a lot of other stuff is going to collapse first and worst – worse.

So, yeah, that's the problem. That is a problem. That argument is a problem. And as I was saying before we hit the record button on this show, it reminds me of an old song that I used to hear. I used to play classical guitar in a restaurant in Baltimore called Zameen Bean Cafe, which I think is still there in Fells Point. And I played two, three, four, five, six nights a week because I didn't have any money and the owner and I were friends. And she said, "Just come in and play and you can make tips and I'll give you a free meal," and she gave me all the wine I could drink, too. It was great.

And this guy used to come in and sing this song by John Prine, an old singer from way back. And I can't resist. OK? I have some of the lyrics in front of me. I just I can't resist if the powers that be want to edit this out, I don't blame them. But the song was called Dear Abby by John Prine. And it's basically a list of Dear Abby type letters complaining about this or that.

OK? And every single time in the chorus, Dear Abby says the same thing. So the first guy says, "Dear Abby, Dear Abby, my feet are too long. My hair's falling out and my rights are all wrong. My friends, they all tell me I've no friends at all. Won't you write me a letter? Won't you give me a call? Signed, Bewildered."

And then Dear Abby says, "Bewildered, Bewildered, you have no complaint. You are what you are and you ain't what you ain't. So listen up, Buster, and listen up good. Stop wishing for bad luck and knocking on wood. Signed, Dear Abby."

I think I think she said, "Signed, Dear Abby," but that's not listed in the in the lyrics here. But anyway, stop wishing for bad luck and knocking on wood is the first thing that came to mind when you mentioned this conversation. And when I started thinking, yeah, the bull case for bitcoin is like the end of the world. They're wishing for the worst.

Corey McLaughlin: It is part of it, it's definitely part of it.

Dan Ferris: So they could be right. It's insane.

Corey McLaughlin: Yeah.

Dan Ferris: It's so and of course, people do accuse gold bugs of the same thing. And I've been an advocate for owning gold for many, many decades and decades, in fact. But I honestly hope I never need the insurance policy of it. I don't want to have to buy things with gold coins.

Corey McLaughlin: Yeah.

Dan Ferris: I mean, I don't want to I don't want society to go to hell in a handbasket. I kind of live well and most of us do. In fact, I would say more people have a really good high standard of living than ever before in human history. I think that's accurate. Fewer people are starving than ever before in human history. So I don't want that to go away.

Corey McLaughlin: Right. It's very easy for us in the United States and for people that have grown up a certain way with all these kind of comfortable luxuries around to take it all for granted, right? Like the reason we're able to talk into these microphones and broadcast this and everything else, and I always think of – is because of American prosperity and what we are compared to the rest of the world. And so that's easily forgotten.

I always get a kick out of when people are complaining about capitalism or anything else, like while tweeting on their Apple iPhone, like it just doesn't – It doesn't register, right? Like the reason you are able to – anybody is able to express an opinion on their phone instantly is because of this system, right?

Dan Ferris: Right. Capitalism had to create had to create Twitter and smartphones so that the proletariat could overthrow it's just crazy. It's crazy.

Corey McLaughlin: Yeah. And the backdrop of this also, though, is like what the government does with monetary policy and fiscal policy and the debt, the U.S. debt. And I mean, there's obviously problems there that look out for the people who are closest to that system most of the time and not everyday people on the street, which is where you get the – which is where the bitcoin argument has roots, right? At its core, it's the decentralization of the financial system. And that's whether people think of it that way or not, that's what's at the core of it.

But yeah, to what expense is that, are you giving up, you know. We think about all the problems – it's very easy to spout off about all the problems in the world, and I do it as much as anybody else. But like, you got to think of the advantages that we have in the current system as well from – when it's done right, which is another discussion. But when it's done right, like we have an advantage here in the U.S.

Dan Ferris: Right. And I would say even when it's done wrong, it's so far superior to anything else. You know, it's just like the ability of a market economy to just take the absolute godawful punishment of central banks and growing big government, just it's been it's amazing. It's incredible. So, yeah, things are great by a historical standard and wishing for it all to go to hell in a handbasket so that your bitcoin is worth a lot in U.S. dollars, it just doesn't make any sense to me. And the same argument for gold, I freely admit that. I don't want the insurance policy part of it to ever come into play. Anyway, you get you get the point.

Let's talk about S&P 500 hitting $5000. And the reason I would – nice round number, right, and thank goodness, it's – I feel like Irving Fisher. "The market has reached a permanently high plateau." Right? It's just going to keep going up forever because it's at 5000. It'll never look back. But of course, I am reminded of when the Dow industrials first hit 1000 in January of 1973 and didn't eclipse that level for another nine years. It just was a sideways, choppy market until the 1982 bottom and then took off.

But so on top of this, S&P 500 hitting new highs, our friend Jason Goepfert over at SentimenTrader.com just published something and his headline was the most technical warnings since 2021 as S&P stocks lose their uptrends over the past three weeks. Technical warning signs have been triggering on the NASDAQ. Historically, these warnings have preceded poor returns within the S&P 500. Fewer stocks are holding above their moving averages.

Another warning. So I'm not a technical guy. I don't know how important that is. And Jason is really, he's a historical guy, like he looks up the history of all of the indicators. And if the market goes up 21 days in a row or something, he'll tell you every time what happened after the market went up 21 days in a row in the next three, six, nine, twelve months or whatever. He's that kind of guy.

So there's never certainty, right? We're not saying, "Oh, most technical warnings," you know. "Sell it all." But it doesn't surprise me. I mean, I'm back on the bearish train because we're back in mega bubble valuations after zero interest rates for many, many, many years, and then the most rapid hiking cycle since 1980. In terms of basis points, the most rapid hiking cycle ever, I think, in terms of percent increase off of 0.25% to 5.5%. It's like, whoa, that's a skyrocket.

So –

Corey McLaughlin: Yeah, it appears that this rally since October, November, which has been pretty strong since the Fed was kind of indicating that it's going to cut rates next year or this year, sorry, this year, kind of getting long in the tooth again with the big tech stocks leading the way and the index is mainly going like sideways to a little up, but the number of stocks trading below their long-term technical averages, which Jason mentioned and some other technical analysts that I follow have been mentioning, has been going down since the start of the year.

And so that's typically a warning sign that whatever the indexes are showing is not as strong as what's really happening beneath the surface. And so, yeah, I think at this point, you just expect a little, some pullback here in the next month or so. I don't know the exact timing of it. I'm also reminded of Jason Shapiro, who we had on recently saying, wait until the market confirms your thinking before putting on a trade or anything on short-term market movement.

But yes, I would be prepared for some kind of pullback, for it to happen and whatever that means to your goals and your portfolio, it means. But yeah, not the time to be getting overly bullish, I would say.

Dan Ferris: I agree. And I'm thinking – you're thinking of Jason Shapiro. That's a great one. I'm thinking of our friend and colleague, Greg Diamond of Ten Stock Trader published by Stansberry Research, who gave me a list. I kept my list, Greg, I kept my list of dates. One of them, he said, was an important date and he just thought they were important dates for turns in the market one way or the other, up, down, whatever.

One of them was February 14, which rapidly approaches. And another one was, he said end of March through April 1. So I'm really, really curious what happens starting on February the 14th, if Greg is right. Also, to your point, Corey, I'm looking at a chart here on Bloomberg of S&P 500 versus Equal Weight S&P 500, one year chart, S&P 500 plus 22%, Equal Weight S&P 500 plus 5%. I mean, wow. That strikes me – I should know the history of these two, but I don't. But it just strikes me as like, wow, that's a wide divergence there.

Corey McLaughlin: It is. It sure is. Now, we've been saying, when does it stop? I don't know. But when it does, it's going to maybe take some people by surprise.

Dan Ferris: And of course, equal weight outperformed in December, but it's back under now. And just since the October bottom, it's basically 22% versus 18%. So that longer term is like, wow, if you're buying those stocks, despite December's performance, you're still like, tick tock, man, what's happening? These are great companies. And a lot of them are. A lot of them are just like cash gushers, and they're not doing anything.

Corey McLaughlin: Right. Exactly, which may lead to some FOMO from people at exactly the wrong time, chasing the Metas, and the video, which is going bonkers again. So yeah, at the same time, there's an argument to me, this could be just a healthy correction and a rotation in a bullish uptrend, which it may end up being. We may see that. But it might not be the end of the world, as we were saying, but the conditions look – I wouldn't be surprised if there's like a 5%, 10% pullback here in the next month or two.

Dan Ferris: Yep. We'll see. I finally took our previous guest, Hari P. Krishnan's advice, and I just stuck a little in my trading account. It's a very small account that if it blows up, my life doesn't change. And I took a little 1% position in a put option against one of the indexes, I think it was Russell 2000, because that's my index. That's where I focus on index-type trades.

But I took a little bearish position like a year or so out, a little more than a year out... 1% of the account, just sit it there, forget about it. And I'm looking forward, like if Greg is right about the turn, it's looking like it would be a bearish turn. If you and I are right about the meaning of this divergence between the really probably top seven or eight S&P 500 stocks versus the other 492, I'm looking forward to see if Hari steered me right or if I executed it properly, we'll see.

And overall, I want to buy stocks. I want to be excited about it. I want to buy great businesses that aren't trading at exorbitant, historically mega bubble type valuations. I don't like doing that. Historically, over the long term, it just hasn't worked out well. But I promise everyone, I'm not like bearish by constitution. I want to make sound long-term investment decisions.

Until I get that moment, like in The Ferris Report, I'm running out of defensive things to do. I've got eight stocks that like four of them are basically guaranteed to not fall or probably go up in a market decline and a handful of others that should outperform regardless. And I've run it out of ideas. And I don't want to have to spend my whole life saying, what's the next idea I need to protect people from a big downturn? And I hope that one day I say, "You know something, there isn't going to be a big route. And I was wrong. And it's a new era and a permanently high plateau or whatever it really is." But it never is. It never has been before.

So here we are. Here we sit and kind of wait.

Corey McLaughlin: Yeah. You're into creating wealth, not destroying wealth, like Cathie Wood, as we saw last week too, got taken out to the woodshed by Morningstar about this article that came out on how ARK Innovation Funds have lost the most out of any funds over the, not just recently, but the last 10 years, which was surprising to me over the last 10 years.

Dan Ferris: Since ARK's inception. They were founded in 2014.

Corey McLaughlin: And you were warning about that, to your point, you were warning about this, when ARK was at the top of the frenzy in tech and bitcoin during all the stimmy periods.

Dan Ferris: Early 2021.

Corey McLaughlin: Which we'll all remember fondly one day, I guess, like the buzz and popularity around Cathie Wood and ARK funds was just – it had all the hallmarks of bubble, and it was right. So anyway, that was trying to pick you up a little bit here.

Dan Ferris: She could do no wrong back then. Yeah, thanks. I mean, it sort of pays to keep your eye out for these frothy, awful moments. And right now, there was absolute certainty then that you couldn't go wrong with money losing highly disruptive, innovative tech. And now you can't go wrong predicting that the Fed's going to cut rates real soon.

Meanwhile, the market is, the indexes are anyway, the Dow, S&P 500 are making new highs and unemployment's still skirting this, whatever it is, 50 odd year low, I think 54 or something. And when all this stuff happened, you think, well, things are maybe stronger than we think. And if they're stronger than we think, the cuts are farther in the future. So all the certainty, it's the certainty that drives me nuts.

Corey McLaughlin: Yeah, and I think that's you're seeing some of, I think you've seen already some market reaction to the idea that the Fed's not going to be cutting rates early this year. I just wonder how much more of that needs to happen or will happen the next month or two. At the same time, you're seeing oil prices back on the rise here a little bit.

And so that's not going to help the inflation. That's not going to help the inflation numbers at all. And so, yeah, if anything, it's just kind of that Fed pause. To me, it looks like just the Fed pause for longer, which isn't necessarily a bad thing for stocks either. It just means that we're just kind of in this like Goldilocks scenario that you probably hear like in the mainstream, just growth.

Growth's OK. Unemployment's low and inflation's still, it's not as bad as it was. And so, yeah.

Dan Ferris: Yeah, we'll see. We shall see how it all plays out, but predicting it and having a lot of certainty about it and going long, this or that, because you just know the Fed's going to cut real soon. I don't like that at all. I think certainty about the future is like a fool's – it's a sucker's bet.

Corey McLaughlin: Agreed. But we do know a guy, our guest here, who knows a heck of a lot about what the signals the market's sending, the bond market in particular and all kinds of things. I'm excited to hear from him, Harley Bassman.

Dan Ferris: Yeah. And Harley's got great ideas about what to do. Like he's the guy you want to talk to about what the hell do we do right now? I think he's got one of the better ideas and his firm created a product to exploit it, which we will talk about with him. But let's do that.

Harley Bassman, also known as the convexity maven, and we'll talk about convexity, don't worry. He's our guest today. You're going to like this. This will be an exciting education in what is normally a boring topic. Get out your pen and pad, take some notes and enjoy our interview with Harley Bassman. Let's talk to him. Let's do it right now.

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Harley, welcome to the show. Thanks for being here.

Harley Bassman: Thank you. Good morning.

Dan Ferris: So I am joined today by my co-host, Corey McLaughlin, and we have questions. So one of them, the first thing I actually want to do, I feel like you're providing an interesting public service for most investors today, because you seem to be on a mission to explain the concept of convexity to people. And I've heard you do it on podcasts and various things.

And I'm like, "Hey, we got to get this guy on, because we never talk about this." I think I've started to get into it, but it's an awkward thing to just sort of explain in a very simple conversational way.

But you seem to be doing a pretty good job of that, and I was hoping that we could start by maybe you might even want to talk about why you're on a mission to do this. And if you could also do it for our listeners, I think that'd be a great way to start out today.

Harley Bassman: I'll start backwards.

Dan Ferris: OK.

Harley Bassman: So I mean, first of all, I've been doing it 35, 40 years, so it's not rocket science per se, at least for me. When you look at the big market, I don't want to call them crashes, but bad things happening to good markets. I don't like to use the word always, but there's always short convexity, lurking near the scene of the crime, always.

The reason why is that people really can't process negative convexity in their heads. It's a risk they can't manage. And there's been actually Daniel Kahneman won a Nobel Prize and wrote a book about this, Thinking, Fast and Slow, where, for example, people are afraid of sharks. People are afraid of lightning, but they'll get in a car and not wear a seat belt. They can't manage, they can't process in their heads the level of risk involved in things. And they can't process how short convexity can work against you so quickly in almost anything in life, you know.

So that's kind of the idea. Why I focus on it, I'm a bond guy. I mean, I'd like to think I can trade a stock, but I can't. I'm a bond guy. And in bonds, there's three buttons you can push, there's three risks you can take. If you own cash, that's overnight money, there's no risk there, assuming there's Treasurys. There's duration risk, there's credit risk, there's convexity risk.

Duration is when you get it back, credit is if you get it back, convexity is how you get it back. The first two are pretty obvious. The third one, people don't kind of get, but that's why I'm focused on that risk. People understand. And it doesn't mean it should always be long or short, but I can go either way. No bad bonds, just bad prices. But people should have an appreciation of when they get into convexity risk, why they're earning it, and if they are happy with it.

Dan Ferris: All right. That's good. With that backdrop, then, I'm hoping that you can kind of deliver your –

Harley Bassman: What is convexity?

Dan Ferris: Yeah, your beautifully simple explanation of convexity is what I'm trying to say.

Harley Bassman: Fine. Look, you're faced with a coin flip or any kind of equal up and down, 10 basis points up, 10 basis points down, whatever it might be. If you make a dollar versus lose a dollar, that's zero convexity. So linear return, OK? If you make two and lose one for equal coin flips, that's positive convexity. You lose three and make two, negative convexity. That's it. Nothing more, nothing less. It's just a non-linear payoff profile, which can either be favorable or unfavorable.

And the question is this, you won't pay the same for all those three things. So if you get 5% for even up and down, well, if you have up two down one, you could buy that at 5%, but maybe it's 4.9%, maybe 4.8%, maybe 4%. What is the right number to make that a fair trade between a one for one bet and two to one? And similarly, if it's down three, up two, you better get paid more for that. That's the question. Should be 5.2%, 6%, 8%, whatever that might be.

And that's why we hired all these PhDs in the '90s, is to go create all these models to make an almost game out what the fair market value is, the theoretical market value. It doesn't mean that's where we trade, but the fair market value. And that's the idea of all these OAS options just to spread analysis is to make a fair bet on what it is.

And let's think about it. I mean, what is a corporate bond? A corporate bond is simply a treasury plus a default option, right, a short put on the company blowing up on you. That's all it is. And that's why you see this. People will arbitrage. Hedge funds, their whole life is just trading the credit market, credit bonds, versus the credit default derivatives market, OK? Mortgages, similar idea. Trade a mortgage bond versus the option market and try and make those things all work properly. So, you get what's called an arbitrage-free condition.

What's arbitrage-free? It just means gold in London and gold in New York can never be different than the price to ship it across the ocean plus the insurance and everything else. That's it.

Dan Ferris: Right. So, it sounds like you pay more, simply put, for a better – the better the risk-reward proposition, the more it's going to cost you.

Harley Bassman: Yep. If you're buying an option. Remember, what's an option? You buy an option, you pay your money, you can make infinite, you can lose what you pay for it. The option is the ultimate positive convexity instrument, right?

Dan Ferris: Right.

Harley Bassman: And if you short an option, most you could make is what you sell it for and your loss is unlimited. So, that's the ultimate short convexity situation. What you want to be careful about is where you start selling options for pennies. We call these tail options, where you get a little money in but have a huge, massive loss if you're wrong. That's where people really get hooked is where they sell these way up to my tail options. They don't think about it too much and then all of a sudden, it blows and they got a problem.

Dan Ferris: Yeah. I'm glad you pointed that out. A lot of folks sell options for income and they do it repeatedly. Hopefully they're not doing that. Hopefully, they're not selling the tail option.

Harley Bassman: At a price. At a price, these things are all OK. I mean, what's an insurance company? An insurance company really is a massive option seller, but they sell for high enough and they're diversified enough, right? They're selling auto insurance. Not that many people crash their cars, but it happens once in a while, so you pay your premium in. The insurance company has hopefully millions of cars to diversify the risk and if they sell the option, the premium they take in at a little more than the losses they take, then it works.

Selling volatility, selling options is not a bad strategy if done in a reasonable size in a controlled manner. What happens is people get greedy and want to try taking all this money early on.

Dan Ferris: Right. People do get greedy.

Harley Bassman: It's a habit.

Dan Ferris: Yeah. It's all too human. There's some greed happening in the markets we watch, which are mostly equity markets as we speak. The other thing I really wanted to talk about with you is, and this is a softball, this is right up your alley, is that I found one of the products that you have at Simplify to be very interesting and that's this mortgage backed securities fund, which is a recent-issue fund. I thought, well, of course, now, that's the proposition I want to get. That's a nice convexity proposition, is it not?

Harley Bassman: It is a terrific product. I will tell you that I'm absolutely stunned that no one brought it before we did. I'm not sure why, because it's just so obvious.

What's a mortgage bond? First of all, look, if you're an equity guy and you're trading stocks and you want to do a 3X, 5X, 10X trade, go buy Nvidia, that's fine. If you're going to allocate money to the bond market, which is basically a limited return income vehicle, it's a base security, you're supposed to always have some bonds in your portfolio to ride things out, how much should you allocate to the mortgage market? The mortgage market is the second biggest market out there to Treasurys. It's bigger than corporates, bigger than munis.

Almost no one trades them because it's a professional's business and they're dirty little animals there. Most people who invest in the mortgage market invest in the mortgage index. I'm not going to name takers here, but there's a couple out there that are very large. The problem with the mortgage index is most of those bonds are 3% bonds that were created two, three, four years ago during QE. Those bonds are bad bonds. They're not going to default, but they're bad bonds.

The new mortgage bonds that are coming out, Fannie, five-and-a-halfs and sixes, these are interesting bonds. They're yielding now almost 150 basis points over Treasurys for a variety of reasons. You can model them like a buy right, where you buy a 10-year Treasury and sell a call against it and earn a very large yield. The 150 basis points over is a one-and-a-half percent over. So if the Treasury is 4%, the mortgage one might be five-and-a-half, that is double the usual spread and it's actually almost 100 basis points more than corporate bonds yield right now.

There's a variety of reasons why this exists. You can talk about them if we want, but I'll just say what I want to do is have people try – to give a vehicle for people to buy these 5.5%, 6% mortgage bonds on a listed exchange basis, because most people cannot buy mortgage bonds directly for reasons and truth be told, you really don't want to.

Dan Ferris: Yeah, for our listener individuals managing their own accounts, they just don't want to bother with it. So, that's an easy way to do it. I agree with you. I was like, you described it, and I thought, well, people do that already, right? No, apparently, they don't. So, you got a leg up on them.

I'm fascinated by the fact that you mentioned that they're yielding more than corporate bonds. I thought, wow, that seems a little upside down considering the higher default risk. It should be the other way around. Should it – very obviously, should it not? I wonder why it is that way.

Harley Bassman: I publish a commentary intermittently. It's at ConvexityMaven.com, my website, send me an email, it's free, I'll add you to the list. My most recent one that I published yesterday, actually, goes into some depth on why this is happening. It has a really nice chart where the pink line is the mortgage spread, and the green line is the corporate bond spread, and they go like this, and they blow apart.

A mortgage bond can be modeled like buying a 10-year Treasury, then selling a three-year expiry call option, so not like the usual stuff where you sell one, two, three-month options on the exchange. This is a three-year option, it's actually a 30-year option, but it looks like a three-year option for reasons. It's much more stable than an ordinary one-month buy-write. When you buy this Treasury, the price is the price.

The question is, when you sell this call against it, what's that price? What's happened is the price of that option you're selling has almost doubled in value. That's why the yield is so plump and juicy. There's no default risk in a mortgage bond, that ain't going to happen. Fannie and Freddie, they're not full faith in credit, but they might as well be.

If you think Fannie and Freddie are going down, man, you should buy a shotgun, a can of tuna and small gold coins because it's not going to end well. Just make sure you bring along the can opener. That's a key thing to bring along.

The reason why this option has gotten so plump is one, implied volatility has gone up a lot. You can see that on the move index, move index is my baby, it's identical to the VIX just for bonds. It's trading like 110, 120, 130, which is much higher than its long-term average, and the yield curve has inverted. I'll just leave it at that, the curve's inverted, and that plumps up the value of the option.

For those two reasons, that's why it's yielding so much. What I will tell you is this, that these par, near par, bonds trading near 98, 99, 100, 101, somewhere in that zip code are very yield curve sensitive. If and when, actually it's when, the yield curve steepens, so the two-year rate, which is over the 10-year right now, when it comes down, you will see these mortgage bonds that spread tighten in from 150 back into 100 to 110, and then when that vol, that move comes down from 120 to 90, that'll bring it down to its long-term average of 75.

Those two things are – they're going to happen simultaneously, because once the Fed does cut, then the risk is – right we don't know when the Fed's going to cut, and we don't know by how much, and those two things are keeping implied volatility, the uncertainty very, very high, as it should be.

The Fed has said, "We're cutting three times this year." They've said it publicly, they say it in their DOTS advertisement, so I'll take it with their word, although Jay Powell did say two years ago, it wasn't going to hike rates until March of 2023, so kind of lied, but he changed his mind, but so far, they said we're going down three cuts this year.

The market's pricing in six cuts, so someone's wrong about this, so there's uncertainty. That's why vols are high. Once the Fed starts cutting, and we get an idea of what's going on, you'll see implied volatility has dropped by a lot, because the risk, the uncertainty is gone. That's why you want to buy these mortgage bonds now, because you get the double whammy of the yield curve steep thing, and vols coming down, and you will see mortgage spreads come in closer to corporate bonds.

The corporate bonds right now at 55 are kind of silly. The average is like 65. The inverted yield curve kind of signals that we're going into a recession. The yield curve, the three-month Treasury versus the 10-year Treasury is the yield curve used in the PhD analysis that showed it's in front of a recession. We talk twos, 10s on Wall Street, because we just do. That's the vehicle we use for trading, so twos, 10s, but really, it's three months versus 10 years in Treasurys, not in swaps.

It's really inverted right now, which means we're supposed to get a recession. If that's the case, the corporates should be unwinding, not tightening. So 55 under the long-term average is kind of nutty. Once again, someone's smoking the happy stuff, unclear if it's Jay Powell or the market, but someone is.

Dan Ferris: I just want our I just want our listeners to know, what Harley is describing, it's a more sophisticated way of simply recognizing that if the Fed cuts, and you're holding those wonderful mortgage bonds that he's recommending you do in whatever form you can, they're going to appreciate rather quickly and substantially.

Harley Bassman: They'll appreciate relatively to other bonds.

Dan Ferris: Right.

Harley Bassman: We can get a steepening also, instead of twos going down, we can get 10s going up, which would also tighten in the mortgage spread versus corporate bonds and Treasurys, but all bonds would go down if the 10-year rate goes up to 4.5%, 5%. It's really more of a relative-value thing. I'm not saying put your money into bonds because you're going to win... I'm saying if you already have a bond allocation, you should be allocating more into mortgage bonds.

Dan Ferris: OK, sure. Yeah.

Harley Bassman: I'm not saying sell equities buy bonds here.

Dan Ferris: Oh, no, I didn't take it as sell equities buy bonds at all. I'm just, yeah.

Harley Bassman: Clear for the audience here.

Dan Ferris: Yes, very good. We like to do that. OK, so but you're comfortable, it sounds like, with the Fed's prediction. That's interesting to me because you pointed out they can change their mind, but like what scenario? Let me back up a little bit. Right now, the stock market's really strong, GDP number is healthy, and financial conditions are easy. If I'm the Fed, I would think, I would hope, if I'm the Fed, do I need to make anything easier? Do I need to cut? I mean, they said they would. We know based on, but they said that a little while ago, right? Time has passed. We're getting new highs in the S&P 500. Is there not some likelihood that those three cuts may not happen or might only be two, might start later? How does that affect your proposition with the mortgage bonds?

Harley Bassman: Well, I mean, it does nothing at all. These bonds will clearly, they're the highest yielding safe asset out there, so that's better than anything else you're going to own. Mike Green, my partner at Simplify and a good personal friend, much smarter than I am –

Dan Ferris: He's been on the show.

Harley Bassman: I mean, he would say that we're already in a recession, the Fed's going to cut eight times. Maybe he's right. What I mean, what I push back on is that there are a few things going on over here. We have nominal GDP running at 5%, 5.5%, right? Nominal is real GDP, 3.3 plus inflation of two and change. I mean, I'm almost at 6% nominal, and usually cash tends trade near nominal, so that's one idea.

I argue that at 5%, 5.25% for fed funds right now, clearly, it hasn't stopped the economy, hasn't stopped the stock market, so I wouldn't call it restrictive yet. Why are they going to cut? I think that where I am is the Fed's going to cut, it's not starting till July, and they'll go three times, because why not?

I think the people who are betting we're going to get more than that are nutty. I think also that you have to appreciate the humanity of these decisions. We are social animals. We like to be friends. We like to talk to each other. I wouldn't call us lemmings exactly, but we're in that zip code. Who wants to go to a party and talk about bonds, for God's sakes? No, you want to talk about all the fun stocks and what you're doing, and all your friends are doing this. You want to be the guy not doing that? No, of course you don't.

This is why we still read Shakespeare and the Greek tragedies 2,000 years later, because what do they capture here? The great failing of humanity is hubris, is ego. That's what it's all about. I mean, look at our politics right now, for God's sakes. That's a demonstration of ego.

And Jay Powell, he's done pretty well. He's head of the Fed. He's worth a hundred million or so. He has a nice family and kids, I'm sure a nice house, maybe even a friendly dog that likes him.

All I'm curious about now really is what's his gravestone going to say? And it ain't going to say Arthur Burns, who cut, took rates up for deflation in the '70s, took it back down again, then took it back up, and boom, the inflation exploded.

Is it his fault? I don't know. Is it Nixon's fault? Is it Johnson's fault? Is it the guns and the butter or the Vietnam War, demographics? Whatever it is, he was the guy who was there when it happened, and he got the blame.

Paul Volcker, he's a saint. Now, Mike would argue that it was all demographics, and it was going to happen anyways, whoever was there. And maybe he's right. OK, maybe he's right. It doesn't matter. He was the guy sitting there, and he gets – he's the hero.

Now, what do you think Jay Powell wants on his tombstone? Either way.

Dan Ferris: Absolutely.

Harley Bassman: An Arthur Burns. So, he's going to drag his feet on this thing till the bloody end, because he's at the last stage of his career. He wants to be a hero, and if he waits an extra month or three. Really, does that matter? No, it doesn't.

So, that's – I'm really putting my bet more on his ego, and I'm not saying that in a negative way. I mean, modesty is not my strong suit, so I have nothing to talk about that. I just think that he's going to hold his feet, and we just got a core PCE of, what, 2.9 year over year? Like, we're not there yet, man.

So, that's kind of my thinking about how it's going to work out. Now, even if the Fed does these massive cuts, what's going to happen to the back end of the market? Historically, so, we're looking at long time, long run, inflation, they want it to be two, fine. Fed funds plus inflation, 50 cents, 50 basis points, real rate of a half, that's good. OK. Look at TIPS, which are cheap right now. Fed funds to two years, 50 cents, 0.5%, that's three. Twos, 10s, 1%, that's four. We're already at 4%. The Fed can drop rates by 300 bps, and the Fed can stay right here, and that wouldn't shock me one lick.

And by the way, the 30-year, probably goes north when that happens, it goes above 10s. So, like, I'm not convinced that this 10-year rate is dropping back to 2% when the Fed starts cutting again. So, I don't see a whole lot of upside in the cash 10-year, theoretically, unless the Fed starts QT again, or there's some exogenous something that drives people out of stocks into bonds. But if the Fed does their ordinary cycle, I'm hard pressed to see it tend to go much below 3.3, even when the Fed cut 300.

Dan Ferris: I'm happy to hear you make this argument about basically Jay Powell being a human being. I was saying a similar thing while he was hiking, I thought, well, he's like the high school quarterback walking down the hall, and he looks on the wall, and he sees a picture of the old hero, and the old hero is Volcker, right? So, "I'm going to be like, Paul, I'm going to save the day, I'm going to be the guy who's remembered for squashing inflation." And I don't know, I'm glad that even sophisticated guys like Harley are thinking in a somewhat analogous manner, so it's good.

So what are, I don't know, I always want to ask people, what are you doing right now? Sounds like right now, you're really just still excited about mortgage backed securities, and that's still your big trade. Do you have another one that's really attractive to you right now?

Harley Bassman: So I was at Merrill Lynch 26 years, ran mortgage trading, ran option trading, all that fun stuff. Truth be told, I'd still be there if we hadn't blown up, which is another fun story, and I came back to California to work with PIMCO for a while, and I retired, and then I got pulled back in by Simplify.

So we're a three-year-old company, and what we do, which is really kind of, I mean, it's very unique to get me off the beach, is that we jam derivatives, futures, options, total return swaps, all these other fun things, professional investment instruments, stuff that I did for my entire career, we put them into ETFs so civilians can get to them.

Up until now, the only way that civilians, non-professionals, could get access was to invest in a hedge fund, which is, I'm not saying it's a bad idea, but I mean, I've always viewed hedge funds more being a compensation scheme that's rated as the asset class. Two and 20, you can't get out quarterly, they can gate you. I mean, really? I mean, if you're an institution, that's fine, but for civilians, really?

We could put these things very cheaply into ETFs, so we could do it because there was an SEC rule change about five years ago. My ex-PIMCO guys came to me because I'm at [inaudible] Beach right now... they're up at Newport Beach. I said, "Wow, this is like amazing."

And the product I created there was, I can't say the name, you could say it though, is this interest-rate-hedge instrument. What we did was we took a seven-year put, a seven-year option on effectively a 30-year Treasury and jammed that into an ETF. This is when the market was trading at like 2% rates.

We brought the fund at 50 in May of 2021. It probably went to 37 as rates went down, and then kaboom, last year, as high as 114. It was a great investment vehicle because you were massively long convexity, unlimited gain, limited loss for people who wanted protection, insurance from higher rates.

We've had the low rates, we've had the high rates, they've come back down again. This product is interesting because it's very yield curve sensitive. Once again, it's a way to basically play the yield curve steepening, especially if you're not crazy bullish on interest rates.

I detail in my last commentary how this product might perform if we get the curve to rotate around with like the 10-year stake right over here. The product, for reasons I will not talk about, it's an option, and the decay of this product is about 1% to 2% this year. Think about that. You're buying an option, it decays only 1% to 2% for a year, which is why I wanted to bring this thing to market because it's a very arcane part of the bond market, but it's actually very liquid.

The bond market is, as I said, it's basically out there, man, and it's very liquid, much bigger than people think. It's just no one talks about it because it's boring.

Dan Ferris: I see. Yeah. Well, I don't even know if I would say boring. It's complicated. It can get complicated, but on the face of it, it is rather simple, right? Price goes up and yield goes down and vice versa. I think if you start there, these other things can, just like your explanation of convexity, can be much simpler.

So I'll look through your commentary for the name of this thing, and maybe I'll talk about it on the show at some point.

But yeah, so I can't help asking, like you were at Merrill in, what, 2008, when they –

Harley Bassman: I was there from 1985 to 2011.

Dan Ferris: Oh, wow. So all through that transition for three years after it. That must have been an interesting three years.

Harley Bassman: You know –

Dan Ferris: No?

Harley Bassman: What do you want to know, man?

Dan Ferris: It was an interesting – well, put it this way, it was an interesting month or two in 2008, right? I mean –

Harley Bassman: I mean, look, the destruction of Merrill Lynch is a classic example of just pure greed and ego. Nothing more, nothing less. I did not see it coming, which is strange because I ran the mortgage department for a while. I was done well before we blew, but I didn't see it coming. I didn't think that someone could take down Merrill Lynch, one guy could do it. And it turns out, basically, five or six guys did for ego and greed.

But the loss actually was, if you back into it, was a short volatility trade. What we owed was these triple-A CDOs, CLOs, and we hedged them by shorting the triple-Bs. And at the time, we kind of thought, people thought, traders thought that the hedge ratio was five to one. So if the triple-A's move by one point, the triple-B's move by five points, so fine. So for every 500 million triple-A's, you would short 100 million triple-B's. And Merrill did this at a tune of 40 billion.

What that trade looks like, imagine buying one single put on a stock struck at 100 and selling five puts struck at 80. As long as you stay above 80, you're golden, man. Once you go through 80, things get ugly pretty fast, because you're short five and only long one.

And that's what Wall Street had on. I mean, Morgan Stanley is a much more interesting situation than Merrill. Merrill was issuing CDOs when we were doing these dumb things. Morgan Stanley was not involved in issuing CDOs. They went in there and put the trade on of five to one as a prop trade before they got rinsed. Unfortunately, they had enough ammo to survive it as well as the Fed came in the day after Merrill blew up.

But it was just kind of foolishness. So what can you do, man? It's never different this time.

What I'd advise for your listeners here is don't get hung up and try to sell the top or buy the bottom. You're never going to do that. I actually bought the bottom once in my career. It was when we first started trading electronically by pushing buttons, which I always hated doing. And I was trying to sell, I hit the buy button by mistake. Forget that. Sizing is more important than entry level.

Look at what you're doing. You want to buy big enough so it has an impact on your portfolio, small enough so if you're wrong, it doesn't take you out. If you do that, you're going to be OK. Don't get hung up and try to tie the market. If an idea is good to you, just go and do it.

Dan Ferris: I have to tell my listeners, look, I always try to get the most interesting guests, folks like Harley who have all this really interesting, sophisticated knowledge, and folks who tell great stories, and he's got stories about Merrill and everything, and eventually we always wind up at position sizing, stop losses, all this basic stuff.

It's like, I'm trying to make this thing sexy, but the world just won't let me. Reality won't let me, and we always wind up here.

Harley Bassman: I hate to break it to you, but you're not going to invent the wheel here. It's never different this time.

Corey McLaughlin: Along those lines, where do you see or where do you suspect there's convexity risk, the biggest right now, and what parts of the market?

Harley Bassman: I think you're circling around to a question about zero-day options.

Corey McLaughlin: All right, very good.

Harley Bassman: Here's the idea. When you buy an option, you're long convexity. When you're short an option, you're short convexity. Every option that trades, there's a buyer, there's a seller. You're not buying and selling versus bond god, you're selling somebody else. Therefore, if I buy or sell the option, and I manage the delta, I manage the risk exposure of it, and the other guy does the same thing, we're going to be buying and selling to each other back and forth, so it'll have no impact.

However, if one side hedges and trades differently than the other, that will overwhelm the system. For many, many years, my ex-employer would sell options on Treasury contracts, very big size, public information, nothing new over here. I buy it as a dealer, I buy them. I would be trading them. When the market went up, I'd sell a little bit because I'm long convexity, so I win on the upside, get longer on the upside, so I sell. Market goes down, I'd buy a few.

He did nothing. He just let the trade run. So, I'm always selling higher prices and buying lower prices and driving the market back toward that strike price. So, that's why you always see what we call pin risk, where you pin on these big strikes. I used to publish every month or quarter the open interest in the interest-rate contracts and say, "Here's the biggest open interest, we may likely drive toward this strike because of my or Wall Street's hedging," so that would dampen volatility.

Right now, it looks like the retail is selling the zero one-day options, and they're not hedging it. You had Susquehanna, Citadel, the big option guy, they're buying it, they're hedging it. That's probably why you're seeing vol reduced and the S&P not moving and the VIX trading at 13, 14, 15.

Now, the other side of the coin is, let's look at GameStop, which I wrote about a year or so ago. It's in my library. There you had retail buying the GameStop options and being the holders and the FOMOs and everything else, and you had Susquehanna and Citadel selling the option, and they were hedging.

As the price went up, they had to buy more because they got shorter because they're just moving the opposite way. That's why you saw these GameStops or AMC, where the retail is buying but not hedging, they kept going crazy because one side was hedging, the other side wasn't. So what you got to do is figure out, is the buyer or the seller being more active in the market? That's your hint now.

As Wall Street tries to publish these net gamma numbers? Are they right? They might have – I mean, maybe. I'm not the biggest believer in this kind of nonsense, but I guess they could tell theoretically if the trades are, if you assume retail is always taking action, if the trades happen on the offered side, you assume retail is buying, happen on the bid side, then retail is selling because Citadel and Susquehanna, they sit there and make a market and they just wait for you to transact above or below the mid-market level and make their profit that way. That's all they want to do. All they want is capture that bid offer. They're not trading. They couldn't care less what direction the market is.

Dan Ferris: OK. Harley, we've actually reached time for our final question, which is the same question for every guest no matter what the topic, but before we do that, though, I just want to point something out. It went by so quick and we didn't get a chance to talk about it.

You all heard Harley say at one point that the move was his baby. The move index is, as you said, the bond volatility index and it's his baby because he birthed it. He created it. So, I just wanted to clear that up, but final question, Harley, and by all means, if you've already said the answer to the final question, feel free to repeat it. That's cool.

Final question, same for every guest is, if you could leave our listener with a single thought today, what would it be?

Harley Bassman: I think it's a matter of big picture away from the markets, OK, to thine own self be true. Don't let your ego drive you to make bad decisions.

So what would be an example of this? In bond-land, like the trader is the big gorilla, and maybe someone doing computer programming or research doesn't feel quite as fun. Don't do that. Go to the bathroom, last stall on the left, close the door and think, "What is my skill set? Where do I have a marginal advantage over other people? Where can I be a little more successful, and what will I like doing?"

Do that. You will succeed if you do that. Do not try to go and conform to other people's ideas, no matter how fun it might be. In medicine, who's the big guy? The surgeon, right? He's the big man on campus. Is the pediatrician or something like that, they have as much stature? Probably not, but you know what? Not everyone wants to go and start slicing heads open. You got to go figure out what you, where you have your little bit of advantage.

When I started on Wall Street, I had an option class in Chicago, and I'd had some computer programming there, so I could plug a computer into the wall. And I get to Drexel, we're a gigantic trading floor, we have three IBM PCs, and I'm one of the few guys that can plug it into the wall.

And they asked, and I interned there for a little bit, and I sat with the short-dated treasury option, the CD's and BA's and all the other one year on end. And this, these guys are so much fun, God, you can't believe it. It was just like in the movies, man, with the guys snorting coke on the desk and the strippers coming in and this and that, and I had the chance to go work with them, or I could start the option desk at Drexel.

And I coded up an option pricing program at Drexel, and it's like, do I want to have fun with these people or just be some boring geek? And I became a boring geek, that's what I did, and that'd be my advice to you is really figure out where you have that marginal skill that'll make you happy and do that. And if you do that, you're going to be fine.

Dan Ferris: Oh yeah, well said. And that's a wonderful message, I'll let it speak for itself. But Harley, thanks so much for being here. Really thank you.

Harley Bassman: Thank you for having me. I appreciate it.

Dan Ferris: Yeah. And you're definitely going to get another invite in the future, so be looking for that.

Harley Bassman: That'd be fun.

Dan Ferris: All right. Thanks again.

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That was wonderful fun. And I feel a trend developing in our final questions with really sophisticated, experienced, highly successful people getting more on the philosophical side than trying to say buy Exxon Mobil or something.

Corey McLaughlin: Yes, I am sensing that too. It's like everybody who's made it with money realizes it's not the end all be all.

Dan Ferris: Right.

Corey McLaughlin: But yeah, what a great interview. Great guy to talk to about the bond market. I was just kind of mostly listening. I mean, been there done that I was just reading through his, his free reports that he mentioned. If you're interested in any of this, just check that out. His latest one is like on all things, bond yields and sorry, yield curve. And like you mentioned, the mortgage backed securities and everything in there too.

So if you want a better sense of where his head's at, definitely check that out.

Dan Ferris: Yeah, go check out – that's right. Check out ConvexityMaven.com. It's very, very interesting stuff.

And also, I realized like, during our interview, 20 things went by that probably deserved further amplification. But you know, I just don't want to stop him because he's obviously a very passionate guy, I think he's a great talker. I mean, I just want to listen to him just wind his way through these ideas. It's wonderful.

And I'm glad that we finally got him on to sort of get us on the path of understanding convexity and bonds and the intersection of options and bonds. It's a really interesting topic. It's something sophisticated folks on Wall Street have been doing for some time.

And like he said his firm Simplify is doing it in these exchange traded products, which I find very interesting. I'm not recommending that you buy any of them. You know, you can check out – we had Mike Green on the show, also of Simplify. You can certainly go to Simplify's website, check him out for your own self. I simply find them very interesting because some of these strategies, like folks at Stansberry do some of this stuff.

Corey McLaughlin: Right.

Dan Ferris: Similar similar kind of stuff. And the whole discussion about a 10-year Treasury buy right being similar proposition to just buying the new issue MBS. I thought that was very interesting. There's so much there with a guy like Harley. I mean, we'll definitely have him back on. I could probably have him back on and just go through notes from this interview. And you know,

Corey McLaughlin: Right.

Dan Ferris: I mean, that's 10 other interviews, you know.

Corey McLaughlin: Exactly. There's so much you could flesh out from what he's talking about. Yeah, just a great honor to listen to him, to be honest.

Dan Ferris: Yeah, yeah, really is. I totally agree.

Corey McLaughlin: All right.

Dan Ferris: Well, that's another super fun interview and another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as we really did.

We do provide a transcript for every episode. Just go to www.investorhour.com. Click on the episode you want, scroll all the way down, click on the word "transcript" and enjoy. If you liked this episode and know anybody else who might like it, tell them to check it out on their podcast app or at investorhour.com, please. And also do me a favor. Subscribe to the show on iTunes, Google Play, or wherever you listen to podcasts, and while you're there, help us grow with a rate and a review. Follow us on Facebook and Instagram. Our handle is @investorhour. On Twitter, our handle is @investor_hour. Have a guest you want us to interview? Drop us a note at [email protected] or call our listener feedback line, 800-381-2357. Tell us what's on your mind and hear your voice on the show. For my co-host, Corey McLaughlin, until next week I'm Dan Ferris. Thanks for listening.

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