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Season 3, Episode 21: Dangers Lurk in Market Structure’s Changing Dynamics (Updated)

With Michael Green, Portfolio Manager and Chief Strategist, Simplify Asset Management

(Updates with transcript below. To get the transcript earlier, sign up to become a premium subscriber and take advantage of this and other benefits).

Michael Green, portfolio manager and chief strategist at Simplify Asset Management, joins the podcast to discuss the changing dynamics of market structure and how these are creating the potential for havoc.

Content Highlights:

  • Market structure: what it means and how it has changed (3:30);

  • How passive investing pools are changing the equation (6:26);

  • How Tesla (TSLA) is the perfect case study for this phenomenon (8:39);
  • The Fed’s impact when it comes to the bond market. This has ripple effect (13:02)

  • The interest rate and inflation outlook in the U.S. (15:34);
  • Background on the guest (20:55);

  • Passive investing has caused a host of confusing signals where the market cycle is concerned (24:37);
  • Business cycles are still alive and well, and this can of course impact the market. Where that stands today (30:05);

  • Market ‘skew’ is dramatically higher and chances of a collapse are increasing. “The market senses something is wrong.” (34:31).

More Information on the Guest:

Video Clips From Our YouTube Channel:


Nathaniel E. Baker 0:35
I am here with Michael Green, portfolio manager and chief strategist at simplify asset management in San Francisco. Michael, you and I had a pre call about this. And the basic premise here that we’re going to talk about is that investors overestimate the impact of the Federal Reserve and other central banks on markets and underestimate market structure. And I’m curious what you mean by market structure. Maybe you can get into that a bit. But I’m also interesting that, as we look forward now to the Fed meeting on September 22, and everybody’s sitting around on pins and needles to see if they are going to announce any tapering. What do you think, the impact of that, if any, will be, but yet to start off, maybe just talk a little bit about your views of market structure? What you mean by that, and why it’s more important to potentially, then the Fed?

Michael Green 1:38
So market structure literally means who are the market participants? And what are the behaviors that they’re engaged in, right, and you can think about the simplest examples of market structure that have occurred over the course of my career, which spanning 30 years now would include things like the ending of the traditional specialist structure on the New York Stock Exchange, or on the American exchange, the collapse of the multi regional exchanges, you sell the Pacific exchange out here, the traded options on a regular basis are the ones one of the primary repositories of options. You had the introduction of decimalisation, right, you’ve had the introduction of high frequency trading, you’ve had the collapse in interest rates, that influences not just the underlying behavior of market participants in terms of how they value a discounted stream of future cash flows, which is certainly an impact, but it’s a little bit less clean than I think people would generally think about. But more important than that, I would actually see us the loss of that kind of high yield or relatively high reasonable return, you know, 2000, you could have gotten five and a half to 6%, from the US 10 year Treasury. Today, you’re looking at one and a half percent, which has forced people into the market for all sorts of alternative yield structures, things like selling call options, or underwriting put options to generate additional yield on their portfolio and obtain the income that they feel they’re being deprived of as they approach retirement. So that behavior is ultimately what I’m referring to when I talk about market structure and behavior of the internal participants.

Nathaniel E. Baker 3:08
Got it. A big one you didn’t mentioned was index funds and the move to passive investing is that one another one there.

Michael Green 3:16
I had a sneaking suspicion we were going to bring that one up in a future discussion. But yes, to me, that is actually the single most important structural change that has occurred in 1996. If you had looked at the market share of passive investment strategies, it would have been somewhere in the neighborhood of 2%. Today, that number is 2% of the US market capitalization. Today, that number is somewhere in the 44% range. And that’s a combination of passive index mutual funds. ETFs, what are referred to as total return swaps, futures, all sorts of indexing strategies that would also include things like commingled investment trusts, CIT is with basically non registered mutual funds that operate slightly lower costs and are often offered in things like 401, KS and IRAs, etc. So those have exploded in size in a manner that almost nothing else can really compare in my analysis, at least.

Nathaniel E. Baker 4:12
Interesting. Okay, so now where does that leave us? And I know that you’ve studied past market cycles past market bubbles, and what does that mean that now for for the current state of markets, that this is all driven by are mostly driven by passive funds and the other things that you mentioned changes in market structure?

Michael Green 4:37
So put yourself in a very simple simulation and just imagine that you have only two types of investors a quote unquote value investor and an index investor, right. The value investor is going to see an increase in price that is not supported by any similar increase in fundamentals as indicative of lower future returns to that Security and will typically be induced to sell. Right? So this is proprietary research that I did over the past couple of years. It’s one of the surprising things. I’m surprised nobody else had thought to survey the investor base and ask this question. But if you survey investors and portfolio managers, and you ask them the very simple question, how do you respond to an increase in valuations, your discretionary manager will say, higher valuation makes you less likely to buy more likely to sell right? Now passive investor, a systematic investor in an index is going to behave actually in the exact opposite behavior. Because when something goes up in price, it becomes a larger share of the index and subsequently captures a larger share of your incremental investment dollar. In other words, you will have a higher propensity to invest on a marginal basis in that security that is appreciated than you otherwise would have, right. So the two investor behaviors almost can’t be thought of as more different. The market weighted passive investor is going to reinforce momentum behavior prices moving higher begets more buying the value investor, the systematic discretionary value investor, who is sorry, the discretionary value investor, who is looking at it from a forward expected return, can Intuit some improvement, some uncompensated or unintended, not yet indicated improvement in fundamentals associated with that price increase, but we always call the what is being priced in, right, but all else equal, they will have a higher inducement to sell. And so when you replace that discretionary value investor, a traditional investor with a systematic passive investor index investor, you’re absolutely have to change the market’s reaction function as the weights between those two investors change.

Nathaniel E. Baker 6:50
Interesting and to illustrate this, we can take the example of Tesla, right. So this is an individual stock that that, as we all know, run up quite a bit over the last couple of years, and was just recently included in the s&p 500. Now, if you’re a traditional, you know, value investor, like you said, and you bought Tesla at 100, or something, you have, at some point probably started shedding these at your holdings, and maybe even sold all of it, except for maybe a small portion. But if as it it’s included in the s&p, and it gets it becomes a larger part of the s&p index holders are obligated to buy this stock, just to match what it’s doing in the index. Right?

Michael Green 7:31
So Tesla is almost the perfect example of this, right? And the reason why it’s the perfect example is because we actually have within Vanguard, two separate types of investors that own Tesla, so Vanguard has, the vast majority of their assets are passive and index oriented. But they have also a subset of sub advised funds that are run by firms like Wellington and Bailey Gifford. They’re actually managed on a discretionary basis. Bailey Gifford was one of the larger discretionary holders of Tesla articulating that they thought forward expectations in terms of performance and the transition to electric vehicles represented significant untapped potential, and they believe that Tesla would appreciate over time, as Tesla began to rise, as it was facing inclusion in the index and index arbitrage wars, those who buy and sell in anticipation of the index participants playing as they began to drive the price up recognizing the vanguard would have to buy somewhere in the neighborhood of 40 million shares. That discretionary arm of Vanguard actually sold into that event. Right. So we actually can see Vanguard’s holdings, they needed to buy about 40 million shares in total, about 10 million of that extra 11 million of that actually came from within a Vanguard discretionary fund.

Nathaniel E. Baker 8:46
So obviously, fundamentals are no longer driving this market. If that’s what’s going on, if you have the indexes moving and that being the type of thing that requires portfolio managers to add these holdings,

Michael Green 8:58
well, I would just encourage people to reorient your thinking, right? Because when we talk about fundamentals, and we say, you know, what is going to happen to Tesla, ultimately, that’s my opinion, or that’s the opinion of the Bailey Gifford portfolio manager or analysts or Cathy Wood, etc, right? Those are opinions. And if you look at the forecasts from an ark investment, or you know, they’ve published their resources, their research, etc. It doesn’t remotely resemble what has actually happened to Tesla, right? If we go back two or three years ago, we look at their forecasts that was for a million robotic taxis being driven around on the roads as of today, right now, I personally have not been run over by a Tesla robotic taxi. So I’m guessing there’s not a million of them out there. But the price is dramatically higher, right. And we can explain the price but what I would describe as the true fundamentals, which is people being forced to buy and sell.

Nathaniel E. Baker 9:50
Okay, so where does that leave us now? And yes, this may over estimate or over Yeah, the impact of the Fed because just It’s just been like, okay, the Fed makes it makes interest rates higher. And that makes money more expensive for people to borrow and therefore, some risk comes out. But does that still hold true? In your opinion, as we look here towards the Fed tightening cycle, potentially?

Michael Green 10:15
So I think it does. But I think that people, you know, the difference between the Fed putting interest rates at zero and the Fed putting interest rates at 25 basis points, like, if you’re truly making an investment decision on the difference of 25 basis points, that’s just silly. Short, right? Like, the uncertainty around just goes back to the point of the fundamentals on Tesla, right, the uncertainty around the fundamentals of Tesla, are so large that that change in discount rate of 25 basis points shouldn’t have any meaningful impact, right? When you think about the cost of equity for a company like Tesla, a tiny fraction of that, certainly today is going to be the risk free component of it, the vast majority of that cost of equity is going to be the uncertainty associated with the forecasts that you’re making for a company where we really have no good idea for what their fundamentals look like going forward, right. So you should discount that relatively heavily. It should lead you lower valuations honestly than what we see. But when you think about the Fed hiking, or lowering interest rates, it has another impact that’s actually quite dramatic. And this was written about by an academic, Jonathan Parker at MIT, who highlights that the Fed has a different impact. When the Fed raises or lowers interest rates, it directly affects the pricing of bonds, and it changes the value of that collateral. And so again, when you think about the actual fundamentals, if I run a balanced portfolio, to a target date fund, for example, that is required to have a weighting of 70% equities and 30% bonds, when I enter into an event, like the events of March 2020, where the equities have fallen, and the Fed is cutting interest rates causing the bonds to rise. My Portfolio becomes unbalanced fairly quickly, and I’m forced to sell bonds and buy equities. Right. So nowhere in there, is there a discount function nowhere in there Am I saying I think equities are more attractive because bonds have, you know, risen in price or because the interest rate is lower. It literally is just a mechanical rebalancing process. And target date funds now represent the vast majority of the incremental dollars flowing into retirement funds.

Nathaniel E. Baker 12:30
Is that right? Wow. Okay. So yeah, so then, you know, the Fed tapering, which would could potentially lead to well, you know, taper tantrums or whatever. I mean, a 10. year has been the yields have been going up a bit, which is implies that, you know, maybe investors are getting ready to sell, especially if there’s a surprise around the tapering announcement, although wouldn’t be a complete surprise. Yeah,

Michael Green 12:53
I think the challenge is, is that we don’t really know, right? So you can create coherent arguments on both sides in terms of the behavior of interest rates, in general, the perception that the Fed is going to taper tends to lead that excuse me, tends to lead to lower longer term interest rates rather than higher because the market is effectively saying they are removing stimulus that is more likely to lead to conditions in which they need to cut interest rates further in the in the future, right. We’re seeing this quote unquote, perplexing behavior where the narrative that exists in the public process is that the Fed is actively suppressing interest rates, what I would actually argue they’re doing is suppressing credit spreads. They are reducing the cost of risky credit. But if anything, they’re probably inflating the cost of government debt in terms of

Nathaniel E. Baker 13:48
Okay, so you would it sounds like maybe you’re in the camp, that the yield is a little bit overvalued at 1.3%.

Michael Green 13:54
I think it’s I think it’s very hard to argue that the US has too low interest rates when I look around the world and I see negative yielding 10 year paper in Europe or in Japan. Certainly there are differences in terms of inflation, although those are overstated, and largely tied to the way that it is measured. Europe has a different measure of inflation than we have in the United States. It understates the cost of housing component. And if you normalize for that the European experience and inflation is not meaningfully different than the US experience and inflation. Japan has similar characteristics where fresh food makes up a disproportionate amount of their index. And so I think we tend to get way too focused on measuring, you know, things in, you know, tenths of a percent right, you know, as us inflation 3.3% or 3.1%. That’s not really what’s driving anything.

Nathaniel E. Baker 14:50
Right. Right. Right. So do you think that inflation is transitory then?

Michael Green 14:56
the term stochastic means we don’t know, right? It’s uncertain the future and the Spend it upon various things, there are components of inflation that definitely feel like they have crossed the Rubicon in terms of their characteristics. But one of the points that I always highlight to people and anyone who’s heard me before, I certainly talked about this over and over and over again, the characteristics of inflation have always been associated with fundamental underpinnings in terms of an outward shift in aggregate demand, right? You either have a catastrophic inward shift in supply of which we’ve just experienced, right, so the pandemic was a significant inward shift in supply by disrupting, you know, very complicated supply chains, and creating conditions under which toilet paper suddenly wasn’t showing up on the shelves, right? That disruption to the supply chain is working its way through and will eventually renormalize barring an escalation with China barring an escalation in a variety of other ways, barring a return of you know, Coronavirus and reshot down to the economy. Like there’s all sorts of things that are happening there, that we don’t know exactly what’s going to happen in the future. But I would, I would caution people to look at the history that we are intimately familiar with the history of the 20th century, which is one of the most inflationary centuries in history. and point out that that century is totally unique in human history for the explosion in human population, and hence the outward shift in aggregate demand associated with it. As we look at the 20th century, we began the 20th century with roughly a billion people in the global labor force. And a worker is simply somebody who says I want to increase my consumption, therefore, I’m willing to trade off leisure time for increased purchasing power, right. So we started out with a billion people, we ended with somewhere in the neighborhood of five and a half billion people, using un population projections, which are hopelessly overly optimistic in terms of population growth. The 21st century looks basically like a move from five and a half billion people to 6.2 billion people. There’s almost no growth whatsoever. Alright, so to see the 21st century in the same inflationary characteristics as the 20th century, to me is very problematic,

Nathaniel E. Baker 17:09
Yeah. And that would certainly change the equation a little bit. All right, cool. I want to come back and ask you some more about this about the historical, you know, interest cycles that we’ve seen, and some other stuff. But first, take a quick break.

Welcome back, everybody here with Michael Green, portfolio manager and chief strategist at Simplify Asset Management. Michael, this is the segment of the show where I like to ask our guests about their background, their professional background and how they came to this state of their career. So yeah, how did you how’d you get started, and you take us back and tell us about that.

Michael Green 18:05
So I, you know, I started in a fairly traditional manner, I went to the University of Pennsylvania graduate from the Wharton School of Business, went to into management consulting, because I was really interested in understanding how businesses work, I worked for a firm called Bain and company and then left to co founder firm called the Parthenon group. And built an expertise, you know, to the extent a 26 year old can have expertise in valuing business units, and along with a couple of peers started a software company in the mid 1990s, that codified those insights. We sold that in 1999, at which point I transitioned to the asset management space, using those tools around valuation. Now the irony, of course, is that puts me into the camp of the traditional value manager, right? You know, my thought process was largely around forecasting the individual free cash flows of a company are figuring out its cost of capital and discounting that back exactly in the manner I was describing for the traditional value manager. I think the one kind of wrinkle that I brought to the table was early on in my Bain career, I was exposed to the idea that industry and sector are far more important determinants of company return at least over a cycle than the individual company itself. And so while there’s a number of asset managers who do very well by identifying and Phil Fisher, common stocks, uncommon profits for framework, you know, the exceptional holdings that power markets, higher the apples, etc, the world, my focus was always on what was the sector or industry that I thought was well positioned for a second section of the business cycle that we were in. That naturally led me to begin to focus in the macro space. And I initially ran separate accounts and mutual funds, mutual funds for a firm called Royce and Associates. Then left was recruited by a firm Canyon partners who was one of the first clients of our software company. And that was my introduction to head For hedge funds in the 2006 to 2008 time period, I became very focused on the housing bubble and participated in canyons trades around that and coming out of that, you know, built an expertise around the use of derivatives for hedging portfolios, expressing bets, etc. We’ve kept Canyon partners i’d founded their New York office built it up to a team of about 15 people and several billion dollars in assets was recruited out of Canyon partners to launch my own firm seated by George Soros. And then that was an epic disaster. That was a story that’s well told in other places, performance was fine, but the business dynamics, the unfortunate dynamics around the business, were challenging. And that, you know, ultimately led me to shut that down. And then, you know, I’ve done various activities the most, the thing I’m most known for is is managing a chunk of Peter TEALS personal capital in the period from 2016 through 2019. And being very proactive in terms of predicting the vol mageddon events of February 2018, and positioning Peter to take advantage of that.

Nathaniel E. Baker 21:13
Okay, interesting with the volume again? I’m trying to remember.

Michael Green 21:16
That was that was the collapse of XIV.

Nathaniel E. Baker 21:19

Michael Green 21:20
inverse, the inverse VIX ETF

Nathaniel E. Baker 21:24
Right, right. Well, this all kind of begs the question, Where is that current cycle? And what sectors do you think are most like?

Michael Green 21:32
So this is part of the dynamic that I think is is unfortunate, because when you move to passive investment, and the marginal flows have shifted so aggressively to passive asset management, that there is no money, there is no marginal money going into the discretionary manager, all that’s happening is actually discretionary outflows. What that means is, is that passive managers actually have a negative impact, right, because they’re constantly being forced to sell the names or the areas that they have insight on, and buy back areas that they might have been short, from a fundamental standpoint, right? That creates very confusing information flows in terms of the market, because as they sell, they depress the price of areas that should theoretically be going higher, and they’re propping up the price of areas that they should that they want to short that they think should be going down. And that then in turn, is amplified by the passive investment vehicles, which look at those marginal activities and continue to buy right and extreme example is we talked about Tesla. If you look at a company like Nikola, which is a competitor to Tesla, pretty much, at least from what I understand, at this point, certainly not investment advice has been acknowledged as a fraud. The founder has been sued for fraud. It was a SPAC that had no revenues, candidates, you know, contract with General Motors has been cancelled. And you know, if you look at who are the largest holders now, or who are the buyers of that security, it’s Vanguard, BlackRock, etc, the passive players continue to buy because it is part of the indices. And they’ve managed to support what is again acknowledged as a business with no underlying fundamentals, it still has a valuation somewhere neighborhood of $5 billion, which feels like nothing in today’s world, but that’s a big company, right? That’s a lot of money. And so you’re, you’re getting very confusing signals in the market, right? It also creates an underlying condition, where the structure of the indices reinforces much of the behavior that we kind of wonder about, right. So when you think about the way that your typical discretionary managers portfolio is constructed, they’re going to be seeking out single names that they think that they can have disproportionate insight on, inevitably that biases them towards smaller names that are less researched by other players. And in many ways, a portfolio manager on the discretionary side has limitations in terms of how diversified their portfolio or concentrated their portfolio can become right. They have rules around diversification. They’re actually for mutual funds and ETFs, explicitly encoded in the Investment Company Act of 1940. Right, right. Well, index funds aren’t subject to those same rules, because they’re trying to match the index. And in fact, the SEC has granted waivers against many types of index funds, in particular large cap growth funds that allow them to run in a much more concentrated fashion than they should be able to under the letter of the law. It’s what’s referred to as a no action letter, right? So as they capture incremental money as the dollars flow into passive, that means by definition, no discretionary manager can hold as much Apple as an s&p 500 Growth Fund, right. So you fire the active manager, you replace it with the s&p 500 growth or the qq Q’s, and you’re creating a natural bid for Apple, right, there’s less being sold out of the discretionary manager portfolio than is being bought in this in the index portfolio. As a result, what happens to the price of Apple, it puts is higher relative to the rest of the market, even though we all acknowledge that Apple’s growth days are largely behind it,

Nathaniel E. Baker 25:07
unless they get a car.

Michael Green 25:09
Even if Apple were to get a car, I think the underlying feature remember on a car is that it is dramatically lower margins.

Nathaniel E. Baker 25:17
No question. Okay. So basically, the whole idea then of cycles is kind of cast into question a little bit. Now, this is not the first time we’ve had that. You’ll recall the late 90s, when they said business cycles didn’t matter. I’m not saying that’s what you’re saying here. But I mean, ultimately, there is still some kind of, you know, be the consumer, be it whatever. It’s something that drives the overall economy, isn’t there?

Michael Green 25:50
Well, when you say drive the economy, we certainly haven’t banished business cycles, right? We’ve had a profit cycle in 2014 to 20, you know, give or take 2018, right, where us profits didn’t grow and actually declined leading into the pandemic pandemic was kind of the penultimate dynamic on that semi, you know, the stimulus that emerged created the trough for the earnings stream for the s&p 500 and for other components. But we’ve absolutely had business cycles, right? What seems to have deteriorated or market cycles, and they’ve been replaced by you know, what I would describe as a roller coaster experience of long climbs punctuated by you know, momentary panic as the market plunges only to, you know, rise back again, again, on what people generally ascribe to the feds stepping in to provide support. I just reiterate the conversation that we had before, right, there’s a systematic component to that, that I think people tend to under appreciate.

Nathaniel E. Baker 26:44
Got it. Okay. So, but then now, do you see things getting a little bit? Like is, are we still expanding? Here with with the business cycle, because one does impact the other? I mean, okay, there’s no more market cycles are there. But still, you can still have massive periods of risk off. And, I guess, risk on like we saw from last March until the present day, pretty much with a couple hiccups.

Michael Green 27:09
So yeah, I would separate the two, right. So absolutely. Market cycles, contribute to business cycles. So when asset prices fall that causes consumers to feel less confident, and they tighten up their purse strings, which can create a profit cycle, all else being equal, I think that’s going to become particularly important, as more and more boomers face retirement, not with the defined benefit plans or high levels of fixed income that their parents enjoyed, but with much higher fraction of their income tied to the variability of equity, market performance, and the much lower levels of dividend yield, and interest rates that we have today. So asset prices becoming a larger contributor to the wealth effect. The That, to me feels far more plausible, than significant earnings declines driving a collapse in the stock market absent again, a what I would refer to as a technical or fundamental feature around stock market repurchases, right, share repurchases. But even there, you know, we’ve seen cycles around that where it has less impact than you might otherwise think. And this is one of the perverse dynamics for me around passive is that reinforcement that we were referring to, to before it takes two forms. One is it has this characteristic of reinforcing momentum, reinforcing the growth of the largest stocks which become larger and larger within the indices. The second thing that happens is the passive investment vehicles don’t hold cash. Right now, that doesn’t seem like it has a huge impact. But if you very simply imagine just the simplest model of the world that could possibly exist, right, so as $1,000 total invested in markets, your typical discretionary manager is going to carry somewhere in the neighborhood of 5% cash, at least historically, right? So $950 worth of equities, and $50 of cash out of that $1,000 that has been invested. That same portfolio construction and same market construction under a passive is going to try to own 100% equities with almost no cash. In fact, the largest mutual fund complex is the vanguard total market index. It’s roughly a trillion dollars in a u-m depending on which classes that you want to include with variations, and cbits. And everything else that you want to include. It has negative $100 million dollars in cash, right? So trillion dollars in assets with negative 100 million dollars in cash. Now they have lines of credit that they can access etc. But there is no substitute for that. Right. And so, you think that the impact of that would be to raise asset prices by give or take 5% right, so I go from 95% equity to 100% equity, equity prices should go up by 5%. Unfortunately, that’s not the way it happens. Because when you buy and sell, you can’t destroy that cash. Cash remaining. And so if you’re moving from active managers, to passive managers, what you actually are doing is changing a cash preference. And since cash has zero variability, right $50, cash is always going to be $50 cash. The only way that that can actually be accommodated is through higher equity prices. Right. In other words, if I want to make that 50 0.1% or 10 basis points of the market, I have to raise equity values to 50,000, away from 950, to 50,000. So a move from 0% of passive to 100% passive causes more than a 50x appreciation in equities. That covers a lot of sins right now, we’re not going to get there because that increase also creates much higher volatility. And I would argue that’s part of what we’re seeing in the markets, we’re seeing dramatically higher level higher levels of what’s referred to as skew, the market is pricing, the deep out in the money, the true risk options that the market collapses by 50% or more over the course of a year. Those are being priced at the highest premiums relative to realized volatility that we’ve ever seen in history, the market senses Something is wrong.

Nathaniel E. Baker 31:10
Yeah, but then how does this whole thing turn? I mean, if there’s so much index, mutual funds out there, and they need to keep buying to rebalance, then what’s going to cause the indexes to drop?

Michael Green 31:22
Well, I think there’s two things that cause it to drop, right one is, is that the larger passive gets as a share of investment, the less of a, what I would refer to as a quanta, or less, the less is required, the less selling is required to stimulate a collapse in the market. Right. Right. So I would point to what happened last March. And the way I would describe the pandemic collapse is active managers sat there in the January, February, very beginning of March period, deeply confused because this was not concealed, right, we knew the pandemic was occurring, we knew that China was shutting down, right, we knew that Italy was in serious problems that the US began to see cases in New York, etc. And yet the markets appear to levitate, right? For someone who’s looking to the market information for the quote unquote, expectations channel, what is actually happening? that’s confusing, right. And, you know, you heard Bill Ackman and others talk about it, like something’s wrong, I don’t know what’s going on my spidey senses tingling, I’m going to go out and buy insurance, right? And you bought credit default swaps. What we saw happen in those events is finally the active investor community broke, they tried to de risk and they found there was nobody to buy from them. Right? Because the passive managers, the minute they’ve bought what has been handed to them in dollar terms, they don’t look at it and say, Oh, the market is on sale. Let’s buy more. Right? They’re full. That’s it. They don’t show up. And so it contributes to what what is mechanically referred to as an increase in elasticity in the market, right. And so inelasticity is effectively How much does price change for a change in supply and demand? And the really staggering statistic. And Vanguard released this as a point of pride, they noted that less than 1% of their customers transacted in unusual manner around March 2020. Right now, 1%

Nathaniel E. Baker 33:22
Okay. 1%.

Michael Green 33:23
Right. Now my reaction is, what would have happened if it was two or three, right? And my simulations basically suggests that that creates conditions very similar to what we saw transpire with the XIV where in a single day, it went to zero.

Nathaniel E. Baker 33:40
Yeah. I mean, it’s interesting, though, that that was still a COVID was still an exogenous shock. Yeah, we saw coming. Yeah, we knew it was happening. But and Failing that, again, you know, that doesn’t seem to really be anything that can kind of turn the whole thing on its head.

Michael Green 33:56
Well, the simplest thing that turns it on its head is that the natural byproduct of raising the value of people’s retirement accounts is that withdrawals for much retirement accounts or pension plans take the form of percentage withdrawals, right. So if I take 4% out of a billion dollar 401k, that’s a lot more money than would be contributed on a continuing basis, right? market goes up 50x the contributions are a function of income, the withdrawals are a function of asset value. And as we move closer and closer to the baby boomer retirement, it’s simply a matter of time before those to flip in terms of their weight. Now, that has been camouflage and its impact because when we talk about passive being 44% of the market, it’s very it’s not homogenous is it you know, in the way that most people think about it, right? So you think 44% that means I own 44% passive and you own 44% passive, and that means 56% of what we hold is, is either held directly or through active managers, right? That’s just not how it works. You are Probably, you know, X percent passive, the vast majority of passive or the vast majority active. And importantly, it’s largely stratified by age. So those under the age of 40 are north of 90%. Passive according to most estimates, those who are over the age of 65, who represent about 70% of the assets are only about 20% passive, right? So what’s actually happening with the continual redemptions and sales that we’re seeing from the active manager community is simply that their client base is really old. And they aren’t getting any new clients.

Nathaniel E. Baker 35:34
The baby boomers have been retiring for some time. I mean, I think of my parents, my mom born 47. Right. That’s kind of a, I guess that’s very beginning of the baby boomers. Yeah, yeah. So right, would it take? When does that whole thing culminate and end if we do the maths here, like the oldest baby, your parents still married? Yes. Okay.

Michael Green 35:55
So your mother retired, probably 62 is, is the typical age for which a female married relationship begins to retire. So retired 99, basically, are 2009.

Nathaniel E. Baker 36:05
I’m sorry. Yeah, I think it was later. 2009. Yeah, I can’t remember.

Michael Green 36:10
That would be fairly typical. There has been the baby boomers, their maximum retirement age is 60, or their target retirement age is 67. Right. So born, the peak of the baby boomers was 1957, that would put you, you know, somewhere in the neighborhood of 2024, would be for that individual. Now, there’s been a number of changes that have happened from a policy standpoint, under the Trump tax reform, we extended that to 72 in terms of the age at which you’re required to begin taking what’s called required minimum distributions. From the tax deferred, we’re now talking about eliminating those entirely, effectively creating conditions under which people never have to take distributions from 401 K’s, which unfortunately, just means the very wealthy people never have to pay taxes and those who actually need the money to eat pay taxes, right? That kind of sucks is I think, the technical term for it, but it is under lobbying from the industry. So those those factors play through. But ultimately, once you approach dramatically high level, higher levels of passive, a second feature begins to interject itself into the market, which is that the markets become dramatically more volatile, right, that inelasticity manifests itself in increased uncertainty around what the price of an equity is going to be at any point in time. And as a result, that actually naturally leads to a similar deleveraging. And so they’re going to get sold in one form or another. We just can’t predict with 100% accuracy when that’s going to force Yeah, of course. But it does sound like to your point that the major move a lot of baby boomers are saw in the workforce and the peak, a lot of baby boomers are in the workforce and have delayed retirement have done everything they possibly can to keep their money working in the markets, including owning much higher levels of equity than they would have historically because of the deterioration in the yields available to them in fixed income, which they should be naturally de risking to.

Nathaniel E. Baker 38:07
That’s a good point. Yeah. All right. Very good. Michael Greene, thank you so much for joining the Contrarian Investor Podcast that I maybe in closing, we could you could tell the listeners how they can find out more about you. I know you’re active on the Twitter, @ProfPlum99 is your handle there is that it is our website to perhaps

Michael Green 38:27
Absolutely. So simplify, we offer ETFs that are designed to take advantage of our insights and thoughts around the market. We are taking advantage of the rule changes that were introduced in 2019 and 2020, that allow ETFs to do many of the strategies that I historically have done in hedge funds and have only recently become available to the public markets or to the non accredited universe. Our website is And you can register there for information around our products. And as you mentioned, you can follow me and my colleagues on Twitter, I’m @profplum99. And then of course, simplify is fairly easy to find it’s si MP l i f y.

Nathaniel E. Baker 39:10
Yeah, is the website again. So thank you all for being with us today. Thank you, Michael, for joining us again. And we look forward to speaking to you again next time.