X Risk and Inflation Hedges: Investing in Volatile Times

Join Andrew Wilkinson as he discusses volatile markets, inflation hedges, and “X Risk” with Steve Sosnick, Chief Market Strategist, and Jose Torres, Chief Economist. Together, they unpack the November jobs report, Fed policy shifts, and strategies for navigating uncertainty in the year ahead.

Summary – IBKR Podcasts Ep. 212

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Andrew Wilkinson 

Welcome to our monthly economics and markets edition of this IBKR podcast. Joining me today, Steve Sosnick, Chief Market Strategist, and Jose Torres, Chief Economist. Welcome, gentlemen. How are you? 

Steve Sosnick 

Wonderful, Andrew. How are you doing? 

Andrew Wilkinson 

Doing all right. Nice and cold up here. And I think we should bring Jose up here this week as well from the Florida sunshine, just because he deserves it. 

Jose Torres 

Interesting you two mentioned that—I literally just booked my ticket three minutes ago, so I’ll see you on Wednesday. 

Andrew Wilkinson 

I’m looking forward to it. You can take us out for dinner.  

All right, in terms of a timestamp, we’re recording today’s podcast following the November jobs report, but just before the consumer price report, which is going to drop later this week. So, Jose, let’s start with you and the positive November employment report. I think about 226-ish thousand jobs created, and the unemployment rate ticking up to 4.2%. Give us your thoughts on the dispersion of hiring, etc. 

Jose Torres 

Sure. It was a pretty strong report, especially considering that the October report was hampered by the Boeing labor strike as well as two natural disasters, which were unfortunate. But that number got revised up from 12,000 up to 35,000 or so roughly. The previous month also benefited from upward revisions, and November’s report came in slightly above expectations. The Street was expecting around 225,000; it came in slightly above that. The unemployment rate ticked up from 4.1% to 4.2%, mainly driven by labor force exits. 

When the labor force declines, the labor force is the denominator in the unemployment rate calculation. So, if the labor force declines, that actually has upward pressure on the unemployment rate. So, we sometimes have a dynamic where we add jobs, but the rate of joblessness increases. Part of that is one survey—the establishment survey—is hard data served off of spreadsheets. On the other hand, however, the unemployment rate comes from the household survey, which are BLS field economists, census economists calling folks, showing up at the doors, asking people. So, it’s more soft data. It’s more variable to how people feel in that particular moment, whereas the hard data is more concrete. 

With the changing administration beginning next month, we have to really analyze the labor force dynamics as they relate to immigration. Because if we have folks that start to go back to their homes—international homes, going back to the countries that they came from—because they’re scared of potential immigration enforcement stateside, then you could have the unemployment rate tick up higher because of that same dynamic I explained earlier: labor force, the denominator, declining. 

Wage growth is still strong against that backdrop. It’s important to understand because we could start moving into labor scarcity. Wage growth was strong—0.4% month-over-month. The Fed still needs to worry about inflation with those kinds of numbers. 0.4% month-over-month is not consistent with 2% inflation, especially in labor-intensive services. Kicking it back to you, Andrew. 

Steve Sosnick 

Can I ask Jose a question? Apropos of the last thing—the labor force, it’s interesting because the dip in the participation rate was either 0.1 or 0.2%, but the labor force is so huge. It’s, what, 200 million people plus, give or take. And so, the 200,000— is that 0.1. I know they’re different surveys, but it’s interesting that we worry about this very tiny, marginal number on both sides. But yet, it gets lost in the picture of the 62.5 versus 62.6,  I think it was for the labor participation rate. 

And, ultimately, that’s a rounding error for the labor force participation rate, but that’s a big number for the non-farms payroll number, the magnitude of which struck me. 

Jose Torres 

Absolutely, Steve. And one thing we’ve been looking at is we want to get to pre-pandemic levels on the participation rate, right? We want to get to that point where folks, generally speaking, need work. They want work. They want to improve productivity. So, we’re looking for 63.3%. That’s February 2020. The pandemic changed a lot of things—work-life relationships, a lot of early retirements. Folks, their portfolios ballooned. If you had a second or third property, God bless you. A lot of folks in their late forties, early fifties retired. Some of the children, the grandchildren also benefited from those tailwinds. 

So, really shifting labor markets. And I think with Trump 2.0 and the red sweep coming into Washington next month, especially against the backdrop of a lot of policy shifts, a lot of talks about government funding relaxations or decreasing budgets in a lot of departments. That’s critical, ladies and gentlemen. 

Remember, most of the job growth has been concentrated in non-cyclical industries, right? It’s been more government, it’s been healthcare, it’s been education. In fact, in last month’s report—November’s report—79,000 jobs came from education and healthcare. 33,000 came from government, right? So right there, you have over a hundred thousand jobs—roughly half the total—coming from those non-cyclical industries. Other sectors we have to wait and see. We’ve been seeing that there is a lift in business sentiment, business confidence. Folks feel pretty optimistic about lighter regulations, lower tax rates, and the onshoring push in terms of manufacturing. We’ll see if those cyclical sectors start to ramp up as the new year rolls in. 

Steve Sosnick 

Might the wealth effect be fighting the labor force participation rate? The fact that, at some level, if I bought Bitcoin at $20,000 and I’m holding it at $100,000, maybe I’m not interested in going to work 40 hours a week. That kind of thing. Or stocks are doing so well, so you can retire early. It’s a fascinating dynamic that, in some ways, we’re upset that the labor force participation rate is declining, but one of the reasons it’s declining might be because people actually have enough money that they don’t need to work. It’s a pretty fascinating dynamic, which I guess, as you said, will play out over the next weeks, months, whatever. 

Jose Torres 

Medium to long term, because work and productivity—that’s really the fundamental underpinning usually of markets, but now not as much because automation is really dominating investment portfolios now as a theme, if you consider technology and AI and all that. So, I think we’re going to keep watching those trends to see how less labor-sensitive the market is and how less labor-sensitive the economy is. It’s going to be really interesting to watch. 

Andrew Wilkinson 

Steve, do you think it did anything either pro or against the Fed moving rates in December? 

Steve Sosnick 

You can argue it did both. As Jose had mentioned, the stronger monthly average hourly earnings definitely pushed the stable prices of the mandate away from where the Fed needs to be. You can argue the higher unemployment rate pushes us maybe a little bit closer to needing to intervene on the employment side of the mandate, but it’s an interesting push-pull. 

Because Powell more or less pushed back on the idea of rate cuts when he spoke at the DealBook conference, which was his most recent speech, basically telling people, “Hold your horses,” to some extent. Meanwhile, the market pushed ahead with rate cut expectations anyway after the number. So, I’m actually thinking now that there’s this feeling, at least amongst the market—and I certainly can’t speak for the FOMC—I’m waiting for the Nick Timiraos article two days before the Fed meeting to tell us what to expect in case it’s an in-play meeting. 

But basically, the way I’m viewing it here is that I think we’re going to see the Fed do one last rate cut before a wait-and-see, because I think they don’t really have a sense of what’s going to come down from a fiscal point of view, and nor should they. Nor will we! You know, the new administration doesn’t take effect until January 20th, which coincidentally is the Martin Luther King holiday, so we’re actually closed that day. And there are certain policies that the incoming president said he wants to implement via executive order. 

Starting January 21^st, the whole picture can be quite different because I can make a case for and against tariffs. I can make a case for and against deportations. And these all have very huge, potentially economic impacts. So, if I’m the Fed, I’m going to maybe do what I want to do and then get out of the way. And I guess to Jose, do you expect any big changes in the SEP [the Fed’s Summary of Economic Projections]? Because for the first time in a while, I think the market is not ahead of the Fed. It’s actually a little bit less aggressive than the dot plot. Do you see the Fed backing off the dot plot a little bit? 

Jose Torres 

I’m quite in the middle, Steve; I don’t have a clear answer there. And the reason is, this Fed has really surprised me. In 2022, we heard a lot about Volcker, we heard a lot about economic pain, right? Then, after March 2023, we had the Regional Banking Crisis with SVB, Signature, First Republic, etc. 

And then, all of a sudden, there just seemed to be such a strong bias to ease at every juncture. Starting with September—September was a 50-basis-point reduction, which you mentioned the Wall Street Journal dynamics, which I think occurred back then, as well, on the weekend. All of a sudden, on Sunday, everyone was talking about a 50-basis-point reduction, Steve. We were all on 25, and then Sunday, everyone’s talking about 50, and I’m like totally offsides because I don’t see it. And then Powell comes out and dishes out 50. 

Andrew Wilkinson 

I went for 50, by the way, just to remind you. 

Steve Sosnick 

Well, it was, not to confuse, It was 50-50, about 50 versus 25. I shared the opinion with you, Jose, that I’m not even clear that we needed 25, let alone 50. But I think the Fed is so biased toward—biased away, I should say—from upsetting markets or scaring markets or upending markets, that I think that story was completely planted to get people on the 50-basis-point side, giving the market a couple of days to adjust rather than having to do it between 2:00 and 2:30 p.m. on a Wednesday afternoon. That was my take on it. 

Jose Torres 

Steve, we hosted Nouriel Roubini and Steven Miran a few months ago on a podcast here at Interactive Brokers about activist Treasury issuance. With that amount of stimulus—the fiscal stimulus so ferocious—I thought that the Fed should have pushed back on that, right? Especially when Chair Powell always talks about how government debt is unsustainable, right? 

What can the Fed do if government debt is unsustainable? As an offset, the Fed can have a more restrictive posture, have a bias toward a more hawkish stance, rather than an easier stance. In fact, two weeks ago, I was with Michelle “Miki” Bowman, Governor of the Fed, and she was very hawkish overall. She is one of the more hawkish governors, but she thinks that the Fed funds rate probably doesn’t have much room to go much lower. She sounded like she was more in the pause camp rather than keep going lower. 

Steve Sosnick 

Wasn’t she the lone dissenter [at the November FOMC meeting], if I’m not mistaken? 

Jose Torres 

She was the lone dissenter, Steve. She was, yes. And up here a little bit north of where I am in West Palm Beach, she gave a presentation, and she let everyone know that she thinks that we’re pretty close to neutral at this point. 

Andrew Wilkinson 

Interesting. 

Jose Torres 

I’d agree. I’d agree. CPI is going to be 2.7%, okay? The reason we have disinflation at all is because commodities and goods have declined in cost. The labor market is still strong. Services are still strong. And you know what? If the Fed keeps trying to defend asset valuations, they’re gonna destroy the labor market. No one’s gonna wanna work soon. 

Andrew Wilkinson 

Brilliant. Next question I have for Steve—he said in one of his Traders Insight articles last week that all the email that’s coming in, he’s inundated with that question when will this end? Implying that the stock market is running on fumes at this point. Steve, your thoughts? 

Steve Sosnick 

There are two things at work here. First of all, the momentum is so strong right now. And that’s not seasonal—that’s just been going on for a while. If you think about factor investing—which, I’ll admit, I’m not a big acolyte of factor investing—but when you break it down, the factor that’s working is momentum. The trend is your friend. Don’t fight the tape. Buy dips, buy rallies, trade—all that kind of stuff is in place. 

And right now, you have a big honeymoon period because, as we mentioned before, the new administration doesn’t take office until over a month from now—call it six weeks—and so you can project anything you want onto that. Tariffs? “That’s just a negotiating ploy, no big deal.” And so you have that. You also don’t have a lot of incentive for big tax-loss selling because, quite frankly, most people have gains. 

You’ll probably see some tax-loss selling in the losers, but you’re not going to sell your winners until the calendar turns—if then. Particularly if there’s a chance of getting rate cuts. Capital gains rate cuts, I should say. So that’s a part of it. 

But what I see in the options market is actually quite fascinating. We all see VIX trading at low levels. But what’s very interesting is the implied volatility premium that people are paying for 10 % out-of-the-money puts is about the biggest it’s been in three to five years. So, call it a 10 [implied volatility differential]. This is one month out in SPX. Because you really can’t hedge your exposure with daily or weekly options. Both the decay fights against you, and it just requires way too much maintenance. So, you’ve got to be thinking out a month to three months if you want to start hedging. 

I’ve got to do the work on the three months because the one month is sort of… Again, there’s nothing happening in this next month necessarily besides the Fed meeting and a seasonally very quiet period. Especially with New Year’s and Christmas both on Wednesdays, those two weeks could probably both be almost completely shot in terms of impetus. 

But from an absolute point of view, let’s say the 10% at-money vol versus the 22% implied vol for options that are 10% below market, that 22% is actually historically quite low. I started to call these things Schrodinger’s puts because they’re both cheap and expensive at the same time. I can’t say there’s a big groundswell for people wanting to hedge, but on the other hand, there’s a little impetus out there of people looking to buy some insurance, or at least not willing to sell the insurance too cheaply. 

So, I start to look, and I see everybody is basically saying, “Oh, they expect the market to be up between six and 15% next year” or mentioning that profit growth is expected to be 15% for the S&P 500. Which, when you think about it, if we’re talking about GDP… What should we call it, Jose, 3% for an optimistic one? Two to 3% for an optimistic inflation, so that’s nominal growth of, call it, 5%, 6 %. 

Where does the other 9% come from in terms of the S&P earnings notes? A good way to go broke is betting against the ingenuity of corporate managements. They’re very good at this. But then the other part, to me, is if that much is priced in, where do you go? I’ll give you the Spinal Tap reference: you’re at 10. Can we go to 11? I don’t know that we go to 11. And then that’s why you see when there’s any weakness in guidance or any hint of revenue growth shortfalls from a company, it gets clobbered because so much good news is priced in. That’s the part that scares me. It goes back to being fearful when others are greedy. And boy, is everyone greedy right now. 

Andrew Wilkinson 

Jose, final word from you. We used to call it tweet risk during the last Trump presidency. We’re going to need a new name for it. I guess we’ll call it X risk. Do you think we should expect more of the same for the upcoming? 

Jose Torres 

I think that the rhetoric is gonna be worse than it was the first time. Because when you consider the cabinet’s members and their attitudes and how they express themselves, they tend to be more open-minded. They say what they feel like saying, so there’s much more X risk there in terms of President Trump or Musk or Ramaswamy writing things on the internet that can roil markets. 

But part of the reason why everyone is in stocks is because they are somewhat of an inflation hedge, even with stretched valuations. And for investors—and Steve, you could probably add more color here—but investors find difficulty navigating asset classes. And US stocks are one of the best ones to be in, especially against the backdrop of inflation, CPI at 2.7%. 

So, let’s look at the two-year. The two-year is at 4.12%, CPI 2.7%, your real interest rate of return is a little above 1 %. Same thing at the 10-year. Real rates one and a half percent, one and a half %, give or take. But with stocks, you have some earnings growth and you can get a return on top of that. 

Against that backdrop, folks remember Trump 1.0. Trump doesn’t want the markets to go down. Trump doesn’t want any volatility. Sometimes he’ll say what he feels like because sometimes he’ll be short-sighted in a conversation or in a particular controversial situation, right? Where he’s not thinking about the markets. And at that particular time, he’s focused on getting his point across or appearing tough or getting what he thinks the US deserves geopolitically, etc. But a day or two later, President-elect Trump is gonna care about the markets again. He’s gonna want to get the markets back up. 

He has Bessent in the Treasury. Bessent’s gonna do what he can to keep tail risk low and to keep markets buoyant. And when investors see higher inflation in the future alongside Trump 2.0, they don’t see many other assets to hide in outside of US stocks. 

Steve Sosnick 

I’m actually going to leave that because I think that was very well said. 

Andrew Wilkinson 

Steve Sosnick, Jose Torres, thank you very much for joining me today. 

Steve Sosnick 

Thank you, Andrew. 

Jose Torres 

My pleasure. Thanks, Andrew. Thanks, Steve. 

Andrew Wilkinson 

And to the audience, don’t forget to subscribe to the IBKR podcast channel, wherever you download your podcasts from. Thanks for joining us! 

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