In this episode, Cem Karsan returns to Excess Returns to break down the market through the lens of liquidity, reflexivity, and options-driven market structure. We cover why he believes we are in a bubble but still early in its trajectory, the mechanics behind today’s volatility dynamics, the role of AI spending in sustaining the cycle, and why traditional 60/40 portfolios may face major challenges in the years ahead. Cem also explains how investors should think about tail risk, true diversification, and building portfolios for a world where liquidity flows dictate outcomes.

Main topics covered

• Why we are in a bubble but still likely to go higher first

• Fundamentals vs liquidity as drivers of returns

• Options as the “3-D” market and how they now drive equities

• Reflexivity and how option flows influence asset prices

• Retail adoption of options and misperceptions in the space

• AI investment boom, tail risks, and market liquidity feedback loops

• Historical valuation regimes and recency bias in markets

• Portfolio construction beyond the 60/40 model

• Tail hedging and the role of long volatility

• Importance of true diversification and managing interest-rate risk

Timestamps
00:00 Bubble dynamics and why being bullish can coexist with danger
03:00 Fundamentals vs liquidity as market drivers
08:00 Rise of options and how they now influence markets
14:00 Reflexivity explained in simple terms
19:00 Mistakes investors make with options and structured products
24:00 AI spending, liquidity expansion, and similarities to 1999
31:00 Tail risks, China/Taiwan, private markets, inflation signals
38:00 Why 60/40 has worked recently – and why it may fail ahead
52:00 Inequality, cycles, crisis as a clearing mechanism
54:00 Building a portfolio for the next decade: diversification, tail hedging, box spreads, and non-correlated strategies
1:04:00 Closing thoughts and takeaway for investors