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We have the most expensive stock market in history prior to 2020. As of this writing, the price-to-sales ratio and the total market cap of equities are near record highs and dwarf the historical averages before the pandemic.

Economic growth must soar in 2024 to justify these valuation metrics. Or the Fed must slash borrowing costs back towards ZIRP. But the latter scenario would only occur if the Fed reacted to an economy falling apart, which is not good news for stocks. Yet, even in the former scenario, the Fed would not cut rates. Nevertheless, the Fed’s dot plot indicates three rate cuts, and six cuts are being priced in by the futures market. Therefore, even in the improbable scenario of exploding GDP this year, it would probably entail rising rates instead of rate cuts, which would still provide a headwind for stocks.

The recession penciled in for last year did not materialise because of the massive fiscal spending and the bailout of the entire regional banking system, a.k.a. Bank Term Funding Program (BTFP). However, the conditions for engendering a recession have not been resolved; they have been exacerbated—regardless of the soft-landing mantra prevalent in the MSFM. The overhanging problem is that the Treasury must find a buyer for $7 trillion of government debt this year alone. $5 trillion must be rolled over, and $2 trillion will be needed to fund the annual deficit. This will put tremendous pressure on the bond market no matter what.

The current liquidity factors that must be measured are the Treasury General Account (TGA), Reverse Repurchase Agreement (RRP), Fed’s balance sheet, Federal Funds Rate (FFR), Bank lending practices, and the BTFP. The Reverse Repo Facility (RRF) and the BTFP have provided positive liquidity. The RRF is being aggressively drained to purchase U.S. Treasuries, and the BTFP is being tapped each week to take banks’ bad assets off their balance sheets, and in exchange, they receive reserves equal to the par value of those distressed assets. This has offset the shrinking Fed balance sheet (Q.T.) and bank lending practices, which are tightening lending standards. Hence, Commercial and Industrial (C&I) loans and M2 money supply is shrinking.


Come March, there should be four negative impulses: the BTFP will expire as planned on March 11th, bank lending practices will remain negative, the RRP facility will be emptied, and the Fed’s Q.T. program is slated to remain in effect–albeit perhaps in the process of being wound down slowly if there is some fracturing of the credit markets. Hence, there should be a significant decline in liquidity in March, which should cause turmoil in the long-term bond market and lead to a sharp correction in equities.

The truth is the spike higher in borrowing costs must soon begin to bite. Record-low, near zero percent borrowing costs that were in place between 2008 and 2022 caused a massive dung pile of debt. As of this writing, corporate debt is up 115% since 2010, rising from $6.4 trillion to $13.8 trillion. The market for CLOs–securitized pools of leveraged loans–has ballooned from $300 billion in 2008 to $1.3 trillion today—that is an increase of 333%! The national debt is $34 trillion and is 122% of GDP, which is a record high. Annual deficits are $2 trillion. The interest on the debt will be $1 trillion this fiscal year. The annual deficit is 45% of revenue, and the outstanding debt is 750% of revenue.

Higher interest rates erode the economic footing like a torrent underneath the foundation of a building. You cannot convince me that this humongous debt overhang will be unaffected by the much higher cost of money.

In the meantime, the stock market is priced for perfection. But how healthy can an economy be when the goods-producing sector is on life support? The economy’s manufacturing sector has been contracting for the past 14 months in a row. The NY area manufacturing sector is in a depression. The level of that index is now at its lowest since the economy shut down in May 2020.

The real estate market is also a minefield. According to the National Association of Realtors, existing U.S. home sales totalled 4.09 million last year, an 18.7% decline from 2022. That was the weakest year for home sales since 1995 and the most significant annual decline since 2007, at the start of the Great Recession and Real Estate Crisis. The commercial real estate market is in shambles, but the ramifications have yet to be felt. $1.5 trillion in commercial real estate loans come due in the next two years. Interest rates have soared, and occupancy rates have plunged to an all-time low. The price of these office spaces and their loans have dropped by 40%. This is a huge problem for banks with 30% of their assets in commercial Mortgage-backed Securities (CMBS).


I understand that the Fed and Treasury will seek to bail out every hiccup in the market and the economy. However, this is old news. The government rode to the rescue in the tech bubble recession at the turn of the millennia and during the global financial crisis and real estate crash of 2008. But neither ZIRP, Q.E., TARP, or any of the alphabet soup of bailout programs served to stop the 50% + debacle in markets.

These inflationary bailouts tend to paper over the issues eventually, but not immediately. In sharp contrast to recent history, if the Fed and Treasury were to try and truncate the recession, debt default, and reconciliation of asset prices by another round of money printing and spending this time around, they would be doing so with the sting of record-high inflation fresh in the minds of consumers and businesses and investors. Therefore, the confidence in the world’s reserve status of USD and the U.S. bond market could be obliterated. We could see a condition where the economy enters a recession, but long-term bond yields go up instead of down, as is usually the case. Such an unprecedented and dangerous combination of higher borrowing costs in a faltering economy would result in carnage for stock valuations.


The main issue here is the continuing drag on the economy that comes with the inevitable refinancing of debt at much higher interest rates and the Fed’s relentless draining of liquidity from the banking system. Quantitative tightening has already drained one trillion from the base money supply. In 2023, 516 publicly listed firms filed for bankruptcy. Many zombie firms had been surviving by issuing new debt to repay existing creditors. That game is over and is not good news for the labour market.

As my friend Chris Whalen of Whalen Global Advisors points out, the U.S. banking industry is deeply insolvent, a fact that will negatively impact earnings for years to come. 54% of all U.S. mortgages have a rate between 2.5% and 4%. This rate is below banks’ funding costs, with the T-bill rate remaining above 5%. Meaning the bank’s business model is upside down. The financial industry owns these MBS and bank loans trading at 70 cents on the dollar.

Most importantly, while these assets are currently down 30%, which is a disaster, this was before the recession arrived. Just imagine how distressed these assets will become once mortgage defaults rise due to a spiking unemployment rate, which causes home values to tumble! Of course, the situation with CMBS is much worse. Here, we not only have the same unfavourable interest rate dynamics but also the high vacancy rates, which have already spiked, due to the work and shop-from-home phenomenon but now will surge once the economic downturn arrives in full force.

The labour market and economy are finally starting to crack. If you are wondering what all the recession obsession is about, it is because the S&P 500 has historically dropped 32% on average during all such economic contractions since 1937, according to RBC Capital. Given that the stock market is now trading at a valuation greater than any other time in history prior to 2020, that plunge from the start of the recession should be much greater than the average.

The time to prepare your portfolio for the recession and phase two of the bear market is now.   EG

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