What if the Bulls are wrong? What if the Bears are right and we're going into not just a temporary tough period of time Dare I say quote Unquote tough Because oh no, our stonks have gone down over the last year. What if we're as Bulls long term wrong? That is, five to seven years of Hell could be ahead of us. Would that change our investing Outlook And and how could that actually manifest well I Think this is really important to pay attention to because markets right now are starting to price in and just starting to some potential wrongness. In fact, look at the expected terminal Fed funds rate up from 4.9 stable to 5.3 A suggestion that maybe higher for longer will end up being much longer years longer rather than just a little bit longer, especially if inflation break evens continue to break as they are on this screen right here which show you the long-term downtrend that we've had over the last year of inflation expectations rotating down on the five-year break-even curve that Trend down has now broken back to the upside since the beginning of the year, over the sign that the economy is still doing pretty dang well right now.

After all, consumers still have someone who on an average bank balance had two and a half thousand to five thousand dollars now sits at somewhere 12.8 thousand dollars of excess savings. Yeah, the excess savings rate has gone down because people are drawing down the excess savings, but those excess savings are substantially higher, leading to an economy that today is just as American Express says spending through to this recession or whatever it is. But what if the real recession is actually ahead of us and not behind us? What if the real pain is in front of us, what could end up happening? and how could that end up manifesting? Well, it could end up manifesting in that when we actually see a meaningful decline in real estate, then we could potentially see a meaningful decline in household spending, which could then actually set our economy into a real meaningful earnings recession and actual GDP recession. And that could mean that we are in an environment where maybe the Federal Reserve doesn't break anything, but where we're actually in a recession where the Federal Reserve cannot cut because inflation has stayed sticky for too long, meaning we're sitting at five percent rates and real rates that are substantially positive, and US re uh, or sort of undoing the unverted yield curve as history has shown us, actually providing the most painful part of the recession that is still ahead Said another way: the most painful part of an inverted yield curve is not the inversion, it's actually the re-stepening and that suggests that the pain is still ahead.

So the Bears have an argument. The strongest argument the Bears have is that inflation will be sticky and that the yield curves steepening will actually be the most painful part. and that could be combined with a real setup of fear from households leading to a real Crush of spending which has not happened yet. After all, if we look at Robert Schiller he's an economist from Princeton famous for the case Shiller indices for Real Estate He warns that it's actually not stock declines that lead consumers to spend less money.

After all, we still have positive GDP and how we had a couple potentially negative quarters of GDP last year which technically say we were in a technical recession, but nobody actually felt like we were in a recession from a sentiment point of view in 2022. In fact, as we've proven multiple times on the Channel people are spending through whatever this technical recession is that we're in right now. But what if that spending through stops and what does Robert Schiller tell us Well Robert Schiller tells us it's not stock declines that lead people to stop spending money. it's a real estate declines that lead people to stop spending money.

And real estate is actually setting up for its most meaningful set of fear and pain this summer that's still ahead of us. So if real estate hits pain in say May to June where all of a sudden interest rates for Real Estate are potentially at seven percent roughly where they sit Now as the 10-year treasury yield continues to rise up and condition Financial conditions continue to tighten. What if real estate does continue to suffer and Peak fear is hit at the same time as rates are around seven percent. Real estate prices year over year start actually showing 10 to 20 percent declines year over year in most markets Peak To now that's already what's happened.

It would take a price recovery to not show to a 10 to 20 declines once we hit May numbers. And when that fear sets in, is it possible that even less people buy real estate institutions begin liquidating their real estate? and now home prices actually fall even more, especially as rents decline. As rents decline, it becomes more desirable to rent rather than buy. And the argument that hey, I'll just pay seven percent because I could rent out my property for a near Break Even or whatever goes away even more because rents fall leading then eventually less people to buy Real Estate Investors Buy less real estate.

Home buyers buy less. real estate prices come down even more. Now what you potentially actually set up for is no floor put under the real estate market and consumers actually spending a substantially less amount of money. Because now we realize uh oh, here's the real recession.

Real estate hits the real recession which actually leads consumers which make up 70 percent of our economy 72 by some accounts to stop spending money. And that drives us into a real recession during a time where thanks to people's excess savings again. I Understand, the excess savings rate right now is low, but people's excess savings are substantially high right now By some accounts, two to five times as high as they were before the pandemic, but because of the fear that comes from actual household declines of wealth. Now, you walk into a real recession.

This is the bear case. The bear case comes out and says it's actually a substantial earnings recession that is That is. Still excuse me. I'm starting to lose my voice a little bit substantially ahead of us and not behind us.

This is what we see day in and day out in reports and equity research that I'm reading. here's one from today. from Barclays you can see it dated February 21. That's today, and short of going through all of it, Basically, earnings declines are still substantially ahead of us, with the most at risk sectors being consumer discretionaries and growth stocks still trading for elevated multiples relative to the rest of the indices.

You can actually see that I Believe in one of these charts. Uh, but short of going and finding exactly where the chart is, I'll just sort of give you the bottom line. But really, Barclays makes this argument that look, we are seeing recessionary levels of earning surprises. that is, we're looking very, very similar to 2006 and 2007 by many metrics when we're looking at some of the red flags popping up from earnings.

This right here showing you the that the second quarter of a 20, uh, 22 or sorry, the fourth quarter of 2022 has seen the weakest earning surprise since the Great Financial Crisis with a modest 72 percent of companies beating forecast uh, EPS Cons or or yeah, a forecast Q4 EPS but the uh, earnings surprise level being at the weakest level since 2007 suggesting Maybe that the quality of forecasts going forward could actually be very, very low. And this sets up your bare case right. This is the what If Kevin's wrong case, right? And it's really a a path of a combination of sticky inflation combined with Peak housing fear Uh, by let's say May 23 combined with the earnings recession, the red flags of which we're already seeing combined with higher terminal rates. and consider this: A lot of folks right now as American Express says are spending through this pain, right? The same thing is what's actually happening with businesses.

And a lot of home buyers. Home buyers and businesses right now are actually hiring to spend through the potential recession, right? The I'll put quotes around it because maybe we haven't hit the real recession right? And that's a problem because if everybody believes that all this inflation is going to end up being transitory, then what you have right now is earnings at companies and hiring of people and businesses that are spending and investing based on the belief that everything's going to be okay. But when the world starts realizing, oh crap, everything is actually not going to be okay, well then what do you have? Well, that's when you actually have layoffs. That's when you actually have people spending less money.

That's when you actually have home buyers who don't go into buying a home right now because they think they can refinance in two years. That's a big problem, by the way. People right now are doing three to one loans, buying down their interest rate for a few years because they really believe that they can refinance in a few years and be back at a three percent interest rate. So the segment here on what if Kevin is wrong.

Let me be clear, there is a very real bear case that exists and it is one of sticky inflation leading to interest rates that are so high for so long that we do end up creating a peak fear environment for Real Estate Again, that's rents declining. That's high mortgage rates. That's people realizing. okay, maybe we're not going to be able to refinance.

Maybe it is cheaper to rent rents declining. Now All of a sudden, rents are declining. Now you potentially walk into a bubble Door a breaking which is not to be confused with Open Door which should go bankrupt uh, but actually an Airbnb and vacation rental bubble which uh, has potentially artificially inflated the asset value of real estate because people are under this impression that you can make so much freaking money from investing in real estate because real estate only goes up. and oh, rents only go up and oh, you could rent it out on Airbnb and make even more money? That's been true, but what if it's not anymore? What if all of a sudden more inventory comes on because people can't sell their homes and all of a sudden rental rates do crash? Then we do create an environment of peak fear where businesses, consumers, homeowners, and Investments start drying up and even though we have excess savings, once the the belief that inflation will go away, breaks and inflation expectations become unanchored, which they already are starting to just look at the chart, it's already starting to happen, right? We have broken the long-term downtrend over the last year here of inflation expectations Fallen Now it's it's still I Mean we could draw this line slightly differently too and suggest that Okay, well come on, like it's still mostly okay.

Like sure, fine. I could draw the line like this and like this and say okay, we're still on somewhat of a downtrend, right? Sure, we could play with it as much as we want, but the problem and look, this has been volatile, right? And remember: I I'm a bull at heart I'm a bull at heart. but I'm providing the bear case because I Like to be aware of what the bear case is and the bear case is not good. The bear case is potentially one that suggests, well, we're actually walking into is, or, or where we are right now is essentially we're on.

We're on a pencil pedestal right now is I Think the best analogy. We're on a pencil pedestal and and the blue and we're wobbling. And the belief is that hey, look, all these numbers are great right now. Hey look, people have more money in their bank accounts.

Everyone still feels Rich Everyone's still hiring. Everything's great, people are making more money, Everyone's still happy. It's kind of like everyone's still drunk. and this is the bear case, right? And the belief is that it's going to take long.

But once it's realized by markets that uh oh, the genie of inflation is out of the bottle and it's not gonna be easy to put it back in now, Maybe we can't refinance in a few years on homes. So uh, home values continue to fall for years, and the real estate cycle continues to break as it generally does for a six-year down cycle or more, which does lead to a collapse of earnings. And that essentially that that pencil pedestal Falling Away People stop spending through the recession. Now the consumer actually drives the market into a recession.

now. all of a sudden, you actually do have serious pain at companies and real layoffs and that's how you actually lead the unemployment rate to seriously rise. But until inflation, which tends to really lag what's actually happening, fully goes away. Fed can't cut rates to bail us out, And now you're potentially setting up for this sort of super bear cycle where maybe there is I mean and there is a real case for this.

Maybe you're in a bearish environment for the next five years that could happen I Don't believe it. Maybe it's because I don't want to believe it, right? Maybe I don't want to believe that you could go through you know, a five-year bear cycle of of layoffs and and not an expansionary market, right? I Think most investors right now, uh, believe that we're going to go right back to an expansionary market and and that that will be true I Believe As if inflation does go away the way we expect it to. but the problem is because everybody expects inflation to plummet, They're still spending, right, And that's what's somewhat leading to the sickiness. Now again, things are trending better, right? Leading indicators are suggesting it's fine.

In other words, leading suggestions from company earnings calls. uh, from company earnings reports from inflation reports on leading data that we get on wage hiring Trends Suggest we are not in a situation of unanchored inflation expectations. We're not in a situation of a wage price spiral which is good, but because of those signals. And because of the signals that, yes, when we get your, you know, when we actually get housing inflationary data to show that inflation is plummeting.

And as long as inflation plummets and stays or stays stable, we can actually Trend towards two percent inflation. And even if we Trend towards two percent slowly and let's say rates say at five percent, as long as anything doesn't break and we don't get a wage price spiral, then we could just sit at higher rates for another year or so. Even if it ends up being two years. It's okay.

as long as people can spend through the next two years, we're good and we get our Nike Swoosh recovery. Everything slowly recovers. Everything's good. We already understand the bull thesis very well, but the bear thesis has a point.

and the bare thesis is that because of all this uh, this spending through we're doing right now, we're really propping up the markets. Uh, and and we're setting up this false expectation that inflation is going to be the genie we get to put back in the bottle. Uh, but if inflation stays sticky. Yeah, there is a serious bear case.

and the serious bear case is that you're going through probably another five years of hell. That's the bear case and it's not coming soon. But that's what the Bears are looking for and it's not going to be something we'll know the answer to in three months. It's something that is probably going to take a year before we start realizing it.

Uh, and and then that's how you could potentially go into a longer run recession now. Yeah, I don't believe that, but I think that is exactly how I could be wrong and it all comes down to the stickiness of inflation and then eventually those that excess consumer spending uh or savings being gone and true fear happening. We have not actually had true fear, but maybe true fear aligns with the steepening of the yield curve which historically it always has. So the Bears have that on their case, right? Historically the worst part is the steepening.

It's not the the inverting you know people like oh, inverted yield curve keeps getting worse and worse and worse. Yeah, just wait for the steepening part. So there's the bear case. and I think the bear case is one that is very reasonable to to pay a lot of attention to.

I Think it's very bad to get blinded by, uh, pure bullishness. uh, especially temporary bullishness. But but it is a uh a a serious uh, concern. uh I don't think it's highly likely.

Uh, but but then again, I think everybody needs to come up with their own definition of of uh, the odds of likely likelihood for that, you know. I think the odds of us going into a five-year bear Market uh or or relatively low, maybe 10 15 percent. but uh, you know it doesn't mean I'm gonna be right about that. Certainly gonna be paying attention to that and see how numbers adjust.

but it's just my take. but that's my take on how Kevin could be wrong.