1. "Don't fight the Fed"

Recessions usually follow the Fed raising interest rates. There's a roughly 6-12 month lag after the fed stops raising interest rates for them to bite. There are short term effects from what the Fed says in public which affect markets on closer to a day-to-day basis which are all emotional (including the FAANG layoffs starting in summer 2022). There are medium term effects from the rate-of-change and absolute levels of actual interest rate hikes which evolve fairly quickly (SVB/FRB). But there are also area-under-the-curve effects which are an integral of the level of the rate hikes which just take time and those are the most punishing.

Most corporate debt hits maturity dates after several years at which point the debt needs to be repaid or else it needs to be paid back. These loans are still considered fixed rate in most reporting but in actuality they're more like an ARM which adjusts. We have a lot of zombie companies and properties which have been financed by cheap debt over the roughly 14 years of ZIRP that are now rolling over into a higher rate environment. We also have a slow rolling commercial real estate disaster caused by online shopping and remote work. That all comes under stress slowly because those businesses which are going to fail will do everything they can to kick the can down the road as far as possible, hoping to survive into the next low-rate environment beyond these rate hikes. It takes time for them to be boxed in by financial realities and fail.

I'd say that the 12 month lag is also just a heuristic and given the quick rate hikes that it won't be surprising that it takes a little longer for the rate hikes to bite this time. The start of the rate hikes also matters and for example they started hiking back in 2004 before the 2008 recession. We also don't know when the rate hikes are done. Everyone expects the Fed to cut in June and do 3 cuts by the end of the year, but with the services inflation readings being up the Fed could also hike again -- which resets the counter on the heuristic.

2. AI Bubble

AI is almost certainly in a bubble right now. That doesn't meant that it is worthless like bitcoin, but that it is like the 1999 pets.com era of the Internet. It is mostly hype combined with a lot of hallucinations and not a lot of profitability (outside of NVDA). The real payoffs right now are going to be in things like medicine which don't involve LLMs and that will stake an enormous amount of capital to develop the drugs and protocols that machine learning helps to design. LLMs are mostly going to be used to put tech support people and relatively unskilled graphic design jobs out of business and flood the internet with bullshit--which won't be good for the human jobs market. At some point we're going to hit the era of LLMs that corresponds to the birth of AWS and the cloud and stuff like that, but that's still in the future and it looks more like the hype bubble is about to pop. At some point everyone will get tired of shipping more of their capital off to NVDA and start using the TPUs that they've got more efficiently.

3. Unemployment is Rising

86% of states have unemployment above their 1-year average, 75% of states have unemployment above their 2 year average, 26% of states have unemployment above their 3 year averages and all those numbers are increasing. Temp employment is off its peak 13%, full employment is of its peak 1.3%. None of this means we're in a recession, but all of it is consistent with a recession on the horizon.

4. Personal Savings has been Drawn Down

There was a massive spike in personal savings due to the pandemic which is the direct cause of the inflation that we saw. People put money in the bank as they weren't taking vacations and spending as much money (the spending for home renovations and lumber during the pandemic when everyone was home didn't make up for it at all). When the pandemic largely ended in 2022 (certainly by people's behavior, which is literally all that matters economically) that money re-entered the economy and naturally bid up prices turning into price inflation. Corporations are pretty much done having confiscated most of that from the bulk of middle class (upper class earners of course still retain a good chunk of it because the rich always get richer). The result though is that we're now seeing a lot more companies starting to cut prices and seeing reduced sales.

Looking at personal savings is much more important to understanding immediate inflation/recession dynamics than looking at the Fed balance sheet and screaming about money printing.

5. Everywhere Else Is In Recession

Economics in Europe and China are bad. Ukraine having hit Russian refineries and stuff like that is rolling over into oil price spikes which should have some inflationary shocks which should hit the markets when they start doing the math on how it it will affect the promise of future rate cuts in the US.

The counterpoints right now:

6. The Fed Is Playing Politics To Not Be Seen As Playing Politics

It is an election year and the Fed is being unusually soft since it doesn't want to be seen as influencing the election, so they are aggressively not giving any fucks about what looks like double bubble in crypto and the stock market. It isn't that they particularly favor Biden, they're all Republicans and would just roll with a Trump 2nd term and discount everything going on in Washington DC as just politics which is beneath their institution. But they don't want to be seen to aggressively pop a bubble in any election year, which is how they play politics in order to not play politics.

7. The Market Always Climbs A Wall Of Worry

All booms/bubbles are characterized by the market shrugging off all the reasons why it can't be going up and going up anyway. This phenomenon of all kinds of bad headlines about the market combined with new all time highs week after week is entirely normal going back decades. And another aspect of this is the saying that perma-bears on the stock market are the "broken clock is right twice a day" kind of people. This always happens.

Summary

I don't think the economy is remotely bad right now, but we're heading for a showdown at some point soon. None of this is sustainable. I didn't quite call this right, I was expecting more of a double-top formation, and it looks more like we're heading into an actual bubble. I'd consider it a very dangerous game to play around with this market, though. The personal savings rate that was all the fuel is gone, and at some point the market is likely to wake up and get very grouchy. Don't fight the Fed.