The Merger Is Complete


This piece is written by a third party because we think highly of the author and their perspective. It may not represent the views of Epsilon Theory or Second Foundation Partners, and should not be construed as advice to purchase or sell any security.


  • Continued V-shaped, economic and risk-asset recoveries are unlikely, but don’t let the facts interfere with a good story. Buy the bull*&-t for a trade into Christmas on fund flows, but don’t buy into the nonsense narratives permanently.[1]
  • The merger between the Treasury and Fed is now complete with Janet Yellen’s apparent appointment as the Secretary of the Treasury, but the closing of the ‘merger’ does not mean much, as she yields no authority outside of Biden’s, and Biden needs Congress (the Senate in particular).[2]
    • Gridlock will prevail if one Georgia Senate seat goes Democrat but with the possibility of a split Senate chamber if both Georgia runoffs go Democrat.[3]
  • Over the next four years and long thereafter, gigantic deficits will require higher taxes. If they don’t, Congressional authority to tax and spend is undermined by the Fed, which effectively replaces Congress’ taxation function when it monetizes deficits.
  • Narratives about what will drive markets have somehow become rules to day-traders. These narratives can unravel in a heartbeat, BUT they can be self-fulfilling for much longer than is rational.
  • Right now, just as during the and housing bubbles, it is indeed brutal fighting the bogus narrative. It’s folly to be short. It’s sad that we live in a ‘don’t let the facts interfere with a good story world,’ but as Aldous Huxley famously said: “just because the facts are being ignored doesn’t mean they don’t exist.”
  • Commercial real estate provides one of the few pockets of value in an almost universally loathed asset class.


The correlated risk-on in equities continued today. For Gen-Z market participants, the stock market has become what the housing market used to be (2004 – 2007) for Gen-X house flippers. “House prices never go down” was the common refrain. The chants of day-traders that “stocks only go up” have become almost cult-like, and social media has provided an unprecedented bullhorn. Here’s one Twitter narrative, which is emblematic of what’s afoot in the world of retail day trading. This particular Twitter handle seems quite smart and capable. Her Twitter persona is ingenious from a certain perspective. She has constructed an expletive laced, yet somehow kinder and gentler, virtual world (a virtual trailer park over which she reigns as Queen – no joke) enhanced by a provocative profile photo and sporadic talk of her sexual exploits. This Tweet was met with universal cheers from her serfdom.

“Fed willing to let PCE get to 3%. Vaccines. Congressional gridlock. And now Yellen. Mix these ingredients in a pot and you get pure rocket fuel for stocks in 2021, and a much broader bull market with cyclicals ripping too. Hey, I don’t make the rules, I just follow ‘em. You do you.”

I will do me.

Whether one likes it or not, narratives have somehow become rules for a wide swath of market participants without an acknowledgement that narratives may change on a dime. This becomes circular when bogus narratives become self-fulfilling… if enough people are duped into believing them. A good deal of this is based on lack of context and experience. That’s one reason why markets can veer so far from reality for so long. It’s not cool to be thoughtful anymore about things like valuation or economic fundamentals. Just believe in the ‘rules.’ If you don’t, you’re dismissed as ‘not getting it.’ Does it still make sense to do analysis? Or is it simply now about 280 characters or less narratives? Frankly, it’s not clear anymore, but just for giggles, here are some thoughts and analysis about this Tweeter’s assertions.


Let’s talk about inflation first. The Fed’s PCE target is a put-on. Inflation isn’t coming in the way the Fed measures it, and the Fed has little influence over it. If 10-years of QE and rates now across most of the curve at zero won’t do it, what can the Fed do? Most importantly inflation hasn’t come in wages. Inflation is a China and emerging markets story. For a decade or more, we’ve been importing disinflation in goods and wages. Wage growth only comes when productivity growth accelerates. Fat chance that happens when zombie companies that can’t raise wages are the new norm. Saving them won’t drive markets higher, but misinformed investment decisions may. It’s an overcapacity story. Ironically, that’s coming from low rates and malinvestments driven by policy decisions.

According to Bloomberg, almost 600 corporations of 3,000 of the country’s largest publicly-traded companies no longer have EBIT/Interest > 1. The same companies added almost $1 trillion of debt to their balance sheets since the pandemic began, bringing total obligations to $1.36 trillion. As the article suggests: “But in helping hundreds of ailing companies gain virtually unfettered access to credit markets, policy makers may inadvertently be directing the flow of capital to unproductive firms, depressing employment and growth for years to come.” I won’t apologize for being something of an Austrian here, but this is yet another reason the U.S. is not achieving sufficient enough productivity growth to produce wage growth. Creative destruction is the core process for that to occur.

The old adage ‘don’t fight the Fed’ is on its last legs. Bill Dudley said it well: “The stimulus provided by lower interest rates inevitably wears off. Cutting interest rates boosts the economy by bringing future activity into the present: Easy money encourages people to buy houses and appliances now rather than later. But when the future arrives, that activity is missing. The only way to keep things going is to lower interest rates further — until, that is, they hit their lower bound, which in the U.S. is zero.”[4] It’s possible, we’re just crazy and ‘don’t get it,’ but the chances that credit cycle is over are close to nil. By Bill’s logic, this is yet another reason why inflation isn’t coming. It’s also why the Fed is not able to help the ‘real’ economy any longer.

As for Janet Yellen’s likely appointment, Bloomberg’s Joe Wiesenthal notes:

“Her reputation as an uber-dove may be somewhat exaggerated. She started raising rates at the end of 2015 when the unemployment rate was over 5%. Since the unemployment rate dropped as low at 3.5% before the virus hit, and since we never really saw particularly rapid wage growth (let alone inflation) during this time, there’s good reason to think that hike wasn’t necessary, and that there was still considerable labor market slack. Same with the hikes throughout 2017. Furthermore the hawk/dove framework isn’t so useful when talking about a Treasury Secretary. When we talk about hawks and doves on the FOMC, we’re talking about how they weight employment and inflation within the dual mandate. The Fed is always turning a dial this way or that to get everything into balance. But the Treasury doesn’t have an easy “tax and spend” dial to turn. If Yellen wanted to come in and help craft a mega stimulus that blows out the deficit, that’d be great, but the only thing that really matters is what can pass the Senate. And so then we’re talking about what kind of deals she can strike with Mitch McConnell or — depending on what happens with the Georgia runoffs — the slimmest possible majority… So thinking about how you get the best budget with that political reality is just a very different thing than weighing inflation and employment in the setting of monetary policy.”[5]

This was so well said, I didn’t even want to paraphrase it. Thanks, Joe, and I hope you’re sleeping better.


Dr. Anthony Fauci indicated on CNN on November 19th that the most vulnerable parts of the population would be vaccinated by the end of the spring with the rest of the population by about mid-year. During that time, mitigation measures would need to continue. This might suggest a move toward normalcy but yet substantially curtailed activity for another 5 months at a minimum. Will a previously untried vaccine type (using mRNA), whose long-term side-effects are unknown, be adopted quickly by such a divided and already mistrusting populace? From the University of Cambridge regarding mRNA and what is needed: “better understanding of vaccine adverse effects is needed – these can include inflammation or autoimmune reactions.”[6]

There is an alternative. Now, we have the AstraZeneca version, which uses more traditional vaccine technology. People will likely be more accepting of it, but that will take longer to come to market. If anything, complacency around any vaccine and a misunderstanding of how long it takes to produce societal immunity may lead to a sense of deadly complacency.[7] We’re already seeing this in holiday travel numbers, and case numbers are skyrocketing. This actually does matter to an economy still teetering and without more fiscal stimulus until at least late January. Alongside a number of other ingredients, this is yet another reason this seemingly convincing rally in cyclicals and small caps will likely fail.

Other ‘Ingredients’

Most importantly, the vaccines don’t cure the underlying problems in the economy which predated the pandemic, and the chance of a double-dip in the fourth quarter is high. That’s the other big reason bullishness on cyclicals and small caps is a farce. The V-shaped recovery is a mirage. As Figure 1 shows, without stimulus, nominal GDP for the first three quarters of 2020 would still have been down roughly 19%. Even with it, nominal GDP was down about 2%. Figure 1 shows nominal GDP excluding government spending dropped from $14.4 trillion to $11.4 trillion. This illustrates just how dependent the recovery has been on stimulus.[8] The messy election, alongside what will likely be an even more divided government, will make another round of stimulus slow in coming.  In part, the result of this political environment, the Treasury has requested the return of unused Section 13(3) funds that enable the Fed’s emergency lending programs like the Primary and Secondary Lending Facilities that have helped backstop the public bond markets.

According to Blomberg, “the Federal Reserve said Friday it would comply with a Treasury Department request to return unused funds meant to backstop five emergency lending programs, moving to tamp down a public rift that arose a day earlier.” The Treasury’s announcement came after Chairman Powell, as early as November 17th stated that it was too early to “put those tools away.” Perhaps the market’s enthusiasm is coming from the fact that Janet Yellen will assure the Fed has renewed access to these funds. But, any Treasury Secretary under Biden would have done that, and the timing of it has not changed. When she does, it won’t matter. Loan demand is weak because that demand has been pulled forward due to years of stimulus. Figure 4 shows lending standards and demand for loans for large and medium sized firms. Only more direct deposits will do the trick, and that won’t happen until there’s another swoon in asset prices.

The economy was already recession-prone pre-pandemic, and U.S. non-financial corporate profits have been trending lower since 2014 alongside ever-increasing leverage. Figure 3 shows the trend in corporate profits and Exhibit 1 of the Appendix shows corporate debt as a percentage of revenues. This will make for a much longer road to recovery.[9] The most powerful rotation into cyclicals we’ve seen thus far will likely fail once again when sufficient profit growth fails to materialize. Extend and amend works for business models that are viable and when cash flows have prospects for strong recovery. Once again, rates and yields are already so close to zero, there’s little room for the Fed to act (short of buying corporate credit in size and equities outright). Does anybody remember the yield curve inversion? Exhibit 2 of the Appendix shows that it right about now that asset prices correct after an inversion about 18-months prior. The stimulus has undone the impacts of the pandemic but it hasn’t changed baseline conditions. While it usually isn’t ‘different this time,’ it is this time.[10]

Even with some measure of Congressional gridlock, how are we to fund deficits that are closing in on $4 trillion? Treasury issuance and taxes. Treasury supply could push long rates higher, as the Fed has its hands full monetizing all of it. Biden will push for higher taxes. It’s just about a fait accompli, but the ultimate composition of the senate will matter a great deal. Even over time, as administrations come and go, taxes will need to rise. If they don’t, Congressional authority to tax and spend is undermined by the Fed, which effectively replaces Congress’ taxation function when it monetizes deficits. There is a price for largesse.


“A question that sometimes drives me hazy: am I or are the others crazy?”
― Albert Einstein

As we wrote in our recent piece on CRE, entitled Is there Hope for CRE?: “We ain’t no Einstein, but we ask ourselves this question about three or four times a day. Equity markets, now seemingly dominated by retail investors and social media narratives, continue to lead public credit markets. Equity markets have devolved into casinos. The overwhelming consensus is for a V-shaped recovery in the economy and markets. Public equity markets are sending a clear signal that participants in that market believe we are now free and clear of recession. Professional equity strategists have now mostly jumped onto that bandwagon out of utter fatigue; they are just about universally bullish. The euphoria is here. While seemingly stubborn, we continue to believe a durable ‘V’-shaped recovery is unlikely. Those of us who are not drinking the mead from the Robinhood punchbowl have suffered fits of existential doubt.

The narratives that are now accepted as ‘rules’ about what will drive markets in 2021 can unravel in a heartbeat, BUT they can be self-fulfilling for much longer than is rational. Right now, just as in 1999 or 2007, it’s brutal fighting the bogus narrative, and it’s folly to be short. It’s sad that we live in a ‘don’t let the facts interfere with a good story world,’ but that’s the current state of affairs. The result of Yellen’s likely appointment as Treasury Secretary moves the U.S. apparatus closer to socialism, but it far from guarantees the performance of U.S. equities, as we have seen in Europe and the much more drastic case of Japan. Yet, while all of this seems to make sense, equities are rising for yet another day on a bull narrative full of holes. As Aldous Huxley famously said: “Just because the facts are being ignored doesn’t mean they don’t exist.” It will pay handsomely to keep this in mind.


Exhibit 1: Non-Financial Corporate Businesses Debt Securities & Loans as a % of Revenue; Source: Fed and AlphaOmega Advisors

Exhibit 2: The Yield Curve Inversion of 3-month to 10-year Treasuries Is Followed by Recession and Risk-Asset Corrections ~18-Months Later; the Pandemic and Stimulus Make this a Harder Read this Time; Source Fed and AlphaOmega


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[1] I feel your pain, Jeremy. “Jeremy Grantham’s GMO is paying the price for yet another contrarian call by its co-founder. Convinced that U.S. equities were unjustifiably expensive given the economic damage from the pandemic, the renowned value investing money manager and his asset allocation chief, Ben Inker, told investors in June that it was time to sell stocks.” Bloomberg News Grantham’s Bear Market Call Tests Patience of GMO Fund Investors

[2] It is one additionally small step towards the destruction of capitalist democracy.

[3] That split would effectively make the Senate democratic with Kamala Harris being the deciding vote and controlling rule and procedure enforcement. Georgia’s election rules require a candidate to receive a majority. If no candidate does so in the general election, a runoff takes place. For the 2020 general election, that runoff is scheduled on January 5, 2021. Sen. David Perdue (R) was up for re-election as his regular six-year term will expire at the end of the current Congress. Neither Perdue nor his opponent, Jon Ossoff likely received the votes necessary to avoid a runoff. Georgia also had a special election for its other Senate seat. Sen. Johnny Isakson (R) retired partway through his term—one scheduled to end in 2022—on December 31, 2019. Georgia Gov. Brian Kemp (R) appointed Kelly Loeffler (R) to fill the vacancy until the 2020 election could determine who would serve through 2022. Neither Loeffler nor her Democratic opponent, Rev. Raphael Warnock, received the majority.


[5] Five Things to Start Your Day, Bloomberg News, November 24th, 2020.


[7] The virus’ progression has accelerated in the developed world with the 7-day average of new daily cases in the U.S. exceeding 150,000 for the first time last week and new daily case levels at about 180,000 and still climbing. Tremendous economic damage can be done over the winter as a vaccine does nothing until it is deployed in spring.

[8] While the direct payments to consumers have worked, other forms of stimulus (like MSLP) were struggling to reach small and mid-sized businesses – the very businesses that are so important to CRE landlords. Business loan demand remains weak and lending standards have continued to tighten.

[9] Non-financial corporate profits: If anything, the pandemic has masked a recession that would have occurred anyway.

[10] Cycles tend to rhyme rather than to repeat exactly. In 2001, corporate credit was at the center of the contraction with public high yield bonds extended to technology high-flyers at the center of defaults. In 2007, the consumer was over levered and residential mortgages and residential mortgage backed securities were at the epicenter of the crisis. In 2020, private corporate and commercial loans, as well as, commercial mortgage backed securities (CMBS) are at the center of the stress.


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6 months ago

Hi Peter
it may sound simplistic so forgive me……..but if we are looking at dwindling sales and low demand in the years to come, then where will the revenues (& hence profits ) come from to pay those taxes, even if the tax rates are increased dramatically ?
it may be that the economy is not headed towards socialism, its already there !!!

6 months ago

What happens when new games are added to the casino? Imagine a world where celebrities, athletes, musicians, Tik Tok stars, teams become tokens. Will Gen-Z want to own Apple or Tesla? Asking for a friend.

Lawrence Pusateri
6 months ago

It seems that every generation must learn at some point that price matters. This feels a lot like 1999-2000.

Mike Jones
3 months ago

The Esperanto translation of this article (with permission of Ben) is at the following location:
(work in progress)

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