Stagflation leading to Recession - The Kodiak Bear Thesis

Valhalla Trading

Stagflation leading to Recession - The Kodiak Bear Thesis

Tickers: SPY, QQQ, IWM, JETS, HYG, and AAL

Topics Covered: Structural and Cyclical Drivers, Eurodollar Futures, OIS Yield Curve Inversion, Housing Market, Crude Oil, Inflation, and Monetary Policy.

This is the sequel to my last DD. I realize that while the market and sentiment has moved in the direction of my original thesis posted on Feb 14th, there were things that were missing that I want to cover here. The disclaimer stays the same, this isnt financial advice, understand the risks and make your own trades. I also think it’s worth mentioning again that even if this thesis does not fall in line with what you believe, every good investor should still know the Bull and Bear case on a macro level.

My conviction remains high, I’m still learning as much as possible and through this process I have come to believe that the Federal Reserve does indeed have levers that directly affect the market, but big picture, they respond more to what the real economy is doing vs being the significant catalyst that drives it.

This is the way I’m thinking about this now. Even with years of accommodating monetary policy (Low rates and QE), we have a slowing economy. We are moving into a new phase where we still have a slowing rate of growth, but now we are taking away the accommodations due to inflationary pressures.

This is an important distinction, this means that even while we had the most ideal monetary policy circumstances for over a decade, our economy has been slowing down and now we are going to take away the accommodations. The reasons why we have a slowing economy is something that for the most part I missed in my last DD, because I only started diving into this recently.

So big picture, why is the economy slowing down? Let’s look at some economic drivers.

Structural Drivers: Demographics and Productivity. This is the real economy. Demographics is population growth and labor market participation, so how many people are actively contributing to the economy and how productive are they? These are structural drivers. Population growth has been slowing down in the US since the 1950’s and is projected to continue slowing down well into the next century. We are still seeing growth in our GDP but if you take out the covid dip and post covid boom, you are left with a slowing GDP since 1999.

Cyclical Drivers: These are drivers that sit on top of the real economy, but the biggest drivers are monetary policy and credit, which as you know go hand in hand. So how much credit does the private sector and thus the average American have access to? Outside of fiscal policy, credit is the real way money gets “printed”
There is only so much credit that we can grant the private sector, and only so much credit the average American can take on UNLESS productivity and real wages continue to grow at a faster pace.

Here’s the problem:

On a structural level, our market participation is sub optimal, and has been declining since the year 2000. Our workforce is generally getting older. Since 2011, 10,000 baby boomers turn 65 years old every single day in the US and this is projected to continue through 2030. The average baby boomer age for retirement is 61-65 years old. I think this played a bigger role in the post covid labor market squeeze than almost anything else. Headlines like to say that people are lazy and there are a bunch of people that would rather eat cheetos on the couch than work, but with a 3.8% unemployment rate I think it is far more likely there were a large group of workers that were 1-5 years away from retirement that enjoyed life at home during shutdown, so they decided to make it permanent. It’s much more convenient to vilify a younger group of workers than to admit we have structural issues at play. We have a shrinking workforce that isn’t as productive as we need them to be to keep the party going.

Then we get to the cyclical problems, we are simply at the end of the greatest debt cycle our country has ever seen. I could rant about the excessive American exceptionalism where everyone believes being rich is a birthright, and how that leads to over comfortability and entitlement. Or about our fiscal and monetary policy decisions from our country’s leaders that for the most part think kicking the can down the road and stealing the prosperity of future generations is doing a good job (both sides of the aisle btw), but to keep it Macro focused, let’s talk about a great perspective called the wealth illusion.

The wealth illusion basically says that because credit is easy and because credit stimulates the economy, businesses and people alike perceive to be in better financial shape than they really are, they are more comfortable taking on more credit. We see this in housing, businesses, over leverage in the stock market, consumer debt, student loans, etc.
This works extremely well until it doesn’t. You get into a scenario where people have equity in their homes, and they are making “more” money so they feel like they are doing good, and that sentiment and access to credit makes them feel like they can afford more than they can. This was also magnified when we sent out 2 trillion dollars in stimulus checks. I remember being dumbfounded when people were using those checks as downpayments on cars, RV’s, and 4 wheelers. (I live in Idaho, so this is what I saw) but this is a great example of the problem at hand. I also saw someone post in TF that there was a new “home equity credit card” scary stuff. This is the wealth illusion, and I would argue that it has been going on since the 80’s, but extremely magnified now.

Eventually what happens is cyclical growth creates bubbles and inflation and the chickens come home to roost because Cyclical growth isn’t sustainable. I believe that is where we are at now.

Real wages in America are going down, while all asset classes are inflating. Real wages is the median household income minus inflation. So the cost of goods are going up faster than the average American’s income. This means that everytime housing, food, and energy increases in price, the everyday Americans discretionary income goes down, and without as easy access to credit this problem quickly spins out of control. Less discretionary income means less demand on everything except what people need to survive. That is the main reason you will hear people talk about gas prices, housing prices, and food prices so much, you can decide not to buy the latest iphone or take the trip to Hawaii, but you have to put food on the table and a roof over your head.

This is why raising interest rates is such a delicate game. Take housing for instance. It doesn’t matter where you live, home prices increased double digits last year alone. Everytime interest rates go up that means monthly mortgage payments on a new mortgage go up too. Meaning that every time rates go up there are less people that can afford to be in the housing market, and eventually prices have to come down, and keep in mind home mortgage rates crossed 4% last week. I think we are already seeing this,I find it very telling that home inventories remain at all time lows, but median home prices are cooling off.

So if we have significant Secular and Cyclical headwinds in a slowing economy, why isnt the equities market running for the hills? I believe it is 3 things:

1: Geopolitical tensions- What is happening in Ukraine absolutely affects the markets, not just sentiment, but actual supply chain challenges, global finance risks, Commodity surges, etc. But I do believe that the market, mainly retail investors believe that the bear trend we are seeing would resolve if it ended tomorrow. But keep in mind the indexes were already falling since the beginning of the year, way before Putin was amassing troops on the border.

2: Jerome Powell and the Federal Reserve- J Pow has a great gift of putting the markets at ease when he talks, he speaks calmly and answers questions with confidence. However all it takes is looking at the what the data shows vs what J Pow says, and what action his team takes to see that there is either a great deal of deception or incompetence, or possibly both. It is interesting that last week they decide to raise interest rates 25bp and say everything is under control, then a few trading days later today, he is whistling to a different tune and sounding much more hawkish. The problem is the equities market HAS taken him at his word. When he says the economy is strong, and that they are going to tackle inflation through raising interest rates and starting QT, but there is nothing to worry about, it is taken as a sign of relief, and it fits most peoples cognitive bias, so most people leave it at that.

3: Euphoria- This last Bull run was one for the record books, it is hard to think about a significant market correction or crash when things have been going so well for so long. It has been long enough that a significant amount of retail traders and even professional traders havent ever actually seen a market crash or correction, so they downplay the likelihood dramatically. It also comes to no surprise that the last few weeks large order outflows have outpaced large order inflows. This tells me that wallstreet is unloading on retail investors that are programmed to “buy the dip”

So who is ahead of this and bracing for impact?

The Bond market.

The Bond market is generally known as the “smart money” this isnt just the boring part of your 401k your advisor has a fiduciary responsibility to tell you to have a little exposure to. This is the big money. Global wealth, Fixed income, massive pensions, mega endowments, even governments of other countries. And the Bond market has been giving us signals since last year.

Part 2, 3/22/22

If you are not familiar with the bond market, just think “credit” market, because that’s what it is, its a place to issue new credit and trade credit securities and products.

What helped me wrap my head around the bond market is to think of another stock market but instead of equities being traded they are trading credit (bonds), and they are betting on the same information that we are. These are actual BIG “fuck you” money institutions, trading in a 41 Trillion dollar market, the smartest men in the room most powerful men on earth type people, and everything that you read about or hear about, they are making trades too. So when these guys are betting that the stock market is going to feel massive pain, we should take notice, and the best way to do that is with the yield curve.

I think there is some confusion about the yield curve. From an equities perspective, it is used as an indicator. But I hear people talk about it like it’s more of a RSI or EMA type indicator, based on data alone.

Now keep in mind, the bond market does two main things, issues new bonds (think credit) and trades those bonds and other credit securities.

All the yield curve is, is actual bonds spread out at different maturities, and the actual yield you get from them plotted on a line graph.

Why is this important?

Let’s look at a few yield curves. (and I’ll explain how they are saying different things)

A normal yield curve is the bond market saying “We are happy with the economy and are comfortable investing in it”

Now when the curve steepens, this is the bond market saying “We are optimistic of the economy and see strong growth ahead”

Well how does it say that?

When you think yields, they move opposite of price (this threw me off for awhile)

So when the yields of long term bonds rise faster than the those of short term bonds

That means that long term bonds are underperforming short term bonds in price.

This is a flattening yield curve.
This is the bond market saying “We see slowing growth ahead”

But again, why?

This means yields of short term bonds are rising faster than those of long term bonds.

Again, yields and price move opposite of eachother.

So that means that long term bonds are outperforming short term bonds in price.

If you were a lender and are worried about the economy would you want a bunch of short term debt on your books? And if you did want to take that risk, would you demand a risk premium?

Of Course you would, that’s why in this scenario short term yields are rising faster

And very rarely do we see the curve become “Inverted”. This is the bond market saying “We see a recession or crisis ahead”

This means that short term yields are ACTUALLY higher than long term yields.

Let’s think about this another way, to prove how crazy it is. It would be like you going to the bank to invest money in a CD and leaving your money in a 3 year CD gave you a better interest rate than leaving it in a 10 year CD.

This is the current yield curve using SOFR or Secured Overnight Financing Rate (The closest thing to OIS without a Bloomberg Terminal)

Last time this yield curve inverted was in 2007.

Same story, Ill have to finish this in the next few days. Part 3 will be how monetary policy ties into this.


I didn’t understand all of it, but thank you for this. I always appreciate reading your insight on the bigger picture.

I’m also leaning on the market being more bearish than bullish, and that last week’s rally was a dud largely due to shorts covering and options activity, e.g. trading-based, and not fundamentals- or news-based.

Disclaimer: I do own SPY 04/14 420p and I picked up QQQ 03/25 340p today for a quicker turnaround. However I am kinda itching to roll out the SPY puts to possibly May or June for theta protection and just to cut down on the overall risk.


Excellent write up. I’m looking forward to part two. It seems the indicators are indeed pointing toward a perfect storm but how long before it becomes obvious to the market and we get that reaction? War seems good for business at present and when that’s done things could get interesting.


Great writeup and summary of macroeconomic factors and the picture it paints when combined on a canvas. Thanks friend.


Brilliantly written, thank you very interesting.


I agree on the demographic and employment points. Prices are rising and wages aren’t as much. Wages are rising though just not as fast as they should or will be rising in the near future, but the US is relatively unaffected by this problem when compared to most of the 1st world other countries facing the same issue.

On productivity, it is actually rising and has been for decades but hasn’t been correlated to wages since the 70s

I wouldn’t say hedge funds are dumping on retail. Retail does not move markets, algos move the market more in a day than retail ever has or ever will.

Before Ukraine it seemed that deflation could be inevitable once supply chains are restored but now that’s probably delayed.

Geopolitically I think the US is in a stronger position than ever especially if China backs away from Russia.

I’d look into the age demographic issues in China and Europe, it’s alot worse there.


I agree with this thesis I think the economy is heading for a recession some time soon. Apparently we were in a similar situation to now right before covid but then the fed just started pumping money now we are going to have to pay the price eventually. The only question is when, if I learned anything from the big short it’s that people will ignore the obvious for as long as they can to make as much as they can. I think we have some time but one interesting thing is cooperate bond puts have large buys under 150 days but no recent buys over 180 days could be an indicator people think it’s coming soon. Most hyg and lqd puts 60 days or less.

Less then 90 day flow

Over 180 day flow

Less then 90 day flow

Over 180 day flow

Even if it doesn’t happen at the very least there is profit to be made at the fear over one.


Well written summary of the climate. For those unsure of why some people have been bearish a while, this leaves no question unanswered. It is indeed a rabbit hole you can go down research wise that gets increasingly disturbing the farther you go. Appreciate your write up


Insightfully put together, you had me at Kodiak Bear… your previous DD was as good, and I will continue to follow this. I am not going in on this, as I am already in it. Great job and keep the learning machine going, only stupid people know everything. Cheers!


Extremely thoughtful and well put together, thank you.

Can hear my old economics teacher telling the class “by the time we know we’re in a recession, it means we’ve already been in one for months……”


I have part 2 updated - Focused on the Yield Curve


“Last time yield curve inverted was 2007”. That definitely worries me that we are about to see a major correction.


I don’t think the correction will be as dramatic as '08, unless we can pinpoint what would trigger the economy to collapse in such a big way.

The Fed seems to be acting with extreme caution as to not cause a recession. Yes inflation is bad, but a big recession is much worse. They’re attempting to apply the brakes gradually instead of slamming them (causing a greater shit show).

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Mortgage rates hit 4.5% today on 30yr Fixed

Median Home price in US $350k

Mortgage payment @ 3% = $1500/Month
Mortgage payment @ 4.5% = $1800/Month

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Thanks for the comment,
You are def making the case the FED is making, trying to create a “soft landing” by raising rates fast enough to slow demand and cool inflation off, but not so fast where they cause a recession.

While this is def possible, I just don’t see them pulling it off.
Hear are my thoughts on it.

On the surface, Inflation would be the better choice vs a recession, but if you look at how inflation affects the economy, it is absolutely brutal to the middle class down, and more times than not leads you to the same place. Mainly because of what I listed in the DD. Inflation squeezes the everyday American’s discretionary income, so there is less demand for almost all products outside of mainly food and energy. Interest rates going up also creates less demand on almost all products outside of the products that people need to live because there is less access to credit, which is how new money gets “printed”

So think about what that means to all of the other publicly traded companies. What are their earnings and guidance going to look like when the demand and access to credit is gone? How are the YoY comps going to look like? How is the market going to react then?

So in a way, I think the fed is talking out both sides of their mouth. On the one hand they are saying the economy and labor market is strong and can handle it, on the other they are saying they need to be more aggressive with tightening because the economy cant handle significant inflation.

Its also worth noting that every single recession since 1955 was preceded by the yield curve inverting. It actually also inverted before the covid collapse in 2020.

Its a great question what would trigger a collapse, I have an opinion on this that Im going to add to this DD, but the short version is,

One mans debt on a balance sheet is another man’s asset. And these assets are used as collateral to take on more credit, I would assume we would see this unwind in a similar way to 08. Where collateral starts changing the lending landscape. Banks have to have access to money to stay solvent. If the assets/collateral they have on their balance sheet is seen as risky, due to prices moving down, or the particular sector sending warning signals. The collateral they have been using to get short term loans starts getting really expensive due to risk premium, and eventually gets to be in some ways useless. Lenders will only feel comfortable parting with money if the collateral its self is high quality. And, if a lender knows some of their loans they have written are backed by risky assets, they will margin call the barrower, creating a vicious cycle. This is what happened to Lehman in 08. JPM asked for billions of dollars they didn’t have, and Lehman couldn’t get a cash infusion because the assets on their balance sheet was mainly MBS, so no new lender wanted the risk. And the house of cards followed.

But unlike 2008-2013, The fed has significantly less tools they can use to help the economy in crisis.
In 2007 the Federal Fund rate was over 5%, giving them some wiggle room to cut rates after the collapse, they also had the luxury of starting the first round ever of QE. Quite a bit different than the $9 Trillion balance sheet and 25-50bps funds rate we currently have.

Thanks again for the comment, and conversation.


What I think will be the catalyst (albeit I have no idea how dramatic this would be) is food prices. Some folks are predicting $150/barrel for oil which has a dramatic impact on transportation costs for every industry including food. Those costs get passed down to consumers, and with middle class wages (which haven’t kept up with inflation) being eaten up (pun intended) by increases in food, energy, and gas. Both Biden and French President Macron mentioned an impending food crisis in the last day or so.

This is a really scary situation that I would argue is more concerning, existentially than the housing crisis in 2008. It is quite possible that the Fed will increase interest rates more aggressively to try to combat the impacts of these staple goods, since they are some of the biggest factors driving inflation/CPI up.

To put this in perspective, this article says that 56% of Americans don’t have enough savings to cover a $1k emergency expense. Per the fortune article above, Americans had to pay an additional $3500 in 2021 on every day goods due to inflation. This suggests a tipping point is coming where the average American can’t pay for the every day goods they need to survive.

(I know how this is coming across, and I don’t mean to be alarmist, just trying to piece together what may be coming at us.)


Here’s the bull version. Don’t mean to be curt but trying to write this down to try and beat traffic:

  1. The US is not at full employment so there’s room to grow. Also, there are no massive layoffs or shuttering of operations. The service industry still hasn’t even come back to pre-pandemic levels.

  2. Stagflation is more of a concern. We almost saw this in Japan with deflation. But Japan is a much older demographic than the US. Also, the Japanese are savers and it is very hard to stimulate the consumer into spending. Americans are the great consumer (crumble), and there is a lot of pent up demand. Either way, the American population is not an old population compared to Japan, South Korea, Italy, and other developed nations.

  3. Policy-wise, there’s an easy way to tackle an aging population: increase immigration. Might not appeal to a lot of people but the US still attracts the best and the brightest from around the world. It is still the freest country on earth. And upward mobility is still better than most countries although other countries are catching up.

So if energy does resolve itself in the later half of this year, which many economists predict it will, that can have a ripple effect to the rest of the economy, and prices decrease thus decreasing the risk of inflation. Sort of typing out loud but this thread is really good to hash out macro trends and indicators as a canvas to our trading strategies. Great job!


Updated yeilds from today. Quite a bit of movement. Also a 10% jump in the “VIX for bonds” MOVE indicator.


Hoping to add to the DD the next few days and start discussing some tickers. Hope everyone has a great weekend.


I was looking at ARKK’s chart and option chain and I saw this big drop in price in feb of 2021, so I thought id go see what the financial news was like at the time. Found a market recap from Nasdaq. Thought I would share how J Pow felt back then to show how off base he has been, and why we should always know the risks if he is wrong now.

Also, even with ARKK being down big this year, I still think there is more to go. A bunch of Over lederaged, Over valued tech companies that have never made money seems like an no brainer

Then a few months later


Wow, they should just join this forum and they could get the news like weeks faster!!!