A Profit Recession Is Coming, An End To Inflation Is Not | Vincent Deluard

Episode Summary

Executive Summary: The episode argues that inflation is structural, not transitory, and will remain high enough to pressure valuations, margins, and credit despite a possible recession in headline growth. Vincent Deluard says the bear market is only in its early stages, with equity pain shifting from speculative stocks to leveraged companies and profit compression. He also outlines idiosyncratic trades, including long oil vs. inflation swaps and long yen/short Nikkei.

Main Topics: Inflation as a secular regime shift (Priority: 5/5): Deluard argues inflation is broad-based, sticky, and likely to stay elevated because of wages, rents, services, labor scarcity, and supply-chain distortions. He sees it as a structural reset after years of disinflation and asset inflation. Bear market in risk assets and valuation repricing (Priority: 5/5): The interview frames the selloff as driven first by higher discount rates and real yields, with the next leg likely coming from weaker corporate earnings and margin compression. Labor market and inequality effects (Priority: 4/5): Deluard claims inflation may improve labor’s share versus capital by lifting wages, especially for lower-income, hourly, and lower-educated workers, while asset owners absorb much of the pain through falling stocks and other financial assets. Monetary policy and the limits of central banks (Priority: 5/5): He criticizes the Fed’s reliance on wealth effects and forward guidance, arguing that rate hikes work slowly, cuts work faster, and terminal rates may still be too low relative to inflation. Corporate profits, zombies, and credit stress (Priority: 5/5): He expects a profit recession before a broad economic recession, highlighting highly levered Russell 2000 companies, zombie firms, and tighter high-yield financing as the next source of market damage. Cross-asset trade ideas (Priority: 4/5): Deluard discusses relative-value and macro trades such as long oil futures versus short inflation swaps, and long yen/short Nikkei as a bet on a BOJ policy break. Bubble unwind in speculative growth and SPAC/IPOs (Priority: 4/5): The discussion ties the collapse of unprofitable tech, SPACs, and VC-funded startups to falling asset prices, fading capital subsidies, and the end of a low-rate growth narrative.

Key Arguments: Inflation is not temporary; it is becoming embedded in wages, rents, and services, and the disinflation process will be much slower than markets expect. The biggest equity damage so far has come from higher discount rates and rising real yields, but the next leg should come from declining corporate earnings and margin pressure. A recession is less dangerous to asset prices than inflation; an inflationary bear market is more severe and longer-lasting than a standard recessionary one. Inflation can reduce inequality over time by lowering real asset values and improving wage growth for lower-income workers faster than for higher-income cohorts. The Fed’s wealth-effect strategy was ineffective in driving real inflation; reversing it through falling asset prices will also be an indirect and slow mechanism. High-yield funding costs and tighter credit should expose overleveraged, low-quality companies, especially in the Russell 2000 and old-economy sectors. The BOJ’s yield-curve control is unsustainable; when it breaks, the yen could squeeze violently higher while Japanese equities fall. Many 2020-2021 speculative businesses were subsidized by cheap capital and weak labor discipline; their unwinding may even be mildly inflationary by removing supply and pricing pressure. Markets are underpricing the persistence of inflation and the possibility of a second wave of inflationary shocks or policy mistakes. Investors should focus on survival, not being right all the time, because even correct macro calls can lose money in volatile regime shifts.

Data Points: CPI inflation: 8.6% - Used as evidence that transitory inflation failed and that asset allocations built for low inflation are now impaired. SP 500 drawdown: Over 20% - Described as the official bear market move already underway. Real yield on 10-year TIPS: About +0.5% (up from around -1%) - Cited as a key driver of equity multiple compression through the discount-rate channel. Increase in real yields: About 150 bps - Used to explain why long-duration equities and growth stocks have rerated lower. Nominal GDP growth: About 12%-15% - Presented as evidence that nominal growth remained strong enough to delay an earnings recession. Earnings growth in Q2: 4%-5% - Illustrated that profits were still positive despite rising costs, but likely to slow next. Russell 2000 zombie-company share: About 20% - Defined as firms unable to cover interest expense and lacking at least 12 months of cash. High-yield yields: Around 8% - Compared with roughly 4% last year to show financing conditions worsening for leveraged issuers. Energy market backwardation: Three-year oil about 30% below spot at the time discussed - Used in the oil-vs-CPI relative-value trade idea. 3-year CPI swap: Around 4%-5% - Shows the market pricing persistent inflation even as oil futures implied much lower future crude prices. Japan producer prices: About 30%-35% YoY - Cited to argue the BOJ is crushing margins even though consumer inflation remains lower. Japan consumer inflation: About 2% - Contrasted with surging producer prices to show margin squeeze and policy distortion. USD/JPY move: From about 110 to 135 - Example of yen weakness under BOJ yield-curve control. Fed funds rate: Around 1.5% at the time - Used to argue U.S. policy remained far below inflation and likely needed to go higher. Terminal-rate market pricing: Just under / around 4% - Deluard argues this is not enough to subdue 8.5% inflation based on historical experience. Bank of Brazil policy rate: About 13% - Used as a comparison showing the U.S. is still much less restrictive than some emerging markets. Germany PPI: 33.5% YoY - Mentioned to argue Europe is not immune to inflation despite recession risk.

Pivotal Quotes: "This is not over. This is the first leg of a very long process." — Vincent Deluard: He describes the bear market as early and expects more downside in profits and risk assets. "I think it will reset many things in terms of generation, in terms of asset prices, in terms of inequalities, in terms of economic growth." — Vincent Deluard: Explains why he views inflation as painful but ultimately economically cleansing over a long horizon. "The biggest driver for the market is going to be how quickly the disinflation process takes place. The market still expects it to happen very, very quickly. And my expectation is that it won't." — Vincent Deluard: Summarizes his core disagreement with consensus on the speed of inflation normalization.

Implications: Listeners should expect sticky inflation, falling profits, and continued pressure on high-duration assets and leveraged credit. The best opportunities may be relative-value macro trades and selective shorts, not broad risk-taking.