Cracks beneath the Surface!
Benny & The Squirrel: Episode 51. With Larry McDonald.
In Episode 51, Benny & The Squirrel welcome Larry McDonald to the show. Larry is the Founder of Bear Traps Report and bestselling author of A Colossal Failure of Common Sense and How to Listen when Markets Speak. You can find Larry on Twitter @ConvertBond or email him at info@thebeartrapsreport.com.
The show was recorded at 4pm EST (4am in Hong Kong - thanks Larry!) on Wednesday 13th May.
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Today’s Slides
Audio only version (for paid subscribers)
Podcast Summary
Home Depot Supplier Stress & Consumer Credit Weakness
Bloomberg’s updated SPLC supply chain function reveals ~30 Home Depot suppliers down 10–40% in past 30 days
Whirlpool flagged as a specific stress case: ~$2B equity vs. ~$7B debt with near-term maturities and CDS blowing out
Broad credit weakness concentrated in consumer-facing and energy-exposed companies
JP Morgan reserves at the Fed are down ~$200B rapidly as banks shift from reserves into Treasuries — effectively “stealth QE” with Bessent and Warsh working in tandem. Banks being forced to absorb ~$1 trillion more in Treasuries while nominally doing QT
Hard assets (copper, silver) are responding to this liquidity injection; silver’s specific move is attributed more to China than broad macro re-pricing
US administration’s core MO is keeping asset markets buoyant — consistent with goosing liquidity
Semiconductor Sector — Extreme Positioning & Rotation (Minute 6)
SOXX is ~64% above its 200-day moving average, an all-time record (previous record: high 40s) — momentum chasers are driving a dangerously extended move
Candle reversals in recent sessions signal money rotating out of semis and back into software
Smart money at Bloomberg chat dinners is shorting semis and going long software with defensible moats (data lakes, regulatory advantages)
The rotation is viewed as a counter-trend trade, with quarter-end/month-end rebalancing (July 1) as a key catalyst to watch
The Strait has been closed for ~72 days; critical minerals and chemicals used in semiconductor manufacturing are at acute supply-chain risk. Street data center construction estimates are “20–30% too high” vs. the on-the-ground reality of energy and materials constraints
High probability of a meaningful semiconductor supply hiccup within 3 months. The market is also extrapolating AI token demand at peak inefficiency — compute efficiency will improve structurally, undermining the capex bull case for semis
Market Breadth Deterioration & Triple-C Warning (Minute 14)
Only 1 in 3 stocks up on an all-time high day; 9% of the index hitting 52-week lows simultaneously — both near all-time records
CCC-rated bonds (junk of the junk) are not making new tights while equities make new highs — the most reliable early warning of economic stress
Annualizing the 3-month CPI trend produces 6–7% inflation before the straits closure and trucking cost breakouts even factor in; 8% inflation in Q3 is a credible risk
Markets are pricing a benign “Trump does a deal” outcome — recency bias from the April 10th tariff reduction rally; Iran’s internal factions (5 groups, 2–3 opposed to any deal) make a neat resolution unlikely
Fed Policy — Bond Market Signals (Minute 16)
Rate hikes have limited power against supply-side inflation; raising T-bill rates may actually sustain boomer spending rather than cool it
The Fed may not need to hike — a credible threat would be sufficient to cool asset prices; the bond market is already signaling this
Market has shifted from pricing 3 cuts to pricing ~half a hike
For the first time in 2.5 years, the 2-year yield has eclipsed the Fed funds rate
In summer 2008, markets priced rate hikes on 5% CPI even after Bear Stearns collapsed — then demand destruction hit rapidly and bonds rallied sharply by year-end
Eurodollars moved from 97.15 to 95.75 then back to 99 within months — the sequencing of inflation shock → demand destruction → bond rally is the working analog for today
Consumer Purchasing Power Destruction (Minute 19)
Zero real wage growth means commodity inflation in food, copper, and oil is directly eroding household purchasing power
Walmart vs. Home Depot spread confirms the market is pricing a major consumer hit and rotating toward recession-proof names
Even “defensive” names like Walmart and Costco trade at extreme valuations — in a market dislocation, everything gets de-rated regardless of business quality
SpaceX / OpenAI / Anthropic — Index Inclusion Scam (Minute 22)
Anthropic, OpenAI, and SpaceX are potentially pulling back from secondary market sales; off-market prices are already getting hit
S&P and Nasdaq index rules are being modified to accommodate these mega-IPOs — combined valuations ~$4 trillion (vs. ~$300B actual float)
Framed as “the scam of the century”: private VC insiders cashing out by forcing shares onto passive investors who are compelled to buy
Jack Bogle’s original 1-year review and the checks-and-balances process is being waived; at 55% passive (and rising toward 60%+), indexes become increasingly gameable
Even with passive money plus closet benchmarkers, genuine demand from sophisticated buyers for $30–40B of IPO stock at these prices is unlikely to materialize
Corporate free cash flow is being diverted from buybacks to AI/data center CapEx — buybacks only became legal 30 years ago and largely exist to recycle stock-based compensation
The 1987 parallel: portfolio insurance created hidden fragility that was invisible until it wasn’t; today’s equivalent is passive flows plus simultaneous mega-IPOs
September/October identified as the risk window — the first major IPO could kill appetite for the next two
Stagflation Dynamics — Software CPI vs. Commodity Inflation (Minute 28)
The CPI component for software has never risen — stark contrast to hot PPI and CPI in commodities
The fiscal deficit is running at ~$1.9–2 trillion (tariff revenue offset by court actions); combined with the AI CapEx bonanza, fiscal impulse is overwhelming consumer weakness
The setup feels increasingly stagflationary — fiscal dominance is structural and persistent
The Three-Pillar Inflation Case
$2 trillion AI/infrastructure CapEx boom — Caterpillar at an all-time record 166% above its 250-week moving average (previous record: 103%)
$1.9 trillion fiscal deficit with no credible path to consolidation
Straits closed for 72 days — second/third/fourth-order effects hitting trucking (all-time high costs), fertilizer, helium, and semiconductor chemicals
Base scenario: inflation shock creates an economic “heart attack,” economy then crashes fast, and bonds rally hard — rate cuts follow
Hard Asset Cycle — Positioning Since the Book (Minute 33)
Bear Traps’ hard asset thesis (uranium, gold, silver, copper) was nearly edited out of How to Listen When Markets Speak by the publisher — the cycle has since validated it
Commodity bull cycle began in March 2020; after a mid-cycle setback, almost everything is now at new highs
Materials, industrials, and energy peaked at ~49% of S&P composition in 1981; fallen to ~12% recently — massive structural mean reversion potential
Nasdaq Valuation — More Extreme Than 1999/2000 (Minute 38)
Nasdaq 100 was ~$12 trillion at end of 2021; now ~$37 trillion — “so much crazier today than in 1999/2000”
The US economy is levered to the S&P unlike any prior period — perhaps not since the 1920s
One key difference from 2000: sentiment is anxious and stressed rather than universally euphoric — investors hold more tech than they’re comfortable with
UK Gilts & G7 Yield Contagion
UK 30-year yields are ~75bps above US equivalents, dragging the US long end higher — G7 sovereign yields are locked in lockstep, hostage to the worst performer
UK government is politically paralyzed: traumatized by the 2022 Truss/Kwarteng bond market shock, too scared to make bold growth or fiscal reform moves
Political instability (Labour governing with an unwieldy majority, Reform protest votes) increases the risk of a UK yield breakout that infects the rest of the G7
Private Credit & Insurance Companies — Hidden Bag Holders
Poorly supervised rating agencies (described as operating out of living rooms) rated hundreds of private credit securities; insurance companies loaded up on the product
AI disruption is now wiping out software companies — previously the most reliable cash-flow generators — which are the backbone of private credit loan books
Insurance companies with exposure to this private credit stack plus unresolved commercial real estate rate risk are the short (MetLife-type names flagged)
Not systemic like subprime, but endowments and pension funds will suffer meaningful losses; the scenario that WOULD be systemic is a runaway inflation shock that buckles the bond market
The 5% 10-Year Trigger
If the US 10-year reaches 5%, the market crashes — too much debt is underwater relative to current rates
Dallas Fed mark-to-market gap: ~$1.8 trillion between par and market value on marketable Treasuries
The post-2022 breakdown in stock-bond negative correlation removes the traditional diversification buffer — in both 2022 and Q1 2025, stocks and bonds sold off simultaneously
China Equities — Trade, Not Investment
Bear Traps issued a KWEB/FXI buy alert 3–4 weeks prior; KWEB was oversold relative to Nasdaq and not pricing any goodwill from a potential US-China deal
Drivers: weakening dollar, potential tariff détente, Xi-Trump relationship dynamics
China’s Kimi platform is allegedly pirating Claude code, running it through Kimi, and open-sourcing the output — structurally undermining the US AI capex trade
If China dumps state-subsidised, open-source AI (as it did with steel and solar), it could vaporise the wealth effect underpinning the US economy without firing a shot
Counterpoint: Alibaba and Tencent are deploying AI for their own operational efficiency — their narrative will eventually reverse, benefiting Chinese equities
With 55% of the S&P in passive hands, most holders have no idea what they own; fund managers are holding more tech than they’re comfortable with — fragility is fully set up
Final Bear Traps Positioning Summary
Bullish: copper, platinum, palladium, industrials, materials, energy — “everything ex-tech”
Bullish China equities (tactical trade)
Bearish US consumer discretionary, high-yield credit, and insurance companies with private credit/CRE exposure
Bearish the broad index at current composition — Rio Tinto and BHP have been destroying Nvidia and the Nasdaq, and are still a fraction of S&P weight with room to run
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