It seems the bond vigilantes have claimed another victim — Donald Trump.

The recent correction in US asset prices encompassing equities, the dollar and, crucially, Treasury bonds has caused the president to cave on much of his tariff bluster. He’s also eased back on his tough talk against Federal Reserve Chair Jerome Powell. That’s a good thing for the US and global economy, but a lot of damage has been done. I, for one, still expect a recession.

More on that later. First, though, let’s talk about the bigger backdrop to the current situation. While shock over Trump’s aggressive self-harming tariff policy is certainly the proximate cause for the fall in US asset prices, the fact remains that after a 16-year bull market, equities are tremendously overvalued. If a trade war didn’t take them down a peg, something else is bound to at some point. 

I’ve been looking around for a vehicle to showcase that overvaluation. And I think I’ve found it in one of the safest and most venerable US companies, Walmart.

After scouring Walmart’s annual 10-K financial reports, I’ve come to the conclusion that most of the rise in the retail giant’s stock price is predicated on multiple expansion. That is to say, the reason investors are paying near 40 times earnings for a share of Walmart is because times have been so good during the past decade and a half that people are simply willing to pay exorbitant prices even for dull and boring companies like Walmart.

What follows is some serious and worthwhile number-crunching. Here’s an outline of where I’m going:

1. You can see the excess euphoria from a 16-years bull market not just in the multiples of earnings people pay for equities, but also in the recent reactions to tariff news and Tesla earnings.
2. This is just as you might expect after such a long period of economic growth, according to economist Hyman Minsky’s financial instability hypothesis. 
3. That euphoria has meant a considerable rise in price-earnings ratios across the market, not just for the Magnificent Seven megacap technology stocks. 
4. So I tried to find the most stable, boring but well-known US companies to see how their shares have progressed over that 16 years. And what I found was that their gains are out of all proportion to the rise in free cash flow and earnings.
5. What does that mean? If we avoid recession, the beat goes on — tempered by high valuations though. But if we have a recession, especially a severe one, it will be catastrophic for stocks as both earnings and earnings multiples will shrink. Prior equity supercycles tell us that.

Did you see Tesla’s catastrophic earnings report?

After the closing bell yesterday, in a session where Tesla’s stock bounced 4.5% off of a triple bottom, the company released earnings that were by almost any measure horrible — a miss on revenue and earnings, profits down 71%, with Tesla only making money because of tax credits from the government. On the earnings call, CEO Elon Musk “sounded very depressed.” And still, the stock rose even more in after-hours trading and in Wednesday trading.

This wasn’t just a Tesla thing. The whole market rallied on Tuesday and Wednesday after the Trump administration signaled both that a trade detente with China was possible and that the president wouldn’t try to fire Powell. Trump even said at one point that tariffs with China “will come down substantially.” If you listen not just to what Trump said, but how he said it, it is a complete 180, a full-scale capitulation on both the trade and Fed issues — even as we’ve heard nothing from China. They haven’t even begun negotiating.

Trump is now clearly fearful of what his economic policy might wreak. Not only did his anti-Powell comments trigger a “sell-America” avalanche on Monday, but on Tuesday, the CEOs of Walmart, Target and Home Depot met with him and told him that his tariff policy would raise prices and empty store shelves. So he caved. And the markets have rejoiced, with long-term bond yields falling as much as 16 basis points in early Wednesday trading. The bond vigilantes win again.

But it’s the stock market reaction that’s telling. Stocks have erased all of Monday’s losses as if Trump hadn’t just blasted Powell as a “major loser.” It’s as if nothing happened. After an almost uninterrupted rise in the US economy, buy-the-dip still dominates people’s view of the stock market. Don’t believe those bearish retail investor surveys. Watch what investors do when any economic speed bump looks to have been overcome. They buy.

The market’s vulnerability is high. Look at Walmart

Here’s the problem. The longer an economic cycle goes on, the more (leveraged) investors feel cheated by not swinging for the fences. It’s as if they are constantly leaving money on the table; the margin for error they incorporate into their models simply proves time and again too large. And so they reduce that margin for error in order to reduce the money they leave on the table. That is, until you get an economic shock that provokes a sustained downturn in the economy. This is what the vaunted economist Hyman Minsky taught us — and it’s something many took onboard after the subprime mortgage crisis in the late noughties.

Debt investors aren’t the only ones who take on too much risk. It’s equity investors, too. And the numbers from Walmart prove it. Let’s start with their most recent 10-K that outlines the company’s numbers for the three years through Jan. 31. What we see is a company that made $19.4 billion in profit for the year just ended and trades today with a market cap of just about $760 billion. That means you’re paying almost 40 times their single-year earnings for the stock. The equivalent figure for Apple is just 30. For Meta it’s 22.

I was surprised by this when I first saw it. I mean, Walmart is not a growth stock. So I looked across time and across companies and found that Walmart, while more richly valued than most, is indicative of a big trend in valuation over the past two decades. For most of the big companies in the S&P 500, you see a prodigious increase in what you pay for cash flow and earnings versus just 5 or 10 years ago.

Using Walmart’s numbers as an example, if you go to their cash-flow statement (to strip out any accounting anomalies) and just look at their free cash flow from operations, here are the specifics: Over the past three years, Walmart produced an average of $33.7 billion in cash from its operations before investments and financing operations — which means the market cap is about 22 ½ times that average cash flow. Go back five years before the pandemic and the equivalent numbers in 2020 were $27.1 billion for a market cap at the end of that fiscal year of around $300 billion. This valued Walmart at 11 times average cash flow — half today’s amount. 

But that’s not all. I looked all the way back to the eve of the financial crisis at the equivalents for January 2005 through January 2008 and I found Walmart delivering an average of $19.5 billion of cash from operations on a market cap of just about $140 billion — or about 7 times cash flow. So effectively, today you’re paying three times as much for a year’s operating cash flow as you were in 2008. And Walmart isn’t alone. I did the exact same exercise with Proctor & Gamble back to 2010 and found a similar increase. Eyeballing P/E ratios across a wide swathe of companies elicits the same outcome.

This matters because history suggests long economic booms are followed by shorter cycles as the economy digests the built-up leverage and asset-market overvaluation to reset to sustainable levels. I mean, Walmart’s multiple could rise to 50 times earnings or 25 times average cash flow, yes. But do you want to invest on that premise?

If you look at past supercycles, when there was an overvaluation, the next cyclical bull market was cut short before losses mounted. We certainly saw that during the Great Depression in the 1937-38 recession as well as during Great Financial Crisis, which started just four years after stocks had bottomed following the internet bubble. But we also saw it in the 1970s.

I always come back to that cycle as a reference because I think of it as a best-case outcome. The 1960 downturn might have cost Richard Nixon the presidential election but it didn’t really knock the wind out of stocks. It wasn’t until the “stagflation-lite” period of the late 1960s that equity prices started to wilt. And it was only then that each cyclical bull market was cut short.  So investors basically got a free pass for almost a decade before things unraveled.

In today’s context, after the 2019 top in inflation-adjusted, decade-long equity returns, there’s been a similarly slow and gradual decline. I chalk that up to the massive monetary stimulus during the pandemic and the huge deficits the government has been running really since the Trump tax cuts in 2017.

In some senses, the damage is done for the US economy though. Trump can backpedal all he wants. The guns-blazing approach his administration has taken to just about everything has left a lasting impact both in terms of a diminished standing of US assets in global portfolios and potential growth in the US economy. We’re still talking about 35% tariffs on Chinese goods even in a best-case scenario.

A bit of panic buying ahead of tariffs, as we’ve already seen for cars in the US recently, will keep the recession at bay for a little while. But reports suggest that port traffic from China to the US is down significantly even while port traffic from China overal. hasn’t declined. The scarcity that retail CEOs told Trump about yesterday is coming. And it will mean higher prices and a slower economy. Combined with a 35% tariff on China, 10% on everyone else, as well as tariffs on steel and aluminum and as yet unknown other penalties, this should be enough to tip the US into recession.

Is it enough to also stop the buy-the-dip mentality of US equity investors though? Only if a recession is protracted and deep. The 2020 recession and recent Fed hiking cycle tells us that. But even assuming stock prices increase at a 6% clip per year from here to the end of 2027 and inflation only rises 3%, my calculations show decade-long inflation-adjusted returns falling to 70% from recent levels closer t0 100% and peaks over 200% in 2019 and 2021. I look at that as an upside scenario as well. So Trump needs to be careful not to needlessly aggravate that slowing with the confrontational approach that has delivered sky-high tariffs on Chinese goods. The fact that US assets are shooting up on relief from his conciliatory statements should help impress this upon him. 

After such a protracted period of stocks almost always going up, a lot of investors have never seen a truly scarring bear market. And they’ve been conditioned to buy the dip. While this ingrained behavior helps to keep markets moving up, it’s also a huge vulnerability. As we’ve seen time and again, investors are willing to sell at a moment’s notice on bad news, fearful of the very overvaluation their buy-the-dip mentality has created. Until now, a buoyant US economy has always bailed them out. But that dynamic may soon be coming to an end.

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