Broker Check

2024 Q1 "History Does Not Repeat Itself"

March 08, 2024

“History does not repeat itself, but it often rhymes.”

Mark Twain



As I write this, I am optimistic about the markets in 2024 and I would like nothing more than to focus on the many positives I am seeing in the economic data that signal strong performance as the year unfolds.  Near term recession signals are waning due to low unemployment and the resulting strength in consumer spending.  When added to the very recent bond and stock market corrections in 2022, I believe we are set up for a solid year ahead.  However, I feel it is time for me to comment on what I see building behind all of the positive current economic data so you are aware of what comes next.


As you know, the core of my investment philosophy is built around two primary positions on the markets.  The first is that investor behavior is a far better predictor of market conditions than any mathematical model can deliver.  The second is that outcomes are better when more attention is placed on minimizing losses in down markets than trying to capture every penny of gain in good markets.  You can miss a portion of gains in good years if you avoid a larger portion of losses in the bad years.  This has resulted in my firm’s culture of risk management as a primary focus and the results are clear when we have bad markets like 2022.


As a part of our focus on risk management, I feel it is important to keep you informed about any systemic risks we see in the economy and how they may affect your assets rather than following the Financial Advisor sales training to stay rigidly bullish and only discuss negatives after bad things have already happened.  To that end, I must tell you that a storm is beginning to form that I expect may bring a very challenging economic environment sometime in late 2025.  The effect of this event on the markets will likely be very familiar to all of us because it rhymes with what we experienced just 15 years ago in the great financial crisis of 2008. 


Historical Perspective

As a refresher, the 2008 economic crisis was brought on by an out of control mortgage lending environment and housing price bubble of epic proportions.  These factors resulted in millions of people stating their occupation as “House Flipper”, which meant they bought properties, sometimes did some menial improvements, and then were able to sell them at a significant profit within months.  The problem was compounded by loose lending standards that were based on stated income, meaning the banks just took your word about your income without verification.  This allowed people to be approved for mortgages with payments they could not afford. 


In the view of the banks, with real estate appreciating at a rate of 8% - 10% per year for the preceding 5 years, they acted as if these were zero risk loans.  Due to loose lending rules, the default rate on mortgages was climbing higher and higher in the years leading up to the crisis, but if a borrower could not make the payments, the bank would foreclose and sell the house for more than what was owed.  It also wasn’t the worst outcome for the borrower.  Yes, they would have to find another place to live and their credit score was negatively affected, but when the foreclosure sale was complete they would receive a payment for any proceeds from the sale that exceeded their mortgage balance.  Of course, for all of this to continue working flawlessly required continual real estate price increases.


In late 2007, real estate prices began to pull back and went negative in 2008.  We quickly learned that as many as 15% of the homes in the U.S. were vacant and were simply trading hands in flipping transactions.  Suddenly, the far higher than average default rate became a huge problem because now the banks could not recoup the entire amount owed in a foreclosure and the borrowers lost their homes while still owing the bank the remaining balance.  The mortgage defaults and their effect on securitized mortgage investments caused banks to fail at a rate not seen since the Great Depression. 


History teaches us that when an economic event is caused by the instability of your government or a lack of confidence in the banking system, its effects on the stock market are 3 times worse than any other type of recession event, which is why the market event from late 2007 to early 2009 saw a massive decline of the S&P of over 50%.  And here is where I am starting to hear villanelle in current market conditions.


Current Outlook

Probably the most significant permanent effect of the Covid 19 lockdowns has been the overnight change in the way we work.  According to Statista (, before the pandemic approximately 24% of U.S. workers worked remotely more often than they worked on site, defined as working remotely 3 or more days each week.  Today this number has more than doubled to over 53% and is likely to stay higher for good.  Simply put, we have fundamentally changed the way we work.

One of the results of this transition is obvious to anyone who works or spends any time in a large office building.  The majority of commercial properties throughout the country have an unprecedented amount of vacant space that is no longer needed to house on site workers.  You might be thinking, “This was all brought up in 2021 and is old news, so what’s the big deal?”  The problem is that commercial leases are much longer than the typical residential lease.  The majority of commercial leases have terms of 7 – 10 years, so the vast majority of leases currently in force are pre-Covid leases.  This means that most of the vacant space in commercial buildings is still under lease and the property owners have continued to receive rent payments since defaulting on a lease ruins a company’s credit rating and the resulting increase in borrowing costs far exceeds the cost of rent.  But one thing is certain, when the lease expires, companies will cancel leases for space they have vacated. 


This has created a delayed Covid time bomb in commercial properties.  When lease cancellations begin to increase rapidly, which I predict will begin to occur in late 2025, property owners will see rental revenue decline quickly to levels that no longer support the mortgage payments on their buildings.  This, in turn, will cause the rate of commercial mortgage defaults to jump dramatically.  And, since the average U.S. bank has over 30% of their loan portfolio committed to commercial mortgages and average mortgage balances are many multiples higher than residential mortgage balances, the default rate will cause many banks to fail as this problem develops.  Again, we will have an economic environment driven by deep concerns over the safety and stability of our banking system which will be very bad for the financial markets.


Looking at the data, CBRE, a large commercial real estate firm, says that over 77% of all commercial buildings in the U.S. report that over 80% of their space is currently leased.  That is great, but again they are only saying the space is currently leased. 

When we look at occupancy rates we see a very different picture.  Occupancy typically varied between 90% and 98% pre-Covid and was nearly 100% right before the lockdowns began.  Today, we have just finally reached 50% occupancy after 3 years and the occupancy increase rate is slowing rapidly.  To further confirm the problem, space available for lease has already exceeded the peak levels of the 2008 crisis and this economic event hasn’t even begun to heat up yet.

Sadly, I am not seeing a way to avoid this.  At current growth rates, it would take nearly 20 years to fill the empty space in our commercial buildings.  I am left with the view that this is an imminent problem that will occur and the only remaining questions are what can be done to protect assets from this and when to take action to do so.  We have been researching tirelessly in recent months to answer the first question and we are watching raw data on lease cancellations to hopefully be able to time this correctly.  I expect that we will see a large increase in lease cancellation rates 30 – 60 days before foreclosures jump and banks begin to fail, so hopefully, we will have enough lead time to adjust.  As we perform more research, the strategy to address this will evolve and we will let you know when it is time to make some large protective changes to your portfolio. 


In the interest of not starting the year with a commentary that is all gloom and doom, I will reiterate what I said in the opening paragraph.  I believe this event does not come to a head until late 2025 and that we should be able to take action before it gets ugly.  Plus, the strategy we are developing should allow us to avoid massive losses if we do.  In the meantime, I see strong, profitable markets in the year ahead and for most of 2025, so there is a lot of growth to capture in the near term.  I will also add that this economic event is not the end of the world and is a necessary correction that must occur in response to such a massive change in the way we work. 


Following the 2008 crisis and the 5 years it took to absorb all of the vacant homes, home prices had dropped to more affordable levels and banks had tightened their lending standards so the real estate market as a whole is much more stable and healthy today even after huge price gains in recent years.  I expect a similar outcome following this event.  We will land in a more stable and rational place that will set us up for future growth and if we can avoid taking a 50% loss, we will have plenty of dry powder to deploy when the timing is right to go bargain hunting. 

The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.