Happy Sunday, I’m Bill Cohan.

Welcome back to Dry Powder, my biweekly email about what’s really happening on Wall Street. Thanks to all the new members who have recently joined the community. If you have a friend or colleague who might be interested in receiving these notes, feel free to share the sign up link with them. (We also have group subscriptions.)

In today’s email, a few thoughts on the current non-recession recession, the Fed’s next moves, and how the White House is trying to spin the bad news. Plus my analysis of the Twitter-Elon standoff, a potential settlement, and why a ruling from the Chancery Court is likely only the beginning of the negotiations.

The White House is supposedly sweating next week’s G.D.P. data, as well they should, but does it really matter if we’re in an official recession, or not? I don’t think so. If inflation is raging along at 9 percent annually and G.D.P. is in decline, the question is what will the American people actually feel? Higher prices for nearly everything or some amorphous sense that our gross domestic product has fallen two quarters in a row? Hence the Biden administration’s new talking points, previewed in this White House blog post, that notes “there are no fixed rules” for determining a recession.

What will be far more telling than a secular decline in G.D.P. will be rising unemployment, job cuts at big tech companies or at Wall Street banks, and a general sense that it will be increasingly more difficult to find a job and to avoid being laid off from a job you have. New filings for unemployment claims last week were the highest since November, although not much ink was spilled about this turn of events. As Harry Truman once said, or is said to have said, “A recession is when your neighbor loses his job; it’s a depression when you lose yours.” So, it seems to me, we’re much closer to the beginning of the long-overdue cycle of economic pain than we are to the end of it. You can’t have more than a decade of risk being mispriced, courtesy of the ZIRP-style policies of our central bank, and expect there to be no consequences, or few consequences. I know everyone wants the pain to be brief, and it’s no fun, but I really don’t see a Fed bailout this time.

Unless the Fed has tricks up its sleeve that we have never seen before, we are closer to having to endure a Paul Volcker-like interest-rate cycle (of the extended double-digit variety) than we are to a near-term return to anything like the low-interest rate environment that the Fed engineered between 2009 and early 2022. With the annual inflation rate now close to double digits, what will it take for real interest rates—the interest rate that investors need to overcome the effects of inflation—to be positive? Wouldn’t that require the yield on the two-year Treasury to be closer to 10 percent than the 3 percent yield it has now? That’s a 700-basis point increase. How many Fed rate hikes will it take before we get anywhere near there and what will the consequences of that be? You want a recession? That will get you a recession.

The choices are stark: either more of the inflation rate that has been the highest in 40 years or a bona fide recession that will lower prices, lower demand, lower profits and lower employment. This is the table the Fed set with its 13-year addiction to low interest rates that was then exacerbated by events beyond its control—a pandemic that interrupted many supply lines and a war in Europe that pushed the price of fossil fuels to historic levels without any substitutes to reduce demand for those fossil fuels. I am not sure how the Fed engineers this landing. It seems to be in hope-and-pray mode now.

As I was told repeatedly when I was writing House of Cards, my 2009 book about the collapse of Bear Stearns, “Hope is not a strategy.” It wasn’t then for Wall Street and isn’t now for the world economy. David Solomon, the C.E.O. of Goldman Sachs, said the other day that the chance of a U.S. recession in the next two years is 50 percent; his own economists put that chance lower, at 30 percent. These estimates mean nothing to me. What matters is our collective confidence in where things are going these days and no matter how you slice it, that’s not good and hasn’t been for a while now.

Until investors capitulate to the bear market, as they did in and around March 2009, when the Dow Jones Industrial Average reached 6500, we’ll have to wait longer for a genuine opportunity to restart the stock-market engines. The Dow is just shy of 32,000 at the moment, merely 14 percent of its all-time high. It’s worth remembering that in October 1987, the Dow fell 22.6 percent in one day. So we’re still far from that kind of capitulation.

The fact that Wood, who has rightly earned her spot as the poster child for investing excess in the past five years, has managed to attract some $2 billion in new money is all the proof you need to know that investors are in “buying the dip” mode rather than “capitulation” mode. I’m sorry to say that the Cathie Wood of the world need to be put out of their professional misery, not given the chance to rise from the dead. But if investors don’t get that idea, well then I guess that’s one indicator of what makes this country great: people can pretty much do what they want as long as they don’t break the law.

There are other indicators besides the inflows to Ms. Wood that we’re experiencing a “dead-cat bounce” rather than the start of another up-cycle in stocks. Look at what’s been happening with some of our favorite speculative assets. Even though Bitcoin is down 53 percent year to date and is one of the worst performing assets in this mini-bear market, it is up 17 percent in the last month. Tesla’s stock, another bellwether of speculative excess, is down 32 percent in 2022, but up 16 percent the last month. Revlon, the cosmetics company, filed for bankruptcy in mid-June, meaning the company determined it could not pay its debts as they became due. Its stock, which will likely be wiped out in the bankruptcy process, was trading around $1 per share when it filed. It is now trading at more than five times that price, at $5.45 per share, which is down from more than $8 a share a few weeks ago. It’s hard to understand why Revlon’s equity is still trading at $300 million while it’s in bankruptcy court and when the company can’t pay its $4.2 billion in liabilities as they become due.

Then there’s the yield on the average junk bond, now 8 percent, a point I have been harping on for months now. That’s more than double what it was last fall, which is good news and a sign that investors are slowly but surely getting paid for the risks they are taking in owning such bonds. But, and this is a big but, the average yield was 8.8 percent only a few weeks ago, meaning that the price of junk bonds has actually rallied some 10 percent in less than a month.

The price of these bonds should be continuing to fall to recognize the ongoing risk of ownership. Instead, the price of junk bonds are rallying. Suddenly, as if investors are expecting the Federal Reserve to bail out the financial markets as it did in 2008, and again in 2020, risk assets are seemingly back in favor. Well, dear reader, as I alluded to earlier, the bad news here is that the Fed is out of tricks. In fact, because of rampant inflation—now running at an annual rate of 9 percent, some 700 basis points above the Fed’s inflation target of 2 percent—the Fed will continue to be raising short-term interest rates, rather than lowering them. In other words, the Fed will be choking off this rally, not fueling it.

I know it’s been a delightful 13 years of Fed enabling and there are many investors out there who don’t remember the 2008 bear market or those before then, in 2001 or 1991 or 1987. Maybe those with short-term memories are the ones fueling the current rebound in stocks and bonds. FOMO, YOLO, etc. And although, again, this is not financial advice, until there is capitulation, true capitulation—outflows from Cathie Wood, not inflows; the yield on the junk-bond above 10 percent, not being lowered to 8 percent, etc., etc.—there will be no equilibrium in these markets, no peace, no hope for a sustained and rational rebound. Don’t get fooled by a promising-looking bounce; this time is different.

That’s an outcome that’s far from certain, but Twitter’s stock is trading with more certainty of a deal now than it ever did in the days, weeks, and months following April 25, when Elon put his signature on the “seller friendly” merger agreement. Unless Twitter shareholders, or Twitter speculators, know something about what’s going to happen in Delaware that no one else knows, there really is no sound explanation for why Twitter’s stock is up around 22 percent since Elon announced, late in the day on July 8, that he was abandoning his deal for Twitter. The only explanation that makes any sense is that Twitter shareholders—no doubt aware that the chancellor assigned to the case recently enforced a similar, smaller merger, and also seems like a no-bullshit customer given her decision not to punt the trial until February 2023—have decided that the April 25 merger agreement is the company’s best asset. Otherwise the stock would be trading in the 20s per share, given its limp financial performance, more akin to a Snap-type market reaction than the increase that we’ve seen in Twitter’s stock since July 8.

We probably do need to have the Delaware verdict—coming in October after a short trial—as well as to have the verdict affirmed, either way it goes, by an appeals court, likely later in October, before the real action starts. Assuming Elon loses as a contractual matter, what will it take for the two sides to make this all go away and pretend it never happened? Last week, I suggested a $5 billion settlement, equal to five years of Twitter EBITDA and the kind of money that will give Parag Agrawal, the Twitter C.E.O. who has probably aged a decade during this four-month fiasco, the time and resources to fix whatever the heck is ailing the company operationally. At $5 billion, there would be enough pain on both sides for it to seem like a real compromise. Elon, of course, will wonder why he has to pay anything, or why Twitter isn’t paying him for the privilege of getting into his sights in the first place. I guess if you get to ride on Ari Emanuel’s boat in Mykonos, you figure the world owes you something.

As for Twitter, or more precisely for its shareholders, $5 billion seems like a major discount to $44 billion, or even a material discount to the difference between Twitter’s value today—$30 billion—and the $44 billion, or $14 billion, which might be one direction the Chancery court might go. It’s also five times more than the $1 billion walk-away fee that Elon thought had been agreed. Compromises arise when there is pain on both sides and both sides feel jilted. I think that’s where we are heading. The compromise could also come with a few bells and whistles, including the idea that Elon will sell his 73.5 million shares into the market over time and promise not to buy any more for something like ten years. That’s a nice walk away face-saving carrot for a guy not used to losing many negotiations.

My friend Scott Galloway posited on Pivot the other day that Elon now has the perverse incentive of driving up Twitter’s stock price in case the court’s punishment for him is the difference between $44 billion and whatever Twitter is trading for when the judgment comes down. The higher the overall value of Twitter at that time, the lower the spread between that price and the proposed purchase price, and ergo, according to this argument, the less Elon will have to pay to get shareholders back to the promised $44 billion. He can obviously keep buying, and maybe even has been. If the stock price gets close to $54.20—a big if, but not out of the question if he were to start buying— then he’ll have to pay less in compensation, should the judgment go that way.

It’s an interesting notion. But even though Twitter has by far the better of the legal arguments here, the chances of this dispute being ultimately resolved by the courts still seems slim to me. If the Chancery rules in Twitter’s favor, the real negotiation will start, and that’s why I still see that $5 billion number in his future. We’ll know more after the various October decisions. Until then, it’s anyone’s guess as to what the wacky Elon Musk will do next. Of course, that’s been both his biggest asset, and weakness, thus far.