Frank’s Outback

There is a restaurant in Pawleys Island named Frank’s Outback. If you’ve ever been there, you have probably heard of it. It is a scene. All the fancy people (with the same plastic surgeon in Mt. Pleasant) go there. I’ve tried making a reservation in May, and there is nothing open until September. But my wife and I snuck in there last week at 5 pm, no reservation.

We were sitting there, eating dinner, when I got a push notification on my phone about Mark Walter selling his WNBA team, the Los Angeles Sparks. I am a little hazy on this, but the Big Short Guys filled me in on the details at DirtCon. Walter founded Guggenheim Partners and got involved big into private credit, and rumor has it that he is selling off assets left and right (including the Dodgers) to plug the hole in his private credit investments. Private credit has been a slow-detonating bomb for two years now, which we have written extensively about on ShortPrivateEquity.com. Walter is looking to receive $700 million for the sale of the WNBA team, which is a lot but still probably not enough to plug the hole.

Then I spent the rest of dinner telling my wife about the existential risks of private credit (romantic!), that private equity firms have been buying insurance companies and stuffing them with private credit to earn greater returns, and that annuity holders and policyholders are at risk. This was news to her. She is used to me being a doomer after all these years, but even she was flabbergasted by this. 

“Does anyone know about this?” she asked. I said, “Sure, people know about it, but it doesn’t matter until it matters, and then it is going to matter.” Paradoxically, I said that this is all tied in with AI, because the volcano of hyperscaler debt has finally forced the credit markets to gag on supply, and now private credit is in an even more precarious position. This is all happening while the South Korea semiconductor bubble is popping, so it is a Crunchwrap Supreme of AI, semis, and bad loans. And it might just take down the whole market.

What, Me Worry?

So the optimists say. I should remind everyone here that private credit is now about twice the size of the junk bond market, and the junk bond market has had the capacity to scare people in the past. If insurance companies fail and people lose their annuities, you can only imagine the congressional hearings. Where are the regulators? 

Well, if you remember, insurance is regulated on the state level, not the federal level, and some states are stricter than others; and these insurance companies have moved a lot of risk offshore, outside of the purview of regulators. Oh! We also have a never-ending war in Iran, and oil is back above $100/barrel, and Trump has committed to bombing Iran again after the midterms. And speaking of the midterms, it doesn’t look good for the Republicans, and if the Democrats sweep, they don’t look kindly on data centers and AI investments—at all.

Who knows what the catalyst will be. Meanwhile, people keep shoving money into index funds. I saw an article the other day that Vanguard is introducing a suite of target date funds that are even more stock-heavy than the ones they already have (more on this below). Stocks for the long run, right? I am more nervous right now than at any point I have been in the last 20 years. If the indexing bubble pops, this is not going to be a run-of-the-mill 20% bear market, like we got in 2022. It is going to be much worse than that.

Too Many Stocks

So, the goal here is to not get killed, and that is what I am here for. I have written this about 10 times in the last year, but if you have 80% stocks, you have too many stocks. If you have 50% stocks, you have too many stocks. If you have 0% in bonds, you don’t have enough bonds. Gold is bidless at the moment and has about the ugliest price action I’ve ever seen, but when Fintwit idiots start calling it a shiny rock (like they did in 2013) and people are passing around articles about alchemy—literally turning mercury into gold—you are probably getting close to a bottom.

Bull markets breed excesses. Suppressing volatility results in more volatility. And there is always fraud at the top. I have seen a few cycles by now—they are all different, but the underlying sentiment rhymes. There is always a transformative technology that promises to create some kind of utopia, there is overinvestment to the point of malinvestment and misallocated capital, and you get a reset.

Over and over again: That’s capitalism. Capitalism isn’t bad just because you suck at it. It takes a legendary trader to catch both the move up and the move down, but that is what we are trying to do here. I’d suggest setting material condition yoke throughout your shirt, because things are going to get dicey.

Poll

Dumbest Thing I Saw This Week

Back to Vanguard’s new suite of target date funds that are even more stock-heavy:

Because what we all need is more equity exposure!

Jared Dillian, MFA