If You’re Not on the Bus, You’re Not With Us

You have probably heard of some troubles in private credit funds recently, including the Blue Owl fund that gated redemptions. And others. We here at Jared Dillian Money have been warning against this for some time. After all, we built an entire website around it: ShortPrivateEquity.com.

You’re probably wondering what to do with this information. First, if you get a solicitation to invest in a private equity or private credit fund, you will want to impolitely decline. That’s easy enough. But how do you profit from the dislocation? I’ve been trying to figure that out for the last two years, and I’m not much closer to the answer.

The easy thing to do is buy puts on the PE/PC names. I have been doing this with Blackstone, the biggest and most liquid, without much success until recently. If you want to short these private equity names, go right ahead. It’s probably not going to be much fun, but if you can put it in the back book and forget about it, they’re probably going to zero or close to it.

The second, and more important, takeaway from this is that PE/PC blowing up will probably mean that the corporate credit markets will come completely unglued. Just two weeks ago, I was seeing that corporate bond spreads were at all-time tights. They have backed off in the last two weeks. 

Credit Bear Markets

We haven’t had a real bear market in credit in quite some time. You might recall that the credit markets had a scare during the pandemic, and then the Federal Reserve rode to the rescue and bought corporate bonds in a round of QE, depriving us of the down half of a credit cycle. I think we are going to get a complete cycle at some point in the near future. I have no interest in buying corporate bonds at 5–6% nominal yields. I would be salivating at buying them with 12–14% nominal yields. Credit bear markets are the best thing in the world, and one little known fact of the financial markets is that distressed investors typically outperform everyone else. Buying distressed bonds is one of the safest and most reliable strategies in the world.

To reiterate, I have no interest in shorting credit. I do not want to short HYG or buy puts on it. The puts are always overpriced. What I do have interest in is swooping in and buying very cheap bonds at 40–50 cents on the dollar with big fat yields. Just be patient, and it will happen.

Let me give you an example. In 2008, I was going shopping for some cheap bonds and came across some Gannett (GCI) newspaper bonds. I think they were trading around 60 cents on the dollar. Newspapers in the financial crisis? Can you think of anything in the world that you would want to buy less? I asked around and was told that if GCI had the ability to refinance, the bonds were probably money good. I issued a buy recommendation in The Daily Dirtnap. GCI refinanced the bonds, and they paid off at par. Of course, nobody was reading me back then, so I was shouting into the void. If you own a portfolio of bonds that yields 12–14% (or higher), there is not much that can go wrong. If everything goes wrong, you probably break even. Even more fun than high-yield bonds are high-yield converts. If you buy high-yield converts at the bottom of the cycle, you can get 40% annualized returns.

To be clear, we are nowhere near that point yet. This is not even the first inning. We are across the street at Stan’s. It’s way too early to be thinking about buying corporate bonds. I hope you read this newsletter and make a mental note for the future. We have a lot more pain to go. 

Still Massive Bubbles

The statistic that sticks in my head is that fully 25% of private credit is in software. The reason you haven’t seen much stress is because these doofs can mark the bonds wherever they want. If you’ve seen The Big Short, you know what I am talking about. At some point, there will be some crisis, they will be forced to write down the bonds, and then all hell will break loose. It also goes without saying that if all of this comes to pass, stocks will probably go down. I have been saying this for several months, but I am not excited about US stocks here.

Having said all of that, doom sells, and I don’t consider myself to be a purveyor of doom. I am long a bunch of stuff unrelated to tech and growth and PE/PC. Let’s be clear: Private equity and private credit were/are massive bubbles. For starters, private credit is twice the size of the high-yield market. Think about that.

Tonight! I am DJing at a club in Nashville. If you are in the Nashville area, come on out to Night We Met—I am playing a four-hour set from 8 pm to 12 am. What else do you have going on? Probably nothing as cool as this. See you there.

Jared Dillian, MFA