“A bank is a place that will lend you money if you can prove that you don’t need it.”
–Bob Hope
Warning “financial crisis ahead”: not often written in the financial media
September 26, 2024 – Yesterday, in a conversation we’ve recorded for the Wiggin Sessions, Mark Jeftovic reminded us of our core mission.
Our advice has been simple. Consistent. Over the years. If you want to build wealth:
Get out of unproductive debt.
Own a business; start or buy one.
Buy companies that pay dividends.
Invest in hard assets and precious metals; “things” with real value.
Easy peasy, right?
So why is it so hard?
We get distracted. Confused.
During our conversation, Mark and I mocked the cottage industry we can’t escape ourselves. There’s a cottage industry set up to parse the words that come out of Fed Governor Jerome Powell’s mouth and the minutes from the FOMC meetings.
Back in the day, it was Alan Greenspan… then Ben Bernanke… and Janet Yellen. Both Mark and I admitted to spending way too much time trying to articulate the Fed’s methods, motives, madness… it’s an addiction we could do without.
The financial media in general doesn’t help. Most writers make their living off covering the latest bubble stocks and fad trends… dot.com, MBS “tranches,” crypto, meme stocks all come to mind.
AI and the “Mag 7,” as you’re no doubt aware, has dominated the financial media since May 2023 when Nvidia announced the planned rollout of its Grace Hopper Superchip. If you were in early, good on ya. Most retail “investors” get in long after the real money has been made.
Meanwhile, a home is the largest asset for most Americans. And gold continues its role as the “anti-investment” inflation hedge. Most “investors” are unwitting speculators in the U.S. dollar and obsessed with the illusive gains of the Wall Street casino.
Forget it, there are other places worthy of your time and investment capital.
Before the financial world became trapped by central banks keeping interest rates artificially low, bonds were a “risk-free” asset.
In 1993, James Carville, the architect of Bill Clinton’s political career famously quipped:
I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a 400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.
Except for a brief moment last October, when Bill Ackman and Bill Gross publicly stepped in and put a floor in the tanking 2-year treasury, there aren’t any “bond vigilantes” left to pop champagne with. Most investors don’t know what a bond vigilante is.
Our portfolio director, Andrew Packer, explains why below. The bond market has gone private. What might that mean for retail “investors?” Let’s find out. Enjoy ~~ Addison
Buyer Beware: The Bond Market Market Dog Isn’t Barking
Andrew Packer, Grey Swan Investment Fraternity
“If you eliminate the impossible, whatever remains, however improbable, must be the truth.”
This logic from the fictional detective Sherlock Holmes provides a good mental starting point when thinking about the economy and the stock markets.
What’s more interesting to me right now, however, is from the 1892 Holmes story “Silver Blaze.”
In it, Holmes notes that there’s the “curious incident of the dog in the night-time.” This refers to a dog who will bark at any stranger, but was quiet on a night when a racehorse was stolen from its stable.
The solution, of course, is that the dog recognized the thief. And by putting the dog in front of the guilty party, the case was readily solved.
This kind of story may sound simplistic today. But in 1892, it was the birth of a new literary trope.
Today, investors are surrounded by a myriad of data. And knowing which data pieces should bark at a sign of danger is crucial for staying ahead of Grey Swan events.
However, there’s one rather curious incident at play. While increasingly complex data about financial markets is readily available, there’s a growing realm that remains invisible to investors.
So, naturally, it’s where danger could lurk and grow while the world remains unaware.
This space? The private market.
Private Markets Are Quietly Sucking Up the Best Assets
Private equity is the best-known part of the private market.
Before I joined the financial publishing world, about 15 years ago, I worked for a small private equity firm. They were looking to do “roll-ups,” or take several similar businesses and buy them up.
For instance, a series of local dentist offices could be bought up. Then, by consolidating all the back-office work (marketing, billing, etc.), the firms could enjoy an economy of scale and increase their profitability.
That’s all well and good. But after interest rates fell to zero, private equity could borrow much more cheaply. They set their sights higher. And looked for ways to make a faster buck.
Soon, private equity became known for buying up entire companies, even well-known household firms. In 2014, for instance, restaurant chain Red Lobster was acquired by private equity.
The private equity firm quickly loaded the company up with debt, and sold off the land underneath the restaurant for $1.5 billion.
Quality deteriorated, as cost-cutting measures became the norm. And without the asset of the land, the restaurants couldn’t pay the rent on the former space they used to own. That’s why so many locations have been shut down – and Red Lobster declared bankruptcy earlier in 2024.
That’s private equity today. It’s why many companies you frequent seem to have gotten worse. Because if they’re owned by private equity, they have.
But there’s another side to the private world as well. And this part of the world could also lead to bigger issues in financial markets. I’m talking about private credit.
Private Credit Surges Amid High Interest Rates
Private equity owns businesses, similar to how you own a fraction of a business when you buy shares of a stock. Private credit is the bond side of the equation, lending money to businesses.
The perfect example of private credit? In 2011, Warren Buffett inked a deal with Bank of America for $5 billion in preferred shares. At a time when interest rates were 0%, Buffett got a 10% yield.
That’s more than what investors could get in shares, which still couldn’t pay a dividend until they passed a series of stress tests. Even preferred shares, which are bond-like investments banks often use, yielded around 5% at best.
That’s the power of private credit. You get a higher return, and lock in a higher yield (especially if you have Buffett’s reputation). And the borrower knows they’re getting capital at a fixed rate, without having to give up ownership.
Today, private credit is huge. And it was a big topic at the FutureProof conference held earlier this month.
You can start investing in private credit deals with as little as $50,000. A few of the folks I spoke with at FutureProof will want you to lock up at least $100,000, and often for at least three years.
In return, you get a steady 8-10% return, plus the promise of your principal back.
Meanwhile, if you want to invest in preferred stocks, you can start at just $25. Your starting yield is in the 4-5% range, tops.
But on the plus side, you can sell during market hours just like a stock. You don’t have to ride through a storm.
Today’s private credit investors are locked in. They can’t sell at once and create a tantrum when a company they’re invested in gets into financial trouble. A three-year lockup is an infinite amount of time when a company gets into trouble six months after you hand over some hard-earned cash.
Credit markets are healthy today, so running into trouble is rare, at least for now.
Clearly, everyday investors who stick with conventional markets don’t have access to these deals. Instead of the Buffett-like 10% returns, they may be able to get 5%.
It’s truly a tool for those who are already wealthy to earn more, with lesser risk than a private equity deal.
With interest rates now on the decline, lenders can lock in higher yields now, and ride out the lower trend in income.
This private credit market is getting increasingly deep, and remains opaque. It’s the dog that won’t bark. Most investors don’t know it’s out there. And unlike the stock or bond market, there’s no way of listing up the total amount of private credit.
When you don’t know who owes what to whom, and for how much, that’s where trouble begins.
Perhaps some bank or insurance company is making risky loans right now to lock in high yields. If so, we won’t find out until there’s another financial crisis. And when that happens, it’ll add gasoline to the fire already underway.
Private credit – the dog that isn’t barking right now – a potential flashpoint for a Grey Swan event. It’s a trend that isn’t easy to follow, but it’s one we’ll continue to monitor with considerable interest. ~~Andrew Packer, Grey Swan Investment Fraternity
So it goes,
Addison Wiggin,
Grey Swan
P.S. Something must be in the air. From my erstwhile writing partner, co-author ofEmpire of Debt, Bill Bonner writing this morning in Bonner Private Research:
Today… we go back to the roots of our newsletter industry… to the days when intrepid writers provided ideas and opinions that mainstream media didn’t want to publish and the public didn’t want to hear.
Patrick Maitland, the 17th Earl of Lauderdale, was a pioneer in the newsletter genre. In 1937, he established the Fleet Street Letter in London. Then, when Prime Minister Neville Chamberlain returned from the Munich Conference with Hitler, he announced that there would be ‘peace in our time.’ And the newspapers and radio stations spread the good news.
But Maitland wasn’t so sure. He set out for Europe to talk to other sources. And when he came back, he had a distinctly different message. Peace was a comforting illusion, he told readers; brace yourselves… gird your loins… for war.
We regret that today we bring a similar message. War is coming. Get ready for WWForever.
In our conversation, Mark Jeftovic told me he’d been reading since the early days of the Daily Reckoning, when Bill and I used to toil away, expatriates in Paris, in a little rented apartment converted into an office at 10 Boulevard St. Germain.
Those were the days…
How did we get here? Bill and I penned a few alternate takes on the financial, economic, and political history of the United States from Demise of the Dollar through Financial Reckoning Day and on to Empire of Debt — all three books are now available in their third post-pandemic editions. You might enjoy one, or all three.
