AI has lured investors into complacency while the next financial crisis is already underway

The financial system is very complex but here’s what’s currently happening. Booming AI CapEx has fueled high valuations across areas of the tech sector and companies connected with the AI buildout. The CapEx has initially taken the attention away from what has been happening but is now reaching levels that can no longer be ignored.

What is happening? Sovereign debt levels of developed countries rising to all time highs vs their GDPs resulting in the bond markets being flooded with a huge supply of government bond debt. This has now happening at the same time as hyperscalers are turning to the debt markets to fund their AI CapEx creating an even bigger supply of debt in the bond markets. This new huge supply of corporate bonds are competing with the already huge supply (and rising) supply of government bonds. So where are the buyers coming from to buy this new massive supply of debt? For the past 30yrs Japan always bought our debt because they had negative interest rates but now the Japanese bond yield is almost 3%! This has resulted in not only the Japanese not buying our debt but even selling our debt to repatriate that capital back to Japan into their bonds. When you have a massive supply of debt and not enough buyers yields MUST GO HIGHER to entice new buyers. This is what’s currently happening with the US 30yr and 10yr treasury’s and no one knows how much higher they have to go. The Fed doesn’t control the long end of the curve.

Higher rates for longer is where the next problem lies. We are coming from a period of low rates. Many bad loans were made during this time. Private credit (shadow banking) is now larger than subprime. There loans are not fixed rates but FLOATING. Defaults in private credit are now estimated at 9%. Rates staying higher for longer will eventually trigger massive private credit defaults that then spread elsewhere. Nobody fully knows how interconnected private equity is with the overall financial system but what we do know is that if private credit defaults massively it will hurt banks, insurers and pension funds that will be forced to react in a way to sets in motion the next domino to fall. Contagion is the word.

In the past, when something like this happens, the Fed cuts rates and starts monetary stimulus. The problem today is that inflation is at 3.4%, way above target. So if the Fed intervenes, which they likely will, inflation will only go higher. Of course a potential oil shock is already looming to make matters worse.

This is where we are today folks. It sounds bleak, I know. The only thing to do currently is to take risk off the table right now and preserve your capital.