Transcription
Welcome back everyone. Thank you so much for being here and thank you to those of you who have become new subscribers on my Patreon and Substack. After my previous announcement last week, it was really great to see so many of you join those platforms.
Unfortunately, as I mentioned before, YouTube started just unsubscribing you from my YouTube channel. Sometimes I see as many as 100 to 200 subscribers just gone in 24 hours, and that's very, very unusual. And of course, I take it as a sign that something far worse might be in store for the channel. So, if you haven't already, please do take a second to become a free or, if you can afford it, paid follower on Substack and Patreon. I always, always appreciate your support, and, uh, we should do that in case, um, something does happen and the YouTube channel is purged.
All right. One of the biggest bubbles in the US economy right now is, of course, the private equity bubble. It is worth an estimated $22 trillion, and nobody's even talking about it. Well, private equity was once presented as the smartest and most dynamic form of capitalism. The idea behind it was very simple, lucrative, and therefore highly appealing. Talented investors would buy private companies, improve operations, grow revenues, cut inefficiencies, and eventually sell those businesses for massive, truly massive profits.
Well, unlike public corporations that are trapped by quarterly and annual earnings pressures and a ton of reporting requirements and a lot of bureaucracy, private companies were supposed to be more agile and innovative, and they were for a while. But since most economic activity takes place in private businesses rather than public markets, investors believed that private equity offered access to the true engine of economic growth. While that narrative transformed private equity from a niche investment strategy into a multi-trillion dollar global industry. But, uh, let's face it, it's, you know, it's safe to say that the very success of private equity created the conditions for its imminent decline, which we're about to discuss next.
As the industry grew larger, firms became increasingly focused on accumulating assets under management rather than generating exceptional investment returns. The incentive structure shifted toward collecting management fees on enormous, truly enormous pools of capital. Today, for example, private equity firms collectively sit on more than $2 trillion in uninvested capital, which creates enormous pressure to complete deals at almost any price, under any circumstances. And that's really never a good sign.
As a result of that, valuations became increasingly detached from economic reality, from accounting and finance reality. Why would that be? Well, it is due to the fact that firms are relying heavily on optimistic growth projections, on leverage, and, of course, financial engineering rather than genuine business improvement. Now, at this point, you would ask me, well, if that's the case, if what you're telling us is true, then why did the framework work for so long, and how did it generate billions and billions in profits? Well, that is an excellent question to ask.
The system actually worked because interest rates remained near historic lows. Cheap debt allowed private equity firms to borrow aggressively, to refinance easily, and to inflate valuations across the industry. But if you follow my work, you already know that the macroeconomic environment has changed dramatically. Higher interest rates, tighter credit conditions, and, uh, slowing growth have exposed the fragility of many private equity-backed companies. The industry is now holding tens of thousands of unsold businesses worth trillions of dollars on paper. Yet, many of those valuations may never be realized in the real market.
Now, what is a good word to describe the situation? I would argue that the best word to describe it is a bubble. The private equity industry is in a multi-trillion dollar bubble that is about to burst. The private equity central promise, superior returns, as I mentioned previously, has started to collapse. Investors accepted higher fees. They've accepted illiquidity and a lack of transparency because they truly believed that private equity would significantly outperform public markets. Well, interestingly enough, that outperformance no longer exists.
In recent years, major stock indices such as the S&P 500, for example, have often delivered higher returns than many private equity funds, despite being cheaper, more liquid, and fully transparent. And that has forced many investors, uh, into an uncomfortable question. The question is, why would you lock money away for decades in opaque, high-fee structures if simple index funds can actually perform better? You can't do that. It just doesn't make any sense.
Well, the industry's lack of transparency has also intensified concerns. Unlike public markets where prices are continuously determined through open trading, private equity firms often value their own portfolios internally, and that is a major red flag. As a former Big Four auditor, I can tell you that management valuations and forecasts and assumptions upon which valuations are typically based should never be trusted without being scrutinized, challenged, and double and triple checked. This lack of oversight and transparency actually creates significant room for inflated or overly optimistic valuations. Investors are now increasingly questioning whether many private equity assets are actually worth what firms claim they are worth on paper, on their balance sheets.
Now, at the same time, broader market conditions have become increasingly uncomfortable to private equity, too. Strong public market performance has made traditional equities more attractive and safer. While economic uncertainty and inflation have pushed many investors towards safer assets such as gold, silver, and commodities in general. Even the shares of major alternative asset managers like Blackstone and Apollo Global Management, um, and, and others have actually declined as investors question the sustainability of the industry's business model.
The most likely future for private equity might not be a total collapse, at least not yet. But I would argue that that future looks like a long-term stagnation. And arguably, there isn't that much of a difference between the two. The industry may continue operating, but with weaker, uh, fundraising, with weaker returns, and, uh, arguably with a growing skepticism from investors. So that aura of private equity as a superior form of capitalism is fading rapidly. What once appeared to be a model of innovation, as I mentioned before, increasingly looks like an over-financialized system that is overly dependent on cheap debt, inflated valuations, and financial engineering.
Ironically, private equity may only survive by becoming smaller and actually returning to its original principles. And, uh, that looks like a more disciplined industry that is focused on genuine operational improvement rather than endless scale and leverage. And, um, in the end, it would have to prove that it can create real value. But the era of this easy money, explosive growth, and, uh, unquestioned faith in private equity appears to be ending. It is gone. The question now is not whether cracks exist in that $22 trillion industry, um, but the real question is how much longer investors will continue ignoring those cracks.
Let me know in the comments if you would like to see more of this topic covered in, uh, in, in, in my work on my channel, as well as over on my other platforms. I would love to hear from you in the comments below. Like, subscribe, and share. And as always, I look forward to seeing you in my next one tomorrow.