Transcription
Um, let me tell you something that keeps me awake at night. I've spent 23 years studying financial markets. I've watched bubbles inflate and burst across three continents. I was in Tokyo when the NIK collapsed. I was in London during the 2008 crisis. Uh, and uh, right now uh, looking at the American financial system from the outside, I'm seeing patterns that should terrify anyone paying attention.
But here's the the strange part. The stock market keeps going up. The S&P 500 is near all-time highs. CNBC runs segments about new paradigms. Retail investors are back buying options on their phones. And if you ask most Americans, they'll tell you the economy is doing fine, maybe even great. So, either I'm wrong or something very unusual is happening beneath the surface. Today, I want to show you exactly what that something is.
Let's start with a simple question. Why hasn't the market crashed? Because by every traditional measure, it should have. In April 2025, when President Trump announced his Liberation Day tariffs, the S&P 500 fell more than 10% in two days. It was the worst week since the COVID crash. Headlines screamed about recession. Fund managers panicked. For a moment, it looked like the reckoning had finally arrived. But then something remarkable happened. The administration paused the tariff increases on April 9th. Markets rallied and by June 27th, the S&P 500 had not only recovered, it closed at an all-time high.
Think about that for a moment. the largest trade war since the 1,932s. A 43-day government shutdown, the longest in American history. Inflation stuck above target for nearly 5 years. A federal deficit of $1.8 trillion. Interest payments on the national debt now exceeding military spending. And the market, it just keeps climbing. From the outside looking in, this defies everything we learned in economics. Markets are supposed to be forwardlooking. They're supposed to price in risk. They're supposed to reflect economic reality. So either the American economy is somehow immune to the forces that govern every other economy on Earth. Or something is artificially holding this market up. I believe it's the latter. And I'm going to show you exactly what it is.
The first thing you need to understand is who's actually buying stocks right now. It's not pension funds making careful allocations. It's not value investors finding bargains. It's not foreign capital flowing into American assets. It's the corporations themselves. In 2025, American companies are on track to buy back more than $1.35 trillion of their own stock. That's not a typo. trillion with a T. Apple alone announced a hundred billion dollar buyback program. Google added another 70 billion. These two companies account for 12% of all buybacks in the entire market.
Now, here's what they don't tell you on financial television. Before 1982, the SEC, America's securities regulator, considered stock buybacks to be legal market manipulation. They banned them. The reasoning was simple. When a company buys its own shares, it artificially inflates the price. It creates demand that has nothing to do with the underlying value of the business. In 1982, the SEC changed its mind. They created something called rule 10b18, which provided safe harbor from liability for market manipulation. In other words, they acknowledged that buybacks manipulate markets, but they decided to allow it anyway. and corporations have been uh exploiting this ever since.
Here's how it works. A company earns profits. Instead of investing in research or building new factories or raising wages, it uses that cash to buy its own shares. This reduces the number of shares outstanding. And when you divide earnings by fewer shares, you get higher earnings per share, even if total earnings haven't grown at all. This is financial engineering, not value creation. But Wall Street loves it because it makes the numbers look better. Executive compensation is tied to stock price and earnings per share. So when a CEO announces a buyback, they're essentially voting themselves a raise. A survey of chief financial officers found that 93% pointed to influence on stock price and outside pressure as the reasons for manipulating earnings figures. 93%. Warren Buffett himself called this disgusting. His exact words were, "It requires no talent to manipulate numbers. Only a deep desire to deceive is required." And yet, here we are. A trillion dollars of artificial demand propping up stock prices quarter after quarter, year after year.
But buybacks alone don't explain everything because even with all that corporate buying, markets should still respond to fundamental economic conditions. Unless those conditions are being hidden from you. This brings me to the banking system. And this is where things get truly alarming.
At the end of 2024, American banks were sitting on $482 billion of unrealized losses on their securities portfolios. Uh that number had grown by 118 billion uh a 32% uh increase in just one quarter. Now, I need to explain what unrealized uh losses means because this is crucial. When a bank buys a bond, let's say a 10-year Treasury, it pays a certain price based on the prevailing interest rate. If interest rates rise after the purchase, the market value of that bond falls. The bank still owns the same bond. It will still get paid back at maturity. But if it tried to sell that bond today, it would lose money. Here's the accounting trick. Under current rules, banks don't have to report these losses on their income statements as long as they classify the bonds as held to maturity. They can pretend uh the losses don't exist. They show up only in the footnotes of financial statements where almost no one looks.
This is exactly what Silicon Valley Bank did. They had invested more than 90% of their held to maturity portfolio in long duration securities, mortgage back securities, municipal bonds, treasuries with maturities over 10 years. When interest rates spiked, the market value of those holdings collapsed. But because of the accounting rules, their financial statements looked fine until depositors got spooked, until there was a run on the bank and then Silicon Valley Bank became the second largest uh bank failure in American history. That was March 2023. Less than 2 months later, First Republic Bank collapsed, becoming the largest. And here's what should terrify you. The conditions that caused those failures haven't gone away. They've gotten worse. When Silicon Valley Bank failed, total unrealized losses in the banking system were $515 billion. Uh they picked later that year at 684 billion and now as of late 2024, they're back up to 482 billion and climbing. One professor who spent a decade working inside the Federal Reserve put it bluntly. All it takes is one bad news story about any of these banks and we could have another banking crisis.
But unrealized losses on securities are only part of the problem. The real time bomb is commercial real estate. If you've walked through the business district of any major American city recently, you've seen it. empty office buildings for le signs that have been up for years. Entire floors of prime real estate sitting vacant office vacancies in the first quarter of 2025 uh reached uh their highest level ever recorded. One in five offices empty. Uh the pandemic changed how people work and many of those changes are permanent. Companies don't need as much space. They're not renewing leases. Uh, and the buildings that once anchored their balance sheets are now worth a fraction of what banks lent against them. Of the 155 largest banks in America, 59 have commercial real estate exposures exceeding 300% of their equity capital. 300%. That means if their real estate loans lose just one/ird of their value, these banks are wiped out.
The Office of Financial Research, a government agency created after the 2008 crisis specifically to monitor systemic risk, has been sounding the alarm. They published a report showing that banks with significant commercial real estate concentration combined with large unrealized securities losses and high levels of uninsured deposits are extremely vulnerable. The exact same combination that uh brought down Silicon Valley Bank. And yet, if you look at the stock prices of these banks, if you listen to their earnings calls, if you read the financial press, you think everything is fine. That's because the losses haven't been realized yet. The accounting rules let banks pretend. The regulators let banks pretend. And so, everyone pretends together hoping that interest rates will fall, that property values will recover, that somehow the math will work out. This is not how healthy financial systems operate. This is how crisis build.
Now I want to talk about something even larger. Something that makes the regulated banking system look transparent by comparison. It's called shadow banking or in polite circles non-bank financial intermediation. The numbers are staggering. Shadow banking now represents $250 trillion uh globally. um roughly 49% of all financial assets in the world and um it operates almost entirely outside the regulatory framework that governs traditional banks. What is shadow banking? It's hedge funds, private equity firms, private credit funds, money market funds, special purpose vehicles, any institution that provides credit or bank-like services without actually being a bank. These entities don't have capital requirements like banks do. They don't have the same disclosure rules. They don't have deposit insurance. And most importantly, they don't have direct access to the Federal Reserve as a lender of last resort.
But here's the problem. They're deeply interconnected with the traditional banking system. American banks have lent more than $1.2 trillion directly to shadow banks. That lending grew 20% year-over-year through March 2025. And the Federal Reserve's own analysis found that banks credit commitments to non-bank financial institutions reached $2.1 trillion at large banks alone. So when something goes wrong in shadow banking, it doesn't stay there. It spreads to the regulated system. The banks that you think are safe become exposed to risks they can't even quantify.
Fitch Ratings, one of the major credit rating agencies, issued a warning uh just weeks ago. They said the shadow banking industry has developed bubble-like characteristics that could trigger a wider global financial shock. They specifically noted the growing involvement of individual investors, increased leverage, creative packaging of debt and uh something called spread compression where investors accept lower returns for risky investments which signals weakening lending uh standards. These are textbook signs of a bubble. The private credit market has grown to over $3 trillion. Default rates are rising. The trailing 12-month rate hit 5.7% in February 2025, up from 5% the month before. And when defaults accelerate, the losses will cascade through the system in ways that regulators don't fully understand. Jaime Diamond, the CEO of JP Morgan, the largest bank in America, said he expects problems in private credit, and warned there could be hell to pay if retail investors gain access to this asset class. When the most powerful banker in America is using phrases like held to pay, you should probably listen.
So, let me summarize what we've covered so far. The stock market is being artificially supported by uh over a trillion dollars in corporate buybacks transactions that were considered illegal market manipulation until 40 years ago. Banks are hiding hundreds of billions in unrealized losses through accounting rules that let them pretend bad investments don't exist. Commercial real estate is collapsing and dozens of large banks have exposures that exceed three times their capital. and the $250 trillion shadow banking system operates outside regulatory oversight while remaining deeply connected to traditional banks. Each of these factors alone would be concerning. Together, they represent a level of systemic risk that I haven't seen since 2007.
But there's one more element I haven't mentioned yet. And uh in many ways, it's the most important, the smartest investor in the world is sitting on the sidelines. Warren Buffett's Bergkshire Haway now holds $382 billion in cash and treasury bills. That's the largest cash hoorde in the company's entire history. It um represents uh roughly a third of Berkshire's total market capitalization. Buffett has been a net seller of stocks for 12 consecutive quarters. The last time he was a net buyer was the third quarter of 2022. He sold massive positions in Apple, Bank of America, and other core holdings. He's even stopped buying back Berkshire's own stock.
When asked about his cash position, Buffett has been characteristically direct. He said there are times when nothing looks compelling. He said his investment rule will never change. Never risk permanent loss of capital. Buffett has a a a favorite market indicator, the total market capitalization uh of all uh stocks divided by GDP. And he said that when this ratio approaches 200%. Uh investors are playing with fire. Uh right now it's at 210%. the S&P 500's uh cycllically adjusted uh price to earnings ratio, what's called the cape ratio or Schiller P hit 39.5 in uh October. That's a level that has historically preceded losses over the following 1, two, and 3 years. When the world's most successful investor with a 60-year track record is hoarding cash at record levels and refusing to buy stocks. That tells you something about current valuations.
And Buffett isn't alone. The Bank of England has warned about growing risks of a global market correction. The International Monetary Fund has drawn comparisons to the dotcom bubble. Multiple analysts have noted that market concentration, the degree to which returns depend on a handful of large stocks, is at its highest level in half a century. The 10 largest companies now account for more than 30% of the S&P 500's market capitalization. This kind of narrow leadership makes the market fragile. If even a few of these companies stumble, the entire index could collapse.
And this brings us to the artificial intelligence question. Because if you're wondering how the market keeps going up despite everything I've described, the answer is largely three letters. AI. Over the course of 2025, AI related companies accounted for roughly 80% of all gains in the American stock market. Nvidia's market capitalization quadrupled from 1 trillion to $4 trillion in less than 2 years, briefly making it the most valuable company in the world. OpenAI's valuation tripled in a single year from 157 billion to 500 billion. The amount of money flowing into AI infrastructure is unprecedented. Microsoft spent $ 35 billion on AI in just three months. Uh Amazon committed to hundred billion for data centers in 2025 alone. Um Meta, Google, Apple, they're all spending tens of billions.
Some of this investment will pay off. Artificial intelligence is a real technology with real applications. But here's a question that should concern any serious investor. Is the market pricing in a realistic future or a fantasy? A report from MIT in August 2025 was devastating. It found that despite 30 to40 billion in enterprise investment in generative AI, uh 95% of organizations are getting zero measurable return. 95% that doesn't mean AI is worthless. It means expectations have massively outpaced reality. It means valuations are based on projections that may take decades to materialize, if they ever do. Some analysts estimate that 15 to 25% of the S&P 500's entire value can be attributed to AI expectations. If if those expectations disappoint, if the returns don't materialize, the market could correct by a,000 points or more.
The dotcom bubble is the obvious historical parallel. In 2000, companies with minimal revenues traded at astronomical valuations simply for having.com in their names. When reality caught up with expectations, uh the NASDAQ fell nearly 80%. It took 15 years to recover. Uh I'm not saying AI is worthless uh the way many.com companies were worthless. I'm saying that valuations can get disconnected from reality. And when they reconnect, the adjustment is painful.
Now, you might be wondering, if all of this is true, why hasn't the market already crashed? It's a fair question, and um the answer reveals something important about how modern financial markets actually work.
The first reason is liquidity. The Federal Reserve has kept financial conditions relatively loose, even as it raised interest rates to fight inflation. Banks have access to emergency lending facilities. Money market funds are stable. There's no acute funding crisis forcing anyone to sell. In a liquidity crisis, everyone needs to sell at once and there are no buyers. That's what happened in 2008. That's what happened briefly in March 2020, but um it's not happening now.
The second reason is passive investing. Today, roughly half of all assets in American equity funds are in index funds, vehicles that automatically buy stocks based on their weight in an index, regardless of valuation. When money flows into an S&P 500 index fund, it buys all 500 stocks. It doesn't ask whether they're cheap or expensive. It just buys. This creates a self-reinforcing cycle. Money flows in, stocks go up, which attracts more money, which pushes stocks higher as long as the flows continue, prices rise regardless of fundamentals.
The third reason is the buybacks we discussed earlier. Corporations are the largest consistent buyers of American stocks. They buy in good times and bad. They buy when prices are high. They buy especially when prices are falling to support the stock and protect executive compensation. This puts a floor under the market that wouldn't exist in a more natural environment.
And the fourth reason is something more psychological. After 15 years of markets going up, interrupted only by brief corrections that were quickly reversed, investors have been conditioned to buy every dip. They believe the Federal Reserve will always intervene. They believe the government will always provide stimulus. They believe that somehow someway the line will keep going up. This is not analysis. This is faith. And faith can sustain a market for a very long time. But eventually reality intrudes.
The question everyone once answered is when does this end? I won't pretend to know the exact date. No one does. As the economist John Maynard Kanes famously observed, markets can remain irrational longer than you can remain solvent. But I can tell you what to watch for. I can tell you what the triggers might be.
The first trigger is interest rates. Everything I've described about bank losses and commercial real estate depends on interest rates staying relatively contained. If the 10-year Treasury yield rises above 5%. Bank unrealized losses could hit 600 to 700 billion. At that level, the accounting games become harder to maintain. Regulators start asking questions, depositors start worrying and confidence which is everything in banking uh starts to crack.
The second trigger is a credit event in private markets. The shadow banking system is opaque. We don't know exactly where the risks are concentrated. But when defaults start cascading, when a large private credit fund can't meet redemptions, when a major private equity portfolio company fails, the interconnections with traditional banks would be exposed. And the speed of modern finance means this crisis unfold in days, not weeks.
The third trigger is earnings disappointment in AI. If the company's driving market returns start missing expectations, if the promised productivity gains don't materialize, if the revenue growth doesn't justify the valuations, the stocks that have carried the entire market will fall and because of market concentration, their fall will drag everything else down.
The fourth trigger is political. The trade war continues. The fiscal deficit continues to grow. Interest payments on the national debt now exceed military spending. At some point, the bond market may demand higher yields to finance American borrowing. And higher yields would cascade through everything. Bank losses, corporate valuations, housing, consumer spending.
Any one of these could be the spark. Or it could be something no one's thinking about yet. That's how crisis work. The cause is usually obvious in hindsight, but invisible beforehand.
So, what should you do with this information? I'm not going to tell you to sell everything and buy gold. I'm not going to tell you the crash is coming next week. I've seen too many predictions fail to make one myself. But I will tell you this, the risks in the current environment are not priced into asset values. The market is behaving as if the best case scenario is guaranteed. It's not.
Warren Buffett's approach is instructive. He hasn't panicked. He hasn't sold everything. He still holds nearly $300 billion in stocks, but he's also holding record amounts of cash. He's being selective. He's waiting for opportunities rather than chasing prices higher. That's not bearish. It's prudent. The investors who got hurt most in 2008 were the ones who were fully invested at the peak because they couldn't imagine prices falling. The investors who got hurt most in 2000 were the ones who kept buying technology stocks because they couldn't imagine the boom ending.