Transcription
I want to talk to you about something that I think is one of the most underappreciated skills in investing and honestly in life. It's not the ability to predict what happens. I've been wrong on timing more times than I care to admit.
What I'm talking about is the ability to recognize what has to happen first before everything else breaks. Because every major financial crisis I've lived through in nearly 50 years in this business, and I've lived through quite a few, every single one of them followed a pattern. The final collapse, the thing that makes front page news, the thing your neighbor calls you about in a panic, that's never where the story starts. The story always starts quietly months before, sometimes years before, in the corners of the market that most people aren't looking at, and almost no one notices until they do. And by then, it's usually too late to do much about it.
Now, why am I telling you this today? Because I think we are in one of those periods right now. Not where the crash has happened, where the things that happened before the crash are happening. And I'm watching them and I want to walk you through exactly what I see, why it matters, and what history tells us about where we go from here. I've been doing this since 1981. I've studied every major financial dislocation going back much further than that. I am not somebody who sounds alarms for sport. Ask anyone who has followed my career. I am the opposite of that. I hate drama. I like data. So when I tell you the early indicators are flashing in a way that concerns me, I'd ask you to take that seriously and hear me out.
Let me start where I always start, which is not with the equity market. The equity market is where everyone looks because it's visible. It's in the news. It's on your phone every five minutes. But equities are almost never where the early signals come from. The bond market is smarter. Not always right, but smarter. And specifically, the credit market, the market for corporate debt is where you see the first cracks form. I want to explain how this works because I think it's something that most individual investors have no idea about. And it's maybe the single most important thing I monitor when I'm trying to figure out if we're approaching a stress point in the system.
When companies borrow money in the bond market, the interest rate they pay is never the same as what the US government pays. There's always a spread, a premium. You're lending to a corporation, not to the sovereign. So, you demand more compensation for the additional risk. The size of that spread tells you how nervous the bond market is about corporate credit. Widespreads mean the market is worried. Narrow spreads mean the market is comfortable, sometimes too comfortable. And what I have observed across decades and what the data consistently confirms is that credit spreads are one of the most reliable leading indicators we have. Not the only one, not infallible, but reliable. The high yield spread, that's the spread between junk bonds and treasuries, has preceded every US recession since the 1970s. Every single one. It widened before the dotcom crash. It widened in mid 2007, months before most people admitted there was a problem with housing. It widened before every major dislocation I have traded through.
So when I look at where credit spreads are today or we're heading into this period, I pay close attention. And what I saw going into 2025 and 20206 was credit spreads near historic lows. The Bloomberg high yield spread sitting at levels you only see a handful of times in history. In fact, levels very similar to May 2007, which I don't need to tell you was not a great time to be buying junk bonds.
Now, the standard argument you hear from people who think this is fine is that low spreads reflect healthy corporate fundamentals, strong balance sheets, good earnings, and there's something to that. The private sector is in decent shape in ways the government is not. I've said that publicly. But here's the thing about credit spreads near historic lows. When spreads have nowhere to go but up, the risk-reward for being complacent is terrible. The potential gain from spreads staying where they are is maybe 2.5% a year above treasuries. The potential loss if spreads blow out to anything close to historical norms is catastrophic. 20, 30% in price terms for high yield bond holders. That's an asymmetric bet you don't want to be on the wrong side of.
And I want to tell you something else about what happens when spreads are extremely tight. It's not just that they reflect risk. Tight spreads enable risk. When it's cheap and easy for corporations to borrow money, they borrow money. They do acquisitions that may or may not make sense. They do leverage buyouts. They buy back stock with debt. They engage in all the behaviors that feel rational in a cheap money environment and look catastrophic in a tight money environment. And all of that debt, all of those obligations incurred during the period of easy money, they don't disappear when conditions change. They become a problem. And that problem has a name. The market calls it the maturity wall.
Here's the situation I've been watching with some alarm. During the zero-rate era, the decade after the financial crisis, and especially the COVID period, companies borrowed enormous amounts of money at very low rates, 5-year loans, 7-year loans, 10-year bonds, all issued at interest rates that in hindsight were extraordinarily cheap by historical standards. Well, those maturities are coming due right now. In 2025 and 2026, the Mortgage Bankers Association estimated that roughly a trillion dollars in commercial real estate debt alone matured in 2025. And that's before you count non-financial corporate debt. Roughly $135 trillion in non-financial corporate debt needs to be refinanced in 2026. In real estate specifically, the total over this two-year window is well over $1.5 trillion. All of that debt incurred when rates were near zero is now being rolled over in a world where the 10-year Treasury is hovering near 4.5%. That's what's called coupon shock. The cost of debt nearly doubled for some issuers. And what was a manageable obligation at 2% becomes a survival question at 4.5%. I pointed this out as a yellow light months ago. That yellow light is now very bright.
The second thing that happens before the collapse that almost nobody talks about is what I'd call the zombie company problem. And this is something I feel strongly about because I've seen it play out in Japan in the 1990s, and in different forms in other markets, and it rarely ends well. A zombie company is a company that cannot actually pay its debts from its earnings. It can only survive by refinancing. As long as money is cheap, it keeps rolling over its obligations and nobody looks too hard at the underlying economics. But the moment money gets expensive or the moment the market becomes even slightly more discerning about credit quality, the zombie company can't refinance. And when it can't refinance, it defaults. And when enough of them default at once, you don't just get corporate bankruptcies. You get credit contagion. Lenders who are owed money by defaulting companies become more cautious. They tighten credit standards. The companies that would have been fine suddenly can't get the credit they need to operate normally. And then the problem spreads into the real economy, into employment, into consumer spending, into the earnings of companies that have nothing to do with the original defaulters. This is how credit problems become economic problems. I've seen it happen. I said before the 2023 regional bank stressed that I was worried about credit tightening and I was right to be worried, though the contagion was more contained than I feared at the time. What I'm watching now has the potential to be less contained.
The third early signal, and this one is the one that almost no retail investor pays any attention to whatsoever, is what's happening in sovereign bond markets outside the United States. Not the US Treasury market, the foreign sovereign bond market. When I broke the Bank of England in 1992 with George Soros, the early signal wasn't in the equity market or the currency market. It was in the inconsistency between the Bank of England's interest rate commitments and what the actual economic fundamentals could sustain. The UK was in a recession, but was committed to a currency peg that required high interest rates. Something had to give. And when something has to give, the bond market figures it out first, usually before the equity market, almost always before the mainstream press and almost certainly before the government admits there's a problem.
I look at what's happening in Japan right now with something that I think deserves far more attention than it's getting. The Bank of Japan spent decades buying its own government bonds to suppress yields. It essentially monetized enormous fiscal deficits by being the buyer of last resort. Well, the Bank of Japan has been quietly, slowly stepping back from that. And when the anchor of bond buying is removed from a market that got used to having that anchor, yields can move in ways that markets aren't prepared for. Japanese bond moves reverberate in ways that most American investors don't fully understand because Japan is one of the largest holders of US Treasury bonds on Earth. When Japanese yields rise to the point where Japanese investors can earn meaningful returns at home in their own currency without currency risk, they have less reason to hold American bonds. And when large holders of American bonds become sellers of American bonds, that puts upward pressure on US yields. And US yield rises, especially disorderly ones driven by foreign selling rather than domestic growth, are one of the more dangerous things that can happen to the American economy right now, given the debt load we're carrying.
Now I want to come back to something I said earlier about recognizing what happens first and I want to connect it to the specific situation in America right now because I think there's there's a sequence here that people are missing. The thing that happens first before a fiscal crisis becomes an actual crisis is that the bond market loses patience. Not all at once, not dramatically, but in the way that it always loses patience through a gradual increase in the term premium, which is the extra yield that investors demand to hold long-term government bonds instead of short-term ones. For decades, the term premium on US treasuries was near zero or even negative. People were so desperate to hold safe dollar assets that they were essentially willing to receive um nothing extra for accepting the risk of holding a 30-year bond instead of a three-month bill. That was an extraordinary situation and it reflected the extraordinary trust in the US government and the dollar's reserve currency status. That trust is now being repriced and the repricing of term premium, that slow rise in the cost of long-term government borrowing even when short-term rates are stable or falling, is one of the clearest early signals I know of that the bond market's patience is running out. It doesn't make headlines. Most people don't know what term premium is, let alone track it. But I track it and what I'm seeing concerns me.
Let me also talk about what I called the three death nails for markets because I think this framework is useful right now and I've seen it overlooked in the commentary about current conditions. The three death nails, the three things that when they rise simultaneously create the most dangerous environment I know of for financial assets are rising interest rates, a rising dollar, and rising oil prices. Think about each one. Rising interest rates increase the cost of everything. Every mortgage, every corporate loan, every government obligation. A rising dollar tightens financial conditions globally because so much debt around the world is denominated in dollars. And a stronger dollar means that debt is harder to service. And rising oil prices are a tax on every consumer and every business that uses energy, which is every consumer and every business. When all three rise together, the financial system faces simultaneous pressure from all sides at once. And right now I'm watching an environment where all three of those variables are moving in concerning directions. Not always all at once. Not always in a straight line, but the underlying pressure is building. And when pressure builds in a system that is already carrying as much debt as the US system is carrying, the release when it comes is rarely orderly.
There's something else I want to address because I think it's the single most dangerous form of complacency I've observed in my career. And I've observed it before every major financial event I've lived through. It's the belief that because something hasn't happened yet, it can't happen. Or the related belief that because the system has absorbed problems before, it will always absorb problems. I heard this in 2006. People were saying, "Yes, housing prices are high, but the system is more sophisticated now. Banks are better at risk management. We have better financial instruments for distributing risk. The Fed will intervene." And of course, those people were partially right. The system was more sophisticated. The banks did think they had better risk management. And the Fed did intervene eventually. None of it was enough because the fundamental imbalances were too large to be wished away by sophistication or intervention. I am not saying we are in a 2006 situation today. The analogy isn't perfect. But the underlying logic that accumulated imbalances don't get resolved painlessly just because they've been tolerated for a long time. That logic is eternal. And the accumulated imbalances in the American fiscal situation today are by any objective measure larger than they have ever been in peacetime history.
I want to be precise about one thing that I think is particularly important for this moment and this title, "Before the Collapse." What happens first? And I want to be honest that what happens first is usually not recognized as the precursor until after the fact. That's the insidious part. The signals are there. They're legible to people who know how to read them. But the consensus narrative, the thing that gets repeated on television and in financial publications, lags reality badly. I started warning about inflation in 2020 and 2021 when the Fed was calling it transitory, when the money supply was growing at 40% annually, and nobody wanted to hear it. I've been warning about the fiscal trajectory for over a decade, going on college campuses giving speeches trying to explain to people what the math actually shows. The warnings were right. The timing was uncertain. That's always how it works. The macro analyst who is right about the direction but wrong about the timing looks foolish for a period before he looks prescient. And most people, rather than sit through the period of looking foolish, stop listening to the warning. They anchor to the last observable reality, which is that things are still fine, rather than to the forward-looking analysis, which is that they won't be.
Let me tell you about the specific sequence I'm watching. First, credit spreads at historic lows with a massive maturity wall bearing down on overleveraged companies. Second, Japanese bond market dynamics that could trigger foreign selling of US treasuries in a world where the US desperately needs foreign buyers to absorb its debt. Third, term premiums slowly rising as bond market patience with American fiscal recklessness erodes. Not dramatically, not dramatically yet, but steadily. Fourth, the three death nails: rates, dollar, oil, all showing signs of converging pressure. And fifth, an equity market that is pricing in continued prosperity with valuations that have very little margin of safety if any of these pressures crystallize in a way that affects corporate earnings.
Now, not all of these things will happen at once. Markets are unpredictable on timing. And I've said many times that timing is the hardest thing in macro, but the sequence, the logical sequence of how financial stress propagates, that part I have very high conviction about. Stress in the credit market leads to tightening in lending standards. Tightening in lending standards leads to reduced economic activity. Reduced economic activity leads to higher unemployment and lower corporate earnings. Lower corporate earnings in a market with stretched valuations leads to significant equity repricing. And throughout that process, the fiscal situation, the $36 trillion debt, the trillion dollars in annual interest payments, the 7% deficit at full employment, all of that makes the government's ability to provide a buffer smaller than it's ever been before.
I said something to Nikolai Tangen at Norges Bank that I I think is worth repeating here because I think it captures my philosophy on this. I told him that contrarianism is overrated. People have this idea that I'm always looking to be on the opposite side of the crowd. That's not how I think. The consensus is right most of the time. You fight it for sport, you lose. What I'm actually looking for is the moment when the consensus is ignoring something obvious because of what George Soros taught me, which is that markets are reflexive. They reinforce their own narratives. When everything is going up, people construct reasons why it should keep going up. When the narrative is that the US economy is strong and stocks always go higher in the long run, people filter out the signals that suggest the underlying architecture is under stress. They don't see the credit spread dynamics or the term premium or the maturity wall because they're looking at the equity market headline and and and the equity market headline tells them everything is fine. This is how every major financial event I've witnessed has played out. The signals were there. The consensus was telling a different story. And then eventually reality won.
So what do I actually do with all of this? Because that's the practical question. I don't sit here and just say things are bad. I have to make investment decisions. And my approach, consistent with what I've always believed, is that you don't take the risk-reward bet that gives you two and a half percent upside in a good scenario and 20, 5% downside in a bad scenario. You avoid that. You look for situations where the risk-reward is fundamentally different. Where you have large asymmetric upside if you're right and limited downside if you're wrong. I've shorted bonds. I've held gold. I've been patient with certain equity situations where the market has dramatically overreacted to near-term noise and ignored long-term value. Tea Pharmaceuticals was a case recently where everyone was looking at today's perception and I was looking at what the perception would be two or three years from now once the business transition became undeniable. Doubled. That's not macro. That's just looking at where the crowd is wrong about a specific situation. But on the big macro picture, my position has not changed. Preserve capital. Don't take asymmetric bets against yourself. Be patient.
George Soros used to say, "Invest and then investigate," which means have a thesis strong enough to put some money behind it, then keep learning. I've been investing behind the thesis that US fiscal recklessness eventually gets priced by the market in ways that are painful for people who are fully concentrated in US assets for long enough that my conviction is high. I'm not predicting tomorrow. I'm not predicting next month. I'm telling you that what has to happen first, the credit stress, the term premium repricing, the bond market patience running out, those things are happening now. And the sequence that follows them historically is not a pleasant one.
My mentor Paul Volcker used to say that the longer you wait to address a problem, the worse the cure has to be. He proved that in 1979 when he became Fed chairman and did what nobody thought was politically possible. He crushed inflation by crushing the economy for 18 months, and it worked. And America got 20 years of prosperity on the back of that willingness to face the problem honestly. I look at Washington today and I am not seeing that quality of leadership on the fiscal question. I'm seeing a 7% deficit at full employment. I'm seeing both parties refuse to touch entitlements in any meaningful way. I'm seeing the interest payments on the national debt approaching a trillion dollars annually and and nobody treating it as the emergency it is. And I know from studying history that when the bond market finally says enough, when it decides it's no longer willing to absorb American debt at current yields, the adjustment is not gradual. It's not smooth. It's disorderly because the market doesn't give you a polite warning and a grace period. The market sends you a bill all at once.
I want to close by coming back to the title, "Before the Collapse." This happens first. And I want to be very direct about what I mean. I am not predicting imminent collapse. I want to be clear about that because I know how these things get interpreted. I've lived through enough cycles to know that systems can remain under stress for longer than any individual analysis suggests. But I am saying that the precursor conditions, the ones that in every historical case I've studied have preceded the major financial dislocations, are present and building. The credit stress is real. The maturity wall is real. The fiscal dynamics are real. The term premium repricing is real. The three death nails are aligning. And the thing that gives me the most concern isn't any one of those individually. It's that they're all happening simultaneously in a system that has less capacity to absorb shocks than at any prior point in American peacetime history because the government has already spent so much of its fiscal ammunition and the Fed has far less room than it would like.
The people who will be hurt most by what I see coming, however and whenever it arrives, are the people who were told that everything was fine. Who were told the US always recovers. Who were told just stay in index funds and don't worry about it. That advice works in a lot of environments. I'm not sure it works in this one. And I've been wrong before. I'll be wrong again. But I've also been right when it mattered most. And I'm telling you right now that the signals I've spent 50 years learning to read are not telling me that everything is fine. They're telling me to pay very close attention and to make sure I have the capital to take advantage of the opportunities that will absolutely exist on the other side of this, because there will be opportunities. There always are. The question is whether you're in a position to see them.