Black Swan events are significant yet low-probability occurrences that can greatly influence society. These incidents are often unpredictable and can have adverse impacts on financial markets due to their potential for risk. A classic example of a Black Swan event was the 2008 financial crisis, triggered by leveraged debt effectively devastating the financial markets following AIG’s credit default swap debacle. This catastrophic event resulted in a hefty $1 trillion of corporate and municipal debt being offloaded.
After that, one situation nearly morphed into a Black Swan event. This was the unexpected market downturn on August 24, 2015. Termed as a ‘flash crash,’ many investors exploited leverage via home equity loans and margin debt to purchase high-yield dividend stocks, creating a considerable market disturbance.
Now, it seems like we could be on the verge of another potential Black Swan event. This impending peril comes from the same sphere that sparked the 2008 financial crisis— the private credit market. Nevertheless, the potential boom could offer opportunities reminiscent of the dot-com era.
The private credit industry has become more interconnected with the private equity world, imposing substantial management fees and sharing profits with managers. This development has led to a boom in the industry, increasing from $432.9 billion in 2014 to possibly $2.0 trillion in the current year.
Concern about this market isn’t limited to spectators and lower-level participants. Remarkably, JPMorgan CEO Jamie Dimon has conveyed worry about potential issues in the private credit market, cautioning against severe outcomes.
Average financial advisors have transitioned from marketing stocks to promoting private credit, with investors earning an 11% yield and receiving their money returned within two years. However, the practice of leveraging debt, which catalyzed the 2008 crisis, appears to be making a comeback. At the peak of this practice in 2008, investors achieved tax-free yields between 13%-16%.
This market collapsed with the failure of credit default swaps. Wall Street took a hit when bids on bonds decreased, and financial behemoths like Citibank had to unwind their leverage and municipal bonds. Some leverage municipal products and A-rated municipal bonds lost up to 97% of their principle at Citibank.
The present private credit market seems to be showing worrying parallels to pre-crisis conditions. This is demonstrated in the instance of Vista Equity Partners’ leveraged buyout of Pluralsight in 2021, backed by more than $1.0 billion of debt financing. The recent issues with debt service costs have led to Vista Equity writing off the entire equity value of Pluralsight, raising questions about the sustainability of such heavily leveraged practices.
As an advisor, I recommend caution when considering private credit offered by Ares Management, Benefit Street Partners, BlackRock, Blue Owl Capital, Goldman Sachs Capital Management, Golub Capital, and Oaktree Capital Management. These firms have been deeply involved in the contentious leveraged buyout of Pluralsight.
Despite the concerns in the private credit market, there are potential opportunities for substantial profit. I predict these opportunities will primarily come from next-generation AI companies primed to revolutionize or automate longstanding business models, much like the dot-com boom 25 years ago. For those aged 50 and above, this could be the last chance to profit from a financial mania in our lifetime. The good news is that we are still in the preliminary stages of this AI Boom, presenting a chance to position our portfolios for future profit.
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