I normally center my newsletters on data I gather from statistics based on historical market actions, earnings of companies, and general economic activity. I will do so again this week, but I wanted to add a bit of an editorial commentary in the beginning as I feel we are in a new and different environment, and therefore a situation that is leaving many quite puzzled and perplexed. The continuous advance being experienced in the markets in the face of two large bankruptcies have left many confused. To begin with, I wanted to address the point of a bubble. In today’s case, it is “The AI Bubble.” A bubble, by definition is a level of advance that cannot be sustained, is based on unstable foundations, and therefore susceptible to popping- the ultimate fear. Well, bubbles are seldom seen beforehand, much like the Great Financial Crisis. If it was such a globally all prevailing malady, how did all the really smart people completely miss it?
So, this brings us to today. I keep on mentioning, time after time, week after week, the $7.7 Trillion sitting in cash on the sidelines, growing at 4% (the rate on 3-month US Treasury bills), totaling in excess of $400 billion per year. This is a level of cash that has the size to completely rearrange the focus of the financial system, and it has. I keep asking myself why, in an unabated, straight up equity market, that there have not been more initial public offerings of large and profitable companies? Instead, there has instead been a virtual explosion of private credit expansion.
The aftermath of the Great Financial Crisis created a massive amount of new regulations within the banking system. As usual, after the horse had left the barn! So instead, the financing that is being provided today is being done by large private lending companies. In Barron’s this past weekend the lead article was about Blue Owl Capital and the vast private financing (non-bank lending) it is providing. The chairman of Blue Owl commented about Jamie Dimon’s post earnings report statement about two bankruptcies and how these were simply the beginning of a cockroach infestation in debt. Marc Lipschultz, the chairman of Blue Owl called this an odd form of fearmongering. Blue Owl, which began in 2020, is a fairly new upstart in the alt financing area, preceded by the likes of KKR, Carlyle, Apollo, and Blackstone just to name a few.
The reason I am bringing this up is that these private debt companies, which are completely unregulated by the FDIC or any other US Government sponsored agency are so flush with cash that they are providing debt financing at interest rates that are making the corporate lending firms almost noncompetitive. At the same time, why would a company go public, and give up management to a directorate board and part of the financial growth if they can borrow at very low rates and possibly a small amount of participation in the way of warrants or some other kind of participatory equity structure. George Walker, CEO of Neuberger Berman said, “It was just a start-up, and now their $26.6 Billion market cap compares to a number of large, century-old financial institutions.” This stunning trajectory of these private markets have tripled to $26 Trillion in assets over the past decade. according to a University of Massachusetts study.
After Lehman Brothers collapsed in September of 2008, Neuberger Berman sucked up Michael Rees of Lehman and started a new fund. In 2020, this new venture merged with Owl Rock and Blue Owl was born. Following this lineage is super important as it shows where these guys with great tentacles and connections came from. They were able to start a new structure sprouting up from older roots, sort of a private debt game of whack-a-mole! Now most of the firm’s direct lending business is done as part of the private-equity buyouts by PE firms like Blackstone and Warburg Pincus. These investments generally entail floating junk bonds, a business pioneered by Drexel Burnham in the 1980’s. IS ANY OF THIS SOUNDING FAMILIAR??? Fast forward to 2020 (COVID money) the private-credit market grew from $2 Trillion to $3 Trillion at the start of 2025- some of which came at the expense of big banks, which have been constrained by regulations created in the wake of 08-09! Lipschutz fired back at Dimon last week with, “I guess [Dimon is] saying there might be a lot more cockroaches at JP Morgan.”
This movie is still yet to play out, but what I am bringing to your attention is one thing I have been focusing on, the level of cash, and where it is finding a home. This article in Barron’s I found very telling in not just about Blue Owl, but about the roots of the people running it and what Jamie Dimon could really be saying about non-bank lending. Just to finish on the subject of the big banks, even though Dimon makes comments about the lending going on outside the money center banks, this is their scorecard for earnings in this third quarter:
AAII Sentiment is “Meh” --- Not Extremely Bullish but Not in the Dumps Either
Sentiment is hard to get a handle on. While investors still seem to be piling into speculative stocks, the optimism is less apparent in more traditional sentiment measures such as the weekly AAII sentiment survey. The most recent “bullish” reading from last week was only 33% (bullish), off the recent high and comfortably below even the long-term historical average (see the dotted line in the graph below). It’s not completely in the dumps like it was earlier this year, but it’s still not hitting the same kind of extremes I’d expect given the rampant uptrend taking place. I have noted on the graph a 1 at the April lows, a 2 a couple of Fridays ago when the market jumped off a cliff, and a 3 for where we are currently. The highs in the survey this year aren’t even up to the same levels as last year, let alone the extremes of 2021 or 2018. I don’t really know what to make of this other than it is a clear indication that at the tops there is a bullish inclination inferring a market going higher, but since these aren’t highs that have been registered in times past, the ebullience has been contained and more measured. I find this quite interesting and important as I believe it has been manifested in breadth expansion.
What I am attempting to make clear is that the AAII surveys are showing that individual investors are still very suspect and negative on the equity markets in general and this seems to be supported by valuations of companies and the newest issue of “circular financing” in AI tech-land. The point often being forgotten is that this isn’t the Dot-Com era. The largest tech companies and companies that are direct beneficiaries of the AI explosion are tremendously profitable and almost completely debt free. If debt is needed, here comes the vast cash hordes of private lending and other financial instruments. I like to say that the money never lies. What it seems to be saying is that earnings are good, better than analysts even expect, and forecasts are being increased, not decreased. Now, back to my regularly scheduled programing! And just for the record, I hate cockroaches and would immediately hire Corky’s for pest control should I ever see one. As it stands, I think that there are not a bunch of cockroaches, but instead a bunch of really upset investors that just aren’t paying attention to what is most important today.
Another reflection that is making people a bit squeamish is the lack of breadth that is being seen. By this I mean that at highs it would be logical to see the number of companies going to new highs be a rising number. This is not the case currently, nor has it been since April of this year. Among the U.S. common stocks in the broad Ned Davis Research multi-cap universe, only 10% stood at 30-day highs through Thursday of last week. Since the thrust signal in May, each rally has ended with the breadth percentage at a lower high. This is a strange phenomenon, and one to at least pay attention to.
As the third quarter earnings season continues on, we got some relatively good news on the federal budget a couple of weeks ago, with the deficit clocking in at $1.775 Trillion for Fiscal Year 2025 (which ended September 30), $41 Billion smaller than the deficit the prior year and $34 Billion smaller than what the Congressional Budget Office projected the deficit would be only two weeks ago.
This week’s note is quite different than the norm, but I felt that addressing the debt situation and how it is being funded to be very important. Past bear markets, while often precipitated by recessions, seem to also be preceded by liquidity drying up in the system. Liquidity seems quite robust today, and earnings seem to be coming out better than expected in the face of lower inflation at the same time. On the tariff front, it appears that many things are being finalized with China, our biggest trade partner. If this should happen, it could translate into even better economics both here and abroad.
- Ken South, Tower 68 Financial Advisors, Newport Beach
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