Equally, none of the non-war issues that drove stock prices sharply lower are resolved. The war isn’t over. Inflation isn’t lower (in fact it’s higher). Energy prices are off their highs but likely to remain elevated for a sustained period of time (possibly the rest of 2026), contributing to higher-than-expected (or hoped) inflation for the rest of 2026. Even Treasury Secretary Scott Bessent now agrees the Fed can/should wait to lower interest rates with the prospect of inflation dimming in the fog of war. The “AI eats software” trade that roughly halved software P/Es, concerns that much of the announced data center builds are vaporware, and fears that a great deal of the money spent on AI will never see a return on investment also remain.

None of these issues is resolved yet the market has regained its pre-war losses. And private credit has yet to produce any good news, just assurances that it won’t destroy the economy all at once (just company by company along with its private equity twins). I agree that private equity doesn’t pose a systemic risk (in the sense that mortgages posed one in 2008), but the long-term damage caused by leveraging up Corporate America over the last few decades has inflicted serious long-term systemic damage that must be acknowledged. And high levels of redemptions from private equity vehicles are likely to continue for the remainder of 2026 which could limit capital available for these companies to make loans and finance transactions (a good thing, but banks could fill the gap, a bad thing).

But the fact that none of these problems have been solved seems to matter. And - just to beat a dead horse for a moment - nobody (NOBODY) is talking about the federal deficit that will hit $40 trillion by October/November and sits out there like the iceberg waiting for the Titanic. The annual deficit is around $2 trillion and the annual interest cost of servicing the deficit is over $1 trillion and both numbers are rising and unsustainable. I fear that all the stock market gains being realized are going to vaporize in a bond market rout when Treasury buyers demand a reasonable return for loaning money to the U.S. government. Right now, in my opinion, they are willing to lend money to the government at a negative real rate (not a consensus view). Treasuries are still considered “safe” but their nominal return is seriously diminished by the real-world rate of inflation which is much higher than official government inflation statistics.

I don’t know how much further this rally will run. The markets was oversold from a technical standpoint before the rally started; now it is at its most overbought level since October (or was a couple of days ago). Software stocks are leading the way though nothing has changed with respect to the threat posed to them by AI, but nobody really had a handle on that threat in the first place. The best reason to sell those stocks is that their valuations were stretched; now they are much lower so it looks safe (to some) to stick their toes back in the water. PE stocks are up about 20% despite absolutely no redemption relief and no sign that their software loans are in better shape than a few weeks ago. In short, the rally is liquidity and momentum-driven which is another way of saying it is due to a shift in psychology that ignores the same conditions that set off the sell-off. If you want to call it market schizophrenia be my guest. To me that’s as solid an explanation as anything else. You sure can’t convince me this is driven by fundamentals or facts.

This graph, borrowed from Societe Generale’s brilliant Albert Edwards, illustrates the sharp drop in software equity values. Perhaps the decline hasn’t yet reached the software loans held in private credit funds (including BDCs and CLOS), but a loss of one-third of the value (on average - every loan is different) suggests that the debt is under pressure…

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“Because the individual parts of a complex adaptive system are continually revising their (“conditioned”) rules for interaction, each part is embedded in perpetually novel surroundings (the changing behavior of the other parts). As a result, the aggregate behavior of the system is usually far from optimal, if indeed optimality can even be defined for the system as a whole. For this reason, standard theories in physics, economics, and elsewhere, are of little help because they concentrate on optimal end-points, whereas complex adaptive systems ‘never get there.’ They continue to evolve, and they steadily exhibit new forms of emergent behavior. History and context play a critical role, further complicating the task for theory and experiment…It is the process of becoming, rather than the never-reached end points, that we must study if we are to gain insight.”

Even with the development of computer technology that Professor Holland predicted (“massively powerful computers should produce a revolution in the investigation of complex adaptive systems”), it remains extremely difficult to forecast the path of the global economy today. The serious stresses manifesting themselves as the war continues reflect conditions building up over decades including the massive growth of global indebtedness, increased interconnectivity among global markets, changing market structures including growth in derivatives, passive investment products, and computer trading, the shift from analogue to digital to tokenized finance, and other conditions that amplify and accelerate market moves. All of these changes significantly increase complexity which in turn renders the ability to forecast outcomes much more difficult.

In The Seventh Sense: Power, Fortune, and Survival in the Age of Networks (2016), Kissinger Associates’ Joshua Cooper Ramo describes how today’s world is dominated by networks. The digital and networked economy is brilliantly examined by my friend Professor Mark Taylor in his seminal book, Confidence Games: Money and Markets in a World Without Redemption (2004), where he identifies and explicates the philosophical/scientific/intellectual origins of our interconnected world. Both books are essential reading for understanding how transformations in technology affected economies and markets in ways that were expected to improve humanity but also destabilized the world. Improving man’s technological capabilities empowered not only his best but his worst instincts, lifting many out of poverty and ignorance while exacerbating wealth inequality, the spread of noxious ideologies, and corruption and violence. This double phenomenon is almost certain to repeat itself with artificial intelligence. In an ironic Hegelian twist, technology simultaneously makes us smarter and dumber, richer and poorer, saner and crazier by tapping more of man’s darkness and light.

In a networked world, everything is connected to everything else. The meaning of every event and the value of every asset is affected by its connection to everything else. Nothing can be understood or valued in isolation. And connections are almost always multiple, not singular. We must think about markets in a holistic way; talking about “small caps” or “large caps” or “investment grade bonds” or “high yield bonds” or “private credit” or “commodities” may be necessary for media or institutional presentations but is otherwise fails to capture the complex array of forces affecting asset values and investment prospects. The silos in which we divide different subjects does them a disservice because they all interact with each other and thereby affect each other’s value. The walls between different things are broken down in a networked world.

Most people are still catching up to this new reality. This is especially true of our political and business leaders who either willfully or ignorantly cling to old ways of thinking. Mr. Ramo wrote in 2016: “our world [is] led into the future by a class of old leaders who don’t understand networks, and a collection of new technologists who don’t understand the world.” Little has changed over the last decade. With octogenarians running Congress, and tech leaders drawn from the Asperger’s spectrum (or just acting like it) running the most valuable companies in the world, we lack leaders capable of effectively managing a networked world (and those who can are demonized by those threatened by change). As Mr. Ramo wrote: “we find our future not in our own hands but instead in the grip of two groups, one ignorant of networks, the other ignorant of humanity.” The incompetence of our political system and the obliquity of our business culture derive from either a refusal (in the case of corrupt politicians) or a failure (in the case of narrow-minded technologists) to understand not simply that everything is connected but how everything is connected and the human consequences of that reality. The “how” requires understanding that the world is constantly changing in ways that place networks and their connections at the center of all things. We need men and women who understand that truth to lead us and leave behind the silos in which we used to operate.

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Even before the attack on Iran, stocks were under pressure. The Iran military operation is likely to be inflationary by increasing energy prices and raising the federal deficit by increasing military spending significantly. That lowers the odds of the Fed lowering rates, odds that were already pretty low. War is among the most destructive economic forces in the world so the longer the Iran action goes, the worse it will be for stocks. If successful, however, the attack on Iran should be beneficial for the global economy and positive for markets. Investors should look through the attack. Traders will do what traders do.

Software stocks have been leading stocks down while the FAANGs are losing their buzz as well (their huge profits consumed by epic AI spending). AI-leader Anthropic inflicted three stages of grief on software stocks in February. On February 3^rd, it announced a legal plug-in for its large language model (LLM) Claude that sent Thomson-Reuters (TRI), LegalZoom.com, Inc. (LZ), and RELX PLC (RELX) down 10% or more. Then on February 20^th, Anthropic announced Claude Code Security, sending CrowdStrike Holdings Inc. (CRWD), Cloudflare Inc (NET) and Okta Inc. (OKTA) down sharply. And then on February 27^th, the company announced that Claude had the capability of modernizing Cobalt databases (used widely for banking, payroll, ATMs and other government services and run 95% on IBM machines) which sent IBM”s stock to its largest drop in 25 years. Despite its disagreement with termination by the Department of War, Anthropic appears to be taking the lead in important parts of AI competition while sowing fear in the software industry. As discussed below, this is causing serious problems in the corporate credit markets because of massive lending to the software industry in recent years.

Markets were also shaken by a negative reaction to another quarter of blockbuster earnings from NVDA. NVDA has dropped after each of its last four earnings reports, each one better than the other, suggesting it may be hitting a ceiling in terms of investor expectations. But there may be a deeper reason, concern that the company won’t be able to maintain its results once the AI building boom slows. OpenAI lowered its future spending forecast from $1.4 trillion to $600 billion shortly before raising $110 billion from AMZN ($50 billion), NVDA ($30 billion) and Softbank ($30 billion) at a $730 billion valuation (down from a previously projected $850 billion valuation). This was another circular deal that is not what it seems (other than it seems absurd to pour that much money into a company losing tens of billions of dollars a year) as AMZN is paying only $15 billion up front with the rest of the money contingent on reaching certain milestones. META and other hyperscalers are also spreading their AI spending beyond NVDA which may also be tempering enthusiasm for the stock. CoreWeave (CRWV) reported another horrendous quarter, driving its stock down sharply, and investors didn’t believe a single word spoken by its CEO in a long interview on CNBC claiming business is great (he doth protest too much). AI needs to start showing results to impatient investors to prevent further stock market declines. Headlines like Block Inc. (XYZ) cutting half its workforce and firing 4,000 may boost the stocks of companies ostensibly saving money but the other side of those announcements are cuts in software and other products that will hurt the economy and markets. AI is not a zero sum game. There is dark side to any efficiency gains it produces that has to be factored into future forecasts.

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“The misallocation of capital – goosing the price of the riskiest and least-productive of assets – set the conditions for boom and bust. The financing of the ‘big state’ set the country on an unsustainable fiscal trajectory. The extraordinarily loose financial conditions created herd behavior among market participants and firms and complacency among policy makers, including regulators. The surge in inflation substantially raised the cost of living for citizens and undermined business planning.”

Mr. Warsh’s diagnosis of the Fed’s errors was dead-on. Further, he possesses the temperament, experience, and intelligence to navigate the complex challenges facing U.S. monetary policy in a period of unsustainable deficits and financial dominance. Policy must change to avoid a reckoning that will damage markets and the economy. No doubt Mr. Warsh benefitted enormously from working with Stanley Druckenmiller, one of the best minds in the markets, over the last decade, as well as from his prior experience as a Fed governor during the Great Financial Crisis. By appointing Mr. Warsh instead of Kevin Hassett, the president wisely chose competence over the perception (valid or not) of blind loyalty. Mr. Trump may have limited his options with the ill-advised criminal investigation of current Fed Chair Jerome Powell (which should be dropped) and the failure to reign in ICE’s tactics, both of which increased the need for a nominee free of political taint (I give little weight to claims that Mr. Warsh’s was due to his relationship with the Lauder family, large Republican donors). Mr. Warsh laid out a bold and compelling vision for reforming a central bank desperately in need of change and stood out among a highly qualified group of candidates for the job. The other candidates, including Mr. Hassett, would have been excellent choices but Mr. Warsh was the best choice. Hopefully he will be confirmed without too much unnecessary political drama though that is probably too much to hope for (the lack of drama) in the current hothouse atmosphere in Washington.

The Fed wisely kept interest rates unchanged at its late January meeting. Even the two dissenters, Christopher Waller (who was a strong candidate for chair) and Stephen Miran (whose temporary appointment ends on January 31^st), only wanted a 25-point cut, which in Miran’s case was unusual because he pushed for 50-basis point cuts at every meeting. Mr. Waller argued that rates should be cut by 50-75 basis points to a 3% neutral rate and Mr. Miran wants even lower rates but neither pushed for that at the January meeting. With stocks trading at record levels, inflation treading above target, the job market stabilizing, and credit spreads sitting at or near record tights, there is little argument apart from fiscal dominance (lowering the cost of servicing the federal deficit) supporting lower rates. And with overt political interference including an ill-advised criminal investigation of Mr. Powell, it was incumbent upon the Fed to show independence and resist purely political calls to lower rates at this time. Rates markets barely reacted, suggesting they anticipated the Fed would stand pat (though stocks and precious metals reacted negatively – see more below). Rates markets are now pricing in little easing for the rest of 2026 and even 2027, but the consensus still argues that the “neutral” rate is 3% (I think it’s higher) which suggests that rates will eventually be lowered to that level (while President Trump still calls for 1% which would be, with all due respect, a terrible policy error). Mr. Powell also confirmed that nobody on the policy committee is thinking about raising rates at this time so hopefully we can snooze until Mr. Warsh takes over.

Paid subscribers can read the rest of the issue which also discusses precious metals prices, private credit fund valuations, AI-related borrowing, rising Japanese interest rates, the toll of fraud on state and federal government finances, and much more. Please consider subscribing today.

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As someone who has been calling for regime change in VZ for years, I strongly support President Trump’s move to seize illegitimate “President” Maduro and his wife and deliver them to the United States to face drug and weapons charged. But the indictment is clearly a pretext for a much more important geopolitical …

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Welcome to Kingstown

“In this world, five percent of people are truly good. Five percent are evil. The rest of us, we wrestle between the two. Who we are, what we are, what we’re willing to do.”

Mike McClusky, Mayor of Kingstown

In the television series Mayor of Kingstown, Mike McClusky (brilliantly portrayed by actor Jeremy Renner) tries to keep the peace among warring factions inside and outside the prisons that constitute Kingstown, Michigan’s primary industry. He manages this bloody task by cutting deals with prison gangs; prison guards; the local police department; the district attorney; and the street gangs terrorizing the city. As a former prisoner himself, and a member of the family that kept peace for decades in Kingstown, Mike exercises power and moral authority in an immoral world by judiciously using violence and persuasion while placing himself and his family at great personal risk.

Mayor of Kingstown vividly portrays uncomfortable truths about our world. Brilliantly written and acted, its violent, unforgiving, cut-throat universe reflects the vicious, ugly, and at times violent nature of American politics as well as the amoral, backstabbing character of financial markets. Mike McClusky spends his days dealing with bloodthirsty killers whose promises are etched in blood. His world is different in degree, but not kind, from politics and finance where people lie without compunction and betray each other at the first chance they get.

That is hardly a happy note on which to open my forecast for next year’s financial markets, and certainly contrary to the happy talk dominating Wall Street these days. But we live in Kingstown, not Mayberry. Our government is propping up the economy on a tissue of lies and borrowed money while driving it straight into another financial crisis. Rather than address problems staring it in the face (unsustainable debt burdens, dangerously widening wealth inequality, rising inflation, etc.), it keeps borrowing trillions of dollars that it knows can never be repaid. And it does so while exhausting its diminishing credibility by generating phony economic statistics and engaging in political battles over minor matters meant to distract from the train wreck caused by years of incompetence and corruption. The confidence game can no longer hide the consequences of its failures; it can only delay them.

Without government support, markets would collapse. Trillions of dollars of fiscal and monetary stimulus drive stock and bond prices higher. But those prices are illusory and unsustainable. Individual stocks and bonds are still affected by the performance of underlying businesses, but many trade at inflated valuations due to their ability to attract capital through passive vehicles like ETFs and the willingness of investors to suspend disbelief and discount the future into infinity.

My forecast for the year ahead is based on my belief that we are living in Kingstown and that market stability is an illusion. A market crisis is still several years away (Ray Dalio places it at three years, I place it in the three-to-five year range), but the conditions for a crisis are deeply embedded and worsening by the day. They are based on the growth of unsustainable public and private sector debt. That is why I repeatedly urge readers to buy gold and save themselves. Further, everyone should avoid investing in places that treat them like the inmates in Kingstown’s prisons which are dark, ugly, dangerous places that many won’t leave alive.

With that introduction, the following should be treated as a thought-piece regarding the major trends and biggest issues facing markets in the year-ahead. Feedback is encouraged and appreciated either directly or through Substack Notes.

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Back here on planet earth, the Fed cut interest rates as expected by another 25 basis points on October 29^th. The only news that emerged from the October Fed meeting was that another December cut was not a certainty which sent stocks down slightly because it contradicted market expectations. With the government closed and limited data to work with, the Fed is flying blind with respect to setting policy. But given the data that is available, it seems set on an easing cycle that has little to do with its dual mandate. Instead, its actions support the argument that we are in a period of “fiscal dominance” where monetary policy is driven by fiscal policy needs which in this case means lowering rates to reduce the cost of servicing the deficit.

Markets celebrated the September inflation report that showed inflation still stuck at 50% above the Federal Reserve’s two-percent target. Not only were markets relieved that inflation wasn’t higher but demonstrated how desperately reliant they are on government support. Markets and the economy look good on the surface because of massive fiscal and monetary stimulus in the form of annual deficits approaching $2.0 trillion (the official numbers are understated) and monetary policy maintaining interest rates barely above the government-calculated rate of inflation (and likely well below the real-world rate). Withdrawal of this support would collapse markets and the economy. At three percent, inflation will reduce the value of a dollar to seventy-four cents in ten years. That’s the best-case scenario. Out in the real world where government statisticians can’t hide and where many prices are rising faster, a dollar will be worth much less in a decade. That is one reason (there are other reasons such as new sources of demand such as Tether) why gold rallied more than 50% this year. As the Fed embarks on another easing cycle (including ending quantitative tightening as funding pressures appear in short-term money markets)[3], the all-clear signal for speculation is flashing red.

Unfortunately, that is also the signal that flashes after a terrible accident as well it should. By lowering rates with inflation fifty percent above its own target and financial markets at record levels of valuation, the Fed is not only abandoning its own target but hammering another nail into the coffin of its credibility. While the Fed retains enormous power over the economy, its claims to political independence and intellectual integrity are discredited by its actions and its track record. It failed to contain inflation, allowing it to hit double-digits a couple of years ago, while currently misinterpreting data from a changing jobs market. Now it is lowering rates without monetary policy justification which will lead to more inflation (dollar depreciation) and more wealth inequality while public and private debt rise and borrowers rely on government support for repayment. Neither the public nor private sectors generate enough money (from taxes in the case of government or revenues/profits in the case of the private sector) to service and repay all the debt being incurred.

Despite all the self-serving justifications offered by Wall Street for lower rates, there is only one compelling reason to lower them – to ease the burden of servicing out-of-control federal deficits. Tariffs are not going to solve the problem (and will contribute to higher inflation). Cost cutting on the DOGE model failed. Higher taxes won’t solve the problem. The deficit will keep rising while several things happen. The federal government will be forced to borrow more money which will force interest rates higher as buyers of government debt demand higher compensation that causes a systemic crisis. It will be forced to cut spending and raise taxes in the form of higher income taxes, use taxes and wealth taxes, but these will be only half-measures and trigger severe political pushback that further water them down. The value of the U.S. dollar will drop further against gold and cryptocurrencies. And wealth inequality will widen further leading to greater social unrest and more populism across the political spectrum (which is problematic because populism feeds racism and other noxious ideas). Such are the wages of “fiscal dominance.”

Since September 2011, public debt increased by 157% from $14.8 trillion to $38 trillion while GDP only increased by 95% from $15.6 billion to $30.5 trillion. Can we reverse this trend? On an intellectual basis, yes. There are ways to slow the rise of the deficit and alter the arc of insolvency. On a political basis, at least for the foreseeable future, the answer is a resounding NO. Currently and for the foreseeable future, there is no sign that the extremists who took over our major political parties are willing to compromise their views; if anything, they are growing more extreme, which means their ideas are becoming less constructive to solving our economic challenges (from which all other challenges flow). Extremists are taking over both political parties. Barry Goldwater famously said “Extremism in the defense of liberty is no vice. And moderation in the pursuit of justice is no virtue.” Today, sadly, we live in an age of extremism in the pursuit of vice and moderation in pursuit of justice and too few are willing to speak truth to power. Like everything in life, this situation will change but it likely will require the system to suffer more damage before that happens. Citizens will have to suffer enough pain to not only demand change but take action to effect change not only at the voting booth but by increasing their political involvement at the local and national level. The process will be difficult, contentious, and potentially violent, but hopefully lead us back to governance by a more moderate, rational, and responsible majority. Until that happens, however, there is virtually no chance that the current budget trajectory will change.

From a long-term investment standpoint, this favors gold and other assets that benefit from inflation but renders it increasingly difficult to generate positive real returns. If you are not earning at least high single digit returns on your portfolio, you are losing ground to inflation (I actually put the bogey in the teens with respect to my own investments). Many years ago, Ben Bernanke took a series of policy steps to encourage risk-taking (having never taken risk himself as an investor). He knew not what he wrought. Now investors have to take enormous risks to maintain their buying power. Hence the bubbles in equity and credit that keep inflating larger and larger.

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· Tariffs are a sales tax paid by producers or consumers; either way, they raise prices, increase inflation, and slow economic growth. The economy has yet to feel the full impact of tariffs but soon will and the impact will be negative.

· While employment numbers have weakened significantly since May, the causes are complex and still subject to question. Likely culprits are tariffs and strict immigration enforcement that reduces the pool of available workers. If the latter turns out to be a significant factor, then the poor jobs reports may be sending a misleading signal of economic weakness that could lead the Federal Reserve to lower rates too far or too quickly.

· The Federal Reserve is lowering interest rates with financial asset prices at record highs (and signs of excesses in financial markets), inflation still above target (it is flattered by comparison with Biden-era highs), and employment possibly stronger than reported due to structural changes in labor markets not reflected in government figures. Lower rates will reduce the cost of funding the federal deficit (assuming the government keeps borrowing short term) but will almost certainly fuel financial market excesses. But lowering short-term rates may lead to higher long-term rates (10+ years), resulting in higher mortgage and other financing rates for businesses as concerns about debt and deficits increase (as they should).

· Federal Reserve independence is at risk as is that of the Department of Justice. And the two are interrelated and damaging to markets. Politicians should respect, not threaten, the independence of these institutions. Not only America but the world looks to the Fed to act independently to protect global financial stability. It also looks to the American judiciary system as a neutral arbiter of justice (though it falls short of that standard). Politicians are foolish to interfere in monetary or judicial policy. They get blamed for enough problems without taking responsibility for setting interest rates or targeting political opponents for prosecution. By doing so, they are bound to commit economic and political malpractice. While other factors are at work, it is no accident that the US dollar is falling while the credibility of two of America’s most important institutions is questioned.

· Stocks are in a bubble. By every reasonable (or unreasonable) measure, even adjusted for inflation (see more on this below), stocks are significantly overvalued. The bubble could continue for a while for reasons outlined below; as the great Richard Russell (author of The Dow Theory Letter) taught us, bull markets are designed to pull in as many investors as possible before ending. That is what is happening now.

· Corporate credit is also in a bubble that could last a while. Not only are spreads (the risk premium) at near record lows, but covenant protections and liquidity are much worse than in earlier periods when spreads were tighter such as 2007. Further, borrower-on-creditor and creditor-on-creditor violence makes owning corporate debt a miserable experience and further lowers risk-adjusted returns.

· The artificial intelligence (AI) arms race is showing signs of a mania. Projections of future adoption and spending are highly unlikely to be realized in time frames required to produce reasonable returns on capital over the next decade. A hard look at payment commitments made by companies like OpenAI and CRWV (see more on CRWV below) are implausible at best. Longer term, nobody knows what will happen and anybody who claims they do is full of you-know-what. But applying common sense is always a good rule-of-thumb when evaluating future promises by technologists.

· All of these factors are interacting to create an incredibly challenging investment environment that looks much easier than it really is. Those who ignore the lessons of past bubbles or who think this time is different are exhibiting hubris that is rarely rewarded.

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Note to readers: This month we are offering the newsletter without a paywall so all of our nearly 10,000 subscribers can have an opportunity to read the entire issue. Hopefully this will encourage more of you to sign up for a monthly subscription. Have a Happy and Healthy Labor Day and everybody please stay safe.

“Nations have built welfare and entitl…

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As President Trump prepares to sign an executive order allowing Americans to buy private investments in retirement accounts, a Wall Street Journal story about the collapse of a high yield municipal bond fund should serve as a warning that priv…

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“Well-nigh two thousand years and not a single new god!”

Friedrich Nietzsche, The Antichrist (1888)

Or maybe not. The world believes it discovered a n…

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“Well-nigh two thousand years and not a single new god!”

Friedrich Nietzsche, The Antichrist (1888)

Or maybe not. The world believes it discovered a new god in artificial intelligence (AI) and machine learning. Many of the gains in today’s market bubble – which looks like the Internet Bubble on steroids – are driven by the AI boom. Each financial bubble seems to exceed the last in size and this one is no exception. But it’s important to understand why this bubble is so enormous. There are several reasons:

· First, the financial system and quantum of global debt are much larger than twenty-five years ago. Massive fiscal deficits and low interest rates inflated the amount of money in the system. According to the International Monetary Fund (IMF), total global debt (including government, corporate and household debt) was around $64 trillion in 2000. As of mid-2024, the IMF estimated total global debt was $314 trillion or 500% higher than twenty-five years ago. Global stock market capitalization peaked at $44 trillion in March 2000 before the bubble burst; as of mid-2024, global stock market capitalization was $110 trillion and is closer to $120 trillion today, or about 300% of its size during the Internet Bubble. And there are only half as many U.S. public companies today as twenty five years ago in which this capital can be invested.

· Second, market structure evolved since 2000 to make it much easier for investors to buy stocks through passive vehicles like ETFs while relieving them of the need to perform any research. Explosive growth of options markets with new products like zero-day options also expanded market participation without knowledge, turning markets into a new form of gambling. Today, unlike in 2000, investors can trade stocks on their phones as easily as playing computer games (with even less thought), which attracts more participants and increases volatility.

· Third, the massive fiscal and monetary stimulus of the last three decades inflated the value of all financial assets, not just stocks. Real estate, art, collectibles, commodities – every asset denominated in fiat currencies rose sharply in value. The S&P 500 is trading at nearly 30x earnings compared to a historical average of 16x and the Nasdaq is trading at 40x earnings compared to a historical average of 22x. Other valuation measures such as the Buffett Indicator, Schiller Cyclically-Adjusted P/E, Price/Sales Ratio, and Dividend Yield are at or near record levels, meaning the levels of the Internet Bubble. These valuations are far above the average earnings growth rate of even the most successful companies (with rare exceptions like NVDA whose growth rate is unsustainable) which many (myself included) consider a reliable long-term valuation benchmark. Such stock prices are unsustainable because the growth rates underlying them can’t support them.

There are different ways to define a bubble. I define a stock market bubble as a trading level far above companies’ ability to generate sufficient income to support their stock prices. By that definition (and others), we are squarely in a bubble now (both in equity and credit). Bubbles can continue much longer than seems possible but ultimately collapse under their own weight (i.e., stock prices move lower toward their companies’ growth rates). This one will end the same way, especially because it is inflating as economic growth is tepid.[1] Real (inflation-adjusted) growth is going to struggle under the weight of tariffs (whose effects have yet to set in) and mounting debt and AI will take years to counter those headwinds (if it ever does). The market is inflated by AI hype, massive fiscal deficits, negative real interest rates, and understandable relief from the end of four years of the Biden Administration’s war on growth (which looks worse the farther in the rear view mirror it appears). Stock prices are also aided-and-abetted by the imbecilic game of managed earnings whereby analysts massage down their earnings estimates (with the complicity of companies) to levels that can be easily beat, confirming that life remains like high school long after we survive our senior prom.

Just as companies around the turn of the millenium spent huge amounts of money building out infrastructure to accommodate future internet growth (which eventually materialized though many companies failed), companies are today spending even more gargantuan sums on LLMs (large language models). The top four hyperscalers (GOOG, META, AMZN and MSFT) are spending more than $300 billion this year on capex – roughly 55% of their annual cash flows. Additional hundreds of billions are being spent by ORCL, SFTBF, IBM, OpenAI, Chinese competitors, Middle Eastern sovereigns and others. This spending orgy is based on almost religious belief that AI will change virtually every aspect of human life. Maybe it will, but maybe it won’t, and maybe every aspect of human life doesn’t need to be changed (or maybe the parts that need to be changed can’t be changed by computers). It seems to me that AI’s greatest promise lies not in LLMs (large language models) but in projects requiring the analysis of mass data like medicine, space travel, military applications and the like that may take time to generate significant financial returns. But it appears Silicon Valley is again focusing on consumer and social media applications rather than more productive applications as Palantir’s Alex Karp warned in his book The Technological Republic. Certainly Mark Zuckerberg’s uninspiring July 30^th statement describing “Personal Intelligence” suggests a need for a more compelling vision for AI than the one that fueled the explosion in the solipsistic social media and entertainment applications that waste so much human capital today.

Some of the financial commitments made today are going to be difficult to accomplish. For example, OpenAI recently committed to pay more than $30 billion annually to ORCL starting within three years for 4.5 gigawatts of datacenter capacity according to The Wall Street Journal.[2] That is equivalent to the power generated by two Hoover Dams or enough to power four million homes. OpenAI recently projected $10 billion in annual revenue so it will need explosive growth to fulfill this contract. The $500 billion Stargate partnership among OpenAI, Softbank, and ORCL has yet to complete a single deal and scaled back its near-term plans as the partners hash out issues such as where to build sites. They now hope to build one small data center by the end of the year according to the Journal. And just like during the Internet bubble, investors are using not only equity but debt to fund these projects. CRWV raised billions of dollars of debt to purchase GPUs from NVDA and build huge AI datacenters and then went public and now trades like a meme stock while waiting to become profitable.[3] META (which still derives most of its revenues from advertising) is also joining the debt bandwagon by raising $26 billion in debt (and $3 billion in equity) from large private credit shops led by APO to fund its AI investments (which include throwing exorbitant pay packages at AI scientists).[4]

Not to be undone, Elon Musk is desperately trying to keep pace by raising billions of dollars at xAI. Weeks after raising $10 billion of equity and debt in June, he is now working with his pal Antonio Gracias’s Valor Equity Partners to raise another $12 billion to buy a massive supply of GPU chips from NVDA that would be leased to xAI for a new data center to train and power the AI chatbox Grok (he is targeting one million chips). Musk recently directed SpaceX to invest $2 billion in xAI and collateralized the $5 billion debt component of the June financing with Grok’s intellectual property among other assets. xAI has very little revenue and is spending money hand-over-fist with 2025 cash burn expected to be about $13 billion according to the Journal. And this spending is just the beginning. Musk says that xAI plans to have 50 million H100-equivalent AI computers in five years. To place these numbers in context, OpenAI’s GPT-4 (state-of-the-art when released two years ago) was trained on just 25,000 GPUs. OpenAI will have one million or forty times that number by year end and xAI plans to have 200x that number in five years. Leaving aside the very material question of how these companies will pay for these chips, they must also obtain the power required to run them since that power doesn’t exist and has to be built. Valor is going to have its work cut out for it and will likely have to focus on Middle Eastern sovereign funds and similar sources to meet xAI’s financing needs [5]

Anyone who questions AI faces the challenge of answering technology experts (genuine and self-proclaimed) who claim superior knowledge of the topic. But the projections on which future AI revenues and profits are based remain highly speculative because they are based on events that have yet to happen; put bluntly, they are based on predictions about the future that is always unknowable. But one characteristic of the future that is knowable is that it is reflexive, meaning human beings and organizations react and adjust to changes rather than remain static. As such, arguments that AI will eliminate jobs without creating new ones or arbitrage away margins without creating new margin opportunities are questionable. Further, it is unlikely that multiple LLM models addressing the same market will all prove successful; more likely, ruthless competition will create a small group of winners and many losers with a great deal of capital consumed in the process.

The quantum of AI spending dwarfs anything previously applied to a specific product or sector in such a concentrated period of time. All of this spending has yet to produce a commensurate amount of revenue or profit but we are still in early days and investors are convinced that it will. Whether the world needs numerous LLMs that perform similar tasks remains to be seen; it’s not clear that these models can

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Equity investors exhibit zero concern about debt and deficits while Wall Street works overtime to stuff the economy with every conceivable form of debt even as increasing volumes of that debt fall delinquent or default. The S&P 500 trades at a P/E multiple of almost 30x while the Nasdaq trades at an even higher multiple of 40x, levels only reached before periods of sharp and painful declines.[2] American companies are buying back their own stock at a near-record $4 billion a day – once again demonstrating their proclivity to buy high despite claims of disciplined capital management. The U.S. dollar traded down about 10% year-to-date as the least-dirty-shirt in the fiat currency club without causing any concern among investors at home or abroad, something on which to keep an eye (along with the price of gold which should be bought). While I am usually the first to warn about overextended markets, I don’t see anything in the immediate future (three months) likely to stop this train. But while all is calm for the moment, we should that Hyman Minsky taught us that stability breeds instability. Signs of market speculation are everywhere in the loosest regulatory environment in memory. The longer things remain quiet, the more we will see risk rise in ways that will eventually turn out badly.

In many respects, the markets are driven higher by fears that didn’t materialize – at least not yet. Tariffs haven’t derailed corporate profits or increased inflation or economic growth - yet. Most forecasters are still calling for earnings to slow (to under 8%), inflation to rise (to 3% or so), and GDP growth to fall (to 1.5%) in the second half of the year. Markets seem unpersuaded by those forecasts. War between Israel and Iran didn’t spread into a regional conflagration that spiked oil prices. War in Ukraine hasn’t spread into Europe – and markets don’t expect it to after the exhibition of American military power in Iran. The American empire hasn’t fallen under President Trump – in fact, in many ways America’s international standing has risen significantly with a successful attack on Iran’s nuclear facilities and a productive NATO summit where the president reaffirmed support for the alliance. Markets welcome these developments which enhance geopolitical and global financial stability (hence lower oil prices and interest rates). And to repeat what was said above, nobody seems much bothered about debt and deficits in the short run as the Big Beautiful Bill moves toward passage (despite the possibility it may prove a political Trojan horse for Republicans).

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Tax and Budget Bill

There is widespread agreement that the fiscal 2026 budget and tax bill passed by the House of Representatives is extremely disappointing with respect to deficit reduction. Even President Trump’s allies are unhappy. As noted above, the lack of deficit reduction adds to the pressure on bond markets. Term premiums in the U.S. are moving higher on U.S. Treasuries with 10- and 30- year yields topping 4.5% and 5.0%, up 0.3% and 0.5%, respectively, since April 2^nd when President Trump unveiled his first tariff proposal. The term premium reached 90 basis points on May 22^nd; to place that in context, it was negative from 2006 through 2014 according to the New York Fed. These are not crisis levels but they are clearly moving in the wrong direction. But the real problem – real as in existential – is that the U.S. is facing a fiscal time bomb and the fiscal 2026 budget and tax bill shortens the fuse.

While there are parts of the bill designed to promote economic growth, they are unlikely to overcome the mounting burden of debt on the economy. There is very little in the bill that addresses the unsustainable spending trajectory of the federal government. One can point fingers in various directions but the real culprits are voters who refuse to elect anyone willing to make the hard decisions necessary to deal with the problem. No politician can keep his job by doing the right thing; job security demands doing the wrong thing. DOGE produced less than it promised not because of its own shortcomings but because of Congressional resistance to meaningful spending cuts. Elon Musk and his team learned what students of government already knew – every government program is supported by political constituencies prepared to fight to the death to defend it. Threatening these constituencies unleashes vicious personal attacks against those trying to do the right thing. DOGE might have benefitted from a subtler approach (Elon Musk is many things but subtle is not one of them) but still would have run into the Washington buzzsaw that cuts to pieces anyone challenging its prerogatives. DOGE reportedly cut $175 billion of unnecessary programs and expenses (that number has yet to be confirmed), a respectable number, but there is much more fraud and waste in entitlement and other protected fiefdoms squandering taxpayers’ money that Congress and a bloated bureaucracy are fully complicit in protecting. The limited number of Senators and Representatives willing to hold out for larger spending cuts deserve credit but are unlikely to block final passage of a bill because the alternative is a massive tax increase that nobody wants (except maybe Bernie Sanders and AOC). The 2026 midterms will deliver the verdict on whether taxpayers will continue to commit financial harikari or try for better in the future. My money is on harikari.

The Congressional Budget Office (CBO) reported in March that if current law remained unchanged, the 2017 tax cuts would expire at the end of 2025 and discretionary spending would shrink as a share of GDP. This would trigger a $4+ trillion tax hike and still leave the 2035 annual deficit at about 6% of GDP while adding approximately $20 trillion to publicly held debt, increasing the debt-to-GDP ratio from 100% to 118% (excluding off-balance sheet items). But rather than take that report as a warning, Congress is unwilling to take an axe to spending. According to the bipartisan Committee for a Responsible Federal Budget, the House bill would add more than $3.3 trillion to the CBO’s deficit numbers over the next decade and hike the debt-to-GDP ratio to 125% (and if so-called “temporary” measures in the bill are made permanent, add $5.2 trillion to the deficit and raises the debt-to-GDP ratio to 129%). Without boring readers with all the gory details, suffice it to say that claims that the bill will stimulate enough economic growth to solve the deficit are unpersuasive. Elon Musk, in leaving DOGE, argued that we can solve the problem through higher productivity and growth through use of AI and robots. To that I say, “From your mouth, Elon, to God’s ears.” Musk’s aspiration is echoed by other technology bulls like the hosts of the All-In Podcast (who also argue that higher growth will require massive expansion of electricity and other power supplies in the United States). While I believe in technological change, I am not as optimistic that technology will save us before we experience another financial crisis. We simply can’t wait for robots and LLMs to save us. And any crisis will delay technology development along with everything else. Those like Ray Dalio who argue we need to cut the annual deficit in half (from 6% to 3% of GDP, from over $2 trillion to $1 trillion) are on the right track. But instead of doing that, Congress is growing the deficit in dollar and percentage terms. We aren’t shooting ourselves in the foot; we are shooting ourselves in the head.

Some interesting ideas are floating around to address the deficit. One proposal is to cancel the roughly $7 trillion of intragovernmental debt on the books. That would cover roughly three years of deficit spending but wouldn’t dramatically change the trajectory of government indebtedness. Another idea posed by Chamath Palihapitiya on the May 17^th All-In Podcast is to monetize some of the $100-200 trillion of off-balance sheet assets (land, oil, etc.) owned by the United States. But unless I missed it, Mr. Palihapitiya failed to include in his suggestion that the United States also owes an equal amount of off-balance sheet liabilities (future entitlement payments, etc.). The Cato Institute estimated these obligations at $70 trillion in 2012.[2] It is certainly much higher today. While it might make sense to use some assets to secure long-maturity Treasury bonds as suggested above, selling the silverware to bail us out of years of reckless spending would just enable more reckless spending. In order to make the tough policy changes needed, we are going to need to change our political DNA. Maybe AI can help us with that.

Geopolitics

Iran

According to the International Atomic Energy Agency, Iran now has enough highly enriched uranium for ten nuclear bombs. As of May 17^th, Iran had amassed 408.6 kilograms (900.8 lbs.) of uranium enriched up to 60%, an increase of 133.8 kilograms (294.9 lbs.) since February. The 60%-enriched uranium is a small technical step away from 90%-enriched weapons-grade material. Iran’s overall stockpile of enriched uranium was 9,247.6 kilograms in May (20,387.4 lbs.), an increase of 953.2 kilograms (2,101.4 lbs.) since February. Iran is the only non-nuclear weapons state producing such material. Iran claims that its nuclear program is for peaceful purposes but that is flatly contradicted by its actions. With evidence like this staring the world in the face, the United States needs to act now. While it is admirable for President Trump to seek a peaceful end to Iran’s nuclear ambitions, it is no longer realistic to follow that approach. There is no evidence that Iran will stop enriching weapons-grade uranium unless forced to do so. Iran’s behavior assures it will breach any agreement it enters. Iran is not entitled to the benefit of the doubt. Military action is the only alternative. Doing so would also deliver a severe strategic setback for Russia and China in the Middle East while boosting Saudi Arabia and Israel. The United States and Israel have a once-in-a-generation opportunity to destroy Iran’s military and nuclear capabilities. Squandering that opportunity would be an historic blunder.

Russia/Ukraine

Ukraine launched a massive drone attack on four Russian airfields today that housed strategic bombers used for air raids. Forty aircraft were reportedly hit at these airfields which are thousands of kilometers away from the front line. No doubt Putin will respond, most likely with more attacks on civilian in Ukraine. This war will keep escalating and killing more people on both sides until the parties can no longer bear the pain. Putin has no interest in ending the war on terms acceptable to the West. The way in which he started and fought the war is a stain on humanity. Even those who (wrongly) blame the West for the war can’t formulate a moral justification for Putin’s escalating war crimes. At least Ukraine is targeting military sites in response, but the cycle of violence is escalating with no end in sight. The United States can only do so much but it must do something to preserve its role at the leader of the free world, a role that still matters. The United States must immediately join with Europe to block Russia’s remaining access to the global banking system (especially exemptions that permit sales of Russian oil). The U.S. Senate must pass the pending veto-proof bill sponsored by Senator Lindsey Graham imposing 500% tariffs on countries buying Russian oil. And the West must send more military aid (money and equipment) to Ukraine unless it wants to see Russia intensify the war over the summer. President Trump has to understand that he has no relationship with Putin. Now he has to show Putin what real power looks like.

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