The era of low rates that begat unicorns and zombies is over. It ended in 2022, but the monsters took several years to emerge from their hiding places and start haunting the overleveraged landscape that created them. Before rates rose, however, private equity firms gorged out on cheap debt to overpay for companies and early-stage companies borrowed to fund themselves despite weak credit profiles. Equity remained the dominant source of venture capital funding through the first part of the AI bubble that accelerated after the introduction of ChatGPT on November 30, 2022, but eventually unprecedented (and likely excessive) capital spending led even megacap tech companies to start borrowing as well. Companies raised trillions of dollars of on- and off-balance sheet debt (the latter is reportedly over $4 trillion) to build products that require years to produce sufficient revenues to pay for themselves. But they are far from done. The buildout requires trillions of dollars of additional capital that will be more expensive than the money already raised with revenues somewhere in the future. For good reasons, investors are worried.
The recent drop in Treasury yields suggests investors are seeking safety as they view an increasingly confusing and precarious landscape (which could become considerably more so after the midterm elections in which I expect Democrats to win both houses of Congress). Yields will come under pressure again when the Fed resumes rates hikes in December (it was prudent to remain on hold a few days before the elections but the Fed still has serious work to do to quell inflation). Real rates (meaning both inflation-adjusted and real-world rates) are still negative, and financial conditions are still far from tight. Apollo’s Torsten Slok reports that inflation is rising again (The Daily Spark, “Inflation Stopped Falling, Now It’s Rising,” November 1, 2026) While the Iran and Ukraine wars are certainly contributing to higher oil and food prices, the primary force lifting inflation remains metastasizing public and private sector debt not only in the United States but around the world. If the wars ended tomorrow, consumer prices would modify short-term, but little would change in the long-term inflation picture because U.S. and global debt would keep growing. This is the structural reason why the direction of rates is higher; investing based on rates falling in the future (barring a crisis leading to flight to quality to government bonds – if they are even seen as “quality” anymore) won’t work out well on a long-term basis.
3Q GDP was less impressive than the headline +3.8% number suggested as inventory restocking accounted for almost half of the 3Q26 gain (thanks to David Rosenberg for pointing that out). There is good reason to expect a downward revision to the 3Q print which was uncritically cited by many who didn’t read the fine print (or who were electioneering or trying to talk up the AI bubble). While consumer spending appeared strong, it was likely boosted by inflation despite real wages flagging. To state the obvious, the economy and markets remain highly dependent on AI, which like everything else relies on policy accommodation to keep the train moving forward.
But even with policy tailwinds, the grossly overindebted U.S. economy is growing much more slowly than in the past. I believe the reason for this is the massive quantum of debt slowly but steadily draining away economic vitality. As David Rosenberg pointed out at the recent Grant’s Interest Rate Observer Fall Conference, growth is much slower today than during the Internet Bubble (when systemic debt was much lower on both an absolute basis and as a percentage of GDP). Real GDP was growing at 4.8% year-over-year at the end of 1999; today it is growing at 2.2%, virtually all of which derives from record tech spending. Mr. Rosenberg also pointed out that in 1999, non-technology capital spending was cruising along at an annual rate of +6.7% while today it is falling at an annual rate of -0.7%. With the long end of the Treasury curve trading at a real yield of 3% and the S&P dividend real yield at 2.5% (using government statistics which understate inflation), the equity risk premium is negative -0.5%. Yet investors – at least until recently – treated AI-related stocks like Treasury bonds in terms of their risk. “We’re completely upside down,” Mr. Rosenberg tells us (Doug Kass has also been harping on the negative equity risk premium for much of 2026). If things are different this time, it’s not because AI is going to play out differently than earlier technology revolutions (boom-bubble-bust-recovery); it will be because today’s Wall Street analysts, strategists and investors (with some limited exceptions like David and Doug) failed to heed well-worn lessons of the past and succumbed to misguided consensus thinking. They don’t call it the madness of crowds for nothing. The concept of the wisdom of crowds is a joke.
Credit Markets
Credit markets are suffering from AI exhaustion as private equity monetizations remain depressed and the industry starts to address a $300 billion maturity wall in 2028 ($140 billion) and 2029 ($160 billion). Software loans account for about one-third of these maturities according to The Wall Street Journal (“Private Equity Risks Hitting Wall of $300 Billion in Debt,” October 27, 2026) and pose heightened risks because of AI competition (i.e., technology risk), lack of hard asset collateral, weak covenants, and the high prices paid by private equity firms for these companies using low-cost pandemic era debt. About one-quarter of the 2028/29 maturities carry CCC+ or lower ratings, which means lenders (if they are even interested in remaining in the credits) will demand double-digit coupons hundreds of basis points higher than existing debt. Few low-rated companies can survive significantly higher rates without restructuring their balance sheets (which speaks to the reason why early stage companies and those facing high technology risk tended to avoid debt financing until the early 2020s). Hugh MacArthur, chairman of Bain & Co.’s global private equity practice, told the Journal that “There are going to be businesses that get the keys tossed back to the bank and don’t make it.” Many of those keys will be to the doors of CCC-rated borrowers. Default rates are still low in percentage terms with Bank of America forecasting them to double next year to 4%, but while that sounds relatively low, the size of the market means defaults and losses could total hundreds of billions of dollars. This will further impair already unimpressive risk-adjusted returns on private equity and private credit funds and do nothing to help break the logjam of over $3 trillion of private companies looking for buyers. After exploiting artificially low interest rates for years after the 2008-9 financial crisis, and keeping many undeserving companies on life support, the private equity industry is facing a zombie apocalypse. Private equity investors will bear most of the pain while their managers keep charging high management fees on their walking-dead portfolio companies until lenders force them to put them out of their misery.
The weakest rungs of the junk market are reeling as investors dump the most distressed U.S. and European corporate bonds (to the extent they can). Yields on CCC-rated borrowers rose to 18% in the U.S. and 21% in Europe from 15% and 16%, respectively, at the beginning of the year (though give credits account for much of the widening). The market could get a lot worse. Companies like Optimum Communications engaging in LMEs (liability management exercises) in which they move assets out of the hands of creditors have seen their bond prices plunge while increasing lender concerns that other troubled borrowers will try to deprive them of their collateral and other rights, further dampening market settlement. When private equity borrowers are out of the money and their loans and bonds have weak covenants, the only thing stopping them from moving aggressively against lenders is preservation of relationships and their reputation – in other words, their character, something that is in short supply on Wall Street. Instead, they claim they are obligated to mistreat lenders to fulfill their fiduciary duty to their own investors – the same ones they are overcharging fees by overvaluing their assets.
There is already one high profile casualty among credit funds (but others are rumored to be in trouble and multiple trading pods inside large multistrategy hedge funds reportedly hit their loss limits and were forced to close) – $22 billion Arini Capital Management in Europe run by 36-year-old Hamza Lemssouguer. Arini is known for making large investments in distressed credits like Optimum Communications, Virgin Media, Brightspeed, Multi-Color, Astin Martin, and Cornerstone Building Brands (some of the worst performing CCC-rated bonds this year). With its main fund down 26% year-to-date, the firm reportedly sold off more than $800 million of debt holdings to settle margin calls, meaning it borrowed money to buy illiquid distressed securities, a mug’s game. At 36 years old, Mr. Lemssouguer was too young to invest during the 2008-9 financial crisis or before that the 1992, 1998 or 2002 credit crises. This is similar to watching Leopold Aschenbrenner immolate his portfolio (stocks require even less experience than distressed bonds to manage). Nobody should be surprised to see funds blow up when too much money is given to managers lacking the experience to manage it.
