The Next Big Market Collision Is Already Underway

I have spent an unreasonable portion of my adult life watching otherwise intelligent people do strange things with money.

The occupation began in financial publishing, mentored by a gentleman who started in the industry “back when a newsletter editor could still read the morning papers, call a few interesting people, write down what bothered him and get the letter into the mail before somebody formed a committee.”

As you may be aware, the gentleman was Bill Bonner. He hired me while I was still in graduate school studying philosophy, of all things. Eventually, our work brought that peculiar métier to The Daily Reckoning, the first email financial letter on the Internet.

And then into Financial Reckoning Day, The Demise of the Dollar and Empire of Debt, each a New York Times, Wall Street Journal and/or International best seller.

Along the way we accumulated economists, investors, geologists, engineers, miners, historians, currency cranks, entrepreneurs, internet marketers and assorted larger-than-life characters who had learned something useful… by being wrong at least once.

The books became our study of booms and busts, fiat money, debt and the political habits that make all three possible.

Among our living network at the time, Dr. Kurt Richebächer kept asking what had actually been saved, what had actually been invested and what had merely been financed. James Dale Davidson and William Rees-Mogg asked what technology did to sovereignty.

From the dusty books in our library, Hayek taught us to distrust anyone claiming to possess knowledge dispersed among millions of people. Minsky warned that enough calm eventually encouraged people to borrow as though calm had become a law of nature.

The concept and mission of the Grey Swan grew out of that network.

During the pandemic, when official policy became stranger by the week, we began gathering people on Zoom simply to compare notes. More than 300 recorded conversations later, we had something resembling a fraternity: less an investment committee than a collection of people standing at different parts of the machine and shouting when they noticed smoke.

Today that machine presents investors with a problem our grandfathers would have found peculiar.

The classical investor saved money, bought a productive asset and expected the people operating it to produce an income. He cared about earnings, dividends, assets and the price paid for them. He might speculate occasionally, but he generally knew when he was doing it.

Most people today do not enjoy that luxury.

If you own an S&P 500 index fund, retirement account or ordinary collection of mutual funds, professional managers and index committees have already placed enormous bets on technology on your behalf.

You don’t have to pick individual tech stocks to have a lot riding on them. Your index fund may have already done that for you. (Source: Investment Company Institute)

Interest rates, passive flows, options positioning, government borrowing and central-bank decisions can alter the value of those holdings before the underlying company has sold one additional widget.

You may consider yourself an investor.

The financial system has quietly made you an “unwitting speculator.”

The distinction matters because two enormous claims on capital are now colliding.

🤖 The Intelligence Age Meets the Age of Debt

The first is artificial intelligence.

I do not doubt that AI will change the economy. The internet did too. Railroads transformed commerce. Electricity reorganized factories. None of those observations prevented investors from losing heroic amounts of money financing the wrong companies at the wrong prices.

Dr. Richebächer would begin with the financing.

The AI companies have already spent staggering sums on chips, data centers, power contracts, transmission, cooling and land. Now more of that buildout is moving from corporate cash flow onto debt markets.

Data centers, chips and power don’t come cheap. And increasingly, AI companies are turning to Wall Street to help cover the costs. (Source: Bank of America Global Research)

By October, investors had begun marking down bonds tied to AI data-center projects and demanding much higher yields from some of the more leveraged borrowers. CoreWeave became the most obvious example. Investors pushed yields on some of its debt toward distressed territory while they reconsidered how quickly all those GPUs would produce enough cash to service all that borrowing.

At almost precisely the same moment, Treasury officials need the same pools of capital.

The 10-year Treasury yield is still hovering above 5%. Earlier this month, it briefly reached nearly 5.4%, a level investors have not seen since the dotcom bust in 2002.

Imagine you manage a pension fund. Jensen Huang and his financing partners would like your next billion dollars for AI infrastructure. Treasury officials would like it to refinance federal debt. The AI project therefore has to offer you enough additional return to compensate for construction risk, technological risk and the uncomfortable possibility that somebody discovers a cheaper way to perform the same computation before your data center has finished depreciating.

That is capital allocation in the old-fashioned sense. Money has alternatives again.

We saw the political side of the problem during an invite-only gathering at the Rayburn House Office Building in Washington. We joined Zoltan Istvan, who was invited to chair a few panels for the benefit of elected officials from the House and the Senate and their parade of staffers.

Hedge-fund and family-office managers listened as members of Congress and industry representatives discussed federal AI regulation. The day before the closed-door meetings, Anthropic employee Jason Coxson had hit social media with the “shocking admission” that generative AI was learning so quickly that without guardrails in place, the tech would “kill all of humanity” by the end of the decade.

Perhaps it should not have raised our suspicion, but representatives from a number of states — Illinois, Kansas, Texas, California, among them — came with their stump speeches on the need for AI to adopt Federal Regulation fully developed… just one day after Coxson’s warning.

The narrative had already gained momentum.

What caught the room’s attention was not simply what lawmakers proposed. Several managers were openly suspicious that executives who had spent years racing ahead of Washington now appeared increasingly willing to have Washington establish the rules.

There are perfectly legitimate reasons to regulate a powerful technology.

There are also commercial advantages to helping write rules that your smaller competitors will later have to obey.

The classical investor should notice both. And be prepared to protect your money either way.

The reason this matters even if you have never owned Nvidia, CoreWeave or a single AI stock is that the U.S. market has become the financial center of gravity for investors everywhere.

American companies account for roughly 44% to 48% of global equity market capitalization and more than 70% of the MSCI World Index.

The U.S. also attracts the majority of global flows into private equity and private credit. Pension managers in Europe, insurers in Asia and retirement savers almost everywhere are already exposed to the same pool of capital now being asked to finance AI infrastructure, federal deficits and the next generation of defense and industrial projects.

There is leverage underneath it, too. U.S. margin debt has climbed to roughly $1.5 trillion, while the total value of American equities stands at more than twice U.S. GDP.

None of these numbers tell us when anything will break. Dr. Richebächer would object if we tried to use them that way. They do tell us how much financial value, borrowed money and expectations now depend on investors continuing to fund the system at prices they find acceptable.

That is why the AI trade and the “Sovereign Bloc” are necessary macro arguments for any investor alive today to consider.

~ Addison

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