Inside today’s Daily Journal…

In 1970 George Akerlof wrote a profound economic paper… about lemons.

“The Market For Lemons: Quality Uncertainty And The Market Mechanism” described mathematically something that everyone knows intuitively: that when buyers and sellers possess asymmetric information, markets fail.

When you’re buying a used car, there’s a very high likelihood that the market price will be inefficient. So what do used car buyers do in response? The rational buyer discounts every used car, as they can’t readily determine a lemon from a peach.

And that leads to a surprising outcome. Anyone selling a high-quality car withdraws from the market. A rational seller will not accept a lemon price for a peach car. The supply of peaches contracts. The pool of available cars now contains a higher proportion of lemons, which is precisely what rational buyers suspected. And as the average quality of the supply of cars continues to decline, buyers discount the price even more. The cycle continues until only lemons remain.

The technical term for this mechanism is adverse selection, driven by information asymmetry. This is how markets fail.

Akerlof won the Nobel Prize in Economic Sciences in 2001 for this insight, sharing it with Michael Spence and Joseph Stiglitz, who extended the framework to labor markets, insurance, and education.

If you have health insurance, you’re experiencing this exact kind of market failure. If insurers cannot distinguish healthy from unhealthy applicants, premiums must be set at a blended rate. Unhealthy individuals find this rate attractive. Healthy ones find it expensive. The insured population deteriorates. Premiums rise to compensate. More healthy individuals exit. The pool of insured becomes progressively more adverse. The market is failing because regulations make it impossible to underwrite healthcare policies accurately, leading to adverse selection.

Any market where quality is difficult to observe, where sellers have an informational advantage over buyers, or where (because of regulation) the price mechanism cannot discount costs will suffer from adverse selection.

Adverse selection is most extreme when the market’s opacity is structural rather than incidental, when the information asymmetry is not a passing friction but a foundational feature of how the market is organized.

This is the real reason that private credit is imploding. Private credit is the most extreme version of the “lemons problem” that modern finance has ever produced.

Unlike public bonds – which are priced continuously in liquid markets by buyers and sellers with competing views on value – private credit has no continuous price discovery mechanism. There is no exchange. There is no required real-time disclosure. There are no standardized audit procedures that independently verify asset quality.

As a result, the net asset values (“NAV”) of private credit funds are mark-to-model constructs. There’s no actual market pricing.

The NAVs are created by an “assumption stack”: a layering of discount rate assumptions, recovery rate projections, and EBITDA forecasts. These assumptions are created, measured, and verified by the same asset managers who earn fees on the funds, including incentive fees on the performance of loan books.

The auditors who review the resulting NAV marks do not independently price the underlying assets. They only assess whether the methodology was applied consistently.

These structural flaws don’t impair the market if capital is flowing into these funds. But… if capital flows out of these funds and these assets must be sold, the information asymmetry is crippling. The seller – the asset manager – has both the informational advantage and the financial incentive to sustain it. The buyer – whether a limited partner, a business development company shareholder, or the retail investor’s fund – is, metaphorically, the used car buyer on Akerlof’s lemon lot.

The market for private credit is, at its foundation, a market for lemons. And that’s going to have a profound impact on our economy through 2029.

Every significant postwar bull market in American equities has been, at its core, a credit creation story.

Equity markets reflect the earnings of companies, but companies earn money by deploying capital, and capital deployment at scale requires credit. The mechanism runs from credit availability to economic activity to earnings to equity prices.

When credit creation accelerates, it generates real economic activity and genuine equity appreciation.

But that also means that when credit creation reverses, the contraction is severe.

The 1980s are the perfect case study in the impact of a major credit cycle on equity values.

The Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Act of 1982 liberated savings and loan (“S&L”) institutions from their traditional mandate of funding 30-year fixed-rate mortgages. Suddenly, S&Ls could invest in commercial real estate! And even better, Michael Milken’s operation at Drexel Burnham Lambert created an institutional market for below-investment-grade corporate debt that offered high returns (and high risks).

Credit poured into Texas real estate, Latin American sovereign bonds, Milken’s junk bonds, and hostile-takeover funding vehicles. The S&P 500 roughly tripled through the decade.

Then the bill arrived: 1,043 S&Ls failed between 1986 and 1995, costing taxpayers an estimated $132 billion. The credit cycle had turned.

The 1990s repeated the pattern in a different sector. The buildout of internet and telecommunications infrastructure was financed through investment-grade and high-yield corporate bond markets at a scale that, in retrospect, required extraordinary optimism about terminal traffic volumes.

WorldCom, Global Crossing, Winstar Communications, and hundreds of competitive local exchange carriers issued enormous quantities of debt against traffic growth projections that were, by any dispassionate standard, aspirational to the point of fiction.

Telecom alone issued more than $1 trillion in bonds through the decade.

When the credit cycle turned, more than $2 trillion in equity market capitalization evaporated. WorldCom’s bankruptcy, which at the time was the largest in American corporate history, carried $41 billion in liabilities.

The 2000s produced the most thoroughly analyzed version of this pattern. I’m sure you know what drove those markets: mortgage securitization.

Total mortgage-backed securities outstanding grew from roughly $3 trillion in 2000 to more than $9 trillion (!) by 2007. The financial innovation was not merely securitization (pooling mortgages) but the tranching of risk through collateralized debt obligations. These structures “enhanced” the credit ratings of these securities to investment-grade by relying on an “assumption stack” that proved catastrophically wrong under stress.

Mortgage securitization directly funded the housing price appreciation that generated approximately $8 trillion in household wealth between 2000 and 2006. But, alas, a reversal of these credit flows destroyed approximately $7 trillion in wealth in 2008-2009.

The S&P 500 peaked in October 2007 and fell 57% before reaching its trough in March 2009. The credit cycle was the engine – its reversal was the demolition.

And the exact same thing is about to happen again. See if you can recognize the pattern.

The post-COVID era produced the most rapid expansion of a single credit instrument in financial history.

Private credit grew from roughly $800 billion in assets under management in 2020 to an estimated $3.5 trillion globally by 2025.

This growth was not organic demand expansion driven by the superior merits of the product. It happened because of three simultaneous structural conditions:

Since 2020, private credit has financed hundreds of billions of dollars in leveraged buyouts. It provided the capital for the software, healthcare, and industrial roll-up strategies that define private equity’s value-creation thesis.

The business development company (“BDC”) wrapper democratized this credit exposure, routing it toward retail and high-net-worth investors who were told, with varying degrees of accuracy, that they were accessing institutional-grade yields previously unavailable to them.

The asset managers who built and managed these platforms – Apollo, Ares, Blackstone, KKR, Blue Owl – saw their equity market capitalizations rocket accordingly.

But now the flows are reversing. The tide is going out.

Last week, investors withdrew $5.35 billion from investment-grade corporate bond funds – the largest single-week outflow since the April 2025 tariff shock. High-yield bond funds lost $3.17 billion, among the largest weekly high-yield outflows, ever. These massive redemptions coincide with a cascade of gating events across the private credit industry that, taken together, constitute the clearest signal since the asset class’s rapid expansion that the cycle has turned.

The temptation is to read these outflows purely as a macro risk-off trade – investors rotating from credit to cash in response to tariff uncertainty, slowing growth, and the oil price shock. That’s not what’s happening. Corporate bond outflows are performing a specific and critical function that the private credit market is structurally incapable of performing for itself: price discovery.

Public market comparables for leveraged credit are widening. Private credit managers, their auditors, and increasingly their regulators must reconcile model-based marks (“assumption stacks”) against what the public market would pay for equivalent risk. This reconciliation is not automatic or immediate – the opacity that defines private credit creates a lag – but it is ultimately unavoidable.

BDCs, which trade publicly and therefore cannot indefinitely obscure this reconciliation, were already trading at roughly 13% to 14% discounts to their reported NAVs by early February 2026 – before the April outflows further widened spreads.

Widening spreads (and falling corporate bond prices) are only the first step.

When public high-yield and investment-grade credit markets reprice, the marginal cost of refinancing for private credit borrowers rises sharply. Many of those borrowers have been surviving on what the industry euphemistically calls “amend-and-extend” — rolling debt maturities while paying higher spreads or electing paid-in-kind (“PIK”) interest rather than cash interest. In a stable or tightening spread environment, this cycle can persist for several years.

But when public markets reprice, the cost of capital for all leveraged borrowers rises simultaneously, including those who have never accessed the public market. The refinancing option becomes more expensive and less available at precisely the moment when the borrower population most needs it.

And that’s what will soon lead to the final step.

Institutional investors who are effectively gated in private credit funds – unable to redeem their capital – must raise liquidity elsewhere. The most liquid assets they hold are typically public investment-grade and high-yield bonds. Selling those assets to fund private credit redemption requests mechanically amplifies public corporate bond outflows. The contagion here is not metaphorical: it is a direct balance-sheet transmission from private credit stress to public credit markets, operating through the consolidated portfolios of the same institutional investors.

The $5.35 billion investment-grade outflow and the simultaneous gating at Ares, Apollo, Blue Owl, Cliffwater, BlackRock’s HPS, and Morgan Stanley’s North Haven private credit fund — all within a roughly three-week window — are not coincidental occurrences. They are two visible manifestations of the same underlying credit cycle turning.

Last month, Morgan Stanley’s credit strategy team projected that headline default rates in direct lending would climb to 8%. That’s approaching the peak rates reached during the COVID-19 crisis. The proximate cause of the defaults is artificial intelligence disruption in the software sector. But the market reality is vastly different from these headlines.

In public credit markets, a default event is well-defined: a missed payment, a bankruptcy filing, a distressed exchange offer at below par. That’s not the case in “assumption” credit.

Private credit has developed an extensive toolkit for avoiding defaults. PIK elections allow interest to be rolled into the principal balance rather than paid in cash — preserving the nominal debt service record while compounding the borrower’s actual debt load. Covenant waivers defer the technical breach that would require formal restructuring. Maturity extensions push the principal repayment into an indefinite future. The “amend and extend” mechanism – or, less charitably, “amend and pretend” – is a rational response by managers who face asymmetric incentives: a formal default crystallizes a loss that must be reported while an extended term or PIK election buys time.

The shadow default rate – the share of private credit borrowers whose economic situations would meet a reasonable definition of impairment even if no formal default has been declared – almost certainly exceeds the headline figure by more than 2x.

Independent research has estimated that between 20% and 26% of private credit portfolios are composed of software-as-a-service (“SaaS”) and broader software sector loans. The direct lending thesis for software was coherent at the time of origination: software businesses generate high proportions of recurring revenue through multi-year contractual relationships, carry minimal capital expenditure requirements, and produce stable EBITDA margins that justify high leverage multiples – 5x to 7x EBITDA was common for well-regarded software platforms through this period.

Artificial intelligence (“AI”) is disrupting those assumptions. It is not necessarily killing the underlying software businesses, but it is compressing the pricing power and customer retention that underwrote the leverage. When a customer can replace a $500,000 annual software contract with an AI-driven alternative at $50,000, the revenue model that supported a 6x leveraged capital structure no longer exists in the same form.

The disruption shows up first in public markets: SaaS equities declined approximately 20% year-to-date through early 2026.

Private credit follows public equity, with a lag and with considerably less transparency.

Morgan Stanley’s 8% default projection is premised on the AI disruption of the software sector as the primary catalyst. Oxford Economics has separately estimated that between 25% and 35% of private credit borrowers face material risk from AI-driven disruption of their business models.

Since the 2007-2009 financial crisis, the share of life insurers’ general account assets exposed to below-investment-grade corporate debt has roughly doubled.

According to Federal Reserve research, life insurance companies’ below-investment-grade credit exposure now exceeds the industry’s 2007 exposure to subprime residential mortgage-backed securities. The Fed’s researchers are stating, in measured academic language, that the insurance sector’s exposure to below-investment-grade private credit has reached a scale comparable to the most dangerous concentration of the pre-crisis period, and that the structures through which this exposure is held are considerably more complex and opaque.

It’s no mystery how this happened.

Apollo Global Management owns Athene Holding, a major life and annuity insurer. KKR owns Global Atlantic. Blackstone manages assets for F&G Annuities and Life and for Corebridge Financial, the life insurance subsidiary spun out of AIG.

Private equity has captured billions in life insurance float and is using it to fund private credit. By packaging below-investment-grade loans into collateralized loan obligations (“CLO”) structures, insurers can reduce their effective capital charge by a factor of 10 without changing the underlying economic risk exposure. Sounds just like mortgage CDOs (collateralized debt obligations), doesn’t it?

The result is that retirement savers – the purchasers of fixed and indexed annuities – are the ultimate bearers of private credit risk at a scale that neither they, their financial advisors, nor, in many cases, their state insurance regulators fully appreciate.

Insurance rating agency A.M. Best estimated in March 2026 that life and annuity insurers held approximately $1.8 trillion in private credit in 2025, representing a record 46% of their total debt holdings.

The institutional architecture of private credit and the long-duration redemption patterns of life insurance mean there’s not going to be a “run-on-the-bank” like there was in 2008.

Additionally, BDC gating prevents the immediate mark-to-market crystallization that would force a fire sale. The closed-end structure of institutional private credit insulates that capital from the redemption pressure driving the gating cascade.

But what will happen is a long, grinding bear market.

Private equity (“PE”) sponsors cannot exit portfolio companies when leveraged credit markets are tightening, because strategic acquirers cannot finance acquisitions and IPO markets demand the kind of multiple expansion that does not exist in a widening spread environment. Holding periods lengthen. Distributions to limited partners dry up. Capital is trapped not merely in the private credit instruments directly, but also in the equity of PE-owned portfolio companies, the holdings of pension funds and endowments, and the unrealized gains of institutional investors who have committed to the asset class at peak valuations. The wealth effect for these institutions – which are themselves major economic actors, funding university research, state pension obligations, and the investment programs of sovereign wealth funds – is contractionary in a diffuse but real way.

Private credit is the primary funding mechanism of middle-market companies. These are businesses with $10 million to $250 million in EBITDA, which constitute the backbone of private employment in the United States.

If BDCs deleverage under stress, middle-market companies face a genuine financing gap with no obvious substitute. This is not an abstract financial market concern. It is the financing of real businesses, real payrolls, and real capital expenditure plans.

And then there’s this…

Spread widening does not stay in one market. The $5.35 billion investment-grade outflow we saw last is already evidence of public market repricing.

As investment-grade, high-yield, and leveraged loan spreads widen, the cost of capital rises across the entire corporate sector, including for businesses that have no direct connection to private credit. Higher cost of capital reduces the net present value of investment projects. It slows capital expenditure. It reduces the incentive to hire for new positions when the cost of funding the incremental investment that would justify those positions has risen. The relationship is not linear – corporate investment decisions are made on more than financing spread – but it is reliable.

Credit cycles transmit to the real economy through the cost and availability of capital and the cycle has turned.

It’s time to be very defensive. A bear market is coming.

Tell me what you think of today’s Journal: [email protected]

Good investing,

Porter Stansberry
Stevenson, Maryland

1. Semiconductors set a scorching pace. The semiconductor market is maintaining its steady climb, with February sales hitting $88.8 billion – a 61.8% increase over last February. After a $791 billion 2025 led by memory and logic chips, these latest figures suggest the sector is well-positioned to reach $1 trillion in annual revenue this year. It is a significant pace, but one that reflects a stabilizing, broad-based expansion across most global regions.

2. Prices rise on end-of-war uncertainty. While stocks rallied this morning on reports that the U.S. sent a 45-day ceasefire proposal to Iran, the ongoing back-and-forth threats and a new series of air strikes against an Iranian petrochemical facility have pushed energy prices higher again – with crude oil above $110 per barrel and U.S. gasoline prices up 38% in the last five weeks, the biggest increase in the past 30 years. And the big jump in the cost of jet fuel has sent the price of airline tickets rising as well… As this persists, higher inflation will likely follow.

3. Jamie Dimon just confirmed what we’ve been saying for months. In his annual shareholder letter, the JPMorgan CEO warned that losses across the $1.8 trillion private credit market will be “higher than expected” when the credit cycle eventually turns – citing weakening underwriting standards, aggressive borrower assumptions, looser covenants, and rising use of payment-in-kind (“PIK”) structures that let borrowers defer repayments rather than actually service their debt.

While gold is trading 17% below its 2026 high, shares of our favorite gold royalty company are down less than 10% from its January high – and have risen 68% since we recommended them to Complete Investor subscribers.

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Carl W. writes:

Porter Comment: Thanks for catching that snafu. Americans consume about three gallons of oil per day, per person.

Dick S. writes:

David R. writes:

Porter Comment: As I’ve explained fully in other places, I regard Bitcoin on par with gold as a proof of work. In many other ways, I believe Bitcoin is a superior reserve currency. If we alter the Permanent Portfolio’s allocation in response to a collapsing bond market, I would maintain the role of Bitcoin in our portfolio.

Please note: The investments in our “Porter & Co. Top Positions” should not be considered current recommendations. These positions are the best performers across our publications – and the securities listed may (or may not) be above the current buy-up-to price. To learn more, visit the current recommendations page of the relevant service, here. To gain access or to learn more about our current recommendations, call our Customer Care team at 888-610-8895 or internationally at +1 443-815-4447.