This 'Boogeyman' Isn't Predicting a Market Meltdown

"I probably shouldn't say this," Jamie Dimon, CEO of JPMorgan Chase (JPM), remarked on an earnings call last October. "But when you see one cockroach, there are probably more."

Dimon was commenting on a blowup in the private-credit sector. An auto-parts supplier called First Brands had gone bankrupt the month before.

The company had been double- and even triple-pledging invoices to increase borrowing... And its executives had enriched themselves from the scheme for years. Once the fraud came to light, the company filed for Chapter 11 bankruptcy in September. It had about $9 billion in debt at the time.

That was the first high-profile blowup in today's private-credit space. And if you agree with Dimon, one meltdown is a sign of more problems down the road.

Fears have been swirling about private credit since then. Folks are worried that hidden problems could spill into the economy at large. But as we'll see today, these concerns, at least for now, are much ado about nothing...

What Caused the Private-Credit Boom

Private credit exploded in popularity in recent years...

Before the financial crisis, big banks used to make direct business loans. But then in 2010, the Dodd-Frank Act forced banks to clean up their balance sheets.

So big banks stopped making as many loans – and private investors stepped in.

Most private loans are floating rate. Their interest rates can go up and down over time, largely based on the Federal Reserve's benchmark rate.

In 2022, the Fed began aggressively hiking rates to tame inflation. That caused a stock bear market... and crushed traditional bond investments. But it made private credit look much more attractive.

The benchmark basket of bonds fell as much as 15% that year... and long-duration U.S. Treasury bonds fell as much 35%. But private-credit loans earned higher yields as interest rates rose. They made good money while almost everything else crashed.

Investors noticed... And private credit began raising huge sums of investment dollars.

Estimates put the total market at about $1.3 trillion today. That's up dramatically from $500 billion five years ago. So while most mom-and-pop investors aren't thinking about this space, it has become a major growth driver for Wall Street firms.

Private-Credit Fears Won't Cause a Market Bust

Of course, whenever money pours into a new (or forgotten) asset class, folks worry about a potential blowup. They think we'll see falling underwriting standards, bad loans, and a string of bankruptcies.

They also fear that this kind of blowup could spill into other markets... hurting folks who never even considered owning private credit.

That fear kicked into high gear last October when First Brands became news. The major publicly traded private-credit (and private-equity) firms have taken stock losses since then. Take a look...

Ares Management (ARES), Apollo Global Management (APO), and Blue Owl Capital (OWL) are a few of the largest private-credit managers. Their stocks have crashed over the past six months. The market wants nothing to do with them today.

Here's what you need to remember, though. These stocks aren't the private-credit investments themselves. They're the investment-management companies.

That means they make money by raising capital, putting it to work, and earning fees on those investments. They don't make money from the investment returns themselves.

So just because share prices are crashing, that doesn't mean the private-credit asset class is doomed... Instead, it just means that investors think the boom times for the management companies are over.

For the actual assets, the First Brands' collapse reminded folks that private loans can sometimes go bad. And recent weeks have brought even more worrying news...

Scared investors in the space have been asking for their money back. In the first quarter, they asked to pull nearly $14 billion from a major group of private-credit funds. The problem is, private-credit funds aren't liquid like stocks. There are limits to how much money they can give back to investors.

As a result, most funds are capping withdrawals... which is a bad look when investors are already spooked.

But at this point, the fears are all about what could happen – not what's actually happening (or even what's likely).

These massive private-credit portfolios – the actual assets held by these companies – simply haven't taken major losses. They're operating as expected, paying out dividends to investors.

Folks don't see that, because these private-credit funds are, well, private. They don't trade on public markets.

Jamie Dimon might be on the hunt for more cockroaches... But I don't expect he'll find many. Even the bankruptcies we saw last year didn't happen because of bad underwriting. They were frauds, and likely the exception to the rule.

In short, private credit is getting more headlines than it deserves these days.

The news might make you fear a major bust, like we saw in 2008... one that could upend the economy and stock bull market.

But a bust isn't coming. So don't let this boogeyman spook you into making bad choices in your portfolio.

Good investing,

Brett Eversole