Let's revisit what I said 10 months ago about the general risk of the leveraged corners of speculation.
Nearly a year ago, I cautioned about the general risks of leverage. At the time, I specifically highlighted the risks of a leveraged crypto currency market. This alone proved prescient last week when a number of coins blew up.
But there's more. We should all be concerned when leverage itself becomes a product, and here we are now, with 701 leveraged exchange-traded funds. Some of these very ETFs use as much as five-times leverage.
As Warren Buffett has said, "When you combine ignorance and leverage, you get some interesting results."
Indeed, leverage is a two-edged sword, and these edges that can cut you, cut deeper.
It's not just the lack of disclosure, absence of due diligence and poor underwriting standards that contributed to the recent bankruptcies of Tricolor (see: Tricolor: The messy collapse of a subprime auto lender explained) and First Brands (see: First Brands Files for Bankruptcy, Revealing Billions of Dollars in Liabilities). There are other numerous signs of the unexpected appearance of leverage that are surfacing in many quarters of our markets and economy:
When is enough enough? Why stop at five-times leverage?
When is enough, enough? Why stop at five-times leverage?
Leverage Is Pervasive
The bigger picture trends of markets and economies using more and more leverage are quite clear:
* Leverage in increasingly crowded passive investing products and strategies (markets are not elastic enough to take in the rising inflows -- this serves to lower the point in which quants may become a destabilizing market influence)
* Nearly 70% of daily option trading has an expiration of one day
* Leverage in structured products
* Leverage in non-deposit financial institutions, private equity and crypto currencies
* Leverage underlying the AI cap spending cycle
* Leverage at the municipal and Federal government levels (with annual federal debt service payments now topping annual U.S. defense outlays)
Some investors lack concern regarding a worrisome credit cycle or a systemic trend or both -- like my pal, the lynx-eyed Dan Greenhaus. Dan writes that "the recent credit market flare-ups are best viewed as a series of one-offs rather than evidence of a broader systemic issue:
I am not in agreement with Dan:
I saw the threat, emergence and consequences of leverage in a column I wrote late last year, titled "A Cause for Concern: The Unexpected and Leveraged Corners of Speculation."
I encourage you to reread that column but here are some of the points I made. First, the entirety of the-then recent four-week market advance (around November of 2024) had been based on an expansion in price earnings multiples. I argued that as narratives multiply and fear/doubt disappear, guards and disciplines would be dropped with many asset classes at all-time highs. But as asset prices rise, I wrote, diligence and the assessment of reward vs. risk should take on greater irrelevance. Yet, unfortunately, just the opposite was occurring.
I also wrote that the concept of "a margin of safety" should be evermore embraced, as it is an essential and integral ingredient to investing over a "market cycle." Also I said we should expect the unexpected ... in the corners of leverage and those who are endorsing the narrative of a "new paradigm" (of higher valuations). I said that, "the most important turning points in markets (and in life) often come at the most unexpected times and in the most unexpected ways."
This commentary was orginally posted in Doug's Daily Diary on TheStreet Pro.
At the time of publication, Kass had no positions in any security mentioned.