The Two Risks Markets Keep Underestimating
These issues are becoming more intractable — and investors aren’t ready.
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Market Risks
Investors certainly have the proverbial wall of worry to climb right now. A deteriorating residential and commercial real estate backdrop, sticky inflation and anemic job growth are just several of myriad concerns right now. However, there are two risks that are becoming more intractable — and investors are being much too complacent in assessing them, in my opinion.
The first is the ongoing crisis in the Middle East, which has now entered its second month. There is no way to know when the Strait of Hormuz will reopen or how that will happen. President Trump in his speech to the nation on Wednesday admitted as much.
The Strait of Hormuz is by far the biggest choke point in the world, and it has been effectively closed for five weeks now. This has triggered a huge rise in energy prices. In addition to oil, a huge amount of LNG passes through this region.
While Saudi Arabia and some Gulf States have heroically rerouted some of their exports through pipelines to get it out to the world, the daily shortfall is huge — a larger impact on the globe than the 1973 OPEC embargo. This has caused gasoline prices to rise in the U.S. to north of $4 a gallon as well as spikes to jet and diesel fuel prices. Fertilizer prices have headed much higher as well, as a huge chunk of world’s urea, nitrogen and phosphate transit the Strait.
If the U.S. is developing the sniffles, the rest of the world has a full-blown flu. Fuel rationing in parts of Asia and Australia will soon become more widespread. Europe is not far behind. And despite five weeks of bombing sorties by the U.S. and Israel, Iran remains capable of retaliation on Israel and U.S. military assets in the regions. What's more, these strikes have caused considerable damage to key energy and other facilities in the Gulf States.
We are also in a new age of warfare than has never been seen outside of the ongoing Ukraine war. This is due to AI and drone technology, which has provided a terrifying boost to asymmetrical warfare, where a hundred Shahed drones can be built for the cost of one Patriot interceptor missile.
My view is this new regional war is going to be much costly and take longer to resolve than most investors are factoring in right now.
The second risk that is becoming more intractable is the emerging crisis in private credit markets, which is getting worse by the week. This week investors got more clarity around KKR & Co. (KKR) and Blue Owl Capital (OWL) gating recent redemption requests from their private credit funds. KKR met 80% of their investor redemptions. Blue Owl allowed less than a quarter of redemptions in one fund and under 15% in another.
The Wall Street Journal came out this week with a concerning report. Based on their perusal of four large private credit funds from Blue Owl, Apollo Global Management (APO) , Blackstone (BX) and Ares Management Corporation (ARES) , it found that the average exposure in these funds to software companies was 25%. This was significantly higher than the 19% reported in company filings.
Private credit's exposure to software is important as these businesses are viewed as very susceptible to AI disruption. These are also asset-light entities. This means if loans go bad, very little will be able to be recovered by the lender via liquidation. That is going to make mark-to-market exercises quite interesting some time in the foreseeable future.
Bottom Line
The second quarter is shaping up to be every bit as volatile for the markets as the tail end of the first quarter. Investors should position their portfolios accordingly.
At the time of publication, Jensen was long KKR (small position via covered call holdings).
