March thirty-first, two thousand twenty-five to April first, two thousand twenty-five
For internal use only by Knowledge Planet [Cross-Market Asset Strategy Notes]; do not distribute!
Table of Contents
Positioning the U.S. (III): Private Credit A fragile symbiosis with pension funds
Positioning the U.S. (IV): K-shaped economy: Leverage, Illusion, and “Paper Prosperity”
I. Foundation
resistance to change and hence greater dependability for the results shown in the past.
II. Insights
Our Viewpoints and ideas on market.
Positioning the U.S. (III): Private Credit and Its Fragile Symbiosis with Pension Funds
Moral hazard never really left..
If this cycle is most reminiscent of 2008, it is not because of the banks or MBS, but because of Private Credit. This time, it is not only bigger, but also more hidden.With policy encouragement and institutional exemptions, this system has become a highly leveraged, lightly regulated, interconnected black box, and downstream from it is the U.S. pension system.Its downstream exposure is the U.S. pension system.
In other words, the housing market certainly has problems too, but from a systemic-risk perspective, by comparison, today’s housing market is no longer the systemic threat it was back then. The corporate credit market’s problems are more urgent because its transmission through the financial system is stronger.
If market liquidity runs into trouble, compared with MBS, the Fed is more likely to step in in the corporate credit market—for example, by establishing some kind of long-term liquidity facility to channel funds to certain parts of the corporate sector—and is less likely to return to the housing market.
The problem in the corporate market is that private credit is expanding very rapidly and has very little transparency, yet it is closely connected to traditional financial institutions. This combination could create real risks—and the Fed currently has very little visibility into this area, which is what makes it complicated.
U.S. Treasury Secretary Scott Bessent has recently praised Private Credit in strong terms, for clear reasons: tighter regulation has left banks with severely limited lending capacity, while Private Credit is “more flexible and willing to take risks,” able to fill credit gaps and support employment and business expansion.
Or, one could say that it is precisely because private credit is unregulated that it fills the gap left by bank lending
One of the new administration’s priorities is financial deregulation. Bessent’s stance on Private Credit has also been fairly positive, because they want to loosen regulation of banks.
The issue with private lending is not whether an unregulated lending system should be opposed. Private Credit can provide financing to businesses that banks are unwilling to lend to because of regulatory constraints, and that is reasonable. The key risk here is that they cannot be allowed both to expand freely and to receive a rapid bailout when things go wrong.
This is a classic moral hazard dilemma. Once the market develops the expectation that “someone will always bail out high-risk investments,” the systemic problem will not come from loans that go bad, but from there being no consequences when things go wrong.
More importantly, private credit is really a “hidden access system,” not a “truly independent system.” It depends heavily on the banking system for liquidity and leverage; it is connected to the banking system itself, while its asset side is directly exposed to pension funds, insurers, and institutional clients.
Many Private Credit funds obtain financing from banks through various channels. Pension funds continually invest in Private Equity and Private Credit, and the latter in particular then provides leverage for the former’s projects, This middle layer looks “market-based,” but both ends are public-sensitive systems.
The key point is that pension funds have become overly dependent on Private Credit.It is not that Private Credit is too greedy; it is that pension funds are too hungry. When interest rates stay at zero for a long time, traditional assets struggle to meet benefit obligations. Pension funds begin chasing “unmarked risk” and treating illiquid assets that cannot be valued over the long term as a “source of stable returns.”
And this time, they have staked too much.
On the other hand, pension funds essentially come with a huge “policy put option” built in, for example, the California Public Employees’ Retirement System (CalPERS)—even if its investments fail, would it really be allowed to go bankrupt? Impossible: if these pension funds run into trouble, they will ultimately be rescued through tax increases.
When U.S. public pension funds make major investments in Private Equity and Private Credit, the issue can no longer be “market-neutral”:If the problem ultimately erupts in public pension funds, governments simply will not be able to avoid rescuing them.
The latent expectation of a systemic backstop is the greatest source of risk.If the leverage chain behind Private Credit breaks, the fallout will not be limited to hedge funds or Family Offices, but will affect the pensions of tens of millions of civil servants, teachers, and firefighters—the voters.This pattern of turning “systemic risk” into a policy hostage could very well be repeated with PE/Private Credit: “If you don’t bail me out, you’ll have to bail out CalPERS, so you might as well bail me out directly.”
So The key going forward is to watch where the regulators responsible for Trump’s financial deregulation agenda intend to build the “firewall”:Should Private Credit be left to bear the consequences, with intervention limited to spillover effects? Or will they say, “To keep the situation from spiraling completely out of control, we have no choice but to grit our teeth, pay a price, and directly bail out these private lenders to protect the entire system..”
In the end, they will most likely choose the “rescue Private Credit first” path.
Although the situation is different, the market has already seen a similar operation once before, in the case of Silicon Valley Bank (SVB). SVB was not remotely a systemically important financial institution; depositors should have borne their own losses. But in order to maintain confidence in the system, even those “non-systemically important” Tech Bros received full protection. If a credit fund really does blow up in the future, the Treasury and the Fed are unlikely to stand by idly,
Private Equity + Private Credit + public pension funds form a “hidden systemic-risk loop.” When risk materializes, the authorities are very likely to use “limited bailouts of private entities” to avoid “a full-scale bailout of the public.”
Private Credit is not outside the system; it is the new front end of systemic risk.The deeper risk is not leverage and liquidity themselves, but the fact that the market already believes someone will provide a backstop when things go wrong. Once that belief becomes reality, the original market logic comes to an end.
2025.03.31
Positioning the U.S. (IV): K-Shaped Economy: Leverage, Illusion, and “Paper Prosperity”
GDP doesn’t care who’s spending. But markets should...
In the years since the pandemic, the term “K-shaped economy” has been used repeatedly, but few people truly understand the divergence in consumption patterns and the market feedback mechanism behind it.The essence of the K-shaped economy is simple: high-end consumption can still support the macroeconomic data because the stock market has not yet collapsed; once stocks catch down, consumer spending will suddenly lose momentum.
The market’s biggest illusion right now is that consumption looks acceptable, so the economy must be fine. But in a K-shaped economy, this is actually the result of paper prosperity, while the real underlying base is already deteriorating.
Simply put: consumption currently looks acceptable on the surface, but the underlying structure is sharply divided (K-shaped). GDP is still being supported in the short term by “high-net-worth individuals + the wealth effect from assets.” Once stocks catch down, high-end consumption will collapse and overall consumption data will lose momentum in tandem—the U.S. stock market has become the economy’s confidence anchor and consumption engine.
After the pandemic The current U.S. recovery is essentially a K-shaped recovery, and the situation at the lower end of the K—that is, among lower-tier consumers—is indeed getting worse. But as long as those at the upper end of the K (higher-income groups) spend enough to keep total consumer spending at a certain level, the system can still hold together.
However, as the opening line of today’s Notes says, I hope everyone keeps this sentence in mind:
GDP doesn’t care who spends it—but we should
One highly representative bullish view is that the United States is not currently poised to “fall into recession immediately” unless the stock market first undergoes a sharp correction. The data show that retail sales have not yet “fallen off a cliff”: performance is weak, but there has been no precipitous collapse. Even with weakness in lower-end consumption, spending by high-net-worth individuals is still providing a backstop.
The K-shaped economy underpins the bulls’ confidence in the consumer data, although conditions are worsening for lower-income groups, as long as upper-income groups remain active consumers, “aggregate spending holds,” and the GDP figures can still hold up, because in the statistics, Spending is spending. GDP doesn’t really care where it comes from....
The biggest problem with this kind of economy or consumption structure is:The marginal consumption of high-income groups is based not on wages but on their stock portfolios. They spend the “paper gains” in their equity accounts; once those gains shrink, consumer spending will contract sharply and immediately.
GDP doesn’t matter who spends the money; as long as someone spends it, the headline data can hold up.
But all of this depends on one thing: the stock market must not crash...
If, under some macroeconomic shock, earnings downgrades, a wave of corporate debt refinancing, and the pressure of servicing debt at high interest rates begin to weigh on share prices and send the stock market back into a downtrend, the problem will become truly serious.What the upper end of the K-shaped economy spends is its “paper wealth,” the psychological surplus created by the stock market. Once the market falls, the entire consumer side will be hit hard. A decline in U.S. stocks will absolutely show up directly in consumer data.
the stock market is the tail wagging the economic dog anymore...
A traditional defining feature of consumer indicators is that sentiment leads and the data lag. This is one way consumer data differ from other macroeconomic data. The University of Michigan Consumer Sentiment Index (especially its outlook for the labor market) shows exceptionally strong pessimism, which is really no surprise. In other words, sentiment is a leading indicator of the data.
The first step is often a deterioration in consumer confidence, followed closely by a contraction in actual consumer behavior. Meanwhile, CFO survey also shows businesses “sitting on their hands” on hiring and capex, These two signals point to the same thing: both ends of the consumption chain are contracting, while the data in between have yet to fully show it.
This is also the source of one of the core points in our Positioning America series: although macroeconomic uncertainty is a factor in this round of valuation contraction among U.S. companies, as repeatedly emphasized in Planet Notes, in the U.S. stock market, micro-level performance is what determines everything, and contraction in the consumption chain is bound to bring a decline in company performance, It’s not that macroeconomics doesn’t matter; it’s that the truth of every narrative must ultimately be tested against financial statements.
In the Atlanta Fed’s Q1 GDP nowcast forecast, the consumer spending component is zero, already a recession-level reading. If it becomes reality, it will be the weakest quarterly reading since the pandemic and the Great Recession. If housing, healthcare, and other “essential expenses” are stripped out, the remaining “discretionary spending” component is already clearly in recession territory.
One reason the K-shaped economy is fragile, another reason is the structure of the U.S. stock market, where current reactions are amplified by excessive leverage, There are too many extreme, leveraged speculative instruments in the market today. These instruments are not the problem in themselves, but they play a key role in amplifying “sentiment shocks”; once the market falls, they can create a negative spiral in the K-shaped economy.
In the previous U.S. stock bear markets, declines were accompanied only by a linear shift toward bearish sentiment. But now, with widespread use of 0DTE (zero-days-to-expiration options) and the presence of leveraged ETF retail investors and institutions, marginal investors actually bear net-worth swings far greater than 5-6%, and even losses multiplied several times over.Once this “tail-end liquidation panic” creates a reverse feedback loop, it amplifies the market’s average decline and quickly spreads to consumer expectations.
At the lower end of the K, one very clear signal today is BNPL (Buy Now Pay Later), the so-called buy-now-pay-later model. BNPL has reached the very end of the consumer chain: DoorDash allows users to pay for fast-food delivery in high-interest installments, This behavior essentially reflects an extremely loose credit environment + users “spending even their last bit of available credit” + a “last-line sentinel” for systemic consumer health—using 37% interest rates to pay for a meal in installments.
BNPL’s expansion into food delivery and low-ticket purchases is one of the red flags for the consumer system.Meanwhile, credit-card delinquencies and severe auto-loan delinquency rates are both rising, yet there is still no sign of borrowing slowing down, and credit expansion continues. At the end of the road, this is less about “confidence” and more about “having no choice but to borrow.”
Excessive valuations + macroeconomic shock = stock-market decline = sharp drop in consumption + earnings downgrades + further declines + recession
2025.04.01
III. Market Pulse
Our latest Comments on the economic and market environment
Note: Everything in this text is for reference only, does not constitute investment advice, and is not a basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as a basis for decisions.