Former Lehman trader: Private credit is "the subprime of this cycle," stay away from "crowded" tech stocks, embrace "scarce" resource stocks
Larry McDonald, a veteran market participant who experienced the bankruptcy of Lehman Brothers, is issuing a new round of warnings to investors.
In a recent interview program, the founder of the independent research firm “The Bear Traps Report” and former Lehman Brothers trader Larry McDonald systematically explained his view of the current market: the private credit crisis has arrived, energy shocks are creating real stagflation, crowded trades in tech stocks are breaking down, and funds are accelerating their shift toward hard assets. This migration to hard assets has just reached the second or third phase.
Private Credit: "This is Subprime"
McDonald was blunt: "This is the subprime of the cycle. Without a doubt, it already is (a crisis)."
He said that through a series of "creative dinners" he came into contact with many top credit investors, and since last year has heard increasingly pessimistic voices—"It's a mess, some people will go to jail for it."
His logic highly correlates with 2008. Before the outbreak of the subprime crisis, sell-side research repeatedly used "idiosyncratic" to downplay risks. McDonald said that in the third and fourth quarters of last year, he saw the word "idiosyncratic" used in sell-side reports hundreds of times, to explain one bad debt after another in private credit—"Either they're lying, or they're completely out of touch."
The structural root of the problem:
Rating agency chaos. McDonald described someone in Westchester County, with a team of eight people in their home, rating thousands of private credit securities bought by insurance companies. He directly likened it to scenes in "The Big Short"—"History is repeating itself."
Severely distorted incentive mechanisms. To attract retail funds, private credit products promised financial advisors "quarterly liquidity," while the asset class itself is extremely illiquid. McDonald said, "They need to bring in this batch of money—I don't want to call it 'dumb money,' but it's the last to enter." Commissions are generous, and everyone has the incentive to keep the game going.
Liquidity crisis has emerged. Most private credit funds currently have a 5% redemption cap (gate), but 10%-15% of investors want to withdraw funds. McDonald pointed out that insurance companies are the largest "bag holders"—they have bought large amounts of private credit for yield, and now some investors are shorting MetLife and other insurers with large private credit exposures.
McDonald believes that once the securitization machine starts to slow, risks will return to banks' balance sheets. Then, the credit crisis will fully erupt. He noticed that an analyst from UBS has already "left the sell-side camp," and begun to warn of large-scale defaults in private credit—"When the first analyst turns, you know Wall Street's credibility is in trouble."
The difference from 2008 is size: McDonald thinks the private credit crisis "won't be as severe as subprime," but is going in the same direction.
Tech Stock "Monkey Tree": $4 Trillion Fallout from $34 Trillion
McDonald likens the crowding in tech stocks to "monkeys crowding a tree"—too many monkeys on the tree, and when the wind blows, weak hands jump off.
The data speaks: Nasdaq 100's market cap has shrunk from $34 trillion to about $30 trillion, with $4 trillion flowing out. The top two S&P 500 weight stocks, Microsoft and Nvidia, together account for 14%-15% of the index, but Microsoft has fallen about 28% from its peak, Nvidia about 19%, while the S&P 500 as a whole has fallen only 6%.
McDonald said, "I'm shocked the S&P only fell 6%." The reason is precisely the large scale fund rotation—from crowded tech stocks toward industrial, materials, energy and other hard asset sectors.
Another logic for tech stock pressure is the sharply rising cost of building data centers: diesel prices are up about 100%, DRAM memory costs have soared, Caterpillar's construction equipment is in short supply, and about 20% of data center locations have problems (overheated climate, water shortage, community opposition), requiring relocation. McDonald believes these factors are compressing Mag 7's profit margin expectations, and the market is pricing in this reality.
Great Migration in Hard Assets: Still in Early Phases
McDonald calls the current asset rotation "The Great Migration," and provides historical coordinates.
From 1968 to 1981, the combined share of industrials, materials, and energy was about 50% of the S&P 500. In recent years, this proportion dropped as low as 9%, now has recovered to about 13%. McDonald believes, it won't return to 50%, but "will go back to 20%-25%," and this migration is still in its early phases.
His highlighted directions include: international resource stocks controlling physical assets such as Glencore, BHP, Freeport-McMoRan, as well as natural gas stocks (especially Canadian and Texas "stranded gas" concepts), coal stocks (Core Natural Resources, Greenlight Capital of David Einhorn holds positions).
In precious metals, McDonald said the team sold gold and silver ETFs (GDX, SLV, SIL) in January, but has started to buy back in the correction. His reasoning: gold miners have pulled back to near the 100-day average, household allocations to gold and silver remain only about 1.25%, far below the ~3% in the 1980s, "still seriously under-allocated."
Energy Shock: Stagflation Is Here, Fed Faces Dilemma
McDonald characterizes the current macro environment as "real stagflation."
Iran's strikes on Middle Eastern energy infrastructure—Bahrain, Dubai, UAE—have affected the entire energy supply chain, from fertilizer, distillates to jet fuel. McDonald judges that even if the Middle East stabilizes, energy price stickiness will last "at least 5-6 months." Reason: increased insurance costs take time to absorb, companies need time to redeploy assets, and the entire regional logistics system has been disrupted.
Energy price rises drag GDP by about 1 percentage point. Meanwhile, AI layoffs are accelerating—McDonald cites, after Square cut 45% of staff, share price jumped 30%, many companies are copying. Consumers bear an "implicit tax" from energy, economic activity slows, recession risk is rising.
This puts the Fed in a dilemma: inflation stickiness blocks rate cuts, but the economic slowdown needs easing. McDonald's view is, near-term front-end rates will be "pegged," yield curve will flatten or invert, not steepen as previously expected by the market.
Last week, this prediction already played out—several funds betting on curve steepening blew up Wednesday and Thursday. McDonald says, "That was real carnage, a few funds imploded last week."
His advice: Buy 2- or 3-year US Treasuries when yields approach 4%. Logic: You earn 3%-4% risk-free; if recession deepens and Fed is forced to cut rates sharply, bond prices surge and total return could reach 8%.
Tail Risks: UK May Be "Canary in the Coal Mine"
McDonald points out the biggest tail risk comes from the UK.
His picture: Weak government, soaring fiscal deficit, economic slowdown, energy costs rising far above the US. If the UK faces debt funding difficulties and bond vigilantes attack, it may be a signal for other high-deficit countries like France and Italy.
For the dollar, McDonald believes it will not lose reserve currency status in the next 10-15 years, but is in a "secular downtrend." With every geopolitical crisis, dollar sees a temporary safe-haven bounce, but this doesn't change the overall direction. He quotes from his book: "Democracy lasts only until voters discover they can loot the public treasury." US debt-to-GDP has gone from 70%-80% in 2008 to 120%-125% now, with a 6% deficit rate, double the 2%-3% average of the past 50-60 years.
Below is the full interview:Opening Introduction
Host (Julia La Roche): Welcome everyone to another special live recording of The Julia La Roche Show. Today, we’re joined by an old friend of the show, former Lehman Brothers trader Larry McDonald. He is the founder of the independent research firm "The Bear Traps Report," and also the author of several best-selling books. His latest book, How to Listen When Markets Speak, just hit its two year publication anniversary—congratulations! Great to see you again.
Larry McDonald: Julia, thank you. I tell my wife Annabella every Sunday at brunch: As a former Lehman trader, maybe if we sell one million books we can make up for the losses on my Lehman shares.
Host: So how many books have you sold?
Larry: Nearly one million combined from two books.
Host: Let’s keep going.Private Credit Crisis: This Cycle’s Subprime?
Larry: The Lehman book’s sales have picked up again lately, because everyone is comparing subprime to private credit, wondering if history is repeating.
Host: Yes, last time we talked you said private credit might be the seed of the next crisis, maybe it’s already simmering. It’s been about four months since last interview, can you walk us through the current market and economic backdrop?
Larry: In my book, in Bloomberg chat groups, in our “idea dinners,” I’ve always tried to do one thing—gather wisdom and build information networks. Last night we had a dinner at the Harvard Club, with the CIOs of hedge funds, pension funds. My goal is to accumulate enough mentors, over years, and get real insights.
When I watch the market, I synthesize buy-side voices, trying to map out a clear narrative line. If you have a high-quality information network, you can see at which stage a market theme is in its lifecycle, and how well the story is understood by the market.
Regarding private credit, I first heard relevant ideas from talented credit practitioners like Boaz Weinstein and Karen Goodwin, who are very direct. Some people I know from other credit cycles have suddenly become very bearish on private credit and BDCs.
So, in Bear Traps Report, we suggest shorting financials for two reasons: one is private credit risk exposure, the other is disruption from software companies and AI. Financials are under dual threat.
Host: Double hit.
Larry: Yes, both happening at once. So we’ve had this period: financials underperforming the S&P 500 by the most since the financial crisis. Now it’s getting oversold. From XLF, the proportion of stocks below the 50-day mean shows it’s deeply oversold within financials.
Host: Back to private credit—speaking of Lehman, many are asking: do you think private credit is this cycle’s subprime?
Larry: Yes, it is the subprime of this cycle. One of the best credit investors I know was at dinner last night, and I heard this repeatedly: it’s a tangled mess and some people will end up in jail for it.
When I sat with Charlie Munger, he talked about the “three M’s”: Mark to Market, Mark to Model, Mark to Myth. That’s where private credit’s problem lies.
But will this infect high-yield and investment grade bonds in public markets? What I’m actually hearing is: it may benefit public bonds. Private credit is for private companies—lots of inflated valuations and bad behavior; public market side has higher credit quality. So we might actually see huge flows from private credit to public credit.
Host: For safety?
Larry: For safety, and transparency.Munger’s Three L’s and Leverage Risks
Host: The “Mark to Myth” is sharp. He also didn’t like leverage, that’s another thing he said gets people in trouble.
Larry: He talked about the “three L’s”: Liquidity, Ladies, Leverage.
Host: Rest in peace Charlie Munger. He left so many gems.
Larry: He’s in the book. I know you sat down with him in Omaha.Liquidity Crunch and Redemption Issues in Private Credit
Host: Did anyone mention redemption or liquidity issues at these dinners? Who can get their money out, how can you exit?
Larry: Before talking about that, let’s mention a more optimistic theme—natural gas. Looking at FCG ETF’s performance, nat gas stocks have outperformed S&P 500, and the valuations are attractive.
Take Canada, there is lots of "stranded gas"—limited by pipeline infrastructure and remote locations, gas can’t get out, so local prices are extremely cheap. Meanwhile, over the next five years, about 820 data centers need to be built. Many locations aren’t ideal—overheated climates, water shortages, facing NIMBY and environmental resistance. This is one reason Mag 7 are under pressure.
Meta has dropped over 20%, Nvidia fell toward 2019 lows, the market is building out data centers expecting completion in five years, but faces rising energy costs, surging memory costs (Micron profits), so Mag 7's outlook is pressured.
For natural gas, some mislocated data centers will shift to Canada, Texas and other low-cost places, supporting nat gas’s bull market over next five years.“Trump Exit Ramp” and Stagflation Risk
Host: That’s an optimistic trade. How many people in the market have misallocated positions today?
Larry: Put it this way: compare the “Trump exit ramp” for 2025 and 2026.
In 2025, the Trump team underestimated the bond market beast, so bonds suffered and financial conditions tightened. Later, Howard Lutnik was locked in the White House storage room for a month, and Scott Vincent appeared frequently on Sunday talk shows, and eventually a precise exit ramp calmed the crisis. S&P soared from April 8, one of the best trades of our careers—we loaded up on hard asset stocks from April to May.
By 2026, the Trump team underestimated Iran’s ability to hit the energy ecosystem and surrounding countries. From fertilizer to distillates to jet fuel, the whole chain was hit. The team is eager to declare victory and end the war, as they need to achieve this before the midterms.
Host: You really believe that?
Larry: Yes, midterms. They want to exit the war, that’s one reason we’re long volatility. I said before, do controversial actions as early as possible, far from elections; by April-May, voters start holding them accountable, especially as Election Day nears.
So in the next 3-4 weeks, the Trump team will push hard for so-called victory. The market may bounce from “TACO” trades (“Tariffs Always Chicken Out”), but this time, there’s a bigger private credit crisis and rising energy prices will hit GDP. Even after the war ends, oil prices will stay sticky, as Iran’s damage to the ecosystem and chain is deep. Bottom line: inflation stays high, economy slows—true stagflation. Stagflation is good for hard assets.
Host: Stagflation isn't friendly to other assets. Can you explain? You think energy prices remain high even after war ends? How sticky?
Larry: Energy logistics are complex. Iran has hit assets in Bahrain, Dubai, UAE, and when a key energy region is disrupted, companies pull out, insurance costs rise. Not just Hormuz, the whole region is messed up. Lowering insurance premiums takes time, redeploying assets takes time. This keeps energy prices high at least another 5-6 months, dragging GDP and limiting Fed rate cut space.
The market previously expected three rate cuts this year, now likely won’t happen.
Host: Wait, are you saying “lift GDP” or “drag GDP”?
Larry: Rising prices for energy, gas, jet fuel, etc. cause about a 1pt GDP loss. That slows the economy.
Looking at the yield curve—the 2yr-10yr spread has been volatile, another dinner topic last night. Many are trading curve steepening, betting 2yr stays low & 10yr goes high. But last week this crowded trade blew up, a few funds imploded Wednesday and Thursday.
Host: I saw news on that.
Larry: Reason: entering stagflation, high energy costs peg the short end, curve flattens or inverts.
Host: What do you think the Fed will do? Cut or hike?
Larry: My prediction: consensus now is sticky inflation means 2yr yields pegged. If you lived through the 1970s-80s, you know with energy shocks, short-term, Fed hikes to fight inflation, front-end rises; then energy shock hits GDP and activity.
Meanwhile, AI is causing mass layoffs—Jack Dorsey at Square cut 45% of staff, stock jumped 30%, triggering widespread imitation; energy price rises act like a heavy tax on consumers. All this means recession risk rises rapidly this year and forces the Fed to cut.
So my conclusion: If you’re watching, buy 2yr/3yr Treasuries near 4%. You lock in 3%-4% risk-free, and if the real credit crisis or recession arrives, Fed cuts rates, bond prices jump and your total return reaches 8%.“Great Migration”: From Financial Assets to Hard Assets
Host: Bond logic makes sense. Last time we discussed how 2026 is a transformation year for investment mechanisms—is that shift happening?
Larry: The Nasdaq 100 once had $34 trillion, now about $30 trillion, $4 trillion has flowed to Chevron, ExxonMobil, copper miners, and other hard asset companies.
We call it “The Great Migration.” From 1968 to 1981, industrials, materials, energy made up ~50% of S&P 500; in recent years, fell as low as 9%; now back up to 13%. Won’t go back to 50%, but 25% is possible. Institutions are reallocating to international equities, hard asset companies like Glencore, BHP, Freeport-McMoRan. In stagflation, these assets perform better.
Host: So money is flowing out of Mag 7. Before, you mentioned double-digit drawdowns—are we seeing the bubble burst, or a healthy correction?
Larry: The top two S&P 500 stocks—Microsoft and Nvidia—accounted for 14%-15% of the index. Since last time, Microsoft is down ~28%, Nvidia down ~19%, S&P 500 as a whole only down about 6%. This shows the structure and rotation you’re seeing: moving from overcrowded “monkey in the tree” trades toward hard asset companies.
Host: Do you expect further S&P drops?
Larry: Trump team will try another exit ramp. Surface-wise, inflation stickiness keeps money flowing out of Mag 7, but under the surface, economic slowdown and looming private credit risk means every S&P rally gets sold, confidence weakens.
S&P and Nasdaq have been flat since last Aug/Sep, investors’ positions have no return, emotional pressure builds, so every rebound gets sold. Overall, I think the market heads lower, but there are strong structural opportunities.Energy Prices and Private Credit Linkages
Host: Is there a link between volatile energy prices and private credit crisis?
Larry: There is. Rising energy directly hikes data center construction/operations—diesel up ~100%; gold mining and other heavy industries suffer; DRAM costs surge, Micron profits off Ma