#417 Nick Nemeth: The Biggest Turn in My Lifetime, Why Credit Contagion Could Hit Everything

Cliffwater

• Nick Nemeth · Mispriced Assets (Substack)Bearish

  Cliffwater's perfectly smooth index is fake and hides embedded private credit losses.

  Nick says the Cliffwater index is perfectly smooth and rises to the sky, which he calls fake, so it understates the embedded losses in private credit portfolios. Growth dilutes those losses over time, but they are still there. He dismisses reports that Cliffwater saw 17% redemptions because inflows rose 20 basis points. He says outflows rose 300 basis points in one quarter, so the 20 basis point inflow figure is misleading.

  “[Cliffwater's] index where it's perfectly smooth and goes to the sky, that's fake. So that's how much embedded losses are probably in these portfolios.”at 30:43

• Nick Nemeth · Mispriced Assets (Substack)Bearish

  Cliffwater's roughly $10B of CLO equity and 'first lien' marketing misstate its real risk.

  Cliffwater holds about $10B of CLO equity, which is the residual, first-loss tranche of a CLO. Nemeth argues investors do not understand that risk. He says Cliffwater markets its book as 97% first-lien senior secured, but a CLO's equity sits beneath the senior tranches and is the first to be wiped out for a third of the portfolio. He also says its liquidity looks sketchy given its unfunded liabilities.

  “They have about $10,000,000,000 of CLO equity. They do not understand that risk, and neither does anyone investing in Cliffwater.”at 38:57

Anthropic

Across the shows: 11 speakers in other episodes, 8 bullish and 29 bearish calls, past 30 days

• Nick Nemeth · Mispriced Assets (Substack)Neutral

  Claude's revenue run-rate is about where expected in January, so not hockey-stick growth.

  Nemeth compares Claude's annualised revenue with what people expected in January or February. He finds it is roughly the same. He says the business is good and great, and token usage has risen, but calling its growth hockey-stick is probably not true. He thinks AI has not shifted to the exponential path that many people had predicted.

  “If you looked at in January or February where people thought Claude was gonna be on ARR by now, it's about the same. ... But, to say that that is hockey sticked up, think is probably not true”at 48:22

• Nick Nemeth · Mispriced Assets (Substack)Bearish

  Silicon Valley insiders loaded up on Anthropic have reason to promote its IPO to buyers.

  Nemeth says trillions of dollars from Silicon Valley are riding on the Anthropic IPO. He argues insiders have to reassure one another that all is fine, and that they need public buyers to buy at the IPO because they are already loaded up in the stock. He uses this to explain why the bullish narrative around the AI boom is not to be taken at face value.

  “We have an anthropic IPO. There's trillions of dollars, not just an anthropic, but generally out of Silicon Valley that's riding on that. Those guys, they gotta tell each other that they're fine, and they gotta tell you buying anthropic at IPO because they're loaded up in it.”at 49:44

Apollo Global Management

• Nick Nemeth · Mispriced Assets (Substack)Bearish

  Apollo's private-asset marks are not enough; investors need to see the valuation assumptions.

  Nemeth criticises the way Apollo reports asset values. Apollo simply says a holding is worth 99.3 one day and 92.5 the next, without showing its assumptions. He argues that is not an acceptable fix for opacity. Public investors can take that risk, but money from 401(k)s and policyholders should come with full disclosure of the assumptions, or it should not be accepted.

  “The idea that Apollo is just going to tell you, oh, today it's 99.3. Today it's 92.5. That's not the solution. You got to see the assumptions.”at 40:39

Credit markets

• Nick Nemeth · Mispriced Assets (Substack)

  Defaults are rising, middle-market loans are a disaster, and credit is tightening beneath the surface.

  Nick says defaults are higher and not caused by software at first, but software loans are now rolling off two-year contracts, and those deals were underwritten with assumptions he calls a joke. He says quality in the broadly syndicated loan market has degraded, with hybrid structures. He calls the middle market a disaster: typical companies with about $50 million of EBITDA are cyclical, with low moats, especially in software. Even the Workday, Salesforce and Adobe types face AI threats, and weaker unlisted software firms would worsen the defaults. Refinancing is harder: the Proofpoint deal, a likely good company, had to widen and add covenants from zero. He concludes the market is tightening beneath the surface.

  “Defaults are higher. It has nothing to do with software. So where software starts rolling off two year contracts and all of a sudden you're seeing those defaults and they're underwritten horribly.”at 7:57

• Nick Nemeth · Mispriced Assets (Substack)

  Triple-A rated CLO tranches will default, so ratings overstate their safety.

  Nick says AAA-rated CLO slices are treated as safer than the US government, using the same justifications he heard after reading The Big Short, that triple-A securities never default. He guarantees some AAA CLOs will default and asks how Fitch and Moody's can call them safer than the US government. He notes the correlation math used for diversification is basically the same as in 2008 CDOs, and that rating agencies are paid to put things in boxes and have created new boxes for Oracle, data center debt, private credit and insurance.

  “I guarantee that there's gonna be triple a rated CLOs that are gonna default.”at 15:27

• Nick Nemeth · Mispriced Assets (Substack)

  Credit markets are highly correlated, so a flight to quality could spread contagion quickly.

  Nemeth argues that credit markets are broadly correlated and that a flight to quality could suddenly cut off credit to businesses that are otherwise fine. He says the Fed would likely help only big companies, as in COVID. He describes a slower route of rolling defaults over several years, like Japan's lost decade. The faster route is an insurer failure that forces asset sales and removes buyers. Reinsurance links through players such as RGA Re, Hanover Re and Swiss Re could carry that stress to hundreds of US insurers that lack the backing they thought they had. The result could be a broad rise in borrowing costs across the economy.

  “The correlation of credit markets is broad. I think that there's going to be a flight to quality all of a sudden. You don't meet the standard, nobody's going to get borrowing.”at 41:46

• Nick Nemeth · Mispriced Assets (Substack)

  Triple-A CLOs will suffer defaults within twelve months, something the market says has never happened.

  Nemeth expects defaults in triple-A rated CLO tranches within the next twelve months. Industry commentary has said such defaults never happen, but he argues they will. The view is that CLO structures carry risks that the ratings do not reflect, and that this will show up within the year.

  “Triple a CLOs. Gonna be defaults there. They've said it's never happened. It's gonna happen. Within the next twelve months, that's gonna happen.”at 52:03

Private credit

• Nick Nemeth · Mispriced Assets (Substack)

  Private credit and insurer leverage is systemic; the next credit issue will come from insurance balance sheets.

  Nick argues the system is very levered and that a broader credit problem will originate in insurers' balance sheets, which he puts at roughly $10 trillion, on the order of the US banking system, rather than in private credit alone. Asset managers who own insurers treat the liabilities as simple duration matching and do not see the interlinked risk. He frames this as systemic, while noting it doesn't mean everything ends tomorrow. He contrasts it with 2008, when mortgages became collateral and synthetic CDOs sat on insurers' books. This time, he expects credit to seize across private credit and insurers, with potentially structurally lower demand for debt.

  “This time, I think that it's going to be a broader credit issue that's coming from the insurance balance sheets that are $10,000,000,000,000 balance sheets on the order of The US banking system.”at 14:00

• Nick Nemeth · Mispriced Assets (Substack)

  Private credit holdings are mismarked, with embedded losses a true mark would expose; insurers' liability discounting also flatters them.

  Nick says many level-three assets in private credit, BDCs and insurers are not marked the way traded credit is, which uses probability of default, carry and liquidation value. He argues the smooth performance of private credit indices is fake and hides embedded losses. Applying a Blankfein-style mark, where you sell 10% to set the price, would open a massive hole. Some portfolios are about 30x levered, and about 22-23x on average excluding mutual funds. With 10% to 25% allocated to private credit, mismarks would be a massive problem, particularly alongside a commercial real estate disaster. On the liability side, insurers choose their own discount rate, such as 8%, based on the asset yield they expect. That can't be achieved in a bear market, and a 5% balance-sheet hit could produce SVB-style failures.

  “So you have a lot of level three assets that are not appropriately marked... None of that happens in private credit. It doesn't happen in the BDCs. It doesn't happen in the insurers.”at 30:17

• Nick Nemeth · Mispriced Assets (Substack)

  Within twelve months, most subscale insurers will be questioned, and about 25% have no way out.

  Nemeth argues most subscale insurers are uneconomical because insurance is a commoditised business. He says they have taken on large risk, and that options such as winding down the balance sheet or writing fewer policies offer no clean exit. He puts roughly 25% of subscale players in that position. He expects scrutiny of why they exist and whether they can compete to start within a year, and he adds that AI and better-informed customers will hurt the sector. Only a few scale players such as Athene, Prudential and MetLife are safe.

  “I think within twelve months, people are gonna start questioning the vast majority of subscale players. ... There's no way out of it for, I would say, 25% of subscale players.”at 52:14

Banks

• Nick Nemeth · Mispriced Assets (Substack)

  Banks' exposure to private credit is much bigger than people think, through both balance sheets and revenue.

  Nick argues banks' exposure is much higher than people think, on both the balance-sheet side and the revenue side. He says the most profitable banks have desks in leveraged finance and direct lending, which pay more than M&A teams, and banks can clip fees in many ways. So bank earnings may be coming from these areas. He stresses this need not be a solvency issue, since bank balance sheets may be fine. The risk would spill out through the credit that leaves the banking system.

  “Although the banking exposure is much higher than people think, not only on a balance sheet side, but a revenue side. These are the most profitable banks, desks at the banks.”at 15:57

• Nick Nemeth · Mispriced Assets (Substack)

  Post-2008 bank rules pushed risk out of banks and into less-regulated private credit and insurers.

  Nick says Dodd-Frank tightened what banks can do after bailouts, including JPMorgan taking $25 billion, and that the implicit government backstop emboldened too-big-to-fail. He argues the rules may over-constrain banks, and the recent loosening of stress tests suggests they were too tight. Investors' appetite for risk does not change, only where it is taken. Lending to high-yield businesses tightened, so demand went to private credit and insurance, which he says doesn't make the risk less of a problem.

  “Human's ability to take risk is what it is. It doesn't change. What does change is where they take risk.”at 18:35

• Nick Nemeth · Mispriced Assets (Substack)

  Banks must be deregulated so they can absorb Treasuries and private assets, which would be best.

  Nemeth argues that banks are the only likely buyers for assets dumped by insurers and private credit funds. He says that deregulation is needed in the banking system so banks can buy those assets. It would also let them pick up Treasuries, which would lower federal borrowing costs. He admits the picture is imperfect but calls this the best outcome for him.

  “There's only one place that could be a buyer for this, and it would be the banks. Now the problem is the banks are also supposed to be deregulated so that they can pick up treasuries and lower our federal borrowing.”at 41:13

US dollar

• Nick Nemeth · Mispriced Assets (Substack)

  The dollar hasn't broken despite heavy money printing; gold and Bitcoin bears have mostly been wrong so far.

  Nick says the debate of his whole investing life has been when the dollar breaks under massive money printing. It hasn't happened. Gold bugs have sounded dumb for saying it would, and Bitcoiners since around 2016-17 have mostly been wrong about dollar weakness. He also mentions Ray Dalio's end-of-empires thesis. He argues the long timeline doesn't mean the risk is gone: relative to financial history, a decade or three decades of delay is a fart in the wind, and these risks can still happen. He is skeptical of a near-term break but doesn't dismiss the long-run risk.

  “when does the dollar break with this massive amount of money printing? And it hasn't happened.”at 6:24

• Nick Nemeth · Mispriced Assets (Substack)

  The dollar could eventually fall out as global currencies debase, and bailouts may outgrow its capacity.

  Nemeth argues the dollar is held only because everyone else is printing money too. If the other currencies lose value, nobody wants paper, and commodities and inflation-resistant assets rise. He sees the next bailout as far larger than the $440B TARP actually drew, perhaps $10-15T. He doubts the dollar can absorb that, especially with the fiscal picture already ugly.

  “I just don't know if the next bailout can possibly be big enough without the dollar. ... What if just all of those currencies become worth a whole lot less?”at 44:22

US Treasuries & yields

• Nick Nemeth · Mispriced Assets (Substack)

  If yields keep rising, borrowers can't refinance and private credit defaults will follow.

  Nick says that if the world is in a secular higher-for-longer regime, or yields keep going up, the cost of debt will put businesses under and refinancing won't happen. Private market managers say their debt is floating, so rate moves don't matter to them. Nick argues it matters greatly for portfolio companies. At SOFR+400, the all-in rate is about 6% when SOFR is around 2%, but about 8.5-9% when SOFR is 4.5-5%, and that compounding interest can't be amended and pretended away forever. Yields have risen since 2022, so the stress is already building, with defaults worse than 2008 numbers.

  “if we are in a secularly higher for longer or potentially just yields are going higher and they're gonna keep on going higher... There's going to be defaults.”at 11:24

• Nick Nemeth · Mispriced Assets (Substack)

  Fed credibility could erode so badly that buyers shun Treasuries even as money printing starts.

  Nemeth says he is less worried about political pressure on the Fed than about the institution's credibility collapsing. If investors stop trusting the Fed, they may refuse to buy Treasuries even when the central bank is printing money to fund a crisis. Investors would ask why they should hold dollars for a bigger money printing run, so the money supply would have to rise sharply. He also says rates are sharply headed higher, which adds to the pressure.

  “What I'm really concerned about is that the credibility of the institution becomes so bad that nobody wants to buy anything relating to US treasuries even when they start printing money.”at 56:02

US inflation

• Nick Nemeth · Mispriced Assets (Substack)

  Money printing isn't showing up as CPI inflation because it is building up in the credit system.

  Nick says M2 does not show the simple arithmetic that commentators cite for inflation. He argues cheap lending from money creation goes into expanding supply and into equities, and that the wealthy get an outsized share of the money. So the price effects show up in a wealth basket, such as Hamptons homes, rather than in the middle-class basket that CPI tracks. He says CPI is a terrible metric, especially in a K-shaped economy. He has held this view for about half a decade.

  “the reason why we're not seeing inflation is because it's just building up in the credit system.”at 3:08

Private equity

• Nick Nemeth · Mispriced Assets (Substack)

  Private equity and credit managers never get marked to market, so they never learn when they're wrong.

  Nick says public markets give constant scorecards, with plenty of chances to be told a stock call is wrong. In private markets, the feedback loop can be seven years, and managers often move firms, so it's never their fault. He calls these managers asset gatherers who stamp and approve deals based on popular stories. He describes private equity value-creation ideas such as bundling janitorial and accounting companies as absolutely insane. If losses come, he expects them to ask for bailouts.

  “So they've never learned whether they are right or wrong. They just have lived believing that they're right.”at 17:45

Commercial real estate

• Nick Nemeth · Mispriced Assets (Substack)

  Commercial real estate is an absolute disaster, and its losses are not marked correctly on insurers' books.

  Nick says the same balance sheets carrying mismarked private credit also hold commercial real estate, which is an absolute disaster and not marked correctly. He adds residential assets, ABS, Carvana subprime auto loans and Klarna BNPL loans to the list of exposures sitting there. What holds it together is that funding doesn't dry up and the FHLB doesn't demand more reserves against those assets. If either happens at the wrong time, policyholders may demand their money back, creating a massive liquidity problem.

  “that can happen at the same time on the same balance sheet that commercial real estate is an absolute disaster and also not marked correctly.”at 31:34

Commodities (broad)

• Nick Nemeth · Mispriced Assets (Substack)

  If fiat currencies lose value, commodities will skyrocket as inflation-resistant assets rise.

  Nemeth reasons that if the currencies of other countries and the dollar both lose value through money printing, commodities will skyrocket because nobody wants paper. Inflation-resistant assets would rise again. He presents this as the consequence of a currency debasement path rather than as a forecast with a timeline.

  “Commodities skyrocket. ... Nobody wants paper. Sure. Inflation resistant assets go up again.”at 44:50

AI infrastructure & data centers

• Nick Nemeth · Mispriced Assets (Substack)

  AI capital spending has become fairly egregious, and the bonds funding it are widening.

  Nemeth argues that AI-related capital expenditure has grown to a fairly egregious level. He says investment-grade corporate bonds, which likely finance much of it, are widening. He reads that as a warning sign for an AI capex cycle that is already stretched, even though AI itself has been good.

  “the capital spend has gotten fairly egregious and all of those investment grade corporate bonds supposedly are widening out.”at 48:37

US stock market outlook

• Nick Nemeth · Mispriced Assets (Substack)

  The stock market should fall in a healthy pullback given rising rates, widening spreads and heavy capex.

  Nemeth lists the pressures: insurance and private-credit risks, rising yields and borrowing costs, high gas prices, AI that is not hockey-sticking, egregious capex, and investment-grade bonds widening. He argues that these deserve a healthy pullback in equities, though not a Great Depression. He says it is hard to see why the market has not fallen yet. He also doubts that the S&P can deliver 10% annual returns from here, and expects either big inflation-driven gains or a massive deleveraging.

  “all of that probably deserves, given the rates are sharply headed higher, that the market would be down in a healthy pullback. I don't know about Great Depression, but down.”at 48:49

US elections & politics

• Nick Nemeth · Mispriced Assets (Substack)

  After the midterms, the government will feel entirely different and policy game theory will shift.

  Nemeth expects the government to feel entirely different after the midterms, with a lame-duck period in which lawmakers start playing for the next election. He sees a coalescence around the Trump administration that will split apart. That will change how data center buildouts, regulation and bailouts get decided, so the political game theory will work differently.

  “the government feels entirely different after the midterms. ... I think there's gonna be a lot of splitting. And what that means is the game theory just functionally changes and how that leads to data center builds or regulation or bailouts is different.”at 53:41

US rates & the Fed

• Nick Nemeth · Mispriced Assets (Substack)

  Kevin Warsh will face his first real test and have to show his 'put' in a panic.

  Nemeth contrasts Warsh with Powell, whose put he calls comfortable. Powell came in with a bazooka during crises and flooded the system with what he called ample liquidity. Nemeth expects Warsh to be tested in the next panic, and that his prior statements about markets will then be checked against what he does in practice.

  “[Kevin Warsh] is going to have his first moment where he's going to have to show where his put is.”at 54:08