Former Lehman trader: Private credit is "this cycle's subprime", stay away from "crowded" tech stocks and embrace "scarce" resource stocks

Larry McDonald, a market veteran who experienced the collapse of Lehman Brothers, is issuing a new round of warnings to investors.

In a recent interview, Larry McDonald, founder of the independent research firm "The Bear Traps Report" and former Lehman Brothers trader, systematically explained his views on the current market: the private credit crisis has already arrived, an energy shock is creating real stagflation, and the "crowded trade" in tech stocks is breaking down, with funds accelerating their flow into hard assets.This "Great Migration" into hard assets is only in the second or third inning.

Private Credit:"This Is Subprime"

McDonald was blunt: "This is the cycle's subprime. No doubt about it, it's already (a crisis)."

He said that during a series of "idea dinners," he came into contact with many top credit investors and, since last year, has heard increasingly pessimistic remarks—"it's a mess; people will end up in jail because of this."

His logic closely mirrors that of 2008. Before the subprime crisis erupted, sell-side research reports repeatedly used the word "idiosyncratic" to downplay risk. McDonald said,in Q3 and Q4 last year, he saw the term "idiosyncratic" used "hundreds of times" in sell-side reports to explain one bad loan after another in private credit—"Either they're lying, or they're completely detached from reality."

The structural roots of the issue are:

Dysfunctions among rating agencies. McDonald described how people with a team of eight working from their home in Westchester County rated thousands of private credit securities bought by insurance companies. He directly compared it to the scenes in "The Big Short"—"History is repeating itself."

Severely distorted incentive mechanisms. To attract retail money, private credit products promise "quarterly liquidity" to financial advisors—even though the asset class is extremely illiquid. "They need to bring this money in—I don’t want to say it's 'dumb money,' but it’s the latest money in." Fat commissions give everyone an incentive to keep the game going.

Liquidity crisis already emerging. Most private credit funds have a 5% redemption "gate," but 10%-15% of investors want their funds back. According to McDonald, insurance companies are the largest "bag holders"—having chased yield by buying vast quantities of private credit, investors are now shorting companies like MetLife that have major private credit exposure.

McDonald believes that once the securitization machine slows down, risks willflow back onto bank balance sheets, and a full-blown credit crisis will erupt. He noted that an analyst from UBS was the first to break from the sell-side consensus and 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 one of scale: McDonald thinks the private credit crisis "won’t be as severe as subprime," but the direction is the same.

Tech "Monkeys in the Tree": $4 Trillion Wiped From $34 Trillion

McDonald used the phrase "monkeys in the tree" to describe how overcrowded tech stocks are—when there are too many monkeys on a tree, if any disturbance occurs, the weak hands will jump off en masse.

The data is clear: Nasdaq 100 market cap shrank from $34 trillion to about $30 trillion, a $4 trillion outflow. The two largest weights in the S&P 500, Microsoft and Nvidia, together make up 14-15% of the index; Microsoft has fallen about 28% from its peak, Nvidia about 19%, while the S&P 500 as a whole is down just 6%.

McDonald said, "I'm shocked the S&P is down only 6%." The reason is large-scale rotation—out of crowded tech stocks and into industrials, materials, energy, and other hard asset sectors.

Another headwind for tech is the dramatic rise in data center construction costs: diesel prices have surged nearly 100%, DRAM memory costs are skyrocketing, Caterpillar equipment is tight, and about 20% of data centers are poorly sited (overheated climates, insufficient water, community opposition) and will need to relocate. McDonald believes these factors are compressing Mag 7 profit-margin expectations, and the market is now pricing in this reality.

The Great Migration of Hard Assets: Still in Early Innings

McDonald calls the current asset rotation the "Great Migration" and places it in historical context.

From 1968 to 1981, industrials, materials, and energy together made up about 50% of the S&P 500. In recent years, that ratio fell as low as 9%, now recovered to around 13%.McDonald believes it won’t return to 50%, but "it will return to 20%-25%," and that the migration is only in its second or third inning.

His top picks include: international resource stocks controlling physical assets such as Glencore, BHP, and Freeport-McMoRan, as well as natural gas stocks (especially the "stranded natural gas" concepts in Canada and Texas), and coal stocks (Core Natural Resources, with David Einhorn's Greenlight Capital a major holder).

In precious metals, McDonald stated his team sold GDX, SLV, and SIL gold and silver ETFs in January, and has started buying them again during the pullback. His logic: gold miners have pulled back to around their 100-day moving average, while household allocations to gold and silver are only around 1.25%—well below the roughly 3% in the 1980s, "still a serious underallocation."

Energy Shock: Stagflation Has Arrived, the Fed Is in a Dilemma

McDonald describes the current macro environment as "true stagflation."

Iran’s attacks on energy infrastructure in Bahrain, Dubai, the UAE, and the rest of the Middle East have rippled through the entire energy supply chain—from fertilizers and distillates to jet fuel. McDonald argues that even if the Middle East situation calms, the sticky nature of energy prices will last "at least 5-6 months" due to higher insurance costs, slow reinvestment after companies withdraw assets, and widespread logistical disruptions.

Energy price increases drag GDP by about one percentage point. Meanwhile, the AI layoff wave is accelerating—McDonald notes, after Jack Dorsey’s Square cut 45% of staff, its stock rose 30%, and many companies are following suit. Consumers are bearing an "implicit tax" from energy, economic activity is slowing, and recession risk is rising.

This puts the Fed in a bind: sticky inflation blocks rate cuts, but economic slowdown demands easing. McDonald thinks short-end rates will be "pinned" in the short term, with the yield curve flattening or even inverting, rather than "steepening" as previously expected.

This view already played out last week—multiple yield curve steepener funds blew up on Wednesday and Thursday. McDonald said, "That was real carnage, several funds blew up directly last week."

His advice: buy 2- to 3-year U.S. Treasuries when yields approach 4%. Logic: you get 3%-4% risk-free yield, and if a recession deepens and the Fed is forced to slash rates, bond prices will surge and total returns could hit 8%.

Tail Risk: UK as the "Canary in the Coal Mine"

McDonald singles out the UK as the biggest tail risk.

His scenario: weak government, huge fiscal deficit, economic slowdown, and soaring energy costs far beyond the U.S. If the UK experiences sovereign funding problems and "bond vigilantes" attack, it could be a leading signal for other high-deficit countries (France, Italy).

For the dollar, McDonald reckons it won’t lose its reserve status for the next 10–15 years, but expects a "secular downtrend" long term. Every time there’s a geopolitical crisis, there’ll be short-term safe haven rallies, but that won’t change the big picture. He quotes from his book: "Democracy can only last until the voters discover they can loot the public treasury." The U.S. debt-to-GDP ratio has risen from 70–80% in 2008 to 120–125%, and a 6% fiscal deficit is double the 2–3% average of the past 50–60 years.

The following 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 have a returning friend of the show, former Lehman Brothers trader Larry McDonald, who is the founder of the independent research company "The Bear Traps Report" and also a best-selling author. His latest book, How to Listen When Markets Speak, just hit its two-year publication anniversary—congrats. Great to see you again.

Larry McDonald: Julia, thank you. Every month during Sunday brunch I tell my wife Annabella: as a former Lehman trader, if we could sell a million books, we'd almost make up for the losses on Lehman stock back in the day.

Host: So, how many copies have you sold in total?

Larry: Close to one million copies combined for the two books.

Host: Let’s keep pushing.

Private Credit Crisis: This Cycle's Subprime?

Larry: The Lehman book has been selling again recently because everyone is comparing subprime and private credit, wondering if history is really repeating itself.

Host: Yes—last time we talked about the potential for private credit to become the next crisis, and maybe the crisis is already brewing. It’s been about four months since our last interview—can you help us outline the current market and economic picture?

Larry: In my book, in the Bloomberg chat, at our "idea dinners," I've always tried to do the same thing—assemble wisdom from all sides to build an information network. Last night we held a dinner at the Harvard Club with hedge fund CIOs, pension CIOs, and some brilliant people. My goal is to build a strong mentor group from years of effort, and gain real insight from them.

When reading the market, I combine voices from the buy side and try to piece together a clear narrative. I’ve noticed that if you have a high-quality information network, you can spot what stage a narrative is in and how widely believed it is in the market.

On private credit, I first picked up negative views from some really talented credit folks—like Boaz Weinstein and Karen Goodwin. Their views are very direct.Some others I know from prior credit cycles have recently become suddenly very bearish on private credit and BDCs (Business Development Companies).

So, in The Bear Traps Report, we recommended shorting financials for two reasons: first, private credit exposure; second, the disruption from software and artificial intelligence. The financial sector is being hit from both sides.

Host: A double whammy.

Larry: Yes, both things happening at once. As a result, we've seen the financial sector underperform the S&P 500 by maybe the biggest margin since the financial crisis. Of course, now it's a bit oversold. The ratio of XLF stocks below their 50-day average shows many names are quite oversold.

Host: Back to private credit—you mentioned Lehman,lots of people are wondering: do you think private credit is this cycle’s subprime?

Larry: Yes, this is the subprime of this cycle. One of the best credit investors I know was at dinner last night and, from many people, I hear the same judgment: it's a mess and, in the end, someone is going to jail over it.

When I sat with Charlie Munger years ago, he talked about the "three Ms": Mark to Market, Mark to Model, and Mark to Myth. Private credit’s problem lies here.

But will this infect high-yield bonds and investment-grade bonds in the public markets? What I’m actually hearing is: it will actually benefit the public bond market. Private credit is linked to private companies, with inflated valuations and bad behavior; while the public market, credit quality is much higher. So, we may see a lot of capital flow out of private credit and into public credit markets.

Host: For safety?

Larry: For safety and for transparency.

Munger's "Three Ls" and Leverage Risk

Host: Munger’s "mark to myth" is brilliant.He also hated leverage—he often said that was another way to get into trouble.

Larry: He talked about his "three Ls": Liquidity, Ladies, and Leverage.

Host: May Charlie Munger rest in peace. He left us with so many great lines.

Larry: He appears in the book. I know you sat with him in Omaha once.

Liquidity Crisis and Redemption Problems in Private Credit

Host: Did anyone at those dinners talk about redemption or liquidity problems? Who can get their money back? How do they exit?

Larry: Before I answer that, let me talk about a more optimistic subject—natural gas. Look at the FCG ETF. Natural gas stocks have outperformed the S&P 500 a lot and are attractively valued.

Take Canada for example—there’s a lot of "stranded natural gas" due to insufficient pipelines and remote locations, making gas super cheap in certain areas. Over the next five years, around 820 data centers need to be built. Many are poorly sited—overheated climates, water shortages, NIMBY resistance, and environmental pushback. This is one reason tech giants in the "Mag 7" are under pressure.

Meta's stock is down more than 20%, Nvidia's is approaching 2019 lows. The market has built in huge data center bets over five years, but they now face rising energy, memory costs (Micron, for example, profiting), etc., squeezing Mag 7 margins.

As for natural gas, some misallocated data centers will move to low-price regions like Canada or Texas, which supports a multi-year bull case for natural gas.

"Trump Offramp" and Stagflation Risk

Host: That’s an optimistic trade. How many people in the market today have their allocation wrong?

Larry: Think of it this way: compare the "Trump offramp" in 2025 and 2026.

In 2025, the Trump team underestimated the bond market beast, causing pressure in bonds and financial tightening. Eventually they forced Howard Lutnik in the White House storage room for a month, put Scott Vincent on endless Sunday talk shows, and finally executed a perfect offramp to calm things down. The S&P soared from April 8. That was one of the best trading opportunities of our careers—we loaded up on hard asset stocks from April to May.

By 2026, the Trump team again underestimated Iran's capability to disrupt the energy ecosystem and its neighbors. From fertilizer to distillates to jet fuel, everything was hit. The Trump team wanted so badly to declare victory and end the war before midterms.

Host: You really believe that?

Larry: Yes, it's midterms. They want out of the war, which is why we are long volatility. I've said before: do all controversial moves as far from the midterm as possible. But as April and May arrive, voters start holding politicians accountable—and especially close to Election Day.

So, in the next three to four weeks, the Trump team will be tough in pushing events, looking for a "win."The market might bounce on things like the so-called "TACO trade" (Tariffs Always Chicken Out). But behind this is a deeper private credit crisis, plus the energy shock is hitting GDP hard.And oil prices will remain sticky high even after the war ends, because the damage Iranian attacks have done to the entire energy supply chain is so severe. In other words: inflation will remain high this year, the economy will slow down—a true stagflation. Stagflation favors hard assets.

Host: Not friendly to other asset classes. Can you elaborate? You think energy prices will stay high even after the war? How sticky?

Larry: Energy logistics are very complex. Iran hit assets in Bahrain, Dubai, the UAE, and once critical energy regions fall into chaos, companies pull out, insurance costs rise. Not just the Strait of Hormuz—the whole region is disrupted. Lowering insurance costs takes time, as does returning assets. This keeps prices high for at least five or six months, dragging on GDP and capping how much the Fed can cut rates.

So prior market expectations for three rate cuts this year may be dashed.

Host: Wait, do you mean "GDP boosted," or "GDP dragged down"?

Larry:  Rises in energy, natural gas, jet fuel, and so on take about one point off GDP—this slows the economy.

Looking at the yield curve—the 2s/10s spread has been volatile, and that was a dinner topic last night. Many are betting on "steepening"—two-year yields pinned, 10-year rising. But last week, these trades got crushed, with some funds blowing up Wednesday and Thursday.

Host: I saw news coverage on that.

Larry: The reason is, once you’re in stagflation, with high energy costs, short-end yields are pinned, the curve flattens or inverts.

Host: So, what do you think the Fed will do—cut, or hike?

Larry: Here’s my prediction: consensus now says sticky inflation will pin the two-year yield. If you’ve lived through the 1970s–80s, you know the energy shock playbook—short term, the Fed may even hike to fight inflation, pushing front-end rates up; later, the energy shock hits the economy and GDP, hurting activity.

Meanwhile, AI is causing mass layoffs—like Jack Dorsey at Square, who cut 45% of jobs and saw their stock rise 30%, spurring copycats. Add in energy-price hikes, which act as a stealth tax. All these raise the recession risk this year, forcing the Fed eventually to cut.

So, my conclusion: if you’re watching now, consider buying 2- or 3-year Treasuries when yields approach 4%. You can lock in 3%–4% risk-free, and if the credit crisis or a recession really hit, the Fed will cut and you’ll get big price gains—maybe 8% total return.

"Great Migration": From Financial Assets to Hard Assets

Host: That bond logic is interesting. Last time, we also talked about 2026 as a turning point for investment mechanisms. Do you think the shift is happening?

Larry:  The Nasdaq 100 was once $34 trillion, now about $30 trillion—a $4 trillion outflow that went to companies like Chevron, ExxonMobil, and various copper miners and hard asset companies.

We call this "the Great Migration" in the book. From 1968 to 1981, industrials, materials, and energy together were about half the S&P 500; in recent years, as low as 9%; now back to 13%. We won’t reach 50%, but 25% is possible. Institutional money is reallocating toward international equities and hard-asset companies like Glencore, BHP, Freeport-McMoRan, etc. In stagflation, these assets do better.

Host: So, Mag 7’s capital is flowing out. You mentioned double-digit drawdowns—we’ve also talked about passive money crowding into those names. Is the bubble breaking, or just a healthy correction?

Larry:  The top two S&P 500 holdings—Microsoft and Nvidia—were 14% to 15% of the index. Since we last spoke, Microsoft is down about 28%, Nvidia about 19%, while the S&P 500 is down about 6% overall. This shows a massive rotation and structural broadening underway. This is what we kept saying: rotating from the overcrowded "monkeys in a tree" into companies controlling hard assets.

Host: Do you expect the S&P to drop further?

Larry: The Trump team will try another offramp. Superficially, sticky inflation will keep pushing capital from Mag 7 into other sectors, but under the surface, private credit risk is quietly building and the economy is slowing. So, every S&P rebound is sold—confidence erodes.

The S&P and Nasdaq have barely moved since last August/September. Many investors are sitting on no gains, building pent-up selling pressure—thus each rally gets sold. Overall, I see more market downside—but there are structural opportunities for outperformance.

Connection Between Energy Prices and the Private Credit Crisis

Host: Is there a link between energy price volatility and the private credit crisis?

Larry: Yes. Energy costs skyrocketing pushes up data center construction/operation costs—diesel up about 100%; gold mining and other heavy industries are also hit; DRAM costs are soaring (Micron profits at Mag 7's expense).

Together, these raise the cost for building data centers, eating away at Mag 7 profit margins. Add earlier site-misallocation—many data centers put in overheated, water-short, or NIMBY areas, with about 20% needing to relocate. This supports demand for Canada’s cheap stranded gas and the coal sector.

Gold, Silver, and Bitcoin

Host: Speaking of precious metals and industrial metals, what’s your outlook on gold and silver now? Gold had an impressive run last year, pushing near $5,500—where is it now?

Larry: Hard assets had an explosive run last year. In January, when the silver options call/put ratio (the skew) hit 8:1, we sold a large portion of gold and silver positions in our trading alerts.

Now there’s been a pullback; silver and gold miners have fallen in part because diesel price rises have compressed margins, but even so, gold remains high enough to generate good profit. Broadly, prices are now near their 100-day moving average—historically a decent buy zone in a bull case.

And from a historical comparison, household allocations to gold, silver, and hard assets are around 1.25%; in the 1980s they were up to 3%—still under-allocated overall.

You could picture it as a bull market where plenty of "tourists" (like people in Hawaiian shirts) just piled in, and as volatility washes them out, the real investors are still buying at lower levels. We saw a similar pattern in uranium stocks—if you buy near the 100-day average and you’re structurally under-allocated, it’s likely a great opportunity.

Host: Did you add back to gold after the pullback?

Larry: We sold all GDX, SLV, and SIL in January and have begun buying back during this pullback. Also, we did something totally new—bought bitcoin for the first time ever.

Host: Wait, first time buying bitcoin ever?

Larry: Yes, first time ever.

Host: Tell us, what’s behind that?

Larry: Two things.

First, the bitcoin/gold ratio (bitcoin divided by gold) was as high as 38x and only recently pulled back to 13x. There’s only 5 years of history, but typically, when it’s in the teens, you should trim gold and buy bitcoin.

Second, the advent of ETFs from BlackRock and others has greatly diversified bitcoin’s investor base. Five to ten years ago, just 18 families controlled 60% of bitcoin supply—so if one whale needed liquidity, they'd tank the market and retail would take a 70% plunge.

Now, bitcoin still has a hard asset profile—scarcity, global inflation hedge. The U.S. (both Trump and Biden) and the UK are running reckless fiscal policy, pumping defense spending without raising taxes, just diluting the currency.

So, when bitcoin/gold falls from over 30x to the teens, it's a sensible allocation to buy the bitcoin dip.

Host: Do you use ETFs?

Larry: Yes, using iBit ETF. For most investors, that’s the simplest way. Note: commodity ETFs like UNG or USO have roll yield that eats away over time—short-term, that’s okay; long-term, you’re better off holding the commodity itself.

The UK Crisis and Global Bond Market Warning

Host: The Bear Traps Report is known for risk detection. What do you think is the most underestimated risk right now?

Larry: The biggest risk is the UK. There’s a real crisis: a very weak government, bad fiscal deficit, a slowdown, with energy costs far worse than in the U.S. The Middle East events hit Europe’s economy hard. I think Nigel Farage could end up as the next UK prime minister.

If the UK runs into sovereign funding problems and bond vigilantes strike, that’s the year’s black swan. France and Italy are also shaky—their long bonds are already breaking out. If energy costs rise 20–40%, consumers get hit, growth slows, tax revenue falls, but governments keep issuing bonds to stay afloat.

Host: Will the UK be the "canary in the coal mine" for others?

Larry: It’s entirely possible. But one thing may save Washington—others’ "dirty shirts" are worse. Whenever there’s a Middle East or global crisis, money races into dollars as a safe haven. That cushions the dollar’s reserve status—for the next decade or so, the dollar isn’t losing it, but in the long run, fiscal trajectory isn’t good.

U.S. Fiscal Dilemma and "Great Migration" Logic

Host: Talk about the U.S. fiscal situation—national debt over $39 trillion, healthcare, defense, Social Security... your view?

Larry: In the book, we quoted Tocqueville and Taylor about the dollar: democracy lasts only until voters discover they can loot the public purse. We’re running a 6% deficit per year, when for 50–60 years it was 2–3%.

The Trump team plans to spend an extra $200 billion on this war, increasing defense from $1 trillion to $1.2 trillion—so more bonds will be issued. When Lehman collapsed in the last crisis, U.S. debt-to-GDP was about 70%–80%; now it’s 120%–125%.

If there’s any economic downturn, tax revenue falls, spending is sticky—and that, really, is the deep driver for migration from financial assets (stocks/bonds—just paper) into hard assets.

Host: What stage of the migration are we in?

Larry: I’d say the second or third inning.

Private Credit Crisis: A Deeper Look

Host:  Is private credit already a crisis?

Larry: No question, it is. Some clients’ comments remind me of 2008—then, ratings firms gave tons of garbage ratings to subprime and CDOs; now, quirky private credit rating agencies have proliferated the past 4–5 years.

Look at insurance giants like MetLife—we’ve been seeing clients shorting insurers exposed to lots of private credit for months. They chased yield and are left holding the bag.

The way they were lured in is just like "The Big Short"—sell-side research said it was safe, little rating teams gave thousands of securities a perfunctory stamp, no real diligence. History is repeating itself.

Host: How can ordinary retail know if they're exposed?

Larry: Karen Goodwin explained this—retail was drawn in by promises of quarterly liquidity to advisors and dealers. For an ultra-illiquid asset class, this is wild. Imagine selling hundreds of private company bonds, with opaque financials, and deep dives are slow and costly, yet quarterly liquidity was promised.

They need retail funding, so many cannot redeem smoothly—a 5% quarterly limit isn’t enough when 10–15% want out.

The biggest warning: "The truth seeps out drop by drop." If you see, as we have in 4–5 months, the narrative start to shift—an UBS analyst, for example, breaking with the sell-side to predict mass defaults, a freeze in loan markets, CLOs freezing—once the securitization machine misses a beat, the conveyor belt stalls, banks must warehouse risk, and a credit crisis erupts.

The narrative is shifting from "just idiosyncratic" to "big trouble," and that’s Wall Street’s credibility risk.

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