Former Goldman Sachs CEO Lloyd Blankfein has warned that the U.S. may soon experience another economic crisis, due to hidden risks in credit markets such as narrow spreads and leveraged private credit. He notes the recurring pattern of major economic crises every 4–5 years and believes that the next one could be approaching, with credit markets creating potential vulnerabilities.
Credit spreads like the ICE BofA HY OAS are at historically low levels, currently around 2.84%, which indicates underpricing of risk. There has been a notable 14.5% year-over-year increase in private credit assets under management, with more leverage being added by entities like insurers. Blankfein expresses concern over the actual worth of some assets, suggesting potential overvaluation.
Optimism in Equities
Despite these concerns, Blankfein remains optimistic about the equity market. He believes Federal Reserve rate cuts could spur growth and sees artificial intelligence as a long-term transformative driver. His investment approach aligns with Goldman’s outlook on a new secular bull market, offering opportunities in areas like technology, services, manufacturing, and global diversification. He has publicly stated confidence in equities, indicating he is “100% in on equities.”
There’s a growing belief that while a crisis is overdue, the Federal Reserve’s two rate cuts earlier this year will continue to support stock prices. We are positioning for this by remaining fully invested in equities, particularly in technology driven by the ongoing AI revolution. For derivative traders, this means using options to maintain upside exposure while hedging against a sharp downturn.
The main risk we see is in the credit markets, where leverage is building up in less regulated private funds. With high-yield bond spreads, as measured by the ICE BofA index, tightening to near 2.75% last month, it feels like investors are ignoring potential dangers for a little extra yield. We are buying cheap, out-of-the-money put options on high-yield bond ETFs like HYG as a portfolio hedge for the coming weeks.
Building Defensive Positions
Market complacency is high, with the VIX dipping below 13 just last week, which makes protection relatively inexpensive right now. We remember the low volatility environment leading up to the 2008 crisis, which shows how quickly sentiment can shift. This is an opportunity to build defensive positions, such as put spreads on financial sector ETFs, without sacrificing much potential profit.
Despite these defensive moves, our main focus remains on the upside in stocks, as AI integration continues to boost productivity and corporate profits. We have been adding to our long positions through call options on the Nasdaq 100, which allows us to participate in the technology-led rally with defined risk. This strategy reflects our view that we are still in the early stages of a long-term bull market, a trend we first identified back in late 2024.
