A small internet startup founded by two Cornell dropouts is about to go public at $9 per share. It’s 9.30am, the market opens, but the ticker for theGlobe.com doesn’t show a price. Millions of retail investors are frantically punching “Buy at Market” into their computers. The initial 3.1 million shares offered are swamped by an avalanche of buy orders, overwhelming market-makers who are trying to price the stock. Every few minutes, the estimated opening quote is adjusted. “Indications at $30!” shouts a trader. Thirty minutes later: “Indications at $50!” Traders are sweating, shouting into their phones, working furiously to find the equilibrium point where supply finally meets demand.

The clock ticks to 11am, and TGLO opens at $87. A collective gasp echoes across trading floors. For the next five hours, the stock’s price oscillates violently. By the closing bell, theGlobe.com settles at $63 and is one of the most heavily traded stocks on the Nasdaq. It’s a shocking, almost surreal, result for a company that just a day earlier was about to run out of cash, and whose business barely generated any revenues. But for as surprising as it may be, this story is not unique. Earlier that year the same script played out again and again: Inktomi, Broadcast.com, and eBay, to name a few.

The mania started three years earlier when Netscape, the maker of the most popular web browser, listed on the Nasdaq. It was still in its infancy and never made a profit, but quickly reached a $3 billion valuation as investors poured money into the dazzling wonders of the internet. And it was, by any measure, a genuine revolution. All of a sudden, ordinary people could read the news from other countries in real time, or look up a fact without going to a library, and many more things that previously required time, money and often also a middleman. But it was not what the internet could already do that captured people’s imagination. It was what it could do, and soon.

The wave of IPOs that followed was met by a new breed of hungry, greedy investors. With the arrival of online trading, anyone could open an account with E*Trade or Ameritrade and buy and sell newly issued stocks from home. Ordinary people and institutional real money accounts were glued to their screens watching their investments go up in value. CNBC just introduced a live all-day reporting from the New York Stock Exchange, and many retail investors started avidly following it from home. It became a self-fulfilling loop: as a stock rose, the channel reported on it, which in turn created even more demand. Companies which added dot-com to their title soared as speculators rushed to buy. And every rising company sent a signal to banks, analysts and venture capital that the market was hungry for more.

David Simons, a junior equity analyst at a mid-sized investment bank on Park Avenue, spent weeks valuing Value America. The company sold everything from electronics to furniture online, but had no meaningful revenue and no idea how to scale its business. David used different valuation methods, but none of them produced a number that would justify the company’s $2.4 billion valuation. So he walked into the office of his managing director, Greg Feller, laying in front of him a pile of papers with his calculations.

“The company is a pile of rubbish. I can’t issue a positive investment recommendation”, said David. Feller looked at the calculations for a moment, then slowly leaned back in his chair. He brought up Henry Blodget, the star analyst who put a $400 price target on Amazon when it was trading at $240. Three weeks later, the stock hit the target and Merril Lynch hired him for a $12 million pay check. When David tried to protest that Amazon’s lack of profits didn’t justify its share price, Feller abruptly cut him off. “This department runs on the fees investment banking generates” he said, adding that a negative recommendation meant fewer IPO mandates and less revenue for their bank.

He stood up and waited for David to reach the door before continuing, “Write the note, David. Say that it’s a buy, and find a price target that works”. David did as he was told, joining the many other analysts who found themselves in the same position.

In this environment, by March 2000 the Nasdaq had risen nearly sevenfold in five years. But the music was about to stop.

On the morning of March 20^th, traders returned to their desks after the weekend, fired up their screens, and read through the news. A market maker at a large bank picked up the latest issue of Barron’s, whose cover read: ‘Burning Up; Warning: Internet companies are running out of cash—fast.’ He glanced over it, casually at first, then his eyes stopped at a company he had in his book. Cash remaining: 4 months. He choked, coughing hot coffee onto his crisp white shirt. More people read through the magazine, and suddenly all came to the same realization: the equity market was a house of cards waiting to crumble. A silent, icy panic rippled through the financial system.

The next day, the Fed raised rates for the fifth time in nine months, while a federal judge found Microsoft guilty of operating an illegal monopoly. Any remaining optimism evaporated instantly, and the Nasdaq tumbled 35% in three weeks. Many investors, including a prominent hedge fund in Connecticut, bought more at the lows, convinced the market had overreacted. And why wouldn’t they? For half a decade, every market dip had been bought, sending stocks to new highs. This time, though, there was no bounce. A brutal wave of liquidations hit the market, dragging into the ground companies like Pets.com just nine months after its IPO.

Retail traders at home watched their portfolios fall back through the level at which they had started. But they didn’t sell. The CNBC presenters were still describing the losses as temporary, still bringing on fund managers who talked about long-term value and the fundamentals of the internet revolution, which remained, they said, intact. Many ordinary people as well as professional fund managers held on through the 2001 recession, and through 9/11.

Then, on December 2, 2001 trust in the American financial system collapsed. In Houston, Texas, the headquarters of the world’s most powerful energy trader looked like a crime scene. Security guards stood by the lobby as federal investigators carried boxes full of documents and traders were escorted out of the premises. On Wall Street, news quickly spread that Enron filed for bankruptcy after manipulating its financial statements. Traders, investors and regulators, all stared at their screens in disbelief. If Enron’s books were all a lie, whose books could they trust?

An institutional fund manager slammed his fists onto the keyboard, shattering it. Then he rang Citi’s equity trader: “Sell, sell all our positions at market”, he said in a resigned tone. In complete and utter disbelief, the same investors that had endured the pain of watching their investments bleed month after month began to surrender.

Across the country, ordinary people logged into their online brokerage accounts, and stared at ruined retirements, canceled college funds, and erased life savings. On the screens, the Nasdaq sliced through all support levels, like a hot knife through butter. By October 2002, the Nasdaq bottomed out 80% lower from its peak. The magnitude was such that it would take the index almost 16 years to reach its previous highs.

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Outside the South Sea Company’s offices in Threadneedle Street, a crowd had been standing in the cold since morning, shouting and demanding the directors’ heads. Many had invested everything they owned in its shares, only to see it all vanish.

It all started in 1719 with a company that had every appearance of a great trading house: one which held a monopoly on trade with Spain’s colonies in South America and a royal charter to ship slaves across the Atlantic. In reality, neither amounted to much, and what little trade there was made no money. Its real business lay in managing the Crown’s debt, and one of its directors, John Blunt, saw how he could make a fortune out of it.

Blunt called the board, stood at the fireplace with his back to the table, and began: “As you might have heard, the Treasury is looking to refinance £30 million it owes to private creditors. I propose we take the whole debt into our own hands, by persuading the creditors to exchange their claims for shares in our company. This way, we can offer the Treasury a lower rate than it currently pays. The Treasury gets its savings, but we get something far better”.

“And what would that be?” asked, impatiently, another director. Blunt replied, a faint smirk playing on his lips: “We will convert their debt at whatever price our shares will be trading at. The higher the price, the fewer shares we need to hand out, and the more money for us.” Everyone in the room understood the incentives, and without another word, they agreed to take on the Crown’s debt.

Following the resolution, Blunt set about sending the share price soaring. Through the early months of 1720 dozens of pamphlets he had paid for began to appear, describing the Company’s trade in silver from the Potosí, the gold of Mexico, the markets of Cartagena and Buenos Aires waiting to be opened. In the coffee-houses men spoke of bullion already loaded and sailing home, and of the fortunes being made in the slave trade. The public started taking an interest, driving the price higher and fuelling further enthusiasm.

The more important work was done secretly, through a few words whispered at a corner of a ballroom, a few gestures at the card table, or through a simple handshake and a smile. The Company’s cashier spent the spring moving through the highest echelons of society, bribing and noting down in his book how many shares were handed to whom. Among others, the Chancellor, the Head of the Government and the King’s mistresses were all drawn into the scheme.

As the price increased, the Company brought in creditors to exchange their claims for its shares. It also allowed ordinary people to purchase new stock by paying only 10% upfront and settle the rest in instalments. Many, from lords to servants alike, were dazzled by their gains: a man who had bought in January had doubled his money in a few months. The conviction that the price could only rise rapidly spread through the city like a fever, and anyone who hadn’t yet bought was considered a fool. To feed the frenzy, the Company even lent money to its own shareholders against shares they already held through its own bank. By August, the price had plateaued around £1,000, an almost eightfold increase since the start of the year. But it was not enough: the price had to keep rising.

Alongside the Company, dozens of other ventures had emerged throughout the summer, each promising unfathomable riches, and people borrowed heavily to buy their shares. Speculators grew intoxicated by the rush, the feeling of invincibility that came from watching their fortunes soar. So they borrowed even more.

Then, a few days into August, the dream came to an abrupt end. Concerned about competitors pulling money away from the Company, its directors pushed the Bubble Act through Parliament. By making it illegal to operate a joint-stock company without a royal charter, they hoped money would flow back and push the share price higher. The South Sea itself was excluded from the act, for it had a royal charter.

Overnight, most of these new ventures were forced to shut and their shares turned worthless. Thousands of speculators found themselves scrambling for cash to meet their obligations, so they turned to the one asset that was still valuable and easy to sell: South Sea shares. The plan meant to drive the price higher backfired, and it set in motion the very selling that would ultimately bring the Company down.

The narrow lane running between Cornhill and Lombard Street, which for months had been packed with men pushing their way to the coffee houses to buy shares, became a scene of pure horror. Over-leveraged speculators rushed to sell South Sea shares, creating a wave of selling that fed on itself. Then came the turn of ordinary men, who had poured their life savings into the Company. Greed quickly gave way to grief.

By the middle of September the price had halved, and the Company, in desperation, went to the Bank of England and begged it to vouch for the Company’s debts. For a moment the Bank agreed. Then, on the 24th of September, the Company’s own bank collapsed. It had lent out vast sums to people buying South Sea shares, and those borrowers were now unable to repay. Rumours spread that it was facing bankruptcy, so its depositors rushed to get their money out. The panic spread to the Bank of England, who quickly withdrew its offer to help the Company in an attempt to save itself. With all hopes of a rescue gone, the price plunged to £150.

In the span of a few months, many people had lost everything. Crowds from the poor and elite alike demanded that the Company’s directors be sewn into sacks and thrown into the Thames. One by one, the people responsible were punished. The Chancellor was expelled and sent to prison, the head of the government ousted, and all of the directors’ estates seized and given to the people as compensation.

After the South Sea Company collapsed, the Bank of England became the dominant financial institution, managing the government’s debt and holding the state’s accounts. It has stood at the centre of British finance ever since. The day-to-day mechanics have changed over three centuries, and the business of managing and selling government debt was eventually handed to a dedicated Treasury office in the late twentieth century. But the principle which emerged from the wreckage of 1720 still stands today: the borrowing of the British state has since been managed through a disciplined institution acting in the public interest. Over time the Bank grew into something even bigger, the lender of last resort, though that role lay more than a century ahead.

There had been manias before, and there have been many after, but we owe the term “bubble” to the South Sea.

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In a corner of the university library, an undergraduate student named Michael Milken pulled from the shelves a slim volume: Corporate Bond Quality and Investor Experience, written in 1958 by W. Braddock Hickman. The book’s main insight was that a diversified portfolio of low-rated bonds had historically outperformed portfolios of higher-rated bonds. Milken was struck by the claim, especially since no one on Wall Street had noticed it.

The corporate bond market of the postwar era was dominated by a handful of life insurance companies and pension funds who bought investment-grade paper from blue-chip issuers and held it to maturity. The small share of public corporate debt that sat below investment-grade consisted almost entirely of “fallen angels”, bonds which got downgraded after the issuing companies ran into trouble. They traded in thin markets at deep discounts to par and mostly between specialists. For companies outside the established investment-grade universe, this meant there was effectively no public bond market to issue into. They funded themselves through bank lines, private placements, or equity, all of which were more expensive or limited in scale.

Milken understood that if he could build an institutional base of investors around sub-investment-grade bonds, an enormous untapped market could open up. In 1970, fresh out of Wharton, he arrived at Drexel Firestone as director of low-grade bond research and was given some capital to trade. He read every prospectus and indenture to find companies that could service their debt, bought their bonds at deep discounts to par, and resold them as spreads tightened. By the time Drexel merged with Burnham and Company in 1973, the high yield desk had become one of the most profitable at the firm, and the new chairman gave him the autonomy to expand it. Over the next four years, Milken used the trading profits to hire credit analysts, build a sales team, and cultivate a small group of institutional buyers.

In April 1977, Lehman Brothers underwrote a public bond issuance for LTV, a Texas conglomerate that had been downgraded from investment-grade earlier in the decade. While for Lehman it was a favour to an old client, for Drexel this was the proof that the market it had been building for years was now ready to take off.

Milken picked up the phone and rang the CFO of Texas International, a small Oklahoma oil and gas exploration company. “I can raise you $30 million in 20-year unsecured paper at 11.5%”, Milken said. Then he called Executive Life, a large insurance company he had spent years building a relationship with: “You are holding 8% paper from blue chips. I have a single-B rated company issuing at 11.5%. Financials are solid and demand is strong. Deal closes tomorrow”. A few more calls and, like that, Milken underwrote his first high yield bond.

Through the rest of the year, the desk underwrote six more, and in the years that followed issuance boomed. Total volume of high-yield debt grew tenfold between 1977 and 1985, reaching nearly 20% of all public corporate debt outstanding in the US.

Milken and his team brought into the public bond market mid-cap companies that had previously been confined to bank lines and private placements: cable television operators, casino developers, healthcare services companies, and low-cost airlines. These were businesses that the investment-grade market had structurally excluded as it required predictable cash flows, low leverage, and established operating histories.

To place their bonds, Milken needed a base of buyers, and every spring he brought both sides together at Drexel’s high-yield conference at the Beverly Hilton in Los Angeles. By the mid-1980s it was known as the Predators’ Ball, named after the corporate raiders who came hunting for takeover targets, and had grown into one of Wall Street’s most important gatherings. Drexel spent millions on hospitality. Frank Sinatra and Diana Ross performed in the ballroom, while escorts entertained attendees in the evenings. Milken delivered the keynote, opening by telling the crowd they were the most powerful people in America.

Drexel had quickly become the dominant underwriter of leveraged buyout debt. In 1983 it cemented that position with the “highly confident letter”, a one-page note stating that the firm was highly confident it could raise the capital for a given transaction. It carried no legal weight, but corporate raiders and private equity firms used it to approach targets multiple times their size with takeover bids. The most notable example was the 1988 acquisition of RJR Nabisco by Kohlberg Kravis Roberts, the largest leveraged buyout in history at that point, financed in part through subordinated debt underwritten by Drexel. The deal made the cover of every business magazine in the country, and the asset class acquired its popular label of Junk Bonds.

By 1989, the Junk Bond market had become almost inseparable from Drexel. Then, in March of that year, Milken was indicted for fraud following a multi-year federal investigation into market manipulation and insider trading. At the time, it was the largest white-collar prosecution in American history.

Meanwhile, after a $650 million settlement with federal authorities and large losses on bridge loans, the money-market funds that had been buying Drexel’s commercial paper refused to continue doing so. Faced with an immediate funding pressure, Drexel’s CEO Frederick Joseph rang Gerald Corrigan, president of the New York Fed, and asked for emergency lending. Corrigan declined. Joseph then rang Treasury Secretary Nicholas Brady and SEC Chairman Richard Breeden, but neither of them were willing to step in. Joseph desperately tried to get funding from several other rival banks, but no one blinked an eye. At last, he called a board meeting, and everyone in the room voted to file for bankruptcy protection.

With Drexel gone and the savings and loan industry being forced by Congress to sell all of its $14 billion Junk Bond holdings, the asset class lost both its main underwriter and a large investor. The final blow came when the US recession of 1990-91 drove default rates on Junk Bonds to over 10%, the highest level since the 1930s.

Many investors assumed the Junk Bond market was finished, and it might have been, had a small group of contrarian buyers not stepped in. Leon Black, who until a few months prior had run Drexel’s mergers and acquisitions department, founded Apollo Investment Management. Together with a handful of former colleagues, he began buying the same high-yield bonds his old firm had underwritten, which were now trading at heavily discounted prices.

By 1992 the US had returned to strong growth, defaults declined and traditional investors started coming back. The boom of the 1990s also brought back many issuers and a broader set of banks who underwrote high yield bonds.

The asset class that Milken built in the 1970s now stands at roughly $1.4 trillion in the US, with most large institutional investors holding it as part of their fixed-income allocation. Newer forms of speculative-grade financing have emerged alongside it, with private credit absorbing much of the recent growth in mid-market and leveraged lending. High yield is also no longer the frontier of credit risk, as distressed debt has now taken that role. It consists exclusively of the debt of companies and governments in severe financial distress, often already in bankruptcy. What Milken created was therefore more than an asset class. He changed the way investors thought about credit risk and gave rise to new generations of leveraged finance.

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On the evening of October 15th, Irving Fisher, professor of Economics at Yale, spoke at the Builders Exchange Club in New York in front of a room full of people from the Purchasing Agents Association. The audience listened carefully as Fisher, one of the greatest economists the United States had ever produced1, declared “Stock prices have reached what looks like a permanently high plateau”.

The Dow Jones Industrial Average had risen from 64 in the summer of 1921 to 381 that September, a near sixfold increase in eight years driven by what seemed like a self-sustaining growth in all sectors. American industry, which had expanded enormously to supply the Allies during World War I, returned to peacetime production through the 1920s and found strong demand both at home — where wartime restrictions had created pent-up consumption — and abroad, where European countries needed everything from steel to machinery to rebuild themselves.

The Federal Reserve was created in 1913 out of a need to maintain the gold standard, provide liquidity to banks, and prevent panics. It required members to hold reserves at one of twelve regional Federal Reserve Banks and gave them the ability to borrow from the Fed against collateral when they needed liquidity. The result was a banking system that could extend more credit. Among the expansions of credit were loans to brokers to fund margin accounts. By 1929 these broker call loans had grown to over $8 billion, with margin requirements falling to as low as ten percent – meaning that an ordinary investor could now buy ten dollars worth of shares for every dollar of their own money.

Beneath the surface, the system was cracking. The number of stocks driving the index higher had been decreasing since the spring. Meanwhile the Fed, in an attempt to cool speculation, had raised rates twice, and the overnight cost of borrowing to buy stocks had spiked sharply as the supply of credit could no longer keep pace with demand.

By the time Fisher spoke in New York, Jesse Livermore, one of the wealthiest and most famous traders in the US, had accumulated a very large short position in the market. The son of a Massachusetts farmer, Livermore quit school at fourteen to post prices on a chalkboard at a Boston brokerage. There he developed a method of reading patterns in charts — what we now call technical analysis — and by twenty had made a small fortune betting on stocks. He shorted stocks in 1907 and made an estimated one million dollars, with a position size so large that J.P. Morgan himself reportedly asked him to stop selling. By 1929 his name was well known across Wall Street, and news of his short position sent jitters through the market.

On October 24th, the market collapsed. There was no single catalyst, but rather sustained market weakness from prior days which had been triggering margin calls on a large scale. When investors could not meet the calls, their stocks were sold automatically by their brokers; the selling drove prices lower, which triggered the next wave of calls. By late morning of the 24th the forced selling had become a cascade. Brokers stood at the trading posts shouting prices into the noise, waving order slips that nobody was taking. Runners moved between the posts and the telegraph room with sell tickets piled in their hands, and the ticker tape, which carried prices to brokerages across the country, was running so far behind that the prices arriving in Boston and Chicago no longer existed in New York. By midday the Dow was down 11%.

Across the street, in a boardroom on the second floor of 23 Wall Street, Thomas Lamont of J.P. Morgan called a meeting. Four other men joined him: Albert Wiggin of Chase National Bank, Charles Mitchell of National City Bank, William Potter of Guaranty Trust, and Seward Prosser of Bankers Trust. Between them they controlled more capital than any other group of men in America. They sat around the table and agreed, without much discussion, that the panic had to be broken before the close. They pooled $130 million between them with the intention of buying blue chips at prices high enough to halt the selling.

Richard Whitney, vice president of the exchange, was instructed to execute the plan. He made his way through the crowd to the post where U.S. Steel was traded and, shouting, placed a bid for 10,000 shares at $205. The price was well above anything that had traded that morning. He then moved to the next post and bid for AT&T, then Anaconda Copper, then General Electric, moving to different posts and placing a bid in each. The men on the floor understood what was happening, and before Whitney could finish his rounds panic had eased. By the close, the market had recovered most of the morning’s losses. That evening Lamont told reporters that the situation was under control and would continue to improve.

While weekend papers carried Lamont’s assurances that the crisis had been contained, when the market opened on Monday the selling resumed. This time though there was no white knight to provide support, and investors resumed the panic selling. By the time the closing bell rang, the Dow was down 13%, the largest single-day decline in its history. The following day was worse still: sixteen million shares traded on the exchange, a volume that would stand as a record for forty years, and the Dow closed another 12% lower. And while the men who only a few days earlier had declared the crisis contained were now watching their $130 million evaporate, Jesse Livermore made roughly $100 million on his short positions across the week.

The Dow would not regain its September 1929 peak until 1954. Over the four years that followed, more than 9,000 American banks failed, and millions of ordinary depositors lost everything they had. Unemployment rose to 25% as consumer demand collapsed and banks stopped lending to the businesses that needed short-term credit to pay for their workers. Meanwhile the Fed, whose mission was to provide liquidity to banks and prevent panics, did neither. Constrained by the gold standard and by an ideology that viewed bank failures as necessary, it raised interest rates in 1931 and allowed the money supply to contract by roughly a third, making the depression worse.

The reforms that followed remain, to this day, the most comprehensive in American financial history. The Glass-Steagall Act of 1933 barred commercial banks from trading stocks with depositors’ money, and introduced a federal insurance scheme to guarantee deposits against future failures. That same year, the Securities Act required public companies to publish audited accounts for the first time. A year later, Congress created the Securities and Exchange Commission, a federal agency with authority to regulate markets, enforce disclosure, and protect investors. It also made insider trading illegal and gave the Fed the ability to set margin requirements for stocks — which were raised from ten to fifty percent. While to this day they remain formally the same, in practice brokers can extend additional credit to clients, allowing leverage of more than 2x.

Nearly a century later, the Wall Street Crash of October 1929 remains a monumental event for modern financial markets. Subsequent collapses — 1987, 2000, 2008 — have been measured against it. The regulatory architecture built in its aftermath has been amended and partially dismantled over the decades, but its core principles — market governance and investor protection — still hold. The figure of Jesse Livermore, meanwhile, has grown into something close to myth and the books that came out of his career — Edwin Lefèvre’s Reminiscences of a Stock Operator and his own How to Trade in Stocks — have become must reads for those interested in markets.

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Walking along the Chicago River in the first week of October, the smell of corn was everywhere. It was harvest season, and the whole of Illinois’ corn was converging on this one muddy river. James Curtis, a grain merchant, arrived at the river bank each morning before dawn and moved between his storage units, checking what had arrived overnight.

This year the harvest was particularly plentiful and good-quality all around Illinois, driving prices per bushel 30% lower. After assessing the quality of each load, Curtis negotiated prices: “$1,200 for 3,000 bushels”, said the farmer. “Mine”, shouted Curtis. In the afternoon, he retreated to his office above the elevator, a small room that smelled of sawdust and ink, and read his correspondence. A letter from his agent Thomas Hale sat on his desk. Hale wrote that corn supply in Buffalo was becoming increasingly scarce as the Rochester mills were running at full capacity. If that rate of consumption continued through winter, stocks would be thin by March. He had also spoken to two of the Rochester mill buyers stationed in Buffalo, both of whom were looking to secure corn for the spring. One had indicated they could take a sizeable consignment with delivery in April, at the right price. Curtis then folded the letter, picked up his coat and walked to the Marine Bank on Lake Street.

The manager, a man named Graves, listened to everything without interrupting. At last, he asked how much more Curtis intended to purchase before the season closed: 30,000 bushels. There was a long pause in which the only sound was the distant noise of the river and the street below, and then Graves agreed to an extension of the credit line at a 10% interest rate. Six weeks earlier, Curtis had sat across from Graves in that same office and asked for a credit line to buy corn for the season.

By late March, as the ice broke in the Chicago harbor, Curtis sent his first shipments east across Lake Michigan and wrote to Hale asking for a market update. The reply came two weeks later carrying unexpected news: Buffalo was softer than either of them had expected. As they did every spring, Chicago merchants had anxiously rushed their corn east the moment the harbor opened, after months of carrying costs and interest payments. While the Rochester mills were used to absorbing it, this year was different. The harvest in Ohio was so abundant that its corn had been moving east by road and canal all winter, so that by the time Curtis’ shipments started arriving, warehouses were already well-stocked. The season proceeded to register the lowest corn prices Buffalo had seen in years, and Curtis, along with many other Chicago merchants who had held corn through the winter, closed his books in June at a loss.

The grain trade in 1850 operated across hundreds of miles through multiple layers of intermediaries, with information moving by letter, and no mechanism to gage supply and demand across regions. The biggest issue Curtis faced was at what price corn would sell in spring. If he could agree on a selling price before the corn was bought, he wouldn’t be exposed to the Ohio harvest or any other external forces.

By September 1850, before the first wagon had appeared on the riverbank, Curtis instructed Hale to approach the Rochester mill buyers and find one willing to commit to a price for April delivery before the harvest began. Within a fortnight, Hale wrote back with terms from a mill owner named Aldrich: 20,000 bushels of corn at 40 cents a bushel, delivery in April. Curtis wrote back agreeing to the terms, folded the letter and walked to the Marine Bank. For the first time, the conversation with Graves was straightforward as he was asking to lend against corn already sold, to a buyer already named and at a price already fixed. Graves studied the letter, asked a few questions about Aldrich’s commercial reputation, and agreed to a larger and cheaper credit line than the previous year. Within a few years contracts of this kind were common enough that merchants were buying and selling them before delivery and a secondary market started to emerge.

The institution that would eventually transform these private bilateral agreements into standardized exchange-traded instruments had already been founded in April 1848 by 82 Chicago merchants. In its early years, the Board of Trade of the City of Chicago (CBOT) functioned mainly as a commercial association, a place where merchants gathered to resolve disputes, discuss harbor infrastructure, and agree on common practices. Through the 1850s, however, the CBOT laid the foundation for standardised contracts by establishing uniform grain grades — No. 1, No. 2, No. 3 — certified by exchange-appointed inspectors whose decisions were binding on all members. A contract was interchangeable with any other contract of the same specification and could be bought and sold between merchants who had never met. In February 1859, the Illinois legislature granted the CBOT a formal corporate charter, backing with law what had previously run on reputation and trust.

In May 1865, the CBOT became the first futures exchange by restricting trading to exchange members, standardizing every contract specification — lot sizes, grades, delivery months, delivery locations — and requiring both parties to post a margin deposit before a trade was valid. Before, to-arrive contracts were based on trust. If prices moved sharply against a seller between October and April, they had every incentive to default and accept the legal consequences which were slow, expensive, and uncertain. With the introduction of a margin deposit, the risk of either party defaulting was significantly reduced.

What emerged from those rule changes is what we now call a futures contract, in which the only variable left to negotiate was the price. Contracts could now change hands dozens of times before delivery, each buyer and seller transacting with the exchange. This resulted in the emergence of speculators, whose sole purpose was to profit from price changes and who would close out their positions prior to delivery. While speculators were viewed with deep suspicion, they were critical in providing liquidity. Every time a merchant like Curtis needed to sell a forward commitment, he needed someone willing to take the other side of the trade, and speculators did exactly that. By the 1870s, fewer than one in ten futures contracts resulted in actual physical delivery.

What followed was an expansion in scope that Curtis, standing on the riverbank in 1849, could not have imagined. Agricultural futures spread from corn and wheat to cotton, butter, and eggs before the end of the century. When the United States abandoned the gold standard in 1971 and currencies began to float, the Chicago Mercantile Exchange recognised that exchange rate risk was structurally identical to corn price risk and launched currency futures. Interest rate futures followed in 1975, while equity index futures in 1982. In 1981, Eurodollar futures became the first contract settled in cash rather than physical delivery, breaking the last remaining connection between a futures contract and any underlying. Today, futures contracts trade on most exchanges worldwide across asset classes ranging from crude oil and natural gas to government bonds and equity indices.

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The clock strikes 6am and the alarm starts ringing. Navinder Singh Sarao gets out of bed, ready for another day of work. He stumbles, half asleep, to his desk at the corner of his childhood bedroom located within his parents’ home in Hounslow, West London. A wiggle of the mouse and six screens light up. Nav scrolls through overnight news, followed by any market movements. The topic taking everyone’s attention at the moment is the possible default on Greek sovereign debt, and any subsequent bailout. Markets are opening weak, with sovereign spreads wider, premiums on Credit Default Swaps higher, and European stocks 4% lower.

This is exactly the kind of day Nav operates best in, one of fear and volatility. At 11:17am he starts placing large limit sell orders on S&P futures — 200, 400, 900-lots — outsizing nearly everything else in the market. In Hounslow, sprinklers go off to water the garden on a peaceful sunny day. Meanwhile in Athens, there are riots outside parliament.

As the day progresses, the order book becomes increasingly imbalanced. Market liquidity is drying up and buyers are stepping back. The sell orders which Nav has been placing account for nearly a third of all visible selling pressure on the exchange. At 2:30pm, the Dow is down over 300 points. The VIX has surged more than 20% since the open. Liquidity in S&P futures has been cut almost in half. In Overland Park, Kansas, a mutual fund company called Waddell & Reed is about to execute a trade.

**

Four years earlier, Nav had been making money for someone else. Fresh out of Brunel University he joined Futex, a proprietary firm on the outskirts of London. While other trainees were still losing money in a simulated environment, Nav was making tens of thousands of pounds on live markets.

As time went on, Nav grew increasingly dissatisfied with having to share his profits with his employer. So, in early 2008, at 28 years old and with a net worth of £2 million, he handed in his notice and left. He decided to set up a trading station in his childhood bedroom of his parents’ house. His strategy was simple but executed ferociously. He would place large sell limit orders on S&P futures, always a few ticks above the market. Other traders would see the selling pressure and prices would drift lower. Meanwhile, Nav would buy and then cancel the sell orders. He repeated this practice, known as spoofing, thousands of times a day. By 2010, he had created an algorithm to automate this.

**

It’s now 2.32pm, and one of Waddell & Reed’s fund managers decides it’s time to hedge the $75 billion portfolio – mostly invested in US equities – and enters a sell order of 75,000 S&P futures worth roughly $4.1 billion. In a market already thin and heavily skewed to the sell side, there are no buyers for such a size. When Waddell & Reed’s algorithm starts selling, the high frequency market maker who has been hit offloads the position on to someone else, who then passes it on to someone else. The same contracts are passed around between firms at rapidly falling prices as nobody wants to hold the risk. Doing so generates large volumes, and because Waddell & Reed’s algorithm is programmed to sell 9% of whatever volume has traded in the previous minute, it creates a snowball effect of selling.

At 2:42pm the market goes into freefall. The Dow drops 600 points in five minutes. $1 trillion in market value gets wiped out. Accenture’s stock goes from $40 to $30, then $20, then…1 cent. Apple shares, on the other hand, soar to $100,000. Prices stop making sense, the market breaks down, and it becomes absolute chaos. At around 2:45pm the Chicago Mercantile Exchange (CME) triggers a five second trading pause on S&P futures. When trading resumes, buyers return and prices stabilise.

By 3pm the market recovered most of the loss and the Dow closed down 348 points on the day. The Flash Crash was over, but it would take years for anyone to fully understand what had just happened. The early theory was a fat finger — a trader somewhere who had typed billions instead of millions, subsequently sending the market into a tailspin. Attention turned to high frequency trading firms, whose algorithms had clearly played a role in the freefall, though whether as a cause or a consequence remained up for debate.

Five months later, a joint report by the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) pointed the finger at Waddell & Reed. The CME pushed back — a trade of that size, they argued, was entirely routine and could not have caused what happened on its own. Many in the market agreed. Nobody, at that moment, was looking at Hounslow.

While the finger-pointing continued, regulators moved quickly. Within months of the crash, US exchanges introduced circuit breakers on individual stocks — automatic pauses triggered if a price moved too far, too fast. Spoofing was criminalised in July 2010, just two months after the crash. In the past, the practice had existed in a legal grey, with regulators largely powerless to act.

Despite spoofing being now a crime, the authorities lacked the tools to detect it. Nav, who had made $880k on the day of the Flash Crash, carried on spoofing the E-mini as if nothing had happened. He accumulated a fortune that would eventually reach $70 million, but most of it was lost by handing it to fraudsters. It was only in 2014, when the CFTC developed surveillance tools sophisticated enough to identify market manipulation patterns, that analysts traced the activity back to him. Nav was arrested in April 2015 for fraud and market manipulation and a year later pleaded guilty to wire fraud and spoofing. In 2020, Judge Kendall sentenced him to a year of home confinement.

Markets had crashed many times before, but May 6th, 2010 exposed the world to a new kind of danger, one where automated systems interacting in a fragile and illiquid market could spiral out of control. The regulatory responses that followed were meaningful but incomplete, and markets have remained vulnerable to crashes of the same nature: the US Treasury flash crash in October 2014, the ETF flash crash in August 2015 and the Sterling flash crash in October 2016.

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Tesla, the company well known for making electric vehicles, is one such company with a P/E of 370. This puts it as one of the top S&P 500 companies by P/E ratios. Even against high-growth US tech stocks — Nvidia, Apple, Google — it screens high. BYD is the closest automotive comparison, and that trades at a fraction of Tesla’s multiple. From the chart below, it’s clear that P/E ratios of traditional car manufacturers are vastly different. A simple glance would suggest that EV manufacturers trade at a 10x premium. What stands out most, however, is the divergence between Tesla’s and BYD’s P/E ratios over the past two years. At a ~$1.25 trillion market cap, investors are largely paying for business units beyond car manufacturing.

Bank of America’s sum-of-the-parts model assigns Tesla’s core automotive business 12% of its total implied value. At the current market cap, that is roughly $150 billion. For context, GM and Ford’s market caps are $67 and $47 billion respectively. Meanwhile Toyota — the world’s largest car manufacturer by volume, with total revenues more than four times Tesla’s entire automotive segment — is valued at approximately $275 billion. Tesla’s U.S. market share peaked at 4.3% in 2023 and has declined every year since (see chart below), while BYD has overtaken it as the world’s largest battery electric vehicle manufacturer.

Policy has moved in the wrong direction too. Since Trump’s re-election, federal purchase incentives have been eliminated, EV mandates revoked, and fuel economy standards rolled back – removing a key tailwind for the industry. Leaving aside the debate over how much premium Tesla’s car business deserves, investors are not buying this stock for the cars.

Tesla’s energy generation and storage unit is the company’s strongest segment, with revenues up 27% in 2025 and gross margins of ~30% across the year. Yet BofA’s model assigns it just 6% of Tesla’s total implied value, or approximately $75 billion. This still leaves over $1 trillion in valuation that must be justified entirely by three businesses that are either pre-revenue or in early pilot phase: Robotaxi, which accounts for 45% of the implied value (~$562 billion), Full Self-Driving (FSD) subscriptions 17% (~$213 billion), and Optimus 19% (~$238 billion).

Robotaxi consists of creating a fleet of self-driving cars that work like Uber. Tesla began paid rides in Austin in June 2025 and plans to expand to seven additional U.S. cities in the first half of 2026. Revenue estimates for the upcoming years vary greatly, but consensus is that breakeven will not be reached until sometime in 2027 and even then the fleet will still be tiny compared to its valuation. Weeks before Cybercab production was due to begin, Tesla lost the engineer who built its Robotaxi software backbone — an 11-year veteran whose departure raises questions about near-term execution.

FSD is Tesla's driver-assistance software, which — once fully autonomous — would allow any Tesla vehicle to operate without human input. Tesla currently charges $99 per month following the move to subscription-only in February 2026, and had 1.1 million paid subscribers globally as of Q4 2025. That's $1.3bn in annualized revenue against a $213bn implied valuation (a 163x multiple), which implies that the subscriber base would need to grow more than tenfold just to approach a conventional tech valuation.

Optimus is the most speculative of the three. It is a humanoid robot designed initially for factory automation, with longer-term ambitions in consumer and commercial applications. Musk has said 80% of Tesla’s long-run value will come from this programme. Production has slipped to late 2026, with meaningful revenue not expected before late 2027.

If you are buying Tesla shares as an automotive investment, only 12% of the business justifies that. The rest is a bet on a tech company that has yet to prove itself, and at the current valuation risks are tilted to the downside. There exists a scenario in which Robotaxi scales slower than expected, FSD monetisation disappoints, and Optimus is still years away than Musk suggests. Given that the current share price requires a smooth rollout of each business, we think Tesla will struggle to maintain its valuation.

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The Kelly criterion was developed in 1956 by John Larry Kelly Jr. at Bell Labs. Kelly noticed that the mathematics of optimal signal transmission over noisy channels was structurally identical to the mathematics of optimal betting. The result was a formula for bet sizing that maximises long-run growth. If you have an edge, bet a fraction of your stake equal to that edge divided by the odds. Bet less and you leave growth on the table. Bet more and you go broke. Overbet a winning strategy and you reduce long-run growth.

When you decide on the size of your bet, you are making two decisions at once. You are deciding how much you stand to gain if you are right (growth decision), and you are deciding how big of a loss you take if you are wrong (survival decision). Losses and gains are asymmetric, so the recovery from a large loss requires a disproportionate gain just to get back to where you started. For example, if you lose 50% of your capital then you need a 100% return just to break even. Kelly formalises this by optimising for long-run growth rather than single-bet returns. Pierre Andurand’s fund illustrates this precisely: the -55% drawdown in 2023 nearly erased two years of exceptional returns (see table below). Over the full period, the S&P 500 marginally outperformed, but with materially lower volatility.

Sitting sober at the blackjack table, Thorp understood something: the Kelly criterion was not only a gambling tool. It was a framework for any decision made under uncertainty with an identifiable edge. In 1962 he published Beat the Dealer, the first rigorous account of how probability and position sizing could beat a casino. In 1969 he founded what became Princeton Newport Partners, one of the first quantitative hedge funds, applying the same logic to markets. The fund returned 18.2% annually after fees over nearly two decades, without a single losing quarter.

The book reached well beyond the gambling community. Bill Gross, then a psychology student at Duke University, read it and went to Las Vegas to test the theory. He turned $200 into $10,000 over a single summer, sizing his bets in strict proportion to his edge. In 1971 he co-founded PIMCO, which grew into the world’s largest bond fund. He ran it the same way he had run his blackjack stake. “Here at PIMCO it doesn’t matter how much you have, whether it’s $200 or $1 trillion,” he said. “Professional blackjack is being played in this trading room from the standpoint of risk management and that is a big part of our success.”

In practice, applying Kelly to markets is harder. In markets, investors rarely know their true probability of profiting from a trade, and conviction tends to inflate that estimate. Even when applied correctly, uncertain inputs make overbetting the default risk. Additionally, a portfolio built entirely on Kelly’s criterion may be subject to high levels of volatility which oftentimes hurts a fund manager’s credibility. While Kelly is designed to prevent you from going bust, short term periods of large losses are still consistent with a winning strategy. Thorp knew these caveats and typically applied half to three-quarters Kelly in practice. Most hedge fund managers today follow the same logic: those who use Kelly typically apply a fractional version.

The overlap between markets and probabilistic thinking extends well beyond Kelly: Steve Cohen, founder of hedge fund Point 72, has credited poker with teaching him to take risks, and Annie Duke, a World Series of Poker champion, now consults for hedge funds on decision-making under uncertainty.

The question Thorp was asking at that blackjack table in 1961 was not whether he had an edge. He knew he did. The question was how much to bet on it. That question led to a book, a hedge fund, and an inspiration to a generation of fund managers. It is also a question most people almost never ask, in markets or anywhere else. The instinct is often to focus on whether you are right, rarely on how much to bet that you are right.

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A Fed hold is widely anticipated, while markets are pricing in a cut in June and a 50% probability of a second cut by year-end. Powell’s tone is expected to be cautious — vigilant on inflation persistence from the oil shock, but stopping short of a hawkish pivot. The policy statement will likely reflect elevated inflation risks and a prolonged data-dependent approach, with no major departures from recent language. Notably, next week will almost certainly be the last meeting chaired by Powell. Some expect incoming chair Warsh to be more dovish given Trump’s pressure for cuts. However, we think this may not be the case.

The ECB is also expected to hold. Compared to the Fed, however, the market is currently pricing in more than one hike by year-end (with the hike to be delivered in September). This marks a decisive shift from prior to the conflict – rates were priced to be on hold throughout the whole year – due to Europe’s sensitivity to energy shocks which drive inflation higher. Recent comments by Governing Council members underline how the ECB will act decisively in a timely manner should energy prices be reflected into CPI medium-term estimates. Pre-war, the tone was neutral to dovish, with more of the concerns around growth. No changes are expected on the ongoing Quantitative Tightening and on the structural portfolio.

With inflation in Q4 projected to be 0.5-0.6% higher due to energy prices, the BoE is now also expected to hold. The February meeting had a narrow 5-4 hold vote split, which was dovish and closer than expected (economists had anticipated a clearer 7-2 hold). This surprise led the market to price a full cut in March. Recent events have therefore marked a material shift in rate expectations. The market is now pricing in no cuts at all for the remainder of the year. Regarding balance sheet normalisation, no changes are expected; the pace of ongoing normalisation may be reduced if rate holds persist.

Overall, the market had been anticipating neutral/cuts rate decisions across G3 central banks for this year. The Iran war has shifted expectations to the hawkish side. As with any situation like this, market expectations can change on a day-to-day basis. Stay tuned.

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The United States has not fought a war on its own soil since the Civil War ended in 1865. This geographic insulation is arguably the single most important factor. When conflict breaks out in Europe or the Middle East, US corporate earnings, supply chains, and physical infrastructure are almost never directly affected. This contrasts sharply with European markets, which have historically exhibited far greater sensitivity to conflict. When North Korea invaded the South in June 1950, West German and broader European equity markets sold off sharply — investors were pricing in the possibility of a Soviet-backed push through Central Europe. The Dow Jones, by contrast, absorbed the shock almost immediately and was up over 16% twelve months later.

The looming risk, or outbreak of war, increases spending in the defence sector both domestically and internationally. When spending on defence increases, payrolls, capex and R&D all increase, providing support to the US economy. The Korean War rearmament programme contributed materially to the sustained post-war economic expansion. The post-9/11 buildup drove a prolonged period of elevated defence outlays. Additionally, the three world’s largest defence contractors, Lockheed Martin, Raytheon and Northrop Grumman are all American. Russia's invasion of Ukraine triggered the largest rearmament of NATO allies in a generation, with the overwhelming majority of supply coming from US-manufactured systems. The Israel-Gaza conflict reinforced this dynamic further: Israel accelerated procurement of F-35s, precision munitions and Iron Dome replenishment — almost exclusively sourced from American manufacturers — while Gulf states, rattled by Iranian proxy activity across the region, responded with a wave of US arms purchases. Saudi Arabia and the UAE together committed to tens of billions of dollars in new US defence contracts in the years following October 7^th 2023. The subsequent escalation involving Iran in 2026 has cemented American defence contractors as the primary financial beneficiaries of Middle Eastern instability, as regional powers doubled down on US military systems.

Perhaps the most underappreciated reason US equities look through wars is more structural: a substantial portion of equity demand is almost entirely indifferent to geopolitics. Every month, hundreds of billions of dollars flow automatically into US equities through 401(k) contributions, pension fund allocations, and target-date funds. The institutionalisation and automation of retirement savings over the past four decades has created a recurring US equity bid that is mostly indifferent to geopolitics. This dynamic is not confined to American savers. Pension funds, sovereign wealth funds and institutional investors worldwide use US equity indices as their primary global equity benchmark, providing a consistent bid in the market.

Finally, geopolitical shocks trigger a flight to safety with the main beneficiary being the US Dollar. Although there was much talk about de-dollarisation during Trump’s second term in office, the Iran war has proven once again that, during periods of uncertainty, global investors see US markets as safest. As in the past, investors rotate out of risk assets and into dollar-denominated instruments: US Treasuries, money market funds, and ultimately US equities themselves. This dynamic was visible following the Gulf War, September 11th, and the invasion of Ukraine: in each case the dollar strengthened materially in the weeks following the shock, compressing the risk premium on US assets relative to the rest of the world. For a foreign investor holding US equities, dollar appreciation provides an additional layer of return on top of any market performance. War-driven dollar strength therefore supports US equity valuations.

While media outlets constantly report on bombings, casualties and spark fear, markets — especially US equities — have largely looked through all this. Since WWII, US equities have, on average, returned 6% in the 12 months following US active deployment. Even in the first 60 trading days, US equity markets have, with one exception, held their ground or risen (see chart below). The US fights its wars abroad, benefits economically from the rearmament they trigger, and attracts capital when uncertainty spikes. Geography, defense spending, the dollar’s reserve status, and the continuous buying flows from passive vehicles are all supportive for US equities.

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Over long horizons, performance concentrates in assets that occupy the structural centre of their respective systems. The relevant question is therefore not which asset may temporarily outperform, but why the benchmark asset so often delivers the most durable risk-adjusted returns.

The answer lies in structural centrality. Assets at the core benefit from embedded demand, deeper liquidity and lower displacement risk. Peripheral alternatives may offer cyclical upside, but they carry a higher probability of obsolescence, illiquidity or structural loss of capital.

Assets such as the S&P 500, gold and Bitcoin function as global reference points within their ecosystems. They anchor pricing, flows and performance measurement. Their benchmark status rests on, among others, three key properties: flow concentration, survival across regimes and asymmetric transmission.

Flow concentration

Benchmarks are embedded in mandates, risk models and performance evaluation frameworks. Passive vehicles replicate them mechanically, derivatives markets are deepest around them, and hedging activity is structured through them. Investors seeking liquidity, scalability and minimal tracking error therefore gravitate toward the benchmark first. Over time, this institutional framework becomes self-reinforcing: performance attracts flows, flows increase weight, and greater weight further entrenches benchmark status. In that sense, benchmark centrality does not merely reflect past dominance but rather it helps to sustain it.

The S&P 500 illustrates this clearly. Broad, low-cost S&P 500 replication vehicles reached scale well before comparable MSCI World trackers. Early benchmark flows therefore concentrated in the S&P 500. As US equities subsequently outperformed, their weight within the MSCI World Index increased mechanically. A larger US weight within global indices in turn directed a greater share of passive allocation back toward US equities. First-mover advantage and relative performance reinforced one another.

Survival Across Regimes

Assets at the structural core of a system endure repeated regime shifts without losing relevance. They survive crises, policy transitions, technological cycles and speculative manias that eliminate peripheral competitors. The S&P 500 has absorbed wars, inflation shocks, banking crises and multiple sector rotations while continuously reconstituting itself around the dominant firms of each era. Gold has persisted across monetary regimes, from the classical gold standard to Bretton Woods to fiat systems, retaining its role as a reserve asset and collateral anchor. Bitcoin has survived successive boom-and-bust cycles that extinguished large segments of the broader crypto ecosystem, yet each cycle has reinforced its relative dominance.

Asymmetric Transmission

Benchmarks also function as the marginal price-setters within their systems. A 1% move in the S&P 500 transmits materially into major European and Japanese indices for example, with cross-market betas rising during stress. The reverse transmission is considerably weaker. Shocks originating in the core propagate outward; shocks in the periphery rarely reprice the centre. Gold anchors relative pricing across the precious metals complex. Bitcoin anchors liquidity and sentiment within crypto.

These benchmark characteristics are not unique to financial markets. In other ecosystems, value and liquidity similarly concentrate in the reference asset. Within collectible markets, flagship items such as first-edition Charizard cards often trade at a persistent premium and exhibit greater price resilience than comparable cards. In art, capital clusters around blue-chip names whose works function as the benchmark for the category. In prime real estate, global capital gravitates toward a small number of cities. The benchmark asset becomes the focal point for valuation, trading and capital allocation, and that focal status compounds over time.

Benchmark dominance reflects embedded flows, survival across regimes and asymmetric transmission. Peripheral assets may outperform cyclically, but over long horizons capital concentrates where liquidity is deepest and displacement risk is lowest. Accordingly, benchmarks offer structurally superior risk-adjusted returns.

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Performance in the S&P 500 has been heavily concentrated in the Magnificent Seven, meaning index returns are increasingly driven by a small number of mega-cap technology stocks. While the S&P 500 remains near record highs, gold’s relative outperformance reflects continued demand for protection against concentration risk, geopolitical uncertainty and risk-off episodes – a dynamic that can persist under the current regime.

1. Balance-Sheet Normalisation, Continued Equity Strength

For years, global equities tracked the expansion of G4 central-bank balance sheets. That relationship weakened after late 2022. Balance sheets continued to normalise, yet risk assets recovered and advanced.

Forward earnings expectations stabilised. Excess liquidity remained elevated. GDP growth and labour markets proved resilient. AI-driven enthusiasm concentrated growth expectations in a narrow group of large firms, sustaining MSCI World performance, largely driven by US equities, despite tighter policy.

2. Equities in a Higher Real-Rate Regime

US real yields rose from roughly –1% in 2021 to 2.5% in 2023 before easing toward 1.8%. Historically, such a repricing would have imposed a sustained headwind for valuations. For most of 2022, it did.

The subsequent equity recovery indicates markets adjusted to a higher real-rate regime. With real yields now easing, US equities face a less demanding backdrop. To the extent the decline reflects improved inflation dynamics rather than weaker activity, it should remain supportive for valuations.

3. Credit Risk Premia Remain Contained

High-yield spreads signal no acute financial strain. Despite the sharp rate repricing since 2022, credit risk premia remain contained by historical standards. Episodes of volatility have followed geopolitical or policy headlines rather than a sustained deterioration in growth or funding conditions. Default expectations are limited, and markets are not pricing material funding stress in the near term.

4. Intra-EMU Fragmentation Risk Remains Limited

Despite French political uncertainty, QT, and tariff-related tensions, intra-EMU spreads have tightened. Wider moves have failed to gain traction. With inflation close to target and limited political disruption, the direction of travel continues to favour tighter spreads.

5. Gold’s Relative Outperformance

Gold continues to outperform relative to the S&P 500 even as indices hover near record highs. This is consistent with stretched equity valuations, debt sustainability concerns, geopolitical risk and elevated concentration in US equities. Retail flows into gold reinforce the trend.

6. Concentration in S&P 500 Returns

   

   

Source: Apollo

The top ten companies account for roughly 40% of S&P 500 market capitalisation. The Magnificent Seven have generated a disproportionate share of returns over the past year.

In such an environment, maintaining equity exposure while adding gold becomes a coherent allocation response to concentration risk and AI-bubble concerns.

7. Implications

Credit and intra-EMU spreads continue to signal stability, while expansionary fiscal policy, lower real yields and strong earnings expectations support equities. At the same time, geopolitical uncertainty, elevated concentration in the S&P 500 and persistent debate around an AI bubble sustain demand for gold. In this configuration, gold’s relative outperformance against the S&P 500 can persist.

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According to the latest Bank of Japan estimates, GDP growth is expected to reach 1.0% in 2026 and 0.8% in 2027, while core-core inflation is projected at 2.2% and 2.1% respectively. The unemployment rate continues to hover around 2.6%, underscoring persistent labour-market tightness. At the same time, the Bank of Japan is proceeding with policy normalisation—slowing JGB purchases and delivering incremental rate hikes—while Prime Minister Takaichi has pivoted decisively toward a more expansionary fiscal agenda. Recent announcements include additional spending on free education, targeted support for strategic sectors such as semiconductors and AI, a suspension of the food tax, and an increase in defence spending from 1.4% to 3% of GDP. In the snap election of 8 February, the LDP secured 316 of the 465 seats in the lower house, and 354 together with the Japan Innovation Party. The scale of the victory materially strengthens the government’s ability to implement its fiscal programme with limited parliamentary resistance.

Japanese rates have been repricing steadily over the past four years, driven by higher term premia and a slow normalisation of BoJ policy. That process has intensified more recently amid concerns over PM Takaichi’s proposed fiscal expansion. According to a study by Allianz Research, Japan’s debt-to-GDP ratio—currently around 200%—could rise to roughly 228% by 2050 if both the food-tax suspension and higher defence spending are implemented, and to over 250% if yields remain at levels implied by current forward rates. While these levels may appear elevated, Japan’s position as a net external creditor provides a medium-term stabilising channel: domestic investors can gradually rebalance away from foreign assets and towards JGBs, helping to cap upside pressure on long-end yields. That said, despite the scale of the recent sell-off, near-term risks remain skewed towards further repricing. Assuming trend growth of around 1% and inflation near 2%, a 10-year JGB yield around 3% appears broadly consistent with the macro backdrop. Additionally, given that many hedge funds have structurally short JGB basis positions (ie. long future vs cash bonds), shocks that lead to higher rates may be exacerbated by position unwinds by hedge funds. While the 30-year sector—having briefly spiked to nearly 4% before retracing to around 3.5%—should find support from real-money demand and lighter issuance, pressure in the 5- to 10-year sector is likely to intensify amid heavier supply. We may therefore see a continued flattening in 10s30s.

Turning to equities, Japanese stocks remain fundamentally supported by the expansionary fiscal stance, which is positive for earnings and supportive of domestic demand. Recent strength has been driven by robust earnings in AI-related firms and semiconductor companies, alongside renewed retail buying, pushing the Nikkei to fresh highs. From a technical perspective, however, valuations appear stretched. Much like in the US and other developed markets, Japanese equities look increasingly vulnerable to adverse geopolitical headlines. The Nikkei 225 is currently trading around 23% above its 200-day moving average. In relative, FX-adjusted terms, it has outperformed the S&P 500 by 22% and the MSCI World by 18% over the past year (See charts below). While this relative strength may appear bullish, the data suggest risks remain skewed to the downside, with recent performance more consistent with a temporary phase of relative outperformance.

On FX, while never officially acknowledged, USDJPY around 160 appears to represent a de facto intervention threshold for policymakers. The most recent episode of suspected intervention occurred on 23 January, when USDJPY fell sharply from around 159 to 153, potentially reflecting a coordinated effort between the BoJ and the Fed. From the BoJ’s perspective, as highlighted in the most recent Summary of Opinions, “the pass-through to prices of higher import prices caused by the yen’s depreciation has become more pronounced,” raising the risk that CPI disinflation slows or even reverses should the yen weaken further. A depreciating yen also feeds into higher term premia and expectations of a more aggressive normalisation path, exacerbating pressure on JGBs. From the Fed’s perspective, a sell-off in JGBs tends to spill over into US Treasuries, with most estimates suggesting that a 10bp move in JGB yields lifts UST yields by around 3bp. In addition, a weaker yen partially offsets the impact of the 15% tariffs imposed by the US on Japan last year. Taken together, these dynamics argue for USDJPY continuing to trade within a range, with the upper bound anchored around 160.

Overall, the outlook remains one of a constructive macro backdrop, ongoing but incomplete rates repricing, fundamentally supported—if stretched—equities, and a yen likely to remain range-bound.

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The geopolitical landscape has become increasingly fragile: Trump’s latest efforts to acquire Greenland risked turning into an open rupture with Europe. On January 17, Trump threatened new 10% trade tariffs “on any and all goods” on a number of European countries, including the UK, if these did not support his plans to take over Greenland. However, Trump’s actions towards Venezuela, followed by his stated intention to acquire Greenland, have deeply shaken European leaders and once more demonstrated how the threat of tariffs under the Trump administration is always looming.

The tariffs were initially set to take effect on February 1, rising to 25% from June if no deal were reached. In response, the EU has moved to reactivate measures previously put on hold after the July trade agreement, including $93 billion worth of retaliatory tariffs. The bloc could also activate its Anti-Coercion Instrument (ACI), which allows for restrictions on access to the EU market across trade in goods and services, foreign direct investment, financial markets, and property rights. While not currently intended, this remains an option of last resort.

Latest economic data point to the resilience of the US economy, with household spending increasing to 0.5% m/m (0.3% previously), while both headline and core PCE came in in line with expectations at 2.8%. Although the labour market is sending mixed signals, the overall picture suggests that the Fed’s wait-and-see policy is well calibrated. At the same time, as the Fed seeks to preserve its independence, it is unlikely to cut more than what is already projected unless strictly necessary. The December dot plot shows that the Fed is expected to cut once this year, while the market is pricing in almost two cuts. A serious threat or imposition of tariffs, leading to a tariff war with the EU, may therefore lead to a market repricing: the short end may drift higher on the back of fewer expected cuts, while the long end may come under more pressure, causing a bear steepening of the curve. The moves may be exacerbated by retail or fast money investors selling US rates aggressively, as observed in April 2025. As suggested by a recent study by the San Francisco Fed, the imposition of tariffs would initially increase unemployment and decrease inflation, acting as a brake on the demand side of the economy (see charts below). Over time, the economy adjusts: unemployment returns to its original level or even declines slightly, while inflation picks up and peaks three years after the initial change in tariffs. At a time when public borrowing is increasing at worrisome levels and the Fed needs to prove its independence by not giving in to Trump’s calls for cuts, an imposition of tariffs with EU retaliation may lead to an aggressive repricing in US rates, especially at the longer end of the curve.

The ECB finds itself in a rather different position. Headline euro area CPI stands at 1.9% (with core still at 2.3%), while unemployment is at 6.3%, near historical lows. Regarding the latest threat of tariffs, ECB President Lagarde stated that this would affect euro area inflation only minimally, given that inflation is already under control. What is more concerning for the ECB is the impact on economic activity that tariffs would bring, as Governing Council member Nagel recently noted in an interview. While the ECB is currently at a neutral rate of 2%, an imposition of US tariffs may push it to loosen its monetary policy stance in order to support growth, potentially leading to a widening in US–European rates (see chart below).

In a more extreme case of tariff escalation, the EU could consider purchasing less of, or even selling, US Treasuries in retaliation. This, if it were to happen, would be gradual, but it would imply that it becomes harder for investors to absorb an increasing supply of US government debt. As pointed out by economist Erik Nielsen, the euro area alone runs a current account surplus of EUR 400–450bn per year, a large share of which is invested in US Treasuries. Following recent episodes of geopolitical tension, there is an increasing number of European policymakers and economists suggesting that part of this surplus should be redirected from foreign investments towards domestic European markets, with a particular focus on defence. A large buyer of US Treasuries may therefore gradually scale back.

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This publication focuses in greater detail on the US economy. While US equity valuations appear stretched from a technical perspective (see chart below), the fundamental backdrop remains supportive, underpinned by (i) a looser monetary policy stance from the Fed and (ii) strong economic growth driven by expansionary fiscal policy. This Goldilocks scenario, however, is akin to walking on thin ice. Should geopolitical risks, debt-sustainability concerns, or labour-market weakness materialise, a meaningful correction in equity markets may likely follow.

Shortly after ending quantitative tightening in November, the Fed announced on December 10 that, in order to maintain an ample supply of reserves over time, it would resume purchases of Treasury bills at a pace of USD 40bn per month until April, after which the pace will be reduced. This measure is supportive for markets, as it injects liquidity, lowers borrowing costs, and may signal reduced concern about undershooting the inflation target. Although the starting conditions differ, this episode of “technical QE” is similar in nature and scale to the programme implemented between October 2019 and March 2020, when the Fed purchased Treasury bills at a pace of USD 60bn per month to stabilise short-term funding markets (see chart below).

According to the Fed’s December projections, the US economy is expected to grow by 2.3% this year and 2.1% next year. Recent data from the Weekly Economic Index (WEI)—a composite of ten weekly economic indicators—together with services PMI data that surprised to the upside at 54.4, reinforce the narrative of a strong and resilient economy. The Congressional Budget Office estimates that 0.9% of this year’s growth will be attributable to the One Big Beautiful Bill Act (OBBBA).

A key concern, however, is the scale of additional federal borrowing implied by OBBBA, which adds pressure to Treasuries—already trading heavy—and increases rates volatility. In a paper published in November, Auerbach and Gale estimate that the debt-to-GDP ratio (defined as debt held by the public) will rise to 183% by 2054 under OBBBA as currently legislated, and to 199% if temporary tax and spending provisions are made permanent. These projections compare with a current debt-to-GDP ratio of roughly 100%, and with a pre-OBBBA CBO projection of 154% for 2054. They further estimate the fiscal gap—the permanent tax or spending adjustment required to stabilise the debt-to-GDP ratio at its current level—at approximately 3.4% of GDP if OBBBA is extended. Overall, growth generated by OBBBA appears likely to represent a short-term boost at the cost of significant long-term fiscal strain.

An additional source of concern is the growing decoupling between economic growth and a labour market that has continued to weaken. Investors had been awaiting January’s jobs report for greater clarity on labour-market conditions. The latest release, however, leaves the market broadly unchanged: monthly job creation came in below expectations (50k versus 70k), while the unemployment rate edged lower to 4.4%. Hourly earnings growth and labour-force participation were in line with expectations. Overall, the report leaves the FED in a wait-and-see position, reinforcing the view that policy is currently well calibrated.

While US equities are currently benefiting from the combination of looser monetary policy and highly expansionary fiscal policy, the equilibrium is fragile. A renewed focus on US debt sustainability, a further deterioration in labour-market conditions, and/or another escalation in geopolitical risks may likely trigger a sharp correction, pushing equity markets into a cold plunge.

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