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In the history of every great catastrophe, you will find some masterly bit of stupidity set fire to the oil-soaked rags.[1] —EDWIN LEFEVRE, author of Reminiscences of a Stock Operator Private markets have entered what may be the most precarious phase of a decades-long speculative cycle, defined by questionable valuations, governance concerns, and aggressive marketing to retail investors. While institutions have already committed trillions to these opaque vehicles, many are now quietly heading for the exits — just as individual investors are being drawn in by the promise of stable returns and enhanced diversification. Yet the warning signs are piling up. From valuation inflation to fee extraction on unrealized gains, today’s market bears striking resemblance to the late stages of past financial manias. This post draws heavily on more than two centuries of US financial history to show how those patterns are resurfacing in private markets. Consider, for example Jason Zweig’s June 6 Wall Street Journal article, which raised serious questions about valuation practices at Hamilton Lane Private Assets Fund. In it, Zweig interviews Tim McGlinn, owner of The AltView, whose work continues to be a valuable resource for those interested in the structural dynamics of private markets. Zweig revealed Hamilton Lane’s use of a valuation methodology that enabled the Private Assets Fund to record generous mark ups on secondary investments — often within days of purchasing them. According to the article, the fund recorded significant markups shortly after acquiring positions — a method akin to purchasing a home for $1 million and then marking it up to $1.25 million based on an external estimate. Such a move, while not unheard of in private markets, may result in perceptions of artificially boosted returns. Yet, despite already earning a 1.40% annual management fee on nearly $4 billion in assets under management (AUM), Hamilton Lane proposed a notable change in March 2025: Shareholders were asked to waive the fund’s 8% preferred return hurdle and allow for the distribution of incentive fees on unrealized gains. This change resulted in a $58 million payment to management, a figure that appears to be heavily supported by the earlier described valuation approach. The motivations behind shareholder support for such a revision are unclear. However, the governance implications are significant. The move suggests a broader trend worth watching in the current market environment — one in which investor protections may be subordinated to fee extraction. McGlinn and Zweig‘s work underscores the need for vigilance and transparency, especially as private markets evolve to attract new classes of investors. While the Hamilton Lane Private Assets Fund targets individual investors, the underlying valuation and incentive dynamics mirror those seen across segments of the institutional private markets landscape. The Rhythm of History Can Be Felt in Private Markets Zweig’s article was unnerving but hardly surprising. This kind of behavior is typical in the late stage of a speculative cycle, and the United States has experienced many over the past 235 years. The first one occurred in 1791 when frenzied traders speculated in “scrip” granting them options to purchase shares in the initial public offering of stock in the First Bank of the United States. Americans have since experienced many more manias and crashes. Each episode felt unique at the time, but viewed across centuries, a familiar pattern emerges. In 2025, there are clear signs that this pattern is repeating in private markets — and that we’ve entered its most dangerous late stage. So, how did this happen? Private markets, which include investments such as venture capital, buyouts, real estate, hedge funds, and private credit, were all the rage among institutional investment plans over the past two decades. Mesmerized by the exceptional returns of the Yale University Endowment at the turn of the 21st century, trustees began shoveling substantial amounts of capital into these markets. Multiple red flags steadily emerged, but they were largely hidden by the slow passage of time. Today, there are seven red flags which strongly suggest that private markets are in the late stage of a classic speculative cycle. At best, this means they are severely overvalued; at worst, it means that at least some segments may qualify as a bubble. Signs of Late Stage Speculation: 7 Red Flags in Private Markets Red Flag #1: Widespread Acceptance of a Flawed Narrative There is no national price bubble [in real estate]. Never has been; never will be.[2] —DAVID LEREAH, chief economist of the National Association of Realtors Beneath the foundations of history’s worst bubbles were widely accepted narratives that ultimately proved to be dead wrong. In the 1810s, American farmers believed that wheat and cotton prices would remain at astronomical levels for many years. In the late 1920s, Wall Street speculators believed that using short-term debt to purchase stocks was safe because the markets would never suffer a sustained decline. In the late 1990s, Americans believed that any company with a “.com” placed after its name offered a sure path to riches. In the early 2000s, Americans believed that real estate prices would never decline on a national level. In the 2020s, it seems almost every institutional and individual investor believes that private markets offer a foolproof way to enhance returns and/or reduce portfolio risk. Few question the validity of this narrative despite mounting evidence that not only is it unlikely to be true in the future, but there is also strong evidence that it failed to materialize in the past. A paradox of investing is that speculative excesses happen only when most investors believe they can’t happen. It is reminiscent of a famous scene in the movie The Usual Suspects, when a shadowy villain Keyser Söze explained how the myth of his existence enabled him to achieve maximum surprise. After completing his crime spree, Söze ended the movie by declaring, “The greatest trick the devil ever pulled was convincing the world he didn’t exist.” Speculative episodes thrive under similar conditions. Red Flag #2: Presence of a Complacent and Siloed Supply Chain What are the odds that people

The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance. 2021. Eswar S. Prasad. ‎The Belknap Press of Harvard University Press. Today, you can’t turn on the television or the radio without hearing an ad for cryptocurrencies or crypto exchanges. Numerous celebrities are touting crypto trading platforms, including professional athletes LeBron James and Tom Brady and actors Matt Damon and Larry David. Are cryptocurrencies the next big investment, a fad, or a currency that will transform the economic and financial landscape? What are some of the advantages and shortcomings of digital currencies? Who will benefit from these new currencies? Eswar S. Prasad attempts to address these questions in The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance. Prasad, the Tolani Senior Professor of Trade Policy at Cornell University and the author of several books on currencies, provides an interesting and insightful exposition on the shifting landscape from traditional paper notes to digital currencies. Prasad begins his discussion of the future of money with a quote from Cecilia Skingsley, the deputy governor of Sweden’s central bank: “If you extrapolate current trends, the last note will have been handed back to the Riksbank by 2030.” Skingsley is not the only government official who sees a grand future for digital currencies. China is another country that has been moving away from paper currency. In the United States, President Biden, recognizing the importance of new digital assets, signed an executive order to ensure digital assets’ responsible development in March 2022. The book is divided into four parts. Part I, “Laying the Bedrock,” looks at the future and promise of digital currencies and provides an introduction to finance for those with little background. Part II, “Innovations,” focuses on the history of fintech and the crypto revolution. Part III, “Central Bank Money” makes a case for central bank digital currencies (CBDCs). Part IV, “Ramifications,” considers the potential consequences for the international monetary system. The “Innovations” section of the book begins with a chapter titled “Will Fintech Make the World a Better Place?” Here, the author takes us through the history of fintech, which he points out is a catchall term for novel financial technologies. It was first coined in 1993 with Citicorp’s creation of the Financial Services Technology Consortium. However, some innovations, such the ATM, have become so ubiquitous that we forget these were once novel technologies. The history includes an interesting look at newer innovations, such as M-PESA, which allowed individuals in Kenya to conduct banking through a mobile phone, as well as peer-to-peer lending, crowdfunding, and on-demand insurance. Many of these new services will pose challenges to traditional financial services companies. Today, fintech is most closely associated with cryptocurrencies, such as bitcoin and Ethereum. However, a discussion of cryptocurrencies cannot begin without understanding the blockchain and how this technology is transforming business and finance. Blockchain technology has been touted as the future of finance and of numerous other areas of business, including securing of medical records, non-fungible token (NFT) marketplaces, and supply chain and logistics monitoring. Most investment professionals will be aware of the blockchain and the concept of a decentralized ledger across a peer-to-peer network, but many may not understand the technology thoroughly. Prasad provides a detailed but accessible explanation of how the blockchain works, from its historical origins to the technology underlying the system. The term “blockchain” is associated with a variety of cryptocurrencies. However, the protocols used to validate transactions differ for various blockchains. Furthermore, each protocol has advantages and weaknesses. Will many alternative protocols continue, or will one emerge as the standard for the industry? Bitcoin uses a “proof-of-work” protocol to validate transactions, which requires block creators, known as miners, to solve a randomly generated cryptographic problem. The approach allows transactions to be validated without a trusted third party. However, this method requires significant computing resources, which need large amounts of electricity to power the computers. Another downside of this approach is that it allows only a relatively small number of transactions to be validated simultaneously. Ethereum uses a “proof-of-stake” protocol. Proof of stake was created to deal with some of the inefficiencies of the proof-of-work approach. Here, the privilege of validating a block is based on how much has been “staked” by competing nodes. However, as Prasad points out, this less resource-intensive approach is not without its shortcomings. Prasad debunks some of the myths of crypto and other digital currencies. For example, many view using cryptocurrencies, such as bitcoin, as a way to maintain anonymity. The reality is that, unlike cash, digital currencies require identifiers for consumers to receive the goods purchased with digital currencies, which removes the anonymity. Blockchain has also been viewed as a secure technology. Although this technology offers greater security than other methods, Prasad points out ways that individuals can hack the various protocols. Like all new technologies, the fintech revolution has brought with it a whole new language to define the new offerings, including hashing, security token offerings (STOs), smart contracts, initial coin offerings (ICOs), hash time locked contracts (HTLCs), and stable coins. The Future of Money allows investors to learn the new vernacular of this field and consider which innovations may offer the greatest investable opportunities. Reading through the book is unlikely to provide any insights into how to value cryptocurrencies or how digital currencies, such as bitcoin, are likely to replace government-issued money as a store of value, a medium of exchange, or a unit of account. However, Prasad offers a glimpse into the potential for digital currencies in the chapter “The Case for Central Bank Digital Currencies.” He maintains that CBDCs can improve efficiency on the wholesale side by improving the way central banks distribute reserves to commercial banks for payment, clearing, and settlement. On the retail side, CBDCs may offer several benefits, including providing a backup payment system, promoting financial inclusion, and improving monetary and fiscal policy. Although these chapters may seem to be of greater interest to monetary economists and central

Activist investor interventions with small, newly public companies can improve their stock performance, a Financial Analysts Journal study finds. In “Shareholder Activism in Small-Cap Newly Public Firms,” Emmanuel R. Pezier and Paolo F. Volpin analyze a private dataset of a UK fund’s engagements with small-cap newly public firms and demonstrate that “behind-the-scenes” engagements resulted in 8% to 10% in cumulative abnormal returns. They attribute these returns to engagements, not stock picking.  I spoke with Pezier, an associate scholar at Saïd Business School, University of Oxford, for CFA Institute Research and Policy Center for insights on the authors’ findings and to produce an In Practice summary of the study. Below is a lightly edited and condensed transcript of our conversation. CFA Institute Research and Policy Center: What is new or novel about this research?  Emmanuel R. Pezier: I suppose there are two novel elements. First, we study small-cap recently IPOed companies. So, the question is, Does the activism “magic” work in small companies, as we already know it does in large-cap firms? And we are bringing entirely new and previously private data into the literature to test that question. Why are small-cap IPOs interesting? Well, they are very important to the functioning of the wider economy, so studying them, their agency and liquidity problems, and how these problems might be resolved by shareholder activism seems worthwhile.  Second, the activist we study is highly unusual in the way it raises its funds. A traditional activist fund, or regular fund, for that matter, raises cash from investors on day one, then uses that cash over time to invest in firms that it chooses, using its stock-picking and activist engagement skills to generate returns. But then the natural question is, How much of their returns has to do with their stock-picking ability and how much of it has to do with their activist interventions? By contrast, the fund we study receives unwanted stock holdings — for example, payments in kind, rather than cash — from investors on day one. And, importantly, it has no say in which stocks it receives. Hence, the returns are unlikely to be due to stock picking, as there is none, and more likely to be due to activism. So, we get a slightly cleaner shot at measuring “how much” the activism magic works.  What motivated you to conduct the study?  We wondered if the kind of activism techniques that are used by high-profile hedge funds in large-cap companies happen in small-cap companies and if they are effective in generating returns. And we answer those questions. The answer is yes, they are, and yes, they are effective.  What are your study’s key findings? There are good returns to be had by engaging with the management of companies that have recently gone public and that are small. And the returns attributable to interventions in these small-cap companies are large. We can’t really generalize and say this type of activism happens on a widespread basis. All we can say is that the fund that we study is intervening behind the scenes and achieving good results, which suggests that activism works in small-cap stocks, like we already know it does in large-cap stocks. Who should be interested in your study’s findings, and why?  I think anyone who has invested in small-cap IPOs could be interested in this paper. Large institutions are being asked to buy more and more of these, oftentimes “premature,” small-cap IPOs because of changes in stock market regulations aimed at encouraging capital formation in young, high-growth entrepreneurial companies. This isn’t going away if you’re an institutional investor — if anything, you are likely to be facing more and more of these IPOs in the years to come. In what ways can the industry use the research findings?  The research delivers insights into how to engage with small firms that have high levels of insider ownership — meaning the scope for agency conflicts is high. These insights should be of value to institutional investors that routinely invest in small-cap IPOs but might lack experience in shareholder activism. What follow-on research does your study encourage or suggest?  Future researchers may wish to examine activist engagements that exploit potential “fault lines,” such as gender, ethnicity, or nationality, which may exist within the board or senior management. In our study, we find that fault lines may exist between the chair and CEO when one of the two is the founder of the firm and there is a large age gap between the two individuals. We believe these fault lines help explain why certain engagements become confrontational and why confrontational engagements unlock the largest returns. For more on this subject, check out the full article, “Shareholder Activism in Small-Cap Newly Public Firms,” from the Financial Analysts Journal. If you liked this post, don’t forget to subscribe to Enterprising Investor and the CFA Institute Research and Policy Center. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images / Buena Vista Images Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source

Investors’ faith in the genius of private equity (PE) fund managers has reached ever greater heights amid new records in fundraising, deal volume, and asset valuations. These trends have continued in 2022 despite — or perhaps because of — worldwide public market losses. Aside from maximizing fee income, the ultimate goal of leveraged buyout (LBO) operators is to optimize returns on the capital they manage on behalf of LP investors. While the subtlety of the craft is not restricted to financial tricks, success in PE has long been marketed via masterful delivery and finessing of the internal rate of return (IRR). What’s in an IRR? PE firms have a repertoire of tools at their disposal to achieve their target returns. The following drivers represent the five pillars of value creation from the fund manager’s standpoint: 1. Maximize Leverage at Inception and Refinance the Capital Structure Frequently That is, recapitalize by raising further debt in order to pay out dividends — hence the term “dividend recap.” With this move, the PE firm partially realizes its investment. This can be controversial. Excessive indebtedness and frequent recapitalizations can stretch a borrower’s balance sheet and inhibit its ability to meet loan obligations or adequately fund growth. 2. Complete Bolt-On Acquisitions This is best performed at lower entry multiples than that originally paid to buy the portfolio company, which makes these add-ons value accretive. Value can then be harvested through the synergies accomplished by merging the acquirer and the targets. This is often the main rationale of buy-and-build strategies for LBOs in the $50 million to $500 million enterprise-value range. 3. Improve Performance and Bolster Cash Flows This is vital during the ownership period. Operational gains can be effected by: Increasing margins through better cost management — relocating production facilities to lower-cost countries, for example — and economies of scale by growing volume. Boosting cash generation by reducing working-capital requirements, cutting capital expenditures, minimizing cash leakage, and entering into sale and leaseback agreements. Discontinuing or disposing of unprofitable or low-margin activities. This practice earned some early LBO players the moniker “asset-stripper” and was common in the 1970s and 1980s when conglomerates with unrelated and underperforming divisions were sold off piecemeal. Nowadays, few targets suffer from the same lack of focus. Growing sales through refined price point strategies, new product launches, etc. 4. Aim for Positive Multiple Arbitrage This implies exiting a portfolio company at a higher valuation multiple than the one paid at the initial investment stage. Such arbitrage depends on the economic cycle. In up cycles, PE managers will emphasize their skills in securing any gain. When such arbitrage turns negative, however, they will blame poor market conditions. Frankly, multiple expansion is heavily cycle-dependent. 5. Optimize the Investment Holding Period This is perhaps the most important pillar. Because of the time value of money, most fund managers seek to partially or completely exit investments as soon as they can. What is meant by the time value of money? That time holds value and that a dollar today is worth more than a dollar a year from now. Why? Because that dollar can be put to work for the next 12 months, earning interest or, through productive investments, growing into more than one dollar over the course of the year. It can also lose some of its purchasing power due to increases in the cost of living over the same period — a critical point today amid rising interest rates and high inflation. This value driver also explains why financial sponsors are obsessed with dividend recaps. While all experienced PE firms place this parameter at the core of their investment strategy, it is both controversial and paradoxical. How can PE firms claim to be long-term value creators if they seek a quick exit at the first opportunity? Early portfolio realization, whether full or partial, greatly contributes to superior returns. Building the Value Bridge PE firms include a graph called the “value bridge” in private placement memoranda. Fund managers use these documents to raise money by demonstrating how they will apply the above factors to create value for their LP investors. One of my previous employers, Candover, was a top-10 European PE shop before being liquidated four years ago. Candover used slightly different metrics from the five pillars listed above in its value bridges, preferring to break out value accretion across four dimensions: sales growth, margin improvement, cash generation, and multiple arbitrage, or some combination thereof. Using this procedure, a value bridge might resemble the following graph: Vintage Fund 2012: Hypothetical Value Bridge, in US$ Millions Without precise methodologies to apportion value across the various drivers, value bridges can be constructed and calculated in countless ways. In its 2016 “Evaluating Private Equity’s Performance” report, KPMG outlined a value bridge that only analyzed value creation across three dimensions: increase in EBITDA, increase in multiple, and change in net debt and interim distributions. The Swedish investment group EQT gave a pithy indication of how portfolio value enhancement was derived in its 2019 IPO prospectus, explaining that “98 percent . . . resulted from company development (i.e., sales growth, strategic repositioning and margin expansion) versus 2 percent from debt repayment.” When going public last year, the UK firm Bridgepoint stated that “From 2000 to 2020, an estimated 77 per cent of value creation across profitable investments has been driven by revenue growth and earnings improvement . . . with a further 25 per cent driven by multiple expansion at exit as a result of the repositioning of portfolio companies for growth and professionalisation, slightly offset by (2) per cent from deleveraging.” Watch Out for the Downturn Excluding loss-making investments from the value bridge is a common trick among fund managers to massage performance reporting. Candover rationalized this behavior, stating that “attributing the loss of value to the different value drivers would be an arbitrary exercise.” It failed to explain why attributing the gain of value to different value drivers wouldn’t itself be arbitrary! Bridgepoint’s public filing describes “value

Disregard all the hype around crypto in general and bitcoin in particular. Blockchain represents the real opportunity that investors should be talking about. The post Let’s Talk Blockchain, Not “Crypto” appeared first on CFA Institute Enterprising Investor. source

Three investment return trends related to the green transition concern me. These apply across all sectors but to automotive in particular. Here is how I see it. 1. Pricing is challenging. The strong automotive demand during the COVID-19 pandemic was fueled largely by wealthier customers and is on the wane, especially for electric vehicles (EVs), which are often second vehicles priced as premium products. Until recently, automakers experienced bottlenecks with their finely tuned production systems. The mismatch between supply and demand adjusted pricing upward to reestablish equilibrium. Cheap financing and a shortage of used vehicles exacerbated this trend. According to Kelley’s Blue Book, US EVs cost US$58,940 on average in March 2023, around $11,000 more than their counterparts with internal combustion engines (ICEs). Despite the 30% increase in new vehicle prices during the pandemic, the monthly lease payments and consumer end cost was lower. This “goldilocks” scenario is now unwinding, with interest rates climbing, residual values falling, and supply chain bottlenecks dissipating. Incentives have sent new car prices lower, especially for EVs. As additional supply hits the market, we can expect a broader mix of lower priced vehicles. And that is before Chinese EV manufacturers with spare capacity more fully enter global EV markets. Historically, the first sign of automotive market weakness tends to manifest in the much larger used vehicle market. Despite the limited supply of prime off-lease vehicles during the pandemic, used vehicle values in the United States have clearly headed south after a period of extraordinary strength. US Used Vehicle Pricing Turned Negative in Late 2022Manheim US Used Vehicle Value Index Source: Cox Automotive Manheim Tesla was the first automaker to recognize that the COVID-19 auto bubble had burst. Despite government incentives — the US government’s Inflation Reduction Act (IRA) offers up to US$7,500 to entice consumers — EV pricing is still a constraint for many purchasers. China is now by far the largest EV market and is also globally dominant in related industries. A recently launched BYD Seagull EV with a range of 300 kilometers and base price of US$11,300 demonstrates this. Pricing pressure in the Chinese market is intense, making exports an attractive outlet. According to Automotive News China, Ford’s Mach-E electric crossover’s starting price in China is US$30,500. That is now a third cheaper than the Mach-E’s price tag in the United States. 2. Supply is plentiful. With automotive industry supply chain disruptions largely in the rearview mirror, EVs are now readily available for purchase. Amid a continued focus on high inflation, automotive oversupply and deflation may be on the horizon. Chinese automakers pivoted a decade ago towards EVs as the government injected an estimated US$120 billion. By unleashing its excess capacity, China may lead in automotive exports for the first time in 2023. While Tesla continues to dominate the Western EV markets, it only controls around 10% of China’s. EVs are designed for global distribution in a way that ICE vehicles never were, since regional emission regulations are redundant. While there has been excitement about new EV entrants to the US market, BYD is the great pretender to Tesla’s global EV crown. Overtaking Tesla on sales of total EVs, including plug-in hybrid electric vehicles (PHEVs), in 2022, BYD has extended its lead in 2023, outpacing Tesla China by 29% in EV sales in the first six months. BYD Is the Largest Player in Global EV SalesEV Titans Sources: Bloomberg NEFBYD includes BEV and plug-in hybrid vehicles (PHEV); Tesla BEV only And supply is only going to keep increasing. The global addressable EV market grew from under 200,000 in 2013 to more than 10 million in 2022. Bloomberg NEF estimates EV sales will hit 35 million in 2030. Tesla plans to increase production to 20 million vehicles from 1.4 million today. According to Zach Kirkhorn, Tesla’s chief financial officer, the capital required to make that leap is US$175 billion over the next seven years. President Joseph Biden’s IRA offers $369 billion in green subsidies, and the CHIPS and Science Act $52 billion in funding for US chipmakers along with manufacturing tax credits worth about $24 billion. We have identified US$33 billion of announced individual EV investments related to the IRA through early 2023. That’s the equivalent of more than a decade of capital raising at Tesla. But this is just the start, according to Atlas EV Hub; vehicle manufacturers and battery makers plan to invest US$860 billion globally by 2030. Tesla Total Capital vs. IRA Motor Commitment Sources: S&P Capital IQ, Automotive News The North American market participants are planning what amounts to a big bang expansion for every step of the EV value chain. The accelerated pace of the expansion will eclipse Tesla’s capital allocation over the last two decades towards building 1.4 million units of global production per year in 2022. Tesla represents a 13% share of the global EV market, including BEV and plug-in hybrid electric vehicles (PHEV). Investment under the IRA, and the US$33 billion already committed by automotive producers, will likely lower returns on capital. Ford expects to lose around US$4.5 billion in 2023 on EVs, an enormous sum on limited production. While losses are typical in the early stages of a lifecycle, investors have to question the potential for positive returns on capital. 3. Will Investors Expect Higher Returns? Using Tesla’s current capital base of US$52 billion as a proxy, the US$860 billion of estimated investments would be the equivalent of 17 Tesla-sized firms. This would lead to substantial additional production capacity on top of stranded existing ICE capacity, with tepid global demand. Tesla took two vehicle generations to report a positive EBIT. Investors in EV production capacity may learn from past mistakes, but they are still likely to wait a vehicle generation, or seven years, before they see positive returns. Given recent price reductions and competition in China, that Tesla’s returns on capital may fall in 2023 is understandable, but we also wonder if the cost of capital will remain elevated. Tesla Has Made Steady Progress

Demand Destruction ≠ Disinflation Global central banks have made an “all-in” effort to front-load policy tightening to dampen demand. But softer economic data in the United States and the eurozone have exacerbated recession fears. As the growth outlook dims, many anticipate demand destruction to lead to lower inflation. That is, tighter monetary policy and the associated higher funding costs will cut into demand and offset the supply shortages resulting from geopolitical instability and supply chain disruptions. This view hinges on the belief that inflation outcomes are largely driven by central bank policies. However, “muted” inflation in recent years, especially during the 2014 to 2016 crude crash, has demonstrated inflation’s insensitivity to demand-side policies. Even the European Central Bank (ECB)’s quantitative easing (QE) in 2015 failed to stoke demand in a way that reduced excess supply. The US Federal Reserve’s dovish policy stance in the decade before the pandemic pushed the Atlanta Fed’s Wu-Xia Shadow Federal Funds Rate below zero multiple times, yet the Fed’s preferred price measure, personal consumption expenditures (PCE), was less responsive to such policy shifts than to the end of the Cold War or China’s entry into the WTO, among other catalysts. Personal Consumption Expenditures vs. Shadow Federal Funds Rate Sources: Federal Reserve Bank of Atlanta, US Department of Commerce, Kekselias, Inc. Similarly, recent quantitative tightening and rate hikes have not created enough demand destruction to counteract geopolitics-related commodity scarcity. Instead of following central bank policy over the last two decades, inflation largely co-moved with commodity prices, or both demand and supply-side factors. Eurozone, US, and UK Inflation vs. Commodity Index Sources: Eurostat, UK Office for National Statistics, US Federal Reserve, Bloomberg, LP, Kekselias, Inc. This casts doubts on the “rates-determine-activities-determine-inflation” framework and suggests that domestic monetary policy cannot lift or dampen inflation on its own. Other factors must come into play. 1. Fiscal Spending = Higher Demand Given QE’s long and variable trickle-down effect, pandemic-era policies sought to counter the demand shortfall by expanding balance sheets and through fiscal stimulus, or printing money and mailing checks directly to households. This drastically decreased the transmission time between central bank easing and realized inflation. The deployment of “helicopter money” rapidly revived demand. As pandemic disruptions eased, the anticipated fiscal tightening never materialized. Instead, fiscal-monetary cooperation became the norm and cash payments a regular policy tool. Following its Eat Out to Help Out Scheme, for example, the UK government announced a £15 billion package to send £1,200 to millions of households. As UK energy prices spiked, Liz Truss, the frontrunner to become the next prime minister, proposed an emergency fiscal spending package to ease the public’s financial stress. On the other side of the Atlantic, many US states have announced stimulus payments to soften the pain of high inflation, and President Joseph Biden has introduced a student loan relief program. The lesson is clear: Central banks are no longer the only game in town when it comes to economic stimulus. 2. Geopolitical Events = Supply Disruptions As multinationals regionalize, near-shore, and re-shore supply chains and prioritize resiliency and redundancy over cost-optimization, energy scarcity in the eurozone has created new disruptions. German chemical production is set to fall in 2022, that could export inflation abroad. As geopolitical instability contributes to domestic economic challenges and more fiscal stimulus is deployed, inflation may be much less responsive to traditional monetary drivers. Under such circumstances, a rigid framework equating tight monetary policy and high prices with demand destruction and disinflation will no longer be operable. For investors calibrating portfolio risks, such conditions may offset the disinflationary pressures of slowing growth. If you liked this post, don’t forget to subscribe to the Enterprising Investor. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Image credit: ©Getty Images / Pavel Muravev Professional Learning for CFA Institute Members CFA Institute members are empowered to self-determine and self-report professional learning (PL) credits earned, including content on Enterprising Investor. Members can record credits easily using their online PL tracker. source

Since its inception, the global financial system has evolved to manage increasing complexity with greater efficiency whilst its fundamental role as facilitator of Pareto-efficient resource allocation has remained intact. So successful has finance been in allocating resources that it has become a primary driver in the creation of negative externalities –- particularly environmental degradation — which pose a significant risk to future economic and social development. This blog post presents an advanced framework for seamlessly integrating “augmented intelligence” into investment decision-making processes. By leveraging a symbiotic relationship between human intelligence, artificial intelligence (AI), and sustainability, augmented intelligence seeks to redefine investment management paradigms. What is the Purpose of Financial Markets? Financial markets are complex adaptive systems (Lo, 2004). Their essential purpose consists of facilitating an efficient allocation of resources among their participants (Mishkin, 2018; Ross & Westerfield, 2016; Fabozzi & Modigliani, 2009). This purpose has not changed since Luca Pacioli introduced double-entry bookkeeping in 1494, the first stock exchange was launched in Amsterdam in 1602, or the interpretation of efficient allocations became standardized and scalable through Harry Markowitz et al. in 1952. What has changed throughout financial market history is the degree of complexity participants have had to master to achieve an efficient allocation. This degree of complexity is determined by the scope of the system and the dynamics within it. Humanity has extended the scope of factors to be considered for an efficient allocation decision over time. Financialization, globalization, and digitization have been dominant drivers in this extension of scope. Today, market participants can allocate their resources across a global capital stock of $795.7 trillion (Vacchino, Periasamy, & Schuller, 2024), which is unprecedented in human history. To master the increased dynamics within the system with its widened scope, market participants have had to adapt their interactions, evolving their traditional belief systems about markets to apply more insightful assessment techniques that seek to understand market complexity. This shift has led to a focus on which behaviors best contribute to integrating different sources of evidence into decisions at the point of allocation. Reasoning has morphed from deductive to inductive (Schuller, Mousavi, & Gadzinski, 2018), leading to an ever more accurate assessment of the dynamics within the financial system. Complex systems produce emergent phenomena, properties that can only be studied at a higher level. The intricate, non-linear interactions between the components of complex systems give rise to new, often unexpected properties or behaviors that cannot be explained simply by examining the system’s individual parts. Emergence is thus a natural consequence of complexity, where the whole becomes more than the sum of its parts. A primary emergent property in the history of financial markets is the dominance of humankind over nature, which came to the fore following the Scientific Revolution in the late 15th century. This dominance has led to an unprecedented density of breakthroughs by humankind, equipping itself with ever more refined and scalable tools to master complexity. Mastering Planetary Time Through Financial Systems As is common for complex adaptive systems, what started as a side effect — a negative externality — has turned into a dominant factor influencing the system. Currently, the financial system is learning how to integrate factors beyond a human-centered worldview. We have entered an era when time is no longer differentially distributed along human and non-human scales. Planetary Time represents the synchronization of human and ecological temporalities, a concept essential for addressing climate change and resource exploitation. As facilitators of capital flow, financial markets are uniquely positioned to drive this synchronization. This requires a paradigm shift from short-term profit maximization to sustainable, long-term value creation. With the necessity for humankind to reintegrate into the homeostasis of planet Earth, the purpose of financial systems — namely facilitating an efficient allocation of resources among its participants — is set in a new context. This leads to the question of how to design a financial system that adopts augmented intelligence (AI, human intelligence, and sustainability) to master the era of planetary time? Academia and practitioners are treating these three elements in silos and is acting too slowly to break through those walls to integrate them into a holistic decision design. What is the status quo for each silo? Human Intelligence in Investment Management Over the past 40 years, behavioral finance has advocated for evidence-based decision-making. We now know significantly more about the quantity of biases and why we tend to make investment decisions full of noise and bias. We have not done enough to help participants in the global financial ecosystem bridge the knowing-doing gap, however, which is essential for accelerating the diffusion of innovation. Either professional investors tend to talk more about behavioral finance than make use of its insights, or debiasing cognitive biases only has a temporary effect (Gadzinski, Mousavi, & Schuller, 2022). What has become more prominent academically is the focus on applied behavioral considerations, such as behavioral design configurations. The intent is not only to raise awareness of cognitive dissonances and their effects, but also to make it easier for decision-makers to improve such configurations with low cognitive effort. Awareness training has proven to be ineffective because it is too superficial in its impulse to facilitate behavioral change (Fleming, 2023). Alternatively, high-performance principles for designing an investment decision support system that produces evidence-based decisions are increasingly being explored (Schuller, 2021). Sustainability in Investment Management Sustainability considerations in the financial system are a possible gateway for augmented intelligence to create the impact in the real economy that is needed to reintegrate humankind into the homeostasis with planet Earth. These considerations have a long, though not critically impactful, history in finance. Many investment leaders recently have embraced sustainable development goals (SDG)-driven investing as a must have for the practice of good investment management. The road to necessity has taken decades to build (Townsend, 2020). However, a compliance-driven approach often relegates sustainability to administrative burdens rather than core investment strategies. What policymakers and regulators have only recently accepted is their inability to be the primary driver to initiate,

Europe is rearming at an unprecedented pace — and the investment implications are just beginning to unfold. After decades of post–Cold War retrenchment, defense budgets across the continent are rising sharply, driven by renewed focus on European security. What began as a response to Russia’s invasion of Ukraine has evolved into a broader economic and industrial transformation. For financial analysts and investors, this shift presents a rare convergence of macro transformation and micro opportunity. As defense spending becomes a pillar of EU economic policy, it is reshaping fiscal dynamics, deepening capital markets, and driving significant revaluation in the defense and aerospace sectors. Understanding how national strategies intersect with EU-level initiatives like ReArm EU will be critical for assessing sovereign risk, sector exposure, and long-term positioning in European portfolios. This post examines how Europe’s defense spending accelerated after Russia’s invasion of Ukraine, with further momentum in recent months. It explores the rollout of the ReArm EU initiative, changes to national budgets and fiscal rules, and how these policy developments are reshaping market opportunities across the continent. ReArm EU: Coordinating Defense, Reshaping Capital Flows A decisive increase in defense spending began in 2022. In March 2025, the European Commission unveiled the ReArm EU program, aiming to mobilize €800 billion for European defense this decade. Rather than a single fund, ReArm EU is a package of measures to reshape defense financing in the EU. First, the EU proposes exempting defense investments from deficit limits, giving member states greater fiscal flexibility. This could unlock an additional €650 billion in national defense spending over four years. It may also boost demand across the continent, including in countries that do not increase spending directly. The plan includes €150 billion in EU-backed loans to support joint investment in air and missile defense, artillery, drones, cyber defense, and military mobility. The aim is to reduce costs, achieve scale, and expand Europe’s capacity to produce essential weapons systems. The financing mechanism would leverage the EU’s common budget by using unused capacity to back EU bond issuance. Some member states remain cautious about common borrowing and the potential shift in fiscal authority to Brussels. The European Commission also proposes redirecting economic cohesion funds to defense and encouraging private investment, including through the European Investment Bank. Security is increasingly seen as essential to economic stability. Instruments like the European Defence Fund (for R&D) and the European Peace Facility (which reimburses members for arms sent to Ukraine) support collective efforts. The broader goal is to strengthen Europe’s defense industrial base and reduce fragmentation. Many EU militaries use different equipment, creating inefficiencies. Initiatives like ReArm EU and the PESCO framework promote joint development and procurement. A more integrated European Defense Technological and Industrial Base (EDTIB) would improve readiness and keep more procurement within the EU. As of 2023, only 18% of EU defense procurement was done jointly, well below the 35% benchmark. This push represents a continent-wide industrial policy shift. In 2024, defense investment exceeded €100 billion, or 30% of all EU defense spending, marking a shift toward procurement and R&D over personnel and legacy systems. National Defense Budgets: Fragmentation Risk? While the EU promotes coordination, fragmentation persists. Europe’s defense industry remains largely national, with limited cross-border integration. Countries differ in their procurement strategies and defense priorities. Poland is NATO’s fastest-growing defense spender, with its budget projected to reach 4.7% of GDP in 2025. Finland and Sweden, both now NATO members, have increased spending to 2.4% of GDP. Sweden aims to reach 3.5% by 2030. France plans a 30% nominal spending increase by 2030. Germany’s shift has been especially notable. Long known for modest military spending and strict budget rules, Germany announced a “Zeitenwende” (turning point) after the Ukraine invasion. It established a €100 billion fund to modernize its military and pledged to exceed 2% of GDP in defense spending. Its defense budget has nearly doubled to €70 billion since 2021. A more recent plan outlines a €500 billion multi-year commitment that would make Germany’s military among the world’s largest. Investors view this increase in debt-financed spending as a potential shift toward Europe becoming a more credible safe haven with some reduction in perceived geographic equity risk. Market Implications of the Defense Spending Surge The increase in European defense spending has long-term implications for markets. For investors, both national and EU-level initiatives open new opportunities in defense. European aerospace and defense stocks have rallied since 2022, with additional gains following recent political developments. Higher defense budgets imply growth for contractors, infrastructure, and innovation in aerospace and cybersecurity. Order backlogs are growing and valuations are rising. At the macro level, rising defense budgets and relaxed fiscal rules will likely lead to higher deficits. Yet this new wave of spending may support growth and counterbalance global trade headwinds. The EU’s growing role as a debt issuer could deepen capital markets integration and enhance the euro’s status as a reserve currency. At the micro level, European defense and aerospace firms stand to benefit significantly. Germany’s Rheinmetall, France’s Dassault, and Airbus have seen strong demand. Italy’s Leonardo and the UK’s BAE Systems are expanding contracts and production. As margins widen and investor sentiment improves, these firms may become a lasting feature in industrial portfolios. Key Takeaways For financial analysts and investors, the rise of defense spending in Europe is more than a policy shift — it’s a structural re-rating of risk and opportunity across the continent. At the macro level, increased public investment could provide a countercyclical buffer to trade-related headwinds, while deepening euro-area capital markets through expanded sovereign and EU-level debt issuance. At the micro level, European defense contractors stand to benefit from years of elevated spending, with growing backlogs, pan-European procurement, and a new wave of industrial policy support. The challenge ahead is assessing how durable this rearmament trend will be and whether national divergence or EU coordination will shape the defense sector’s next phase. Either way, defense may be emerging as a new strategic pillar of European growth and a critical theme for

It’s been only a little more than a month since the US Presidential election, and already analysts’ heads are spinning over the potential impact of trade policy. President-elect Trump has made numerous tariff threats, leaving researchers to wonder which, if any, he’ll follow through on — and what the consequences for asset prices might be. Academic economists overwhelmingly dislike tariffs for a variety of reasons. Chief among them is that they help the few at the expense of the many and likely sap long-term economic growth.[i]   Recent research suggests that the targeted tariffs in 2018 and 2019 had only a brief effect on financial markets.[ii] In a Liberty Street blog, economists at the New York Fed showed that large-cap US equities responded negatively to tariffs imposed during the first Trump Administration at the time of their announcement, but not before. [iii] That is when tariffs hit, stocks fell, at least for a time. Specifically, researchers found that US stocks fell on the day tariffs were announced (tariff day), and that this change was robust to other economic news that might plausibly affect stock prices. In this blog, using a similar but simpler approach, I extend parts of their analysis to small-cap US equities and small-cap equities in major foreign markets. I explicitly show the change in response to tariffs of a safe asset (the 10-year US Treasury) and expected volatility (as proxied by the VIX). Additionally I test the claim that average returns on tariff announcement days were indeed different from non-tariff-announcement days. I confirm that tariff announcement days were indeed bad for equities, here and abroad. Safe-haven assets (proxied by the U.S. 10-year Treasury) protected capital, just as an investor would have hoped. Tariffs also appear to have had no lasting effects on expected US stock market volatility. The VIX reverts to pre-tariff levels quickly after a tariff shock. These responses are unlikely to have happened by chance — though we can’t rule out possible bias. My analysis is performed in R, and data used is available from Yahoo Finance and FRED. Tariff dates are taken from the New York Fed’s blog.[iv] For those who want to replicate or change the analysis, R Code is available online. What Happened on Tariff Day? Table 1 shows, by tariff day date, the one-day price-return percentage change for the S&P 500 index (sp_chg), the Russell 2000 index (rut_chg), the FTSE 100 index (ftse_chg), the DAX index (dax_chg), the Nikkei 225 index (nikkei_chg), and the Hang Seng index (hsi_chg) on the 10 days Tariffs were imposed. In the case of the VIX (vol_chg) 10-year U.S. Treasury (ten_chg), differences in levels are used. On some tariff-announcement dates, certain foreign markets were closed, in which case returns were “NA.” Tariff announcements on average coincided with falling equity markets, rising 10-year US Treasury prices, and heightened expected volatility, as the New York Fed’s researchers found. Table 1. What happened when the 2018 and 2019 tariffs hit. date sp_chg rut_chg ftse_chg dax_chg nikkei_chg hsi_chg vol_chg ten_chg 2018-01-23 0.217 0.345 0.213 0.712 1.292 1.659 0.070 -0.030 2018-03-01 -1.332 -0.335 -0.778 -1.969 -1.558 0.647 2.620 -0.060 2018-03-22 -2.516 -2.243 -1.227 -1.698 NA -1.093 5.480 -0.060 2018-03-23 -2.097 -2.189 -0.442 -1.767 -4.512 -2.452 1.530 -0.010 2018-06-15 -0.102 -0.048 -1.698 -0.737 0.498 -0.429 -0.140 -0.010 2018-06-19 -0.402 0.058 -0.359 -1.217 -1.772 NA 1.040 -0.030 2019-05-06 -0.447 0.059 NA -1.014 NA -2.898 2.570 -0.030 2019-05-13 -2.413 -3.178 -0.550 -1.519 -0.720 NA 4.510 -0.070 2019-08-01 -0.900 -1.515 -0.025 0.526 0.090 -0.763 1.750 -0.120 2019-08-23 -2.595 -3.088 -0.466 -1.154 0.402 0.501 3.190 -0.100 MEAN -1.259 -1.213 -0.593 -0.984 -0.785 -0.604 2.262 -0.05 Source: Yahoo Finance, FRED Effect Significance The changes in Table 1 appear large, but they could be due to chance. To strengthen the main finding that tariffs are bad for stocks, at least in the short run, I estimate models of the form: Daily Change = Constant + Tariff + Error, where Tariff is a dummy variable using simple linear regression. Results from this comparison of means are reported in Table 2. Estimates of the effect of tariffs are shown in the first row (Tariff), while average returns on non-tariff days are shown in the second row (Constant). Standard errors are in parenthesis below each estimate, and significance is denoted by asterisks using the typical convention, as explained in the table note.   Mean values in the last row of Table 1 are of course exactly equal to Tariff coefficient plus constant estimates in Table 2. We didn’t need to run regressions to estimate the mean effect. Rather, the value in this exercise is in the error estimates, which allow us to determine significance. Table 2. Regression results. Dependent variable sp_chg rut_chg ftse_chg dax_chg nikkei_chg hsi_chg vol_chg ten_chg Tariff -1.321*** -1.258** -0.605* -1.022*** -0.818* -0.585 2.273*** -0.053*** (0.394) (0.506) (0.343) (0.390) (0.461) (0.522) (0.660) (0.018) Constant 0.062** 0.045 0.013 0.038 0.033 -0.019 -0.011 0.001 (0.030) (0.038) (0.025) (0.030) (0.033) (0.037) (0.050) (0.001) Observations 1,743 1,743 1,679 1,689 1,549 1,589 1,743 1,742 R2 0.006 0.004 0.002 0.004 0.002 0.001 0.007 0.005 Note: *p<0.1; **p<0.05; ***p<0.01 Source: Yahoo Finance, author’s regressions The effect of tariff announcements on large-cap stocks is highly significant (t-statistic = 3.4), while the effect on small-cap stocks is less so (t = 2.5). The accuracy of the estimate of foreign markets to tariff announcements is a mixed bag. Only the DAX’s response estimated remotely accurately (t = 2.6). Interestingly, Hang Seng index mean returns aren’t different, statistically, on tariff announcement days. On these days, tariffs appear to hurt US and other developed-market equities more than Chinese equities. Meanwhile, reactions of safe assets (t = 2.9) and volatility (t = 3.4) to tariffs are of the expected sign and reasonably strong. (Technical note: using “robust” standard errors doesn’t change these conclusions). The skeptical reader may still question causality. My simple model has no controls. I haven’t attempted to rule out other possible influences on the dependent variable. The New York Fed’s researchers, however, did do this — admittedly only for US equities — and it didn’t