The US economy has weathered numerous shocks, leading investors to believe it's invulnerable. This growing complacency is a significant risk, as it discourages proper hedging and preparation for the next crisis. When a new shock inevitably hits, its impact could be magnified, especially with limited fiscal space for a government rescue.

Years of low interest rates encouraged risk-taking, resulting in a large pool of low-rated loans (B3/B-). Now, sustained higher rates are stressing these weak capital structures, creating a boom in distressed debt opportunities even as the broader economy performs well.

The most imprudent lending decisions occur during economic booms. Widespread optimism, complacency, and fear of missing out cause investors to lower their standards and overlook risks, sowing the seeds for future failures that are only revealed in a downturn.

The credit market appears healthy based on tight average spreads, but this is misleading. A strong top 90% of the market pulls the average down, while the bottom 10% faces severe distress, with loans "dropping like a stone." The weight of prolonged high borrowing costs is creating a clear divide between healthy and struggling companies.

The market is not heading for a 2008-style crisis with massive default spikes. Instead, it will experience a sustained period of 3-5% default rates for several years. This cumulative "slow burn" will be painful as many over-leveraged companies, financed in a zero-interest-rate environment, face restructuring.

While corporate bond yields seem attractive, this is almost entirely due to high government rates. The actual credit spread—the premium investors receive for taking default risk—is at a multi-decade low. Investors are being poorly compensated for the risk they are taking on corporate balance sheets.

Historically, lower-quality credit cycles involved periods of high returns followed by giving all the gains back in a downturn. Post-GFC, the absence of a sustained recession has allowed private credit to outperform high-quality bonds by 7% annually without the typical "give it all back" phase, masking latent risks.

Traditional analysis focusing on BBB-rated companies with negative outlooks misses significant risk. Data since 2010 shows roughly 50% of companies falling from investment grade to high yield did not have these obvious warning signs, making credit risk assessment more complex.

Persistently low high-yield credit spreads, despite global turmoil, don't signal corporate health. This is a structural market shift where the riskiest debt has migrated from public markets to the opaque world of private credit, artificially suppressing spreads and hiding true risk.