Stability begets Instability as surely as Day follows Night
Monthly Market Commentary: August 1, 2017
Recently, a Bloomberg column by Alberto Gallo caught my attention for its insights about the “Minsky Moment.”
According to Gallo, "In his theory on financial markets' fragility and instability, the late Hyman Minsky argued that ‘from time to time, capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out of control.’ Following the 2008 crisis, he inspired the term ‘Minsky moment’ to describe a sudden market collapse that follows the exhaustion of credit."
Gallo thinks that, "Today, we may be approaching a second Minsky moment. After the 2008 debt crisis, central bankers reacted with unconventional tools. If the problem was excess debt, the remedy applied was to lower interest rates and buy large quantities of it. Quantitative easing helped to avoid an even deeper recession, but it didn't solve the root causes of the crisis. Global debt levels are up 276 percent in the last decade to $217 trillion, or 327 percent of GDP, according to the Institute of International Finance. But this time around the issue isn't only excess debt – it is also that prolonged loose monetary policy may have left us with at least three collateral effects. The first is a misallocation of economic resources. By keeping rates at record-low levels, central banks have made it easier for inefficient firms to survive, as in a rising tide that lifts all boats. The second is a rise in wealth inequality, where the wealth effect from rising asset prices benefited asset owners and the old more than the young and the poor. The third is a suppression of risk premia and volatility across financial markets.”
I agree with most of what Gallo has to say, except that there is actually a lot of volatility already, which manifests itself in different asset prices simultaneously (except in the S&P 500), which has produced some unpredictable results. If you consider how the asset purchases of the ECB and the BoJ have vastly exceeded the Federal Reserve’s balance sheet expansion in 2016 and 2017, you would have assumed in advance US dollar strength and not US dollar weakness (though since the beginning of the year, this report has repeatedly argued that the US dollar was grossly overvalued).
The point is that we had plenty of volatility already within stock, commodity, bond and currency markets. The US dollar and the Euro are the world’s most actively traded currencies and between May of 2016 and the end of the year, the Euro lost more than 10% against the US dollar. This year the Euro has recovered and has so far gained 12%. Given the size of this market and its economic and financial importance I would regard these movements as very volatile.
I am actually bringing up the subject of volatility because some investors will argue that markets no longer make any sense. To this I would respond that frequently markets will move "without making sense" at the time of the initial move. But later, when we look back at market moves they make perfect sense. Therefore, when I see such a large move of the Euro against the US dollar I ask myself if the market is not implying that the Fed’s rhetoric about tightening monetary conditions is just what it usually is in the case of central banks: empty talk by some "ignoranti" with no or little action following through.
In the next twelve months, making money from equities will become trickier than in the first seven months of this year as some sectors, markets, and individual stocks do well while others decline. In the US, I would expect the FANG and related stocks to perform poorly, whereas mining, fertilizer, and commodity related companies (including oil) perform relatively better.
I wish my readers superb summer holidays and don’t forget Lin Yutang' words:
"If you can spend a perfectly useless afternoon in a perfectly useless manner, you have learned how to live."