05 July 2019

Prediction: A Minsky Moment is coming sooner than you think

Tipping points, unstable situations, Minsky Moments.  In 1996 Greenspan used the now famous phrase "irrational exuberance" to describe the Dot-Com bubble of the 1990s. "But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions," he asked.

He was foreshadowing the coming Minsky Moment when the bubble popped. We are almost there, again.

Well, the US markets have reached a new record high. They have been pushing for that, ignoring data and building on the dream of new records. Each tweet from Trump is met with either a small market retreat (if bellicose) or a jump when he declares victory and withdraws (what I call the "Vietnam Solution"). Each manufactured crisis is shrugged off for the noise that it is, while each resolution of the manufactured crisis is greeted as a stunning "victory", and the markets move accordingly. Irrational Exuberance anyone?

Yet behind all the noise is the real economy, both the US and the Global economy as composed of a myriad of individual and linked economies. The reality is that the real economy(ies) are not in great shape, and this has not been priced in.

The past two weeks I've been watching the US markets go up and up, while at the same time the safe-haven, go-to-when afraid Gold price has bounced above $1400 for the first time since 2013. Normally when stocks go up, fear assets such as gold go down.

The US is now in uncharted territory, having entered the longest recovery on record. So just how much more "up-side" is there, or are investors "picking up nickels in front of a steamroller"?

Meanwhile, industrial production indices such as the monthly ISM are falling, and in some national (Germany) and US regional cases have fallen below 50, meaning contraction.

House prices have been falling in London for over a year, and housing starts and purchases in the US have been falling for months

The yield curve has now fully inverted. Why does this matter? Every (US) recession for the past 50 years has been preceded by a yield curve inversion, with the average time to start of the recession being 9 months from date of inversion. The yield curve inverted in March.

This to a background of continually rising corporate debt through the issuance of corporate bonds. "Companies from advanced economies, which hold 79% of the total global outstanding amount as of 2018, have seen their corporate bond volume grow by 70%, from USD 5.97 trillion in 2008 to USD 10.17 trillion in 2018." These bonds loads are easy to manage in a world of low interest rates and high liquidity.

And - the Fed is talking about cutting rates. Really? Cutting rate in the best economy ever? The entire point of starting to raise rates was to ensure there was enough "ammunition" (Feb rate cutting ability) to withstand another recession.

Finally, some are saying that the US (and the globe, for that matter) may already be in a recession.

Yet the US unemployment rate continues to fall, the participation rate (the percentage of the population that is employed) remains stubbornly lower than before the Great Recession.

So, when will we have our Minsky Moment, when sentiment turns and the rout begins in earnest?

It cannot be far away. And three months is probably very far at this point. 

How far will markets fall? That is anyone's guess. But they will fall, and it will be farther than most people would imagine today.

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