Market's Partying Like It's 1998, VAR Models Need a Xanax

Take a quick gander at the analysis below and see if you don't agree it's a pretty good summary of the recent state of play in financial markets as China launched the latest salvo in the global currency wars by devaluing the yuan.

  • "A buildup of overheating pressures, evident in ... inflated property and stock market values."
  • "The prolonged maintenance of pegged exchange rates, in some cases at unsustainable levels, which complicated the response of monetary policies."
  • Exchange rates that "came to be seen as implicit guarantees of exchange value, encouraging external borrowing and leading to excessive exposure to foreign exchange risk in both the financial and corporate sectors."
  • "International investors had underestimated the risks as they searched for higher yields at a time when investment opportunities appeared less profitable in Europe and Japan, owing to their sluggish economic growth and low interest rates."
  • Wild swings in a key currency exchange rate "contributed to the buildup in the crisis through shifts in international competitiveness that proved to be unsustainable."

They sort of nailed it, no? Except this analysis wasn't written about today's markets. It was written in 1998 by staff of the International Monetary Fund to explain the Asian financial crisis. The ripples from that eventually spread through global markets, including a sovereign default in Russia and the eventual failure of genius that spelled the end of Long-Term Capital Management. 

The comparisons aren't perfect, but they're close enough to make people like Michael Shaoul, chairman and chief executive of Marketfield Asset Management, look back at the year Google was founded for a playbook to help understand what could be happening now. He started noticing the similarities last October when a sudden dip in stocks reminded him of October 1997, which was followed by a near bear market in the summer of 1998 as concerns that haunted markets in October came back into focus.


"Indeed many of the same ingredients are in place today that existed 17 years ago," Shaoul wrote in a recent note to clients. "Common to both periods are the following factors: Commodity prices and emerging market currencies have been under pressure for several months and this weakness has started to spread to equities and credit issues. In 1998 this was resolved by a broad market selloff that spread to the most popular portion of the market even though this had no plausible link to the central concerns."

While the move in China's currency may not be enough to wreak total havoc on the gross domestic product of other nations, that's not to say it can't wreak havoc on financial markets as value-at-risk models that had assumed less currency volatility are torn to shreds. Explains Shaoul: "The capacity to carry positions at the same calculation of risk has been depressed in recent sessions, which is one reason why we have experienced a fairly violent reversal of risk appetites." 

For stock investors, the good news about the 1998 comparison was that the  S&P 500 recovered from its 19 percent drop in about three months. 

Just for giggles, it's also maybe worth noting that it wasn't too long after that 1998 turmoil that Donald Trump started making noise about running for president for the first time. The past doesn't repeat itself. But, as Stephen King wrote, darned if it doesn't harmonize sometimes.