Beware Market Whiplash
As volatility continues to plumb new lows in stocks, bonds, currencies and commodities, those who scribble about markets seem increasingly worried that there will be a backlash.
Interest in the risk of a "Minsky Moment" -- the phrase coined by Paul McCulley in 1998 to sum up economist Hyman Minsky's"Financial Instability Hypothesis"-- is surging. Check out this weekly chart of occurrences of the word "Minsky" in the stories that run across my trusty Bloomberg terminal:
Minsky, who died in 1996, arguedthat long periods of stability and harmony can reach tipping points, which then rapidly degenerate into chaos. "Whereas experimentation with extending debt structures can go on for years and is a process of gradually testing the limits of the market, the revaluation of acceptable debt structures, when anything goes wrong, can be quite sudden," he wrote in 1982.
Here's a chart from Bank of America Merrill Lynch showing that cross-asset volatility is at its lowest since the bank started compiling the index at the start of 2000:
Bill Blain, a strategist at Mint Partners in London, had this to say in his morning market report today:
"Risk assets appear to have given up fearing the Fed -- which should really have the Fed fearing risk assets."
Worries about what the death of volatility portends aren't about mean reversion; the death of Long-Term Capital Management in 1998 was all the evidence you need to know that John Maynard Keynes was right in his assertion that markets can stay irrational longer than you can stay solvent. It's more about what might be happening in the shadows as traders and investors get creative in a Darwinistic reaction to a lack of action, and what happens when everyone rushes for the same exit if they think they smell smoke. That movie ended very badly last time.
McCulley adopted the phrase "Minsky Moment" when he was a money manager at Pacific Investment Management Co. to summarize the Russian debt implosion 16 years ago. It was recycled after Lehman Brothers went bust in 2008 and financial markets went into meltdown. Based on the chart above, it's in vogue again -- as is McCulley, who retired in 2010 and is returning to Pimco as its chief economist on a part-time basis. Let's hope it's just a coincidence that he and Minsky are both back.
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