This year’s MoneyWeek conference was great (you can read a quick run down of the day’s events here).
Yes, I know I’m biased.
But we had some absolutely fascinating speakers, from demographics expert Paul Hodges to former White House advisor Dr Pippa Malmgren, covering some of the most important topics in finance today.
As you might have guessed, one such topic was the bond market…
The Minsky moment can be anything
There’s a palpable sense of frustration around in the investment world at the moment.
James Montier of GMO, speaking to Citywire, summed it up recently: “This is definitely the most difficult time to be an asset allocator. It’s very hard to find value.” He has increased the level of ‘very liquid’ assets – in other words, reduced his risk heavily – to the highest point since 2008.
Even those who are invested more heavily usually couch their rationale for doing so using terms like ‘relative value’. In other words – everything is expensive, but this thing is a bit less expensive than everything else.
It’s a mood that reminds me of 2007. A sense of complacency mixed with underlying desperation. A sense that this can’t continue, but that equally, there’s no obvious explanation for why it can’t continue.
It’s a sense that I like to think economist Hyman Minsky would recognise.
As Paul Hodges pointed out at our conference, one of Minsky’s greatest insights was simply that “stability is destabilising”. In other words, when everything is going along smoothly, people take that for granted, and start to believe that it’s always going to be that way.
That’s a problem. Because this very perception drives changes in human behaviour that make a nasty crash inevitable.
As we all know, investment is ultimately about trade-offs between risk and return. If investors believe an investment is risky, they want a large return. If they believe it’s low risk, they’ll accept a lower return.
The danger is that long periods of stability are circular and self-reinforcing. If nothing bad happens for a long period of time, then people start to assume that nothing bad will happen. Not only that, but they also see that people who got in early have been rewarded for their daring.
As a result, they’ll happily invest in things they once would have seen as very risky without demanding much of a reward for it. It’s a lethal blend of complacency and a desperate need to keep up with the Joneses.
Fear of missing out is trumping fear of a crash
Look at what’s been happening in markets. We started from a position of fear following the massive crash of 2008/09. As a group, investors became massively risk-averse. Then enough time passed, prices fell far enough and conditions changed enough (central banks promised to never let anything ever go bust again) to tempt some people to put some money back into the market.
Nothing bad happened to these investors. In fact, they did very well. So more and more people got tempted into the market. And over time, anyone still displaying more fear than greed lost out badly.
It gets to the point where ‘fear of missing out’ trumps the fear of being stuck in the market during another crash. Investors who were late to the game are left looking at overvalued markets offering little by way of satisfying returns.
But rather than keep their powder dry until the next crash materialises, they use borrowed money (which is freely available, because everyone is so complacent), to boost their potential returns and enable them to play catch-up.
In other words, the longer the period of stability, the more fragile the underlying structure of the market becomes. Eventually you get to a stage where it doesn’t take much to knock the whole thing over.
That’s the ‘Minsky moment’ – when everyone wakes up and realises that the comfortable escalator they’ve been enjoying a smooth, steady upwards ride on, terminates in a cliff edge.
What could trigger a Minsky moment for today’s investors?
It’s impossible to say exactly how this all unfolds. The key thing to understand is that a Minsky moment could be triggered by virtually anything. The fact that it’s almost impossible to point to a specific trigger is neither here nor there – it’s the fragility that matters. It takes very little to knock a house of cards over.
But it’s clear to me that the bond market is ground zero for the next crisis. It’s the market that has been most affected by central bank intervention, and it’s the market that will be left most vulnerable as and when that changes.
It doesn’t help that, according to Bloomberg, “almost a third of traders [currently working on Wall Street] have only known near-zero rates”. How do they cope when that changes? They’ve never been exposed to a cycle of rising interest rates before. What will happen when the limits of central bank intervention are exposed?
I think we’ll find out sooner rather than later. In any case, if you missed the conference on Friday, our speakers covered these topics in a lot more detail. You can pick up the DVDs here.
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