And on the flip side - just because the bubble doesn't pop this year doesn't mean your assessment of the fundamentals is wrong. The market can stay irrational for a longer time than you can remain solvent.
I remember in the late 80's when things actually seemed pretty good - but all through Reagan's presidency, the press had been lambasting "supply-side economics" (and even his VP called it "voo-doo" economics). I can't say with certainty that there wouldn't have been a recession during Bush's first term without all the negative publicity but it certainly became a factor in his unsuccessful bid for a second term.
The curious thing is that if you perform a pump-and-dump on one or more stocks you get in legal trouble. If you perform a pump (or more likely dump) on the economy as a whole, then you must be a journalist.
No, the recession during Reagan's first term was because Volcker cranked up the interest rate to shut down inflation. It worked, but it hurt the economy in the short term.
Uhm, the yield curve inverts well before a recession and with a variable look-ahead period, typically 6-18 months before, so it worked as prescribed.
All of those articles are actually spot on. If this indeed is a recession; we'll know a year from now because that's the typical delay in NBER's recession announcements.
Another way to look at the idea is that volatility seems to be ~constant, and any efforts to suppress it (by easing) result in a surge later on (hard landing). What we may see is the unwind of the easy money that has been sucking risk premiums out of the markets. Capitalism cannot work without risk premiums/cost of capital/hurdle rates. It's not capitalism any more because the capital has no decision to make (everything will be funded, no matter how good or dumb).
And as this advances people will be reminded that stocks are not "basically better savings accounts", and that while they thought they're "long term investors" they are in fact not. The price agnostic buyer of ETFs will turn into a price agnostic seller. Happened many times in the past.
"Capitalism cannot work without risk premiums/cost of capital/hurdle rates. It's not capitalism any more because the capital has no decision to make (everything will be funded, no matter how good or dumb)"
I think you and a lot of people have lost perspective and are putting the cart before the horse.
The whole point of capitalism, the only justification, is to benefit society by driving profits to zero.
The stock market is not a machine to produce profits, it is a machine to eliminate opportunities for profits.
Profit is an intermediate step to the basic social purpose of moving resources where they are needed. The collapse of interest rates and profits are evidence of success.
Risk premiums are something else than profits. They're much more intangible, much more "macro".
If you have three companies, two of which will produce $1M (when discounted with interest rates), and the third one has the prospects of producing $1M but will actually produce $0 due to some fatal flaw in the idea (i.e. will lose everything), but you don't know and can't know which one is the loser - how much should each stock be worth? Assume there's no debt.
It's pretty obvious that it should be less than $1M per company. That's what the risk premium is - the difference between discount rates used for a risky project vs the discount rate used for a non risk asset (i.e. interest rates).
No risk premium means everything is discounted as a "sure thing", as if it was a government bond. It's inherently anti-capitalistic because it means that the capital doesn't get to decide what's possible, what's probable, and what's likely.
Also, note that risk premiums have, a priori, nothing to do with aggregate returns. Risk premium is what you'd make if everything went well. But it often doesn't go well. In my example if all three companies traded for $666k and you bought all three you'd end up with the same amount of money at the end (once the loser is known).
I didn't/don't think that's what the phrase means.
If the expected value is $666,666 then wouldn't be the risk premium be the discount you want for the risk of getting zero, compared to an investment that definitely returns $666,666?
I also feel like I read recently about a study showing that investors are empirically (at least to some extent and at least these days) willing to pay more for more "risk", kind of like lottery players.
I'm a little foggy about why, with the low cost of diversification, investors would demand a risk premium greater than zero, at least.
> If the expected value is $666,666 then wouldn't be the risk premium be the discount you want for the risk of getting zero, compared to an investment that definitely returns $666,666?
Risk premium is something that connects future profits to the present, to create an expected value. It is in fact, typically, a yearly rate expressed in percent. Simple example: say the 10 year bond is 2%, you slap 5% risk premium on top of that and you get 7%, with which you discount future profits to the present expected value. Why 5%? Well that's why I'm calling it "intangible". It's risk, it's hard to say what risk is when often you could not have possibly anticipated all the problems. But you know that they're there. All of the recorded history of humanity confirms that trouble is always there.
> I'm a little foggy about why, with the low cost of diversification, investors would demand a risk premium greater than zero, at least.
Well that's up for everyone to decide [what risk premium do they want]. I'd personally stay on the side that assumes that failure, any level, size and scope of failure, is always possible.
Broad diversification was always possible and executed at the institutional scale. It really doesn't change all that much. All that changed is that the "small guy" can have it. In particular it does not mean that risk was somehow banished from the world by Jack Bogle's work.
In your toy example, it's a huge difference. You have a 1/3 chance of losing all your money without it, but a zero chance if you own all three.
With the stock market, it's not clear exactly what diversification gets you because nobody has the future correlation matrix, but it must be worth something. I think millions of people are implicitly assuming the whole market can't go to zero.
As a venture capitalist, I am mostly with you on the big picture idea of how to view "everybody else's interest in capitalism functioning" here. But I will quibble with the term "profit."
I would say "driving rents to zero." There's a well understood notion of earning an accounting profit, and an economic profit, even under perfect competition.
It's "rents" that perfect competition and market "efficiency" can arb away.
High economic rent corresponds to low risk premium. Utilities are a great example, they trade almost like bonds (not quite; there's still risk in them, just look at the famous Californian one).
Also, "high rents = low risk premium" is the whole idea behind Buffett's moats. He correctly anticipated that risk premiums were far too high for businesses with durable competitive advantage (like coca cola), so he kept buying them even at "high prices", i.e. at apparently "dangerously low risk premiums". And then the premiums eroded even further as the companies proved resilient to competition. That's why, I think, he keeps buying Apple stock despite it being priced so dearly.
The problem begins when you assign a ridiculously low risk premium to something that's so obviously risky, like the recent Silicon Valley "tech" startups, which have no moats, no profits, no margins, tons of competition. But the issue goes well beyond Silicon Valley.
> The whole point of capitalism, the only justification, is to benefit society by driving profits to zero.
I actually agree with the sentiment; but I'll quibble because bringing profits to 0 is very easy and we don't need capitalism to do that; cavemen managed a 0-profit society without any difficulties.
The point of capitalism is about creating a concept of property rights then letting everyone simultaneously make decisions that optimise their outcomes given their circumstances. We've noticed over the centuries that, surprisingly, the snags that might reasonably be anticipated turn out not to matter and capitalism works really well for maximising prosperity. Crazy world.
> The collapse of interest rates and profits are evidence of success.
Interest rates aren't low because people are making decisions that they think are sensible in the absolute; they are low because a suite of irrational government policies are undercutting the market and making rational actors do stupid things with money. It beggars belief that a free market would decide that there are nearly no risks in the future. Risks are the highest they've been in the last 30 years.
"It beggars belief that a free market would decide that there are nearly no risks in the future. Risks are the highest they've been in the last 30 years."
Why? If you put your retirement savings in VT, do you think there is a risk of losing your money, outside the end of the world or a temporary decline when you happen to want to withdraw?
I don't think it is fruitful to argue this is true or not, I'm just presenting this as something plausible I think many if not most investors believe these days, explicitly or implicitly.
But if you really have no chance of losing your money in the stock market as a whole, why should it give you extra returns over bonds? Maybe it doesn't?
You tricked me; I didn't reread my original comment and wrote up something irrelevant. Fixed now. If you read it closely you may discover that it said interest rates are too low; nothing to do with stock markets. They are taking their lead from interest rates though so I doubt they are well prices.
The idea that stocks and bonds should give the same return is bad; the risk in stock is measurably higher than in bonds. In stock, legally nothing strange has to happen for an investor to come out with less money than the initial principle. In bonds; someone has to go broke. There is a clear difference in the level of risk involved.
> do you think there is a risk of losing your money, outside the end of the world or a temporary decline when you happen to want to withdraw?
If we handwave away the risk of having less money at the time of selling then at purchase time then yes, I suppose stocks would be riskless. If we assume the risks won't eventuate; anything appears to be riskless. Eating uncooked chicken is perfectly safe if we assume that there aren't any bacteria in it. That handwave is wholly unreasonable.
>Capitalism cannot work without risk premiums/cost of capital/hurdle rates.
Still works: As someone who was throwing pennies in front of the credit risk steam roller since 2018 (long OTM puts on junk bonds with 4-12months of expiry, roll every 2 months), people were gladly picking up,
I would give my theoretical first born for markets to go back to ATH so I can make a bigger pos on long on tail risk… helps when writers/dealers were (and still are) pricing options with black scholes horrible assumptions for OTM and when not near expiry…now they gotta buy back at +20x with help from the discount window (shout out to head of the 3 time felonious JPM: Jamie Dimon, hope for a swift recovery… id have heart problems too if my TBTF bank was at the discount window).
Mispriced risk is amazing, and cheap to be long while playing other high risk (high prob payoff, short tail risk) strats until it pays off.
These fake interest rates set by the FRBNY bureaucRATS with their daily manipulations in coohoots with the +20 brokest-dealers, only make tail risk cheaper to buy.
I agree and I also have some Taleb-like tail hedges.
My point, though, is that no risk premiums doesn't work for the economy, not for you or me. It causes bad companies to exist. It causes bad projects to be funded.
But that's the thing, there are risk premiums, but most of the time their not priced in way that reflects the risk "accurately" because the writers don't think they'll have to pay out (and as along as most insurance works by calculating payout probabilities and collecting payment as income, there will be systemic incentives to massage probabilities of the unlikeliest events, rather than say, treating it as short term loan where you can derive income from lending part of it in money markets while still covering payouts, and returning the value/rolling the coverage for the next interval).
And sure, it might enable companies to survive longer if premiums were higher, but "bad" companies/projects can still come into existence because its not obvious ahead of time that if choosing at random (or even if you made an better than random guess, you cant eliminate the possibility), which particular company will be a "bad" company, or a "bad" project.
True. But what are we to do? How is a casual reader supposed to know who counts as a dismissable permabear? This is just a link to a Wikipedia article, it would be odd to downvote it just because it talks about the top, it is hardly even an implication.
If you don't follow the markets and don't know the various commentators record and reputation just buy index funds and focus your attention on something more enjoyable.
I'm not an economic expert and don't really know what to make of that. It seems crazy that people are willing to loan money to the U.S. government for 30 years at a rate of 1.25%.
As a taxpayer I guess I can be cautiously happy that the government will incur less interest on its debt for now.
In the modern financial system, risk-free debt is basically as good as cash on a balance sheet. If you need to turn it into cash, you just dip into the repo (“repurchase agreement”) market.
Over the past few decades the global financial system has steadily become completely unrecognizable from the standpoint of classical economics. Debt is not debt, savings is not savings, and printing money is no big deal (or so they say).
> In the modern financial system, risk-free debt is basically as good as cash on a balance sheet. If you need to turn it into cash, you just dip into the repo (“repurchase agreement”) market.
The global repo market is valued at $12T USD, and only 75% of it is backed by "pristine collateral", such as government bonds. That means that $3T of it is in equities or derivatives. The fed's balance sheet is only $4T USD in comparison. Additionally, $.5T is in private capital groups, which are entirely opaque, have poor lending standards, and there's no visibility into counterparties or volume.
Keep in mind, India's Yes bank that was just nationalized failed due to liquidity problems. There is a theory that global liquidity is being challenged, and central banks may not have the appetite to provide a backstop at the volume required.
Instead of a short squeeze where asset prices rise and blow up people with naked/levered short positions on them, it's in effect, a long squeeze, where asset prices fall and then take a cascading fall as the result of leveraged (indebted) people trying to exit their positions.
2008 "underwater mortgages," where houses were worth less than the loans to pay for them cost was a Minsky moment.
But above, the forced sale (bankruptcy avoidance) vs. profit taking a better view.
It's the difference between describing causality and reporting facts.
Not every top is caused by a Minsky moment. For instance, inventories could overshoot and then less stuff needs to be made for a while. Or central banks could raise interest rates to fight inflation. These are two of the most common causes of relatively benign recessions and market tops.
> I think the bigger question is what is the difference between a Minsky moment and an inverse-short squeeze (a long squeeze?)?
Casually speaking, it’s the difference between a forced sale of an asset in order to repay debt after a long period of growth, and the incented but not mandatory sale of an asset which has increased substantially in price over a brief time, which is now abruptly declining, by owners hoping to salvage some of the gain.
Personally I don't think so. All the selling so far is first order obvious things... Airlines, travel...
The knock on effects are less predictable and will come later in the crisis. A lot of lower income workers are going to be hit hard as service sector takes a big hit. Those workers tend to spend all their income, so every dollar lost there translates to another dollar the broader economy loses.
>All the selling so far is first order obvious things... Airlines, travel...
I'm not an expert, but there's lots of money in index funds too, and those might be getting sold as well. The other first order obvious thing being people will want some cash.
There’s a difference between capital and printed money. Capital is the result of forgone consumption, of producing more than is consumed. Much of what people call “capital” is really just inflated paper claims to assets. A share of stock is not capital, it is just a fractional claim on the residual earnings produced by a business. Capital isn’t magically created when stock prices are bid up, because the underlying assets (“capital”) of the business don’t change.
This is where the problem lies. Sure, liquid assets are as good as cash... until they aren’t. If everyone tries to convert assets to cash simultaneously, then cash gets scarce really quick and the difference between the two becomes clear.
This is completely relevant to the Minsky moment, because it is the illusion of wealth created by inflated asset values that leads people to take excess risks.
The price of borrowing has never been lower. Stable governments can borrow at negative real rates. When prices drop it means there is more supply than demand.
Although, given the 1918 Flupandemic and several other historical precedents, it should not have been a black swan, since it was known to occur. I've heard these referred to as "gray swans"; i.e. things that have the same impact as black swans but even prior to the fact there were people who were predicting it.
For example, the David Quammen book "Spillover" essentially predicts it, and it was published in 2013 (subtitle: "Animal Infections and the Next Human Pandemic").
I do think this is appropriate though since a key characteristic of a black swan is that people can look right at it but not see it due to psychological biases.
Agreed, but "black swan to most people but white swan to a few" is harder to say than "gray swan".
For that matter, Nassim Taleb himself predicted that the American mortgage industry was, I think he wrote something like "a barrel of dynamite" or some words to that affect. But, for most people, the mortgage crisis was a black swan.
The original metaphor, though, was that no matter how many swans you looked at in Europe, and how carefully, you would have zero data to tell you that black swans were possible, until you went to another country and discovered them.
You know, if people are sitting at home not doing anything for an extended period of time, that's actually inflationary whether they print money or not.
Pretty simple: if you're two people locked up in your Kung Flu bunkers; someone has a 50lb sack of rice, and the government keeps sending you both cash, the price for a cup of rice is going to go up.
This next recession will be very ugly. I hope everyone on here is prepared. Last time the dollar was a safe haven asset, so those that saved were ok. We will have stagflation and the price of the dollar will collapse.
I think we will finally get inflation! Corporations will move productions out of China. I expect at least 20% will come out of China and into higher cost locations. This will drive up costs. We had it too good for too long.
A pebble? Not likely, and certainly not with the hyper low interest rate environment.
There were lots of rocks larger than pebbles over the last few years: China trade war with escalating tariffs, global trade anxiety, Trump political chaos (Russia and generally), impeachment, Middle East chaos, US / Iran, US / North Korea (daily, escalating threats of nuclear war), Brexit. None of them derailed the market from pushing higher.
It required a boulder precisely because of the interest rate environment. A pebble would not have done anything. China's economy just got put into the freezer for the past two months, the global economy is under serious threat, and even now the market remains very richly priced. It might yet require something even larger than a boulder to take this market down fully.
I think you may have a short memory. The international situation has never been very different qualitatively than it is today. Iran has been a mess for 50 years, much of that time far worse than now. We have been at war with north korea for 70 years, some of that with actual armies marching and shooting each other. In the 70s and 80s planes were being hijacked and bombed every week. Hundreds of thousands of people died from AIDS. All the while the economy was up, down, or indifferent to these things. The world is constantly in turmoil, listen to a billy joel song for more details.
Both can be true. Chinese industry crawled to a halt for almost a month. We got "lucky" insofar as it happened right when Chinese industry annually crawls to a halt for two weeks, but there will be knock-on effects for sure.
i wonder whether by triggering (not causing) correction earlier than later the virus actually softened the otherwise much stronger crash which would have anyway happened sometime later due to all that overpumping/overinflating of the economy with the cheap money during the recent years (resulting in particular from the low rates amplified by the tax cuts).
As the amount of the third type, the ponzi borrowers, grows it is more and more indicative of an impending Minsky Moment.
https://www.cnbc.com/2020/02/11/ponzi-schemes-hit-the-highes...