Over the weekend, DB’s credit strategist Aleksandar Kocic discussed what Minsky Dynamics for the “New Normal” look like based on a matrix that charted the various progressions of Leverage vs Volatility, with four possible end states. However, since that graphic explanation proved too problematic for some, another Deutsche macro analyst, Alan Ruskin, released a far simpler representation of the current (and historical) Minsky cycle, which compartmentalizes the world’s various assets in their 7 discrete states along the Minsky cycle (as defined in Charles Kindelberger’s ‘Manias, Panics and Crashes – A History of Financial Crises’). These start with the 1) macro shock ‘displacement’, move to 2) ‘healthy expansion’, to 3) ‘leveraged driven gains’, to 4) ‘euphoria’, 5) ‘insider profit-taking’, 6) ‘liquidation and panic’ and onward and downward to 7) ‘revulsion and discredit.’
Where are we now?
Before the answer, first here are some caveats from Ruskin:
Sometimes it is obvious, but deciding which state any asset is in at any point in time is a true art form, and the most important decision from an investment standpoint. While assets often sequence as Minsky suggested, assets can get stuck for prolonged periods, or, some stages are so fleeting they can count as being skipped. In the last Alpha Alert on Minsky cycles back in 2014, it was noted that assets with severe supply constraints (most obviously esoteric assets like Stradivarius violins, but also more relevant assets like Sydney housing) tend to get locked into certain upswings, or simply don’t conform to traditional cycles. But for the vast majority of financial assets, the Minsky framework and the sequencing is useful.
In his approach to defining the 7 Minsky states of assets in 2017, Ruskin first goes back to 2014, and notes that “intriguingly many of the assets that were well placed in 2014, were in the revulsion stage back in 2011, including property in the US, EU periphery debt, and Japanese stocks, that were all back in fashion by 2014. In 2014, Chinese Russia, Ukraine, HK real state, silver and Netherlands property were in the revulsion stage and since 2014 have all subsequently had ‘their day back in the sun’. JGBs and JPY were also in discredited/revulsion stage in 2014, and for these assets it feels like the clock has almost stopped, suggesting that everything does not change completely in a 3 year time span.”
The underlying philosophy here is simple: sell what’s in its euphoria/overtrading stage and buy what is discredited, in the “revulsion” stage.
What does Deutsche Bank see as being in the revulsion stage now?
“Long Bond vol, short EM carry (at least until very recently) and Venezuela. In three years will we be laughing about how low bond vol was in 2017 (surely yes); and will Venezuela be this year’s Argentina?”
Perhaps, but what he forgot to mention is that “Long VIX” is also in this category. And as every hotdog stand owner knows by now, the next violent VIX burst higher without an immediate slam lower, could be the catalyst that blows up not only half the investing worlds, but unleashes the next QE – as central banks won’t just sit there as everything crashes – in the process short-circuiting the cycle and restarting from square one (unless of course a reset is impossible, as Kocic discussed on Saturday).
Finally, before we show what the Minsky Cycle for 2017 looks like, there is one major caveat: “the main difficult with the Minsky framework currently is properly identifying the displacement or macro trigger.” as Ruskin warns, or what is the catalyst that pushes the cycle into its next phase. His answer:
The Sintra message of an end to emergency easing, and rate normalization, is one likely displacement or macro ‘triggering’ event. The question is whether this will be amplified or not? This displacement could be greatly added to if:
i) US fiscal policy drives a sharper increase in USD yields; and/or
ii) will be enormously influenced by the extent to which developed market disinflation surprises on the up or downside.
A genuine large displacement/triggering would be if rate normalization is now combined with even a small increase in goods and services inflation that leaves Central Banks behind the inflation curve. Very small shifts in goods and services inflation are capable of having outsized asset cycle implications. In contrast, global disinflation can temporarily dissipate the rate normalization shock by allowing Central Banks to tighten gradually and on their own timetable. Ultimately this only adds to risky asset’s upswings and creates a longer potentially bigger Minsky cycle.
Lastly, there is also a parallel displacement occurring that tends to apply to specific assets. This is the backlash to globalization, that in combination with fragmentation of traditional media, is encouraging rapid shifts in political alliances and populist messaging. Tectonic political shifts have become have become more important for global markets. The GBP was an example of a currency that was catapulted from healthy expansion to revulsion in a few days, and is only now clawing its way back toward healthy expansion. Some of the assets that fit most clearly into categories like Argentina, Ukraine, Egypt are dominated by a political dimension.
Not surprisingly 8 years into a global upswings and 9 years into extraordinarily easy money, it is hard to find assets that fit into the healthy expansion phase. It is easier to pick assets that fit under ‘Euphoria and over trading’ or seem to have recently passed that stage. In part because of the Chinese equities collapse from euphoria in 2015, Chinese equities look like they are reasonably placed to fit under “leveraged expansion”. In contrast, bitcoin has the exponential price appreciation that is the normal hallmark of euphoria or over trading.
With all that in mind, here is Ruskin’s vision of where in the Minsky cycle global assets find themselves now…
… where they were in 2014…
… and in 2011.
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