A Minsky Moment. That's a great term, and as I was reading an excellent piece by Andrew Hunt of Andrew Hunt Economics yesterday, I noted his use of that phrase with regard to Chinese debt. While I had heard the term, I had to Google a further explanation. In short, a Minsky moment is when excessive speculation leads to excessive demand for credit and excessive leverage. When sentiment begins to turn and that credit dries up owing to lenders' conservatism, the whole enchilada collapses, and the excessive speculation is turned into cash-hoarding panic. It seems from my reading that Dr. Hyman Minsky only had a tepid following among the community of economists until his death in 1996. When Lehman Brothers collapsed on September 15, 2008, though, Dr. Minsky became a hero posthumously. The Great Financial Crisis unfolded exactly according to his game plan; it was indeed a Minsky Moment.
The question now, almost 11 years to the day after Lehman's implosion, is: could we have another Minsky Moment? Is there a chance we are in a credit bubble now, and just have not noticed it yet? The bond markets have sold off markedly this week, but as I noted in my RM columns last week and at the end of August, seeing a 30-year U.S. Treasury yield under 2% and a 5-year UST yield under 1.5% made me very uneasy about the global economy.
The U.S. stock market, as it often does, is saying "fuhgeddaboudit" with this week's rally, but stock traders, especially in today's top-down, ETF-driven environment, will be the last to know when a Minsky Moment arrives. No, it is the bond market, and its ever-present nose for inflation, that sends out those signals.
An inverted yield curve may be a sign that demand for long-term debt is heading into bubble territory. The current yield on the 3-month U.S. Treasury bill of 1.94% is low by historical standards, but it is, even after the recent selloff at the long-end, still much higher than the 1.74% yield on the 10-Year. Dr. Minsky would likely tell us that inversion is driven by excessive speculation in the 10-year UST, a situation which Andrew Hunt referred to by invoking 'the greater fool theory". It doesn't matter how much of a premium to face value you pay - and to buy a German, Japanese or Swiss bond, you would be locking in a capital loss if you held to maturity - if you can convince someone else to buy it for more. Then your theoretical capital gain is erased. That the world's central banks are such eager purchasers of sovereign debt, especially those issued by the U.S. Treasury, which is also an urge purchaser of its own debt, further exacerbates the situation.
So, use the 3-month/10-year UST spread as a guide to when speculation on the 10-year - by far the most liquid security in any world market - is excessive. History shows the perils of ignoring the yield curve.
The yield curve inverted in January 1988 and 1990 produced, according to NYU professor Aswath Damodaran's records, a return of -3.06%. While that may not seem catastrophic, it was the only year with a negative return in a span of 18 years from 1982-1999.
The yield curve inverted again in February 2000, and, wouldn't you know it, we just happened to see the tech bubble burst. The years 2000 (-9.03%), 2001 (-11.85%) and 2002 (-21.97%) produced the worst cumulative three-year performance for the S&P 500 since 1930-1932. Finally, in May 2007, the yield curve inverted for the final time after inverting and de-inverting twice in the prior 18 months. We all know what happened then. The 36.55% decline posted by the S&P 500 was the worst since 1931.
So, we should be looking at the yield curve inversion as a climax of a Minsky-like bubble in the bond market. We should also be prepared for a terrible time in the equity markets to follow the bursting of said bubble. The U.S. doesn't have too much debt, it just has too much cheap debt. But, if official figures are ignored and estimates by experts such as Andrew Hunt are followed, China may currently be carrying a debt load that amounts to 2x its GDP. As the Chinese economy slows dramatically in the face of the Trade War, however, it is only a matter of time before that economy struggles with that massive debt load, which it also has to repay in rapidly devaluing currency. In that scenario global contagion would grip the credit markets, and safe haven trades in U.S and European sovereign debts would surely see a Minsky Moment.
It's something to chew on. If nothing else, write some calls to protect your long stock positions, but the late Dr. Minsky's work would suggest you should be more bearish than that.
