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The Super Minsky Moment

When Nassim Taleb coined "The Black Swan Event" he did Wall Street a huge favour - He gave them plausible deniability to ignore all risk and claim after the fact that no one could see it coming. As the theory goes, markets are "random", so the probability of a crash taking place on any given day is de minimis. That may well be true, but over longer timeframes, the probability of crash becomes inevitable, which is the opposite of rare.

I often hear speculators claiming that all market crashes are Black Swan events - no one could have seen it coming ahead of time. For example the pandemic crash. In theory, the pandemic was the ultimate Black Swan event, because unlike 2008 it was not inherently economically driven, it was a health crisis. And yet, it was called COVID-19 because it began in late 2019, but the market didn't crash until March 2020. In the meantime, markets were front-running Fed rate cuts and a Bitcoin halving. Similar to now. And, the market was seriously overbought when it finally imploded. So perhaps it's true that investors can't predict all crashes, but that doesn't mean they should be maximum leveraged amid extreme risk. My own experience has been that even if a risk off event is a "Black Swan", it's cold comfort to get wiped out.

Minsky Theory happens to be the opposite of Black Swan theory. According to Minsky Theory, the longer the cycle the greater the risk that people are doing stupid things with money. Which means the probability of a financial crisis grows over time and amid extreme complacency. This graphic helps to explain Minsky Theory. At the beginning of the cycle investors are careful and make sure that all covenants are met and borrowers are solvent with a large equity buffer in case of default. Think of a bank requiring a 20% down payment on a new home at the beginning of the cycle. However, as the cycle progresses lending standards are eased and before you know it banks are making "NINJA" loans to illegal aliens circa 2007. NINJA = "No income, no job, no assets".

But then the crash and they get prudent again.

The problem is that when global central banks rescued markets in 2008, they put markets on permanent life support. And so markets of course were under the influence of moral hazard. Each bailout had to be larger and faster than the previous one. Until the pandemic came along which required the largest combined fiscal and monetary stimulus in human history with no comparison. Which prevented deleveraging.

There has been no market or economic deleveraging since 2008. And yet most bullish prognosticators assume that this "cycle" started at the 2022 bear market low. Hence it's in the early phases.

Weekend Barron's:

"...there’s more to worry about than just big gains and nosebleed valuations. Disinflation is slowing. The Federal Reserve isn’t going to deliver the seven rate cuts that markets were expecting at the start of the year. Signs of froth are certainly showing in places like Bitcoin, which surged 23% over the past seven days and is just 6.4% below its record high, and single stocks like Super Micro Computer, which have ridden the artificial-intelligence hype to astronomical heights"

Even the concentration of the market’s gains in a handful of stocks—the Magnificent Seven—is seen as a reason to fret about the sustainability of the rally"

It’s time to stop worrying..."

Instead of expecting the worst, investors should just accept that the bull market that began in October 2022 is only half over, at least based on history"

What we see via this chart of the Global Dow is that each pullback has become shallower than the previous one and in the lower pane concentration risk has grown with each pullback. Which is exactly what Minsky Theory would predict - that investors are massively complacent and eager to add risk with every pullback.

Except, that if this cycle actually dates back to 2008, then it's not a mid-cycle it's the longest cycle in the past 100 years.

In summary, this is all a massive bet on whether or not central banks still have control over this monstrosity they've created.

For those who believe central banks are still in control, I suggest that you realize there is only one central bank actively cutting rates right now. And they happen to have the worst performing stock market in the world.

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