After last year’s epidemic, people saw the power of global central banks, and a crisis that had not been seen for hundreds of years was passed by “printing money out of thin air”. But even so, the financial tsunami that occurred just after the epidemic is still fresh in the minds of investors and could become a historical memory as much or more vivid than the Great Depression and the subprime mortgage crisis. Warren Buffett said “I’ve seen it all before”.
After a year, a similar flavor seems to be faintly appearing. In recent days, in addition to the dollar and U.S. bonds and other liquid assets, from U.S. stocks to commodities, from gold to crypto coins, almost all risk and some safe-haven assets (gold) are in a state of great volatility. While volatility is the norm for financial markets, the last few days have been somewhat similar to last April’s financial tsunami in terms of shock mechanics, and this is what makes people feel uneasy inside – while central banks appear to have unlimited ability to go long, the financial markets are not at the same point as they used to be, and besides, the central banks’ biggest enemy is starting to emerge – large inflation (CPI > 5%).
Recall that when an epidemic occurs, the basic shock and contagion process is divided into two phases.
Stage 1: Epidemic occurs or becomes severe – tightening expectations (plus inventory panic from OPEC production increase) – oil and other energy prices plunge – extreme panic, risk appetite big drop (risk off) – active position reduction to sell assets – risky assets and some safe-haven assets plunge – high liquidity assets such as the dollar and U.S. bonds rise –Continued selling of assets –Further plunge in asset prices…
When prices fall to a certain level and begin to widely touch the stop-loss line or closing line, the financial markets enter a new “phase”, or a huge qualitative change: the market began to shift from a fairly mild position reduction, position adjustment, to a passive cover, close positions, as well as unresisted position explosion. At this time, panic began to spread further, “run fast” game began to be generally staged, coupled with a variety of digital platforms and means of communication, the spread of financial crisis, the end of the world and other panic narratives, the market began to “liquidity black hole” the limit of the situation collapse. At this point the shock enters a new phase.
Stage 2: Risky assets (e.g. junk bonds, highly valued stocks) plunge in price – hitting the closeout line or stop-loss line – passive position covering or selling – insufficient funds to cover positions can only sell high-quality assets, even safe-haven assets (treasury bonds) – widespread market-wide, broad asset class plunge, only liquidity such as the dollar index rises – extreme panic, prices plunge further – Blowouts become common – cash hoarding across the market, no one dares to trade, black hole of liquidity appears – meltdown ……
Financial markets are in a dysfunctional (collapse) state, if the central bank and other “traders of last resort” do not immediately enter the market to do more, to become the only long, then the market is likely to theoretically collapse to a state of zero leverage, because at this time the short side has no counterparty (the bottom of the “master (the “masters” are eliminated in one round). Considering that markets are always overshooting and overreacting, this is generally more severe than the state of leverage out. Such extreme scenarios were seen in the French John Law bubble, the 1929 US Great Depression, the 1990 Japanese real estate crisis, and the 2008 US subprime mortgage crisis, where valuations were generally killed off by more than 60%, and the highest declines could eventually accumulate to 80%.
These days, with the unsealing of the UK and significant new cases, the upcoming opening of the Olympic Games in Japan (although not allowed on site, the accumulation of athletes from various countries is also a big risk), etc., expectations of an aggravation of the epidemic have started to emerge again, which, together with OPEC’s adoption of increased production, first led to a big drop in crude oil prices, which later started to hit the stock market. This is very similar to the international financial markets in April last year.
However, the rhythm of history, while somewhat similar, does not generally repeat itself exactly. This is because many variables have changed. In general, the long and bearish forces have changed more significantly: although the epidemic is no longer serious, but other “black swan” factors are breeding; although in the monetary easing union of central banks, liquidity is not a problem, but the asset bubble is also surprisingly high, the tree has almost grown to the sky; although the economy is starting to recover or even is overheating, but the situation in each country is not synchronized, and higher inflation is blocking the space for central banks to ease again ……
Let’s use comparative analysis to see the similarities and differences between now and last year’s financial tsunami in various aspects.
1, the point of impact. The first impact point is the epidemic, although the current Indian variant of the virus has spread momentum, but obviously not as serious as last year, the current period at the end of the post-epidemic, then serious is only sporadic outbreaks, it is impossible to total outbreaks. China has basically been completely controlled (Nanjing has started to appear again, but it is estimated to be regional), and countries such as Europe and the US have almost achieved herd immunity, while other countries are also experiencing staged, sporadic outbreaks. With the spread of vaccines, the whole epidemic will be in a receding phase. But for the impact on financial markets, it is mainly a marginal shock and expectation differential. That is, although it is not serious overall, if it exceeds expectations, it will also have a significant impact on the financial markets. If a new virus emerges, it is a different story, but at least the experience of countries in prevention and control has improved dramatically.
The second shock point is the accumulation of other conflicts in the post-epidemic period, which could produce some very extreme event shocks. Recent Sino-U.S. relations have, as we predicted (“The dawn is back, but the season is bitterly cold – the world and China after the U.S. election”), eased on the economic and trade front but become increasingly tense in terms of ideological confrontation and geopolitics. U.S. military aircraft have repeatedly crossed the border, the situation in the Taiwan Strait is in a delicate atmosphere, etc. Meanwhile, the riots in South Africa and the debt crisis in Latin American countries may become new impact points. These shock points will often appear in the form of “black swans” to the unknown unknown hidden in a corner, and then suddenly appear to form a powerful shock wave triggered by the financial tsunami.
2. Fundamentals. When the epidemic first occurred, demand collapse (deflation) was the main problem, the extreme manifestation of which was the collapse of energy demand due to the shutdown of production, resulting in a plunge in crude oil prices and even negative futures prices. But with the successful redemption of demand by easy money, the main conflict shifted to supply repair. Of course the endogenous supply fix will lift demand accordingly, but this depends on the relative pace of inflation to disposable income, or real income growth. For the U.S., the biggest problem encountered here is that subsidies to personal accounts in the wake of the epidemic have substantially reduced the willingness of the average working class to participate in employment, severely constraining supply chain recovery, especially in the service sector. The result is that the U.S. now has the problem of an improved unemployment rate but still low participation rates. So when we look at the fundamentals of the U.S. now, we cannot simply look at aggregate indicators. The problems the U.S. is now facing have shifted to the structure, and the manifestation of this structural problem is higher inflation. If the U.S. cannot successfully exit the excessive easing policy after the epidemic, the fundamentals will hardly recover in a healthy and stable way. Therefore, we remain cautious about the recovery of the global economy.
3. Capital side. The global funding surface is still in a relative surplus, and the U.S. fiscal account is still lying with nearly two trillion dollars of cash. However, compared with the rapid exogenous injection after the outbreak, the current money supply has gradually started to move from an incremental state to a stock state, and has gradually weakened at the margin. In terms of the underlying financial mechanism, the generation and increase of liquidity following a severe financial crisis, followed by the opening of monetary easing, is divided into three phases.
The first stage, when the financial crisis is at its worst, when people are in a state of panic hoarding cash, and although there is money in the hands of the market and banks in general, most of them are very shy about lending, and money is cached and not transformed into liquidity, so only the base money exogenously supplied by the central bank increases rapidly and the money market becomes exceptionally loose.
In the second stage, market panic gradually receded, banks and other credit institutions gradually opened normally, private borrowing gradually resumed (private sector leveraging), and the money derivative mechanism began to resume. The supply of broad money (M2) begins to increase. What makes this epidemic different from the previous ones is that the Fed issued money directly to individuals and households, causing a significant increase in base money, which had the consequence that private individuals could increase their cash without leveraging, which is the biggest difference from the previous ones. The bonuses sent directly by the central bank to individuals have created a huge “free cash flow” at the macro level, and part of this money has created a huge demand for purchasing power, creating huge inflationary pressures without a rapid recovery in supply; the other part has entered the financial markets, and retail investors in the United States have grown dramatically since last year, with the proportion almost reaching a record high in recent decades. new highs in recent decades, becoming a new driver of new historical highs in stock prices; at the same time real estate prices have also begun to pick up ….
In the third stage, as the prices of stocks, real estate and other assets continue to climb, the financial market everything skyrocketed and generally entered a bull market state, at which time the creation of liquidity began to enter the outer layer, that is, leveraged to create liquidity but not create money, such as multiple repo between non-bank financial institutions, ETF leveraged, on and off-site matching, preferred inferior grading funds, etc., these although creating leverage and liquidity, but not not create money (i.e., no bank credit is generated).
Since the fourth quarter of last year, the financial markets have entered the third stage of money creation, i.e., the stage where everything is surging and the financial markets are generally bullish and generally leveraged. But this state of affairs began to change after the second quarter of this year, when the “taper” panic of the Great Inflationary Exchange and monetary policy exit began to emerge. Now, things have subtly changed, and people are beginning to expect stagflation, i.e., continued high inflation brings expectations of monetary easing exit, and the exit of monetary easing brings expectations of deflation, and this shift in expectations is reflected in an increasingly flattened yield curve. In recent days, ten-year U.S. bond yields once broke 1.2%, in fact, is a reflection of this expected conversion. Undoubtedly, the inflection point of monetary policy has long been visible, the funding surface has been at the forefront of the great ebb. Only the current will be in the retreat of the tangled state, “the first warmth when the most difficult will be interest”. This quantum entanglement of uncertainty state, will certainly bring about significant fluctuations in the market.
4. Policy side. In this epidemic-induced economic and financial crisis, we have seen the power of the central bank and currency, relying on the printing and issuance of money, surprisingly a century-old crisis from the brink of collapse. However, the side effects of this heavy-handed approach are also obvious. If in the past the Federal Reserve’s operations in the financial markets, only to bring about distortions in the financial markets, then this pandemic central bank through SPV institutions directly to small and micro enterprises, individuals and families to issue relief and unemployment benefits, has gone far beyond the scope of monetary policy, in essence, is the fiscalization of monetary policy, fiscal deficit monetization, is the central bank directly involved in social transfer payments and redistribution, this policy tool in When dealing with a serious crisis, this policy tool will have the effect of “administering strong medicine to serious illnesses”, but the cost of the side effects is also extremely high. Previous monetary easing brought about bubbles or large fluctuations in financial assets, and generally did not cause inflation. But this time, the cost of monetary easing finally appeared directly, that is, nearly forty years since the great inflation.
In addition, this monetary easing has caused a more serious consequence, which is the distortion and destruction of the labor factor market. A large number of low-income classes, accustomed to living on subsidized relief for more than a year, were significantly less willing to enter the labor market and participate in employment. This is the “crowding out” effect of the central bank’s transfer and redistribution instruments on the labor market, which is a deep-seated and serious problem. However, for the Biden administration, considering the voter support and mid-term elections, it cannot stop the relief completely, and the “ratchet effect” (from frugality to luxury is easy, from luxury to frugality is difficult) is likely to bring resentment from the public. So the policy side of the current big dilemma is also a dilemma, if you continue to keep loose, large inflation has not allowed; if the immediate withdrawal of easing, just recovered demand may be aborted, the resentment of voters will deepen. Therefore, the Feds are also entering a state of entanglement, dilemma, in and out are justified. However, we must clearly understand that the gradual withdrawal of the epidemic period of unconventional easing is an inevitable choice, only the specific point in time or the pace is still uncertain.
5, the psychological side. The policy side of the tangle is bound to bring the market’s psychological side of the tangle. On the one hand, people saw the power of the central bank to save the day after the financial market meltdown caused by last year’s epidemic, and generally have a “macro-rigid” complex, the short in front of the central bank, the largest long dare not act rashly, and with the Federal Reserve in line with the action of the long after the epidemic tasted the sweet, but the short was consumed Almost. So even though the funding side and policy side began to step into the inflection point, but most investors still dare not rashly bearish. On the other hand, the market is indeed a bit windy, investors are straining to listen carefully to the rhythm of the music stop, “run fast” triggered by the stampede may occur at any time, just waiting for the impact of the event, the market’s psychology may be a shock reversal, the long side will also evolve into the short side, the psychological side through the investor trading decision Behavior to form the financial side of the impact, into the liquidity shock state described above (stage 1 and stage 2).
6, the technical side. From a technical point of view, the global asset classes are basically in a high level of sideways oscillation state. For U.S. stocks and commodities in particular, they have already about doubled since their lows more than a year ago, a return that is very objective and arguably an all-time record when leverage is taken into account. Keep in mind that this is a wave that came out of a major global crisis that occurred once in several hundred years, and there is a willingness to take profits in a large number of funds. From a technical point of view, the high level of horizontal oscillation, especially large fluctuations, is a signal that the market has changed.
When will a new financial tsunami occur? Because of the strong intervention of governments and central banks and the current disorderly market expectations, we cannot accurately predict. Although the Federal Reserve and other central banks have a large monetary easing “superpower”, but at the same time need to see the current global financial assets are also very high, that is, once another financial tsunami, the cost of bailouts will certainly be greater. Last year, the Federal Reserve spent nearly $5 trillion to fight the crisis, when the NASDAQ index was only about half of the lowest point now. If the financial tsunami happens again, it may cost more than $5 trillion. In particular, the central banks’ MMT myth is fading and the twilight of the gods is approaching as a god of fate above the gods has emerged: – mega-inflation. While Fed officials believe this is only temporary, the judgment of fate is inevitable.