Summer 2014

Thinking of Minsky

2014 is shaping up to be a remarkable year. Stocks, bonds and commodities have all advanced together for the first time since 1993. The S&P 500 is up around 7% at the halfway mark building on the extraordinary gains of 2013. The stock market advanced in the face of skeptical investors and increasingly stretched valuations, some 65% to 100% above their historical averages depending on your yardstick. By metrics we trust the market has only been more highly priced in 1929 and 2000. Except for a small swoon in February, the move upward has been steady and remarkably calm.

This advance occurred despite Russians on the move in Ukraine and the rise of possible terrorist states in Syria and Iraq.  Margin debt, when investors borrow money to buy stocks, hovers near an all-time high after declining a bit over the past couple of months. The U.S. economy surprisingly shrunk in the first quarter of 2014 and still the market advances. A steady advancing market in the face of poor values and geopolitical risk is certainly not unusual. The market advanced smartly as protestors clogged the streets and the war in Vietnam was escalating in the highly priced market of 1968.

Current conditions do not warrant a bunker mentality but the current combination of high prices, near record margin debt, and geopolitical risks are cause for some caution.  Another factor adding to this posture is the extraordinary calm of the stock market in 2014. It seems counter intuitive, but calm and stable markets begat volatile markets. This was the main point of economist Hyman Minsky, who 15 years after his death has a lot to tell us about today’s markets.

To paraphrase, Minsky said that stability in markets masks underlying risks, encouraging investors and bankers to take on more risk.  Securities prices are driven higher, encouraging investors to take on increasingly speculative debt eagerly provided by financiers. As the proceeds from debt finds its way into the market, prices increase further. This cycle continues until it is unsustainable and the market falls, correcting these excesses in what is referred to as a “Minsky Moment.”

We witnessed such moments in technology stocks in 2000 and in the housing market in 2008. The richer prices we see today in stocks, the willingness to take on margin debt, the Fed’s easy money policy and the lack of real market volatility do not yet add up in severity to the conditions prior to the tech bust or the housing crisis. However, Dr. Minsky’s work reminds us to keep a close eye on the risks accumulating in the buoyant market of 2014.

The Altavista Investment Team - Summer 2014