Highway to Hell

Romain/ septembre 2, 2020/ Finance/ 0 comments

In March, Bill Ackman made a stunning comment on CNBC, when he said “hell is coming”. However, a few days after that, we learnt that Pershing Square had finally gone all-in on US recovery. Even if the degree of dishonesty was stratospheric, Ackman could be finally right about what is coming from an economic perspective. 

To be clear, the US economy may enter a depression soon. And there are many reasons for that. 

Market for Lemmings 

The first reason is the fact that financial risks have risen to a record level. Do not get confused by the stock market rebound: the Nasdaq mania is not the anticipation of a strong recovery. It is the preliminary sign of a coming financial disaster that is likely to destroy household’s confidence for good. 

The inevitable crash that will occur sooner or later could be one of the worsts crises since the 1929 crash, and perhaps since the burst of the South Sea Company bubble. What people fail to understand, is that the big tech mania is likely to lead to a massive funnel effect. 

First, the level of concentration is at a record level as everyone is rushing to buy the same technology shares or large cap ETFs (see To Be Passive is to Let Others Decide for You). Second, short volatility bets are a big threat, as many investors (especially structured funds) believe that selling puts has become risk-free thanks to the “Fed put” (see Stranger Things). Last but not least, more and more traders are now buying short-term out of the money call options, forcing market makers to hedge their books buying index futures or stocks. 

Needless to explain why this “concentration + short downside volatility + gamma squeeze” cocktail is highly explosive. When it reverses, or at least when the tech bull run stops, then you may expect a record volume to the downside. Everyone will become a seller of the same securities: retail traders, ETFs, options sellers, market makers, and every trend follower on Earth.

In other words, most investors or traders might be trapped in a room on fire with one small exit door. 

The economic impact of such a crash might be devastating as the American financial system is already under perfusion.

“But the Fed Has Our Backs, Right?” 

In my opinion, if it happens, then the Federal Reserve is likely to fail too, as the Banque de France did during the 18th century. Zero interest rates and infinite QE have already been implemented. What could be heavier than that? Equity QE? At this point of the bubble, the US central bank may have already lost control, which means that a financial collapse might be unstoppable. 

Besides, beyond the terrible impact of Covid-19 pandemic and months of lockdowns, it is important to understand that Western economies are structurally ending an economic super cycle (i.e. a Kondratiev wave), as evidence by slowing GDP growth rates for the past three decades. First, because of ageing population that has led to deflationary pressures and lower revenue growth. Second, because the Chinese boom is over. 

The Trade War Boomerang Effect 

The importance of China on US economy has always been underestimated. Hu Jintao stimulus plan in 2009 had been one of the main drivers of the world post-Lehman recovery. However, he was severely criticized by his successor Xi Jinping who claimed that such measures were responsible for China’s financial imbalances. 

Today, Chinese authorities say that they have opened a new era, evolving toward a lower but “more sustainable” growth model. Moreover, China is also willing to become more independent from an economic and financial perspective. Therefore, you should not bet on a massive stimulus plan from the PRC that would save the US economy. Especially after years of so-called “trade war” and aggressive remarks by the Trump administration. 

So far so good?

To summarize, the Fed already went all-in, huge amounts of debt have been added, defaults and bankruptcies are rising, China is no longer willing to support the ”best economy ever”,  and the political picture of America is a giant mess. Thus, all that remains is a virtual wealth effect driven by a market that has become an old-school casino.

Please bear in mind that economic systems and capital markets are complex systems. They are driven by nonlinear dynamics and self-organized criticality. Everything looks fine, until it is not. Beyond a certain point, that we may not be able to measure precisely, the fragile order of those systems is likely to be suddenly broken. Risks do not matter, until they do significantly. There will be no additional warning, as well as no turning back. This is how nature works.

Who remembers this French movie scene? “It’s about a society on its way down. And as it falls, it keeps telling itself: ‘So far so good… So far so good… So far so good.’ It’s not how you fall that matters. It’s how you land.”

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