ACTIVTRADES WEEKLY

By Ricardo Evangelista

www.activtrades.bs

The first warning of an avalanche usually comes from the noise it makes, as the mix of snow, rocks and other debris rolls down mountain slopes at speeds that can reach 30 kilometres per hour. Seasoned mountaineers and skiers know that before it can be seen, the approaching danger can often be heard. They also know that by the time they see the white sliding mass approaching, it is usually too late. The time to act and look for shelter is when the initial roar is heard.

A similar principle can be applied in the financial markets. Crises are usually preceded by warnings. Unfortunately, despite lessons from the past, many investors invariably end up missing those signs. Before the 2008 financial crisis and subsequent global recession, indicators that it was approaching were there, but most chose to ignore them, blinded by greed and the all-too common ‘this time it’s different’ attitude.

But not everyone had their head buried in the sand. As early as 2006, Michael Burry, a shrewd American hedge fund manager, noticed the insane levels of leverage and derivatives speculation associated with the real estate market in the US. Burry started betting against the system, predicting that large numbers of mortgage holders would default on their repayments.

Michael Burry was, of course, right. Events eventually snowballed and almost caused the collapse of the global financial system. This episode was famously reported by Michael Lewis in his bestselling book, The big Short, which was also adapted to cinema. Going back to the avalanche analogy, we can say that Michael Burry heard the roar of the approaching landslide and acted, while others, including regulators, central banks and governments, remained oblivious to the danger until it was too late.

Fast forward to the present day. Warning signs have appeared, and investors will ignore them at their own peril. The US Federal Reserve started to tighten monetary policy by hiking interest rates and reducing its balance sheet. The US central bank’s hawkish pivot contrasts with its pandemic-era stance. The combination of monetary and fiscal stimulus made necessary by COVID created an abundance of money that fed into unprecedented risk appetite among traders and propelled stocks, crypto currencies and other speculative instruments to all-time highs. This scenario has now changed, and some believe that we are hearing the noise of the approaching avalanche.

According to a recent article in The Economist, since the beginning of the year global stock markets have lost $12 trillion in value. Bonds lost $7 trillion and cryptos’ market cap shrunk by $2 trillion. The problem here is that many large financial institutions, including banks, pension funds and countless businesses (especially in the technology sector), are heavily leveraged and exposed to complex financial products that are set to suffer as the markets drop.

During the pandemic, central banks acted as buyers of last resort, supporting investor confidence by providing a safety net. It is perhaps time for them to once again come to the rescue. The Fed and its peers should listen to the ominous sounds coming down from the mountain slopes of global finance. Maybe it is time to accept that 2 percent inflation is no longer a realistic objective. Repositioning targets to the 4 percent level, for example, would require less stringent monetary policies, easing the pressure on the markets and on the real economy.