For the past several years, beginning with the collapse of the US housing finance market in 2008, debt and equity markets worldwide have been subject to periodic shocks and jolts that have given rise to what’s now known as the “Armageddon Trade.”
Reminiscent of the market positioning that occurred in advance of “Y2K” at the turn of the new century, a bevy of commentators took turns predicting that the market crashes that were triggered by the collapse of the securitization market for mortgage debt were about to be triggered again by various “black swan” (i.e., odds of happening conventionally, perceived like winning Power Ball) events either in America or overseas. This would lead to gigantic losses for security holders with “long” positions, and, of course, tremendous gains for short sellers who would have two ways to win. One, if those black swan events actually occurred, and two, if they could convince enough people that they would, so that they would dump their stocks and bonds in a “pre-fire” fire sale into the willing hands of the shorts when the alleged “crisis” was seen to have passed.
Of course, the Armageddon Trade talk was buttressed by actual occurrences that nobody predicted in their scope and impact. The near death experience of the American mortgage banking and investment banking industries really did happen, along with the fall of Lehman Brothers, the distressed sales of Bear Stearns, Merrill Lynch, Countrywide Mortgage, Wachovia Bank, and Washington Mutual, the resignations of the heads of Citibank, AIG, Bank of America and other financial giants accompanying their bailouts by US taxpayers, and the bailout/bankruptcies of GM and Chrysler.
If all this destruction of wealth could happen in the world’s most important economy with its global reserve currency, then was it so hard to believe that Greece would default? Or that Germany would abandon the Euro? Or that the Euro would collapse to arithmetic parity with the US dollar or worse? Or that the European Central Bank would prove too weak to act decisively? Or that Italy, Spain and Portugal would follow Ireland and Iceland into virtual receiverships along with their banking institutions? Or that France would finally succumb to its excesses? Or that China would collapse into recession? Or that the US would default on its outstanding debt as a result of the new political Tea Party mistaking the so-called “debt ceiling” law for a credit card limit? Or that the US government would actually shut down for weeks to satisfy the same minority Tea Party and their talk radio sponsors?
As it happened, however, none of these confidently predicted Armageddon events actually happened, dealing a blow to the credibility of the “Chicken Little” school of market sentiment. Instead, US stocks climbed 20-30% in 2013, depending on your choice of scoreboard. Yet as the new year began, the bad news bears put together a new disaster scenario to encourage the investment winners of the past year to take advantage of the “selling opportunity” while they still could, thereby driving down stock prices and rushing money into Treasuries, which were increasing rather than decreasing in value despite the Fed’s December decision to begin tapering its own debt securities purchases. The bears had of course positioned themselves in Treasuries in advance of their latest Armageddon call.
This time around, however, the doomsayers had to weave a much more complex and interrelated, cumulative case for the end of the world as we know it. This included pointing to the following. China was slowing toward a hard landing, based on one month’s PMI data in advance of an earlier than usual Chinese New Year, which always depressed economic activity temporarily. Another imminent “Lehman moment” collapse in China of their “shadow-banking” trust loan finance sector because the collapse of coal prices would not support repayment. A slowdown in US hiring (by some but not all measurers) and retail sales (for some but not all vendors), obviously temporarily impacted by unusually severe winter weather in two-thirds of the country. The potential for a rolling emerging market currency collapse brought on by runs against the Argentinian, Turkish and Hungarian currencies, which in global GDP terms do not amount to a hill of beans, plus a new Italian government crisis. And finally a protracted fight in the US Congress over the extension of the debt ceiling through the 2014 election cycle brought on by the Tea Party caucus in the House and Ted Cruz in the Senate.
This 2014 doomsday scenario succeeded initially in driving a “semi-correction” of 5% in equity values and concomitant rally in ten-year Treasury note values. The cable TV financial networks rallied to the correction cause (if only because they had been calling for one all during 2013 to no avail), bringing on a host of guest commentators predicting a 20% correction (S&P down to 1480), a new bear market, and even a return to recession negative GDP growth this year with the impending collapse of global finance and all commodity markets except gold. Many of them saw it coming in the supposed “weak volume” recovery of 2013 – it would prove a false dawn, as one prophesized.
But as the old prophet Bob Dylan put it even in his Super Bowl commercial, “things have changed.” The markets got smart. They looked under the hood of the global economy found problems, but not crises that couldn’t be handled by the powers that be. China bailed out a weak trust bank, proving they learned the Lehman lesson. That country’s trade figures improved in January, presaging stabilization in manufacturing while the government pursues economic reforms to reign in excess lending – good things that will help prevent crises. Italy had a relatively smooth transition to more energetic and popular leadership (learning the Berlusconi lesson). The House and Senate extended the debt ceiling, no strings, no filibusters (learning the Gallup Poll lesson) and the merging market central banks acted quickly to face reality of currency runs, proving they learned the Thailand lesson.
In short: plenty of worry for the famous wall that markets often climb, but no Armageddon’s on the horizon. Maybe we can get back to “normalcy” after all, even with increased market “volume” more to the upside. Even with that supposed crisis sign, low volume proves to be a fraud. As Bloomberg has reported, trading volume measured in shares has indeed been down over the past five years, by 27%. But the average price of shares is way up for the same period (from $24 to $77, well over double!). So volume measured in total market value has actually grown by a third over that period. Score one for grade school arithmetic. Chicken Littles, it seems, just can’t do the math!
By Terry Connelly, Dean Emeritus, Ageno School of Business, Golden Gate University
Previously published on http://www.huffingtonpost.com/terry-connelly/finally-the-end-of-the-fi_b_4809501.html
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education