Hussman Weekly Market Comment: The Minsky Bubble

“In the ruin of all collapsed booms is to be found the work of men who bought property at prices they knew perfectly well were fictitious, but who were willing to pay such prices simply because they knew that some still greater fool could be depended on to take the property off their hands and leave them with a profit.”

- Chicago Tribune, April 1890

In his classic treatise on speculation, Manias, Panics and Crashes (originally published in 1978), the late Charles Kindleberger laid out a pattern of events that has periodically occurred in financial markets throughout history. Drawing on the work of economist Hyman Minsky, the conditions he described are likely far more relevant at the present moment than investors may recognize.

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It’s worth observing that the 10-year Treasury yield is also well above the weighted average interest rate since 2010 (weighting by the quantity of Fed purchases), which means that the Fed is underwater on its holdings. Bernanke himself noted at his recent Humphrey-Hawkins testimony that the recent rise in interest rates had wiped out all of the Fed’s unrealized gains, though he feigned ignorance about how much the Fed would lose if interest rates increased by 100 basis points. The math is easy enough, so let’s do it for him. At $3.5 trillion in assets having an estimated duration of about 8 years, against only $55 billion in capital, a 100 point increase in interest rates would wipe out the Fed’s capital five times over. The Fed would probably show an insolvent balance sheet today if its holdings were actually marked-to-market.

While there is a very tight historical relationship between the quantity of monetary base (per dollar of nominal GDP) and short-term interest rates, and a strong but weaker relationship between base/GDP and long-term interest rates, there is virtually no long-term relationship at all between base/GDP and equity yields or prospective equity returns (see Aspirin for a Broken Femur). This is a fact that is likely to hit home over the completion of the present cycle, but at least to-date, QE has encouraged speculation on the view that somehow the creation of new monetary base provides an impenetrable safety net for stocks and a permanent ceiling for risk premiums. Meanwhile, margin debt on the NYSE now stands well above 2% of GDP – a level also (and only) reached at the 2000 and 2007 peaks.