Slow-burning Minsky moments

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First of all, we have to get something out of the way.

To the left is the new headshot James Montier is using for his pieces at GMO versus his old one on the right. What the hell? We quite liked the old shirts. But someone got ripped in lockdown.

Anyway, Montier is out with a new note this week, on what he calls “slow burn Minsky moments”. It’s a good one.

Minsky moments are named after the economist Hyman Minsky, who observed that stability tended to eventually breed extreme instability. Pacific economic and financial conditions nurture credit booms and market bubbles, for example, which can for a long time reinforce the tranquility — until something suddenly breaks.

Back in the 1990s, Pimco’s Paul McCulley first dubbed the point where the stability morphs into financial carnage for a Minsky moment, and the term took off after 2007-08, for obvious reasons. Suddenness is kinda central to the whole idea, so Montier’s concept of “slow burning Minsky moments” is a bit jarring.

The argument is that the size and extent of the global private sector debt build-up has bred economic fragility that leads to a series of predictable mini-Minskys — or “grey rhinos” as some call them: large, obvious scenarios that are easily ignored until they suddenly charge you.

We seem to live in an era of rolling financial crisis. I suspect this is the result of a massive build-up of private sector debt. Sometimes these build-ups are accompanied by very high rates of credit growth, giving rise to a credit bubble. On other occasions, these build-ups sit simmering in the background, largely unnoticed until the proverbial s**t hits the fan, when they suddenly act as an amplifier causing a much steeper decline than would otherwise have been the case. I call these systemic vulnerabilities “slow burn Minsky moments.” Sadly, most markets appear to carry the fingerprints of these moments today.

. . . . When we look around the world, we can see lots of countries that appear to be characterized by the problem of a slow burn Minsky moment: a chronic build-up of private sector debt that leaves the economic system extremely vulnerable. As I have opined countless times over the years, forecasting is a mug’s game. The future is, sadly, unknowable, so when these inherent vulnerabilities actually start to matter is beyond my ken. However, those who choose to ignore their existence are playing the same game as Chuck Prince, the ill-fated CEO of Citigroup, who, back in 2007 opined, “When the music stops . . . things will be complicated. But as long as the music is playing, you’ve got to get up and dance.” 

Most of the GMO note explores various facets of the private sector debt universe — which will be broadly familiar to anyone who has picked up a financial newspaper at some point over the past decade — and what investors can do to guard themselves against slow-burning Minsky moments.

Going long volatility is an excellent hedge against a big equity market sell-off, but as Montier points out, because of the ongoing cost when markets remain calm it is “the investment equivalent of death by a thousand cuts”.

Montier has therefore previously advocated going long quality stocks and short junk bonds as a better tail risk insurance strategy, but he worries that quality currently trading at its highest valuations relative to junk since the early 1980s makes it less certain to work.

Surprisingly, he also seems to brush off cash, despite noting that it is the “oldest, easiest and perhaps most underrated form of tail risk hedge”. And at a time when cash actually has a chunky positive real return (at least in the US).

Montier therefore advocates for going long value and short growth, which feels like the obvious answer to any question at GMO. Honestly, we should have guessed we’d end up there somehow. But you can read the full thing yourself here.