Yesterday, I wrote about "Minsky moments" - the point in time at which a speculative bull market finally breaks and panic selling begins. Today, I want to look at some research produced by Morgan Stanley (MS, Financial) that discusses the idea that last month’s market collapse might have been just such a moment and what that could mean for investors.
Could this be the low?
Morgan Stanley’s equity research department has recently made headlines by claiming that the recent selloff actually signals the end of a cyclical bear market. While this may seem like a strange claim given the performance of the S&P 500 over the last two years, it does hold some water when one considers that a lot of smaller, less well-known stocks had not experienced the same gains - for instance, the Russell 2000, which tracks small-cap companies, has traded sideways since peaking in August 2018.
In addition, Morgan Stanley's economists estimate that the U.S. will run a fiscal deficit of 18% this year as a result of the spending it will have to undertake to counteract the economic damage done by the virus and associated lockdowns. The recession that the U.S. economy is currently in the midst of was created by the flood of cheap credit in the corporate and shadow banking sectors.
Economic data is likely to continue getting much worse, but the market has been rallying. One reason for this, according to the research note, is that the government has been extraordinarily accommodating to companies that have taken on large amounts of debt by encouraging banks to lend and relaxing their capital requirements.
“There are several reasons why we think the lows for this bear market are likely in. First, recent lows were made during what can only be described as forced liquidation by the levered players; i.e. the shadow banks. It’s hard to imagine that the kind of liquidation we just witnessed in March could happen again given the lower levels of leverage. Second, this past week, credit market stabilised thanks to unprecedented support from the Federal Reserve and other central banks - and for the past ten years, we have had no doubt in their resolve to stabilise both the funding and credit markets. Third, economic and earnings data will be grim over the next month, but markets may have already discounted this.”
In short, the bank believes that markets have already repriced, and that previously leveraged players have delevered sufficiently so that another selloff is unlikely. Though this prognosis may turn out to be overly rosy, it is certainly a real possibility.
Disclosure: The author owns no stocks mentioned.
Read more here:
- What Is a Minsky Moment?
- Peter Lynch: Here Is the Most Important Thing About Investing
- Warren Buffett: Here's How Ordinary Investors Can Benefit From Wild Price Swings
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