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Creepy Pre-Lehman Déjà Vu

That Creepy Feeling

About two weeks ago, as I was making myself a cup of tea at the office, I was suddenly overwhelmed by a feeling of déjà vu. August 2019 felt a lot like the August of 2008. Something in that brew was unnervingly familiar, and I don't mean Earl Grey. It was the combination of faltering economic fundamentals with stubbornly rising US equity market, mixed with the unhurried pace of the day-to-day business in the financial industry that touched a nerve in me.

Come to think of it, back in 2008 everyone knew there was a lot of debt out there, even though nobody was sure how much exactly. Bear Sterns had nearly gone belly up and was acquired by J.P. Morgan earlier in spring, so the risks were hardly imaginary. Lehman was still around and its executives were criss-crossing the Pacific courting Korea to prop them up by buying a stake.

Yet, economy looked good enough. The FT ran a column called Commodities Boom, emerging markets were growing like crazy. So, the bankers kept trotting around business-as-usual, even though the typical August lull was even more quiet than usual, and there was a sense of some impending problems to come.

What's the Prognosis?

The déjà vu gave me the creeps two weeks ago. Since then, more alarm signs started flashing. Yield curves inverted in the US and the UK. S&P 500 retreated from its historical peak of the low 30 hundreds, and government debt yields in the EU and Japan are deep in the negative territory. EU economy seem to have lost its main engine as Germany started contracting. Even Chinese GDP growth is slowing down (if you believed the numbers they had been publishing before in the first place).

But even more importantly, there is again a lot of debt out of there. Only not as much in the private as in the public sector. The Fed tried to shrink its balance sheet, but was caught up by the deteriorating economic fundamentals largely caused by the trade wars (and criticised by President Trump, who started the trade wars in the first place). Having raised interest rates a bit, the Fed actually has some ammunition to manage a downturn, whereas the ECB and BoJ have got nowhere to go.

So, what's going to happen? Well, paraphrasing Nassim Taleb (of whose work I am admittedly a big fan), I don't know what the Black Swan is going to be like, I only know that there is going to be one (or maybe many). It is unlikely that it's the banking system that will be the epicentre this time - that's one of the few things governments actually tried to prepare for, so we shouldn't expect another bank bail-out. But there is so much pressure in the system, that something has to give. Not sure when or how, but with plenty of destabilising political factors in sight, it probably will.

And I would be absolutely thrilled to be proven wrong.
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