High Yield Spreads, Minsky Moment & Putin

I’m bracing for what could be a pretty severe market correction. There is a lot of leverage being used in the market with little appreciation of the risks, sometimes referred to as a Minsky Cycle. Once that cycle takes hold and market players realize that they are overexposed to risk, there’s gonna be some bloodletting as liquidity disappears.

It is already happening in commodities. Keep an eye on high yield spreads, they are already on the uptick…

BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread - 2015 09

BofA Merrill Lynch US High Yield Master II Option-Adjusted Spread – 2015 09

So in the mid term (1-5 years), with a reasonable expectation that interest rates will begin to go up, with the very real possibility of seeing a moderately deflationary environment, continued deleveraging (or the increased need of it) and its impact on consumption, and an increasingly tight labor market which could lead to higher labor costs that many firms will be unable to pass onto consumers, equity prices may need to adjust the effect on earnings.

The next several months will indeed be interesting to watch, both in terms of the markets but also in terms of geopolitics. Russia’s moves in Syria are the wildcard I’ve been expecting and somewhat of a game changer. The stakes have been greatly increased.

Putin has proven himself to be a very competent strategist and master of opportunity. Remember this is a man who in a relatively short period of time rose from obscurity to his current position. He has a romantic view of what Russia should be and look like, and his moves are consistent with that. This is partly what makes him so dangerous and difficult to understand or predict at times. His moves in Ukraine are part of a larger historical backdrop of maintaining a buffer zone with the west. His move in Syria is looking like a risky but clever attempt to increase his leverage not only on the West but also with Iran and Syria.

Putin Chess

The U.S. has no doubt suffered a blow by this new development in terms of reduced leverage. How we respond will be critical, and before anyone starts blowing the war horn, we should proceed with extreme caution. The situation in Syria is a complex one and becoming increasingly more so.

What concerns me is how China will perceive this situation. If Russia continues to show success at pursing its “national interests” in the manner that it has, what is stopping China from doing so in the South and East China sea? They are already placing pieces on the board. So perhaps they are taking a piece from Putin and just waiting for the right opportunity…

About Jose Velez

I received my degree in economics and finance from the University of Texas at Dallas School of Economic, Political and Policy Sciences in 2006. Since then I have worked within the energy industry focusing on regulatory and environmental issues.
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