Reflecting on The Seven Samurai* - This is no time for complacency.
“Just when you think that you are safe, you are most vulnerable.”
-- The Seven Samurai
As we approach the end of the year it appears that equity markets are still content to pursue their upward path, with U.S. equities setting all-time records along the way. At the same time the CBOE Volatility Index (VIX)--which market participants look to as a gauge to measure fear in the market--remains low. In addition, since as far back as 2009 investors seem to have been rewarded for “buying the dips” and adding to their equity holdings during equity market downturns.
Even at these high levels of traditional valuation, the case for further appreciation in the equity markets could be supported by a continuation of the following conditions: continuing synchronized global economic growth, positively-sloped yield curves, benign global inflation, narrow credit spreads and a low real (inflation-adjusted) cost of capital which contributes to higher valuations of future earnings streams.
At 3EDGE we remain at or near our maximum equity ranges across our strategies. However, this is certainly no time for complacency. We remain vigilant and on the lookout for any potential canaries in the coal mine that may provide evidence of an impending market correction and perhaps even the onset of a Minsky Moment. A Minsky Moment is a crisis named for famous economist Hyman Minsky, who argued that oftentimes a lengthy period of market stability tends to breed complacency resulting in a build-up of excesses and imbalances, sowing the seeds of the next period of instability.
We have been talking for a while now about such a scenario in terms of the potential for an equity market melt-up which could occur when the remaining market skeptics capitulate and the fear of missing out on additional appreciation in the equity markets becomes overwhelming. The remainder of cash on the sidelines then pours into the equity markets causing an almost parabolic rise in equity prices. This situation often presages the onset of one final push upward and then a sudden reversal, followed by a major, oftentimes painful, market correction.