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The Minsky moment theory and its relevance to Brexit

The Brexit vote had markets turning bearish. Photo: Reuters

The Brexit vote had markets turning bearish. Photo: Reuters

Whoever has studied economics has encountered the ‘Minsky moment theory’ named after economist Dr. Hyman Minsky, who had noted that in times of stability, traders tend to inflate asset prices by leveraging their positions, with the consequence that markets shift towards a bearish mode, while a dash for the exit puts pressure on asset prices which shift towards a plunge. After the bubble bursts, the debt burden due to leverage remains and can depress activity for a long time. Undoubtedly, last Thursday’s Brexit vote was one of the most important events over the past years and some sort of correlation with the theory is surely unquestionable.

After the bubble bursts, the debt burden due to leverage remains and can depress activity for a long time. Last Thursday’s Brexit vote was one of the most important events over the past years and some sort of correlation with the theory is unquestionable.

Despite polls throughout the campaign having indicated a neck to neck race, the percentage of undecided voters was still significant and it seemed that markets were betting that those undecided voters would ultimately be conditioned by uncertainty and shift towards consensus, voting to remain. Odds at leading betting agencies were certain the remain campaign would win, with odds at the remain front at 1.13 against 8 for a leave vote, 88 per cent chance and 12 per cent respectively.

Interestingly - and to some market participants surprisingly enough - the build-up until Thursday evening was strong, implying that market participants were building-up their positions possibly also through leverage. In fact, during the week markets in Europe spiked by just over 4.5 per cent (Dax), while the Sterling rallied by 2.4 per cent in confront of the Dollar. Ironically enough the Sterling continued to gain ground late on Thursday evening when Nick Farage the (UKIP party leader and one of the most prominent Brexit campaigners) stated that the ‘remain’ would win by a thin margin.

A turnaround commenced throughout the night and the ‘Minsky moment theory’ kicked-off with a major sell-off, which led to a rapid and impulsive collapse in market-clearing asset prices, a sharp drop in market liquidity, and a move to cash. The Sterling crashed to 11 per cent, the FTSE 100 8 per cent, while in Europe the Euro Stoxx 50 plunged by 10 per cent, as investors dashed to safety.

In my view, the recent sell-off has created opportunistic trading positions and this was witnessed over the past days in which markets gained considerable momentum. That said, uncertainty on how the transition of exit will take place is still at elevated levels and thus investors should act with caution when dipping into the current attractive valuations. Despite contingency plans are surely in place, this was also highlighted by the Bank of England, their trigger and their implications are still unclear and thus volatility is imperative.

Last Friday’s sell-off relevance to the ‘Minsky moment’ is surely a mild momentum when compared to the crisis way back in 2008. That said, as the exit terms are yet to be determined, let us not assume that this will be a plain sailing exit. So sit back and relax, the ride could get interesting.

This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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