At the same time, the huge liquidity that has been driving markets may be more apparent than real as a lot of it is really debt. It could disappear at a stroke.
The irony is that 10 years ago, during the Asian crisis, the problem was geographic contagion with problems in one part of the world – Asia and Russia – spreading to other places – Latin America – more on the basis of fear than a rational appreciation of local conditions. Now investors distinguish sensibly between geographies but they may instead fall victim to spillover between different asset classes.
Five years ago, asset classes were largely uncorrelated and institutions put money into emerging market, small-cap stocks and hedge funds to diversify away from mainstream equities. But, says Richard Bernstein, chief investment strategist for Merrill Lynch, in a recent FT blog: “Today, only bonds and cash are negatively correlated with the S&P 500, and commodities are roughly ‘uncorrelated’. Asset classes such as hedge funds and non-US stocks offer almost no diversification benefit right now.”
Henry Kaufman extends the argument to a blurring between credit and liquidity. Mr Kaufman, who was chief economist for Salomon Brothers in the 1970s and 1980s, said in a recent speech that liquidity used to be an asset-based concept meaning cash and tangibles. Now, in the era of leverage, it could just as easily mean credit. Hence if the market is spooked, leverage is going to be reduced across the board regardless of asset class.
On this basis, the next glorious sell-off could be quite an event as investors sell anything and everything all at once.
