Since we have been in a bull market for such a long time, with favourable conditions being provided by central banks, we find ourselves in a situation where many traders and investors don’t even know what it’s like to experience a real downturn or crash.
In stocks, we have had relatively smaller corrections taking place since the post financial crisis recovery, but no sustained selling. We are talking about almost a whole decade. A lot of people think a bear market is just a minor fleeting event that comes and goes in a relatively short amount of time.
This is something that was discussed in an article on Bloomberg recently, with the headline: “Is Wall Street’s Untested Millennial Majority a Risk?” and it raises an interesting point of discussion.
During the financial crisis, the market dropped more than 50% from peak to trough. Anyone that worked in the financial markets during that time will still have the nightmare etched in the back of their mind as these smaller corrections hit the market. These traders know that one day, it will become something much deeper than a small correction.
The Bloomberg article quotes Paul McNamara who heads a team of five people managing $11.5 billion. He says: “You have to have had that stage where you are looking at the screen through your fingers to really appreciate risk-reward in this industry […] Not just seeing things go wrong, but going so much more wrong than you imagined was possible.”
McNamara is one of very few employers in the city that avoids hiring anyone that has not endured an “absolute disaster”, with his youngest team member being 39 years old. However, half of the 4,800 fund managers surveyed in London, New York and Paris were found to have less than 9 years experience. Therefore, never having endured a real crisis.
A related article in Zero Hedge points out that the Wall Street Journal reported during the aftermath of the Swiss flash crash (after the Swiss National Bank decided to stop pegging the euro), that the volatility surged thanks to worried young traders on currency dealer desks shutting off the liquidity, in a panic.
However, the problem may not be limited to millennials, but may be an issue of most market participants having a short memory of the past. 2009 is a long time ago now and as Jacob Frenkel, the chairman of JPMorgan Chase says: “One of the dangers of a long detour is that people start to forget what we are detouring from”. He then goes on to say: “If you have unconventional policies that are lasting for so many years, they may become the new convention”.
Millennials may not have worked through the dot.com bubble, the financial crisis or other collapses in the market, but they have been first to adopt new markets that the ‘old-timers’ in general were slow to adopt.
Many millennials cashed in on the rise of cryptocurrencies and saw the subsequent corrections there. Perhaps they have an advantage of being able to accept new ‘normals’, whether that be new markets like cryptos or new economic cycles and market activity. Unlike the older generations who have seen too much of the old way, to be able to adjust.
In fact, that brings us onto a great point brought up in The Economist. Perhaps the markets are seeing a new normal and people stuck with the old way of thinking are the ones that are going to suffer. The Economist argues that the shift from a manufacturing-dominated economy to a services-dominated economy means a longer economic cycle makes more sense. All the people that believe the cycle must be nearing its end, simply because of how long it has been, may be missing the point.
In a manufacturing-dominated economy, when demand is booming, companies will need to buy more materials, commodities and components, as well as hiring more staff for manual labour. This demand will push up prices and therefore inflation, which will inevitably lead to the central banks tightening their monetary policy.
However, as demand starts to drop thanks to the tighter conditions, companies are left with surplus inventory and too many members of staff. They will have to lay-off staff and cut off their orders immediately. This accelerates the downturn and therefore leads to the recovery coming sooner, so the cycle can start again.
Now that we are in a services-driven economy, things are different. Companies do not need to stockpile products before they can sell it, so they are less susceptible to the inventory cycle. This means the cycles can last for a longer period of time. In addition to that, The Economist also points out that the longer cycles may be due to monetary policy and the current iteration of the system being used.
Incidentally, The Economist raised another interesting point (not directly relevant but worth keeping in mind), that due to the huge levels of credit in the economy (which is even higher relative to GDP than in 2007) the new cycle may no longer be based on the inventory cycle but the credit cycle. We think if this is based on a credit cycle we could see the cycles shorten once again, rather than remaining longer.
Therefore, perhaps the older generations need to adjust to the new normal and perhaps this really is only a correction, with no crisis around the corner. However, who would really argue with Ray Dalio, one of the most successful hedge fund managers of all time, whose company Bridgewater has disclosed that it is holding over $13 billion in short positions. Particularly, to build a position against Italian Banks in anticipation of the March election.
On the other hand, one may argue that it was the older generation that made the mistakes which led to particular crisis situations, so who wants to listen to them anyway?
Although there are certainly pockets of millennials that have no concept of sensible risk management. As we saw after the VIX fallout and in strange online groups, such as the Wall Street Bets subreddit, where losing huge sums of money seems to be an achievement.
What do you think about this topic? Are millennials a risk, due to being ill-equipped for a crisis. Or are we seeing a new era that no one has seen before? Are the older generations the risk in the markets since they cannot embrace the new paradigm? And will their own fears of market crashes simply cause a slow-down in progress being made?