INSUBCONTINENT EXCLUSIVE:
By Chris AnsteyHow bad will the next crisis be JPMorgan Chase Co
has an idea.
A decade after the collapse of Lehman Brothers sparked a plunge in markets and a raft of emergency measures, strategists at the
bank have created a model aimed at gauging the timing and severity of the next financial crisis
And they reckon investors should pencil it in for 2020.
The good news is, the next one will probably generate a somewhat less painful hit
than past episodes, according to their analysis
The bad news Diminished financial market liquidity since the 2008 implosion is a “wildcard” that’s tough to game out.
The JPMorgan
model calculates outcomes based on the length of the economic expansion, the potential duration of the next recession, the degree of
leverage, asset-price valuations and the level of deregulation and financial innovation before the crisis
Assuming an average-length recession, the model came up with the following peak-to-trough performance estimates for different asset classes
in the next crisis, according to the note.
A US stock slide of about 20 per cent.
A jump in US corporate-bond yield premiums of about 1.15
per centage points.
A 35 per cent tumble in energy prices and 29 per cent slump in base metals.
A 2.79 per centage point widening in spreads
on emerging-nation government debt.
A 48 per cent slide in emerging-market stocks, and a 14.4 per cent drop in emerging
currencies.
“Across assets, these projections look tame relative to what the GFC delivered and probably unalarming relative to the
recession/crisis averages” of the past, JPMorgan strategists John Normand and Federico Manicardi wrote, noting that during the recession
and ensuing global financial crisis the SP 500 fell 54 per cent from its peak
“We would nudge them all at least to their historical norms due to the wildcard from structurally less-liquid markets.”
JPMorgan’s
Marko Kolanovic has previously concluded that the big shift away from actively managed investing -- through the rise of index funds,
exchange-traded funds and quantitative-based trading strategies -- has escalated the danger of market disruptions
He and his colleagues wrote in a separate note Monday of the potential for a future “Great Liquidity Crisis.”
“The shift from active
to passive asset management, and specifically the decline of active value investors, reduces the ability of the market to prevent and
recover from large drawdowns,” Joyce Chang and Jan Loeys wrote in the Monday note
Actively managed accounts make up only about one-third of equity assets under management, with active single-name trading responsible for
just 10 per cent or so of trading volume, JPMorgan estimates.
Liquidity Worries
This change has “eliminated a large pool of assets that
would be standing ready to buy cheap public securities and backstop a market disruption,” Chang and Loeys warned.
One silver lining is in
the recent rout in emerging markets: it means assets in developing countries have cheapened this year, helping limit the peak-to-trough
declines during the next crisis and offsetting a buildup of leverage, Normand and Manicardi wrote.
Besides the liquidity question, Normand
and Manicardi highlighted the length of the next downturn as a critical unknown in gauging how bad things will get
The longer a recession lasts, typically the bigger the hit to markets, their analysis of past episodes shows.
“The recession’s duration
is a powerful drag on returns, which should dovetail with some readers’ concerns that policy makers lack the necessary monetary and fiscal
space to extract economies from the next recession,” they wrote.
