Hari P. Krishnan - Market Tremors: Quantifying Structural Risks in Modern Financial Markets

Thanks also goes to (in alphabetical order): Stuart Barton, Ranjan Bhaduri, Nicholas Brown, Diego von Buch, John Burke, Brian Casselman, Kevin Coldiron, Christopher Cole, John Cummings, Nick Denbow, Vasant Dhar, Bob Doherty, Mark Finn, Jonathan Gane, Mike Green, Dan Grombacher, Jason Hill, Wayne Himelsein, Corey Hoffstein, Demetris Kofinas, Jon Marcus, Marty Mazorra, Nick Mazorra, Avery More, Chris Morser, Jon Marcus, Norbert Mitwollen, Stephen SOG O'Gallagher, R. M. Pathy, Joan Plensa, Sri Prakash, Patchara Santawisook, Mark Serafini, Kris Sidial and Tim Usher Jones for numerous interesting discussions regarding the book.

Ash Bennington would like to thank his family for their unwavering support: Adrienne Carchia, Carl Carchia and his late father Enrico Benigno.

Finally, HPK would like to give a special thanks to his immediate family: Kailash, Sudarshan, Lalitha, Rajee, Savitri, Raman and his late father Padmanaban. All have been helpful in their own special way.

People who count their chickens before they are hatched act very wisely because chickens run about so absurdly that it's impossible to count them accurately.

Oscar Wilde

As we look out across the spectrum of global markets in the middle of 2021, there are no visible signs of overt distress. In fact, we see the opposite: many markets appear Zombifiedsaddled with astronomical levels of public and private debt as yields remain pinned to the zero bound. Meanwhile, many veteran investors are bewildered by asset prices that no longer seem linked to traditional valuation metrics, such as price to book value. On a recurring basis, the high priests of finance try to justify the most recent rally on financial news networks to a growing legion of benumbed investors.

Against this surreal but seemingly benign financial backdrop, the authors of this book find themselves wrestling with several thorny questions: Are there circumstances where market volatility is persistently low, while a rising danger lurks beneath the surface? Can we identify structurally weak asset classes where a small price shock will spiral into a major sell off? If so, how can we defend against price meltdowns and liquidations before they actually occur?

As we will discover in the chapters that follow, the answer is a qualified Yes! There are many important situations where we can improve upon standard risk estimates, based on our knowledge of the major players in a given market and how they are likely to act. In service of that goal, this book is intended for readers who wish to understand and profit from situations where risk is rising in the financial network while credit spreads and realized volatility remain low.

To begin this journey, it is worth reflecting upon how the availability of credit affects asset prices over time. It is widely understood that leverage and volatility tend to move in opposite directions in the later stages of the credit cycle . Leverage is high, yet equity prices are grinding up and credit spreads are stable or declining. Credit is cheap and can be readily deployed into the equity and corporate bond markets. This means that investors have the firepower to buy the dips, which dampens downside volatility until the cycle breaks.

Historically, the US credit cycle tended to last six to eight years, measured from peak to peak. We could say with some degree of certainty where we were in the cycle. Asset booms and busts were somewhat predictable, as they corresponded to peaks and troughs in the quantity of credit available. Since 2008, however, this template has been altered by Central Banks , who now seem to equate economic stability with low asset price volatility. The expansionary phase of the current credit cycle has become extremely long in the tooth, given the ever increasing presence of the Fed .