I've seen a few headlines today referring to the Evergrande issue as "China's Lehman Moment". I have no idea whether it will be the case or not but I wanted to post briefly on liquidity.
In 2008, I was working at a large global investment bank, watching the world melt down around us. By that point, I had spent about 8 years in fixed income capital markets, which was ground zero for the mess so the storm was intense. That episode, along with the Euro crisis in 2011/12 really taught me a lot about liquidity. Below are a four lessons I took away.
1) Liquidity is easily and often taken for granted but when it evaporates, it's the only thing that matters. Know in advance where the emergency exits are at all times by knowing what you will sell if forced to raise liquidity. That is often a function of gauging recovery potential across your portfolio once stress subsides.
2) During times of stress, pressure mounts and will relieve itself any way it can. During the GFC as long as markets were open, people were forced to react to a variety of every changing stimuli that were causing selling pressure. The banks eagerly awaited Friday afternoons when the market would close and stay closed for the weekend, giving everyone time to be proactive in looking for ways to sway confidence rather than react. If macro contagion truly does end up spreading, I can see a scenario where crypto gets hit harder and quicker than other asset classes since its open 24/7. One possible mitigating factor could be the large amount of hodling in cold storage that goes on. Harder to sell what's not on an exchange.
3) There's a concept called 'stress betas', popularized in research by a gentleman named Marty Leibowitz at Morgan Stanley. The short version is that because diversification is often expressed through adding riskier asset types (small cap stocks or alt coins for example), it can actually works against you during these times of stress when correlations tend to move towards one. Thus, the benefit of including riskier asset types is really not a story of diversification so much as it is a story of increasing potential returns. This has definitely been the case in crypto over the last 24 hours.
4) If there is leverage in the system and truecontagion hits, cash will be king. The whole fiat argument will be suspended as the global demand for dollars will explode due to contractual arrangements. However, as central banks are likely to respond by injecting liquidity into the system to stave off deflation, once the panic subsides, the outlook for the dollar is likely to darken. Timing all of that will be insanely difficult, if not impossible as there will be a number of head fakes and false starts.
Just a few thoughts to consider.
As always, this is not investment advice and please do your own research.
Cheers,
NZFX
