August and October are typically the most volatile months of the year and it is likely investors may once again see that phenomenon repeating itself in 2019. There is no scarcity of potential catalysts if you consider the state of European banks, trade wars and and the possibility of an hard brexit, just to mention a few.

Valuations are stretched to put it mildly and it does not take a lot of imagination to see financial markets getting choppy over the next few months. Should that be the case investors may want to turn to “Occam’s Razor” for counsel. The 14th Century philosopher problem solving principle states that the scenario which requires the least assumptions is the most likely to play out. On the same token, based on the events of the last decade, we should assume that, if markets start to suffer, we will see yet again a new round of intervention aimed to support asset prices.

In the aftermath of the 2008 crisis, unprecedented monetary easing has ensued creating massive asset inflation on one side of the ledger and massive debt on the other one. Such unprecedented level of global debt is now hanging on the global economy as the proverbial Damocles’ sword and the policy makers’ primary job is to make sure that the sword never drops and financial and economic disaster is averted.

Two questions however remain: how “bad” will things need to get for policymakers to step in and what tools will be needed this time to prevent the worst to happen. As per the former, the recent events Q4 2018 may shed some light; December 24th the S&P closed 19.8% off the recent high, just above the psychological 20% decline that would have typically marked the start of a new “bear market”. Not good, as people coming back from the holidays would have most likely compounded the selling. The immediate combined effort of US Treasury and Fed managed to stop the decline and the rest is history.

More difficult is to address the second answer. It is reasonable to assume that the same measures deployed so far are unlikely to be effective in case of serious market turmoil. A clue to the notions policy makers are bent on doing “whatever it takes”, is the increase frequency in the use of the word “unconventional” in the statements of major central bankers. Given the global massive stock of debt, the precarious situation of European banks and the likes, I suspect that new efforts will have to be indeed very “unconventional” to stem what could be panic selling in markets such as low grade corporate bonds that may have little or no liquidity. Think; “Fed buying GE’s paper or equity ETFs”.

As a major market collapse and economic recession do not bode well for the next electoral cycle, is all but sure the next round of intervention will be extraordinary. Likewise, it is also plausible that such measure may succeed in arresting the plunge and that the “party” will keep going for some more with rates making new lows and bonds and equities making new highs. You know the drill.

Yet, at some point, the deployment of ever more extreme policies like Modern Monetary Theory (“MMT”), may undermine market participants’ confidence in the “real” value of assets, as prices can be manipulated at will by politicians. Do not forget after all that the word “credit” comes from Latin credere, meaning to believe. If confidence in the future purchasing power of traditional financial assets, first and foremost the mighty dollar, starts to falter, a crack may start to appear between “nominal” and “real” values. We will then be all invited to attend the inevitable “banquet of consequences”.

This article was originally published on LinkedIn

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