Sunday, May 16, 2021 02:38 PM

Forget inflation. Deflation is the most immediate threat facing global financial markets today — specifically the deflating speculative bubble that fueled much of last year’s risk asset rally.

  • For the second time in about as many months, investors saw a surprise leverage-driven selloff, when a slump in Taiwan stocks Wednesday triggered margin calls that quickly pushed the local benchmark into a record decline
  • Coming so soon after the late-March blowupof Archegos Capital Management, the selling frenzy should be a warning sign that the tables are turning against the world’s leveraged investors
  • Everywhere you look, the darlings of what some have called the greater-fool theory of investing — that there will always be someone to sell to at a higher price — are under attack, largely because that one-last buyer has finally balked at paying up
  • Bitcoin has tumbled about 30% from its record high, the ARK Innovation ETF is down by closer to 35% and the Goldman Sachs Retail Favorites Index had fallen into a technical correction
  • The writing was on the wall when the 20-day moving average of call options traded in the U.S. stock market — a decent gauge of speculative demand — peaked in February and began to roll over
  • In Taiwan’s case, its successful management of Covid and a stockmarket led by its world-class chipmaker had attracted huge investor interest, and some were juicing their gains with leverage
  • At one point the benchmark Taiex Index was up about 20% year-to-date and the value of margin debt had surged 46% this year to about $10 billion at its peak at the end of April — the highest since 2011. That leverage fell by a net $461 million on Wednesday when the Taiex tumbled as much as 8.6%, according to exchange data compiled by Bloomberg
  • For comparison, U.S. margin debt topped $822 billion by the end of March — the latest available data — up 72% year-on-year. A day like Taiwan just had for the U.S. would be the equivalent of a $38 billion margin call
  • Of course, dip buyers could soon emerge. But it’s hard to see the same speculative fervor taking hold again in an environment where there are legitimate concerns about the impact of inflation on portfolios, regulatory risk haunting big tech and cryptocurrenciesand the Federal Reserve paring back its massive stimulus
  • Fewer speculators leave global markets without a key marginal buyer that helped them climb more than one wall of worry last year, and increases the risk of a disorderly selloff if continued declines in riskier assets trigger more margin calls
  • NOTE: Cormac Mullen is an editor on the Markets team with more than a decade’s experience as an equity analyst and trader in Europe. The observations he makes are his own and are not intended as investment advice