Nosebleed.

Right, so we’ve been trading and investing in an environment characterized by the market version of martial law for the better part of a decade now.

Think of it as Aleksandar Kocic’s “state of exception.”

“In its core, policy response to the crises was an extension of what in a political context is known as the state of exception,” Kocic wrote, back in July, before noting that the whole idea of the state of exception is a paradox: “Market laws had to be suspended to restore normal functioning of the markets.”

That paradox (effectively breaking the market in order to fix it) only resolves itself when martial law is lifted or, more colloquially, when the training wheels are removed.

The risk is that if the state of exception lasts for too long, everyone forgets how markets are supposed to function. What was temporary becomes permanent and those who suspended the rules in the first place lose the incentive and even the capacity to give up the power they exercised in creating the state of exception in the first place. The self-reinforcing dynamic implicit in this system is readily apparent today. Here’s Kocic again:

Everyone is incentivized to participate in the reinforcement of the state of exception, while various forms of contestation of the power are inhibited. For example, attempts at shorting bonds are penalized by a steep curve, protection against volatile unwind is discouraged through wide vol calendars, negative carry etc.

And that gets to what, in my view, is the most pernicious part of the dynamic. Namely that the longer this lasts, the more entrenched the feedback loops become, and those feedback loops by definition make the situation ever more precarious. When attempts to contest the state of exception are punished mercilessly and consistently, resistance becomes futile, as it were. So everyone acquiesces. And in this context, acquiescence means participating in and perpetuating the feedback loops that are creating bubbles.

The other possibility here is that by persisting in this, we’re exhausting our capacity to respond to future crises. Of course, if one waits around long enough, another crisis is bound to occur. When that happens not only will we be short on ammunition (e.g. if the next crisis started tomorrow, we’d be going into it from ZIRP/NIRP and with already bloated CB balance sheets), we’ll also be approaching it from nosebleed levels thanks largely to the fact that we never exited the state of exception instituted to cope with the previous crisis.

So try to think about the laundry list of potential headwinds the market faces in the context of everything said above.

And to help you visualize exactly what I mean when I say that when the next crisis rears its ugly head, “we’ll be approaching it from nosebleed levels thanks largely to the fact that we never exited the state of exception instituted to cope with the previous crisis,” I present the following charts from Goldman with no further comment…