Monday, October 27, 2008

Global equities seesaw -- and exaggerate

This chart compares the S&P 500 to Germany's DAX index; note that the y-axis has a similar range of magnitude for both equity markets. European equities have been more volatile than US markets mainly because of swings in the value of the dollar. Abstracting from the dollar's swings, both German and US equity markets have tracked each other pretty closely. In short, this is globalization, and we're all in this together.

The problem that started with declining home prices in the US and was magnified by subprime mortgage loans has now spread to the entire world. The market value of all the stocks in the world, when measured in dollars, is now down a staggering 53% from the high one year ago. World market capitalization has fallen from $62.6 trillion to $29.6 trillion, a loss of $33 trillion! And the pundits are talking about a global recession getting underway.

A thought experiment: let's say that the value of all the homes owned by US households is down 25% from the high, which is probably a stretch but would be in line with the fall registered by the Case-Shiller home price index. Using the Fed's data, that would mean US homes have lost $5 trillion in aggregate value and are now worth only $15 trillion (which is what they were worth 5 years ago).

I'm having trouble understanding how a loss of $5 trillion in the US housing market, while certainly not trivial, could trigger a loss of $33 trillion in global stock markets. Something is out of whack, and I think equities have over-reacted.


Anonymous said...

Creat point. But I’m then led to wonder what’s really behind the overreaction?

My guess is that it is a combination of uncertainty about the upcoming election; a fear that even with that uncertainty all signs are pointing to an Obama tax-happy administration along with an unrestrained congress (no checks in place from the opposing party); with a bit of MSM bias thrown in for good measure (after all, the MSM needs to hype up the bad economy to get their man elected). I wouldn’t surprise in the least if assuming Obama is elected the bad news about the economy softens a bit to make it easier for him to spend.

Your thoughts?

Scott Grannis said...

I've made numerous posts on this subject, and I agree that Obama fear is definitely playing a role in this financial panic.

Yet I can't help but think that a) Obama won't be able to do all the things he would like to do, and b) markets seem to have priced in a pretty disastrous scenario regardless.