(January 22, 2008) More on putting the current stock market troubles into perspective.
World market capitalization–the values of all the shares on all the stock markets in the world–more than doubled from just over $25 trillion five years go to $66.6 trillion 10 weeks ago on 10/31/07. Since then it has fallen by more than 12%, or $9.1 trillion.
Both the spectacular size and duration of the run up and the abruptness of the fall are noteworthy.
One point–the recent reversal has not erased the gains. Even at today’s stock market levels people’s stock market wealth is $30 trillion higher today than it was just five years ago.
Second, the recent decline is simply too big to attribute to either U.S. mortgage delinquencies or the prospect of a U.S. recession. To date, banks have written off just over $100 billion of mortgage value (which equals just 0.96% of the $10.4 trillion of mortgage debt owed by U.S. households at the end of Q3/07.) Global market cap has fallen by 91 times that amount, or $9.1 trillion.
The same goes for U.S. market cap, which rose by $7 trillion from $12 trillion 9/28/03 to $19.0 trillion on 10/14/07 and has fallen by $3.1 trillion (16.3%) since then to $15.9 trillion at yesterday’s close. That’s a lot of damage to attribute to $100 billion of mortgage losses.
A recession won’t do it either. Let’s say that if there were to be a recession it would wipe out the free cash flow of the entire S&P 500 for one year. Based on our estimates, the first year of free cash flow represents less than 2% of the Intrinsic Value of the S&P. Yet losses are 8 times that amount to date.
If we can’t explain the size of the losses on either mortgage delinquencies or the prospect of a recession then what is going on?
I look for an explanation in the structure and behavior of the asset markets themselves. I prefer to look at the capital markets as information networks, in the spirit of Hayek and von Mises. Network theory tells us that, from time to time, networks suffer temporary blackouts. We are in one now. Just like electricity blackouts, network failures happen quite suddenly. But they end quite suddenly too.
JR
Please provide me your email, Mr. Rutledge. I am a Brazilian journalist, editor of a business magazine, and I´d like to talk to you. Leonardo
Hi Dr. Rutledge, I am a big fan. Thanks for starting to blog again, I was going through Rutledgeblog withdraw! I have been trying to find an explanation too, and here is what I found: I think this correction/bear market is all about the Fed. We have a banking crisis caused by the Fed first being too easy, and then too tight for too long. The crisis is made worse as the Fed failed to appreciate the severity of the crisis and forgot it’s primary mission (which is to provide stability to the financial system in times of crisis). This banking crisis is very dangerous, it’s similar to the one we had in 1929, i.e., an inexperienced Fed presiding over the bursting of a credit bubble. In addition, the lifting of the uptick rule exacerbated the volatility and thus induced massive panic and made things much worse. If you are interested, I have some data that shows that the Fed was too tight and took the banking crisis too lightly until today. I hope the Fed will give us another aggressive cut next week. If not, then we will be in trouble.