(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.