Disaster In The Global Equity Markets

Some people assume that very little is happening in global equities presently. They assume that "things are a bit quiet", as there is a pre-war lull, but the markets will find a positive direction as the Iraqi question is resolved.

The assumption that the crisis will be resolved without unforeseen consequences is questionable: so too is the assumption that the markets will be positive post-Saddam. But the main point explored here, is whether there is a lull.

There is no lull. The Iraq problem is masking existing trends of declining equity prices, advancing credit creation, and rising oil and gold prices. These trends were in place a year ago, but some are accelerating, especially oil which has surged to $35 a barrel.

Markets need to be examined in a useful timeframe. Ten years is useful, but one year will suffice to establish an important point that has been curiously overlooked. While most people are aware of the operation of the bear market, the sheer magnitude of the losses will come as a shock to many readers, and even experts may glean some insight from the broader picture. Obviously Wall Street has suffered. In the last year the Dow has lost 18.5% and the NASDAQ 21%. But the Dow is composed of very few, high -value stocks, and it gains by a periodic change when it discards losers and recruits winners like Microsoft. So analysts often prefer to use different indices. The S&P 500 is more useful for deterring the market’s health, and it had lost more than the Dow (21.5%). This is close to the Russell 2000, which has lost 20.5%.

So it would seem that the loss is about 20%, but this conceals some carnage in specific sectors. Those investors who punted on biotechnology will be bemused by a 32.5% fall in the Amex Biotechnology Index. The NASDAQ High Technology lost 24.9%. These are widely tipped as the most important future growth sectors. Those investors, who sought safety, might have lost money in Transportation (down 22.7%) and the ultra safe utilities lost an amazing 26.7%.

Admittedly, the Asia-Pacific region appears to have fared better. Using the most popular index for each country ( the Hang Seng, the Nikkei etc), Hong Kong was down only 14.3%, China 12.9%, Australia 17%, Japan 17.3%, and Taiwan 19.6%. While there were good relative performances from India (steady) and Thailand (down o.5%), there were disturbing losses in Singapore (24%) and South Korea (23.6%)

Europe is a disaster area. Even that great role model, Ireland, which some commentators press New Zealand to emulate, lost 28.6%. The big exchanges suffered terribly. London lost 26.5% which was somewhat better than the sober Swiss who lost 32.1%, the thrifty Dutch who lost 40.2%; France lost 34%, Belgium 34% and Italy 22%.

I was surprised to find that Germany was the worst performer, losing 45.4%. This is a mind boggling result. Imagine the chagrin of investors who lose close to half of the value of the share portfolios! To add insult to injury, German house prices have been deflating since 1994, and have often lost half of the 1990 value.

The Germans are super sensitive to the value of money. Their folk memory is that families were wiped out by the inflation of the 1920’s and the defeat of 1945. They have supported sound money policies (until recently) and will be very hurt the stock exchange’s betrayal. The Swiss and Dutch are very thrifty people too, and will find it hard to cope with a massive erosion of their wealth.

A thriving stock and housing market gives a population a "feel good" sentiment, which economists call the wealth effect. This increases consumer confidence and stimulates spending. The reverse is happening in Germany. Like the Japanese, they will observe rising unemployment, which is close to record levels) and curtail their spending. Germany is a candidate for a severe downturn, and is entering its second recession in two years.

It will be noted that no large exchange has been spared. The US, UK, EU, Hong Kong, Singapore and Japanese exchanges are all severely down. This is in addition to great losses in 2000, 2001 and early 2002. A strong housing market in the US, UK, Australia and New Zealand has mitigated the gloom. But Japanese and German property is still deflating, causing unmitigated gloom.

This almost universal fall in equity values is obviously diminishing consumer confidence (What wealth?) but may also be undermining the financial security of a generation. The baby boomers of modern world expected to retire with a nice nest-egg or pension. But almost everywhere, those who invested in shares have taken very large losses. Some will now curtail their spending. Many have emulated Nero and have fiddled while Rome was burning: they have maintained their level of spending, not infrequently by lowering the equity in their homes by refinancing their mortgage, or they have increased personal and household debt.

While additional saving is necessary in bear markets to maintain a chance of reaching financial goals, it seems that the consumer, especially in the USA, is still spending and not saving.

There could be worse to come. Some firms have been desperate to keep up their share value, and have been tempted into creative accounting; this has caused massive losses to shareholders in Andersen, Enron and now Royal Ahold. That is bad enough, but secondary to systemic financial difficulties.

Many firms have been hurt by the losses in the asset portfolios. Some have had to sell stock to maintain a required liquidity ratio.A ustralasians have seen the large insurer, AMP, resort to raising capital to meet its London obligations. Should markets erode further; some insurance companies will be obliged to sell stock into a declining market. A flood of sales will possible cause the market to over-shoot, so some large spikes are very possible.

Banks are also under strain. Japanese, and now German banks are looking fragile. It must be remembered that the collateral on their loan advances is sometimes in property or stock, both of which have broadly declined in quality.

A financial accident is a real threat. While there have been notable collapse in the last couple of years, no major bank, insurance company, security firm or asset manager has gone to the wall. BCA Research said "it is amazing that we have burst one of the great asset bubbles, yet have not had any systemic financial sector problems". Nevertheless, its "stress index" is still in the danger zone, and even last December warned that it could not "rule out an accident, especially if the equity market has another major sell off".

A sell off is probable if a shooting war starts in Iraq (there was one in the Gulf War). One expects there to be a quick recovery, but even a short-term plunge could deliver a mortal blow to a struggling financial institution.

Moreover, the protracted high price of oil will be hurting some oil importing economies. It is unlikely that an oil shock will hurt the USA, but there is reason to exact a protracted high price to cause difficulties for the EU, India, China and Japan. High oil prices damage most economies as demand is somewhat inelastic. Demand for other goods fall. There is good research which suggests that an oil price of more than $30(in 2002 dollars) is likely to drive the world into recession.

Neville Bennett
Christchurch, New Zealand
n.bennett@hist.canterbury.ac.nz
March 4, 2003

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