Wednesday, May 29, 2024
Business & EconomicsFinance

Coronavirus and the Stock Market Correction

Fears over coronavirus have sparked a global panic, evidenced in this week’s stock selloff. Today, the market was sent into correction territory, having lost about 10% of its valuation. The US stock market was “worth” about $40 trillion on Friday. Today, it’s “worth” about $36 trillion. To put this into perspective, the 1929 crash that sparked the Great Depression lost 25% of its capitalization, equivalent to about $400 billion today. (For the uninitiated, investors call a 10% dip from a peak a “correction,” while a 20% dip is called a “bear market,” given the technical evidence for it being much easier to recover from a 10% decline than from a 20% decline).

But the sudden spike in volatility– how eager investors are to quickly sell off 5 or 10% of the entire market- is even more troubling when you compare the ratios. To be sure, 1929 was ugly and sent the United States– and, indeed, much of the world- into a terrible economic depression. But a comparison between the 1929 peak and the 2020 peaks show something far more troubling. Even accounting for inflation and all that jazz, the ratio of market capitalization to GDP was actually lower in 1929 than it is today.

What does that mean in lay terms?

This ratio is sometimes called the “Buffett Indicator” because of Warren Buffett’s affinity for it as a gauge of whether investors should put money into the market or not. If the total stock market capitalization is worth more than the entire sum of all products in the economy (GDP), that means that people are trying to make money from moving money around rather than actually creating goods or services. Basically, Warren Buffett says, you should avoid investing if it starts getting close to 100%. But we’ve seen the numbers go way above 100%– they’re currently above 140%, even with the recent dip. Compare that to 124% in 1929. These valuations are further evidenced in how much debt we seem to be okay with assuming. 

CCN, a Norwegian website founded to talk about cryptocurrency that has since blossomed into a vaguely legitimate source for financial news, has been sounding the alarm on the debt bubble for months. Most observers agree that the Trump tax cuts did more to prop up market valuations than they did for anything else. I wrote before that Trump likely wants this as a way to keep the market high as he heads into an election he is unlikely to win should the market collapse.

Comparison of market values in 1929 to 2020 August 1929 Feb. 21, 2020 Feb. 27, 2020
Stock Market Capitalization (Valuation), inflation-adjusted $1.349tn [1] $41tn $37tn
US Gross Domestic Product (approximate, inflation-adjusted) $1.1tn [2] $25.8tn [3] $25.8tn
Ratio of capitalization to GDP (approximated) ~124% 158.9% [4] 143.4%

In other words, fears over coronavirus– which sound quite warranted– have exposed the vulnerability of our financial thinking to these huge swings in volatility. Scary though coronavirus is, I’ve said for a couple of years now that it’s highly probable that something will spark some sort of cascading collapse of our debt-driven economy. And that’s fine, honestly, if it forces us to rethink consumption.

The major unfortunate part of any sort of collapse in equities is that it tends to trickle down– in a way that wealth does not (sorry, Ronnie)- to the people who need money the most (and who spend more, dollar for dollar, than the wealthy anyway, contributing marginally to more economic growth). Seeing as that population includes upwards of 20% of Americans who have a negative net worth, it’s also quite probable that things are going to get way worse before they get way better.

Nat Zorach

Nat M. Zorach, AICP is a city planner, community development professional, and MBA candidate at American University's Kogod School of Business, based in Detroit.

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