In the U.S., it’s stocks up and housing down; in rest of the world, it’s the rocket-like movement of stocks unlike their historical lift-like movements; and housing seems to be up or facing a temporary downturn, depending on the specific market.

Dow Jones – the 30-stock index of the New York Stock Exchange (NYSE) is ruling in record high zones. It crossed 13,600 even for a brief while and thereby did set some 25+ record highs so far already this year. S&P 500 with both heavyweights and relatively smaller mid-caps has joined that party in the last few sessions, and is hovering around 1525 levels, points away from historical closing high. Russell 2000, the measure of the small-caps has been scaling new highs consistently in last couple of years, and is ruling at 835-level.

It’s only Nasdaq Composite Index that’s still at half the level of its peak of dot-com boom days of early 2000, ruling above 2570 level now and still miles away from the 5000+ level it saw seven years back.

And in emerging markets, the story is much brighter. Chinese markets are up three times in last as many years, and yearly gains of close to 100% year-after-year has become more of the norm than the exception. True, words from legends like Alan Greenspan again warned on possibilities of ‘Dramatic Contraction’ in Chinese stock prices, and more of such warnngs would come as dizzying heights are reached consistently and continuously.

Out of closed to $50+ trillion dollars of asset values that stock markets globally offer, nearly 40% or more of that market-cap is in the US. China, even when Hong Kong is included, represents hardly couple of trillions of dollars in paper assets; domestic market in China being close to one trillion dollar in market-cap, and that in Hong Kong is closed to another $2-trillion. True with the rapid rise, figures of couple of months old may even  look as underestimates with every passing day.

One must keep in mind that many U.S. firms enjoy a global presence more than their counterparts from other economies; however in valuation terms that gets reflected in respective nations gross market-capitalization (for listed overseas ventures of the U.S. headquartered firms).

Price-Earning ratios in emerging markets are reaching stratospheric levels. Domestic FMCG shares in China quotes at 165 PE level, as Bloomberg pointed out couple of weeks back. That’s even higher than the PE that dot.com players enjoyed before the dot.bomb days. 30+PE for main-market indices in China or in few other emerging markets no longer cause eyebrows to be wrinkled.

On the other hand, barring Japan, interest rates globally have not remained soft in last 3-4 years. Housing is badly down in the U.S.; and with nearly 70% mortgage rate in the U.S.; many feared that a 25-30% price fall from their peak would wipe out all the housing assets of the individuals because of their leveraged positions. In many regions, the fall has already reached closed to that dangerous level. Though many were optimist that the bottom had already been found in housing in the U.S. in the early days of the slump; sub-prime rate problems along with consistently and regularly found new bottoms reveal that in housing, U.S. may still be far from the bottom. And in housing itself, individual U.S. citizens have collective borrowings of more than $ 10 trillions. Guesstimates state that in real-estate mortgages too, U.S. alone may account for more than 40% of global real-estate mortgage value.

It’s obvious from the growing sub-prime rate problems that the housing sqeeze has affected the vanishing middle-class and the worse-off section of the U.S. society more severely than the affluent ones. The ownership of assets slowly is shifting from the working classes to the Investment Bankers, PE players or to the rich in this manner. The poor and the stupid always joins the party late, and thereby pays a heavy penalty for dreaming to own a house, allowing the other class to profit in the boom, and also in the bust cycle.

With prices falling, many saw an end of their housing ATM days. And enough has been written on the impact of consumer spending as consumers feel the pinch of falling real estate prices, or higher payouts on their mortgages. Consumer spending incidentally drives nearly 70% of the U.S. economy.

In terms of size of economy, U.S. contributes around 25% of global nominal GDP, and little less than 20% when GDP is measured in Purchasing Power Parity (PPP) basis; in trade U.S. contribution is around 19% of global exports, whereas in imports it’s 29% of global imports. In terms of savings, the less is said about U.S. contribution to the pool of global savings, the better it is.

So what clearly comes out from above is any squeeze in asset valuations in stocks or real estate globally would hurt U.S. economy more (as consumers in the U.S. would get squeezed at a much faster rate, nearly at double the rate for the rest of the world) due to the exceedingly overweight status U.S. enjoys in these asset-classes beyond what its size of economy permits.

Add with this economic challenges, challenges posed from outside like that of Iraq, Afghanistan, Iran, higher oil prices, trade deficits, baby-boomer generation retiring, indications of slowing growth rates, an impending collapse of social security and deficits in medical insurance; one is forced to wonder where from the optimism in U.S. stock markets come?

True, one must look at the clear positives as well. U.S. blue chips look much cheaper than stocks anywhere else with PE of nearly 18 (back in 2000 before dot.com bust days, they were at nearly 30 level); there’s been double-digit growths in many blue chips year after year. Add to that the wave of global consolidation, through endless big-ticket acquisitions and mergers,  from mining to  media space, that indicates future days of competitive markets to be limited with larger and larger firms having more and more control over consumers in pricing their products.

On top of it, when one considers the few trillion dollars of reserves lying almost idle with central bankers in emerging nations, losing their values as dollar falls (majority or even closed to 70% of that holding being in dollar-dominated assets) and closed to $ 2 trillion of savings that Chinese people alone accumulated over last couple of years, one is at a loss in channelizing this huge sum. China, with it’s closed to 50% savings rate, would add a trillion dollar each year in savings and closed to another trillion dolar in trade-FII-FDI related inflows.

That huge quantum of money is still not chasing any assets, true recently China have allowed a drop of that reserves, a meager $3 billion to be invested in financial assets by collaborating with Blackstone.

So how do we read these varying facts and figures, to complete the jigsaw puzzle on where financial markets are headed, and which country would stand where in case any long-term downturn becomes a reality?

If one believes that any asset, as long as that’s a physical asset and fiat money is worth holding as the supply of paper money, as it has been in last few years and as it’s likely to be in foreseeable future, would justify holding physical assets better than holding paper money, valuations don’t matter for the very long term. However shocks and sneezes, from China to the U.S., have at times shook the principle of this school of thought. Carry trade with Yen may not last indefinitely, as yen finally has to stabilize in international forex-markets.

Propagators of conspiracy theories smell another such theory that alone explains this apparent juggernaut. And that theory is irrespective of the attractiveness of asset prices, what U.S. can NEVER swallow is a falling real estate prices with a stagnant to falling stock prices. If U.S. consumers feel the pinch from both the ends with rising inflations (an output of increased cost of imports as dollar falls), its consumer driven economy is bound to jump into deep recession.

So the 1st priority for the Fed. and for all the policy makers in the U.S. is to ensure that stocks look healthy, people feel good that their asset values are not all that bad in-spite of falling real estate prices. To do that, whatever money supply is needed both within the U.S. and outside of it would be met. Yen-Carry trade as offered by friendly Japan and burgeoning trade deficits as offered by not so friendly China only help in achieving that goal of the U.S.

And the danger on the other hand in case that prime objective is not met can be devastating.  U.S. has already lost significant part of its global authority with the rapid rise and strength of few other economies; now if its own economy moves into a recession, the voices from within would only grow stronger to call the troops abroad back home early; because Congress would no longer find it easy to fund those hundreds of billions of dollars of tax-payers money on war-spends abroad.

As per this conspiracy theory, if things go as per these policies; markets around the world are not likely to come down to any drastically lower level until the Beijing Olympics which starts in August 2008. Because China would not also like to rock the present global status-quo boat much until then; and a complete U.S. housing revival is also not likely before that.

China remains vulnerable on stock-market fall whereas U.S. stands  vulnerable from multiple fronts. For the time being, both work together to safeguard each from their respective vulnerabilities; and incidentally there is a synergy in their actions. This synergy may not last long as Beijing is likely to be most vulnerable days before the Olympics.

After the Olympics, Beijing may care less about fueling its own vulnerability any further; it may rather opt to tackle that.

That may put a blow to the U.S. economy.

It housing partly recovers in the U.S. (unlikely by 2008), there would be two opposite forces on the direction of stock prices after 2008. Till then its party time for most asset class, barring U.S. real estate, because of easy liquidity in Dollar, Yen, & Yuan.

And if housing fails to recover till then, U.S. would need different strategy to bolster its economy and global standing as the support from easy Yuan can’t be taken for guranteed post the Beijing Olympics.

Ranjit Goswami is a Research Scholar with the Indian Institute of Technology (IIT), Kharagpur, India; and is the author of the book “Wondering Man, Money & Go(l)d’“.

 

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