Submitted by Joseph Carson, former chief economist of AllianceBernstein
The US equity market is on another streak, posting a double-digit gain since the start of the year and extending a bull run that has lasted 10 years. In terms of pure numbers, equities occupy a position far above any other asset, and in everyday life stocks have jumped ahead of real estate as a store of wealth for Americans.
From a risk management perspective, policymakers should consider broadening the definition of “too big to fail” to include market segments and not just financial groups since, at various times, the main risks to the economy and financial system have been the high value of assets on the private sector’s balance sheets.
The power and influence of equities should not only be assessed by the numbers, but also by how the market has become part of daily public and political conversation as well as a driver and verification of policy.
At today’s prices, the market value of publicly traded equities is estimated to be about $33tn, not far off the record high of $36tn recorded in the third quarter of 2018. Measured in relation to nominal GDP, the market value of equities stands at about 1.6 times. The record high of 1.7 times was reached twice before, in Q3 2018 and Q1 2000.
Household holdings of equities, both directly and indirectly held, stand at almost $30tn, and represent the highest valued asset on household balance sheets. Equities account for 33 per cent of total household financial assets, topped only by the 37 per cent share recorded in 2000.
Equities have exceeded the market value of real estate on household’s balance sheets for six consecutive years. The only other time equities exceeded real estate was in 1998-1999, which came on the heels of five consecutive years of 20 per cent to 30 per cent gains in the equity market.
News on the equity market dominates the airwaves. Today there are several financial markets shows dedicated to stocks, and even news TV broadcasts post an equity ticker showing how the market is faring. Updates on the equity markets are as frequent and as common as weather reports.
The equity market has become an important driver of consumer and business confidence and is often viewed as the single most important “real time” barometer of current and future economic conditions.
Monetary policymakers often look at the equity market for a validation of their views on the economy and policy stance. Many analysts think the recent pivot by the US Federal Reserve to pause from further rates hikes was directly linked to the near 20 per cent sell-off in equities in the fourth quarter of 2018. And political leaders such as President Donald Trump have been pointing to the stock market as a barometer of the success or failure of their policies and even their leadership.
None of this suggests a correction in the equity market any time soon, but it does illustrate how it has risen to a level of financial, economic, public and political importance never seen before. That raises the natural question: “Is the equity market too big to fail?” That clearly was a valid issue back in the late 2000s when the housing market — a key driver of growth and liquidity — crashed, triggering widespread damage to the economy and financial market.
When it comes to the equity market, that question can only be answered in hindsight, but after 10 years of gains risks are rising, especially since recent gains appear to be linked to the promise of easy money and not stronger corporate earnings.
Policymakers have consistently argued that it is impossible to identify asset bubbles and the best defence against them is robust supervisory and regulatory oversight. That policy does not work in practice when the risks sit on the balance sheets of the private sector and easy money is part of the problem.
At today’s levels, the equity market is too big to fail without causing substantial damage to the economy that would be far greater than what happened after the tech bubble burst in 2000, since policymakers have far less capacity to reduce interest rates and real estate is unlikely to provide the same buffer for investors or the economy.