RIA Novosti
October 15, 2008
Hour of the bear on the Russian stock market
MOSCOW. (Tatyana Marchenko for RIA Novosti) - Based on stock market analysis, which is a crucial indicator of economic health, the Russian and global economies are running a fever. Was the disease unavoidable, or could it have been prevented?
A technical analysis used to scrutinize the stock market in these cases does not provide any answers, while a macroeconomic analysis is applied only rarely.
The dynamics and meaning of the stock market capitalization to GDP ratio, calculated by dividing the total stock market value of all publicly traded companies by nominal gross domestic product, are extremely important for assessing a market's strategic perspective.
Our analysis of this ratio for the G8 and BRIC (Brazil, Russia, India and China) countries in 1995-2008 pointed to specific changes in the ratio and its dependence on the GDP growth cycle. When a market is overvalued, as shown by an abnormally high market cap to GDP ratio (above 100%), it is bound to fall, thus slowing economic growth.
The capitalization to GDP ratio is high in Britain and the U.S. (180%-200%), rapidly developing economies (100%-150%) and the world as a whole (120%). The figures for developed and developing countries differ for obvious reasons, such as differing development rates in their financial systems and market institutions, and the varying structure of their economies' corporate sectors. Developmental status notwithstanding, exceeding the limit of 100% is dangerous for both developed and developing economies.
Our survey of the ratio's dynamics in the world showed that the global financial crisis was provoked by overvalued markets, while the mortgage meltdown only spurred rapid growth and spread of the crisis.
The financial crisis in Russia did not start only because of the global crisis. A macroeconomic review of Russia shows rapid deterioration in May-August 2008, with soaring prices and slowing dynamics in investment in fixed capital, in industrial production, and in economic growth rates.
Russia's market capitalization to GDP ratio in 2007, at 116%, was almost double the figure for Germany (64%), more than double for Italy (51%), and only slightly lower than in the U.S. (144%) and Britain (141%). However, the U.S., Britain and Germany lead the World Economic Forum's Financial Development Index of 52 of the world's leading financial systems, where Russia ranks only 36th.
The 2008 financial crisis has proved that Russia's market capitalization to GDP ratio was below the level sufficient for a developed economy.
Russia had all the requisite fundamental reasons for a financial crisis, including an overvalued stock market and the deteriorating macroeconomic indictors. From May 19 to October 6, the RTS index fell by 65%, whereas other global indices fell by only 25%-30%. This distinction in depth between the Russian stock market drop and the fall of global stock markets is more evidence that the global financial crisis was the final push that sent the Russian stock market over the edge.
A fall in GDP growth rates, after the market capitalization to GDP ratio reached its peak, pointed to a forthcoming decline in Russia's economic growth. According to FBK analysis, the country's economic growth is unlikely to exceed 4% in 2009.
What sets the limit for market capitalization to GDP ratio?
The depths of a market plunge depend on the state of the economy and are the reasons behind changes in investors' mood.
For example, if bears start to dominate the market, or the downward trend has been provoked by painful external or non-binding internal factors, the stock market fall is unlikely to be catastrophic (20%-30%).
When the change is provoked by a serious deterioration of macroeconomic indicators, compounded by negative external factors, the fall will be steeper (30%-50%).
Lastly, if the reasons for the negative change are rooted in macroeconomic indicators yet no effective measures have been taken to adjust the trend, and the number of external and non-binding domestic negative factors is very large, the fall can turn into a plunge (50%-90%).
The Russian stock market has fallen for the latter reasons.
A decline in the market capitalization to GDP ratio does not necessarily call for emergency measures to stabilize the stock market. However, governments must resort to such measures at the height of the crisis.
Many countries use financial injections to support their stock markets.
In August 2007, the U.S. Federal Reserve approved the injection of $7 billion into the national stock market and the Japanese central bank allocated 400 billion yen ($3.4 billion) to resuscitate its market.
Some time before that, the European Central Bank and the U.S. Federal Reserve allocated an additional $350 billion to stop the mortgage meltdown.
Lately, the Fed approved a $750 billion expenditure on distressed mortgage-related assets in late September 2008.
The Russian authorities have approved trillions of rubles in market allocations, but this measure has not greatly improved the situation. The stock markets continued to fall, although their short-term reaction was very positive.
Allocations are the best measure in the short term, when the crisis threatens to spread to the banking sector already drowning in a financial crisis.
What else can the country's financial authorities do?
The best anti-crisis measures include limited budgetary assistance to the banking sector; sale of state-owned assets and a ban on the acquisition of ailing assets; approval of a program to stabilize and urge the revival of financial markets; and a program of macroeconomic stabilization focused on containing inflation.
Tatyana Marchenko is a senior expert at FBK, one of the first private auditing companies in Russia.