According to Fisher Investments analyst Brad Pyles (read more of his work here):
The European Union (27 countries including the UK ) represents roughly 26% of global GDP. This is similar to Asia at the end of 1997. As Asia went through its own solvency crisis (better known as the Asian Contagion), its GDP fell -0.6% in 1998 (see table below). While this caused Asia to underperform, it did not cause a global bear market. Furthermore, when you exclude China (whose GDP dropped near a two decade low but remained above 7% y/y), Asia’s GDP dropped -1.9% in 1998 while composing a slightly smaller percentage of global GDP than the current EU, but still a larger portion of global GDP than the current EMU.
This appears to show that a large portion of the global economy can modestly go negative for an extended period of time without causing a bear market, provided the global financial system remains intact and the rest of the world continues to grow. Consider that even the large 1998 correction did not occur until the Asian Contagion’s secondary effects took down Long Term Capital Management and threatened the global financial system.
Increasingly, I hear the tide of bears arguing that persistent consumer deleveraging is “chronic” and will hinder consumption—and therefore the economy—from here forward.
This demand-side theory sets aside the inconvenient truth that deleveraging has been going on in the US more or less for the last 2 years as GDP hits new all-time highs and personal spending is well up from recession lows. In truth, today’s Deleveragists are by and large the same bears that said consumer over-indebtedness would be the death of us all too through the bulk of last decade.
Which is it? Or, better, what’s the magic leverage number that will make everyone comfortable and happy?
My sense is that no such number exists. Household debt levels can and will be used as a rhetorical device to prove whichever case is convenient for the arguer. A plain accounting of such things relative to GDP and capital markets performance over history tells us otherwise.
A purely anecdotal observation: an investor’s sense of time is often skewed. We’ve all heard “time flies when you’re having fun”, but I think the opposite is probably true in bad times: “time drags when the chips are down”.
The bear of 2008 not only still has sting for folks, but that period felt like it took forever and a half. Conversely, we’re into the third year of a new bull market and most don’t even realize it. Whizz-bang-boom! That was fast! Folks I talk to around the country—average investors of all sorts—seem to feel this way. They don’t see stocks are starting to approach their previous all-time highs, GDP in many regions (including the US ) is back at all-time highs, or earnings are set to make new all-time highs this year. Time flies when it’s not so bad.
Part of this is likely prospect theory: the Nobel Prize winning notion that people tend to dislike a loss 2.5 times more than they like a similar gain. So the sting is bigger, especially after an outsized bear market. But I also think the mind naturally plays tricks on us in terms of its perception of time—epochs of intense negativity have that agonizing, never-gonna-end feel to them. Whereas, when things are recovering or moving up generally, maybe attention gets diffused elsewhere, you worry less and less, and the next thing you know, time has flown by.
I have nothing to back this up other than my intuition and personal experience—here’s hoping a behavioral economist will take this question up soon (maybe someone already has and I just haven’t seen it yet). Either way, this is one of those issues where it pays to let the data tell you what’s going on—this includes history. Our memories are often distorted and we need to be reminded just how things happened.