Global stock markets crashed as the conflict between the Ukraine and Russia intensified and then they rebounded as tensions eased, claim news media around the world. Investors may have knee-jerk reactions to the threat of war. However geopolitics in the Crimea may pale in comparison to China’s looming credit bubble and a U.S. stock market facing the final stretch of a bull run that started five years ago.
Russia accounts for only 2.9 percent of the total global economy with a gross domestic product, or GDP, of $2.2 trillion, Credit Suisse analysts wrote in a report March 3, citing International Monetary Fund data. The economy in the Ukraine makes up only 0.4 percent of global GDP.
“So in itself, it is hard to see the Ukrainian crisis having a significant impact on global growth,” Andrew Garthwaite, an analyst at Credit Suisse and his colleagues wrote. “Given Russia’s reliance on its energy-related export revenues it seems unlikely that it would seek to cut off supplies.”
As the world’s largest energy producer, Russia produces 13 percent of the planet’s oil and 20 percent of its natural gas. Energy accounts for more than half of its export income, according to the American Enterprise Institute. Half of Russia’s government revenues come from energy related taxes and levies. It would suffer greatly from angering Europe, which could impose trade sanctions or seize its overseas assets, valued at $270 billion or 13 percent of GDP, Credit Suisse wrote.
Russia has the most to lose if the conflict escalates given that its economy, currency and stock market were already declining before the crisis erupted. The ruble — which has depreciated more than 20 percent in the past year — hit new historical lows against the U.S. dollar and euro this week. The Market Vectors Russia ETF (ticker: RSX), a U.S. fund investing in Russia’s stock market, plunged 18 percent in the past 12 months, according to Morningstar. It significantly lagged its benchmark, the iShares MSCI Emerging Markets ETF (EEM), which fell 6 percent over the same period. Furthermore, it depends on other countries to borrow money.
“Russia has tried hard (and successfully) to open up its local currency debt market to foreign investors while making inroads in improving the investment climate,” Francesc Balcells, executive vice president and portfolio manager at PIMCO, wrote in a client note. “A confrontation with the West would erode many of these achievements, driving more foreign investors away.” The Newport Beach, Calif.-based investment firm manages $1.9 trillion in assets.
The Real Threat Is China
The news media around the world may claim that the Ukraine and Russia conflict threatens global stock markets because they sold off at the same time Russia threatened military action. However that could be a coincidence. Just the week before, the U.S. stock market reached new highs as Russian troops descended on the Crimea. The more significant threat to global stock markets is China, says Credit Suisse. The world’s second-largest economy is projected to grow 7 percent this year, the slowest in three decades.
“It has the third biggest credit bubble of all time, the biggest investment bubble of all time and real estate investment as a proportion of GDP (is) at the same level as during the peak of the cycle in Ireland and Spain,” Credit Suisse stated in its report.
China’s inevitable real estate bubble implosion will trigger the next Great Depression, contends economist Harry Dent, founder of Dent Research in Delray Beach, Fla.
“At the top of the last bubble (2005 to 2008), China was building five million homes a year, even though average annual household formation was just 2.6 million,” Dent wrote in the March 4 issue of his newsletter, Survive & Prosper.” However instead of scaling back when everything crashed, the Chinese went in the complete opposite direction. In 2011, there were 19 million housing starts, but only 5.8 million new households. That means nearly 70 percent of the new homes constructed that year alone were completely unnecessary.”
China not only overbuilt but also blasted real estate prices into the stratosphere. In Shenzhen, the average home costs 35 times a typical person’s income. That is the equivalent of earning $50,000 a year and buying a $1.75 million home. By contrast, in London homes cost 15 times more than income.
U.S. Bull Run Needs A Rest
The SPDR S&P 500 ETF (SPY) — the most widely used gauge of U.S. stock market — has chugged ahead the past five years straight. It climbed a phenomenal 32 percent last year. It has rallied nearly 300 percent from its bear-market trough from March 2009. It is long overdue for a correction and so investors will use any excuse to sell.
“The S&P 500 is in the eighth or ninth inning of the rally off the March 2009 lows,” Bill Strazzullo, chief market strategist at Bell Curve Trading in New Jersey, said in an email. “The risks, at current levels, far outweigh the rewards across a number of major indices.”
Strazzullo added: “No one knows the level and day where this rally will finally end but that is not the exercise that a trader or money manager should spend time trying to figure out. The real question is when does the risk/reward equation start to get heavily skewed in one direction?”
Should the U.S. stock market hit the skids, investors may need not worry. U.S. corporations are sitting on record amounts of cash with $1.5 trillion in buying power. They could use the money to do mergers and acquisitions and support share prices by buying back their own stock, Credit Suisse says.
Regardless of the turmoil between the Ukraine and Russia let alone the rest of the world, the threat of a global stock market correction always looms. They cannot continue rising indefinitely. Also when they take a dive as they always do, the media will claim that the sell off was caused by whatever happened the same day.
By Quynh Ho