[Lee Jong-woo's Economic Reading] Corona-triggered Plunge... Is It a Prelude to the US 11-Year 'Bubble Collapse'?

Market Concerns Spread Due to Economic Slowdown, Nasdaq Drops 10% in a Week
If 'COVID-19' Is a Temporary Setback, Short-Term Stock Recovery Expected
However, If It Is a Bubble Burst, Long-Term Decline Over 40% Anticipated

The Nasdaq index has fallen more than 10% within a week. The cause was the novel coronavirus infection (COVID-19). When the disease first emerged, it was expected that the situation would soon calm down and stock prices would stabilize, but reality was different. In the past, stock prices rose immediately once concerns about a disease weakened, but this time it was not so. Regardless of the number of confirmed cases, stock prices fell sharply. This phenomenon occurred as market attention shifted from the disease to concerns about economic slowdown.

There have been instances in the past when the U.S. market plunged sharply in a short period. There were three similar cases in the past decade, with 2011 being one of them. After stock prices had fallen significantly due to the financial crisis, they began to recover, and the rebound was completed in August 2011. At that point, stock prices dropped nearly 15% within a week. The second case was in 2015. When Standard & Poor's (S&P) downgraded the U.S. credit rating by one notch, stock prices fell nearly 11% within a week. The last case was in 2017. Due to the Federal Reserve's (Fed) consecutive interest rate hikes, stock prices dropped 13% over seven days.

These three short-term plunges did not last long. Therefore, there is hope that this plunge will also recover quickly after the drop. Of course, there are counterarguments to this outlook. Some say that this decline is merely disguised as COVID-19 but is actually the bursting of a bubble that has formed over 11 years.

The future stock price outlook depends on how one views the decline. If the drop is due to the COVID-19 factor, stock prices will recover soon. Although from mid-February market attention shifted from COVID-19 itself to concerns about economic slowdown caused by the disease, stock prices still moved based on this factor, so the impact is unlikely to last long. On the other hand, if it is a bubble bursting process, the decline is just beginning. The drop can only end when the bubble completely disappears, and considering that stock prices fell by an average of more than 40% from the peak during past bubble collapses, there is still more decline ahead. It should also be noted that bubble adjustments occur in assets other than stocks. Among various assets over the past 11 years, Nasdaq has risen the most. This was supported by solid earnings and high growth potential of its constituent companies. If such an asset enters a strong correction first, other assets including real estate will inevitably decline sequentially. This is because many assets including stocks rose due to the same factors of low interest rates and abundant liquidity. Since the reasons for the rise are the same, it is natural that the decline will proceed in a similar manner.

For now, I want to believe that the stock price decline is due to the temporary negative factor of COVID-19. Although stock prices have fallen, the decline rate still does not reach the levels seen during the three plunges since 2010. There are no signs yet that the U.S. economy has slowed down. If the decline deepens and stock prices fall more than 20% at once, or if the decline is not a single event but occurs repeatedly, then another consideration is needed, but that stage has not been reached yet.

Even if the U.S. stock price decline ends quickly, it is undeniable that this drop has revealed several vulnerabilities. First, the global economy including the U.S. is likely to be seriously affected by COVID-19. Even before COVID-19 emerged, the U.S. economy was not in good shape. Many forecasts expected growth rates to be lower than last year, and the possibility of a double-dip recession due to slowing consumption and investment in the second half of the year was being discussed. This external shock of COVID-19 was added to this situation.

In 2018, the combined gross domestic product (GDP) of South Korea, China, and Japan was $18.4 trillion, larger than the U.S. GDP of $17.9 trillion. If the first-quarter growth rates of these three Asian countries, including South Korea, fall to half of their usual levels and the annual growth rates significantly miss expectations due to COVID-19, the U.S. economy will inevitably be impacted as well. The principle is simple. If the U.S. economic growth rate suddenly drops to half of its usual level for any reason, the global economy and financial markets will be significantly affected. It would be strange if the global economy were unaffected despite problems in an economy larger than the U.S. caused by COVID-19.

The influence of interest rate cuts has also weakened. Since October last year, the driving force behind the rise in U.S. stock prices has been interest rate cuts. Stock prices rose nearly 25% over four months through three rate cuts, but the response was weaker than before. During the first and second rounds of quantitative easing in 2010 and 2013, the U.S. stock market rose 250% and 160% respectively over two to three years. This time, it only rose 25% over four months. Considering this weakening influence, even if the Fed cuts rates again in the future, the effect is expected to be limited.

Several phenomena observed just before the end of a major bull market have also been seen. Until now, no single company's market capitalization in the U.S. market had exceeded 5% of the total market. Microsoft did so during the 2000 IT bubble, and Apple did not exceed 5% even during the 2012 iPhone boom. This time, both companies have exceeded 5% market capitalization share. Adding Amazon, which accounts for 4% of market capitalization, the three companies together make up 14% of the U.S. market. This is a phenomenon caused by too many stocks being highly priced and power concentrating in a few limited stocks. Tesla's stock price, which was a concern for bankruptcy just a few months ago, has more than tripled in six months. It is now larger than the combined market capitalization of GM and Ford. This reflects an excessive valuation of growth potential. The price-to-earnings ratio (PER) of the S&P 500 index rising to 19 times can be understood in a similar context. These are all phenomena caused by a significant rise in the stock market, raising suspicions that the bull market is nearing its end. When questions arise about whether stock prices match their intrinsic value, the market becomes volatile even with minor external shocks. This time, COVID-19 played that role.

The U.S. stock price decline does not end with the U.S. It also pulls down stock prices in many other countries, including ours. Since many countries' stock prices rose through the U.S. stock price increase since last October, the impact of the U.S. stock price decline is inevitably greater. If the U.S. stock price decline is part of a bubble bursting process, its influence will be beyond imagination. It signals the end of an 11-year asset price rise. Our stock market can take comfort in the fact that it has not risen much, so even if U.S. stock prices fall, it will not decline significantly, but this comfort can only work after stock prices have fallen.

This content was produced with the assistance of AI translation services.