Guest Post by John P. Hussman
On the first day of March 2017, the combined market capitalization of U.S. nonfinancial and financial stocks reached $34 trillion. Those trillions of dollars in paper wealth filter down to the investment statements of millions of investors, reflected in quotes on computer screens and blotches of ink on paper. Over the completion of the current market cycle, we estimate that roughly half of U.S. equity market capitalization – $17 trillion in paper wealth – will simply vanish. Nobody will “get” that wealth. It will simply disappear, like a game of musical chairs where players think they’ve won by finding chairs as the music stops, and suddenly feel them dissolving as if they had never existed in the first place.
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As I noted in 2015, because equities are correlated with other assets, the total private net worth of U.S. households and corporations tends to change by about $1.50 for every dollar that U.S. equity market capitalization changes. With total U.S. private net worth currently at about $120 trillion, it would currently take an equity market loss of only about 20% to wipe out $10 trillion in U.S. private net worth (0.2 x 1.5 x 34). By contrast, an expected 50% loss of U.S. equity market capitalization over the completion of this market cycle (a decline that would not even bring historically reliable valuation metrics below their long-term historical norms), would produce an expected loss of over $25 trillion in U.S. total private net worth.
To understand how paper wealth vanishes, recognize that market capitalization is merely the product of two objects: the number of shares outstanding, and the price of those shares. For example, there are currently nearly 9 billion shares of General Electric outstanding. If a dentist in Poughkeepsie sells a single share of GE to some buyer, just 10 cents below the price of the preceding trade in the stock, fully $900 million dollars of market capitalization is instantly erased from the U.S. stock market as a result of that one $30 stock trade. Nobody “got” the $900 million. The lost market capitalization didn’t “go into” bonds, or real estate, or gold, or cash on the sidelines, or anything else. It just plain vanished. Conversely, if our dentist buys a single share just 10 cents above the preceding trade in the stock, fully $900 million dollars of market capitalization is instantly “created” as a result of that one $30 stock trade.
Because of those fluctuations, investors across the nation imagine that they are actually gaining or losing “wealth” as market capitalization appears and vanishes. They alternately celebrate and suffer because they can’t distinguish wealth from the illusion of wealth. When one understands how ephemeral market capitalization can be, it may become clear why I’m so adamant about the actual claim that investors actually obtain by owning a share of stock.
None of the cash spent by retirement funds to buy securities disappears; it is spent by somebody at the respective company who got their share and the rest was stolen.
The musical chair analogy used is a bit different than the game we played as children. Instead of 100 people fighting over 99 chairs, when the music stops with this economy there will be 100 people fighting over one chair. In an added twist, this economy has produced a rigged game as the one chair is already occupied.
This article is perfectly captured in this scene from the Wolf of Wall Street. I routinely watch this video to remind myself that Wall Street is a Ferris wheel
“Its not f*ck’n real”
Sorry, I disagree with this analysis. For the market cap to increase by 900 million, all existing shares would need to be valued at the same price as the one share that was traded. Selling (or buying) one share does not change the market price of all of the other shares.
I think I’ll agree with the Phd.
The market has priced all shares 10 cents below the previous price. It isn’t two people agreeing to a price. Anyone trying to sell a share of GE at that point in time will get 10 cents less. It’s the market price.