The Mass of Markets

I am not here to pick any fights this week. Nor to tell my readers how all the more famous investors and economists of the world are getting it wrong (they must be doing something right since they are famous, and I am not quite so much).  Instead I want to focus on some interesting statistics about markets and economies that can help frame a perspective about markets. The size of different markets, along with the size of different market participants, is something that is little talked about in the main stream investment mediums. This is what I am calling the Mass of Markets, and in some future post may be so brave as to try and detail these relationships; but first, a primer.

It is widely known that the U.S. GDP, overall measure of economic activity, weighs in at about $14.5 Trillion.

Below is a chart from the International Monetary Fund IMF on how this compares to rest of the world.

For 2009

As you can see, the whole of the European Union, added together, is a larger economic market than the United States by a couple Trillion dollars. Also note that in 2010, it is widely accepted that China has surpassed Japan as the second largest national economy in the world.

It is also fairly well known that we have a debt problem here in the United States and currently have a National Debt that comes it at around $12 Trillion. This is akin to a household having a debt load of roughly 80% of its annual income. We also find that we run a budget deficit of 10% of GDP. This means that our debt load is growing right now at about $1.5 Trillion per year.

The question is; when does this burden break our backs? Well, by comparison Japan has a Debt load of roughly 180% of its GDP and can still find willing lenders in the open markets. While we do not want to emulate Japan, (remember some of my last posts on deflation talks), this does show that an economy may not fall apart under this kind an even greater debt load. Someone should poll the Japanese and find out how their standard of living is. From what I have read, the citizens of Japan are not rioting in the streets.  In fact, they are still the biggest purchasers of their governments debt.  Japanese sentiment is a topic for another day.

Now look at this. The total mortgage debt load in the U.S. weighs it at $14.9 Trillion as of the last quarter of ’08 (according to the federal reserve). This means that there are more households owing more money on their homes than all the goods and services sold in the United States (sounds incredible until you stop to think about the number of households in the country). Of this nearly $15 Trillion, $9.2 Trillion has been pooled, sliced and sold off on secondary markets. This is what is called securitization; the mortgage bonds that were the ignition of our global financial crisis.

The important thing to remember about this is that back in 2007 and 2008, when some of the pools that contained what I call NINJA (No Income No Job or Assets) loans, and those people began having trouble paying back those loans, we experienced what Mohammad El-Erian, CEO of PIMCO referred to in his book, When Markets Collide, as a Market for Lemons. A Market for Lemons is an economic theory that suggests if you have one or two terribly problematic cars on a used car lot, the price of the good cars can also be brought down by the fear the customer has of getting sold a “lemon”. This is exactly what occurred in the $9 Trillion dollar market for securitized mortgage loans. People were afraid of getting sold junk and the whole market seemed suspect.

Some people said that the problem would be contained in housing. Well its hard to see of a $9 Trillion dollar market not having an impact on the greater economy. For comparison purposes here are some other market figures.

Market Cap of the Wilshire 5000 (actually over 6000 companies in the U.S.) – $12.7 Trillion

The biggest 500 of those, the S&P 500 – $10.2 Trillion

Total U.S. Bond market in 2008 weighed in at around $33 Trillion. We can add in another $5 Trillion or so of additional government debt and money market instruments that have been added in the last two years.

The largest U.S. corporation in terms of market capitalization is Exxon Mobil (XOM) at $310 Billion.  In second place is Apple (AAPL) at $252 Billion.

The value of all the gold ever mined in the world stands right now at about $6.3 Trillion based on a price of around $1250 per troy ounce.  Five years ago that was a less than a $2 Trillion market.

What does all this mean?  It means that the more massive a market, the bigger its gravitational pull on other markets.  For instance, if Apple gets some bad news and IPads don’t sell as well as they expected, the whole market index can feel a hit.  However, a small bio-tech company can go out of business without so much as a headline.

This same relationship plays out in bigger markets.  Many big investors will point out the fact that, while the stock market is a lot sexier, the Bond market really calls the shots in the economy.  This is, in part, because as the biggest and most liquid market in the world, it has a deeper and more far reaching effect on people.  Now we can talk all day about the structural differences in the different markets, but the point remains that mass should not be over looked.

Investors would do well to remember Newton when venturing into the global financial markets.

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