“An old cliché holds that when the U.S. economy sneezes, the rest of the world catches a cold,” says David Wessel today, reporting on new IMF research which seems to show quite the opposite. “Sometimes,” he concludes, “a sneeze isn’t contagious.”
The problem with the research is that it’s the forward-looking bits, like the box on financial contagion by Peter Berezin, which are the most pessimistic when it comes to global spillovers from the US.
Prices for similar assets across countries have become more correlated with increasing financial linkages. In particular, for industrial countries, correlations among stock market indices and bond yields have increased…
There is a clear asymmetry in cross-country asset price correlations, with correlations increasing significantly during bear markets and recessions…
The importance of the United States appears to increase substantially during periods of market stress. For example, correlations across national stock markets are highest when the U.S. stock market is declining… Thus, it would seem that from the standpoint of U.S. investors, the benefits of global diversification tend to decline just when they are needed most…
50 percent of a shock to U.S. equity prices is transmitted to Europe after controlling for common shocks in both regions.
I should imagine that the linkages might be even greater when it comes to the behavior of high-yield debt during the next slowdown. If weakness in the US housing sector spills over into credit in general, it’s hard to see how the European debt markets could remain immune, since global liquidity tends to go where the yields are highest. On the other hand, of course, that very movement of liquidity from Europe to high-yield US debt would help to mitigate any domestic US credit crunch.
It’s also worth noting that the US remains very far from recession, and all this remains highly theoretical. There’s no shortage of doom-mongers who can construct a scenario at the drop of a hat where everything spills over into everything else and the world goes to hell in a handbasket. We’re even seeing such bearishness among fund managers now, with the UK’s Ken Murray selling half of his equities in anticipation of a US recession and a 20% global stock-market correction. But Murray’s total portfolio is tiny: just $350 million, or less than the annual income of some hedge-fund managers.
There are always doom-mongers, and, eventually, they will be proved right. But anybody purporting to know when that’s going to be is, frankly, a fool — as those people who sold equities after Alan Greenspan’s “irrational exuberance” speech in 1996 found out to their cost.