What’s a few trillion gone from investors’ portfolios?

The global selloff has erased $5 trillion from stock and bond markets in October

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The recent stampede by investors has erased about $5 trillion in
value from global stock and bond markets in October alone. But that
shouldn’t be severe enough to affect the economy, for now, according to
economists at Deutsche Bank.

Still, unless the markets regain
their footing soon, the pressure for the Federal Reserve to reassess
their monetary policy will continue to mount, they said.

“Academic
studies of the wealth effect find that households and companies don’t
react to short-term fluctuations in their wealth but instead react to a
moving average of where their wealth levels are,” said Torsten Slok,
chief international economist at Deutsche Bank Securities, said in a
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As the chart below illustrates,
global markets shed roughly $5 trillion in market cap just this month,
but the total value of equity and debt markets has increased $15
trillion from 2017.

“The bottom line is that we need a
more significant correction before it will begin to have a meaningful
impact on the economic outlook,” he said.

The Fed said wages and
prices are rising in its 12 districts and overall economic activity
expanded at a “modest to moderate” pace, according to the Beige Book released on Wednesday.

The
report, which compiles anecdotal observations about the economy, by and
large suggests that the Fed is likely to stay on course to execute its
fourth rate rise of 2018 in December and deliver additional increases
next year unless there is a more dramatic unwind in the financial
markets.

Read: Fed officials stress future rate hikes not set in stone

Much of the stock market’s volatility have been blamed on worries over the adverse impact of higher rates as the 10-year Treasury yield

TMUBMUSD10Y, -1.35%

 spiked in early October to 3.261%, a
level not seen since 2011. A rise in yields leads to steeper borrowing
cost for corporations and eventually can slow economic expansion. It can
also call make bonds an attractive alternative to more volatile
equities.

See: Investors weigh whether to ditch stocks for bonds as yields finally offer an alternative

Gross domestic product grew 3.5%
in the third quarter, compared with 4.2% in the second quarter,
according to a government report Friday. Data showed that consumer
spending rose in the latest quarter but was offset by a slowdown in
business and residential investment.

Even so, with U.S. stocks
reeling, the threshold for the Fed to reconsider its hawkish stance may
be near, according to Matthew Luzzetti, senior economist at Deutsche
Bank.

“The recent financial market turbulence should not affect
the Fed outlook dramatically unless it becomes more severe and
protracted,” he said earlier this month.

For that to happen, the
Deutsche Bank’s financial conditions index would have to move down to
near zero, per the following chart.

“A further 10% decline in
equities, which would amount to a roughly 15% decline from the recent
peak…would be needed to tighten financial conditions by enough to
materially impact the Fed,” said Luzzetti.

U.S. stocks headed south Friday with the S&P 500

SPX, -1.73%

 and the Dow Jones Industrial Average

DJIA, -1.19%

 turning red for the year as
disappointing results from a handful of megacap companies weighed on
investors’ sentiment.

The sharp selloff this month has prompted
at least one market expert to suggest that stocks are in the midst of a
sustained downward spiral.

“With the S&P 500 only five weeks
removed from its all-time high, we’ve not been definitive about
labeling this move a new cyclical bear market. But it’s very likely we
are experiencing one,” said Doug Ramsey, chief investment officer at
Leuthold Group, in a report.

He noted that the MSCI ACWI Ex-USA
Index, a benchmark for 46 foreign markets, closed only 0.1% away from
“official” bear territory and the market action reminds him of the
dismal summer days of 1990.

Read: S&P 500 on the verge of entering correction territory for the second time in 2018

“While
the big event in that year’s first half was the Japanese stock market’s
collapse from its late-1989 high, foreign markets of all stripes were
down sharply by the time the S&P 500 saw its final high in
mid-July,” he said.

Back then, the MSCI ACWI Ex-USA bottomed out ahead of the S&P 500, something which Ramsey expects to recur fairly soon.

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