5/11/2012: Lehman Bros & Irish ISEQ - II

And a bit more on indices dynamics:

Some interesting longer term trends from the major indices and VIX revealing the underlying structure of the Irish and the euro area crises. Note: data covers period through September 2012.

Starting from the top, here are indices of major stock prices, normalized back to February 2005 for comparative purposes. Relative to the peak, currently, CAC40 stands at around -41.9%, while FTSE MIB is at -62.5%, FTSE Eurotop 100 at -31.7%, FTSE ALL Shares at -11.22%, DAX at -8.41%, S&P500 at -6.15% and IBEX35 at -48.5%. Meanwhile, 'special' Ireland's ISEQ is at -66.9%.

Chart Index 1.0 and Index 1.1.

Clearly, Ireland is the poorest performer in the class.

Now, it is worth noting that Ireland's stock market is also 'distinguished' by a very 'special' characteristic of being the riskiest of all markets compared, with STDev of returns at 36.45 (on normalized index). Compared to the French market (STDev=22.34 for the period from the start of 2005 through today), Italian market (STDev = 28.95), FTSE Eurotop 100 (STDev = 18.90), FTSE All Shares (STDev = 13.70), German DAX (STDev = 23.05), S&P500 (STDev =14.55) and Spanish market (IBEX STDev = 23.70), Ireland is a risky gamble. Given that the direction of this bet, in the case of Ireland has been down from May 2007, virtually uninterrupted, the proposition of 'patriotic investment' in Ireland's stocks is an extremely risky gamble.

Normalizing the indices at their peak values (set peak at 100), chart below clearly shows the constant, persistent underperformance of the ISEQ.

Chart Index2.0

Now, let's take a look at the core driver of global fundamentals: risk aversion as reflected in VIX index. In general, rising VIX signals rising risk aversion and should be associated with falling stock valuations. Once again, for comparative reasons, we use indexed series of weekly returns for 1999-September 2012. Up until the crisis, Irish stock prices behaved broadly in line with the same relationship to VIX that holds for all other major indices. Chart below illustrates this for FTSE Eurotop 100, but the same holds for other major indices. VIX up, risk-aversion up, stock indices, including ISEQ, down.

Chart VIX1.1

Around Q1 2009 something changed. ISEQ lost any connection with 'reality' of the global markets and acquired life of its own. Or rather - a zombie life of it own. No matter what the global appetite for risk was doing, Irish stocks did not have much of a link with global investment fundamentals.

Another interesting point of the above chart is that Lehman Brothers were not a trigger for Irish crisis (as many of us have been saying for ages, despite the Government's continued assertions to the contrary). Irish market peaked in the week of May 21st, 2007, Lehman Brothers folded on September 15th, 2008, with most of the impact in terms of our indices occurring at September 15th-October 6, 2008, some 16 months after Irish markets began crashing. Prior to Lehman Brothers bankruptcy, ISEQ dropped from a peak of 147.3 to 61.6, while following the Lehman Brothers and until the global stock market trough of March 2, 2009, ISEQ fell to roughly 31.9 reading. So even in theory, Lehman bankruptcy could have accounted for no more than 29.7 point drop on the normalized ISEQ, while pre-Lehman drivers collapsed ISEQ by 85.7 points. 

More revealingly, ISEQ steep sell-offs through out the entire crisis have led, not followed, sell-offs in major indices. In other words, if Lehman caused the global market meltdown, then ISEQ 'caused' Lehman bankruptcy. Which, of course, is absurd.

There are many other stories that can be told looking at the Irish Stock Exchange performance, especially once higher moments to returns distribution are factored in, but I shall leave it to MSc students to explore.

5/11/2012: Lehman Bros & Irish ISEQ

Here's an interesting little factoid. The theory - usually advanced by the Irish Government - goes that Lehman Brothers bankruptcy has been a major driver of the Irish crisis. I have disputed this for ages now and more and more evidence turns up contrary to that when more and more data is considered.

Now, here's a new bit.

Suppose Lehman Bros did contribute significantly to the Irish crisis gravity. In that case, given Lehman Brothers bankruptcy contributed adversely to the global markets, we can expect a dramatic contagion from the global markets panic to Irish markets. One way to gauge this is to look at the changes in correlations between the measure of overall 'panic' in the international markets and the behaviour of the returns to Irish stock market indices.

Let's take ISEQ index for Irish markets and VIX for a measure of the panic sentiment in the global markets. Let's take weekly returns in ISEQ and correlate them to weekly changes in VIX. I use log-differencing in that exercise and 52 weeks rolling correlations.

What should we expect to see? If the 'Lehmans caused Irish crisis or worsened it' theory holds, we should expect correlation between ISEQ weekly returns and changes in weekly VIX readings to be negative (VIX rising during the crisis signals rising risk aversion in the markets). For Irish markets to be influenced significantly, or differently from other markets around the world, such negative correlations should be larger in absolute value than for other countries.

What do we see? Here is a table of averages:

Contrary to the hypothesis of 'Lehmans caused Irish crisis', we see that throughout the period of the crisis, ISEQ suffered shallower, not deeper, spillover from global risk aversion to equity valuations, save for Spanish IBEX index. In other words, evidence suggests that Irish 'disease', like Spanish 'disease' was driven more by idiosyncratic - own market-specific - factors rather than by global panic.

Here's the chart, showing just how consistently closer to zero ISEQ correlation to VIX was during the post-Lehman panic period:

And here is a chart showing skew in the distribution of weekly returns which shows that during the crisis, Ireland's ISEQ suffered less from global markets 'bad news' spillovers (at the point of immediate global markets panics, such as Lehmans episode), but exhibited  a much worse negative skew than other peers in the period from June 2010 through Q1 2012.