The stock market signals are very positive. The Dow exceeded 15,000 recently and the FTSE is edging towards 7,000 – all time highs! Theoretically, the stock market reflects the performance of the economy: the recorded earnings of its company constituents. Modern technology, with instant communications and analysis, has shifted the market emphasis from real profits to expected profits, but the basic link remains. Hence, the present stock market signal is that earnings are good and an economic recovery is coming that will make them even better.
The alternative argument is that monetary stimulus from the central bank authorities is falsely fuelling the equity upturn. Quantitative easing (QE) and its hybrids have pumped $-trillions into the world financial system and this money has not all gone into the real economy (through increased bank loans and higher business investment) but has gone into assets (stocks an bonds). Hence, when the money ‘tap’ is turned off, the markets will drop again. The current market reflects a false dawn.
But, if it was just a ‘money-rush’, we’d be seeing higher inflation and higher growth already. Actually, whilst the monetary base has exploded, M2 monetary growth has not. Perhaps, the banks should be applauded (what!) for not indulging the authorities’ QE nonsense of potential over-stimulation. (QE needs to be scaled back and interest rates raised.)
The market is anticipating a lower share of government in the economy and new technologies that will boost growth in the long run. Therefore, it is seeing an undervalued corporate population whose future returns could be quite strong. On balance, I think the rebound in share values is real and can continue. Of course, values can easily be blown away again by further shocks from sovereign debt debacles and policy mistakes. Negative risks are still high. But, if these risks are not realised, the stock market recovery should be heralding a wider moderate but sustained economic recovery for the medium term – not now in 2013 but perhaps in 2014+. For the first time in quite a while, I find myself on the positive side of the consensus.
This does not mean I am totally optimistic. There are some big clouds out there, coming from the euro-zone, falling real incomes and inflation expectations. Growth is still likely to track below trend for the foreseeable future. But, I think I am feeling some winds of change. I’ll be right if those businesses with cash, with good products and services, and with aspiration start to plan for higher investment and hirings this summer.