No summer break on financial markets?

Does the amazing stock market rally of late once again signal a departure of financial markets from the real economy? Are the stock markets going crazy? Since early July the FTSE has jumped roughly 18% and the DAX by almost 20%. Given the preponderance of forecasts with very negative GDP figures this year and no substantial recovery in 2010 this seems hard to explain.

But the financial markets are not alone in taking heart again; green shoots of confidence are also budding in the corporate world. In most countries business expectations and stocks are tracing a similar path, with corporate expectations even slightly in the lead. Hard data such as new orders and production are starting to confirm this picture.

Although the real economic improvement is still fairly weak, the data tells us that a Keynesian scenario of a quick recovery has become more likely. Business activity will continue to recover, especially as inventory stocks have been run down and need to be replenished. The downbeat scenario of a protracted recession with deflationary endencies, “The 30s reloaded”, has lost most of its scare. This scenario has been averted by the massive policy reactions prompted by the crisis. Of course, it will take a number of years to work off the structural problems like property bubbles, excess household borrowing or fiscal debt. But from a cyclical point of view, the important thing is that the paralyzing uncertainty created by the possibility of a great depression scenario is waning. This is what financial markets are pricing in.


 Dr. Michael Heise

PDF (95 kb)