The wisdom of markets?

4 November 2015

There is a perceived wisdom that markets in aggregate reflect all available insights and therefore provide the best of all macro-economic forecasts available. On this basis the economic growth prospects have deteriorated markedly, as manifested through the late summer stock market sell-off. It is undeniable that compared to the 2015 outlooks of late 2014, this year has not shaped up as positively as had been expected by consensus opinion and indeed market anticipation until mid-April. At the same time we have not for a very long time experienced so much disagreement between market strategists, economists and markets themselves from week to week. Last week we commented on the stock markets' rally due to receding fears of a premature rate rise in the US and the global growth slowdown. We warned, however, that from a technical analysis perspective markets appeared vulnerable in the very short term to sudden sell'‘offs, as '˜fast money' speculative investors may be inclined to take short term profits. This, more than anything else was what put selling pressure on markets during the first 3 days of the past week. The media may have cited disappointing US retail sales figures or weak Chinese import values, but to my mind those are just random trigger events. On no particular change in data flow at all, markets staged an impressive rebound from Thursday onwards, only to once again end the week pretty much where it had started. In-between, we witnessed much discussion whether it is positive that the US rate rise is likely to be delayed until next year, or whether global economic development, after the current slowdown in the rate of growth, will soon see outright contraction (i.e. a negative rate of growth). We observe that the majority of classically trained economists appear convinced that the current slowdown will pass. They argue that it is predominantly down to the fact that pain of immediately lower investments by the oil and commodities sectors is much faster felt than the vastly more significant long term stimulus to consumer spending and corporate expenditure as a result of lower energy and raw material input prices. Investment strategists on the other hand, many of whom in the short term go more by market psychology and past experience of similar market scenarios, are more fearful. They ascribe a not inconsiderable probability to the possibility that negative capital market sentiment could spill over into the real economy and thereby turn economic realities from a continued path of slow growth to - at least a short term '‘ recession. At last but not least market action itself appears to bounce back and forth between the varying outlooks - one week fear of a return of a global recession dominates the direction of trading and the next it is the expectation of continued, albeit slow global growth. So, returning to the headline - do markets know more and better right now? Judging from the erratic up and down over the past weeks we strongly suspect they - currently - do not. For the time being it is a wait and see game, until data observations from the real economy confirm the economic direction one way or the other. In this respect, we had a bit of a mixed bag over the past week. The UK shone, with employment and wage data showing stronger progress than expected. 120,000 more people gained employment over the last quarter and the UK public currently enjoys a 3% year on year increase of wages in purchasing power terms. Data in the US recorded an only slightly less positive picture, although the decline in the resources sectors is having a more negative impact there on corporate earnings growth. China still shows no signs of a hard economic crash, while the authorities continue act with determination to prevent anything worse than a stabilising slowdown from the previous break-neck speed of expansion. We suspect that over the next weeks micro economic news-flows in form of the quarterly corporate earnings result announcements will drive market sentiment more than macro-economic news. While I expect corporate Europe to continue to show healthy growth, this is less likely in the US. We also expect that any improvement in macro-economic facts will result in counterbalancing fears of the inevitable perspective of a US rate rise. As a result markets are very likely to continue to trade along the lines of the cartoon above.