With yesterday's announcement that the US economy is now growing, there was a palpable feeling that the economic downturn is now over. Most large European countries returned to growth already in 2nd quarter and the Asian economies did likewise. The laggard is the UK economy, where the consumers are seriously hampered by high (mortgage) debts and falling property prices. Australia and Norway have increased their short term interest rates. So where do we go from here?
The first thing to notice is that everywhere there is evidence that government expenditure is important in pulling the economy out of the quagmire. Secondly, consumer spending is timid, and is likely to remain so for some time. Thirdly – and it should be no surprise – business investments are growing briskly after some quarters with collapse in this spending category. All of this is quite obvious, is well documented, and not surprising.
In other words, the next question is whether the market consensus will continue to run behind the facts. We have had a long season of positive surprises in many ways. First, companies reverted relatively quickly to profitability. Then, we saw that the business optimism returned. Now we see that business investment is becoming a driver of the economic activity faster than expected a year ago.
I admit to having been off the mark in February in predicting the timing of the beginning of the economic recovery. The economic stimulus from public expenditure programmes arrived faster than I expected back then. However, the earnings recovery set in sometimes in March and the market sensed that right. However, as I made clear in my comment of last week, a lot of real-money investors missed the upturn and have been running after the market since then.
It means that the stock market currently is stuck between a number of factors pulling in different directions. There are still some positive surprises to be had, as it will still take time before the consensus catches up with the economic reality. Stock valuations may indeed be stretched – but who knows really what earnings will be in a year from now. There are all the institutional investors who are still underweight in equities compared to their benchmark. Bond yields may be kept artificially low by significant yield curve manipulation in the face of massive emissions still to come.
All of that means that there is enough to talk about when trying to guess where the market will go. I believe that for now the liquidity issue is the most important one and will continue to drive the market in the weeks to come, and that chances for a good rally into the holiday season are high. Some time after Xmas, the economic and corporate news may indeed turn out much better than they are now. But at that point, it will not be a surprise to the market any more, and in order to find the new market direction we will have to look for the next trend.
The recent swings in the market may well be interpreted as being a harbinger of changes to come. Looking at the market volatility over the past two weeks in the market reveals no such thing. The size of the up- and downturns and their speed are identical to episodes we have seen several times since March. So in that respect there was nothing new this week. Except, of course, that it is now official that the recession is on its way to be replaced by economic growth.